2. Why International Trade ?
The unevenly distributed natural resources on the
globe resulted in interdependency amongst
nations, giving rise to exchange of goods and
services to meet mutual requirements
Resulting in International Trade
Trading globally gives consumers and countries the opportunity
to be exposed to goods and services not available in their own
countries. Almost every kind of product can be found on the
international market: food, clothes, spare parts, oil, jewelry, wine,
stocks, currencies and water. Services are also traded: tourism,
banking, consulting and transportation
3. Import / Export…
Purchase of Goods and Services from International
Market for sale or consumption in Domestic
Market is called Import
E.g. India Import Crude Oil , Iron ore from international
market
Goods and Services produced in Domestic Market
and sold in International Market is called Export
E.g. India Export Engineering Good , Iron & Steel
4. A economy which encourages international trade is
called as open economy. A useful measure of openness
is the ratio of a country‘s export or import to its GDP
India’s Import Export % to GDP
35 1
30 0
25 -1
20 -2
15 -3
10 -4
5 -5
0 -6
1976
1986
2002
1970
2004
2006
2010
1982
2000
1964
1966
1974
1978
1980
1984
1988
1992
2008
1960
1968
1962
1972
1994
1990
1996
1998 Export % GDP Import % GDP Deficit
5. Economics…
Basic Economic Theories of International Trade: Answer to the question why?
Theory of Absolute Advantage
Theory of Comparative Advantage
Heckscher – Ohlin Model
6. Economics…
Theory of Absolute Advantage By : Adam Smith 1776
International trade takes place because one country may be more efficient in
producing a particular good than another country, and that other country may be
capable of producing some other good more efficiently than the first one. This
provides an incentive to trade as both the countries can benefit from specialization
and the resultant increase in productivity
Example:
Country Aircraft Supercomputer
Country A 20 Labor Units 10 Labor Units
Country B 10 Labor Units 20 Labor Units
*Assuming all other factor of production are used in equal amount
Here, Country A enjoy absolute advantage in producing Supercomputer
Country B enjoy absolute advantage in producing Aircraft
Let’s assume country A exchange 1 supercomputer for 1 Aircraft
Then Country A will be able to use 10 Labor to produce a Supercomputer and get a
Aircraft and use other 10 Labor to product supercomputer for domestic use
Country B will also benefit in same fashion
7. Economics…
Theory of Comparative Advantage By : David Ricardo 1817
According to the absolute advantage theory, two countries enter into trade when both
of them hold an absolute advantage in the production of at least one product. The
question arises here is whether two countries can benefit by trading with each other
even if one of them has an absolute advantage in all the commodities. According to
the theory of Comparative Advantage propounded by the English Economist David
Ricardo in 1817,trade is possible as long as both the countries enjoy comparative
advantage in at least one of the product
Example:
Labor Hour Required to produce
Country 1 Unit of Steel 1 Unit of Cement
Country A 5 10
Country B 15 20
*Assuming all other factor of production are used in equal amount
Here, Country A enjoys absolute advantage in producing both the commodities
Let’s assume that both the countries have 600 unit of labor-hour at their disposal
which can be either use for producing Steel or Cement
8. Economics…
Theory of Comparative Advantage cont…
Labor Hour Required to produce *assuming 600 labor hours are available
Country 1 Unit of Steel (Max) 1 Unit of Cement (Max)
Country A 600/ 5 = 120 600/10 = 60
Country B 600/15 = 40 600/20 = 30
For producing each unit of steel, the production of a particular number of units of
cement has to be forgone and vice versa. The quantity of cement thus forgone in order
to product one unit of steel is called the Opportunity cost of steel
Opportunity cost involve in production of Steel and Cement
Country 1 Unit of Steel 1 Unit of Cement
Country A 60/120 = 0.5 120/60 = 2
Country B 30/40 = 0.75 40/30 = 1.33
India has a comparative advantage in providing world class services in low
cost. So we earn a net export of 43,747 cr (April June 2011) from service sector
9. Economics…
Heckscher-Ohline Model By : Eli Heckscher and Bertil Ohlin 1920
According to this theory, there are two types of products Labor Intensive and Capital
This model explores the possibility of two nations operating at the same level of
efficiency, benefiting by trading with each other reason can be traced to the
difference in their Factor Endowment
The labor rich country is more likely to produce labor intensive goods and
the capital rich country most probably produce capital intensive goods. This countries
will then trade these goods and reap the benefits of international trade
India has a high skilled labor force available comparatively at cheap
rate which is very attractive to foreign capital giving a room for
development in both Service sector and Manufacturing Sectors
So Engineering goods as well as Software Services
10. Economics…
Balance Of Payment
A country’s Balance of Payment is a systematic statement of all economic transaction
between that country and the rest of the world. Its major components are the current
account and the financial account.
