LAST MINUTE REVISION G UIDE

Unit 6

Bala kumar.R.J
 Unit 6

INTERNATIONAL SPECIALISATION

MEANING A process of a country concentrating on producing those goods

and services in which they have an advantage
BENEFITS  Efficiency in production
 Absolute advantage( where one country is able to produce
 more and with low cost than other)
 Comparative advantage ( where one country is able to produce
 at lower opportunity cost than another)
 Increased output
 Superior factor endowments
 Consumers all over the world benefit
 Increasing their standard of living
 Increase market size and economies of scale
 Build up reputation
DISADVANTAGES  May be at risk if a substitute is available near by
 May be at risk if the raw materials are imported
May be at risk if the exchange rate changes
Decline in demand for other type of goods and services
CURRENT ACCOUNT OF BALANCE OF PAYMENT

Structure of current account

 Visible trade: - Records trade in goods such as oil, steel etc. It is calculated by subtracting
visible imports from visible exports. If exports of goods are greater than imports, visible trade
is in surplus. If imports of goods are greater than exports, visible trade is in deficit. This is
sometimes called trade balance. Invisible trade: - Records trade in services such as
 tourism, healthcare etc. It is calculated by subtracting invisible imports from invisible exports.
If exports of services are greater than imports, invisible trade is in surplus. If imports of
services are greater than exports, invisible trade is in deficit. Income flows: - Inflows and
outflows of income from employment and investments are
recorded. Examples could include wages, salaries, bonus, rent, profits, dividends, interest etc.

Current transfer flows: - records the value of aids, donations received from other countries
and sent to other countries.

An inflow in the balance of payment is sometimes referred as a credit item
An outflow in the balance of payment is sometimes referred as a debit item

CURRENT ACCOUNT DEFICIT

 Occurs when the combined value of the four sections(goods, services, incomes, aids) of the
debit(outflow of money) side is greater than the combined value of the four sections of the
credit(inflows of money) side in the current account. A current account deficit may occur
 without a deficit in all the four sections

CAUSES OF CURRENT ACCOUNT DEFICIT

 Lack of factor endowments

 Economic growth in the country
 Lower growth in other countries
 A higher exchange rate

CONSEQUENCES OF CURRENT ACCOUNT DEFICIT

 Spending beyond their means

 Imported inflation
 Lower output
 Lower employment and income
 Lower pressure on exchange rate
HOW TO OVERCOME CURRENT ACCOUNT DEFCIT

 To reduce imports, use trade barriers

 Subsidies to encourage domestic production
 Lowering the exchange rate to make exports cheaper and imports expensive
 Encouraging MNC’s and foreign investment
 SEZ ( Special Economic Zone)

CURRENT ACCOUNT SURPLUS

 Occurs when the combined value of the four sections(goods, services, incomes, aids) of the
credit(inflow of money) side is greater than the combined value of the four sections of the
debit(outflows of money) side in the current account. A current account surplus may occur
 without a surplus in all the four sections

CAUSES OF CURRENT ACCOUNT SURPLUS

 Better factor endowments

 Lower Economic growth in the country
 Higher growth in other countries
 A lower exchange rate

CONSEQUENCES OF CURRENT ACCOUNT SURPLUS

 Foreign currencies
 Higher output
 Higher employment and income
 A higher pressure on exchange rate
 Lower debt
 Possible inflation
EXCHANGE RATE

The rate of one currency expressed in terms of another currency

TYPES OF EXCHANGE RATE

TYPES ADVANTAGES DISADVANTAGES

FIXED  Certain  Government
 A type of exchange rate where  Improve investors’ reserve is used to
against the
otherrate
currencies by
is fixed  confidence maintain it
the government or central  Increase trade and  Reserve cannot be
bank. investment used for other
Government maintains the No speculative purpose
 fixed exchange rate using its movement in  If the rate is fixed at
exchange rate a higher rate, then
foreign exchange reserve Speculation is the BOP could be
and interest rates. unfavorable
 If the value is falling, they act of trading
step in to buy more foreign currency in
currency. And if the value is the foreign
rising, they step in to sell exchange market
more currency. in order to make
 Interest are raised to profit. The people
encourage more saving if who do this task is
the value is falling
and the speculator
lowered when the exchange
rate is rising.
FLOATING  Market
determined  Instability
 A type of exchange rate rates are the best  Reduce confidence
where the rate is determined rates for buyers and  Reduce trade and
by the market forces of sellers  investment
demand and supply of the  of
No need Lots of speculative
currency. government foreign movement in
 Changes in demand and currency reserve to exchange rate
supply brings changes in maintain
exchange arte  So government can
focus other areas

