6[1].Principle of Reciprocal Demand

8/11/2019 6[1].Principle of Reciprocal Demand

1/39

Principle of

Reciprocal

Demand

By: John Stuart Mill


2/39

Brief Biography of John Stuart Mill John Stuart Mill, the eldest son of James Mill, was born in Londonon

20th May, 1806. Educated a home by his father, Mill had studied theworks of Aristotle, Hobbes, Plato, Jeremy Bentham, Ricardo andAdam Smith by the time he had reached the age of twelve.

At the age of seventeen formed a discussion group called theUtilitarian Society.

Mill also began having articles published in the Westminster Review, ajournal founded by Jeremy Benthamand James Millto propagateRadical views. He also wrote for other newspapers and journals. Milltook an active role in the campaign for parliamentary reform, and wasone of the first to suggest that women should have the same political

rights as men.(1806-1873)

In 1834 Mill founded the Radical journal, theLondon Review. Two years later, he

purchased the Westminster Reviewand merged the two journals.

In 1833 Mill became a close friend of Harriet Taylor. The two worked closely together but

Harriet was married and her husband, John Taylor, was unwilling to give her a divorce. Afterthe death of John Taylor in 1849, Harriet married John Stuart Mill.

In the 1865 General ElectionJohn Stuart Mill was invited to stand as the Radical candidate

for the Westminsterseat in Parliament and was defeated in 1868 General Election..

After leaving the House of Commons, Mill was now able to finish off the book he had been

writing for some time, The Subjection of Women (1869). Harriet Taylorhad died in 1854 but

her daughter, Helen Taylor, worked closely with him on the book. John Stuart Mill died on8th May, 1873.
http://www.spartacus.schoolnet.co.uk/Jmill.htmhttp://www.spartacus.schoolnet.co.uk/ITlondon.htmhttp://www.spartacus.schoolnet.co.uk/PRbentham.htmhttp://www.spartacus.schoolnet.co.uk/PRunitarian.htmhttp://www.spartacus.schoolnet.co.uk/Jwestminster.htmhttp://www.spartacus.schoolnet.co.uk/PRbentham.htmhttp://www.spartacus.schoolnet.co.uk/Jmill.htmhttp://www.spartacus.schoolnet.co.uk/Jwestminster.htmhttp://www.spartacus.schoolnet.co.uk/Wtaylor.htmhttp://www.spartacus.schoolnet.co.uk/GE1865.htmhttp://www.spartacus.schoolnet.co.uk/PRwestminster.htmhttp://www.spartacus.schoolnet.co.uk/Pcommons.htmhttp://www.spartacus.schoolnet.co.uk/Wtaylor.htmhttp://www.spartacus.schoolnet.co.uk/Wtaylor.htmhttp://www.spartacus.schoolnet.co.uk/Pcommons.htmhttp://www.spartacus.schoolnet.co.uk/PRwestminster.htmhttp://www.spartacus.schoolnet.co.uk/GE1865.htmhttp://www.spartacus.schoolnet.co.uk/Wtaylor.htmhttp://www.spartacus.schoolnet.co.uk/Jwestminster.htmhttp://www.spartacus.schoolnet.co.uk/Jmill.htmhttp://www.spartacus.schoolnet.co.uk/PRbentham.htmhttp://www.spartacus.schoolnet.co.uk/Jwestminster.htmhttp://www.spartacus.schoolnet.co.uk/PRunitarian.htmhttp://www.spartacus.schoolnet.co.uk/PRbentham.htmhttp://www.spartacus.schoolnet.co.uk/ITlondon.htmhttp://www.spartacus.schoolnet.co.uk/Jmill.htm


3/39

Principles of Political Economy

John Stuart MillsPrinciples of Political Economywaspublished in the revolutionary year 1848 when the greatFrench Revolution took place and also the year of the

publication of The Communist Manifestowritten byKarlMarxandFriedrich Engels.

In some sense the publication ofPrinciples of PoliticalEconomymet with the requirement of the ruling class tooffset the influences of Marxism.

Given this background and theoretical research Mill hadmade in his bookPrinciples of Political Economyhad

become the supreme statement of classical economics and,for nearly half of a century, the standard textbook of thestudents of department of economics in almost alluniversities in Europe and North America.


