Home ADVANCED LEVEL TOPIC 16: INTERNATIONAL TRADE ~ ECONOMICS FORM 6

TOPIC 16: INTERNATIONAL TRADE ~ ECONOMICS FORM 6

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TOPIC 16: INTERNATIONAL TRADE ~ ECONOMICS FORM 6

TOPIC 16: INTERNATIONAL TRADE ~ ECONOMICS FORM 6

INTERNATIONAL TRADE

– Is the trade taking place between two or more countries.

Bilateral trade – Is the trade taking place between two countries
Multilateral trade : Is the trade taking place between more than two countries.
Domestic trade: Is trade involving exchange of commodities within the country.

Qn:- What is the difference between International and domestic trade?

The following are the differences:-

Domestic trade few document while international require many.
Domestic trade requires use of domestic currency while International requires use of other currency.
Domestic trade does not require use of very standardized goods while International trades require standardized goods with quality.
There are few barriers to domestic trade while there are many to International trade.
There is free movement of production factors i.e. capital and labor in domestic trade. There are restrictions to mobility of factors of production in International trade.

Reasons for International trade “It must for International’ trade” Discuss:-

Different countries are endowed with different natural resources not found in other countries.
There is a different in human skills among the countries, talents and creativity leads to production of different commodity which has to be exchanged.
There is an even distribution of capital and technology. Countries with high capital and high level of technology will produce and export.
The benefits from trade in terms of revenue, profits and International relation.

Importance of International trade:-

It increases competition and quality of goods.
In enables countries to dispose surplus
It brings foreign exchange.
In increase International relations
It leads to specialization in production
It leads to mobility of factors of production especially labor and capital.
It leads to expansion of market
It helps to improve the balance of payment
It increases consumer sovereignty

DISADVANTAGES OF INTERNATIONAL TRADE

It affects the growth of infant industry
It leads to importation of harmful products
It leads to over reliance on imported commodities
It leads to over reliance on imported commodities
Importation can lead to inflation i.e. Imported Inflation
It leads to capital freight in case of foreign investment
It leads to repatriation of profit.
It can lead to political black mail where countries are forced to adopt policies due to over dependency.

Qn.:- 1. International trade is must, Discuss

Discuss the problem faced by developing countries in international trade.

Barriers for International trade:-

Barriers are limitation or difficulties which limit smooth flow of commodities in International trade. They can either be natural or artificial (man mode).

NATURAL BARRIERS

(i) GEOGRAPHICAL BARRIERS

Long distance implies high cost of transport affecting the smooth flow of commodities.

1/ Social and cultural difference

2/ Changes in the weather condition (world climatic pattern)

3/ War uprising

4/ Ignorance of goods and services available elsewhere

2. ARTIFICIAL (MAN MADE) BARRIERS

Tariffs (custom duty); It’s a tax which government imposes on goods entering the country. It is aimed at controlling imports by making them expensive. It can either be specific or adventurer.

Exchange controls; Businessmen exchange commodities using the currency of the exporting country. The government hence restrict trade by controlling the amount of foreign currency to be used.
Uses of subsidies; the government can give subsidy to exporters to increase export and reduce import.
Use of Quota; is a situation where the government fixed a certain amount of goods to be imported though licensing.
Total ban (embargoes); is situation where government restricts completely the importation of a given commodity.
Custom Draw backs
Administrative restriction; is a situation where the government refuses to disclose important information about a product to foreigners so as to protect local industry from competition.

Reasons for restricting import:-

To correct the balance of payment disequilibrium i.e. tariffs are used to correct BOP deficit by making import expensive.
To protect infant industries which cannot withstand competition?
To promote employment of resources.
To reduce dumping of inferior goods.
To protect declining of industries
To promote key/major industries particularly Agriculture and Tourism
To diversify the economy

Qn: Discuss the argument against protectionism:-

The following are the argument against protectionism:-

It reduce customer sovereignty
It discourages competition
It leads to low quality of goods.
Import tariffs (custom duty) can lead to inflation as result of high price in import.
It lowers the volume of trades
It may lead to unemployment resulting from lack of market.
It is against the theory of comparative advantage and absolute advantage.

THEORIES OF TRADE

There are two theories of trade namely:-

1. Theory of absolute advantage

2. Theory of comparative advantage.

THEORY OF ABSOLUTE ADVANTAGE

This theory was advocated by Adam Smith. It states “A country is said to have absolute advantage in the production of a commodity if it can produce that commodity more efficiently than the other country”.

