International Trade

International Trade

International trade is the voluntary exchange of goods and services between nations over international borders.

Rational For International Trade

The rationale for international trade is the reasons that incentives trade across borders.

Necessity

Necessary trade goods are goods, services that cannot be easily produced and resources that cannot be substituted within a given economy.

These goods must therefore be sourced by other nations from the economy that has the desired goods.

Absolute/Necessary Advantage

Absolute/necessary advantage is a concept relating to international trade wherein one country’s economy can produce more of a good given the same resources. Therefore, it is necessary to specialize in the production of goods it has a comparative advantage for.

The economy with the absolute advantage often chooses to specialize in the production of said goods.

Convenience

Convenience trade goods are goods, services that can be easily produced and resources that can be substituted within an economy.

These goods therefore do not have to be sourced by other nations from a specific economy that has it as many economies have the goods.

Comparative Advantage

Comparative advantage is a concept in international trade that describes a situation where an economy can produce given level of production at a lower opportunity cost than another economy

The economy with the comparative advantage often chooses to specialize in the production of said goods.

Opportunity cost

Opportunity cost calculation

Opportunity cost is the value of the option(s) foregone/given up for the current option chosen.

Opportunity cost = cost/gain

Terms of trade

Terms of trade is a comprehensive measure of the value of imports a given number of exports can cover, expressed as a ratio of export index to import index.

Terms of trade = exports/imports *100

Terms of trade description:

An increase in the terms of trade is referred to be favorable.

A decrease in the terms of trade is referred to be unfavorable.

Gains from trade

Gains from trade are the advantages that countries experience as a result of their engagement in trade.

Gains from trade:

1. Absolute or Comparative Advantage as a result of countries’ differing climates and factor endowments.

2. Absolute or Comparative Advantage as a result of greater factor productivity.

3. Economies of scale as a result of specialization in specific industries.

Factors that affect the level of Imports in a country:(factors affecting demand)

1. Climate, factor endowments and seasons

2. Domestic/local income levels

3. Domestic product prices versus foreign product prices.

4. The exchange rate (higher local exchange rate/ currency value = higher imports)

Factors that Influence the level of Exports in a country: (factors affecting demand)

1. Climate, factor endowments and seasons

2. Information and changing tastes of consumers in the rest of the world.

3. Foreign income levels.

4. The exchange rate (higher local exchange rate/ currency value = lower exports)

5. Quality of imported goods (higher quality of imports = lower quality of inferior[in terms of quality] exports)

Protectionism

Protectionism is the enforcement of economic policies and trade barriers to benefit and shield local industries by limiting imports from foreign competitors.

Arguments for Protectionism:

1. Protection of domestic jobs

2. Infant industry argument

3. Prevent dumping of foreign goods in local markets

4. Desire to achieve a favorable balance of trade

5. Negotiating tool for international economic activity

Forms of Protectionism Policies:

1. Tariffs: Tax levied on goods and services imported to a country.

2. Import quotas and licenses

3. Ban on imports from specific geographic areas

Balance of Payment(BOP) VS Balance of Trade (BOT)

The balance of trade is a measure of the difference in value of a country’s exports and imports.

The balance of payment is a comprehensive record of a country’s economic transactions with the rest of the world.

Balance of Payment(BOP) Components: The Current Account

1. Net Trade in Goods

2. Net Trade in Services

3. Net Transfers

4. Net Return on Locals’ Foreign Investment

Balance of Payment(BOP) Components: The Financial (deals with investment) /Capital Account (deals with asset transfers)

1. Foreign Direct Investment and Asset Sales to Foreigners

2. Locals’ Investment Abroad and Asset Purchases

Net Capital Outflow

A Net Capital Outflow occurs when a country has more foreign investments than foreigners’ investments locally.

Balance of Payment(BOP) Components: Official Reserve Account

Official reserves are the government store of foreign currency and securities held by the central bank of a country.

It is used to balance the balance of payment account.

In times of POP surplus, the reserve account has a + balance (as it has increased) and a - balance in times of deficit.

BOP Inflows VS Outflows

Inflows are all economic transactions that bring money into the country. However, outflows are all transactions that carry money out of the country,

BOP Surplus vs Deficit

BOP Surplus : Inflows > Outflows

BOP Deficit : Inflows < Outflows

Causes of a BOP Deficit:

1. Increasing local demand for imported goods and services

2. Falling demand for locally produced goods by foreigners

3. Individual and governmental transfers out of the country being greater

   than those coming in

4. Individual and governmental transfers out of the country being greater

   than those coming in

5. Individual and governmental transfers out of the country being greater

   than those coming in

Effects of BOP Deficit

1. Unemployment might increase as foreign demand for locally-produced goods fall

2. Exchange rate depreciation/ fall in value of local currency vs foreign currency

3. Falling foreign exchange reserves as foreign reserves are being used to balance greater outflows than inflows (net inflows). [VERY IMPORTANT USE OF RESERVE A/C]

Measures to reduce BOP Deficit

1. Reduction of aggregate demand through deflationary monetary and

   fiscal policy.

2. Import controls

3. Devaluation to reduce imports and make exports cheaper

Cause of BOP Surplus

1. Falling demand for imported goods and services

2. Increasing demand by foreigners for locally produced goods and services

3. Individual and governmental transfers into the country being greater than

   transfers out

4. Investment incomes paid into the country to domestic investors who

   invested abroad being greater than those being paid out to foreigners who

   invested locally

5. Greater investments in the local economy by foreigners than foreign

   investment made by domestic residents abroad.

Effects of BOP Surplus

1. Falling unemployment as increased demand for locally produced goods and services

2. Exchange rate appreciation as increased demand for local currency for foreigners to buy local goods and services

3. Increase in reserves as net outflows are added to reserves

Measure to reduce Surplus

1. Increasing aggregate demand through reflationary monetary and fiscal

   policy

2. Reduction of import controls

3. Revaluation of the currency/ increase in local currency value comparted to foreign currency to incentivize now cheaper imports and make exports more costly

Exchange Rate

The exchange rate is the rate at which one country’s currency can be exchanged for another foreign currency (e.g. 1USD = 7TTD)

Types of Exchange Rate:

1. Fixed: exchange rate is determined by government

2. Floating: exchange rate is entirely determined by market forces

3. Managed: exchange rate is primarily determined by market forces with some intervention by government or central bank

Adjustments in Fixed Exchange Rate:

1. Upward Adjustment/Revaluation: increase in value of local currency vs foreign currency determined by the government

2. Downward Adjustment/Devaluation: decrease in value of local currency vs foreign currency determined by the government

Adjustments in Floating Exchange Rate:

1. Appreciation: increase in value of local currency vs foreign currency as a result of

   (i) shift to right/increase in demand (ii) shift up/decrease in supply of local currency

2. Depreciation: decrease in value of local currency vs foreign currency as a result of

   (i) shift to left/decrease in demand (ii) shift out/ increase in supply of local currency

Factors Influencing Exchange Rate [determinants of demand and supply for local currency]

1. Domestic prices compared to foreign prices

2. Domestic income levels

3. Tastes, Preference and Bandwagon Effect

4. Level of interest rate returned on savings within country

5. Speculation