5. J. S.

MILL AND RECIPROCAL DEMAND

J. S. Mill (1806-73)'s Principles of Political Economy (1848) was written as

"a work similar in its object and general conception to that of Adam Smith,
but adapted to the more extended knowledge and improved ideas of the
present age" (Mill [1907], p. xxviii). It was highly successful as the last of
the great books of the classical economics founded by A. Smith. From the
point of view of the history of international trade theory, it is, in general, to
be remembered by its extension of Ricardo's theory of comparative costs to
take account of the effects of reciprocal demand on the terms of trade. We
must emphasize, however, that Mill seems to started the so-called modern
interpretation of Ricardo, which we criticized in Chapter 4.
Chapter 18 of Mill's Principles, which contains his theory of international
trade, consists of two parts, the original first five sections and sections 6-9
which he added in the third edition (1852). According to Edgeworth [1898]/
"[t]he splendid edifie of theory constructed in the first five sections is not
improved by the superstructure of later date which forms the latter part of
the chapter. This second story does not carry us much higher."
Mill opened the superstructure as follows. "Thus far had the theory of
international values been carried in the first and second editions of this
work. But intelligent criticisms (chiefly those of my friend Mr. William
Thornton), and subsequent further investigation, have shown that the doc-
trine stated in the preceeding pages, though correct as far as it goes, is not
yet complete theory of the subject matter" (Mill [1909], p. 596). The theory

iF. Y. Edgeworth (1845-1926). Professor of Oxford University, who founded, with Walras,
the modern general equilibrium theory.

T. Negishi, Developments of International Trade Theory

© Springer Science+Business Media New York 2001
54 PART I

of international value discussed in the first sections is, of course, that of

reciprocal demand.
"This Law of International Value is but an extension of the more general
law of Value, which we called the Equation of Supply and Demand.-the
supply brought by the one constitute his demand for what is brought by the
other. So that supply and demand are but another expression for reciprocal
demand: and to say that value will adjust itself so as to equalize demand
with supply, is in fact to say that it will adjust itself so as to equalize the
demand on one side with the demand on the other" (Mill [1909], pp. 592-3).
Why, then, is this not complete? The reason is, Mill argues, "that several
different rates of international value may all equally fulfil the conditions of
this law" (Mill [1909], pp. 596-7). According to Mill, the existence of such a
portion of indeterminateness in the rate at which the international values
would adjust themselves indicates that not the whole of the influencing cir-
cumstances have yet been taken into account. To supply such deficiency, Mill
takes into considerations, in addition to the quantities demanded in each
country of the imported commodities, "the extent of the means of supplying
that demand which are set at liberty in each country by the change in the
direction of its industry" (Mill [1909, p. 597).
As for the former, Mill assumes a unit own-elasticity of demand with
respect to price, zero cross-elasticities of demand with respect to price and
a unit income elasticity of demand that "any given increase of cheapness
produces an exactly proportional increase of consumption; or, in other
words, that the value expended in the commodity, the cost incurred for the
sake of obtaining it, is always the same, whether that cost affords a greater
or smaller quantity of the commodity" (Mill [1909], p. 598). In other
words, the proportion in which the total income is to be spent on each com-
modity is a given constant, irrespective of the level of income and the prices
of commodities.
For the two country (England and Germany) two good (cloth and linen)
case, then, Mill can demonstrate that the relative international value (the
terms of trade) is uniquely determined. Let us assume that England
(Germany) has the comparative advantage in the production of cloth (linen),
and England (Germany) is specialized in the production of cloth (linen) after
trade. The terms of trade t (the price of cloth in terms of linen after trade)
is solved from
n=pm/t (1)

where m is "the cloth previously [Le., before trade] required by Germany, [at
the German cost of production," n is "the quantity of cloth which England
can make with the labour and capital withdrawn from the production of
linen [after trade]" and p is "the cost value of cloth (as estimated in linen)
in Germany (Mill [1909]," pp. 600-1).2