The theory is based on following assumptions:-

There two countries and two commodities.
Labor is homogenous in both countries
There is no difference in technology in both countries
Mobility of factors of production is perfect
There is free trade
There is no / transport cost
There is perfect competition
The valued of commodity is determined by amount of labor units used in its production.

For example:-

Item
Uganda output per labor
Tanzania output per labor
Coffee
15 kg
2 kg
Tea
4 kg
10 kg

From the above Uganda has absolute advantage in the productive of coffee while Tanzania has absolute advantage in Tea. One unit of labor can produce 15 kg of coffee and only 4 kg of tea.

One unit of labor in Tanzania can 10 kg of tea and only 2kg of coffee. Both countries can gain in trade if each would specialize in the production in which it has absolute advantage.

If one labor in Uganda can produce 15 kg of coffee by specializing. Uganda can produce 30 kg of coffee and if Tanzania would specialize in production it can produce 20 kg.

It can be illustrated as follows:-

After specializing:-

Item
Uganda output / labor
Tanzania output per labor
Coffee
30kg
0kg
Tea
0 kg
20 kg

Output before trade & specialization:-

Item
Uganda output per labor
Tanzania output per labor
Total output
Coffee
15 kg
2 kg
17 kg
Tea
4 kg
10 kg
14 kg

Output after trade and specialization

Item
Uganda output per labor
Tanzania output per labor
Total output
Coffee
30 kg
0
30 kg
Tea
0
20 kg
20 kg

Specialization would lead to:-

An increase in output in both countries
It would lead to full utilization of resources of both countries
All countries will gain from exchange of commodities.

Qn. Given the following information:-

Production /
Fuel
Labor per units
Food
Country A
10
5
State which of the two countries has absolute
Country B
8
2
advantage in production of either / commodity

II. THEORY OF COMPARATIVE ADVANTAGES

Is a condition in which a country produces some goods or services at a lower cost in terms of opportunity cost of other good and have services which could have been produced.

It is based on comparison of production cost and it is expressed in the form of comparative ratio which gives the opportunity cost.

It state that “ If one country is less efficient in the production of both commodities and another country is more efficient in both commodities the two countries can benefit from trade by specializing in the production and export of commodity in which it has a low opportunity cost.”

For example:-

Output per labor country A
Output per labor country B
Coal
3
9
Wheat
30
40

According to the above data country B has comparative advantage in the production of both products coal and wheat this is because one unit of labor in country B produces one units of coal compared to 3 units of coal produced by one unit of labor in country A.

According to comparative advantage the two countries can trade and gain from trade as follows:-

Country A
Country B
Coal
30/3 = 10
40/4 = 4.4
Wheat
3/30 = 1/10 = 0.2
9/40 = 0.0225

Country A has comparative advantage in the production of wheat while country B has comparative advantage in the production of coal.

Example 2:

Given the following production per unit labor:-

Fuel
Food
Country A
10
5
Country B
20
2
Fuel
Food
Country A
5/10 = ½ =0.5 of food
10/5 = 2 of fuel
Country B
2/10=1/5=0.2 of food
10/2=5 of fuel

Country B has a comparative advantage in production of fuel while Country A has a comparative advantage in production of food.

Qn: Your given

Country
Cotton (Tones)
Sisal (Tons)
Tanzania
4
2
Sudan
12
4

The figure represents Input quantities per unit of output of the corresponding commodities.

Which country has absolute advantage in production of (i) sisal (ii) Cotton, give reasons.
Which country has comparative advantage in production of (i) sisal (ii) cotton, give reasons.
With reasons suggest how the two countries can specialize in production of two commodities so as to encourage between them.

Assumption of theory of comparative advantage:-

It assumes that it has no transport cost
Labor are homogenous
There is free trade
There is perfect competition
There only two countries or nations.
Factors of production are perfectly mobile.

Criticisms against the theory of cooperative advantage:-

The assumption of two countries and two commodities is unrealistic.
Labour is not homogenous
Transport cost must be involved
There are other factors of production which are important compared to labour.

Application of comparative advantage theory:-

In encourages specialization
It leads to balance of payment between the trading countries.
It encourages free trade
It provides a basis for trade (international trade).
It enables proper utilization of resources.

Terms of Trade (T.O.T):-

Is the rate at which a country goods (export) are exchanged against those of other country(import)
It is the ratio between price index of export and price index of import.

