An Introduction to International Trade
This chapter is devoted to answer some questions as: how
important is international trade to the nations of the world?
Which countries trade with other countries? What goods do
Question 1: Define the following terms:
1- Gross National Product (GNP)—value of final goods and
services produced by domestic factors of production.
- Refers to production by domestic factors, no matter
where they are located.
2- Gross Domestic Product (GDP)—value of final products
produced within a country.
Refers to production within a country, no matter whether
the factors of production (labor and capital) are domestic
3- Exports—goods and services produced in one country and
sold to other countries.
4- Imports—goods and services consumed in a country but
which have been purchased from other countries.
5- Trade Deficit—a country has a trade deficit if its imports
exceeds its exports.
6- Trade Surplus – a country has a trade surplus if its exports
exceed its imports.
7- Index of Openness—a measure of how much a country
participates in international trade; defined as the ratio of a
country’s exports to its GDP (or GNP).
- Open Economy—a country with a high value of the
index of openness.
- Closed Economy—a country with a relatively low index
of openness. International trade is only a small part of
their economic activity.
Question 2: Why do the countries trade?
1- Without trade, a country must be self-sufficient. It must
produce everything its citizens want to consume.
2- With trade, countries can specialize in the production of
goods that they can produce, and satisfy other needs by
3- Making a country more efficient, when it exports goods
which use abundant resources and imports goods which use
4- Trade could increase competition.
5- Trade Creates new entrepreneurial opportunities, expands
the choice of goods and services, and creates jobs.
6- Enhances the domestic competitiveness.
7- The country will come up with new technology and
innovations will be taken place.
8- Access to cheaper raw-material.
Question 3: compare between free trade &
Occurs when a government doesn't attempt to influence,
through quotas, duties or other means, what its citizens can
buy from another country or what they can produce and sell to
A- Advantage of free trade:
1. Free Trade means more jobs to go to other countries but
only jobs that required very little skills.
2- The aim of free trade is to analyze and refrain barrier in
order to customize easy exchange of specialized and skilled
labor force and division of labor, resulting enhanced
B- Disadvantage of free trade:
1. Short term unemployment in relatively inefficient sectors
of the economy.
2. Other countries sometimes do not trade fairly and
difficulty in establishing infant industries.
3. The government revenue will fall.
4. The domestic products will be neglected and the
consumers will switch to the other (foreign) products.
Refers to policies, rules and regulations that help nation
place barriers in the form of tariffs while trading with any
A- Advantages of the trade protectionism are:
1. If a country’s local industry is not very strong, imposing
trade barrier would make foreign goods expensive and
this will provide a chance to the local firms to compete
on the font of price.
2. The increased duties result in tax revenue for the
3. The aims of protectionism are to preserve jobs.
B-disadvantages of protectionism are:
1. The local firms are being protected and they are
competing on price not the quality
2. The artificial protection can work well for the products
inside the country , but when the products will be
exported; it’s a false sense of security.
3. It is against the principle of free markets.
International Trade Theories
This chapter is devoted for studying international trade
theories starting from the mercantilism trade theory till the
Then we try to give you some questions to elaborate these
theories, which may help you.
Question 1: Explain the following theories:
1- Mercantilism Theory
Theory of Mercantilism:
Nations should accumulate financial wealth, usually in the
form of gold,
Increasing exports and decreasing imports (through
imposing taxes on imported goods, ban on the
importation of other goods, and special laws and taxes
designed to favor certain industries at the expense of
Importance of trade surplus because it leads to a net gold
inflow, and thereby to national wealth and power.
Mercantilist countries practiced the so-called zerosum game, which meant that world wealth was
limited and that countries only could increase their
share at expense of their neighbors.
2- Absolute Advantage
Absolute advantage theory (Adam Smith’s Model).
Absolute advantage theory a country can produce a good
using fewer productive inputs than is possible anywhere else in
the world, so each country should concentrate on the
production of those goods it produces most efficiently.
This theory based on the concept of an international division of
labor by the specialization of nations in the production of only
a few goods.
