Chapter 9 International Trade & Exchange rate
What You will Learn in this Chapter
* Study the theory of Comparative Advantage
* Differentiate between Terms of Trade and Balance of payments
* Explain Exchange Rate Determination
* Describe the Concepts closely related to exchange rate of exchange
A. The theory of comparative Advantage:
In his book ‘Principles of Political Economy’, David Ricardo (1817) explained his theory of Comparative Advantage (comparative costs). This theory, subsequently modified by John Stuart Mill, is the foundation of the theory of ...view middle of the document...
The ‘Visibles’ refers to the inflow and outflow of commodities whereas the ‘Invisibles’ refer to insurance charges, banking services, shipping charges etc. While studying the Terms of Trade, we are concerned with the ‘visibles’ that is commodities. Invisibles are not to be considered in the terms of trade.
The next important aspect is to consider the prices of these traded commodities. The terms of trade relate to the prices of exports and prices of imports of commodities entering trade. The terms of trade may be favorable or unfavorable. If the prices of exports of a country are relatively higher than the prices of imports then the country will be enjoying a favorable situation in terms of trade but if the prices of imports are higher than the prices of exports then the situation in terms of trade will be unfavorable.
C. Balance of Payments:
The Balance of Payments (BOP) is a summary statement of all the transactions between the ‘Residents’ of one country and the rest of the world for a given period of time, usually a year. The BOP records all official international transactions during a year; for example, the commodities exported and imported, money lent abroad and borrowed, tourist expenditures, interest or dividends etc. They all go to make up the BOP.
The BOP generally consists of two major accounts, current & capital accounts:
a. Current account consists of all receipts and payments arising out of merchandise (commodity) and non-merchandise transactions among the countries. Merchandise transactions refer to transactions in ‘Visibles’. Non-merchandise transactions represent ‘invisibles’ exports and imports.
The current account can be classified into two – Balance of trade and balance of invisibles. Balance of trade is the difference between receipts and payments arising out of merchandise or visible exports and imports. Balance on invisibles is the difference between receipts and payments out of invisibles or non-merchandise transactions. It is obvious that a favorable BOT does not necessarily mean a favorable balance on current account. Note, invisibles exports refer to the services rendered by residents or resident organizations to foreigners or foreign organizations. Conversely, invisible imports consist of services rendered by foreigners or foreigner organizations to residents or resident organizations.
b. Capital Account: There are certain capital transactions that include borrowing and lending of capital, repayment of capital and sale and purchase of assets from residents to foreigners and from foreigners to residents. It refers to the international flow of funds to the other.
Equilibrium in BOP is said to exist when the receipts from exports are exactly equal to payments on imports. Disequilibrium in BOP takes two forms: Surplus and Deficit. Deficit arises when import payments are more than exports earnings.
The Exchange Rate:
When we buy foreign goods or invest in another...