Terms of Trade is given by:

T.O.T = (PRICE INDEX OF EXPORT)/(PRICE INDEX OF IMPORT)×100

=PX/PM×100

Where;

PX is price index of export

PM is price index of import

Qn:- Suppose from 1980 – 1990 the export price index of Tanzania rose from 100 to 150 while the import price index rose from 100 to 170 .

Calculate the terms of trade.

Soln:

T.O.T (1980) = PX/ x 100 = 100 x 100/
PM 100
= 100%
T.O.T (1990) = 150 X 100 = 88.2%

In 1990 terms of trade in Tanzania worsen, in had to export of large physical quantity of goods to buy the same amount of import goods.

Qn. 2: Given the following prices of import and export, Calculate the terms of trade:-

YEAR
1
Export price Average price
Import prices Average price
1990
540
4500
1991
594
6480
1992
621
4860
1993
648
5400

Calculate price index:-

Soln:

Price index = Pn/ x 100
Po
Price index 1990 = 100 % Price index (M) 1990 = 100%
Price index (1991) = 594/ x 100 = 120% Price index (1991) = 6480/ x 100% = 144%
540 4500

Price index (1992) = 621/x 100 = 115% Price index (1992) = 4860/ x 100% = 108%
540 4500

Price index (1993) = 648/x 100 = 120% Price index (1993) = 5400/ x 100% = 120%
540 4500

Total price index:-

Year
Export
Import
1990
100
100
TOT 1990 = PX = 100 x 100 = 100%
PM 100
1991
110
144
TOT 1991 = Px = 110 x 100 = 76%
Pm 144
1992
115
108
TOT 1992 = Px = 115 x 100 = 107%
Pm 108
1993
120
120
TOT 1993 = Px = 120 x 100 = 100%
Pm 120

Different ways of measuring term of trade (T.O.T)

Net barter / commodity terms of trade

Is the ratio of price index of exports and price index of imports

T.O.T Net barter =100

Income term of trade / capacity to import.

It is the ration between the product price index for export and quantity of export to the price index of imports.

Income T.O.T = PX Qx/Pm x 100

Where, Ox is quantity of export = Vx/PX

Vx = volume of export

PX = price index of export

(iii)

Gross barter T.O.T = Qx/ QM x 200

Where; Qx is quantity of export

QM is quantity of import

Favorable terms of trade:-

It occurs when a country export prices rises while the import prices decline or remain constant. This implies that a country can get more import by exporting the same quantity of export.

Unfavorable terms of trade:-

Countries terms of trade are said to be unfavorable when the price of export declines or remain constant while the price of import rises. This implies that there is less foreign exchange comings from export.

Balance terms of trade:-

Balance terms of trade occurs when terms of trade between two countries is equal to one.

Determinants of term of trade:-

These are the factors which determine whether terms of trade are favorable, unfavorable or balance.

Forces of demand and supply

When the demand of export raises the price of export increases leading to favorable T.O.T and Vice versa

The degree of monopolization

When there is a monopoly, high degree of monopoly power terms of trade are favorable.

Import Quota:-

This means quantitative restriction. It leads to unfavorable terms of trade to the exporting countries.

Devaluation

This is lowering of country currency which lead export to be cheaper and import expensive hence unfavorable.

Tariffs (import duty):-

Increase in import duty leads to increases in import prices, leading to unfavorable terms of trade

Causes of unfavorable terms of trade:-

Increase in supply of exports which lead to decrease in their prices.
Decrease in demand for a countries export leading to fall in export price.
An increase in demand for import leading to an increase in their price.
Political instability affecting production.

Factors leading to favorable terms of trade:-

Decrease in supply of export which leads to increase in their prices.
Increase in demand for a countries export leading to rise in export price.
A decrease in demand for import lead to decrease in their prices

Reasons for deteriorating terms of trade in leads:-

Qns: Discuss why terms of trade in lack are mostly unfavorable:-

Discovering of synthetic materials in developed countries this includes nylon and plastic bags.
Introduction of import substitution industry in developed countries. Developed countries have build industries which produce the originally imported products.
Diminishing returns.

In LDC’s most countries are ago based countries and due to limitation of land and increase in population affect etc.

Most of products produce in LDC’s have low price elasticity and Manufactured products have high price elasticity
Introduction of raw material saving technology which reduces the demand of raw material by developed country e.g. recycling
Monopoly power of primary products like petroleum used in production. Most of the products are found in developed countries.
Technology level In LDC’s

In LDC’s have low technical progress.

Qn. Discuss the possible solution for deteriorating terms of trade in LDC’s:-

The following are some of the solution:-

Controlling import by reducing imports, using import substitution method, recycling.
Using economic integration where countries come together and remove barriers such barriers include tariffs.
Use of export promotion

Export promotion increases the demand of export leading to increase in price.

