OFFER CURVES

&

TERMS OF TRADE

Derivations of Offer Curve

Definition: An offer curve of a country

indicates the quantity of imports and exports

the country is willing to buy or sell on world
markets at all possible terms of trade

Derivations of Offer Curve

The offer curve can be used to demonstrate

how equilibrium prices are attained in

international trade.
This curve can also be used to explain the
price and trade volume effects phenomena
such as economic growth and changes in
consumer tastes.

Derivations of Offer Curve

In fact, an offer curve is a combination of an import

demand curve and export supply curve.

The construction of the offer curve is
completed by connecting all possible points at
which a country is willing to trade, with
resulting curve labeled OC1
http://www.youtube.com/watch?v=imsTtWzgO34

Y
Y3
(PX/PY)1

Y4

(PX/PY)2
Y

X3
OCA

X4

X
(PX/PY)2
(PX/PY)1

Y6
Y5
X5 X6

7-5

Deriving Country Bs Offer Curve

This will reflect Country Bs willingness to trade at

different terms of trade.

Bs offer curve bows towards the axis with Bs
import good on it.

(PX/PY)1

Y10
(PX/PY)2

Y11
Y

X10

X11 X

(PX/PY)1
(PX/PY)2
OCB

Y12
Y9
X9

X12

7-7

Terms of Trade Equilibrium

The international terms of trade (that is, P X/PY) will

be the slope of a line passing through the point

where the offer curves cross.
This equilibrium point takes into account demand
and supply conditions in both countries.

Terms of Trade Equilibrium

Y

OCA

(PX/PY)E

OCB
Y1

If these are the terms of trade,

country A will desire to export
X1 units, and country B will
want to import X1 units.
X1

Terms of Trade Equilibrium

Y

OCA

(PX/PY)E

OCB
Y1

If these are the terms of trade,

country A will desire to import
Y1 units, and country B will
want to export Y1 units.
X1

How Do We Know Its Equilibrium?

Any terms of trade other than (PX/PY)E will result in

excess demand for one good, and

excess supply for the other.

Therefore relative prices will adjust until (P X/PY)E is

reached.

Disequilibrium
Y

OCA

(PX/PY)1

OCB

Disequilibrium
Y

OCA

(PX/PY)1

Y1

OCB

Y2

At (PX/PY)1, country A wishes

to import Y1 units, but country B
is only interested in exporting Y2
units. That is, there is an excess
demand for good Y.
X

Disequilibrium
OCA

(PX/PY)1

OCB
At (PX/PY)1, country A wishes
to export X1 units, but country B
is only interested in importing X2
units. That is, there is an excess
supply of good X.
X2

X1

Disequilibrium
Excess demand for Y causes PY to rise.
Excess supply of X causes PX to fall.
Thus, (PX/PY) falls.
In other words, the terms of trade line gets flatter,

moving the countries in the direction of equilibrium.

Moving Towards Equilibrium

Y

(PX/PY)

OCA

OCB

General Equilibrium Analysis

The intersection of the two curves defines the
equilibrium relative commodity price at which trade
takes place between them.
Only at this equilibrium prices will trade be
balanced between the two nations. At any other
relative commodity price, the desired quantities of
imports and exports of the two commodities would
not be equal. This would put pressure on the relative
commodity price to move toward its equilibrium level.

General Equilibrium Analysis

Equilibrium Relative Commodity Price with Trade

Usefulness of the General

Equilibrium Model
General equilibrium model shows the
conditions of production in the two nations, the
tastes or demand preference, the autarky point
of production and equilibrium price in the
absence of trade, and the comparative
advantage of each nation. It also shows the
degree of specialization in production with trade,
the volume of trade, the terms of trade, the gains
from trade and the share of these gains going to
each of the trading nations.