2As was pointed out and corrected by Chipman [1979], however, Mill made a slip and could
not derive (1) correctly.
 J. S. MILL AND RECIPROCAL DEMAND 55

linen

m=OC

o C cloth

Figure 3. Germany

See Figure 3 which describes the situation of Germany. The quantity of

linen is measured vertically, and that of cloth, horizontally. The maximum
quantity of linen Germany can produce is OBI and that of cloth, OAI' The
point G indicates the production and consumption of cloth and linen in
Germany before trade (at autarky). Then, Mill's m is equal to OC. The slope
of the line Al BI is p, i.e., p = OBdOA I.
Similarly, Figure 4 describes the situation of England. The maximum
quantity of linen England can produce is OB 2 and that of cloth, OA2 • Suppose
the point E indicates the production and consumption of cloth and linen in
England before trade (at autarky). If England is specialized in the produc-
tion of cloth after trade, then, Mill's n is equal to DA2 •
Then the equation (1) can be explained as folows. German expenditure on
cloth before trade is pm in terms of linen, since p is also the before
trade price of cloth in terms of linen there. Now German demand for English
cloth after trade is pm/t, from the assumption of the unit own-elasticity
of demand with respect to price which is now changed from p to t,
while German income in terms of linen remains unchanged before and after
trade at OBI in Figure 3. This German demand should be equal to the
after trade supply of cloth from England, which is equal to n by definition.
Equation (1) expreses the equality of demand and supply of cloth in the
international market. We can solve the equation (1) for the terms of trade
which will prevail after trade, i.e., t, from the data available to us before
56 PART I

linen

o D cloth

Figure 4. England

trade, i.e., p, m and n, if we assume that each country is specialized com-

pletely after trade.
Chipman ([1965] and [1979]) evaluated Mill's solution of t from the equa-
tion (1) very high, as the historically first demonstration of the existence and
the uniqueness of the equibrium of demand and supply. In the original first
five sections of Chapter 18 of Mill's Principles, the equilibrium of inter-
national trade is certainly well described by the principle of reciprocal
demands, but it is merely described by numerical examples and its existence
is not yet demonstrated until Mill added new sections in which the equation
(1) is included. A question remains, however, whether Mill should have
introduced, in addition to the quantities demanded in each country of the
imported commodities, "the extent of the means of supplying that demand
which are set at liberty in each country by the change in the direction of its
industry." Already Bastable ([1900], p. 2W argued as follows.
"The attempt made by Mill to amend his theory by intrducing the addi-
tional element of the amount of capital set free for the production of exports
is, as he even admit, a failure; for, in the case of two countries and two
commodities, the amount of free capital, or, as I should prefer to say, "pro-
ductive power," is evidently determined by reciprocal demands, so that
nothing is gained by the laborious and confusing discussion in secs. 6, 7, 8
of chap. xviii."

3C. F. Bastable (1855-1945). Professor of University of Dublin. See also Chapter 6 for the
role he played in the discussion of the infant industry protection.
 J. S. MILL AND RECIPROCAL DEMAND 57

As Chipman ([1979]) showed,

(2)

where Al (A2) is the maximum quantity of cloth Germany (England) can

produce, and al (b 2) is the constant proportion in which expenditure is
assumed to be devoted to cloth (linen) in Germany (England). This is because
the German national income in terms of cloth is OAI before trade, as is seen
in Figure 3, the English national income in terms of cloth is OA2 before trade
in Figure 4, and b 2 = 1 - a2, where a2 is the constant proportion in which
expenditure is assumed to be devoted to cloth in England. Then, the equa-
tion (1) can be written as
(3)

