Foreign Trade

Presented by Mrunal K. Selokar [2013BCS065] Suraj A. Bobade [2013BCS072] Kirti N. Bajaj [2013BIT044]

Foreign Trade• What is foreign trade?• Foreign trade is the exchange of capital, goods,

and services across international borders or territories, which could involve the activities of the government and individual

Basis for Foreign Trade

• Resource Endowment

• Unequal distribution of resources

• Self sufficiency

• Gain from foreign trades

Resource Endowment

The basis of international trade is the difference in the resource endowment of different nationsWhat is resource endowment?

“It is the availability of natural and man-made resources that can be used to produce goods and services.”

Unequal Distribution of resources

• Resource distribution refers to the distribution of resources, including land, water, minerals, fuel and wealth in general among corresponding geographic entities (here, countries).

• Countries may not have the resources that are important to them, but trade enables them to acquire those resources from places that do.

• Eg. Japan is a country with very limited natural resources, and yet is one of the richest countries in Asia.

Self Sufficiency• Definition:

“ It is the state of not requiring any aid, support, or interaction with others for survival.”• It is also termed as Autarky.• Autarky is the quality of being self-sufficient.• Autarky exists whenever an entity can survive

or continue its activities without external assistance or international trade.

• No country can claim self sufficiency in it’s resource requirements or a perfectly balanced supply of resources

Gain From Foreign Trades

• In economics, gains from trade refers to net benefits to agents from allowing an increase in voluntary trading with each other.

• Gains from international trade are in the form of increase in production, cheaper goods and services, increase in consumption, higher level of welfare and many other related advantages including socio – politics.

Adam Smith’s Theory of Absolute Advantage

• INTRODUCTION:• It may be possible for all countries to produce all

commodities they need, in spite of resource constraints. BUT, production cost for goods for which the country is deficient in resource endowment will be extremely high.

• Therefore, it is advantageous for a country to • specialize in the production of commodities which

it can produce more efficiently• Import the goods which it might produce at high

cost.

Adam Smith’s Theory of Absolute Advantage

Absolute advantage:The ability to produce a greater quantity of a

good, product, or service than competitors, using the same amount of resources.

The theory says, “A country tends to specialize in production

of commodities in which it has absolute advantage in cost of production.”

Adam Smith first described the principle of absolute advantage in the context of international trade, using labor as the only input.

Example:

Country Rice Jute

India 30 60

Bangladesh 50 20

Per Quintal Labour Cost (Man-hour)

India has an absolute advantage in rice production. Bangladesh has an absolute advantage in jute production.

30/60=1 : 220/50=1 : 0.4

In their domestic trades,• India will have to sacrifice 2 quintal of rice to produce 1 quintal

of jute.• Bangladesh will have to sacrifice 1 quintal of jute to get 0.4

quintal of rice.

By theory of absolute advantage,• India would specialize in rice production and import jute.• Bangladesh would specialize in jute production and import

rice.

According to Adam Smith, trade between the two countries will prove advantageous to both since both of them can avail, given the labor force, a larger quantity of both commodities and at a lower cost.

• 50/30=1.67

• If India specializes in rice production, it can get 1.67 quintals of jute for 1 quintal of rice.

• If Bangladesh specializes in jute production, it can import 0.67 quintals of rice for 1 quintal of jute.

Ricardian Theory of Comparative Advantage

Assumptions of Ricardian Model• Two countries, denoted home and foreign.• Two final products.• Each good uses only one input (labour) in production. • Labour is homogeneous in quality.• Constant labour requirement per-unit of output.• No cost of transportation, no trade barriers.• Perfect competition in factor and product markets.

What Ricardian Theory Says…Ricardian Theory: A country exports that commodity in which it has a comparative labour-productivity advantage.

An Example…

Rice Jute

India 30 60

Bangladesh 50 80

Per Quintal labour cost

Domestic Exchange Rates of India & BangladeshIn India:• 1 Quintal of Rice=30/60=0.5 Quintal Jute• 1 Quintal of Jute=60/30=2 Quintal Rice

In Bangladesh:• 1 Quintal of Rice=50/80=0.626 Quintal Jute• 1 Quintal of Jute=80/50=1.6 Quintal Rice

Distribution of Gains• Which country will gain more???• Gainful exchange rates for India:

between 0.5 to 0.626 Quintals• Gainful exchange rates for Bangladesh:

between 1.6 to 2 Quintals• Gains are distributed on the basis of their production efficiency.• No country gains at the cost of other.

Criticism…• Labour is not homogeneous

varies in skill & productivityvaries according to wages

• Labour is not the only factorland & capitalstate of technology

• Demand Side Ignored• Other Criticisms

Thank You!