International trade


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International trade

  1. 1. Gains from Trade
  2. 2. 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
  3. 3. 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
  4. 4. 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
  5. 5. 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
  6. 6.  India It 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.  Bangladesh It has comparative advantage in jute production Relative cost of jute production ( 80/50 = 1.6 Qtl of rice) is less than India’s(60/30= 2Qtl of rice). Country Rice Jute India 30 60 Bangladesh 50 80
  7. 7. Gains from Foreign Trade Internal Exchange Rate (Quintal) Bangladesh India Rice Jute Rice Jute 1 0.5 1 0.625 50/80 30/60 2 1 1.6 1
  8. 8. 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.
  9. 9. 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.
  10. 10. Balance Of Payments
  11. 11. 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.
  12. 12. 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.
  13. 13. 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 : Unfavourable Balance of Trade: X>M 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)
  14. 14. Components of BOP BOP Current A/C Capital A/C Merchandise / Visible Short Term Capital Movement Invisible Export / Import Long Term Capital Movement Unilateral Transfers Changes in Gold and Exchange Reserves
  15. 15. Current Account It includes all transactions which give rise to or use up National Income. Credit : Value which are receivable Debit: 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
  16. 16. 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.
  17. 17. Components of BOP Current Account Balance 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
  18. 18. Components of BOP Capital Account Balance 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 (-)
  19. 19. 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
  20. 20. Indias BOP
  21. 21. Capital A/C
  22. 22. India’s BOP
  23. 23. Bop Disequilibrium BOP Equilibrium : Total Receipt = Total Payment Demand for foreign Exchange = Supply BOP Disequilibrium : Demand > Supply : Demand < Supply : Deficit 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)
  24. 24. 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.
  25. 25. 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
  26. 26. Causes and Kinds BOP Disequilibrium 2) Political Factors   3) Political Instability may experience large capital outflow and inadequacy of domestic investment and production. War and changes in trade route can also cause disequilibrium. 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.
  27. 27. Correction of Disequilibrium Correction Of BOP Automatic Measures Deliberate Measures Monetary Measure Trade Measure Miscellaneous
  28. 28. 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
  29. 29. 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
  30. 30. 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
  31. 31. 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.
  32. 32. 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.
  33. 33. Correction of Disequilibrium 3) Miscellaneous Measures Obtaining foreign loans Development of tourism Incentives to enhance inward remittances Encouraging foreign investment.
  34. 34. 20 20 20 20 20 05 04 03 02 01 -0 6 -0 5 -0 4 -0 3 -0 2 -0 1 00 -9 9 -2 0 00 99 98 -9 8 -9 7 -9 6 Imports 20 19 19 97 96 95 -9 5 -9 4 -9 3 -9 2 Exports 19 19 19 94 93 92 91 600000 19 19 19 19 Post 1991 Trade Trends 700000 F Invest 500000 400000 300000 200000 100000 0
  35. 35. Movement in Foreign Exchange Reserve