International trade is the exchange of goods and services across international borders or

territories.

Industrialization, improved transportation, Globalization, Multinational Corporation and

advancement in technology have all had major impacts on the international trade system .

When there is international trade countries purchase foreign countries products which they
cannot produce(imports) and they sell products they can produce(exports)

Concepts in international trade:

1. Closed Economy-Is one that does not engage in international trade.

2. Open Economy -This is one that engages in international trade and as such they export
and import goods and services. They have both a domestic and foreign market
Some economies are more open than others eg Guyana, Trinidad and Barbados , USA,
India etc compared to Venezuela and Cuba

Protectionism

This is the policy of protecting home industries from foreign competition, this is done through the
imposition of trade barriers on imported goods and services. Eg up until 2006 the Caricom
countries protected the cement industries by placing external tariffs on cement imported from
outside the region.eg from DR USA and China.

Free trade:

This is a policy of imposing no restrictions on the movement of goods and services between
countries. Increasingly more countries are engaging in free trade because they find it beneficial.
The main body concerned with Trade between countries is the World Trade Organization. It
has over 160 members and it was set up on 1st Jan 1995.
-It's objective is to reduce trade restrictions.
-Provide an impartial/unbiased means of settling disputes
-Help global trade flow as freely as possible

Specialization
This is the concentration of effort into a particular activity or a narrow range of activities. The
main advantage of specialization is :
1. Greater output- It is for this reason many countries focus on producing few goods and
services that there are good at making . Their aim is to produce a surplus and then trade
with other countries.
The principles/Theories of international Trade

1.Adam Smith's Theory of Absolute Advantage

A country is said to have an absolute advantage in production if it can produce more
goods or services than another country by using the same amount or fewer
resources/factors.
This suggests that having an absolute advantage, a country is able to more productively
efficient than the other country. Therefore, Smith suggested If another country has an
absolute advantage in the production of some other good, these two countries can
specialize and focus their resources on whichever good they have the absolute
advantage and trade.
Examples
Assume that there are two countries US and Canada and they produce two goods
(shoes and shirts). The resources of both countries can be used to produce either shoes
or shirts for their consumption. Both countries make both products, spending half of their
working hours on each .

Table A
Countries Shoes Shirts

USA 100 75

Canada 80 100

Total 180 175

From the example above the US makes more shoes than shirts and Canada makes
more shirts than shoes, The suitable thing to do by using the theory of absolute
advantage is for each country to specialize in whichever they can produce more of . The
US should only make more what they are good of (which is shoes) and for Canada
it would be shirts.

Table B
Countries Shoes Shirts

USA 200 0

Canada 0 160

200 180
They would now have more shoes and shirts . The United States can trade 100 units of
shoes for 80+ units of shirts. By doing this both countries would benefit and consume at
higher levels.

Even if one country is more efficient in production of all goods(produce more of both
goods ) than their counterparts, both countries can still gain by trading with each other
as long as they both have different opportunity costs /relative inefficiencies.

Ricardian Model of Comparative Advantage - (David Ricardo)

A country is said to have a comparative advantage in the production of goods

when it can do so at a lower opportunity cost than the other country . The principle
of comparative advantage shows that the absolute cost does not matter for international
trade but the opportunity cost of production. The opportunity cost of production of a good
can be measured in terms of how much the production of a good needs to be reduced
in order to increase the production of another good by one more unit . The theory of
comparative advantage was put forward by David Ricardo and it is for this reason it is
called the Ricardian model.

Assumptions of the comparative Model

1. Two equal sized countries, two goods- this theory assumes this because the
principles are clearer and easier to follow .
2. There is full employment of resources; if one or the other of the economies have
less than full employment or factors of production then this is excess capacity .
3. Perfect mobility of production in a country- This is necessary to allow production
to be switched with cost between the goods.
4. Constant Opportunity Cost- the opportunity cost at any quantity remains the
same.
5. Perfect competition
Example
Suppose we have two countries of equal size France and Germany that both produce and
consume two goods . Cars and Trucks . Their productive capacities results in the following:

Cars Trucks

France 200 400

Germany 600 1500

Total Q(output) 800 1700

Germany has an absolute advantage over France in the production of both. There seems to be no
mutual benefit to trade
However comparative advantage and opportunity cost shows otherwise.

