international trade
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Gains from Trade
Adam Smiths Theory of Absolute Advantage
Country should specialize in the production of commodities
which it can produce most efficiently – Lower Cost of Production.
A country tends to specialize in production of commodities in which it has Absolute Advantage
Per Quintal Labour Cost (Man- hour)
Country Rice Jute
India 30 60
Bangladesh 50 20
Adam Smiths Theory of Absolute Advantage
Would should country’s be doing?
India India should specialise in Rice production. As India has to sacrifice 2 Qtl of Rice for 1 Qtl of Jute. It can import jute from Bangladesh
1Qtl of Rice = 1.5 Qtl of Jute (30/20)
Per Quintal Labour Cost (Man- hour)
Country Rice Jute
India 30 60
Bangladesh 50 20
Adam Smiths Theory of Absolute Advantage
Would should country’s be doing?
Bangladesh Should specialise in Jute Import Rice from India As in domestic trade they get 0.4 Qtl of Rice (20/50) for Jute If they trade they get 0.67 Qtl of Rice (20/30) for 1 Qtl of jute
Per Quintal Labour Cost (Man- hour)
Country Rice Jute
India 30 60
Bangladesh 50 20
Ricardo's Insight What if one country has absolute advantage in both the
commodities?
Is trade possible?
As long as countries have comparative advantage in the production of both the commodities specialisation and trade would always be possible.
Per Quintal Labour Cost (Man- hour)
Country Rice Jute
India 30 60
Bangladesh 50 80
IndiaIt can produce both the goods efficiently.It has comparative advantage in rice production.It can produce Rice at 60% (30/50) cost then Bangladesh.It has comparative disadvantage in jute because cost of
jute production is twice the cost of rice production.
BangladeshIt has comparative advantage in jute productionRelative cost of jute production ( 80/50 = 1.6 Qtl of rice) isless than India’s(60/30= 2Qtl of rice).
Country Rice Jute
India 30 60
Bangladesh 50 80
Gains from Foreign Trade
Internal Exchange Rate (Quintal)
India
Rice Jute
130/60
0.5
2 1
Bangladesh
Rice Jute
150/80
0.625
1.6 1
Who Gains from Trade?
Who Gains India or Bangladesh?
It depends upon the determination of commodity exchange rate between two countries.
India’s exchange rate ranges between 500Kg to 625 kg of Jute
for 1 Qtl of Rice. Bangladesh it ranges between 1.6 to 2 Qtl of Rice for 1 Qtl of
Jute. If Exchange rate in foreign trade are same as internal rates then
both the country gain.
Heckscher-Ohlin Theory of Trade
The comparative advantage in the cost of production is due to the difference s in the factor endowment of the nations.
It refers to the overall availability of usable resources in the country.
A country tends to specialise in the export of a commodity whose
production requires intensive use of its abundant resources and
imports a commodity whose production requires intensive use of its
scarce resources.
Balance Of Payments
Definition
“It is a systematic record of a country’s economic and financial transactions with the rest of the world, over a period of time”.
Transaction of goods and services and income between an economy and the rest of the world.
It standard double- entry book – keeping. Credit = Debit
The BOP must always balance.
The time period is one year – financial or calendar.
Purpose
It provide data for the Economic analysis of the country’s as the
partner in International trade.
It reveals the changes in composition and magnitude of
foreign trade.
It predicts future performances on past trade performances.
It also revels the weak and strong points in the country’s foreign
trade and thereby Govt intervention for corrective measures.
Balance of Trade vs BOP
Balance of Trade : It refers to the difference in value of Imports and Exports i.e “ Visible Items”
Favourable Balance of Trade : X > M Unfavourable Balance of Trade: X< M
Balance of Payments: Includes both Visible and Invisibles items
( Such as Services by shipping, banking and insurance, interest payment, dividend, expenditure of tourist, foreign
investment, external lending and borrowing, NRI deposits etc)
Components of BOP
Current Account
It includes all transactions which give rise to or use up National Income.
Credit : Value which are receivableDebit: Value which are payable.
a) Merchandise / Visible Exports and Imports Merchandise Exports : Sales of Good abroad Merchandise Imports: Purchase of Goods from aboard
b) Invisible Items Invisible Exports: Sales of Services Invisible Imports: Purchase of Services
c) Unilateral Payments Gifts, Private remittances, grants , disaster relief
Capital Account
Which increase or decrease country’s total stock of capital.
a) Short Term Capital Movement Purchase of short term securities Speculative Purchase of Foreign Currency Cash balances held by foreigners Net balance ( + /- ) of current account
b) Long Term Capital Movement Direct Investments in Shares, bonds and in real estate and physically
assets which investors hold a controlling power. Portfolio investments in stocks and bonds Repurchase and resale of securities Direct export and import of capital goods
c) Gold and Foreign Exchange reserves They are maintained to stabilize the exchange rate of the home currency and to make payments to the creditors in case of deficit.
