International trade material

1. Theory of International Trade
Meaning: International or foreign trade is the trade between two or
more countries e.g. trade between Nigeria and the rest of the world.

2. Difference between Domestic Trade and Foreign
Trade.
Domestic Trade is the trade within a country while foreign trade is the
trade between or among countries. Other differences include:
1. Use of foreign currencies in international trade.
2. Trade restrictions through bans, quotas, tariffs in
international trade.
3. Huge transportation cost in foreign trade.
4. Free mobility of factors of production in domestic trade.
5. Language and custom differences.
6. Differences in legal systems.
7. Differences in measurement of weights.

3. Reasons or Basis for International Trade
1. Differences in environment and endowment between countries e.g.
climate, soil fertility, natural resources, capital stock, labour skills.
2. The need to satisfy various human wants.
3. The need to create wider markets.
4. Variation in the cost of production between countries.

4. Barriers to International Trade
• Differences in currency
• Natural barriers e.g. distance, sea, deserts.
• Artificial barriers e.g. trade restrictions- bans, quotas or tariffs.
• Differences in law and customs.
• Language barriers.

5. Advantages of International Trade
• Increase in the world output of goods.
• Creation of wider markets
• Improvement in standard of living.
• Efficient allocation of world resources.
• Improves World peace.
• Creation of employment opportunities.
• Control of private monopolies.
• Accelerate economic growth.

6. Disadvantages of International Trade
• Dumping leading to the collapse of infant industries.
• Excess dependence on other countries.
• Unbalanced growth of the economy as a result of specialization.
• Importation of dangerous goods.
• Overproduction.

7. Theory of Comparative Advantage
The theory of comparative advantage states that countries derive
mutual benefit when they engage in the production of goods and
services in which they have the least opportunity cost or the greatest
advantage. The principle is hinged on the idea of division of labour and
specialization. This principle was propounded by David Ricardo.

8. Illustration of the Law of Comparative
Advantage
To illustrate the principle of comparative advantage, consider the
following assumptions:
1. Two countries
2. Two goods
3. No transportation cost
4. No change in technology
5. Labour is the only factor of production

9. Case I: No specialization (and no Trade)
Country Cost of
Production
(labour
hours)
Output Opportunity
Cost
Garri Cocoa
Nigeria
India
10
10
10 bags
100
bags
150
bags
20 bags
10G=150C i.e. 1G=15C
& 1C=1/15G
100G=20C i.e. 1G=1/5C
& 1C=5G
ade)

10. Case II: With specialization (and no Trade)
Country Cost of
Production
(labour hours)
Output
Garri Cocoa
Nigeria
India
20
20
-
200bags
300 bags
-
Total 200 bags 300 bags

11. Case III: Specialization (and Trade) If the terms of
trade are such that 1G=1C
Country Cost of
Production
(labour hours)
Output
Garri Cocoa
Nigeria
India
20
20
80 bags
120 bags
220 bags
80 bags
Total 200 300

12. Analysis of Case III
From the three cases above, the following could be deduced
1. There is increase in world output.
2. There is improved standard of living.
3. There is efficient allocation of the world productive resource as a
result of specialization.

13. Limitations of the Comparative Cost Theory
1. There are more than two commodities in the world
2. There are more than two countries in the world
3. The efficiency of the countries of the world varies
4. There are other factors of production other than labour.
5. The cost of production in the world cannot be the same.

14. Terms of Trade
• Terms of Trade
• Terms of trade may be defined as the rate at which a country’s
exports is exchange for its imports.
• Terms of trade (TOT) = index of export price/index of import×100
• If TOT>100=favourable TOT
• Similarly if TOT<100=unfavourable TOT

15. Reasons for the Worsening TOT
• Export of primary products
• Huge import of capital goods
• Production of low quality products

16. Ways of Improving TOT
• Use of inflationary policies.
• Appreciation of the currency.
• Reduction in the demand for imports.
• Collective bargaining.
• Imposition of higher export duties.

17. Commercial Policy
A country's commercial policy includes the use of tariffs and other
trade barriers, such as restrictions on what goods to be imported or
exported, and which countries are allowed to import or export goods
to the home country.

