J.S.Mill made Ricardo’s theory of comparative cost determinate by stating the conditions for equilibrium terms of trade. Comparative cost difference between the countries sets the outer limits between which international trade can take place profitably.

It does not tell where, between the limits, international trade will actually take place. Mill provides answer to this question.

J. S. Mill propounded the theory of reciprocal demand or the law of international values to explain the actual determination of equilibrium terms of trade. According to him, the equilibrium terms of trade are determined by the equation of reciprocal demand.

Reciprocal demand means the relative strength and elasticity of demand of the two trading countries for each other’s product in terms of their own product.

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A stable ratio of exchange will be determined at a level where the value of imports and exports of each country is in equilibrium.

In Mill’s own words, “The actual ratio at which goods are traded will depend upon the strength and elasticity of each country’s demand for the other country’s product, or upon reciprocal demand. The ratio will be stable when the value of each country’s exports is just enough to pay for its imports.

Mill’s theory is based on the following assumptions:

(i) Full employment conditions;

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(ii) Perfect competition;

(iii) Free foreign trade;

(iv) Free mobility of factors;

(v) Applicability of the theory of comparative cost;

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(vi) Two country, two commodity model.

Ellsworth has summed up Mill’s theory of reciprocal demand in the following way:

(i) The possible range of barter terms is given by the respective domestic terms of trade as set by comparative efficiency in each country.

(ii) Within this range, the actual terms depend on each country’s demand for the other country’s produce.

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(iii) Finally, only those barter terms will be stable at which the exports offered by each country just suffice to pay for the imports it desires.