international trade/exchange rates & bop

international trade

the exchange of all goods and services between one country and another.

free trade

a trade policy that does not restrict imports or exports; it can also be understood as the free market idea applied to international trade.

opportunity cost

the next best option foregone, so if a nation decides to specialise in the production of one good or service, they use up resources which will prevent them from using them in the production of another.

absolute advantage

a nation enjoys an absolute advantage, over a different nation, when they are able to produce a good or service at a lower unit cost.

comparative advantage

an economic term that refers to an economy's ability to produce goods and services at a lower opportunity cost than that of trade partners.

possible gains from trade (for consumers)

lower prices, greater choice, improved quality (due to competition and specialization)

possible gains from trade (for producers)

benefits of Economies of Scale, improved access to resources/inputs/technology, increased efficiency in the allocation of resources, source of foreign exchange (the export revenue will also lead to a multiplier effect)

why do countries trade?

different comparative advantages (climate, skilled labor, land, capital, etc)

limitations of assumptions made in ricardo’s comp. advantage theory

each nation does not enjoy perfect knowledge of what to produce. presumes constant returns to scale in its calculations. ignores transport costs and or trade barriers. quality of goods and services may not be the same. comparative advantage model is overly simplistic.

trading blocks

enable free trade between geographically close countries (lower prices, higher growth, greater comp, etc)

key trade blocs

EU, NAFTA, ASEAN, SAFTA, Mercosur, AU

economic integration

involves different countries coordinating and linking their economic policies, for example bilateral trade agreements between two nations or at the other end of the scale, a monetary union such as the EU

free trade area

a more comprehensive arrangement than preferential trading areas. (NAFTA)

customs union

agreement between member countries to ensure free trade within those countries but also set up common external barriers.

common market

customs union plus, consisting of common standards on goods and services and the free movement of capital.

economic union

involves a common currency, such as the euro as well as universal monetary policy. 

political union

consists of a larger and consolidated group of nations or states, that share a joint government that is internationally acknowledged (UK, UAE)

dumping

exporting a product at a price that is lower in the foreign market than the price charged in the exporter’s domestic market (government of country that produces/dumps does so by subsidizing the exporting businesses to enable them to sell below cost)

why do barriers to trade exist

winners (consumers) versus losers (producers) have incentive to fight since no guarantee to be compensated

protectionism

when restrictions are placed on the free movement of goods and services. 

tariff

tax placed on an imported good or service, put in place to protect domestic industries, but also as a method of raising tax revenue. 

quota

a limit on the numbers or value of a good or service that a country will allow into the country, either a quota representing the total volume of a specific product that is allowed into the country, or broken down by country.

domestic subsidy

instead provides financial incentives for domestic firms to compete with low priced goods and services produced overseas.

red tape/bureaucratic barriers

often considered to be hidden barriers, as officially they do not exist.  

embargo

extreme quota, complete ban on imports (usually form of political punishment)

why governments impose trade barriers?

protect own domestic industries from low cost producers, protect domestic jobs, prevent dumping, avoid over specialization, correct current account deficit, correct budget deficit, strategic/security reasons

hidden trade barrier examples

min. import price limits, customs/administrative entry procedures, documentation requirements, product standards, health/safety limits, ad campaigns

preferential trading agreement

PTAs offer preferential (i.e. lower tariff barriers) between participating nations, but not free trade between members.  PTAs apply to specific goods and services only, rather than a universal agreement covering all products.

bilateral agreement

an agreement between two nations or trading groups that gives each party favoured trade status.

multilateral agreement

 an agreement between a number nations or trading groups that give each party favoured trade trade status.

trade creation

creation of new trade opportunities between two or more countries as a result of the formation of a customs union or free trade area. The production typically switches from a high cost producer to a lower cost one.

trade diversion

occurs when the production of a good or service diverts from a low cost producer to a higher cost one. 

exchange rate

described as the price of one currency relative to another

what is the forex market characterized by?

demand and supply of currencies

floating exchange rate system

an exchange rate system in which the currency rate is determined by supply and demand, without influence from the government.

appreciation

when a currency rises in value as a result of changes to demand and / or supply of the currency.

depreciation

when the value of the currency falls as a result of changes to demand and or supply of the currency.

devaluation

when the value of a nation's currency falls, relative to other currencies, as a result of a deliberate policy decision by the government or central bank.

revaluation

when the value of a nation's currency rises, relative to other currencies, as a result of a deliberate policy decision by the government or central bank.

fixed exchange rate system

put in place by a government or central bank which ties a country's  official exchange rate to another country's currency (usually the $ or Є) or the price of gold.

managed exchange rate system

the exchange rate is allowed to fluctuate, but central banks will influence the exchange rates to maintain a certain range.

balance of payments

statement of all transactions between the residents of a country and the residents of other countries

credits

payments recieved

debits

payments made

current account

a measure of the flow of funds from trade in goods and services, plus other income and transfer flows

current account deficit

where the value of total imports of goods and services plus net income flows are greater than the value of total exports of goods and services

current account surplus

where revenues from the exports of goods and services plus net income flows are greater than the spending on the imports of goods and services

capital account

relatively small part of the balance of payments and does not have a significant effect on the balance, consists of capital transfers + transactions in non-produced, non-financial assets

capital transfers

transfer of financial assets due to transfer of goods and assets by migrants, sales of fixed assets(selling of tangible assets internationally), inheritance taxes, gifts,debt forgiveness, etc

transactions in non-produced, non-financial assets

sales and purchases of rights to land and other natural resources, patents, copyrights, franchises

financial account

FDI (opening office in foreign country), portfolio investment (bonds, stocks), reserve assets (gold, foreign currencies)

marshall-lerner condition

rule that tells how successful a depreciation or devaluation of a currency’s exchange rate will be as a means to improve a current account deficit

fall in exchange rate will reduce current account deficit if
PED(exports) + PED(imports) > 1