Cars Trucks

France OC Cars-(400/200)=2 OC trucks=200/400 =0.5

France has to give up 2 trucks France has to give up 0.5 car
to get 1 car(2oc) to get 1 truck(0.5 OC)

Germany OC Cars-G (1500/600)=2.5 OC Trucks-G(600/1500)=0.4

Germany has to give up 2.5 Germany has to give 0.4 cars
units of trucks to get 1 Unit of to get 1 truck (2oc)
cars(2.5oc)

Formula for opportunity cost= Quantity of good given up/ Quantity of good gained
Observations;
France has a comparative advantage in Car production (with a smaller opportunity cost of 2 units
compared to France's opportunity cost of 2.5 units of trucks for 1 car).
On the other hand Germany has a comparative advantage in the production of Trucks (0.4 units of
cars has to be given up to get 1 truck) whereas Germany has to give up 0.5 Cars to get 1 truck.

These countries can benefit by trading goods. They can do so by specializing in the production of
the goods they have the lower opportunity cost , this means they can produce it at a relatively
cheaper price compared to the other country .
Total output with specialization would be higher than without specialization.

Cars Trucks

France 800 00

Germany 00 2000

Total q(output) 800 2000

EG. 2

In the table Below Country A produces more of both goods(Wheats and Fruits) than Country B.
There one might think that there is no benefit for engaging in International Trade for country A.

Wheats(W) Fruits(F)

Country A 100 50

Country B 5 20

Total q(world output) 105 70

Caluculating Opportunity Cost

Formula for opportunity cost= Quantity of good given up/ Quantity of good gained

Wheats(W) Fruits(F)

Country A OC Wheat= (50/100) =0.5 OC Fruit= (100/50) =2

This means A has to give up THis means country A has to
0.5 Fruit to gain 1Wheat give up 2 units of wheat to get
1 Fruit

Country B OC Wheat= (20/5)=4 OC Fruit=( 5/20) =0.25

B has to give up 4 fruits to gain B gives up 0.25 fruit to gain 1
1 wheat wheats

Clearly Country A has a lower opportunity cost in producing wheat(0.5 compared to 2), and
Country B has a lower opportunity cost in the production of Fruits(0.25 compared to 40.
Therefore these two countries may specialize(or in some cases partially specialize) in the good
they are better at producing.

The table below now shows the result of specialisation due to comparative advantage .
Wheats(W) Fruits(F)

Country A 200 0

Country B 0 80
 Total q(world output) 200 80

By specialising the world output is now higher for both goods.

Gains from Trade

These are the advantages a country obtains as a result of trade . If there were no trade each
country would have to be self-sufficient .The following are :

1. Consumer Benefits- There is a bigger and better range of goods and services which they
would not have been able to consume otherwise. These additional goods on the local
market may even lead to lower prices overall.
2. Benefit to producers- Local producers gain from trade when the goods and services are
sold abroad in foreign markets, These producers enjoy economies of scale and this can
mean higher profits. Cheaper prices may even be trickled down to consumer.eg
Japanese MNCs such as Sony and Toyota.

3. Innovation - Trade promotes innovation within an economy as countries that have reduced
trade barriers tend to be fast growing economies and possess more technological innovation
Japan, South Korea, Singapore, USA

4. Foreign Exchange - An economy earns an increased amount of foreign exchange through

international trade. This facilitates growth and development.

5. Access to capital goods made overseas - The Caribbean region is highly dependent on
sourcing equipment and technology that is made in the industrialized world.

6. Leads to global efficiency - Just like new technology adds to efficiency and productive
capacity. International trade can cause GDP to increase global productive capacity .

Disadvantages of International Trade:

1. International Trade can make a country dependent on other countries for vital goods, e.g.
food stuff. Eg. if prices increase or these countries have a dispute, the importing countries will
suffer.

2.International Trade exposes domestic industries to unfair foreign competition. Foreign firm
may be well established and able to produce better quality goods compared to local
counterparts.

3. Developing countries trade primary products such as minerals and agriculture produce.
When these countries deplete their resources from continuous trade they will no longer
have other alternatives.
Factors that influence International Trade

When a country participates in International trade ,they export and import goods.

The import Side:

1. Domestic Income Levels- Higher income enables consumers to purchase more imports
while lower incomes means less imports.
2. The domestic currency value- -When the value of the domestic currency appreciates
(rises compared to other currencies ) consumers are persuaded to buy foreign products
since they are now relatively cheap and it takes less domestic currency to buy more
units of a foreign one
3. Quality of domestic goods and services vs foreign goods and services - If domestic
goods are of low quality when compared to imported goods they country will obviously
import and vice versa.
The only way a country may import low quality goods from foreign is if they are at cheap
prices. Eg China

4. Availability of items locally- If items especially necessities are not produced locally a
country will have to import the commodity( Foodstuff, Clothing, Oil, etc)

5. Information about the mass media and changing tastes of consumers - The western
world and culture has influenced the lifestyle of many other countries, especially the
Caribbean . This has the effect of electronics, clothes, shoes and other products being
brought into the Caribbean

6. Tariff/ Tax rates- If taxes are low people may import more

Export Side
1.Foreign Income
When foreign consumers enjoy high income, they will be inclined to purchase products
manufactured in other countries.

