CHAPTER 7: INTERNATIONAL TRADE & FINANCE

Activity 1
This activity is based on the following weekly agricultural production and consumption information of
countries A & B.

• Production information.

Assume that both countries have 10 000 minutes per week available to produce two kinds of agricultural
goods (maize-based and animal-based products). The maximum units of the two kinds of agricultural
goods that country A can produce per week are respectively 5000 metric tons of maize-based products
and 2000 metric tons of animal-based products. The maximum units of the two kinds of agricultural
products that country B can produce per week are respectively 4000 metric tons of maize-based products
and 8000 metric tons of animal-based products.

𝑻𝒐𝒕𝒂𝒍
𝒕𝒊𝒎𝒆 𝒕𝒐 𝒑𝒓𝒐𝒅𝒖𝒄𝒆 𝟏 𝒖𝒏𝒊𝒕 𝒐𝒇 𝒑𝒓𝒐𝒅𝒖𝒄𝒕 = 𝒕𝒊𝒎𝒆⁄𝑴𝒂𝒙
𝒖𝒏𝒊𝒕𝒔

Minutes taken to produce 1 metric ton of the agricultural products

Maize-based Animal-based
Country A 𝟏𝟎𝟎𝟎𝟎𝒎𝒊𝒏 ⁄𝟓𝟎𝟎𝟎𝒕𝒐𝒏𝒔 𝟏𝟎𝟎𝟎𝟎𝒎𝒊𝒏⁄
= 𝟐𝒎𝒊𝒏 𝟐𝟎𝟎𝟎𝒕𝒐𝒏𝒔 = 𝟓𝒎𝒊𝒏
Country B 𝟏𝟎𝟎𝟎𝟎𝒎𝒊𝒏⁄ 𝟏𝟎𝟎𝟎𝟎𝒎𝒊𝒏⁄
𝟒𝟎𝟎𝟎𝒕𝒐𝒏𝒔 𝟖𝟎𝟎𝟎𝒕𝒐𝒏𝒔
= 𝟐. 𝟓𝒎𝒊𝒏 = 𝟏. 𝟐𝟓𝒎𝒊𝒏

• The pre-trade consumption pattern (in metric tons).

Maize-based Animal-based
Country A 600 1000
Country B 3000 700

Assume that the price ratio is 1:1 and that the two countries would trade 900 metric tons of maize-based
products for 900 metric tons of animal-based.

𝑶𝒑𝒑 𝑪𝒐𝒔𝒕𝑴𝒂𝒊𝒛𝒆−𝒃𝒂𝒔𝒆𝒅 = 𝑨𝒏𝒊𝒎𝒂𝒍 − 𝒃𝒂𝒔𝒆𝒅 𝒎𝒊𝒏⁄𝑴𝒂𝒊𝒛𝒆 − 𝒃𝒂𝒔𝒆𝒅 𝒎𝒊𝒏

𝑶𝒑𝒑 𝑪𝒐𝒔𝒕𝑨𝒏𝒊𝒎𝒂𝒍−𝒃𝒂𝒔𝒆𝒅 = 𝑴𝒂𝒊𝒛𝒆 − 𝒃𝒂𝒔𝒆𝒅 𝒎𝒊𝒏⁄𝑨𝒏𝒊𝒎𝒂𝒍 − 𝒃𝒂𝒔𝒆𝒅 𝒎𝒊𝒏

Opportunity cost ratios

Maize-based Animal-based
Country A
𝟓𝒎𝒊𝒏⁄ 𝟐𝒎𝒊𝒏⁄
𝟐𝒎𝒊𝒏 = 𝟐. 𝟓 𝒂𝒏𝒊𝒎𝒂𝒍 𝒃𝒂𝒔𝒆𝒅 𝟓𝒎𝒊𝒏 = 𝟎. 𝟒 𝒎𝒂𝒊𝒛𝒆 𝒃𝒂𝒔𝒆𝒅
Country B 𝟏. 𝟐𝟓𝒎𝒊𝒏⁄ 𝟐. 𝟓𝒎𝒊𝒏⁄
𝟐. 𝟓𝒎𝒊𝒏 𝟏. 𝟐𝟓𝒎𝒊𝒏
= 𝟎. 𝟓𝒂𝒏𝒊𝒎𝒂𝒍 𝒃𝒂𝒔𝒆𝒅 = 𝟐 𝒎𝒂𝒊𝒛𝒆 𝒃𝒂𝒔𝒆𝒅

