Module-5

International trade
• International trade is the exchange of • Disadvantages of International Trade
goods and services between countries. • Dependency on Foreign Markets
• It allows countries to obtain products • Job Losses in Certain Sectors
or services they cannot efficiently • Exploitation of Developing Countries
produce themselves and sell those • Trade Imbalances
they can produce more efficiently. • Environmental Degradation
• Advantages
• Access to a Larger Market
• Specialization
• Variety of Goods and Services
• Economies of Scale
• Increased Competition
• Foreign Investment and Economic Growth
Theories of International Trade
• The theory of Absolute Advantage was introduced by Adam Smith in his seminal work
The Wealth of Nations (1776). According to this theory, a country has an absolute
advantage if it can produce a good more efficiently than another country, meaning it can
produce the good using fewer resources (like labor, capital, or time).
• Key Concepts of Absolute Advantage:
1.Efficiency: A country has an absolute advantage when it can produce a particular good
using fewer inputs than another country.
2.Specialization: Countries should focus on producing goods where they have an absolute
advantage and trade with others to obtain goods where they are less efficient.
3.Mutual Benefit: By specializing in goods where each country has an absolute advantage,
trade between countries can be mutually beneficial, allowing for more efficient resource
use globally.
• Example of Absolute Advantage: Country Wheat Cloth Produced
• Let's consider two countries, Country A and Country B, and Produced per per Day
two products: wheat and cloth. Day
• Country A can produce 100 tons of wheat per day, while Country
B can only produce 60 tons. Therefore, Country A has an absolute
advantage in wheat production.
• Country A can produce 100 tons of wheat per day, while Country
Country A 100 tons 30 meters
B can only produce 60 tons. Therefore, Country A has an absolute
advantage in wheat production.
• Without Trade:
• Country A produces 100 tons of wheat and 30 meters of
cloth. Country B 60 tons 90 meters
• Country B produces 60 tons of wheat and 90 meters of cloth.
• After Specialization and Trade:
• Country A specializes in wheat and produces 150 tons.
• Country B specializes in cloth and produces 120 meters.
Comparative Advantage Theory
(David Ricardo, 1817)
• A country has a comparative advantage in producing a good if it can
produce it at a lower opportunity cost compared to another country.
• The concept of opportunity cost is central to this theory, as it
highlights the trade-offs
• Opportunity Costs: Country Wheat Cloth
• Country A: Produced Produced
• Opportunity cost of producing 1 ton of wheat = 30/100 = per Day per Day
0.3 meters of cloth.
Country A 100 tons 30 meters
• Opportunity cost of producing 1 meter of cloth = 100/30
= 3.33 tons of wheat.
• Country B:
• Opportunity cost of producing 1 ton of wheat = 90/60 =
1.5 meters of cloth.
• Opportunity cost of producing 1 meter of cloth = 60/90 =
0.67 tons of wheat. Country B 60 tons 90 meters
• Comparative Advantage:
• Country A has a comparative advantage in wheat
production because its opportunity cost for producing
wheat (0.3 meters of cloth) is lower than Country B’s
opportunity cost for wheat (1.5 meters of cloth).
• Country B has a comparative advantage in cloth
production because its opportunity cost for producing
cloth (0.67 tons of wheat) is lower than Country A’s
opportunity cost for cloth (3.33 tons of wheat).
Heckscher-Ohlin Theorem (H-O
Theorem)
• According to this theory, a country will export goods that require abundant and cheap
factors of production, and import goods that require scarce and expensive factors.
• A country with an abundance of labor will export labor-intensive goods.
• A country with an abundance of capital will export capital-intensive goods.

1.Wheat is a land-intensive good (i.e., it requires more land relative to labor to produce).
2.Cloth is a labor-intensive good (i.e., it requires more labor relative to land to produce)
3.Country A has an abundance of land.
4.Country B has an abundance of labor.
5.Country A exports wheat to Country B in exchange for cloth.
6.Country B exports cloth to Country A in exchange for wheat
Balance of Payments
• (BoP) is an economic record that captures all financial transactions
made between a country and the rest of the world over a specific
period. It includes inflows (exports, foreign investments, and
remittances) and outflows (imports, debt repayments, and foreign
investments made by residents).
• It includes the Current Account, covering goods, services, and
remittances, and the Capital Account, which tracks investments and
loans.
Current Account
• This includes:
• Goods Trade: Exports and imports of physical products. For example, if
India exports software services and imports crude oil, the export
revenue and import expenses are recorded here.
• Services: Earnings from services like IT and tourism.
• Primary Income: Interest and dividends from foreign investments.
• Secondary Income: Transfers like remittances sent by Indian workers
abroad.
• As of October 2024, India’s current account has shown slight volatility.
The deficit widened to $9.7 billion, approximately 1.1% of GDP,
indicating increased import demand amid moderate export growth.
Capital Account
• Foreign investments, loans, and other forms of financial capital. For example, a
U.S. company investing in an Indian startup is a capital inflow recorded in this
account.
• Loans and borrowings – It includes all types of loans from both the private and
public sectors located in foreign countries.
• Investments – These are funds invested in the corporate stocks by non-residents.
• Foreign exchange reserves – Foreign exchange reserves held by the central bank of
a country to monitor and control the exchange rate does impact the capital
account.