4/39

From Smith & Ricardo to Mill

Comparative advantage explains the pattern of trade. It also furnishesa strong argument for trade gains and tells much about readjustment of

production and the basic laws that determine the real rate of exchangesbetween the exportable and importable goods. But to explain theactual pattern of production, or the exact terms at which one countrys

products exchange for those of another, we also need detailed

knowledge of demand and supply. This was firstly verbalized by JohnStuart Mill and then put into graphic form by Alfred Marshall and F.Y.Edgeworth.

Adam Smith and David Ricardo both told us that the rate of exchangein international market must fall into the range with domesticexchange rates of the two countries as the two extremes. When we talkabout how to determine the real international exchange rate we couldonly imagine that a serious competition between the two countriesdetermined the real international exchange rate. We could also saynothing about why a country might be more profitable to its trade

partner and why the latter could only obtain less gain.


5/39

Theoretical Contribution of John Stuart Mill

Mill firstly revealed the mechanism of how

to determine the rate of exchange in

international market and how to distribute

the total gains from trade between the two

traders by detailing specific relationship

between them.


6/39

Dual Status of Traders

As what Mill argued that in trade between

two countries each country takes status both

as the seller and the buyer.

As a seller each of them offers its exports to

the other. And, simultaneously, each country

imports particular goods from its trade

partner as a buyer in international market.

For any country in trade buyer is its original

status while seller is just the derived status.


7/39

Principle of Reciprocal Demand

That is to say the two participants of trade in Recardianmodel must establish a specific relationship with eachother, this is the reciprocal demand relationship.

It is this reciprocal demandthat actually determines the

prevailing terms of trade and how much gains obtained bya particular country.

In other words John Stuart Mill had resolved the problemof how to exactly reach the rate of exchange in

international market. Comparative advantage and law ofreciprocal demand due to John Stuart Mill constitute thetwo basic building blocks of the classical theory ofinternational trade.


8/39

Reasons for Trade

In Mills view at least two reasons that

will lead to the actual international trade:

It is cheaper to import some productsfrom the other country than to produce.

It is difficult to seek more profitable

employment for the production resources.


9/39

Some things it is physically impossible to produce, exceptin particular circumstances of heat, soil, water, oratmosphere. But there are many things which, though

they could be produced at home without difficulty, and inany quantity, are yet imported from a distance. Theexplanation which would be popularly given of thiswould be, thatit is cheaper to import than to produce

them: and this is the true reason. Just because this true reason England might import corn

from Poland and pay for it in cloth, even though Englandhad a decided advantage over Poland in the production of

both the one and the other. England might send cottons toPortugal in exchange for wine, although Portugal mightbe able to produce cottons with a less amount of labor andcapital than England.


10/39

Profit Equalization in the Home Country

Mill argued that these sorts of trade could only takeplace between two countries separated from eachother with a long distance rather between the twoplaces in the same country.

Mill noticed, trade could not happen betweenadjacent places because factor movement makes itpossible to reach profit equalization thus no onewill enjoy advantages over the other traders.

An example of profit equalization:

If the north bank of the Thames possessed an advantage over the southbank in the production of shoes, no shoes would be produced on thesouth side; the shoemakers would remove themselves and their capitalsto the north bank, or would have established themselves thereoriginally. The shoemakers could increase their profits by simply

crossing a river.


11/39

Profit Differentiation among Countries

Between distant places, and especially between differentcountries, profits may continue different because personsdo not usually remove themselves or their capitals to adistant place without a very strong motive.

It needs but a small motive to transplant capital, or even

persons, from Warwickshire to Yorkshire; but a muchgreater to make them remove to India, the colonies, orIreland.

To France, Germany, Switzerland, capital moves perhapsas readily as to the colonies; the differences of language

and government being scarcely so great a hindrance asclimate and distance.

To countries still barbarous, or, like Russia and Turkey,only beginning to be civilized, capital will not migrate,

unless under the inducement of a very great extra profit.


12/39

Profit Inequalities among Countries Cause Trade

Between all distant places therefore in some degree, butespecially between different countries, there may existgreat inequalities in return to labor and capital, withoutcausing them to move from one place to the other insuch quantity as to level those inequalities.

