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. 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. 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. 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.
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
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. 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.
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. 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. 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. 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. 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. 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. 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. 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. 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
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. 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. 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. 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.
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. 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. 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. 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. 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. Correction of Disequilibrium
3) Miscellaneous Measures
Obtaining foreign loans
Development of tourism
Incentives to enhance inward remittances
Encouraging foreign investment.