18. Objectives of Commercial Policies
• Increase the volume of trade with other countries
• Encourage domestic industries by preserving essential raw materials.
• Stabilization of foreign trade
• To encourage import of capital goods to speed development

19. Instruments of Trade Restriction
1. Tariffs
2. Foreign exchange control.
3. Devaluation
4. Embargo
5. Import monopoly
6. Quotas
7. Preferential duties.
8. Import liscences.

20. Economic Integration
Meaning: Economic integration is the process where countries
coordinate to reduce trade barriers and to harmonize monetary and
fiscal policies. In other words, countries with common interest come
together with the aim of removing barriers to encourage the free flow
of inputs, information, technology, goods and services amongst them.

21. Types of Regional Economic Integration
1. Preferential Trading Area (PTA): This is the least form of economic
integration. Here countries with common interest coordinate to reduce
tariffs and quotas on certain negotiated goods and services. Thus,
countries in this bloc have preferential access to certain goods and
services only. A good example of the PTA exist between the EU and
African- Caribbean nations where tariffs and quotas are reduced on
certain manufactured goods for primary commodities

22. 2. Free Trade Area: Under this integration, member nations remove all
trade restrictions amongst them and impose different external tariff
policy on non-member states. In other words there are no internal
tariff barriers and different external tariff policies. Some examples of
FTA include (made of the US, Canada and Mexico) NAFTA, African
Continental Free Trade Agreement, EU- Canada Free Trade Agreement,
EU-Japanese Free Trade Agreement, US-South Korea Free Trade
Agreement.

23. 3. Customs Union: This is an economic integration or bloc with
common internal and external tariff policy. Internally, free trade exist
among members of the bloc. Again, members of the bloc adopt
common external tariff policy when transacting with non-member
nations. The EU is a perfect example of a customs union. Other
examples include Southern African Customs Union and the Eurasian
Customs Union.
4. Common or Single Market: This is a deeper state of economic
integration. The integration is built on four freedoms: free movement
of labour, free movement of goods, free movement of services and
free movement of capital. Examples are EU, ASEAN (10 countries) and
Caribbean Single Market and Economy (CARRICOM).

24. 5. Monetary Union: This is also known as the single currency market.
Under this bloc member nations use the same currency, adopt a
common central bank and harmonize their monetary policies. Examples
are EU, Eastern Caribbean Currency Union and West African Currency
Union (CFA).
6. Full Economic Integration: This is pure integration which calls for
harmonization of all policies i.e. monetary policies, fiscal policies,
supply-side policies including sharing of political power. The UK is a
good example of full integration.

25. BALANCE OF PAYMENT (BOP)
Meaning of Money: Money is anything that is generally acceptable as a
medium of exchange for goods and services or in settlement of debt.

26. Features or Characteristics of Good Money
• Acceptability: It must instill confidence in people to accept.
• Durability: It must be fairly durable or last long.
• Divisibility: It must be capable of being divided into different
denominations (e.g. #5,#10, #100, e.t.c)
• Portability: It must be easy to carry about
• Homogeneity: Same unit in each denomination must be a replica of any
other unit in the same denomination.
• Stability: It must be fairly stable in value.
• Relative scarcity: It must not be in excess else its value will fall
• Easily recognizable: It must be easy to identify.

27. Role or Functions of money (Explain the following
functions in terms of International Trade)
1. Medium of exchange: It is given in payment and taken in exchange for
goods
2. Store of value: Money is a form of reserve for future spending or
payments even though its value falls during inflation.
3. Standard for deferred payment: Money enables payment for goods and
services to be postponed till a later date provided the rate of inflation is not
skyrocketing.
4. Unit of account: Money enables transaction records to be accounted for
since prices are denominated in monetary units
5. Measure of value: Money helps in determining the worth of goods and
services.

28. Meaning of Balance of Payment:
Meaning of Balance of Payment: Balance of payment (BOP)
is a summary account of a country’s transactions with the rest
of the world during a given period usually one year. In other
words, it is a comprehensive statement of a country’s
expenditure and income in international trade. BOP is
important because it helps in monitoring the external
transactions of a country in order to prevent bankruptcy.