New consumption combination for Country A:

Specialises in Animal-based
Maximum units of production of Animal-based (given) = 2000 tons
Export 900 tons of Animal-based
 Import 900 tons of Maize-based
After trade
Maize-based = 900 tons imported from Country B
Animal-based = Max units– exports = 2000 tons – 900 tons = 1100 tons
New consumption combination: 900 Maize-based & 1100 Animal-based

Gains from trade Country A

Gains from trade = new consumption – pre-trade consumption

Pre-trade consumption Animal-based = 1000 tons

New consumption Animal-based = 1100 tons
Pre-trade consumption Maize-based = 600 tons
New consumption Maize-based = 900 tons

Gains from Animal-based = 1100 tons – 1000 tons = 100 tons

Gains from Maize-based = 900 tons – 600 tons = 300 tons
Gains from trade Country A: 100 tons Animal-based & 300 tons Maize-based

New consumption combination for Country B:

Specialises in Maize-based
Maximum units of production of Maize-based (given) = 4000 tons
Export 900 tons of Mazie-based
Import 900 tons of Animal-based
After trade
Animal-based = 900 tons imported from Country A
Maize-based = Max units– exports = 4000 tons – 900 tons = 3100 tons
New consumption combination: 900 Animal-based & 3100 Maize-based

Gains from trade Country B

Gains from trade = new consumption – pre-trade consumption

Pre-trade consumption Animal-based = 700 tons

New consumption Animal-based = 900 tons
Pre-trade consumption Maize-based = 3000 tons
New consumption Maize-based = 3100 tons

Gains from Animal-based = 900 tons – 700 tons = 200 tons

Gains from Maize-based = 3100 tons – 3000 tons = 100 tons
Gains from trade Country B: 100 tons Maize-based & 200 tons Animal-based

Calculate/determine the following:

Task Answer
In which one of the two agricultural products should country A specialises? Animal-based
(lower opportunity
cost ratio)
In which one of the two agricultural products should country B specialises? Maize-based
(lower opportunity
cost ratio)
What is the new consumption combination for country A after trade? 900 Maize
&
1100 Animal
What is the gain of trade for country A? 100 tons Animal
&
300 tons Maize
What is the new consumption combination for country B after trade? 900 Animal
&
 3100 Maize
What is the gain of trade for country B? 100 tons Maize
&
200 tons Animal

Activity 2
Assume the following table. Calculate the RCA index for both product lines.

RCA = market share in product

total share of world exports

Total Maize-based Animal-based

products products
World exports $1000bn $50bn $60bn
Country A $50bn $8bn $6bn
exports
Share of = 𝟓𝟎⁄𝟏𝟎𝟎𝟎 × 𝟏𝟎𝟎 = 𝟖⁄𝟓𝟎 × 𝟏𝟎𝟎 = 𝟔⁄𝟔𝟎 × 𝟏𝟎𝟎
exports = 𝟓% = 𝟏𝟔% = 𝟏𝟎%
RCA index
= 𝟏𝟔⁄𝟓 = 𝟑. 𝟐 = 𝟏𝟎⁄𝟓 = 𝟐

In which of the two product lines does the country have a revealed comparative advantage?

RCA in Maize-based products

Higher RCA index and higher growth in share of exports

Activity 3
Assume that you want to import a particular kind of component that you want to sell in the South African
motor vehicle repair market. The unit price is $45 (the current exchange rate is R12 per $1). Your
intention is to import 1500 units of this particular component. Calculate the following.
Task Answer
Assume that the government is charging you an ad Step 1: calculate the unit price in Rand
valorem tariff of 25% per unit. What is the price (in = $𝟒𝟓 × 𝑹𝟏𝟐 = 𝑹𝟓𝟒𝟎 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕
South African rand) of this specific component per
unit? Step 2: calculate price per imported product
= 𝑹𝟓𝟒𝟎 + (𝑹𝟓𝟒𝟎 × 𝟐𝟓%) = 𝑹𝟔𝟕𝟓 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕
What is the total tax revenue that the government Total tax revenue
will collect if you import the 1500 units? = (𝑹𝟓𝟒𝟎 × 𝟐𝟓%) × 𝟏𝟓𝟎𝟎 = 𝑹𝟐𝟎𝟐𝟓𝟎𝟎
Assume that the government also imposes a Composite tariff per unit
further specific tariff of R10 per unit on these = 𝑹𝟓𝟒𝟎 + (𝑹𝟓𝟒𝟎 × 𝟐𝟓%) + 𝑹𝟏𝟎
components. What is the composite tariff per unit? = 𝑹𝟔𝟖𝟓 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕

Activity 4
You are given the following information about South Africa's international trade in 20X17:
The exchange rate is R13/$
Balance of payments surplus = R40 billion

BOP = current account (X – Z) + financial account (FDI + portfolio investment)

Rand appreciates/US$ depreciates if exchange rate moves from R13/$ to R10/$

(dollar is less valuable in terms of rand because we need less rand to buy $1)
Same as saying:
(rand is more valuable in terms of dollars because we need less rand to buy $1)

Rand depreciates/US$ appreciates if exchange rate moves from R13/$ to R15/$

(dollar is more valuable in terms of rand because we need more rand to buy $1)
 Same as saying:
(Rand is less valuable in terms of dollars because we need more rand to buy $1)

Task Answer
There was a deficit of R85 billion on the current account at the end BOP = CA + FA
of 20X17. What was the state of the financial account of the BOP? 40bn = -85bn + FA
FA = 40bn + 85bn = R125bn
inflow/surplus
Ceteris paribus, if the exchange rate should change to R10/$, what Rand has appreciated (US$
do you expect would happen to South African exports to the USA. depreciated)
Exports will decrease

Activity 5
Assume the following exchange rates: R13.25/$ and €2.25/$.
Cross rate Rand/€ exchange rate:

Using direct quotations

R/€ = R13.25/€2.25 = R5.88
€1 = R5.88

Using indirect quotations

R1 = $0.075
€1 = $0.44
R/€ = 0.075/0.44 = €0.17
R1 = €0.17

Task Answer
What is the indirect quotation for the Rand/$ exchange rate?
= $𝟏⁄𝑹𝟏𝟑. 𝟐𝟓 = $𝟎. 𝟎𝟕𝟓/𝑹
What is the cross rate for the Rand/€ exchange rate? R5.88/€ direct quotation
€0.17/R indirect quotation
Assume you want to buy a piece of clothing that will cost you €20. €𝟐𝟎 × 𝑹𝟓. 𝟖𝟖 = 𝑹𝟏𝟏𝟕. 𝟔
What will this piece of clothing cost you in South African Rand? or
€𝟐𝟎⁄
€𝟎. 𝟏𝟕 = 𝑹𝟏𝟏𝟕. 𝟔
Assume that the exchange rate changes to R12.85/$. Is the South
Rand is appreciating
African Rand appreciating or depreciating?

Activity 6
Assume that the spot rate is R12.45/$ in the South African currency market but the spot rate is R12.12/$
in the US currency market. Answer the following questions that deals with the sequence of arbitrage in
the currency markets.

$1 costs R12.45 in South African currency market

vs
$1 costs R12.12 in US currency market

Trading rule:
Buy low: Buy dollars in US currency market (assuming $100 - cost R1212)
Sell high: Sell dollars in South African currency (assuming $100 – receive R1245)

Task Answer
On which of the two currency markets will you buy US
Buy dollars in US currency market
dollars?
On which of the two currency markets will you sell US Sell dollars in South African
dollars. currency market
 Assume that you have R121 200 available to speculate in
the currency markets. What amount of US dollars will you = 𝑹𝟏𝟐𝟏𝟐𝟎𝟎⁄𝑹𝟏𝟐. 𝟏𝟐 = $𝟏𝟎 𝟎𝟎𝟎
buy?
Assume your previous answer. What will you sell this
= $𝟏𝟎 𝟎𝟎𝟎 × 𝑹𝟏𝟐. 𝟒𝟓 = 𝑹𝟏𝟐𝟒 𝟓𝟎𝟎
amount for?
What is the profit (in South African Rand) that you can make = 𝑹𝟏𝟐𝟒 𝟓𝟎𝟎 − 𝑹𝟏𝟐𝟏 𝟐𝟎𝟎
through arbitrage in these spot currency markets? = 𝑹𝟑𝟑𝟎𝟎 𝒑𝒓𝒐𝒇𝒊𝒕

Activity 7
Assume that the following exchange rates in the currency markets are R16.45/€, $1.35/€ and R12.95/$.
You have R16 450 available to speculate with in the currency markets. Answer the following questions
that deals with the sequence of arbitrage in the currency markets.