The capital belonging to a country will, to a greatextent, remain in the country, even if there be no mode

of employing it in which it would not be moreproductive elsewhere.

Yet even a country thus circumstanced might, andprobable would, carry on trade with other countries.


13/39

What is Commerce?

Commerce is virtually a mode of cheapeningproduction; and in all such cases the consumer

is the person ultimately benefited; the dealer,in the end, is sure to get his profit, whether thebuyer obtains much or little for his money.


14/39

Trade Benefit

Concretely speaking, in Mills ideas international trade willat least bring the traders with two sorts of benefit:

First of all it would be possible for a country to acquire someproducts which could consumed by its people, but can not beproduced by the country with the existing production

circumstances; Secondly, it is possible for all the participants of trade to

bring their productivity into a much fuller play. That willnecessarily raise the overall productivity of the whole worldup to a high level and consequently increase the universal

welfare of the people. The higher world productivity derived from the comparative

advantages enjoyed by the traders is the ultimate source of thegains from trade.


15/39

Source of Trade Benefit

What consists the benefit of internationalexchanges, or in other words, foreign commerce.Setting aside its enabling countries to obtain

commodities which they could not themselvesproduce at all, its advantage consists in a moreefficient employment of the productive forcesof the world.

The higher world productivity derivedfrom thecomparative advantages enjoyed by the tradersis the ultimate source of the gains from trade.


16/39

Produce both for Itself and for the Other

If two countries which trade with each otherattempted, as far as was physically possible, toproduce for themselves what they now importfrom one another, the labor and capital of thetwo countries would not be so productive, thetwo together would not obtain from theirindustry so great a quantity of commodities,

as when each employ itself in producing, bothfor itself and for the other, the things in whichits labor is relatively most efficient.


17/39

Comparative Advantages from Altogether Inferiority

It is possible that one of the two countries may bealtogether inferior to the other in productivecapacities, and that its labor and capital could beemployed to greatest advantage by being removedbodily to the other.

While the labor and capital of a country remain inthe country, they are most beneficially employed inproducing, for foreign markets as well as for itsown, the things in which it lies under the least

disadvantage, if there be none in which itpossesses an advantage.


18/39

Comparative Advantages Determine Trade Patterns

Trade pattern between the two countries, in other

words, what country would exports and importswhat commodities, must be determined accordingto each countrys comparatively advantageousstatus.

That implies a country must export itscomparatively advantageous product and importsome other product in which it dose not havecomparative advantage.

It is not a difference in the absolute cost ofproduction, which determines the interchanges, buta difference in the comparative cost.

(

)


19/39

As Mill said: It (a country) would export articles of some sort, even toplaces which could make them with less labor than itself; because thosecountries, supposing them to have an advantage over it in all

productions, would have a greater advantage in some things than inothers, and would find it their interest to import the articles in whichtheir advantage was smallest, that they might employ more of theirlabor and capital on those in which it was greatest.

It may be to our advantage to procure iron from Sweden in exchangefor cottons, even though the mines of England as well as hermanufactories should be more productive than those of Sweden; for if

we have an advantage of one-half in cottons, and only an advantage of aquarter in iron.


20/39

School of Demand vs. School of Supply

John Stuart Mill particularly put his stress on the side of

demand when he initiated his so-called reciprocal demandtheory. In his view import, or in other words, demand,must be of much more importance than export indetermining the real terms of trade. That respect must bean obvious character of Mills ideas on international

trade. Mill strongly argued that the only direct advantage of

foreign commerce consists in imports and consumers arethe ultimate beneficiaries of foreign trade. Indeed, exportsare very important for a country. The significance ofexports, however, is only expressed as the means of

payment for imports from abroad. That is to sayin Millsideawhen a country participate trade it firstly takes thestatus as a demander. Another status of a trader, supplier,is just derived there from.


21/39

School of Demand vs. School of Supply

That is very much different from his predecessors, AdamSmith and David Ricardo, who insisted that trade wouldopen a larger more profitable market for countries whosetechniques and skills of producing commodities weresuperior to their competitors.