where Bl is the maximum quantity of linen Germany can produce, as is

shown in Figure 3, since p = Bt/Al . The right-hand side of (3) is the demand
for cloth of Germany and the left-hand side is the demand for linen of
England, both in terms of linen. The terms of trade t can be uniquely deter-
mined by the equation of reciprocal demands (3) and there is no need of
introducing "the quantity of cloth which England can make with the labour
and capital withdrawn from the production of linen," i.e., n. Even from the
point of view of Chipman, therefore, Mill's superstructure is to be admitted
as laborious and confusing.
What is more important for us is, however, to confirm that Mill consid-
ered the model of an international trade, which we called the modern inter-
pretation of the Ricardian model in Chapter 4. Such a model is entirely
different from the true Ricardian model. This is because such entirely un-
Ricardian assumptions are made in the model that (1) there exists only one
factor of production, labor, which requires remnuneration, (2) the total labor
population of each country is given and (3) the productivity of labor remains
unchanged irrespective of the level of production. In other words, the exis-
tence of lands of different qualities which implies the diminishing returns is
assumed away so that each country is to be specialized completely in the
production of the exportables in a two country two good model of interna-
tional trade.
Although Mill used the expression "the labour and capital" to define his
n in the above (Mill [1909], p. 600), it is clear that by this labor and capital
he meant a single factor of production whose total quantity in each country
and the productivity are given and unchanged. This is because, firstly, he
assumed the complete specialization after trade. "Let us now suppose that
England, previously to the trade, required a million of yards of linen, which
were worth, at the English cost of production, a million yards of cloth. By
turning all the labour and capital with which that linen was produced to the
production of cloth, she would produce for exportation a million yards of
cloth" (Mill [1909], p. 598). Secondly, as we already explained, the equation
(1) presupposes that the national income of each country in terms of her
exportables remains unchanged between before and after trade.
58 PART I

Of course, Mill should not be blamed for this. These are simplifying
assumtions to derive equation (1). Any theorist is entitled to assume some-
thing to develop his theory. Mill should be applauded because of these
assumptions, by which he could successfully solve (1) explicitly for the terms
of trade. Besides, Mill did not mention wrongly that it is the Ricardian
model. We should conclude, then, that the so-called Ricardian model of the
modern interpretation of Ricardo should rather be called Mill's model of
international trade.
References

Bastable, C. F., 1900, Theory of International Trade, London: Macmillan.

Chipman, J. S., 1965, A Survey of the Theory of International Trade: Part 1:
The Classical Theory, Econometrica, 33, pp. 477-519.
Chipman, J. S., 1979, Mill's "superstructure": how well does it stand up?
History of Political Economy, 11, pp. 477-500.
Edgeworth, F. Y, 1894, The Theory of International Values, III, Economic
Journal, 4, pp. 424-443.
Mill, J. S., 1909, Principles of Political Economy, London: Longmans, Green
and Co.
Problems

1) Consider the maximization of utility function U = alogx + (1 - a)logy,

being subject to the budget constraint px + qy = Z, where a, x, y, p, q and
Z are respectively, positive constant less than 1, the quantity of good x,
that of good y, the given price of x, that of y and the given income. Cal-
culate the elasticity of x with respect to p, q and Z. See Problem 1 of
Chapter 2.
2) In Figure 4, England's consumption of two goods is at the point E in
autarky (before trade). After trade, she is specialized in the production of
cloth at the point A2 • Draw the locus of the consumption points after
trade, starting from E, as the terms of trade is improved from OB 2/OA 2 ,
assuming assumptions on the demand elasticities which Mill made to
derive the equation (1). (See the explanation of offer curves in Chapter 8
below).
APPENDIX TO CHAPTER 5
MILL AND THORNTON

The so-called Mill's superstructure in Chapter 18 of his Principles is con-

structed so as to avoid the non-uniqueness of the terms of trade, determined
by the principle of reciprocal demands. There seems to be, however, two dif-
ferent kinds of non-uniqueness of the equilibrium terms of trade. The first
case is that of multiple (or even continuous) intersections of demand and
supply curves, which Mill ruled out by his assumptions on demand func-
tions. The second case of non-uniqueness is caused by the possible shifts of
demand and supply curves so that the equilibrium finally to be reached
cannot be determined uniquely. Such shifts may be due to exchanges at non-
eqUilibrium prices. l
Mill stated that his superstructure is to reply to intelligent criticisms of
his friend William Thornton. 2 As far as the publication is concerned, Thorn-
ton's criticism of the law of supply and demand started from Thornton
[1866], which was reprinted with revisions in Thornton [1969], though
Chipman [1965] conjectured, perhaps correctly, that Thornton had in earlier
private conversation stimulated Mill to reconsider his theory of international
value. 3 It is, then, very likely that Thornton's criticism was originally con-
cerned with the second case of non-uniqueness but Mill misunderstood it as
that of the first case.