Components of BOP
Credit (Receipts) Debit (Payments)
Export of Goods Import of Goods
Export of Services Import of Services
Interest profits and Dividend Received Interest profits and Dividend paid
Unilateral Receipt(Gifts, grants, disaster relief)
Unilateral Payments
Current Account Balance
Components of BOP
Credit (Receipts) Debit (Payments)
Foreign Investment – Direct, Portfolio Investment Aboard – Direct, Portfolio
Short Term Borrowings Short Term Lending
Long Term Borrowings Long Term Lending
Foreign Exchange Reserves (+) Foreign Exchange Reserves (-)
Capital Account Balance
BOP are always Balance
BOP is based on double – entry book keeping in which both sides of a transactions, receipt and payment are recorded.
Export:
Outflow of goods / Inflow of foreign currency
Import:
Inflow of Goods / Outflow of foreign currency
Both outflow and inflow are recorded in BOP A/C
Indias BOP
Capital A/C
India’s BOP
Bop Disequilibrium
BOP Equilibrium :
Total Receipt = Total Payment
Demand for foreign Exchange = Supply
BOP Disequilibrium :
Demand > Supply : Deficit
Demand < Supply : Surplus
Deficit in Current A/C is offset by Surplus in Capital A/C
Surplus in Current A/C is offset by a deficit in capital A/C
( By loans / borrowings or depleting its gold /foreign exchange reserves)
Causes and Kinds BOP Disequilibrium
1)Economic Factors
a) Price Change Change in Price level causes BOP disequilibrium. The change in price level may be inflationary or deflationary. Inflation makes import cheaper and export costlier. Increase in imports as domestic prices become higher than import
prices Decrease in exports as domestic price rises. Deficit in BOP
b) Development Disequilibrium Large scale development expenditure increase the purchasing
power Increases demand and prices Increases in large imports.
Its common in developing countries as large scale import of capital goods.
Causes and Kinds BOP Disequilibrium
c) Cyclical Disequilibrium
Business cycle fluctuations causes disequilibrium. The country’s which are dependent upon Imports faces
large deficit during inflation Moderate deficit or surplus during depression.
d) Structural Disequilibrium
Depletion of Natural Resources Changes in Technology Alternative source of Supply Development of better substitute
Causes and Kinds BOP Disequilibrium
2) Political Factors
Political Instability may experience large capital outflow and inadequacy of domestic investment and production.
War and changes in trade route can also cause disequilibrium.
3) Other Factors Disturbances or crop failure Rapid growth in population leads to large scale imports of
foodgrains. Changes in taste preferences and fashion causes change in
export and import.
Correction of Disequilibrium
Correction of Disequilibrium
A) Automatic Measures
BOP disequilibrium may be automatically corrected If the market forces of demand and supply are allowed to have a free
play, in course of time equilibrium would be restored. For ex
If there is deficit in BOP Demand for Foreign exchange exceeds its supply This result in increase in exchange rate Fall in value of domestic currency Exports cheaper and import costlier Increase in Exports and fall in imports Equilibrium in BOP
Correction of Disequilibrium
1) Monetary measures
a) Monetary Contraction / Deflation
Contraction or Expansion of money supply For Example: Deficit in BOP Contract the Money Supply Reduces purchasing power Decrease the demand Reduces domestic prices Decrease in imports and increase in exports
Correction of Disequilibrium
b) Devaluation
Reduction of the official rate at which the currency is exchanged for another currency
Devaluation is done to improve its BOP Export prices fall, Export increases Import prices goes up, import reduces Deficit of BOP reduces
Condition for the successful working of Devaluation
Elastic demand for imports and exports Structure of Imports and Exports Domestic Price stability ( Should not lead to Price rise) International co-operation Hike in import duties, reduction in export duties, export license, export
promotion programme
Correction of Disequilibrium
c) Exchange Control
Central Govt has complete control over foreign exchange reserves.
Exporters surrender foreign exchange in exchange of domestic currency.
Govt release foreign exchange only for essential imports.
Its not a permanent solution to long – run disequilibrium because it suppresses demand for Imports and not cure Deficit.
Correction of Disequilibrium
2) Trade Measures
Export promotion measures and import substitutions
a) Export Promotion:
Reducing Export duties
Export subsidy
Export incentives and facilities.
b) Import Control:
Increasing Import duties
Import quotas
Import license and prohibition.
Correction of Disequilibrium
3) Miscellaneous Measures
Obtaining foreign loans
Development of tourism
Incentives to enhance inward remittances
Encouraging foreign investment.
Post 1991 Trade Trends
0
100000
200000
300000
400000
500000
600000
700000
1991
-92
1992
-93
1993
-94
1994
-95
1995
-96
1996
-97
1997
-98
1998
-99
1999
-200
0
2000
-01
2001
-02
2002
-03
2003
-04
2004
-05
2005
-06
Exports Imports F Invest
Movement in Foreign Exchange Reserve
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