29. Components of BOP
BOP comprises current account, capital account and monetary movement
account.
• 1. Current Account: This account is concerned with the receipts and
payments for goods and services that are recently produced. The current
account is divided into visible trade account and invisible trade account
• (a) Visible Trade Account(Balance of Trade or Merchandized Trade): This
is the record of the payment for and receipts of tangible goods in
international trade. Tangible goods are goods we can touch and feel e.g.
cloths, oil, rice, e.t.c.
• (b) Invisible Trade Account: This is the records of payments for and receipts
of services in international trade. Services include, banking, insurance,
transportation, foreign income in form of profits, rent, dividends, e.t.c.
• Current account= (visible + invisible) trade account

30. 2. Capital Account: This account deals with the inflow of capital and
outflow of capital of a country within a given period of time. Capital
could be in form of investment, grants or loans.
3. Gold Movement or Monetary Movement Account: This account
shows how the deficit and surplus on current account and capital
account are settled. A capital account or current account experiences a
deficit when receipts are less than payments (i.e. unfavourable balance
of payment). However, when receipts exceed payments it is termed
surplus. Settling the deficit and surplus on both current account and
capital account is called monetary movement account.

31. Balance of Payment Equilibrium
• Balance of payment Equilibrium occurs when a country’s total receipts
from other countries equals the payments to other countries

32. Balance of Payment Disequilibrium
• This occurs when total receipts are greater than or less than total
payments resulting in either surplus or deficit

33. Balance of Payment Surplus
Meaning: Balance of payment surplus occurs when a country’s receipts
exceed its payments in international trade.
Uses of Surplus Balance of Payment
The surplus balance in the monetary movement account is used up in
the following ways:
1. Increasing foreign investment.
2. Increasing lending and aid to other countries.
3. Increasing foreign reserves
4. Payment of foreign debts

34. Balance of Payment Deficit
Meaning: Balance of payment deficit occurs when a country’s expenditure
flows exceed its income flows.
Causes of Balance of Payment deficit
1. Huge cost of serving external debt.
2. Political instability.
3. Low level of technological development.
4. Poor social and economic infrastructure.
5. Existence of import-dependent industries.
6. Excessive government expenditure.
7. Low level of agricultural production.

35. Ways of Financing Balance of Payment Deficit
(Short-term measures.)
1. Export promotion.
2. Grants and aids from friendly countries
3. Sale of foreign investments
4. Short term loans
5. Borrowing from international financial organisations.
6. Running down external reserves.

36. Balance of Payment Adjustments (Long-term
measures)
Short-term deficits in the balance of payments are considered normal
and could be financed through the short-term measures outlined
above. However persistent long-term deficit is not healthy and could be
adjusted through the following measures:

37. 1. Fiscal Policies:
• Tariffs-increase tariffs on imports and reduce/remove same on exports.
• Subsidizing exports
• Deflationary policies e.g. reduction in government expenditure and
increase in personal income tax
2. Physical Measures:
• Quantitative controls such as import quarters
• Embargo or outright prohibition of certain goods
• Issuing of import licenses
• Foreign exchange controls

38. 3. Import substitution: Development of the industrial sector through
direct intervention or incentives such as tax holidays.
4. Tight monetary policies e.g. increase in the bank rate or any
contractionary monetary policy.
5. Devaluation: Deliberate reduction in the value of a country’s
currency in relation to others.
6. Adoption of an appropriate exchange rate regime
7. Export promotion: trade liberalization, trade fairs and profit
retention by expatriates.

39. Devaluation and Depreciation
Devaluation refers to the official reduction of a country’s exchange rate
in relation to other currencies while depreciation of a currency refers
to the reduction in the value of a currency in relation to others as a
result of changes in demand and supply in the foreign exchange
market.