1 As for exchanges at non-equilibrium prices, see Hicks [1946], pp. 127-129. See also

Hollander [1985], pp. 276-277.

2 As for W. T. Thornton (1813-1880), see Ekelund [1997] and Picchio [1987].
3Both Mill (since 1836) and Thornton (since 1847) were members of Political Economy
Club. Thornton [1866] seemed to be discussed in the Club, on 6, December, 1866. See
Negishi [1998].
64 PART I

Thornton [1866] presented several counter examples to the "equation

theory" that the equation of supply and demand determines price, among
which the most important is the example of the so-called Dutch auction for
fish resorted by certain fishermen, and its contrast with the usual English
auction.
"When a herring or mackerel boat has discharged on the beach, at Hast-
ings or Dover, last night's take of fish, the boatmen, in order to dispose of
their cargo, commonly resort to a process called "Dutch auction." The fish
are divided into lots, each of which is set up at a higher price than the sales-
man expects to get for it, and he then gradually lower his terms, until he
comes to a price which some bystander is willing to pay rather than not have
the lot, and to which he accordingly agrees. Suppose on one occasion the lot
to have been a hundredweight, and the price agreed to twenty shillings. If,
on the same occasion, instead of the Dutch form of auction, the ordinary
English mode had been adopted, the result might have been different.
The operation would then have commenced by some bystander making
a bid, which others might have successfully exceeded, until a sum was
arrived at beyond which no one but the actual bidder could afford or was
disposed to go. The sum would not necessarily be twenty shillings: very
possibly it might be only eighteen shillings. The person who was prepared
to pay the former price might very possibly be the only person present
prepared to pay even so much as the latter price; and if so, he might get by
English auction for eighteen shillings the fish for which at Dutch auction he
would have paid twenty. In the same market, with the same quantity of fish
for sale, and with customers in number and every other respect the same,
the same lot of fish might fetch two very different prices" (Thornton [1866],
[1869], pp. 47-48).
Mill thought hat this is an example of the first case of the non-
uniqueness of the equilibrium, defined in the above, in the sense that there
exists no unique intersection of the given demand and supply curves. In his
review of Thornton [1869], Mill interpreted this example that "the demand
and supply are equal at twenty shillings, and equal also at eighteen shillings"
(Mill [1967], p. 637) and that it is an exception to the rule that demand
increases with cheapness. Then Mill recanted the wages fund doctrine 4 in
view of this particulat case of indeterminancy due to demand that is inelas-
tic with respect to price. Supply being given constant, this is the case where
schedule of supply and demand are coincidental, at least within certain
limits.
"When equation of demand and supply leaves the price in part indeter-
minate, because there is more than one price which would fulfil the law [of
the equation of demand and supply]-the price, in this case, becomes simply

4Wages fund doctrine is the short-run wage theory of classical economics. The wage is
determined by the demand for labor (wages fund) and supply of labor (labor population).
Given the size of wages fund, therefore, the total wage income cannot be increased by trade
(labor) unions.
 MILL AND THORNTON 65