Improvement in technology

Using of modernized machines.

Control population

Increase in population leads to increase in demand and vice versa.

Investment in manufacturing industry which produce goods with high elasticity.
Discovery of new resources.

BALANCE OF TRADE (B.O.T)

Is the difference between the value of the countries visible export and visible imports:-

Visible trade involves buying and selling physical goods.
Invisible trade involves buying and selling services

Balance of trade can either be favorable or unfavorable:-

Favorable balance of trade occurs when the value of export exceed the value of import.
Unfavorable balance of trade occur when import value exceed export value.

B.O.T = Total value of (x) – Total value of (M).

BALANCE OF PAYMENT (BOP):-

Is an accounting statement that shows the difference between in flow (receipts) and outflow (payment) of foreign currency within a specific time.

Balance of payment is divided into the following account:-

CURRENT ACCOUNT

This is an account that has the following accounts:-

Goods and services account.
Unilateral accounts which deals with grants and loans

The following is shown in the current account:-

The difference between visible export and visible import
The difference between invisible export and invisible import.

(Visible export – Visible import) + (Invisible export – invisible import) = Net current balance.

The net balance can either show surplus or deficit. Deficit means there is more out payment than in payment.

CAPITAL ACCOUNT:-

Net long term capital in flow

Net short term capital inflow

Net short term government capital inflow

Net long term government capital inflow

If the sum above is positive there is a surplus and if negative there is deficit.

FINANCIAL ACCOUNT

This accounts record international monetary flows such as investment in business, real estates and in stock exchange.

Disequilibrium in balance of payment:-

Occurs when total payments to abroad exceed total receipts from abroad.

The following are its major causes:-

Increase in demand for imports

The more you import the more money you pay:-

Decrease in demand of export product.
Devaluation policy which makes export expensive and import cheaper.
Unfavorable terms of trade
Poor climatic condition particularly agricultural based countries.
Trade sanction
In adequate capital goods leading to low level production.

Methods of controlling disequilibrium B.O.T:-

Reducing importation through trade restriction.
Promote export
Devaluation of currency combine with import restriction
Proper utilization of resources
Seek for more financial assistance
Restrict or reduce capital outflow

Qn: Suggest reasons for persistent balance of payment deficit:-

EXCHANGE RATES

Is the price of a countries currency expressed in terms of another country currency.

TYPES OF EXCHANGE RATE

Floating / free exchange rate

This is an exchange rate that is determined by market forces. i.e. demand and supply.

The forces of demand and supply make exchange rate flows upward and downward.

ADVANTAGES

There is no government intervention
It helps in managing the deficit in balance of payment.
It helps indicate the strength of the currency.
It makes the price of domestic currency against foreign free and fair.
It reduces competitive exchange rate depreciation among countries.

DISADVANTAGES

It causes uncertainty to businessmen
In some cases there is government intervention leading to no free exchange rate.
It leads to inflation, particularly imported inflation.
Leads to misallocation of resources
It has speculative effect to businessmen
Fixed exchange rate:-

– It is a system where by countries fix their values of currency in terms of other countries currency or

– Its an exchange rate which government set and maintain rate of exchange through central bank.

ADVANTAGES

It helps to remove uncertainties
It discourages speculation among businessmen
It reduces inflation especially imported inflation
It is easier to predict future prices
It enable economic integration to take place among different countries
It enables the government to plan and implement its responsibility easily

DISADVANTAGES

It imposes a burden to the government, central bank in controlling the exchange rate.
It affects the balance of payment equilibrium by:-
overvaluing the currency
undervaluing the currency
It may lead to inflation
It makes it difficult to control a deficit in balance of payment.
MULTIPLE EXCHANGE RATES

Is an exchange rate system where a given foreign currency is purchased at different rate (price) for a local currency

The exchange rate depends on government interior in controlling importation for example basic needs are given at lower exchange rate while luxury goods are given a higher exchange rate.

PEGGED EXCHANGE RATE:

Is a system where the price of particular / domestic currency is stick/ fixed in relation to a given foreign currency, for example TSH and dollar where all the prices of goods and services in Tanzania are determined by dollar.

INTERNATIONAL INSTITUTIONS USED IN INTERNATIONAL TRADE

I.M.F:- International Monetary Fund
I.B.R.D: International Bank for Reconstruction and Development (World Bank)

I.F.C: International Finance for Cooperation

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