Step 1: Calculate the cross rate

R/$ market rate = R12.95 (given)
vs
R/$ cross rate = R16.45/$1.35 = R12.19
Trading rule:
Buy low: Buy Euro
Sell high: Sell dollars
R/$ market rate > R/$ cross-rate therefore sell dollars in the market

Step 2: Take R16 450 and buy Euro at market rate of R16.45/€
R16 450 /R16.45 = € 1000

Step 3: Take €1000 and buy dollars at $1.35/€

€ 1000 x $1.35 = $1350

Step 4: Take $1350 and buy Rand at market rate R12.95/$

$1350 x R12.95 = R17 482.50

Step 5: Calculate profit

R17 482.50 – R16 450 = R1 032.50

Task Answer
What will you buy with your R16 450 and what amount of that buy Euro at R16.45/€
specific currency?
R16 450 /R16.45 = € 1000
Given your previous answer, what other currency (and amount) will Take €1000 and buy dollars at
you purchase? $1.35/€

€ 1000 x $1.35 = $1350

Given your previous answer, what are your proceeds in South Take $1350 and buy Rand at
African Rand when you sell the foreign currency in the currency R12.95/$
market?
$1350 x R12.95 = R17 482.50
What is the profit (in South African Rand) that you can make R17 482.50 – R16 450 = R1
through arbitrage in these currency markets? 032.50

Activity 8
Assume that the current spot rate is R12.35/$ and the six-month forward rate is R11.85/$. You have R11
850 available to speculate with. You are betting on an exchange rate of R14.15 in six months’ time.
Answer the following questions that deal with the sequence of transactions in the spot and forward
currency markets.

Market expects appreciation if: current spot rate > 6m forward rate
Market expects depreciation if: current spot rate < 6m forward rate
 You expect appreciation if: your bet in 6m time < 6m forward rate
You expect depreciation if: your bet in 6m time > 6m forward rate

Arbitrage
Step 1: take R11 850 and buy dollars at 6m forward rate R11.85/$
R11 850/R11.85 = $1000

Step 2: take $1000 and sell at spot rate 6m from now R14.20/$
$1000 x R14.20 = R14 200

Step 3: calculate profit

R14 200 – R11 850 = R2350

Task Answer
Is the market expecting the South African Rand to depreciate or to The market expects an
appreciate over the next six months? appreciation of the Rand
(R12.35/$ > R11.85/$)
Are you betting on the South African Rand to depreciate or to You expect the Rand will
appreciate of the South African Rand? depreciate
(R14.15/$ > R11.85/$)
What will you do with your R11 850? take R11 850 and buy dollars
at 6m forward rate R11.85/$

R11 850/R11.85 = $1000

Assume that the exchange rate at the end of six months is R14.20. take $1000 and sell at spot
Explain briefly what you would do on the exchange markets. rate 6m from now R14.20/$

$1000 x R14.20 = R14 200

What is the profit that you are making on the currency markets? R14 200 – R11 850 = R2350

Activity 9
Assume the theory of purchasing power parity (PPP). Assume that the current US dollar/Rand exchange
rate is R12.45/1$. The average price of a product A is R60 in South Africa while the price of the same
product is $4.80 in the US.

Task Answer
What should the PPP-based R/$ exchange rate be, R60 = $4.80
ceteris paribus? = 𝑹𝟔𝟎⁄$𝟒. 𝟖𝟎 = 𝑹𝟏𝟐. 𝟓𝟎/$

Activity 10
This activity deals with impacts on the demand-for-dollar curve, the supply-of-dollar curve and the
Rand/$ exchange rate.

Description Answer
Assume a net increase in the imports of goods, ceteris paribus.
Indicate the impact on the demand-for-dollar or the supply-of-dollar Increase in imports = increase
curves. in demand for foreign currency

demand-for-dollar curve shifts

rightwards

Assume the previous question. Wil the Rand/$ exchange rate

Depreciate
appreciate or depreciate?
Assume a net purchase of South African shares on the Increase in investment inflows
Johannesburg Stock exchange, ceteris paribus. Indicate the = increase in supply of foreign
impact on the demand-for-dollar or the supply-of-dollar curves. currency

supply-of-dollar curve shifts

rightwards
Assume the previous question. Wil the Rand/$ exchange rate
Appreciate
appreciate or depreciate?