Introduction to Economics - LEC 13 (International Trade, Balance of Payment and Exchange Rate) PDF

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Introduction to EconomicsLecture 13International Trade, Balance of Payment and Exchange Rate :In this week's lecture, we will talk about the concept of comparative advantage. We will see that comparative advantage is the basis for mutually beneficial trade. We will also consider policies that will r...

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Introduction to Economics Lecture 13 International Trade, Balance of Payment and Exchange Rate: In this week's lecture, we will talk about the concept of comparative advantage. We will see that comparative advantage is the basis for mutually beneficial trade. We will also consider policies that will restrict trade between countries and their welfare effect. We will also discuss the main components of the Balance of Payments. And lastly, we will talk about the exchange rate market and see how the exchange rate is determined. Learning Objectives:

 Explain comparative advantage in trade;  Understand policies that restrict trade (Tariffs, Quota);  Understand the Balance of Payments (BOP)  Explain what type of transactions are recorded in the Current Account. Financial Account and Capital Account.  Understand the Foreign exchange market and how exchange rates are determined

Global Trends and Patterns in International Trade -

Except during extreme crisis events like the Great Depression and the two World Wars, the twentieth century displayed the growing importance of world trade

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Since 1945, the formation of the IMF, the World Bank and the enacting of the GATT meant that trade barriers started to fall, and reductions in the costs of transportation extended the types and volumes of goods traded

Comparative Advantage in Traditional Trade Comparative Advantage: -

The ability of an individual, firm or country to produce a good or service at a lower opportunity cost that other producers

Opportunity Cost: -

The highest valued alternative that must be given up to engage in an activity

What does Australia have in Abundance? Relative factor abundance determines comparative advantage: -

Minerals Energy Land Skilled labour Other

Government Policies that Restrict International Trade Tariffs: -

Tariffs are the most common form of interference with free trade. Like any other tax, a tariff will increase the cost of selling a good. Tariffs reduce consumer surplus and lead to a deadweight loss. Tariffs increase producer surplus and generate revenue for the government.

Quotas: -

A numerical Limit imposed by the government on the quantity of a good that can be imported into a country The effects of a quota are similar to that of a tariff

Balance of Payment (BOP) BOP is an account that records the transactions of a country with the rest of the world. The BOP has three main accounts: -

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Current account: o The part of the balance of payments that records a country’s net exports and net income. Financial account: o The part of the balance of payments that records purchases of physical and financial assets a country has made abroad and foreign purchases of physical and financial assets in the country. Capital account: o The part of the balance of payments that records migrants’ asset transfers, debt forgiveness and sales and purchases of non-produced, non-financial assets.

Current Account:

Financial Account

Capital Account

The Foreign Exchange Market and Exchange Rates -

Trade between countries normally requires the exchange of the currency of one country for that of another

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Nominal exchange rate: o The value of one country’s currency in terms of another country’s currency.

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The market exchange rate is determined by the interaction of demand for and supply of currency in the foreign exchange market.

The Foreign Exchange Market and Exchange Rates -

Currency Appreciation: o Occurs when the market value of a currency rises relative to another currency Currency Depreciation: o Occurs when the market value of a currency falls relative to another currency

Changes in the Exchange Rate: •

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If the exchange rate depreciates, this may: –

Make exports more attractive

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Make imports more expensive

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Increase the relative size of a country’s debt

If the exchange rate appreciates, this may: –

Discourage exports

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Make imports cheaper

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Reduce the relative debt size...