• The deficit or surplus in the current account is managed through the finance from
the capital account and vice versa.
Balance of Payments (BoP)
Deficit
• occurs when a country's total payments to other countries exceed its
total receipts from them, leading to a net outflow of foreign
exchange. This deficit suggests that the country imports more than it
exports.
• BoP Deficit=Total Payments (Outflows)−Total Receipts (Inflows)
• If India imports goods worth $100 billion but exports only $70 billion,
it has a trade deficit of $30 billion.
 Balance of Payments (BoP) Deficit: Key Causes
1.High Import Demand
• When imports of essential goods (e.g., oil, technology) exceed exports, leading to a trade imbalance.
• Example: India’s energy imports contribute significantly to its BoP pressures.
2. Low Export Competitiveness
• Higher production costs or currency strength can make exports less attractive globally, reducing
export revenue.
• Contributing factors include high wages, lack of technology, and infrastructure constraints.
3. Foreign Debt Obligations
• Repayment of international loans and interest creates capital outflows, worsening the BoP.
• Regular debt servicing increases financial strain, particularly with high external debt.
4. Global Economic Conditions
• Economic slowdowns among major trading partners reduce demand for exports.
• Global recessions can lead to lower income from exports, affecting the current account.
5. Currency Depreciation
• Depreciation raises import costs, adding to the trade deficit.
• While it can make exports more competitive, the increased import bill often outweighs gains.
 Measures to Correct BoP
Disequilibrium
1. Promote Exports
• Incentives for export industries (tax breaks, subsidies)
• Diversification to stabilize export income
2. Reduce Imports
• Support local production as an import substitute
• Tariffs and quotas on non-essential imports
3. Adjust Exchange Rate ( depression next slide)
• Depreciation to make exports cheaper, imports costlier
• Floating rates to align currency with trade balance
• Fiscal & Monetary Policies
• Curb excess demand (reduce spending, increase interest rates)
• Attract foreign investment
4. Trade Agreements
• Enter bilateral and multilateral trade deals to boost exports
Depreciation
• A decline in the value of a country’s currency relative to other currencies, making
imports more expensive and exports cheaper in international markets.
• Example:
If the Indian rupee (INR) depreciates from 80 INR/USD to 85 INR/USD:
• Impact on Imports: Imported goods become costlier, as more rupees are needed
to buy the same value in dollars.
• Impact on Exports: Indian products become cheaper abroad, increasing demand
for exports.
• Effects of Depreciation:
• Boosts Exports: Helps domestic industries by making goods more competitive
internationally.
• Increases Import Costs: Leads to higher prices for essential imports, potentially
raising inflation.
Devaluation
• a deliberate downward adjustment of a country’s currency value by
its government or central bank.
• Devaluation is a policy decision aimed at making exports cheaper and
imports more expensive.
• Benefits: Devaluation can make exports more competitive globally
and stimulate economic growth by increasing demand for
domestically produced goods.
• Downsides: It can lead to inflation, as the cost of imported goods
rises, impacting domestic consumers and businesses dependent on
foreign inputs.
 Free Trade
• is an economic policy where countries allow the unrestricted import and export of goods
and services without imposing tariffs, quotas, or other trade barriers.
• Advantages of Free Trade
1. Economic Growth
• Increases GDP by allowing specialization and efficiency.
• Countries grow faster with open trade policies.
2. Lower Consumer Prices
• Reduced tariffs and barriers lower import costs.
• Consumers have more purchasing power and choices.
3. Boosts Innovation
• Competition drives innovation and quality improvement.
• Encourages development of new technology and practices.
4. Job Creation
• Opens global markets, creating export-driven job opportunities.
• Jobs in competitive sectors often offer higher wages.
 Protectionism
• Policies that restrict imports to protect domestic industries from foreign competition.
• Tariffs, quotas, subsidies for local businesses.
• Advantages:
1. Protects Domestic Industries
• Shields emerging industries from foreign competition, allowing them to grow and become
globally competitive.
2. Preserves Jobs
• Supports local employment by reducing reliance on imports, especially in manufacturing and
vulnerable sectors.
3. National Security
• Ensures critical industries, like defense and technology, are maintained domestically, reducing
dependence on foreign suppliers.
4. Reduces Trade Deficits
• Limits imports, helping lower the trade deficit and improve the balance of payments.
5. Encourages Local Investment
• Attracts investment into domestic industries, with incentives for local expansion and growth.
Tariff and Non-Tariff Barriers
• Tariffs are taxes on imported goods. When a country places a tariff on
an imported item, it makes that item more expensive, which can
encourage people to buy locally made products instead.
• Example: If India puts a tariff on imported smartphones, the price of
those phones goes up, making Indian-made smartphones more
appealing to buyers.
• Non-tariff barriers are other restrictions that don’t involve taxes but still
make it harder to import goods.
• These include things like limits on the quantity of imports (quotas),
special quality standards, or licensing requirements.
• Example: India might set strict quality standards for imported food,
making it harder for foreign companies to meet the rules and sell in
India.
God Bless you