Module 3 International Economics – International Trade

 

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International Trade Assessment:-

 

Trade

  • Buying and selling goods and services from other countries
  • The purchase of goods and services from abroad that leads to an outflow of currency from the COUNTRY – Imports (M)
  • The sale of goods and services to buyers from other countries leading to an inflow of currency to the COUNTRY – Exports (X)

 

The Flow of Currencies:

 

Specialisation and Trade

Different factor endowments mean some countries can produce goods and services more efficiently than others – specialisation is therefore possible:

Absolute Advantage:

  • Where one country can produce goods with fewer resources than another

Comparative Advantage:

  • Where one country can produce goods at a lower opportunity cost – it sacrifices less resources in production

 

Balance of Payments

  • When countries trade there are financial transactions among businesses or consumers of different nations
  • Money constantly flows into and out of a country
  • The system of accounts that records a nation’s international financial transactions is called its balance of payments (BP)
  • It records all financial transactions between a country’s firms, and residents, and the rest of the world usually over a year
  • The BP is maintained on a double-entry bookkeeping system

 

 

The BP is the difference between receipts and payments

 

 

The BP includes three accounts:

 

Balance of Payments and Exchange Rate

  • If a country’s expenditures consistently exceed its income, its standard of living falls
  • Its exchange rate vis-à-vis foreign monies declines
  • When foreign currencies can be traded for more dollars, U.S. products are less expensive for foreign customers and exports increase
  • Simultaneously foreign products are more expensive for U.S. buyers and the demand for imported goods is reduced

 

Balance of Trade

  • Difference in value between its Exports and Imports
  • Export is the sale of goods and services to foreign markets
  • Import is the purchase of goods and services from foreign sources
  • Difference in value between its Exports and Imports

 

Favorable Balance of Trade :

  • When Exports are more than Imports

Negative Balance of Trade or Trade Deficit :

  • When Imports are more than Exports

Trade deficits may contribute to

  • failure of business ,
  • loss of jobs ,
  • lower standard of living and other economic and social problems

 

Exchange Rates

Floating Exchange Rates:

  • Price determined only by demand and supply of the currency – no government intervention – India

Fixed Exchange Rates:

  • The value of a currency fixed in relation to an anchor currency – not allowed to fluctuate – UAE

Dirty Floating or Managed Exchange Rate:

  • Rate influenced by government via central bank around a preferred rate – China

 

Foreign Exchange Markets

Foreign exchange: all forms of internationally-traded monies including currency, bank deposits, checks, and electronic transfers.

Foreign exchange market: the global marketplace for buying and selling national currencies

Exchange rates fluctuate constantly.  E.g., yen-dollar

exchange rate:

  • 1985 – 240 yen to the U.S. dollar.
  • 2017 – 114 yen to the dollar (nearly 40% appreciation).

 

How Exchange Rates are Determined

In a free market, the “price” of any currency (rate of exchange) is determined by supply and demand:

  • The greater the supply of a currency, the lower its price
  • The lower the supply of a currency, the higher its price
  • The greater the demand for a currency, the higher its price
  • The lower the demand for a currency, the lower its price

 

Appreciation and Depreciation: Example

Euro appreciation: If the euro-dollar exchange rate goes from one euro = $1.25 to one euro = $1.50, the euro becomes expensive to Americans

Euro depreciation:  If the euro-dollar exchange rate goes from one euro = $1.25 to one euro = $1.00, the euro then becomes cheaper to Americas

 

Foreign Exchange Rate

Ratio of the currency of one nation to the currency of another nation

When the value of the currency depreciates

  • exports are profitable and imports cost more
  • China keeps its currency intentionally depreciated as it Exports more than it imports !!!

When the value of the currency appreciates

  • exports become less profitable and imports cost less
  • Decrease in Japanese exports to U.S.; Increase in U.S. exports to Japan

 

Example – Currency Depreciation- good for exports

Suppose $1= 114 Yen Which means Yen is a weaker currency. Now when Japan exports , it will receive 114 yen  x for 1 $. Suppose the currency depreciated further;

Now $1 = 120 yen

So now it will receive 120 yen  for 1$ which is profitable

 

Example – Currency Appreciation – good for imports

Suppose $1= 100 Yen which means the currency has appreciated Now when Japan imports , it will  spend only 100 yen for 1 $. Suppose the currency appreciated further;

Now $1 = 95 yen

So now Japan will spend 95 yen for 1$ when importing which is profitable.

 

Exchange Rates

Determinants of Exchange Rates:

  • Exchange rates are determined by the demand for and the supply of currencies on the foreign exchange market

The demand and supply of currencies is in turn determined by:

  • Relative interest rates
  • The demand for imports (D£)
  • The demand for exports (S£)
  • Investment opportunities
  • Speculative sentiments
  • Global trading patterns
  • Changes in relative inflation rates

 

Exchange Rates