This specialization could lead to:
• level of world production exceed the sum of autarky
• the surplus produced in this situation could then be
divided between countries through international trade,
• so that all would have more than they would without
we have two countries (A) and (B), and two products Soybeans
(S) and Textiles (T), the numbers in the table reflect the hours
it takes to make 1 unit of output of certain good in a certain
country, as follows:
From the previous Example we see that workers in country
A can produce S in less time than workers in B , A is said to
have an absolute advantage in the production of S. while
workers in B can produce T in less time than workers in A, B
is said to have an absolute advantage in the production of T.
Criticism:- (on mercantilism)
1. there is a set of institutions, laws and regulations put by
governments to restrict international trade and hence the
international division of labor, so Smith attacks the
mercantilism system and to promote free international
2. Smith argued the opinion of mercantilists because this
system served to lower the wealth or standard of living of
2- comparative advantage theory
Comparative advantage theory (David Ricardo’s Model).
Comparative Advantage Theory: A country has comparative
advantage in the production of a good if it can produce that
good at a lower opportunity cost relative to another country.
• Example : we have two countries (A) and (B), and two
products Soybeans (S) and Textiles (T), the numbers
indicate the amount of labor time required to produce 1
unit of output of a particular good in a particular country.
From Example we see that:
country A has an absolute advantage in both goods.
Country A is 4 times more efficient in the production of
good S relative to country B (compare 3 hours with 12
However, A is only 4/3 more efficient in the production of
T relative to country B (compare 6 hours with 8 hours).
Because A's greatest absolute advantage is in the production
of S, it is said to have a comparative advantage in S.
Likewise, because B's least absolute disadvantages in the
production of T, B is said to have a comparative advantage
If international trade takes place, A will export S, and B
will export T.
According to the law of comparative advantage, once trade is
allowed between the two countries, each country should move
to specialize in the production of its comparative advantage
good and then export the excess of the production of that good
to the other country in exchange for the other good.
Comparative Advantage as Country A Produces More S, and
Country B Produces More T.
Per Unit Gain
In Production of S
In Production of T
If country A specialize its production in the direction of
comparative advantage, its output of S will rise.
The resources of this expansion must come from the T
industry, which means the output of T must fall by 1 unit, and
the 6 hours of labor time in T can be employed in the S
industry, and the result will be expansion of output of S by 2
The output of S falls by 1 unit, and the 12 hours of labor time
in S can be employed in the T industry, and the result will be
expansion of output of T by 1.5 units.
And the gain from specialization in the world will be +1 unit in
S and +0.5 in T.
4- H-O Model
The Hecckscher-Ohlin Model.
Heckscher and Ohlin built their theory around two basic
characteristics of countries and products:
1. Countries differ from each other according to the factors
of production they possess.
2. Goods differ from each other according to the factors that
are required in their production.
The Direction of International Trade at HO Model:
The direction of international trade flows between two
countries is determined by: the endowment of the factors of production (labor &
that a country which is capital abundant will export the
capital intensive goods.
And, the country which is labor abundant will export the
labor intensive goods.
Test of HO Model: The Leontief Paradox.
A test of HO model conducted by Leontief using input –
output data for the United States and the main finding is that
despite the fact that the United States was the most capital
intensive country in the world, it exported goods that were
relatively labor intensive and imported goods that were
relatively capital intensive, which is known as Leontief
alternative theories of international trade to explain
1- Human Skills theory, developed by Donald Keesing.
instead of focusing on differences in capital and labor
across countries, the emphasis should be on differences
in endowment of skilled and unskilled workers.
Country with large endowments of high skilled labor
will have comparative advantage in products that are
relatively intensive in skilled labor.
Keesing model provides an explanation of the Leontief
Paradox, because the United States has highly trained
and educated workers, U.S exports tend to be skilled
2- Product life Cycle theory.
by Raymond Vernon
The product life cycle is divided into three stages:
A- New product stage:
1. In this stage goods are invented mostly in the
2. And at this period there is no competition.
3. The invented company of the new product seeks to
export this product to other developed countries.
B- Maturity product stage:
During this stage, the company find the necessity to invest
C- Standardized product stage:
This is the final stage, where the company (country)
loses its comparative advantage in producing the product
and this advantage shifts to another country which could
produce this product with lower cost.
