OFFER CURVES AND THE TERMS OF TRADE
Appendix 3.2
Offer curves are an alternative way to represent the reciprocal demand that determines the terms of trade.
Figure A 3.2 shows A's desired trade for three different values of the terms of trade. As the TOT line gets steeper we see A's desired imports rise from T0 to T3, while desired exports rise from S0 to S3. As the TOT rises A is able to achieve a higher standard of living.
This change in the TOT is 'favorable' to A because it favors the good that A exports.
Figure 3.3 plots A's desired exports against A's desired imports.
If we think of the TOT as a price then as it rises A 'offers' a specific exchange of S for T.
The offer curve combines supply and demand behavior in one curve. It takes money prices out of the picture. Instead of offering to pay a certain number of dollars for a good, countries are going straight to making a barter offer.
In this approach money is a distraction and models that dispense with it get to the 'real' economics of trade.
Country B also has an offer curve.
Figure 3.4 puts the two offer curves on the same diagram.
There is only one TOT where the desired exports and imports all match. This is the equilibrium TOT.
At this equilibrium the two country's CICs must be tangent to each other.
Production choices, consumption choices, the terms of trade, goods prices and the exchange rate are all consistent with each other in general equilibrium. Unless there is some shock to the system the world will remain in this equilibrium state.
