The economists presented
many trade theories between the countries. Key among them is Recardo’s theory.
But Ricardian failure to determine the exact rate of international exchange
between the two countries.
Therefore, John Stuart Mill
presented RECIPROCAL DEMAND THEORY. It derives from Recardo’s
Comparative theory.
“Reciprocal demand is two
nations relative strength and elasticity of demand for each other’s commodity
in respect of their product.”
This model buildup on
some assumptions.
·
The trade takes place between two
countries, A and B.
·
Trade is in two commodities.
·
In both countries the production is
governed by constant return to scale.
·
The trade between two countries is
governed by the principle of the comparative costs.
·
The pattern of demand is similar in two countries.
·
There is perfectly comparative condition
in the market.
·
There is no restriction on trade and
government follows a policy of laissez faire.
·
There is full employment of resources in
both the countries.
·
The exports of each country are sufficient
to pay for its imports.
·
Mill has considered that amount of labor
is fixed, and different units of goods are produced with this fixed amount of
labor.
·
Trade is based on comparative advantage
between both countries.
The reciprocal demand measure through offer curves. Therefore, offer curves refer as reciprocal demand curve.
OB= domestic term of
trade England
OE=England’s offer curve
OG= Germany’s offer curve
OR=International Term Of
Trade Line
Shaded area = No trade
Zone
Output Produced With
Fixed Labour Units
Mill’s theory of
reciprocal demand can be explained on the basis table.
|
Country |
Units
of wine |
Units
of cloths |
|
England |
10 |
10 |
|
Portugal |
6 |
8 |
Specialization
Based on comparative
advantage
|
England |
Portugal
|
|
Specialize
in Wine. Export
Wine. Import
of Cloth |
Specialize
in Cloth. Export
Cloth. Import
of Wine. |
Domestic Term of Trade
England’s Domestic term
of trade
1W=1C
Portugal’s Domestic term
of trade
3W=4C or 1.5W=2C
Or
0.75W=1C
Gains from trade
England must sacrifice 1W
for producing 1C.
If England must sacrifice less than 1W by
importing 1C then international trade will be in favor of England.
Germany can produce only
0.75W by sacrificing 1C.
If Portugal gets more than 0.75W by
exporting 1C then international trade will be in favor of Portugal.
The theoretical structure
of J. S. Mill’s theory of reciprocal demand rests upon the foundation of
Ricardian principle of comparative cost.
However, he could
introduce exchange rate theory and identified who will benefit from it.
Written by S. H. C. Oshadhi
Reference :
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