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*CHAPTER 4(Core Chapter)DEMAND AND SUPPLY, OFFER CURVES, AND THE TERMS OF TRADE OUTLINE4.1 Introduction4.2 The Equilibrium Relative Commodity Price with Trade - Partial Equilibrium AnalysisCase Study 4-1: Demand, Supply, and the International Price of PetroleumCase Study 4-2: The Index of Export to Import Prices for the United States4.3 Offer Curves4.3a Origin and Definition of Offer Curves4.3b Derivation and Shape of the Offer Curve of Nation 14.3c Derivation and Shape of the Offer Curve of Nation 24.4 The Equilibrium Relative Commodity Price with Trade - General Equilibrium Analysis 4.5 Relationship Between General and Partial Equilibrium Analyses4.6 The Terms of Trade4.6a Definition and Measurement of the Terms of Trade4.6b Illustration of the Terms of Trade4.6c Usefulness of the ModelCase Study 4-3: The Terms of Trade of the G-7 CountriesCase Study 4-4: The Terms of Trade of Developing and Developed CountriesAppendix: A4.1 Derivation of a Trade Indifference Curve for Nation 1A4.2 Derivation of Nation's 1 Trade Indifference MapA4.3 Formal Derivation of Nation's 1 Offer CurveA4.4 Outline of the Formal Derivation of Nation 2's Offer CurveA4.5 General Equilibrium of Production, Consumption, and TradeA4.6 Multiple and Unstable EquilibriaKey TermsOffer Curves Commodity or net barter terms of trade Reciprocal demand curve General equilibrium modelTerms of tradeLecture Guide1.Some Instructors may wish to cover only Sections 1 and 2 of this chapter and skip offercurves. I would not do that since offer curves are a very useful theoretical tool of analysis that has been utilized for over a century. Some modern authors, in the desire to be innovative, are either dropping this tool of analysis from their text or relegating it to a short appendix. I think this is misguided and wrong.2.I would cover Sections 1-3 in the first lecture and Sections 4-6 in the second lecture,paying special attention to the shape of offer curves and to the relationship between general and partial equilibrium analyses.Answer to Problems1. See Figure 1.The equilibrium Py/Px=P'2=1/P2.2. See Figure 2.3. See Figure 3.4. See Figure 4 on page 34.5.a) A nation's offer curve is similar to a demand curve because it shows the nation'sdemand for imports.b) A nation's offer curve is similar to a supply curve because it shows the nation'ssupply for exports.c)An offer curve shows how much of its import commodity a nation demands in orderto supply various amounts of its export commodity. The usual demand and supplycurves measure the quantity demanded and supplied, respectively.6. a) See Figure 5.b.)The quantity of imports demanded by Nation 1 at P F' exceeds the quantity of exportsof Y supplied by Nation 2. Therefore, Px/Py declines (Py/Px rises) until the quantity demanded of imports of Y by Nation 1 equals the quantity of exports of Y supplied by Nation 2 at P B=P B'.c.)The backward bending (i.e., negatively sloped) segment of Nation 1's offer curveindicate that nation 1 is willing to give up less of X for larger amounts of Y.7. a) See Figure 6 on page 34.b)The nation with the offer curve with the greater curvature gains more from trade.c)The nation with the offer curve with the greater curvature gains more from tradebecause the greater curvature of the offer curve reflects the nation's weaker or less intense demand for the other nation's export commodity.8. See Figure 7.From the left panel of Figure 4.4, we see that Nation 2 does not export any amount of commodity Y at Px/Py=4, or Py/Px=1/4. This gives point A on Nation 2's supply curve of the exports of commodity Y (S). From the left panel of Figure 4.4, we also see that at Px/Py=2 or Py/Px=1/2, Nation 2 exports 40Y. This gives point H on S.Other point on S could similarly be derived. Note that S in Figure 7 is identical to S in Figure 4.6 in the text showing Nation 1's exports of commodity X.From the left panel of Figure 4.3, we see that Nation 1 demands 60Y of Nation 2's e exports at Px/Py=Py/Px=1. This gives point E on Nation 1's demand curve of Nation 2's exports of commodity Y (D). From the left panel of Figure 4.3, we can estimate that Nation 1 demands 40Y at Py/Px=3/2 (point H on D in Figure 7) and 120Y at Py/Px=2 (point H' on D).The equilibrium relative commodity price of commodity Y is Py/Px=1. This is determined at the intersection of D and S in Figure 7. At Py/Px=3/2, there is an excess supply of R'R=30Y and Py/Px falls to Py/Px=1. On the other hand, at Py/Px=1/2, there is an excess demand of HH'=80Y and Py/Px rises to Py/Px=1. Note also that Figure 7 is symmetrical with Figure 4.6 in the text.9.a) The analysis in the answer to Problem 8 refers to partial equilibrium analysis because it makes use of the traditional demand and supply curves. These refer to the market for commodity Y and abstract from all the interconnections that exist between the market for commodity Y and the market for all the other commodities in the e economy. As such, it provides only an approximation to the answer sought.b)The analysis of Figure 4.5 relies on offer curves. These incorporate demand andsupply information in both nations and for both commodities (in our two-nation, two-commodity world). As such, they allow us to trace a change in demand or supply, for either commodity, in either nation, on the demand and supply of the other commodity and in the other nation, as well as the repercussions from the original change on the demand and supply for both commodities in both nations.Thus, Figure 4-5 refers to general equilibrium analysis. This is admittedly more difficult than partial equilibrium analysis, but it also provides a complete and explicit answer to the problem.c)The partial equilibrium analysis shown in Figure 7 here and in Figure 4.6 in the textand the general equilibrium analysis provided by Figure 4.5 are related because both are derived from the same basic information (the production frontier and the indifference map of each nation). Partial equilibrium analysis, however, utilizes only part, not all, of the information provided by the production frontier and the indifference