INTERNATIONAL TRADE

2. CHAPTER 16 INTERNATIONAL TRADE

3. DEFINITIONS INTERNATIONAL TRADE International trade refers to exchange of goods and services between the people of two countries of the world. INTERNAL TRADE Internal trade refers to exchange of goods and services within the political boundaries of a country.

4. Natural Resources Monetary Units Immobility of Factors of Production DIFFERENCES BETWEEN INTERNATIONAL TRADE AND DOMESTIC TRADE National Policies Size of Market and Total Transaction Documentation Protectionism

5. DEFINITION The ability of a country to produce more efficiently than another country. ABSOLUTE ADVANTAGE THEORY Assumptions: There are only two countries in the world. Only two goods are produced. Free trade exists between these two countries. No transportation costs are involved. Identical production functions between trading countries.

6. ABSOLUTE ADVANTAGE THEORY (cont.) Malaysia and China are producing cotton and rice. Production before specialization SPECIALIZATION WILL TAKE PLACE Malaysia has an absolute advantage in producing rice. China has an absolute advantage in producing cotton.

7. ABSOLUTE ADVANTAGE THEORY (cont.) Malaysia and China will produce rice and cotton respectively. Production after specialization INTERNATIONAL TRADE TAKE PLACE Total world output has increased with specialization.

8. ABSOLUTE ADVANTAGE THEORY (cont.) Assume that there is an arrangement to trade 1 tonne of cotton for 1 tonne of rice. Production after international trade takes place WHAT HAPPENS IF A COUNTRY HAS AN ABSOLUTE ADVANTAGE OVER BOTH GOODS? SOLUTION : COMPARATIVE ADVANTAGE Both countries are better off with more goods as a result of international trade.

9. ABSOLUTE ADVANTAGE THEORY (cont.) DEFINITION The ability of a country to produce goods at a lower opportunity cost than another country. Production before specialization NEED TO CALCULATE THE OPPORTUNITY COST SPECIALIZATION WILL NOT TAKE PLACE Malaysia has an absolute advantage in producing cotton. Malaysia has an absolute advantage in producing rice.

10. ABSOLUTE ADVANTAGE THEORY (cont.) Opportunity cost is defined as desired goods that one has to forgo to obtain other goods. OPPORTUNITY COST SPECIALIZATION WILL TAKE PLACE China has lower opportunity cost in the production of rice. Malaysia has lower opportunity cost in the production of cotton.

11. ABSOLUTE ADVANTAGE THEORY (cont.) Malaysia and China will produce cotton and rice respectively. Production after specialization INTERNATIONAL TRADE TAKE PLACE

12. Terms of trade Refers to the rate at which goods are exchanged. COMPARATIVE ADVANTAGE THEORY Malaysia agrees to trade 40 tones of cotton in exchange to 10 tonnes of rice. Production after international trade takes place Term of trade: 1 Rice = (6 + 2) = 4 Cotton 2

13. INTERNATIONAL TRADE DEMERITS MERITS • Increase world output • Varieties of goods and services • Relationship between trading partners • Higher income and economic growth • Sharing of knowledge and technology • Depletion of country’s reserves • Economic and political dependence • Transportation costs

14. To protect infant industries To protect against unfair trade practices To protect domestic employment DEFINITION Policy practised by a nation on other nations in which certain barriers are imposed on trade for economic or non-economic reasons. Industrial diversification PROTECTIONISM Source of government revenue REASONS FOR PROTECTIONISM To correct an adverse balance of payment

15. TARIFF TOOLS OF PROTECTIONISM EXPORT SUBSIDY QUOTAS EXCHANGE COTROL EMBARGOES IMPORT LICENCE

16. BALANCE OF PAYMENTS Structure of Malaysian Balance of Payments 1. CURRENT ACCOUNT Statement of systematic record of all economic transaction between one country and the rest of the world during a given period of time. 2. CAPITAL ACCOUNT 3. OFFICIAL RESERVE ACCOUNT