Vernon had explained Leontief paradox as when the United
States lose its comparative advantage in producing capital
intensive goods and this comparative advantage switch to
another country, the U.S tend to import capital intensive goods
from this country, and that explains why the United States
imports are capital intensive goods.
Tariffs and Nontariff Barriers
We have focused our discussion on the causes and
consequences of international trade. We have seen that
international trade leads to the redistribution of production in
an economy. It also affects the returns paid to factors of
production. For both of these reasons, some individuals in
every society favor government policies aimed at affecting the
volume and composition of international trad
Question 1: Define the following terms.
1-Commercial policy is known as actions taken by a
government to influence the volume and composition of trade
flows (into or out of a country).
2- Tariff: A tax imposed by a government on either exports or
3- Quota: A government imposed limit on the value or
quantity of an import or export goods.
4- Subsidies: Payments by a government to an industry to
encourage exports or discourage imports.
5- Nontariff barriers: A wide range of government policies
than tariffs designed to affect the volume or composition of a
country's international trade
6- Consumer surplus: is the difference between the amount
consumers are willing to pay to purchase a given quantity of
goods and the amount they have to pay to purchase those
7- Producer surplus: is the difference between the price paid
in the market for a good and the minimum price required by an
industry to produce that good.
8-Embargo—complete ban on import of a certain good.
9- Tariff Rate Quota (TRQ)—allows a certain quantity of a
good into a country at low or zero tariff rates, but applies
higher tariff to quantities exceeding the quota.
10- Voluntary Export Restraint (VER)—an indirect quota
resulting from an exporting country ―voluntarily‖ limiting
Question 2: Illustrate the following with discussion.
1- The gains from free trade (import side).
Say country A in equilibrium, the price of grapes would be
PA And the quantity produced would be QA.
Now, suppose we introduce international trade into this model.
We assume that the world price of grapes Pw is lower than PA.
This will cause
Consumption to expand to
domestic production to fall to Q1
domestic production will comprise imports.
What are the economic impacts of these changes in the
grape market in country A?
consumers are better off; they are able to purchase this
product at a lower price than before trade. Domestic
producers are worse off; the lower price leads some
suppliers to reduce the quantity supplied.
- The welfare effects in the import market of a move to
2- The gains from free trade export side.
Suppose this represents the market for honey (H), in autarky
before trade the price of H is PA, and would equal QA .
Suppose that the world price of H is equal to PW.
Then, after international trade is introduced, domestic
suppliers would move to expand output in response to the
now higher price.
At the same time, the domestic quantity demanded would
fall, and the new quantity supplied would be Q4 , while the
new quantity demanded would be Q3 units.
The difference represents exports of H to the rest of the
The welfare effects in the export market of a move to free
Because the price has increased, consumer surplus falls.
The total reduction of consumer surplus would be $(e + f).
The higher price, however, raises producer surplus. The
increase is equal to $ (e + f +g). The net impact for national
welfare to rise by $g.
3- The effect of an import tariff.
Suppose the government of A imposes a tariff on imports of
grapes of t dollars.
Let's consider the effect of the tariff on production and
Under free trade, domestic production was Q1 units, while
consumption was Q2 units. Imports represented the difference
between these two amounts.
After the tariff, production rises from Q1 to Q3units.
- When considering the effect of the tariff on price, once the
tariff is imposed, it is passed through to the economy in the
form of higher prices for the foreign product. Since domestic
producers are selling an identical product, they raise their
prices as well.
- Total consumption of grapes falls. This is due, to the higher
price consumers must pay for the product. Hence, quantity
demanded falls from Q2 to Q4.
- Tariff causes a reduction in imports for two reasons:
First: domestic output expands.
Second: domestic consumption falls.
Finally, tariffs lower the standard of living of a country
relative to free trade, because they hurt consumers more
than they help producers.
4- The economic effects of quota.
The curve DM is the domestic demand curve, and the curve
SM is the supply curve of domestic producers. The world price
is assumed to be $1000.
Under free trade:
Residents of this country would consume 50,000 units, 10,000
of these would be produced locally, and 40,0000 would be
The government imposes a quota on imports:
A quota that limits imports to 20,000 units. Because of
the reduction in imports, the prices of the product M will
start to rise and this will encourage local producers to
expand their output levels.
