Economics: International Trade

Definition of Concepts:
Trade- Trade is the exchange of goods and services.
International Trade- International Trade refers to exchanges of goods and services between
countries and citizens of these countries.
Balance of Trade- The difference between values of exports and imports of visible and
invisible trade.
Balance of Payment- An account which records nation’s international transactions with the
rest of the world.
Current account- Measures the flow of expenditure on goods and services, indicating on a
broad scale a country’s income gained and lost from trade.
Capital account- Shows the inflows (credits) and outflows(debits) with regard to capital
movements in a country.
Net international reserves (NIR)- International reserves (or reserve assets in the balance of
payments) are those external assets that are readily available to and controlled by a country’s
monetary authorities.
Balance of payments disequilibria- A situation where a country’s balance of payments
account is not in balance, that is it is either in deficit or surplus.
Tariff- A tax imposed by government on imported products to protect local or infant
industries against outside competition.
Common External Tariff (CET)- A tax charged by countries that are apart of customs union
to those trading partners who are not part of this union.
Quota (non-tariff barriers)- The amount of goods that a firm or and industry imports into a
country. A government may restrict the amount of goods imported and therefore put a
restriction on trade.
Exchange rate- The price of a unit of one nation’s currency for the purpose of conversion to
another.
Exchange rate regimes- how a nation manages its currency in the foreign exchange market.
World Trade Organisation (WTO)- The world’s principal trading organization devoted to the
principles of free trade.
Rationale for International Trade
International trade allows countries to expand their markets and access goods and services
that otherwise may not have been available domestically. As a result of international trade,
the market is more competitive. This ultimately results in more competitive pricing and
brings a cheaper product home to the consumer.
Absolute advantage- the principle of absolute advantage refers to the ability of a party to
produce a good or service more efficiently than its competitors.
Comparative advantage- An economy's ability to produce a particular good or service at a
lower opportunity cost than its trading partners.
Gains from trade- Gains from International trade refers to that advantages which different
countries participating in international trade enjoy as a result of specialization and division
of labour.
Factors that influence International Trade
Level of Exports
 International Prices
 Population Growth rates
 Domestic Production
 Domestic Prices and exchange rates
Level of Imports
 Domestic Income
 Domestic Prices and Inflation
 Exchange Rates
 Changes in local taste
Terms of trade- The rate or ratio at which one product is exchanged for another. Expressed
another way it is how much of a country’s exports will be used to purchase its imports.
Balance of Trade- The difference between values of exports and imports of visible and
invisible trade.
Balance of Payment- An account which records nation’s international transactions with the
rest of the world.
3 MAIN GROUPS FOR OFFICIAL ACCOUNTING PURPOSES
Current Account
Measures the flow of expenditure on goods and services, indicating on a broad scale a
country’s income gained and lost from trade.
Current Account Balance- The sum of visible and the invisible balance. This balance shows
the difference between earnings and payment on goods and services.
Two Main Components of Current Account
The Visible Balance- The visible trade account is also referred to as the merchandise trade
balance, because it consists of the exports and imports of physical goods. E.g., manufactured
goods, raw materials, machinery and oil.
Invisible Trade Balance- This account is used to record transactions in services as well as
incomes from investments. No record is made in this account of any physical goods
purchased. E.g., tourism, shipping, insurance and banking.
 Capital Account
Capital account- Shows the inflows (credits) and outflows(debits) with regard to capital
movements in a country.
Capital Movements are transactions in fixed assets and financials assets.
The movements of capital might be short-term or long-term.
Short- term capital movements could include private and official money flows entering
international financial centres in search of higher rates of interest and the security of capital.
Example; Private short term capital movement may include deposits and sales of securities.
Long-Term capital movements include capital movement of private and government money
flows for investment purposes.
Example; Private long term capital movements are investments made by private individuals
directly in overseas ventures or indirectly through the purchase of shares in a company.
Official Financial Account
The official financial account shows how deficits are covered and how surpluses are utilised.
A deficit (expenditures exceed revenue) may be financed by borrowings or the country may
decide to draw down on its foreign exchange reserves, or both.
A surplus (income earned exceeds expenses paid) may be used up by repaying outstanding
debts or adding to country’s foreign exchange reserves.
Debit and Credit Entries in Balance of Payments
Example 1. An export is recorded in the balance of payments as a credit for the movement of
goods, but a debit in means of payment such as cash or debtors.
Example 2. An import is recorded the balance of payments as a debit for movement of goods
but a credit in means of payment such as cash account or creditor’s account.
Factors that give rise to surplus
 Falling demand for imported goods and services
 Increasing demand by foreigners for locally produced goods and services
 A decrease in foreign holidays
 Increase in foreign visitors
 Greater investments in the local economy by foreigners than foreign investments
made by domestic residents abroad.
Factors that give rise to deficits
 Increasing demand for imported goods & services
 Falling demand for locally produced goods & services by foreigners
 An increase in holiday taken abroad
 A decrease in visitors to the country
Calculate surplus as excess of receipts over payments. Surplus= excess of
receipts/overpayments
Calculate deficit as excess of expenditure over receipts. Deficit= excess of
expenditure/receipts
Consequences of Balance of Payment Deficit
1. Increase in unemployment
2. Falling foreign exchange reserves: A deficit means outflows are greater than inflow. To
finance the deficit, it is necessary to draw on reserves.
3. Exchange rate depreciation: a deficit means that the domestic residents are demanding
more foreign currency
Measures to Reduce BOP deficit
1. Reduction of aggregate demand through deflationary monetary and fiscal policy
2. Import Control: (forms of)
Embargo: direct ban on the importation of a particular good
Quota: a limit on the amount of a good that can be imported
Tariff: a tax placed on an imported good
3. Devaluation:
Recall that a devaluation of a currency is a fall in the value of a country’s currency. The
lower the level of the currency the lower the level of imports.

Consequences of Balance of Payment Surplus

1. Falling Unemployment: foreigners demand more locally produced goods and services will
cause firms to expand to meet the demand and also employ more labour.
2. Increase in reserves: BOP surplus adds to the country’s foreign exchange reserves
3. Exchange rate appreciation: increasing demand for domestic currency by foreign firms
and individuals will lead to an appreciation of exchange rate.
4. Inflationary pressures: if the source of the BOP surplus is increasing demand for goods
and services, this can be inflationary (demand –pull). This is especially true if there are not
enough idle resources with which to increase supply to meet the increasing demand.
 Measures to Reduce BOP Surplus
1. Increasing aggregate demand the reflationary monetary and fiscal policy:
Reflationary monetary policy includes the reduction in interest rates. Consumers will save
less and spend more to include imported goods.
Reflationary fiscal policy is an increase in government spending and reduction in taxes. This
will increase the level of income and consumers will increase general spending as well as on
imported goods.
2. Reduction of Import Control:
When import controls are removed the price of imports falls. More imports will be demanded
and this will increase outflows out of the country. Other things being equal, the size of
surplus will fall.
3. Revaluation of the currency:
Recall that a revaluation is the rise in value of a country’s currency. The higher the level of
the currency, the higher the level of imports.
Factors that Influence the Level of Exchange Rate
 Fixed, Floating and Managed exchange rate regimes.

 Appreciation and depreciation of a currency.

 Revaluation and devaluation.

 Downward and upward adjustments to the value of a currency.