Lecture.

Trade Theory with Demand and Supply Analysis

KO, Ch. 5

Outline
6.1 Equilibrium without Trade
6.1.1 Relative Demand Function 6.1.2 Relative Supply Function 6.1.3 Demand=Supply

6.2 Equilibrium with Trade

6.2.1 Terms of Trade (TOT)

6.3 Changes in TOT

Equilibrium Relative Price

p p p
a *a

US

India A

How is the post trade price decided?

6.1.1 Relative Demand Function

Since the tastes and preferences are assumed to be the same in the HO model, we have the same indifference curves for both the countries.
B pA p= pB A q= B p

a a b b

p1
c

c RD

q A

6.1.1 An Example of the Relative Demand Function

U =U =A B
* 1

dU = B 1 A 1 dA1 A B dB

For dU =0, 0 = B 1 A 1 dA1 A B dB dB B = dA 1 A B p= 1 A dB But , p= dA

pq= 1

(RD)

6.1.2 Relative Supply Curve

p
RS b a c a

6.1.3 Equilibrium
B

B c a b c
A

b a

RS a b RD

6.1.3 Equilibria under Autarky

p , p*
b a c b a Foreign a RS* RS

p* a pa
c RD

Home A

q* a

qa

q ,q *

6.2 Equilibrium With Trade

p , p*
RS* B c

RST
RS a a c Foreign a c

Home A

A A* q ,q , BB*
*

6.2.1 Terms of Trade

p, p
*

RS*

Relative price (p) after trade is the terms of trade for both the countries.
RST
RS

Price of Exports Price of Imports

= TOT

p* a p pa

RD

An increase in TOT of India means an increase in the relative price of the good that she exports (A, in our case). This would simultaneously mean a worsening TOT for the US.

*a

q q

A A* q ,q , BB*
*

6.3 Changes in TOT

p

RST

They can take place due to Changes in Supply in either or both the countries Changes in Demand in either or both the countries.

p
RD

A A * BB *

Problem Set.1
To be returned by 23rd August (Monday) before the lecture.

Weightage for the problem sets would be 5% of the total marks http://groups.google.co.in/group/HUL214?hl=en

Guest Lecture.1

Utsa Patnaik
Professor, Centre for Economic Studies and Planning, JNU

Gains from Free Trade

A Fallacy or Reality MS 525 29th August (Saturday) 10.15 a.m.
In lieu of the guest lecture, the lecture on 27th (Thursday) would be cancelled.