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Price Level and International Trade

Rupesh Puri

King’s College/ Westcliff University

BUS 311a- Concepts of Macroeconomics

Professor: Ashmita Gautam/ Samvida Pathak

July 25, 2021

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Price Level and International Trade

Measuring a price level means creating a hypothetical basket of goods and services that

represents a set of consumer purchase and calculate how the total cost of buying basket of goods

increase over time. Inflation is the increase in the overall price level of all goods and services and

not individual goods. It is measured as the percentage change between price levels over time. In

order to measure the price level, economist compute a weighted average of the prices of the

items in the basket[ CITATION Gre201 \l 1033 ]. The weights are based on actual quantities of

goods and services people buy.

Part A- Price level

The basket of goods and services includes of different items individual, business and

organizations buy. Price level represents the purchasing power of money or the inflation.

Economists use Consumer Price Index (CPI) which is a measure of the cost in period of basket

of goods and services relative to the cost of basket of goods. CPI = Value of basket in current

year divided by Value of basket in base year multiplied by 100.

Substitution bias arise because if the price of apple is high but the price of oranges is low,

than consumers might shift consumption to oranges by which they can avoid experiencing the

price increase[ CITATION Aca16 \l 1033 ]. It does not takes into account the change in

purchasing power because the basket of goods might be fixed.

The quality/ new good bias arise because it there would be rise in cost of living with the

improvements in the quality of existing goods and invention on new goods which are not taken

into account. Since, the basket of goods and services are fixed while measuring CPI substitution

and new good bias arise. For example- If apple charges iphone higher than previous year adding
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charger to it than to calculate inflation as per the previous year rate would impact because it is a

whole new/ added product.

Part – B Level of Trade and Trade Imbalance

A high level of trade indicates more than 50% of its production or goods produced in nations is

exported to other countries. Trade imbalance is when countries run persistent surpluses on their

trade whereas other experience persistence and often large deficits. There are three factors that

influence national’s level of trade. Size of economy, Geographic and History of

Trade[ CITATION Kri141 \l 1033 ]. Level of trade is measured by the percentage of exports of

the GDP or the size of economy whereas trade balance is the different between export and the

import.

a- Large economy normally have lower level of international trade because more of the

trading is done within the country. It has a little less impact on international trade

balance. For example- US being the biggest economy has the trade deficit of $68.9

billion and it export only 14% of the GDP, which is lower level of trade in

comparison to other country.

b- There is an imbalance between domestic investment rate and domestic saving rate,

which includes government and private savings. It leads to trade imbalance but has

little to do with level of trade. If the domestic investment would be higher than people

would not be motivated to manufacture or produce new things in the country which

force the economy to import more than the exports[ CITATION Hai11 \l 1033 ].
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c- Many large trading partners geographically nearby would increase the levels of trade.

For example- Sweden has many trading partners across Europe and long history of

foreign trade has high level of trade[ CITATION Ope18 \l 1033 ].

d- A large budget deficit means a country exporting less and importing more. This

economy has large demand for financial investment and is likely to have an inflow of

foreign capital.

e- The countries with strong tradition of discouraging trade affect or reduces the level of

trade. However, this does not have to do with the trade balance as it is determined by

imports and exports.

Numerical- Part C

Given the information in the questions.

Exported Goods = £192 billion

Exported Service = £77 billion

Imported Goods = £225 billions

Exported Services = £66 billion

Receipts of Income from abroad (import) = £140 billion

Income Payment going abroad (export) = £131 billion

Government transfer to rest of the world (export) = £23 billion

Government received payment from rest of world (import) = £16 billion

a- U.K merchandise trade deficit for 2001

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= Value of Imports – Values of Export

= (225+66) – (192+77)

= 291- 269

= £ 22 billion

It means UK has £22 billion trade deficit in the year 2001. Trade deficit means the value of

goods imported in the country subtracted by value of goods being exported.

b- Current Account Balance for 2001

= (X-M) + NY + NCT

X = Export of goods and services, M = Import of goods and services.

NY = Net earnings from abroad, NCT= Net transfer payments

= (269- 291) + (131-140) + (23-16)

= -22 + (-9) + (7)

= - 24.

The current account balance for 2001 is –£ 24 billion. The trade balance is also negative and Net

transfer payment is also negative which shows Uk imported more goods than exported and sends

out more money to other country.

c- The payment on foregin investment and government transfer were counted on the

positive side of current account balance for the United Kingdom in 2001 because the

services received by UK was from these payments made. UK has imported more amount

as income from foreign investment. Government transfer are those amount country
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donate through different NGOs and IGOs to end the hunger, poverty or to help some

countries[ CITATION Bil12 \l 1033 ]. The transition of government is they sending

money to abroad without receiving any direct goods and services.

Conclusion

My father remembers of buying lentils in rs 20 at the time of insurgency. After the

democracy or over the period, now it cost 150-200 rupees. This is inflation, over the period of

time the price of the commodity increases. It is measured through the CPI (Consumer Price

Index) which has a fixed set of basket of goods and services. Level of trade is the percentage of

exports from the GDP or the economy size. Small economy having trading partners near to them

and history of international trade tend to having higher level of trade. Large economy with less

trading parties nearby and limited history of international trade relatively have lower levels of

trade. Balance of trade is the difference between value of country’s exports and value of its

imports.
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References
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Greenlaw, S. A. (2020). Principles of macroeconomics (2e). OpenStax.

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