40. Effects of Devaluation
1. It makes exports cheaper
2. It makes Imports to be expensive
3. Reduces imports
4. Increases exports
5. Improves balance of payments
6. Results in creation of more employment opportunities

41. Effects of Devaluation on BOP
The conditions in which devaluation improves the BOP include
1. When a country’s exports have fairly elastic demand
2. When there is no competitive devaluation.
3. When wages are fairly stable in the devaluing country.

42. Advantages and disadvantages of exchange rate
systems
Advantages of fixed exchange rates
1. Certainty - with a fixed exchange rate, firms will always know the
exchange rate and this makes trade and investment less risky.
2. Absence of speculation - with a fixed exchange rate, there will be no
speculation if people believe that the rate will stay fixed with no
revaluation or devaluation.
3. Constraint on government policy - if the exchange rate is fixed, then
the government may be unable to pursue extreme or irresponsible
macro-economic policies as these would cause a run on the foreign
exchange reserves and this would be unsustainable in the medium-
term

43. Disadvantages of fixed exchange rates
1. The economy may be unable to respond to shocks - a fixed exchange rate
means that there may be no mechanism for the government to respond
rapidly to balance of payment crises.
2. Problems with reserves - fixed exchange rate systems require large
foreign exchange reserves and there can be international liquidity problems
as a result.
3. Speculation - if foreign exchange markets believe that there may be a
revaluation or devaluation, then there may be a run of speculation. Fighting
this may cost the government significantly in terms of their foreign
exchange reserves.

44. • Deflation - if countries with balance of payments deficits deflate their
economies to try to correct the deficits, this will reduce the surpluses
of other countries as well as deflating their own economies to restore
their surpluses. This may give the system a deflationary bias.
• Policy conflicts - the fixed exchange rate may not be compatible with
other economic targets for growth, inflation and unemployment and
this may cause conflicts of policies. This is especially true if the
exchange rate is fixed at a level that is either too high or too low.

45. Floating Exchange Rates
Advantages of floating exchange rates
1. Protection from external shocks - if the exchange rate is free to
float, then it can change in response to external shocks like oil price
rises. This should reduce the negative impact of any external shocks.
2. Lack of policy constraints - the government is free with a floating
exchange rate system to pursue the policies they feel are appropriate
for the domestic economy without worrying about them conflicting
with their external policy.
3. Correction of balance of payments deficits - a floating exchange rate
can depreciate to compensate for a balance of payments deficit. This
will help restore the competitiveness of exports.

46. Disadvantages of floating exchange rates
1. Instability - floating exchange rates can be prone to large
fluctuations in value and this can cause uncertainty for firms.
Investment and trade may be adversely affected.
2. No constraints on domestic policy - governments may be free to
pursue inappropriate domestic policies (e.g. excessive expansionary
policies) as the exchange rate will not act as a constraint.
3. Speculation - the existence of speculation can lead to exchange rate
changes that are unrelated to the underlying pattern of trade. This will
also cause instability and uncertainty for firms and consumers.

47. 2014

49. WAEC PAST PAPERS
(a) Balance of Trade = Visible(exports-imports)=$(500-650)=-$150
(deficit)
Items Dr($) Cr($)
Merchandized 40000 52000
Total

50. National Debt or Public Debt
Meaning: The national debt or public debt consists all the loans taken
by the government from both internal and external sources on short-
term, medium-term or long-term basis.

51. Reasons for National Debt
1. To finance huge capital projects
2. To meet national emergencies
3. To meet increasing demand for social infrastructure.
4. Temporary financing of budget deficit
5. To attain full employment
6. To reduce the burden on tax-payers.
7. High rate of deadweight debt.

52. Instruments or Items of National Debt
1. Negotiation
2. Treasury bills
3. Treasury certificates
4. Bonds.
4. Development stocks.
5. National savings scheme.

53. Effects of Debt Burden
1. Reduction private consumption
2. Reduction investment

54. Impact of Debt Burden
The impact of debt burden depends on the source of debt and use
1. Debt from internal sources+
2. Debt from external sources-
3. Use for productive ventures+
4. Financing consumption goods-

55. Debt servicing
Debt servicing refers to the cost of borrowing. This cost include
interest, capital and charges on