17. The current account contains receipts and payments on goods and services. • The current account has four components: CURRENT ACCOUNT • Merchandise trade balance

18. CURRENT ACCOUNT (cont.) Balance of Payment for Malaysia in the Year 2004 (in RM Million)

19. CURRENT ACCOUNT (cont.) • The current account contains receipts and payments on goods and services. • The current account has four components: • Merchandise trade balance • Service balance

20. CURRENT ACCOUNT (cont.) Balance of Payment for Malaysia in the Year 2004 (in RM Million)

21. CURRENT ACCOUNT (cont.) • The current account contains receipts and payments on goods and services. • The current account has four components: • Merchandise trade balance • Service balance • Net income

22. CURRENT ACCOUNT (cont.) Balance of Payment for Malaysia in the Year 2004 (in RM Million) Balance of goods and services = Merchandise trade + Service balance

23. CURRENT ACCOUNT (cont.) • The current account contains receipts and payments on goods and services. • The current account has four components: • Merchandise trade balance • Service balance • Net income • Current transfers

24. CURRENT ACCOUNT (cont.) Balance of Payment for Malaysia in the Year 2004 (in RM Million)

25. CURRENT ACCOUNT (cont.) • The current account contains receipts and payments on goods and services. • The current account has four components: • Merchandise trade balance • Service balance • Net income • Current transfers BALANCE ON CURRENT ACCOUNT = TRADE BALANCE + SERVICE BALANCE + NET INCOME + CURRENT TRANSFER

26. CURRENT ACCOUNT (cont.) Balance of Payment for Malaysia in the Year 2004 (in RM Million)

27. CAPITAL ACCOUNT • The capital account records the payment flows and purchases of foreign assets by Malaysians or Malaysian assets by foreigners. • The are two types of accounts: • Capital Account

28. PRINCIPLES OF ECONOMICS CAPITAL ACCOUNT (cont.) Balance of Payment for Malaysia in the Year 2004 (in RM Million)

29. CAPITAL ACCOUNT (cont.) • The capital account records the payment flows and purchases of foreign assets by Malaysians or Malaysian assets by foreigners. • The are two types of accounts: • Capital Account • Financial Account

30. CAPITAL ACCOUNT (cont.) Balance of Payment for Malaysia in the Year 2004 (in RM Million)

31. OFFICIAL RESERVE ACCOUNT The official reserve account consists of government gold and foreign currency reserves and government reserve with IMF and SDR.

32. OFFICIAL RESERVE ACCOUNT (cont.) Balance of Payment for Malaysia in the Year 2004 (in RM Million) A balancing item that enables credits and debits to be equal

33. IMPORTANT FORMULAE • Merchandise trade balance = Merchandise export – Merchandise import • Service balance = Services export – Services import • Balance in current account = Merchandise trade balance + Service balance + Net income + Current transfer • Balance of capital account = Capital account – Financial account • Overall balance = Balance in current account – Balance in capital account + Errors and omissions • Reserve assets = – (Overall balance) • Basic balance = Balance in current account + Long-term capital account BALANCE OF PAYMENTS

34. Disequilibrium occurs when there is a deficit or surplus in the balance of payments. DISEQUILIBRIUM IN THE BALANCE OF PAYMENTS Discourage imports Using the government’s reserve Inflation MEASURES TO CORRECT DISEQUILIBRIUM Export promotion Devaluation

35. DEFINITION The price of one currency in terms of another currency. EXCHANGE RATE

36. EXCHANGE RATE (cont.) Gold Standard The value of all currencies fixed directly to gold and have a fixed relationship to each other. Bretton Woods System Countries have to peg their currencies against the U.S. dollar instead of gold. Flexible Exchange Rate System Most trading countries will allow their exchange rates move up or down in order to stabilize any excess supply or demand based on supply and demand in the foreign exchange market.