Theory of Reciprocal Demand | International Economics Notes & MCQs

Theory of Reciprocal Demand in International Economics

The Theory of Reciprocal Demand, developed by John Stuart Mill in the 19th century, explains how the terms of trade (the rate at which countries exchange goods) are determined by the mutual demand between trading nations. It extends David Ricardo’s comparative advantage theory by addressing the equilibrium conditions for international trade.

Key Concepts

1. Reciprocal Demand: The interaction of demand between two countries for each other’s goods.
2. Terms of Trade: The ratio at which one country’s exports are exchanged for another’s imports.
3. Comparative Cost Limits: The range within which terms of trade must fall to ensure mutual benefit.

Assumptions

• Two countries (A and B) and two goods (X and Y).
• Constant production costs (no economies of scale).
• Perfect competition and full employment.
• No transportation costs or trade barriers.

Mechanism of Reciprocal Demand

Comparative Cost Basis:

Countries specialize based on comparative advantage. For example:

Country	Labor Hours per Unit (X)	Labor Hours per Unit (Y)
A	10	20
B	12	24

Country A specializes in X (lower opportunity cost: 0.5Y per X), and Country B in Y (lower opportunity cost: 0.5X per Y).

Determining Terms of Trade:

The terms of trade settle between the domestic exchange ratios of the two countries.
Example:

• Country A’s domestic ratio: 12X = 10Y (1X = 0.83Y).
• Country B’s domestic ratio: 10X = 8Y (1X = 0.8Y).
• Equilibrium terms: If A exports 125X for 100Y (1X = 0.8Y), both gain compared to domestic ratios14.

Role of Demand:

• If Country A’s demand for Y is stronger, terms of trade shift in favor of Country B (more X needed per Y).
• If Country B’s demand for X is stronger, terms favor Country A.

Offer Curves and Equilibrium

Offer Curves: Introduced by Alfred Marshall, these curves show how much of a good a country is willing to export/import at different terms of trade.

• Country A’s Offer Curve: Reflects willingness to export X for Y.
• Country B’s Offer Curve: Reflects willingness to export Y for X.
• Equilibrium: The intersection of offer curves determines the terms of trade where mutual demand balances36.

[Offer Curves]

occurs at the intersection of offer curves (E), establishing terms of trade (TOT)*3.

Criticisms and Limitations

1. Simplistic Assumptions: Ignores multiple countries, goods, and dynamic factors like technology changes15.
2. Supply-Side Neglect: Focuses on demand but overlooks production costs and resource allocation56.
3. Unequal Bargaining Power: Larger economies may dominate terms of trade, disadvantaging smaller nations3.

Modern Relevance

• Trade Negotiations: Explains how bilateral agreements (e.g., USMCA) balance mutual demand.
• Global Value Chains: Reciprocal demand underpins specialization in interconnected production networks.
• Policy Debates: Informs arguments for protectionism (e.g., tariffs) versus free trade36.

Conclusion

Mill’s Theory of Reciprocal Demand remains foundational in international economics, illustrating how mutual demand and comparative costs jointly determine trade terms. While later models (e.g., Heckscher-Ohlin) incorporate supply-side factors, Mill’s emphasis on demand dynamics provides critical insights into real-world trade negotiations and equilibrium136.

Top 20 MCQs on Theory of Reciprocal Demand (with Answers)

Who developed the Theory of Reciprocal Demand?
a) Adam Smith
b) David Ricardo
c) John Stuart Mill
d) Eli Heckscher
Answer: c) John Stuart Mill8


The Theory of Reciprocal Demand explains:
a) How absolute advantage determines trade
b) How mutual demand determines terms of trade
c) How tariffs are fixed
d) How factor abundance determines trade
Answer: b) How mutual demand determines terms of trade13


Reciprocal demand refers to:
a) Mutual supply of goods
b) Mutual demand of two countries for each other’s goods
c) Price of exports
d) Only one country’s demand
Answer: b) Mutual demand of two countries for each other’s goods34


According to Mill’s theory, the terms of trade are determined by:
a) Comparative cost alone
b) Reciprocal demand of trading countries
c) Absolute cost
d) Factor endowment
Answer: b) Reciprocal demand of trading countries13


The offer curve in international trade theory represents:
a) Only supply
b) Only demand
c) Both demand and supply for foreign goods at different terms of trade
d) Price of exports only
Answer: c) Both demand and supply for foreign goods at different terms of trade4


Which of the following is NOT an assumption of the reciprocal demand theory?
a) Two countries
b) Two commodities
c) Multiple factors of production
d) Constant costs
Answer: c) Multiple factors of production


The equilibrium terms of trade are established at the point where:
a) Export supply equals import demand
b) Offer curves of both countries intersect
c) Domestic prices are equal
d) Tariffs are zero
Answer: b) Offer curves of both countries intersect