a question whether sellers or buyers hold out longest; and depends on their
comparative patience, or on the degree of inconvenience they are respectively
put to by delay.-If it should turn out that the price of labour falls within
one of the excepted cases-the case which the law of equality between
demand and supply does not provide for, because several prices all agree in
satisfying that law; we are already able to see that the question between one
of those prices and another will be determined by causes which operate
strongly against the labourer, and in favour of the employer.-The doctrine
hitherto taught by all or most economists (including myself), which denied
it to be possible that trade combinations can raise wages, or which limited
their operation in that respect to the somewhat earlier attainment of a rise
which the competition of the market would have produced without them,-
this doctrine is deprived of its scientific foundation, and must be thrown
aside (Mill [1967], pp. 642-43, 646).
Thus, Mill worried about the first case of the non-uniqueness, not only in
his superstructure of international value, but also in his discussion of wages
fund doctrine, on the basis of his interpretation of Thornton's example of
Dutch and English auctions.
As was pointed out elsewhere for the case of wages fund doctrine,
however, Mill actually misunderstood the true implication of Thornton's
example of Dutch and English auctions (Negishi [1986]). Mill considered that
it is an exceptional case to the rule that demand increases with cheapness.
Thornton then replied to Mill as follows. "In this particular case it would
not be possible for supply and demand to be equal at two different prices.
For the case is one in which demand would increase with cheapness. A
hawker who was ready to pay 8s. for a hundred herrings would want more
than a hundred if he could get hundred for 6s. There being then but a given
quantity in the market, if that quantity were just sufficient to satisfy all the
customers ready to buy at 8s., it follows that it would not have sufficed to
satisfy them if the price had been 6. If supply and demand were equal at the
former price, they would be unequal at the latter" (Thornton [1870], pp.
57-58).
If the demand and supply are equalized at the price determined in Dutch
auction, then demand is larger than the supply at the lower price determined
in English auction. Since a single person is assumed to get all the supply,
however, he will not bid up the price further in English auction, since he
knows that by so doing he cannot satisfy his remaining demand. The lesson
of this example of Thornton [1866] is, therefore, that exchange is possible,
and even inevitable, to take place at such a price that demand is not equal-
ized to supply there. Other examples given in Thornton [1866], those of a
glover and of a horse, can also be interpreted in the same way.
Thornton [1866] continued his criticism against demand and supply equi-
librium theory. "Even if it were true that the price ultimately resulting from
competition is always one at which supply and demand are equalized, still
only a small portion of the goods offered for sale would actually be sold at
any such price. Suppose the glover to whom we have already once or twice
66 PART I

referred, to have five hundred pairs of gloves on hand, to begin by selling at

three shillings a pair, and to be tempted, by the rapid sale of two hundred
pairs at that price to raise the price to four shillings; suppose him to be sub-
sequently tempted to raise it to five and six shillings successively, but not to
be able to sell at the last-named price, and therefore to reduce it to five
shillings, at which price the last hundred pairs are sold. The price ultimately
resulting from competition would then be five shillings, and this may, for the
sake of argument, be also assumed to be a price at which supply and demand
would be equalized. But at this price only one-fifth of the whole quantity
would be sold, the other four-fifth having been sold at price at which supply
was in excess of demand.-But when we speak of prices depending on certain
causes, we surely refer to prices at which all goods, or at least the great bulk
of them, not that at which merely a small remnant of them, will be sold. How
can we say that the equation of supply and demand determines price, if
goods are almost always sold at prices at which supply and demand are
unequal?"
If Thornton [1866] is ever concerned with the non-uniqueness of equilib-
rium price, it is now clear that it is the second case defined in the above
which is due to shifts of demand and supply curves caused by exchanges at
non-equilibrium prices. Mill misunderstood, however, Thornton's criticism
and consider the first case of the non-uniqueness in his superstructure. 5
If Mill's superstructure aimed to reply to Thornton's criticism of demand
and supply eqUilibrium theory, then, Mill should have dealt with the second
case of the non-uniqueness of the equilibrium. Mill's assumption on demand
made to avoid the first case of the non-uniqueness is, fortunately, also helpful
to deal with that of the second case. In addition to Mill's assumption, let us
assume that two countries, Germany and England, have the identical taste,
so that the world demands for both commodities, cloth and linen, are inde-
pendent of the distribution of income between countries. In other words, the
changes in demand for any commodity of any country caused by a redistri-
bution of the world income is offset by those of the other country completely.
In the model used in Chapter 5, Germany is specialized to the production
of linen Bl (see Figure 3) and England, that of cloth A2 (see Figure 4). The
world income is then Bl + tA2, where t is the international price of cloth in
terms of linen. The condition for the demand and supply equilibrium for
cloth in the worldmarket is
(1)

where a is the constant proportion in which the expenditure is devoted to

cloth (identical for both countries). The equilibrium terms of trade t can be
solved as
(2)