MANAGED FLOATING An exchange rate type where market forces and

government play a certain role in determining and
maintaining.
CAUSES OF EXCHANGE RATE FLUCTUATIONS

TYPES OF FLUCTUATIONS

APPRECIATION Increasing the value of the DEPRECIATION

currency against other currencies due to the Falling the value of the currency against
changes in the other currencies due to the changes in the
market forces of demand and supply in market forces of demand and supply in
floating exchange rate floating exchange rate

REVALUATION DEVALUATION
Government raising the value of the currency Government lowering the value of the currency in
in fixed exchange rate fixed exchange rate

CAUSES OF EXCHANGE RATE FLUCTUATIONS

 Demand for the currency

 Supply of the currency
 Inflation Interest rate
 Level of exports Level of
 imports State of the
 economy Speculations
 Business activity
 Economic growth



CONSEQUENCES OF EXCHANGE RATE FLUCTUATIONS

APPRECIATION DEPRECIATION

 Exports expensive  Exports cheaper

 Exports revenue falls if demand for  Exports revenue rises if demand for
exports is elastic. ( may not fall if exports is elastic. ( may not fall if demand
demand for exports are inelastic) for exports are inelastic)
 Imports cheaper  Imports expensive
 Imports expenditures rise  Imports expenditures fall if demand for
 When imports are greater than exports is elastic. ( may not fall if demand
exports, BOP unfavorable(deficit) for imports are inelastic)
  When exports are greater than imports,
Lower output and employment
 BOP favorable(surplus)
 Higher output and employment

TRADE

Trade between countries is known as international trade. Trade between countries without any trade
restrictions are known as free trade
FREE TRADE

ARGUMENTS FOR /REASONS ARGUMENTS AGAINST

 Increased production  Infant Industry Argument.
 Encourage specialization  Harmful goods
 Competition  Dumping
 Innovation  Balance of payment deficit
 Prestige  Culture damages
 Friendship
 Benefits to consumers
 Foreign exchange gains
 Employment
 Economic growth

TARDE PROTECTION/ TRADE BARRIERS

Restriction placed on imports in order to encourage domestic production

TYPES OF TRADE PROTECTION

 Tariffs: - Tax on imports. Tariffs make imported goods more expensive to buy, because the
cost is passed on to consumers. Higher prices reduce demand for the imported goods and
help a nation’s own industries compete. Tariffs also increase government revenue, which can
help reduce a nation’s budget deficit. Quota: - A physical limitation on imports. Subsidies:- A
 financial help from government to domestic firms Exchange control:- Restriction of foreign
 currency for the importers Embargoes:- Complete ban on imports Standards:- are rules
 about the quality of imported



ARGUMENTS FOR AND AGAINST TRADE PROTECTION

ARGUMENTS FOR ARGUMENTS AGAINST

 Revenue for the government  Limit choice
 Avoid dumping  High price of imports
 Reduce harmful goods  Retaliation
 Encourage domestic infant industries
 Favorable BOP
TRADE BLOCS

TYPES DESCRIPTION EXAMPLES

1 Free trade area • Member countries have free trade NAFTA (North American
Individual tariff when trading with non- Free Trade Agreement)
• member country

Member countries have free trade

2 Custom union • Gulf Cooperation
Council (GCC)
• Common external tariff when trading
with non-member country
All features of custom union
3 Common market • East African Common
Free mobility of factors of production Market,
African and Common
West
•
market.

European Union
4 Economic union • All features of common market

• Common policy on trade, agriculture,

manufacturing
Common currency
•

THE END