Therefore, trade directly implies the increasing the capacityof those countries to offer more goods in internationalmarket. Only with such increase in production can theowners of capital, i.e. the producers, obtain the real benefitsfrom trade.

Thus in the development of international trade theory JohnStuart Mill is one of the famous representatives of theschool of demand, while Adam Smith and David Ricardocould be concluded into the school of supply.


22/39

The Only Direct Advantage of Trade

Mill wrote as the follows: The only directadvantage of foreign commerce consists in

the imports.

A country obtains things which it eithercould not have produced at all, or which it

must have produced at a greater expense of

capital and labor than the cost of the thingswhich it exports to pay for them.


23/39

How to Determine Value of Imports?

The value of commodities produced at the same place, orin places sufficiently adjacent for capital to move freely

between themlet us say, for simplicity, of commoditiesproduced in the same countrydepend (temporaryfluctuations apart) upon their cost of production.

But the value of a commodity brought from a distantplace, especially from a foreign country, does not dependupon its cost of production in the place from whence itcomes.

On what, then, does it depend? The value of things in anyplace depends upon the cost of its acquisition in thatplace; which, in the case of the imported articles, meansthe cost of production of the things which is exported topay for it.


24/39

An Example of Value Determination in Trade

The value, then, in any country, of a foreign

commodity, depend upon the quantity of homeproduce which must be given to the foreigncountry in exchange for it. In other words, thevalues of foreign commodities depend upon the

terms of international exchange. What, then dothese depend upon? What is it which, in thecase supposed, causes a pipe of wine fromSpain to be exchanged with England forexactly that quantity of cloth?It is not theircost of production. It is the law of supply anddemand that determines the terms ofinternational exchanges.


25/39

An End and the Means to the End

From the above illustration we know that, as whatMill argued, acquisition of imports from abroad isthe purpose of trade while exports are just meansof payment for imports.

In order to import some useful commodities fromabroad exports of a country should have a realdemand in the other countries.

By this token, a country should produce both for

itself and for consumers in the other countries. Otherwise its exports could not be sold in

international market and consequently the countrycould not import any commodities at all.


26/39

Different Value for the Same Good in

Different Countries

To produce a particular commodity in acountry particular labor input should beemployed.

Given different circumstances in productionof different countries, supply of productionresources, level of technology, management ofproduction, and so on, labor requirement ofproducing the same commodity in differentcountries must not be equal to each other.


27/39


28/39

Case Study: Trade between England & Germany

Mill raised an example of trade between England and

Germany.

Suppose that 10 yards of broadcloth cost in England as

much labor as 15 yards of linen, and in Germany as

much as 20.

CLre 10:15Domestic Exchange Ratio

in England

Domestic Exchange Ratio

in Germany CLrg 10:20


29/39

Respective Comparative Advantages and

Trade Benefit

The respective domestic exchange ratiosbetween the two goods obviously indicate that

England has comparative advantage in

producing clothsince 15L/10C is less than20L/10C and Germany is comparatively

advantageous in producing linenbecause

10C/20L is less than 10C/15L. Therefore, it would be the interest of England

to import linen from Germany, and of Germany

to import cloth from England.


30/39

Terms of Trade and Benefit Distribution

When each country produce both commodities foritself, 10 yards of cloth exchanged for 15 yards oflinen in England, and for 20 of linen in Germany.

They will now exchange for the same number of yards

of linen in both. For what number?

If for 15 yards, England will be just as she was, andGermany will gain all. If for 20 yards, Germany will

be as before, and England will derive the whole of thebenefit.

If for any number intermediate between 15 and 20, theadvantage will be shared between the two countries.

A R ti l T f T d d th R ti


31/39

A Rational Terms of Trade and the Respective

Gains If, for example, by higgling or bargaining of the market, 10 yards of cloth

exchange for 17 yards of linen, England will gain an advantage of 2 yards on

every 15, Germany will save 3 out of every 20. The problem is, what are the

causes that determine that proportion 10C/17L in which the cloth of England

and the linen of Germany will exchange for each other.

International

Exchange Ratio CLR 10:17

Gains of trade of England:

2 more L acquired for exporting 10 C

Gains of trade of Germany:3 L saved for importing 10 C.

