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Complete notes on International Trade

International Trade

MEANING International trade refers to the exchange of goods and services between the countries. BASIS OF INTERNATIONAL TRADE International trade arises because: (a) The production of different kind of goods requires different kind of resources used in different proportions. (b) The various kind of economic resources are unevenly distributed throughout the world. (c) The international mobility of resources is extremely limited. For these reasons nations which have an abundance of land relative to labour will concentrate on the production of land intensive commodities such as wheat and meat. They will exchange these

Complete notes on International Trade

goods for capital intensive goods such as T.V. computers which are produced by those countries who have abundance of capital relative to land.

ADVANTAGES OF INTERNATIONAL TRADE. Nurkse calls trade as the engine of growth. We find the statement quite true on the basis of a number of reasons. Some are given below.

Optimum use of resources.

(2) Trade encourages to produce and export those commodities in which a country has comparative advantages. Resources are allocated automatically to most efficient use. (2) Increase in production: Trade encourages specialization. Trading countries obtain maximum production by allocating available resources to best possible use. (3) Raw material for industries. International trade has made it possible to set those industries in a country for which raw material is

Complete notes on International Trade

not available locally. eg establishment of ghee industry in Pakistan was not possible without the facility of importing raw oil from other countries.. (4) Increase in employment opportunities. International trade encourages specialization and expansion of export oriented industries. Expansion of industrial base provides enormous job opportunities in a country. Textile industry is an example in Pakistan. (5) Discouraging of monopolies: International trade discourages monopolies in a country and introduces a healthy competition among sellers. eg Import of tractors has broken up the monopolies of local manufacturers and prices of tractors in Pakistan have fallen. (6) Import of technology: The deficiency of technology in a developing country can be covered by importing technology. (7) Economic stability: International trade can help to stabilize an economy. Expansion of export opens new job opportunities and Imports or export of goods can stabilize prices in an economy.

Complete notes on International Trade

(8) Extent of market. Introduction of trade increase the extent of the market and therefore surplus produce can be exported to different markets of the world and industries can be encouraged to further increase their production. (9) Emergencies: During the days of emergencies and natural calamities, shortages of food and other necessities may occur. This situation can be tackled by importing required commodities fro other countries. (10) Social and cultural value: Trade not only encourages economic development in a country but it also provides an opportunity to establish a universal brotherhood through the interaction of the people of trading countries. This opportunity of mixing up of people of different countries and races promotes international culture and civilization and therefore guarantees peace.


Complete notes on International Trade

Although there are many advantages of international trade yet there are certain disadvantages as well. Some major disadvantages are discussed as under (1) Economic dependence (2) Imported inflation (3) Cultural Problems (4) Loss in case of political differences (5) Problems of adverse balance of trade (6) Dumping (7) Problems for local industry


All the theories of International trade attempt to answer the questions that what determines international trade and why do countries gain by

Complete notes on International Trade

trading. The theory of comparative advantage or theory of comparative cost was formulated by David Ricardo thus says.

THE THEORY "If one country can produce each of two products more efficiently than another nation, then the country should specialize and export the commodity for which its comparative advantage is more and other country should specialize and export the commodity for which its comparative disadvantage is less. The two nations will then have more of both goods by engaging in trade.

Explanation: To explain this theory we make following assumptions. 1) 2) labour is the only factor of production The quality of labour is same in both the countries

Complete notes on International Trade


There is no cost of transporting goods from one country to

another 4) 5) There are no trade restrictions. There is perfect competition in factor and product markets.

Under these conditions if both the countries apply one day of labour (one worker working one day) in the production of wheat and cloth, the resulting output is as follows Country (cloth/wheat) Japan Pakistan 20 units 15 units 20 units 10 units 1/1 1.5/1 cloth wheat cost ratio

It is clear that Japan is more efficient in producing both wheat and cloth. But if we look carefully, we will find that it would be advantageous for Japan to specialize in the production of wheat and

Complete notes on International Trade

import cloth from Pakistan. This becomes clear from following analysis.

Situation Before Trade. In Japan the cost of production of both wheat and cloth is same and therefore before trade one unit of wheat will be exchange with one unit of cloth. On the other hand in Pakistan one unit of wheat will be exchanged for one and half units of cloth in Pakistan.

Situation After Trade. Now Japan can get more than one unit of cloth by giving one unit of wheat On the other hand Pakistan can get one unit of wheat by giving less than 1.5 units of cloth.

Fixing The Rate Of Exchange The rate of exchange thus be between the two limits.

Complete notes on International Trade

1 units of wheat=1 units of cloth (minimum) & 1.5 units of cloth (max)

Gains From Trade: Suppose the rate of exchange is settled at: 1 units of wheat = 1.3 units of cloth Now by specializing in the production of wheat Japan would gain 0.3 units of cloth per unit of wheat and Pakistan would gain 0.2 unit Of cloth per units of wheat imported. thus both countries gain from specialization and international trade.

CRITICISM: (1) Labour cost assumption is unrealistic. The theory assumes that there is only labour factor which produces goods and therefore the only cost of production is the wage paid to the labour, which is not realistic.

