CHAPTER ONEINTERNATIONAL TRADE AND THE BALANCE OF PAYMENTS

Trade is simply a buying and selling of goods and services from one to other.

International trade is a trade between residents of two countries.

المحاضرات موقع

www.hims.edu.eg

Import is the purchase of goods and services from foreign countries leading to outflow of foreign currency.

Export is the sale of goods and services to foreign countries leading to inflow of foreign currencies.

Why do countries trade?Without trade, A country must be self-

sufficient. It must produce everything its citizens want to consume.

With trade, Countries can specialize in the production of goods that they can produce, and satisfy other needs by trading.

There are two classic international trade theories explained why the countries trade,

Adam Smith's theory of absolute advantage

Ricardo's theory of comparative advantage

Which explained the causes and gains from

international trade.

Absolute advantage theory

Theory of absolute advantage demonstrates that: international trade will be beneficial

when One nation has an absolute advantage in one good and the other nation has an absolute advantage in the other goods

One country is said to have:

an absolute advantage when it can produce more of the good than another country, by the same quantity of resources.

Assumptions: (a) There are two countries in the

world

(b) Labor is only one factor of production

(c) The cost of a good depends on the amount of labor

(d) No transportation cost exists.

Example

Japan Egypt Nations

20 units 10 units Cars

15 Yards 20 Yards Clothes

It can be seen that:The Egypt has an absolute advantage in clothes production, as its workers' productivity in cloth is higher than that of the Japan.

Similarly, Japan has an absolute advantage in cars production.

Principle of Absolute Advantage

Each nation benefits by specializing in the production of goods that it produces at a lower cost than the other nation,

whileimporting the goods that it produces at a higher cost.

Comparative advantage theories

What IfEgypt has absolute advantage in both goods

WhileJapan has disadvantage in both goods????

Japan Egypt Nations

10 units 30 units Cars

5 Yards 30 Yards Clothes

3 times

6 times

1 2

Example

Egypt is six times as efficient in clothes production but only thrice as efficient in cars production

Egypt has a greater absolute advantage in clothes than in cars,

while Japan has a smaller absolute disadvantage in cars than clothes

Each nation specializes in and exports that good in which it has a comparative advantage

Egypt in clothes, Japan in cars.Trade enables both countries to have gain from trade.

Egypt Japanonion 100 units 75 units

watches 200 units 150 units

Define the advantage and specialization in the next case:Case 1

Egypt has................ In producing and exporting………………….While Japan has…………………in producing and exporting……………………

Balance of Paymentsbalance of payments is defined as the record of transactions between residents and non-residents over a specified period.

Three main components :•The current account, •The capital account •The official statements b

•The Current Account (CA);

The current account is subdivided into 4 sections

• The merchandise trade account (Exports or imports of goods.),

• The services account ( tourists’ expenditures, and shipping fees)

• investment income account (International interest and dividend payments and the earnings of domestically owned firms operating abroad).

• the transfer payments account (unilateral current transfers (like gifts and foreign aids).

•The Capital Account:

The Capital Account includes the purchase and sale of financial and non-financial assets.

•The Official Account:

Includes the net change in foreign exchange reserves and official government borrowing.

FOREIGN EXCHNGE MARKETSAND EXCHANGE RATE

The foreign exchange market is the market in which individuals, firms, and banks buy and sell foreign currencies or foreign exchange. The foreign exchange market for any currency is composed of all the locations (such as London, Paris, Zurich, Frankfurt, Singapore) where currencies are bought and sold for other currencies.

Exchange Rate

The exchange rate between the dollar and the Egyptian pound is equal to the number of pounds needed to purchase one dollar.

For example, if 1$=6LE this means that six pound are required to purchase one dollar.

EQUILIBRIUM FOREIGN EXCHANGE RATES

The exchange rate is determined, just

like the price of any commodity, by

the intersection of the market

demand and supply curves for dollar

QEx

R

100 200 300

65

7 E

D

D

S

Surplus

Deficit

ExportsImports