ECU_07202 LECTURE 6.ppt gghhjiuilkjknnuhu

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1. Topic Six: International Trade
1.Introduction
2.Basis of international trade
3.Theories of international trade
–Absolute advantage theory of international trade
–Comparative advantage theory of international
trade
4. Terms of Trade
5. Balance of Payment
6. Advantages of international trade
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2. Introduction
•The study of international economics is divided into two
branches:
(i)The study of international trade
(ii)The study of international finance
•International trade focuses on the real transactions in
the international economy, that is, on those transactions
that involve a physical movement of goods or a tangible
economic resources.
•International trade involves bilateral and multilateral
trade between and among countries.
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3. Introduction
•International finance focuses on the monetary side of
the international economy, that is, on financial
transactions.
•In fact the word trade implies the exchange of goods
and services; thus international trade therefore,
means exchange of goods and services that take
place across the country’s boundaries.
•International trade involves import (buying of goods
and services from foreign economy) and export
(selling of goods and services to another country).
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4. Basis of international trade
•Why nations trade?
1. Resources endowment which are needed to fulfill production (La, L and K).
Nations of the world differ in their resources endowments.
For instance, while some countries are better endowed with larger mineral
deposits, some are rich in oil and gas, some have larger human resources, others are
rich in fertile soil while some enjoy good and favorable climatic conditions, others are
well equipped with technology etc. This uneven distribution of resources is the basis of
international trade.
2. Gains/benefits from international trade
Nations gain from international trade as they specialize in the production of goods and
services which benefit them.
The evidence of gains from international trade was provided by Adam smith under the
Theory of Absolute advantage which was later improved by David Ricardo to form the
Theory of Comparative advantage.
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5. Basis of international trade
3. Reduce dependence on your local market
Your home market may be struggling due to economic
pressures, but if you go global, you will have immediate
access to a practically unlimited range of customers in
areas where there is more money available to spend.
4. Increases chances of success
Unless you’ve got your pricing wrong, the higher the volume of
products you sell, the more profit you make, and overseas
trade is an obvious way to increase sales.
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6. Basis of international trade
5. Increase efficiency
Benefit from the economies of scale that the export of your
goods can bring – go global and profitably use up any
excess capacity in your business, smoothing the load and
avoiding the seasonal peaks and troughs that are the bane
of the production manager’s life.
6. Increase productivity
Statistics from Chamber of Commerce state that companies
involved in overseas trade can improve their productivity by
20% – imagine that, over a third more with no increase in
plant.
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7. Basis of international trade
7. Economic advantage
Take advantage of currency fluctuations – export
when the value of the Tanzania shilling is low
against other currencies, and reap the very real
benefits.
8. Innovation
Because you are exporting to a wider range of
customers, you will also gain a wider range of
feedback about your products, and this can lead to
real benefits.
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8. Theories of International Trade
•The theory of absolute advantage was established by Adam
Smith.
•Actually, it may be possible for all countries to produce all the
commodities they need in-spite of their resource constraint.
•However, the cost of producing commodities for which a country
is deficient in its resource endowments would be high.
•It would be advantageous for a country to specialize in the
production of commodities which it can produce most efficiently.
•According to Adam Smith, countries should specialize in
the production of commodities in which they have absolute
advantage in the cost of production.
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9. Absolute advantage theory of international trade cont…
•Absolute advantage by using labor theory of value.
quintal = 100 kg
Per quintal labor cost (man hour)
Country Rice Maize
A 30 man hrs60 man hrs
B 50 man hrs20 man hrs
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10. Absolute advantage theory of international trade cont…
•According to the table, country A uses 30 man hrs in the
production of rice and 60 man hrs in the production of maize.
•Country B uses 50 man hrs in the production of rice and 20
man hrs in the production of maize.
•Thus, country A is more efficient in the production of rice as
compared to maize while country B is more efficient in the
production of maize as compared to rice.
•Accordingly, country A has absolute advantage in the
production of rice while country B has absolute advantage in
the production of maize.
•Country A will specialize in the production of rice and country
B will specialize in the production of maize, and through
exchange trade will take place.
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11. Comparative advantage theory of international trade
•It may be recalled from the theory of absolute advantage that
trade between two countries can be possible only if both the
countries have absolute advantage in the production of at least
one commodity and absolute disadvantage in another.
•That is, if a country has an absolute advantage in in the
production of all the commodities and the other country has
absolute disadvantage in the production of all the commodities,
there is no ground for trade between them.
•David Ricardo accepted the theory of Adam Smith (absolute
advantage) and extended the argument to the cases in which
one country is more efficient in producing both the commodities.
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12. Comparative advantage theory of international trade
•According to Ricardo, although one country can
possess absolute advantage in the production of all
the commodities and the other country has absolute
disadvantage in the production of all the
commodities trade can still be gainful.
•Furthermore, Ricardo argued that comparative
cost relates to the opportunity costs of producing
the commodities and not the absolute costs.
•What is opportunity cost? Consider maize and Rice
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13. Comparative advantage theory of international trade cont…
•The country should specialize in the production of commodities in
which it has a comparative advantage.
Assumptions which guide the theory of comparative advantage
(i)Ricardo assumed that labor is the only factor of production
(ii)Labor is homogeneous
(iii)Labor supply is constant
(iv)Trade between the two trading countries is free (no barriers)
(v)There is no transportation cost
Per quintal labor cost (man hour)
Country Rice Maize
A 8 man hrs9 man hrs
B 12 man hrs10 man hrs
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14. Comparative advantage theory of international trade
The opportunity cost of rice and maize
Country A should specialize in Rice
Country B should specialize in Maize
CountryRice Maize
A 8/9 (0.89) units
of maize
9/8 (1.125)
units of rice
B 12/10 (1.2) units
of maize
10/12 (0.83)
units of rice
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15. Comparative advantage theory of international trade
•To produce 1 unit of rice in country A it requires 8 man hrs
and 9 man hrs to produce maize in the same country. Thus
its more expensive to produce maize than rice in country A.
•In country A, the opportunity cost of producing 1 unit of rice =
8/9 units of maize and 1 unit of maize = 9/8 units of rice.
•In country B, 1 unit of rice = 12/10 of maize and 1 unit of
maize = 10/12 units of rice.
•Thus it is cheaper to produce maize in country B (0.83 units
of rice) than producing it in country A. The opportunity costs
of producing maize are therefore lower in country B than in
country A.
•It is cheaper to produce rice in country A (0.89 units of
maize) than in country B. The opportunity costs of producing
rice are therefore lower in country A than in country B.
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16. Terms of trade
•The terms of trade is defined as the quantity of domestic goods
that must be given in exchange for 1 unit of imported goods.
•Terms of trade = (Xp/Mp)*100% where as Xp and Mp stand for
export prices and import prices respectively.
•If Xp > Mp, then terms of trade > 100% implying favorable terms
of trade
•If Xp < Mp, then terms of trade < 100% implying unfavorable
terms of trade
•And when Xp = Mp, terms of trade = 100%
•Terms of trade of developing countries are unfavorable in most
cases. The main reason is that developing countries export raw
materials with low prices as compared to the prices of imported
finished products. (Marshall-Lerner condition)