These market forces will bring about new equilibrium;
prices continue to rise until desired imports fall to the
quota level of 20,000 units (the price must raise until the
difference between domestic demand and supply equals
This occurs at a price of $1,500, at this price 44,000 units
will be purchased, 20,000 of these will be imported, and
the remaining 24,000 will be produced locally.
As with tariff, quotas serve to limit trade and raise prices.
The welfare effects of quotas:
the imposition of the quota raises the domestic price and
therefore lowers consumer surplus.
Consumers lose the amount $(a + b+ c+ d), producer
surplus represents higher profits by $a, and the triangles
$(b + d) represents the cost of society of imposing the
quota (deadweight costs).
Area c is the value of quota rent: Profit that accrues to
whoever has the right to bring imports into the country
and sell these goods in the protected market.
Consider the rectangle that defines area c. The base of
the rectangle represents the amount of imports allowed
into the country (20,000 units); the height of the
rectangle is the difference between the world price
($1000) and the domestic price ($1,500). The difference
between these two prices reflects the per unit (additional)
profit that can be earned by whoever has the right to sell
the imported product.
Q: Who gets the quota rent?
- Domestic producers or importers
- Foreign producers.
Question 3: Compare between tariff & quota.
They are similar in their effects on They are similar in their effects on
prices, output, and imports.
prices, output, and imports.
Tariff revenue goes to government quota rent depends on who gets
With a tariff, an increase in
with a quota, no new imports are
demand will be met by a rise in
Question 4: there is a relationship between trade &
economic growth. Discuss.
Trade enhances economic growth through imports of capital
- Trade enhances international diffusion of technology.
- Trade expands market size.
- Trade can enlarge the pool of savings necessary for
Question 5: there are arguments for protectionism.
Arguments for Protectionism:
There are some arguments for protection, we discuss them as
1- Balance of Payments Problems:
If a country exports less than its imports, the balance of
payments deficit will result.
2- Government revenue.
All governments need tax revenues, and Tariffs produce
3- Income Redistribution.
Trade policy can be used to redistribute income from one
sector of society to another.
In some countries, one of aims of commercial policy is to tax
the rich so as to aid the poor.
4-Protection of Infant Industries.
New industries may need protection until they have mastered
5- Protect Jobs.
Foreign imports are cheaper and consumers are going for the
cheapest product which is also with a good quality.
By restricting imports and making imports more expensive,
Countries can help their domestic industries and protect its
6. To Prevent Dumping.
When selling products/goods overseas for a lower price than
An Introduction to International
This chapter is devoted to study the trade in financial assets.
Such trade may be related to the financing of goods and
services trade, but it may also be related to investors altering
their portfolios, multinational firms transferring assets from
one subsidiary to another, government buying and selling
different currencies to change exchange rates.
Question 1: Define the following terms.
1- The Balance of Payments (BOP): is a record of a
nation's transactions with the rest of the world, in other
words the BOP reflects the country's international
2- A country with a trade surplus: exports more goods
than it imports.
3- A country with a trade deficit imports more than it
4- Balance of payments deficit: BOP debit items
exceed the credit items in value.
5- Balance of payments surplus: BOP credit items
exceed the debit items in value.
6- Foreign Exchange Market (FEM)—the market
where monies of different countries are traded.
7- Exchange rate—price of one country’s money in
terms of another.
of an unexpected change in the exchange rate.
9- International investment—portfolio investment and
international financial systems.
systems— history of
The Balance of Payments
This chapter is devoted for studying the balance of payment,
practically after studying this chapter you can solve the
Question 1: Discuss the followings:
1- The features of the balance of payment.
Features of the BOP
BOP follows the accounting procedure of double-entry
bookkeeping (debits & credits).
A credit entry records an item or transaction that brings
foreign exchange into the country.
BOP will always balance.
A BOP deficit (surplus) means that the debit entries
exceed (are less than) the credits. This imbalance applies
2- Double entry accounting in the BOP.
Is an accounting method which records each transaction as
both a credit and a debit.
