International Trade

• Definition: International trade is the exchange of goods and services

between countries.

• Example: If you walk into a supermarket and can buy South American
Bananas, Brazilian coffee and a bottle of South African wine, you are
experiencing international trade.

• Increased efficiency of trading globally/ Explain specialization of

international trade by example:

Global trade allows wealthy countries to use their resources-whether

labour, technology, or capital-more efficiently. Because countries are
endowed with different assests and natural resources (land, labour, capital
and technology), some countries may produce the same good more
efficiently and therefore sell it more cheaply than other countries. If a
country can not efficiently produce an item, it can obtain the iotem by
trading with another country that can. This is known as specialization in
international trade.

Let us take a simple example:

Country A and country B both produce coton sweatres and wine. Country A
produces ten sweaters and six bottles of wine a year while country B
produces six sweaters and ten bottles of wine a year. Both can produce a
total of 16 units. Country A, however, takes three hours to produce the ten
sweaaters and two hours to produce the six bottles of wine (total of five
hours). Country B , on the other hand, takes one hour to produce ten
sweaters and three hours to produce six bottles of wine ( total of four
hours)

But these two countries realize that they could produce more by focusing
on those products with which they have a comparative advantage. Country
A then begins to produce only wine, an country B produces only cotton
sweaters. Each country can now create a specialized output of 20 units per
 year and trade equal proportion of both products.. As such, each country
now has access to 20units of both products.

We can see that for both countries the opportunity cost of producing both
products is greater than the cost of specializing. More specifically, for each
country, the opportunity cost of producing 16 units of both sweaters and
wine is 20 units of both producst after trading. Specializtion reduces their
opportunity cost and therefore maximizes their efficiency in acquiring the
goods they need.

• Advantages of international trade:

Exports create jobs and boost economic growth.They give domestic

companies more experience in producing for foreign markets. Over time,
companies gain a competitive advantage in global trade. Trdae also makes
companies more efficient. Research shows that exporters ar more
productive than companies that focus on domestic trade.

Imports allow foreign competition to reduce prices for consumers. It also

gives shoppers a wide variety of goods and services. Examples include
tropical and ou-of-season fruits and vegetables.

• Disadvantages of international trade:

The only way to boost exports is to make trade easirer overall.

Governments do this by reducing tariffs and other blocks to imports. That
reduces jobs in domestic industries that can not compete on a global scale.
It also leads to job out sourcing. Countruies with traditional economies
could lose their local farming base. That is developed economies subsidize
their agribusiness. Both the united states and European union do this.

• Importance of international trade:

1. International trade enables the fuller utilization of resources.

Underdeveloped countries are not in a position to use their mineral
 resources. So they export their raw mateirals to developed couintries
where the same are needed the most.

2. Because of international trade the trading partners gets goods

cheaper tha otherwise. Because every country produce goods in the
production of whichj it has to occur less comparative cost.

3. By virtue of international tarde consumers gets an opportunity to

consume a large variety of goods produced by different
countries.This improves the quality of goods.

4. International trade enables every country to dispose off their surplus

production. Some countries produce more than their requirement.
They sell this surplus production in other countries and avoid the
occurrence of deflationary pressure in the domestic economy.

5. International trade encourages countries to compete with each other

in the production of different kinds of goods at low cost of
production. Cometitiveness stimulates productivity.

6. It widesn the extent of market. Every country makes an attempt to

produce different goods in large quantity. This induces production on
large sacle and htereby generates economies of scale.

7. International trade stimulates the spirit of competition among the

entrepreneurs. Novel techniques of production are devised to
produce quality goods at low cost. Advancement of technology id thr
key to economic development.

8. International tarde promotes mutual cooperation among different

countries.it creates an atmosphere of goodwill and friendship among
the trading countries.

• What is free market economy?

An economic system where the government does not interfere in business

activity bin any way.
• Advantages of free market economy:

1. Consumer sovereignty: In a free market, producers produce what

consumers want at aa reasonable price. It gives the consumer more
choice for their purchase.

2. Absence of bureaucracy: Free market reduce cost, lead to more

innovation and research and development through the absence of
red tape. Entrepreneurs do not have to waut for the government to
tell them what to make. They study demand, research trends and
meet the customers needs through innovation. This also encourages
competititon amongst firms to improive theior product and servie.

3. Optimum allocation of resources: resources in the market are better

distributed and allocated. Since consumers are willing to pay for a
certain quantity of a product, producers are willing to pay to acquire
raw materials. Otherwise producers produce too much of a good that
no one wants.

• Disadvantages:

1. Since profit maximization is the biggest motivation for firms, they

may try to reduce their costs unethically by polluting the
envireonment or by exploiting workers.

2. Merit goods: goods and services that are not profitable will not be
produced. Rural communities will suffer as a result i.e regarding
transport and post. For example, rural hospitals may not be
profitable to run but are necessary.

3. Unemployment: Certain members of society will not be able to

work with elderly or the unemployed (because their skills are not
marketable) . They will be left and will fall into poverty.

4. Firm power: Large firms can still dominate certain markets, even
where there is competition and exploit suppliers. Amazon has
 done this in the book industry by dictating unfair terms to
publishers.

• Distinguish between Foreign Direct Investment(FDI) and Foreign Portfolio

Investment(FPI): Foreign direct investment involves establishing a direct
business interest in a foreign country, such as buying or establishing a
manufacturing business, while foreign portfolio investment referes to
investing in financial assets such as stocks or bonds in a foreign country.

Foreign direct investment tends to involve establishing more of a

substantial, long-term interest in the economy of a foreign country. FPI
typically has a shorter time frame for investment return than FDI.

Unlike FDI, FPI does not offer control over the busisnes entity in which the
investment is made.

FDI FPI

Management Projects are Projects are less

efficiently managed efficiently managed

Involvement- Involved in No active involvement

direct or management and in management.
indirect ownership control; Investment
long term interest instruments that are
more easily traded ,
less permanent and
do not represent a
controlling stake in an
enterpreise.
 FDI FPI

Sell off It is more difficult to It is fairly easy to sell

sell off or pull out securities and pull out
because they are
liquid

Comes from Tends to be Comes from, more

undertaken by diverse sources i.e. a
multinational small company’s
organisations pension fund or
through mutual funds
held by individuals;
investemtn via equity
instruments (stocks)
or debt (bonds) of a
foreign enterprise.

What is Involves the transfer Only investment of

invested of non-financial financial assets
assets i.e. technology
and intellectual
capital, in addition to
financial assets

Volatility Having smaller in net Having larger net

inflows inflows