I. Current Account
Merchandise (or Trade Balance)
Services
Investment Income
Unilateral Transfer
II. Capital Account
Private
Government
Official Reserve Changes
Other
The Balance of payment has two fundamental parts. The current account represents
the spending and receipt on goods and services along with transfers. The financial
account includes purchases and sales of financial assets and liabilities.
An important principle is that two must always sum to zero
Current Account + Financial Account –I + II = 0
11. Economics…
GOVERNMENT TOOLS
Despite all the obvious benefits of international trade , Government have an
inclination to put up trade barriers in order to discourage import
1. Tariff Barriers
2. International Price Fixing
3. Exchange Controls
4. Non-Tariff Barriers
1. Quota
2. Embargo
3. Subsidies to Local Goods
4. Local Content Requirement
12. Economics…
Risk Involved in International Trade
Risk and reward always go hand-in hand True to this maxim, the advantage of
international trade are also accompanied with additional risk broadly categorized as
Country Risk : It is a risk of an exporter not receiving his payments
from the importer due to some country specific reasons It is
basically related to the countries macroeconomic condition,
Political condition, Credibility and Social condition, even when the
capacity of the importer to pay is not impaired by any of these
reasons, the payment may not come through due to some currency
exchange restrictions suddenly impose by the importing country
Exchange Risk: Changes in Exchange Rates may have an
unfavorable effect on sales, prices costs and profits of exporter and
importers
13. Finance…
International Monetary System
System of Exchange in Currencies at specific exchange rate facilitating international
trade is called International Monetary System
Foreign exchange rate is the price of one currency in terms of another currency
The settlement of international transaction takes place by conversion of
currencies into one another and the transfer of funds across nations
Example :
An importer in India importing goods from America has to pay the amount in
USD , suppose 1 USD can be Brought at 50 Rupee this payment is made through
International Monetary system
14. Finance…
Factors Affecting Exchange Rate
Foreign exchange rate is the price of one currency in terms of another currency.
Economic forces of Demand and Supply of the currencies determine the price of
foreign currency
Example: Suppose India and USA is in trade
The supply of Indian Rupee comes from Indian Market for the
payment of goods and services from America where American Dollar is demanded
likewise Supply of American Dollar comes from American Market who demands
Indian Rupee for payment of goods and services from India this bilateral Demand-
Supply determines the exchange rate of the currencies in trade
Factors affecting the demand and supply
1. Interest Rates
2. Rate of Inflation
3. Political or Military Unrest
4. Domestic Financial Market
5. Business Environment
6. Economic Data
7. Balance of trade
8. Government Budget
9. Rumors
15. Finance…
Exchange Rate Cont….
Fixed Exchange Rate
Floating Exchange Rate
Floating with limited flexibility
India follows a system between a freely floating and fully managed system. This type
of system is known as Managed float system .Exchange rates are allowed to float
freely, but RBI intervenes when it feels necessary in the way it considers suitable.
16. Finance…
The Anatomy of a FOREX Quote
The currencies are always traded in two-way quotes pairs,
INRUSD =48.62/48.75 here USD is being bought or sold, with
its value being expressed in terms of INR, USD is referred as the
base currency
Direct Vs. Indirect Quote:
Indirect Quote : $/100 Rs : 2.0525/67 here the bank would be buying
dollars @ $2.0567/Rs 100 and selling dollars @ $ 2.0525/Rs 100
The corresponding Direct Quote would be : RS/$ 48.62/48.72 here the bank
would be buying dollars @ Rs 48.62/$ and selling dollars @Rs48.72/$
In India Direct Quote is used from August 2 1993
17. Finance…
BID / ASK RATE
The rate at which a bank is ready to buy a base currency is call Bid Rate
The rate at which a bank is ready to sell the base currency is called as Ask rate
All the information is express in a quote as given
INRUSD = 48.62/48.72 which means the currency in trade is USD
express in Indian Rupee where bank is ready to buy USD @ 48.62 Rs
and is ready to sell USD @ 48.72 Rs