Credit entries represent the source of financing and the debit
entries represent the uses of that financing.
A- Credit transactions result in receipt of payment from
Transportation and travel receipts
Income received from investments abroad
Gifts received from foreign residents
Aid received from foreign governments.
B- Debit transactions involve to payments to foreigners,
Transportation and travel expenditures.
Income paid on investments of foreigners.
Gifts to foreign residents.
Aid given by home government.
Overseas investments by home country residents.
Each credit transaction has a balancing debit transaction,
and vice versa, so the overall balance of payments is always
Question 2: What happens if the country has a
current account deficit?
The country must borrow (sell domestic securities)
to the rest of the world to finance the current
As foreigners accumulate domestic securities, the
domestic currency value falls which, in turn, raises
net exports and consequently income.
What happens if the country has a current account
In addition, domestic interest rates rise which, in
turn, lowers consumption and investment spending.
WTO & its Dimensions
This chapter is expanded upon discussion by focusing on
recent trade policy initiatives, and we also discuss in
some details the role of international organizations and
agreements, such as the World Trade Organization
Question 1: What's the role of the following
A-World Bank: "Development Assistance".
Provides loans to developing countries and the official goal are
the reduction of poverty. Established by the Bretton Woods,
B-International Monetary Fund (IMF): Financial Assistance.
Established by the Bretton Woods, 1944.
C-World Trade Organization (WTO):Trade Policy Regulation
and Negotiation, 1995.
Question 2: Explain the main principles of GATT.
The principles of GATT:1- Most Favored Nation (MFN).
discriminate between their trading partners. Which means
grant someone a special favor such as lower customs duty rate,
and do the same for all other WTO members, that’s all
members are equal under GATT.
2- Non discrimination.
Which means not discriminate between national and foreign
economic units giving them national treatments.
Under the WTO agreements, members must reciprocate the
reduction in tariff & nontariff barriers. The exception of that
are the infant industries in developing countries to enable it to
compete in international markets.
This principle allows countries to protect their local or
national industries through tariff as a tool to protect infant
5- Preferential treatment for developing countries.
That developed countries must provide preferential treatment
for developing countries and to aid these developing countries
in conducting the development programs which include open
their markets in front of developing countries products.
Which means depends only on tariffs as a protection tool not
on nontariff barriers as quotas because of the lack in
transparency in nontariff barriers.
7- Multilateral negotiations.
That means negotiation is the basic tool to solve commercial
dispute under GATT.
Question 3: Uruguay Round of Multilateral Trade
A- Agreement on trade in goods, include agreements
1- Agriculture Agreement.
2- Agreement on manufactured goods including agreement on
textiles and clothing.
4- Trade Related Aspects of Commodity Measures.
B- General Agreement on Trade in Services (GATS).
The agreement covers all internationally traded services, for
telecommunication, tourism, consultants…..etc.
C- Trade Related Aspects of Intellectual Property
Areas covered by the TRIPs Agreement:
1- Copyright and related rights.
3- Geographical indication.
4- Industrial design.
6- Layout designs of integrated circuits.
7- Undisclosed information, including trade secrets.
Question 4: Regionalism versus Multilateralism.
Explain in details.
It is important to remember that regional trade liberalization is
very much different from the process of multilateral
liberalization that is the corner stone of the WTO.
In regional trade arrangements, countries lower their trade
barriers only for a small group of partner countries and
discriminate against the rest of the world.
Within the WTO, trade liberalization by any one member
country is extended to all other members on an unconditional
MFN basis, here there is essentially no discrimination.
Regional agreements facilitate the work at the WTO, for the
1. Regional integration is a tool to overcome national trade
barriers and to boost competitiveness.
2. Big bilateral deals can remove obstacles on certain topics
and be much more comprehensive than the commitments
that a given country can make in multilateral rounds.
3. Bilateral agreements are essential to improve the WTO
negotiations especially in the periods of freezing of the
relations in the WTO.
1-According to chapter Two , summarize the international
2-According to chapter three, illustrate the impacts of
tariff & Quota, then compare between them.
3- According to chapter 4 & 5, discuss the balance of
4- According to chapter 6, discuss the WTO & its