maps, as generalequilibrium analysis does.10. See Figure 8 on page 36.In Figure 8, Nation 2 is the small nation and we magnified the portion of the offer curveof Nation 1 (the large nation) near the origin (where Nation 1's offer curve coincides with P A=1/4, Nation 1's pretrade relative commodity price with trade). This means that Nation 2 can import a sufficiently small quantity of commodity X without perceptibly affecting Px/Py in Nation 1. Thus, Nation 2 is a price taker and captures all of the benefits from its trade with Nation 1. The same would be true even if Nation 2 were not a small nation, as long as Nation 1 faced constant opportunity costs and did not specialize completely in the production of commodity X with trade.11.See Figure 9 on page 36. Figure 9 shows that in the unlikely event that both nationsfaced constant costs, the offer curves of both would be straight lines until both nations became completely specialized in production. Afterwards, offer curves would assume their normal shape and determine the equilibrium Px/Py=P E at their intersection at point E.12.a) If the terms of trade of a nation improved from 100 to 110 over a given period oftime, the terms of trade of the trade partner would deteriorate by about 9 percent over the same period of time.b) A deterioration in the terms of trade of the trade partner can be said to be unfavorablebecause the trade partner must pay a higher price for its imports in terms of its exports. This does not necessarily mean that the welfare of the trade partner has decreased because the deterioration in its terms of trade may have resulted from an increase in productivity that is shared with the other nation.13.Under the conditions of tight supply that prevailed during the 1970s, OPEC wasgiven credit for the sharp increase in petroleum prices; but when excess supplies arose from the second half of the 1980s to most of the 1990s, OPEC was unable to prevent almost equally sharp price declines. Thus, OPEC does not seem able to set petroleum prices.App. 3. See Figures 10 and 11.App. 4. See Figure 12.App. 5. See Figure 13. At P', Nation 1 wants to import and export more than Nation 2 is willing to trade. As P' falls, Nation 1 will want to trade less and Nation 2 more, until Pc, where the amounts traded are in equilibrium. The opposite is true at P*.Multiple Choice Questions1. Which of the following statements is correct?a. The demand for imports is given by the excess demand for the commodityb. the supply of exports is given by the excess supply of the commodityc. the supply curve of exports is flatter than the total supply curve of the commodity*d. all of the above2. At a relative commodity price above equilibriuma. the excess demand for a commodity exceeds the excess supply of the commodityb. the quantity demanded of imports exceeds the quantity supplied of exports*c. the commodity price will falld. all of the above3. The offer curve of a nation shows:a. the supply of a nation's importsb. the demand for a nation's exportsc. the trade partner's demand for imports and supply of exports*d. the nation's demand for imports and supply of exports4. The offer curve of a nation bulges toward the axis measuring the nationsa. import commodity*b. export commodityc. export or import commodityd. nontraded commodity5. Export prices must rise for a nation to increase its exports because the nation:a. incurs increasing opportunity costs in export productionb. faces decreasing opportunity costs in producing import substitutesc. faces decreasing marginal rate of substitution in consumption*d. all of the above6. Which of the following statements regarding partial equilibrium analysis is false?a. It relies on traditional demand and supply curvesb. it isolates for study one market*c. it can be used to determine the equilibrium relative commodity price but not the equilibrium quantity with traded. none of the above7. Which of the following statements regarding partial equilibrium analysis is true?a. The demand and supply curve are derived from the nation's production frontier and indifference mapb. It shows the same basic information as offer curvesc. It shows the same equilibrium relative commodity prices as with offer curves*d. all of the above8. In what way does partial equilibrium analysis differ from general equilibrium analysis?a. The former but not the latter can be used to determine the equilibrium price with tradeb. the former but not the latter can be used to determine the equilibrium quantity with tradec. the former but not the latter takes into consideration the interaction among all markets in the economy*d. the former gives only an approximation to the answer sought.9. If the terms of trade of a nation are 1.5 in a two-nation world, those of the trade partner are:a. 3/4*b. 2/3c. 3/2d. 4/310. If the terms of trade increase in a two-nation world, those of the trade partner:*a. deteriorateb. improvec. remain unchangedd. any of the above11. If a nation does not affect world prices by its trading, its offer curve:a. is a straight lineb. bulges toward the axis measuring the import commodity*c. intersects the straight-line segment of the world's offer curved. intersects the positively-sloped portion of the world's offer curve12. If the nation's tastes for its import commodity increases:a. the nation's offer curve rotates toward the axis measuring its import commodityb. the partner's offer curve rotates toward the axis measuring its import commodityc. the partner's offer curve rotates toward the axis measuring its export commodity*d. the nation's offer curve rotates toward the axis measuring its export commodity13. If the nation's tastes for its import commodity increases:a. the nation's terms of trade remain unchanged*b. the nation's terms of trade deterioratec. the partner's terms of trade deteriorated. any of the above14. If the tastes for a nation import commodity increases, trade volume:*a. increasesb. declinesc. remains unchangedd. any of the above15. A deterioration of a nation's terms of trade causes the nation's welfare to:a. deteriorateb. improvec. remain unchanged*d. any of the above。