If one country’s demand for the other’s product increases, the terms of trade will:
a) Move in favor of the importing country
b) Move in favor of the exporting country
c) Remain unchanged
d) Become indeterminate
Answer: b) Move in favor of the exporting country


According to Mill, the gain from trade is maximum if the international terms of trade are:
a) Nearer to the domestic terms of trade of the importing country
b) Nearer to the domestic terms of trade of the exporting country
c) Equal to the world price
d) None of the above
Answer: a) Nearer to the domestic terms of trade of the importing country3


The theory of reciprocal demand is most applicable when:
a) Both countries are of equal economic size
b) One country is very large
c) One country is very small
d) There are many countries
Answer: a) Both countries are of equal economic size


The strength and elasticity of a country’s demand for another country’s commodity is called:
a) Market demand
b) Reciprocal demand
c) Individual demand
d) Marginal demand
Answer: b) Reciprocal demand4


Which of the following is a limitation of the reciprocal demand theory?
a) Ignores demand
b) Assumes constant costs
c) Considers only supply
d) Applies to many countries
Answer: b) Assumes constant costs


The terms of trade will be more favorable to a country if:
a) Its demand for imports is less elastic
b) Its demand for imports is more elastic
c) Its exports are inelastic
d) Its exports are elastic
Answer: a) Its demand for imports is less elastic


Offer curves were introduced in trade theory by:
a) John Stuart Mill
b) Alfred Marshall
c) David Ricardo
d) Adam Smith
Answer: b) Alfred Marshall


If reciprocal demand does not exist between two countries:
a) No trade will occur
b) Trade will increase
c) Terms of trade will be indeterminate
d) Both a and c
Answer: d) Both a and c


The reciprocal demand theory is an extension of which earlier theory?
a) Absolute advantage
b) Comparative advantage
c) Factor proportion
d) Product cycle
Answer: b) Comparative advantage


Which of the following best describes the main focus of reciprocal demand theory?
a) Supply conditions
b) Demand conditions
c) Technology
d) Labor productivity
Answer: b) Demand conditions


The intersection of two countries’ offer curves determines:
a) Domestic price
b) Equilibrium terms of trade
c) Production possibility frontier
d) None of the above
Answer: b) Equilibrium terms of trade


According to Mill, the actual rate of exchange between goods is determined by:
a) Relative costs of production
b) Reciprocal demand
c) Absolute advantage
d) Factor abundance
Answer: b) Reciprocal demand1


Which statement is TRUE regarding reciprocal demand?
a) It ignores mutual demand
b) It only considers supply
c) It determines the international terms of trade
d) It is not related to offer curves
Answer: c) It determines the international terms of trade13

These MCQs cover the core concepts, assumptions, mechanisms, and implications of the Theory of Reciprocal Demand in international economics.

References:

1. https://jmc.edu/econtent/ug/4116_Theory-of-Reciprocal-Demand-and-Terms-of-Trade-Dr.A.Hidhayathulla-20UEC5CC11-III-BA-Economics.pdf
2. https://www.taylorfrancis.com/chapters/edit/10.4324/9781003424598-12/john-stuart-mill-founder-theory-reciprocal-demand-masatomi-fujimoto
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4. https://www.scribd.com/document/560784367/Mills-Theory
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7. https://www.youtube.com/watch?v=xAPzyDwGyYA
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10. https://www.youtube.com/watch?v=fnchhNUJgYo
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12. https://sde.uoc.ac.in/sites/default/files/sde_videos/ECO3C09.pdf
13. https://www.studocu.com/in/document/alagappa-university/international-economics/brief-note-on-reciprocal-demand/52746960
14. https://mcqmate.com/discussion/237849/mill%E2%80%99s-theory-of-reciprocal-demand-indicates-a
15. https://www.scribd.com/document/657822026/International-Trade-Chapter-Unit-1-Solved-MCQs-set-1-McqMate-com
16. http://www.shvocc.edu.in/images/PDFs/Sem-VI-Business%20Economics-VI%20MCQ.pdf
17. https://nktdegreecollege.org/uploads/students/TYBA_-_Sem_VI_-_International_Economics_-objectives_question_bank.pdf
18. https://testbook.com/objective-questions/mcq-on-theories-of-international-trade--5fc42832a1bc541cc2ffc9c8
19. https://deufob.files.wordpress.com/2016/08/international-economics-multiple-choice-questions.pdf
20. https://ganc.mizoram.gov.in/uploads/attachments/327ac44f35a5bc641006bc79e80fff34/economics-ii-question-bank.pdf
21. https://www.examveda.com/the-theory-of-reciprocal-demand-is-developed-by-245060/