The problem is, what are

the causes that determine

that proportion 10C/17L in

which the cloth of Englandand the linen of Germany

will exchange for each

other.


32/39

Reciprocal Demand Determines Terms of Trade

How the law of demand and supply, inother word reciprocal demand, determines

the terms of trade and thus the distributionof possible total gains from trade betweenthe two participants could be illustrated bythe following hypothetical reciprocal

demand table. From this table we couldhave a graphic presentation of how thereciprocal demand equilibrate international

market.


33/39

Hypothetical Reciprocal Demand

R

Germany England

Dgc or Mg

c Sg

l or Xg

l Sec or X

ec D

el or M

el

10C :15L 20000 30000 0 0

10C:16L 13000 20800 6000 9600

10C:17L 10000 17000 10000 17000

10C:18L 8000 14400 11000 19800

10C:19L 4000 7600 13000 24700

10C:20L 0 0 16000 32000

Reciprocal Demand of Germany and Englandon Good C and Good F


34/39

Equilibrium in International Market

0

5000

10000

15000

20000

25000

30000

35000

10C : 15L 10C : 16L 10C : 17L 10C : 18L 10C : 19L 10C : 20L

Terms of Trade

QuantityDemandedorSupplie

German y Demand for clot h Germany Supp ly of lin en En gland Supp ly o f clo th Englan d Deman d fo r linen


35/39

From the above table and figure it would be obviouslyto see that only when 10 units of cloth could exchangefor 17 units of linen in international market doesGermanys willingness of offering of linen exactlyequals the amount required by England at this rate.

Simultaneously, Germanys willingness of demand oncloth exactly equals the supply of England.

That is to say international market of linen and clothare both cleared at such rate of exchange. In otherwords, at the existing exchange value linen England

requires will exactly pay for the quantity of clothwhich, on the same terms of international trade,Germany requires.

The demand on each side is precisely sufficient to

carry off the supply on the other.


36/39

Basic Requirement of Trade Equilibrium

When two countries trade together in two commodities, the exchange

value of these commodities relatively to each other will adjust itself to

the inclinations and circumstances of the consumers on both sides, in

such manner that the quantities required by each country, of the

articles which it imports from its neighbor, shall be exactly sufficient

to pay for one another.

Market will continuously adjust and

ultimately reach a particular

international exchange ratio at whichthe reciprocal demand of the two

countries for the two goods must be

exactly equal to each other.

e g

c cX M

g e

l lX M


37/39

Relative Extensibility of Reciprocal Demand

Determines Share of the Possible Total Trade Gains

The only general law, then, which can be laid down, is this: The values at which a

country exchanges its produce with foreign countries depend on two things: first, on

the amount and extensibility of their demands for its commodities, compared with its

demand for theirs; and secondly, on the capital which it has to spare from the

production of domestic commodities for its own consumption.

The more the foreign demand for its commodities exceeds its demand for foreign

commodities, and the less capital it can spare to produce for foreign markets,

compared with foreigners spare to produce for its markets, the more favorable to it

will be the terms of interchange: that is, the more it will obtain of foreign commodities

in return for a given quantity of its own.


38/39

That must another important conclusion raised by

John Stuart Mill.It must be the relative extensibilityof reciprocal demand, or in other words the relative

degree of inclination of acquisition of goods from

one another, that actually determines the real terms

of trade and consequently the distribution ofpossible total gains from trade between the two

trade partners.


39/39

Questions and Problems:

Briefly illustrate the background of the publication of MillsPrinciple of

Political Economy?

As the major representative of the School of Demand what is the

principal difference between Millstrade theory and those of Smith and

Ricardo?

Try to describe the basic points of reciprocal demand principles.

Try to raise an example to illustrate the process in which the equilibrium

terms of trade could be concluded.

How to understand the relative extensibility of reciprocal demand, or in

other words the relative degree of inclination of acquisition of goods

from one another, and its effects in determining how to distribute the

aggregate trade benefit between the two trade partners?

Try to analyze the long run tendency of economic relations between the

two sides of Taiwan strait by applying the reciprocal demand principles.

Documents

6[1].Principle of Reciprocal Demand