5In 1871, however, Mill seemed to understand Thornton correctly. See Mill [1909), p. xxxi.
See also Negishi [1986).
 MILL AND THORNTON 67

where b = 1 - a is the constant proportion in which the expenditure is devoted

to linen. It is independent of any redistribution of the world income, caused
by exchanges made at non-equilibrium prices.
Thus, Mill's model in his superstructure can deal with the second case of
the non-uniqueness, i.e., Thornton's criticism of demand and supply theory,
if the identical taste is assumed for two countries. This additional assump-
tion seems to be a neutral one. A unique rate of international value can be
determined by the principle of reciprocal demands equation, even if demand
and supply curves of individual commodities are shifted as a result of
exchange transactions at other rates of international value.
Still Thornton can wonder that the equilibrium theory is a truth of small
significance since it does not explain disequilibrium prices at which the bulk
of the goods offered for sale are actually sold. It is true that Mill can explain
the equilibrium terms of trade, but cannot explain the distribution of gains
from trade between countries, since the latter depends on how international
trade at disequilibrium terms of trade takes place. Mill the classical econo-
mist could not but express his hope that only a small portion of goods may
be sold at disequilibrium (Mill [1967]). After the marginal revolution,
however, we can reply to Thornton that the equilibrium theory is of great
significance even if a small portion of goods are sold at the equilibrium price
which is finally established after the bulk of goods are sold at disequilib-
rium. This is because the marginal rates of substitution (ratio of marginal
utilities between two commodities) are equalized among buyers and sellers
through such trades at equilibrium price so that a Pareto efficient allocation
of commodities is established.
References

Chipman, J. S., 1965, A Survey of the Theory of International Trade: Part 1:

The Classical Theory, Econometrica, 33, pp. 477-519.
Ekelund, R B., 1997, W. T. Thornton: Savant, Idiot, or Idiot-Savant? Journal
of the History of Economic Thought, 19, pp. 1-23.
Hicks, J. R, 1946, Value and Capital, Oxford: Oxford University Press.
Hollander, S., 1985, The Economics of John Stuart Mill, Oxford: Blackwell.
Mill, J. S., 1909, Principles of Political Economy, London: Longmans, Green
and Co.
Mill, J. S., 1967, Thornton on labour and its claims, (1869), in idem,
Essays on economics and society, Tronto: University of Tronto Press,
631-68.
Negishi, T., 1986, Thornton's criticism of equilibrium theory and Mill,
History of Political Economy, 18, pp. 567-577.
Negishi, T., 1998, Mill's Superstructure, How It Should Have Been, Aoyama
Journal of International Politics, Economics and Business, 42, pp. 27-39
(in Negishi [2000], pp. 105-117).
Negishi, T., 2000, Economic Thought from Smith to Keynes, Aldershot:
Edward Elgar.
Picchio, A., 1987, Thornton, William Thomas, 1813-1880, J. Eatwell, M.
Milgate and P. Newman, eds., The New Palgrave, 4, London: Macmillan,
p.636.
Thornton, W. T., 1866, A New Theory of Supply and Demand, Fortnightly
Review, 6, pp. 420-434.
Thornton, W. T., 1869, On Labour: its wrongful claims and rightful dues, its
actual present and possible future, London: Macmillan.
70 PART I

Thornton, W. T., 1870, On Labour: its wrongful claims and rightful dues, its
actual present and possible future, 2nd ed., London: Macmillan.
Problems

1) By using a demand curve, explain Thornton's example of the different

prices in Dutch and English auctions (see Negishi [1986]).
2) By using Edgeworth's box diagram, explain the conclusion of this
appendix.