Economics 11B

Section 6: International Trade

Topic: International Trade
International trade - is the exchange of goods and services across international boundaries or
territories.
The rationale for international trade - As individuals in a modern economy, we do not produce
all that we consume. We are each endowed with different talents and abilities. Each of us (adults)
specialise in a given occupation, trade this factor service for money, and then use this money to
purchase other goods and services. Such specialisation leads to increased output for all.
Countries, as with people, are also endowed with different resources. It makes sense for each
country to specialise in a product or products that it is good at producing, trade this, and purchase
what it cannot produce. As will be seen later in this chapter, such specialisation leads to increased
output.
Topic: Terms used in International Trade
 Balance of trade - The difference between the value of a country's exports and imports of
goods over a specific period.
 Current account - Part of a country's balance of payments that records its trade in goods
and services, income receipts, and unilateral transfers (gifts, grants, etc.) with other
countries.
 Capital account - The segment of a country's balance of payments that tracks capital
transfers and the acquisition or disposal of non-financial assets between residents and
non-residents.
 Net International Reserves (NIR) - The overall holdings of a country's foreign currency
assets (e.g., foreign exchange, gold) minus its foreign currency liabilities (e.g., foreign-
denominated debts).
 Balance of payments - A systematic record of all economic transactions (trade in goods,
services, and financial assets) between residents of one country and the rest of the world
over a given period.
 Balance of payments disequilibria - Refers to situations where a country's balance of
payments is not in equilibrium, indicating deficits or surpluses in the current account or
capital account.
 Tariff - A tax imposed by a government on imported goods, adding to their cost and
making domestically produced goods more competitive
 Common external Tariff (CET.) - A uniform tariff rate is applied by a group of countries
that form a customs union on imports from non-member countries.
  Quota (non-tariff barriers) - A restriction is imposed on the quantity or value of certain
goods that can be imported or exported during a specific period.
 Exchange rate The rate at which one currency can be exchanged for another determines
the value of international transactions.
 Exchange rate regimes The systems that governments use to manage their currency's
value in relation to other currencies, such as fixed exchange rates, floating exchange
rates, or pegged exchange rates.
 World Trade Organisation (WTO.) An international organisation that deals with the
global rules of trade between nations, aiming to promote free trade, resolve trade
disputes, and facilitate international commerce.
Topic: The Theory of Absolute and Comparative advantage
Absolute advantage - A country has an absolute advantage if it produces more goods and services
compared with other countries with the same quantity of resources.
Comparative advantage - A country should specialise in the production of the good in which it
has the least opportunity cost or the most significant advantage.
Topic: Gains from Trade
 Firms can earn valuable foreign exchange.
 Creates increased employment.
 Increased efficiency of firms.
 Consumers get access to a greater variety of goods.
 Being able to buy better goods cheaper than those produced domestically.
Topic: Factors that influence International Trade
 Import factors
- Domestic income levels
- The exchange rate
- Domestic product prices versus foreign product prices
- Quality of domestic goods
 Export factors
- Foreign income level
- The exchange rate
- Quality of imported goods
- Changing tastes of consumers in the rest of the world
Topic: Terms of Trade
Terms of Trade - This is the ratio of export prices to import prices.
Export price index
Terms of Trade (TOT )= × 100
Import price index

Topic: Balance of Trade & Balance of Payments

Balance of trade - is simply the difference between the values of exports and imports visible.
Balance of Payments - A systematic record of all economic transactions (trade in goods, services,
and financial assets) between residents of one country and the rest of the world over a given
period.
Components/ sub-sections of the Balance of payments:
1. Current account
2. Capital account
3. Official financial account
Format of the Balance of Payments
Topic: Balance of Payments Deficits
Causes of the balance of payments deficits:
 Increasing demand for imported goods
 Falling demand for locally produced goods and services by foreigners
 Investment incomes paid out to foreigners are greater than investment income coming
into the country
 Individual and Government transfers out of the country are greater than those coming in.
Consequences of a deficit:
 Increase in unemployment
 Falling foreign exchange reserves
 Exchange rate depreciation
Measures to reduce a deficit:
 Deflationary monetary policy
 Deflationary fiscal policy
 A fall in the value of the currency
Topic: Balance of Payments Surplus
A balance of payments surplus occurs when a country’s total exports are higher than its import.
Causes of the balance of payments surpluses:
 Falling demand for imported goods and services.
 Increasing demand foreigners for locally produced goods and services
 A decline in holidays taken abroad
 An increase in foreign visitors to the country.
Consequences of a surplus:
 Falling unemployment
 Increase in reserves
 Exchange rate appreciation
 Inflationary pressures
Measures to reduce a surplus:
 Reflationary monetary policy
 Reflationary fiscal policy
 Revaluation of the currency
Topic: Exchange Rate Systems
Exchange rate regime - This refers to how a country's exchange rate is determined.
Factors influencing the level of exchange rate:
 Changing taste
 Interest rate changes
 Domestic prices compared to foreign prices
 Speculation
 Domestic income levels
Exchange rate regimes are the framework or system that a country's central bank or monetary
authorities use to determine the value of its currency relative to other currencies in the foreign
exchange market.
Types of exchange rate regime:
 Fixed exchange - When the government sets the exchange rate, the rate is said to be
‘fixed’. The government, through the central bank, announces a value for the exchange
rate. When the rate is fixed, the government can choose to change the rate at any time. If
the government makes a downward adjustment of the exchange rate, this is a
devaluation of the exchange rate. This means that the domestic currency has become
cheaper on the foreign exchange market. If the government makes an upward
adjustment of the exchange rate, this is a revaluation of the exchange rate. This
means that the domestic currency has now become more expensive on the foreign
exchange market.
 Floating/flexible exchange - Under the floating exchange rate system, the forces of
demand and supply operate to determine the value of the currency. There is no
interference by the government. This exchange rate regime is more often called a freely
floating exchange rate system. A depreciation of a currency is a fall in the external
value of that currency due to changes in the forces of demand and/or supply. An
appreciation of a currency is a rise in the external value of that currency due to
changes in the forces of demand and/or supply.
 Managed exchange - When the currency is floating, it can fluctuate considerably from
day to day. It can gain value or lose value rapidly over a short period. These fluctuations
can cause residents to lose confidence in the currency. They can also hinder international
trade, as a currency can change value between the time at which a trader buys imports
and the time at which he actually pays for his purchase. In many countries, the currency
is allowed to float. However, a government, through its central bank, can intervene in the
foreign exchange market to maintain the rate at a certain value or within a range of values
(for example, TT$6.25 < US$1.00 < TT$6.35). This is a managed exchange rate regime
(or managed float).