Complete notes on International Trade

(2) labour is not homogeneous. The theory assumes that all the units of labour in trading countries are equal in their productive capacities. But in real world some workers are more efficient than other due to the difference of environment or technical skill etc. (3) Labour is mobile between countries. This theory assumes that labour is internally mobile while it is perfectly immobile between countries. This assumption is also not valid due the development of modern means of transportation. (4) Cost of transportation. The theory assumes no transportation

cost. This is a quite impractical assumption, because goods cannot be transported without incurring transporting costs. (5) Tariffs and customs duties. The theory assumes that there is

no restriction on international trade. Governments do not impose any duty on imports or exports. At present the concept of free trade is idealistic. (6) Limited scope. The theory is developed on the assumption of two countries producing two commodities with one factor of

Complete notes on International Trade

production only. In real world there are many countries involved in international trade producing a variety of commodities. (7) Complete specialization. It is not possible for a country to specialize and produce only one commodity and import rest of commodities from abroad. In fact complete specialization is not possible. (8) Perfect competition. The theory is based on the assumption of perfect competition. But in actual the situation of imperfect competition prevails.

Conclusion: The theory gives a reasonable explanation for the basis of international trade and the resultant benefits. Although we have assumed that there is no transportation cost, but the theory remains valid even though the transpiration costs are to be incurred by the trading countries. The essential conditions that should exist is the country should be able to get more in exchange for its goods from he

Complete notes on International Trade

foreign countries than what it gets at home even after including the cost of transportation. Thus the theory holds goods even today provided government of the country does not impose any restriction on the movement of the goods between the countries.


Balance Of Payment And Balance Of Trade

To know about a country's external payments position, it is essential to be clear about two things, viz., balance of trade and the balance of payment.

BALANCE OF TRADE. Balance of trade refers to "Account of the money value of merchandise imports and exports during a given period of time."

Complete notes on International Trade

In it we include only visible items of export and import and leave the invisible one.

BALANCE OF PAYMENT. The Balance of payment refers to "Statement of money value of all transactions between a nation and the rest of the world during a given period of time." The balance of payment includes in it, not only the visible items of export and imports but also the invisible items such as payment for services, expenditures on foreign missions etc.

DIFFERENCE BETWEEN THE TWO: Balance of trade includes only the transactions regarding physical or visible goods. while Balance of payment show the over all external payment position of a country's international transactions of both the goods and services and other monetary transactions. To sum up the balance of trade is a part of balance of payment.

Complete notes on International Trade

MEANING OF DEFICIT IN BALANCE OF PAYMENT: When the total receipt of a country fall short of total payment it has to make to the foreign countries for the purchase and sales of goods and services and other items, the balance of payment is said to be in deficit. Persistent deficit in balance of payment of a country indicates the weak performance of an economy and therefore steps must be taken to correct the deficit in B.O.P.

CAUSES OF DEFICIT IN BALANCE OF PAYMNENT Following are the important causes of deficit in balance of payment of a country. 1: 2: 3: 4: 5: Inflation Adverse TOT Structural backwardness Early stage of development Political instability

Complete notes on International Trade

6: 7:

Population explosion Consumption oriented society

MEASURES TO CORRECT ADVERSE B.O.P. Government can resort to various measures for improvement in balance of payment position. Some suggested measures are mentioned as under. 1) 2) 3) 4) 5) 6) 7) Monetary and fiscal policies. Import substitution policy. Export promotion measures. Export of value added goods. Diversification of exports. Tariff concession to export oriented industries. Quality control measures.

11) Devaluation of currency. 12) Population control.

Complete notes on International Trade

Meaning: The rate at currency of one country is exchanged with the currency of other county is called exchange rate. In other word units of currency of a country which are required for the exchange with each unit of foreign exchange i.e. U.S $ dollar e.g. Rs. 57 = $1, is the exchange rate between US$ and Pak rupee. There are three methods or systems for determining the exchanges rate. (1) Floating exchange rate system. (2) Managed floating exchange rate system. (3) Fixed exchange rate system. In the following discussion determination of exchange rate in floating exchange rate system is discussed.


Complete notes on International Trade

When the exchange rate is freely determined by the forces of demand and supply of foreign exchange, it is called floating exchange rate. Thus, when demand/supply of foreign exchange rises or falls the exchange rate moves accordingly. To explain this system we assume that we are dealing with the exchange rate of Rs. in terms of US $ DEMAND FOR FOREIGN EXCHANGE : Basically the demand for foreign exchange depends upon the demand for imports by that country eg. Demand for import by Pakistan. If Pakistan's demand for imports is high then there will be a great demand for US $. SUPPLY OF FOREIGN EXCHANGE : On the other hand, the supply of foreign exchange or US $ will depend upon the exports of a country, for example Pakistan. Therefore if there are more exports from Pakistan, supply of the US $ in Pakistan will go up. EQUILIBRIUM : Thus, the equilibrium between these two forces of foreign exchange will determine the exchange rate under the floating

Complete notes on International Trade

exchange rate system. This is shown in two hypothetical diagrams below : On the vertical axis we measure the units of Rs. per unit of US $ and on the horizontal axis we measure the quantity demanded and supplied of foreign exchange i.e. US $. The curves, i.e. DD represents the demand for U.S.$ due demand for imports from Pakistan. and the SS curve represents the supply of US $ which depends upon the exports of Pakistan. At equilibrium point E the exchange rate is determined at Rs. 57 for US $ 1, and the equilibrium quantity is US $ 40 billion. Supposing that the DD curve shifts upward to D'D' meaning that demand for U.S. $ has gone

Complete notes on International Trade

up. Thus at point E' the new exchange rate is Rs. 75 for U.S. $ 1 and the equilibrium quantity is $ 60 billion. Since more Rs. are required per US $ this shows that the Rupee has depreciated in the international market and that the U.S. $ has appreciated in terms of Pakistan Rs.