17. Terms of trade
•Factors Affecting Terms of Trade
•TOT is dependent to some extent on exchange
rate, inflation rates and prices. A variety of other
factors influence the TOT as well, and some are
unique to specific sectors and industries.
•The size and quality of goods
 also affect TOT.
Larger and higher-quality goods will likely cost
more. If goods sell for a higher price,
 a seller will
have additional capital to purchase more goods.
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18. Balance of Payment
•Balance Of Payment (BOP) is a statement which
records all the monetary transactions made
between residents of a country and the rest of the
world
 during any given period.
•BOP statement of a country indicates whether the
country has a surplus or a deficit of funds i.e when
a country’s export is more than its import, its BOP is
said to be in surplus. On the other hand, BOP
deficit indicates that a country’s imports are more
than its exports.
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19. Balance of Payment
•There are three components of balance of
payment , that is, current account, capital account,
and financial account.
1. Current Account – goods and services
2. Capital Account- capital transactions, land and
properties (non-financial)
3. Financial Account- This account measures the
changes in the foreign ownership of domestic
assets and domestic ownership of foreign assets
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20. Advantages of International Trade
1.Increased Revenue: One of the top
advantages of international trade is that you
may be able to increase your number of
potential clients. Each country you add to
your list can open up a new pathway to
business growth and increased revenues.
2.Decrease Competition: Your product and
services may have to compete in a crowded
market in the TZ, but you may find that you
have less competition in other countries.
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21. Advantages of International Trade
3. Longer product lifespan: Sales can dip for
certain products domestically as Tanzanians
stop buying them
 or move to upgraded
versions over time.
 
4. Easier cash flow management: When trading
internationally, it may be a general practice to
ask for payment upfront, whereas
 at home
you may have to be more creative in
managing cash flow while waiting to be paid
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22. Advantages of International Trade
5. Better risk management: One of the significant
advantages of international trade is market
diversification.
 Focusing only on the domestic
market may expose you to increased risk from
downturns in the economy.
6. Benefiting from currency exchange: Those who
add international trade to their portfolio may also
benefit from currency fluctuations. For example,
when the TZS is down, you may be able to
export more.
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23. Advantages of International Trade
7. Disposal of surplus goods: One of the
advantages of international trade is that you
may have an outlet to dispose of surplus
goods that you're unable to sell in your home
market.
8. Opportunity to specialize: International
markets can open up avenues for a new line
of service or products. It can also give you an
opportunity to specialize in a different area to
serve that market.
 
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24. Thank You
For
Lis
tening!!!!
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