2.Foreign Currency Value- When a domestic currency depreciated against a foreign currency,
the domestic goods are now relatively cheaper for foreign consumer, these foreign consumers
then buy more units, leading to higher exports.

3. Domestic Product prices vs foreign product prices - If domestic prices are high compared to
foreign product prices the country will no longer be able to export a large quantity of goods
however if they are low, exports will be high .

4. Quality of goods produced locally - If local goods are of high quality compared to foreign
goods, export demand will be high, however the opposite is true, if local goods are of poor
quality exports will be low.

Trade Liberalization Vs. Trade Protection

Trade liberalization is the removal/reduction of restrictions or barriers to encourage free

exchange of goods between nations.

Trade protection is the deliberate attempt to limit imports or promote exports by putting
up barriers to trade.
Trade protection refers to the policies to prevent trade despite the many benefits of free
trade. If a country is trying to reduce imports to support a local industry or business, it is
referred to as protectionism.

Problems with trade protection:

1. Consumer welfare is reduced due to higher prices and consumer restricted

quantities.
2. Fims that are protected from competition have little incentive to be productively
efficient.
3. It may also lead to retaliation of other countries.

The opposite of trade protection is trade liberalization. Where Greater trade among
nations is encouraged.
Types of trade protection/barriers to trade.

1. Tariffs - This is a tax /duty placed on goods imported into a country . Tariffs increase the
price of imports. Like all indirect taxes , tariffs have the impact of reducing supply and
raising the equilibrium price of imports . This gives a competitive advantage to home
goods and services as their prices become more attractive.
2. Quota - a certain quantity limit on the amount of goods that can be imported into a
country at a given time.
Effects of a quota
It leads to a higher equilibrium price since supply is reduced. By introducing quotas, a
government may be able to reduce the trade deficit and improve the BOP position however
Just as tariffs the impact prevents the domestic consumer from benefitting from the advantages
of international trade (lower prices and variety) .

3. Export promotions/subsidies - In this, the government pays money to its own farmers to
help keep prices down and make imports seem less attractive . The government can
also promote exports through exhibitions, trade fairs and market research . The benefit
of export promotion is that it improves the BOP position.
4. Import Standards- A country may institute certain product requirements that may make it
difficult or expensive for importers to comply with. This method, just as the previous
ones, will reduce the supply of imports on the domestic market . This will lead to higher
equilibrium prices and people will consume more domestic content.
5. Minimum Domestic Content- This is a requirement that states some percentage of the
products content must be from the domestic economy . e.g the local content law
6. Import substitution - A country may resort to import substitution when they reduce the
volume of imports and try to be self-sufficient. To make this possible the government
must give special care to certain industries such as tax concessions, technical
assistance, subsidies and provision of in-puts, This is another way of protecting trade
and growing small industries.
7. Embargo- This is the most drastic form of trade protection . This is a complete ban on a
product , a group of products
Arguments for free trade/ Arguing against trade protectionism.

1. Greater choice for consumers

2. Open domestic markets to more competition and this increases efficiency and reduces
monopolies.
3. Creates larger markets to domestic firms which will allow them to benefit from
economies of scale, this results in lower prices for consumers.
4. Imports can satisfy excess demand that domestic producers cannot fulfill(Good that are
not available locally is imported)
5. Encourages interdependence between nations and cooperation. This results in better
trade relations and less likely to have conflict.
.

Arguments for trade protection/ arguments against free trade

1. To protect infant industries-This is one of the oldest arguments in favor of tariffs . By

protecting new industries from established foreign competition ,a tariff can give a
struggling industry time to become an effective competitor. A trade protection measure is
an attempt to prevent or reduce cheaper foreign goods on the local market in an attempt
to boost small local industries.
2. The job protection argument- Supporters of this argument especially unions saying that
tariffs should be used to keep exports high and allow local businesses and by extension
local jobs to flourish . By producing locally, local jobs will be protected and the economy
is able to develop.
3. To lower or prevent balance of payment(BOP) deficits /or improving the bop- tariffs,
quotas embargoes or any other policy are used to assist in reducing imports relative to
exports in order to bring equilibrium in the country's BOP by improving its current
account . This is used mainly by developing nations.
4. To raise revenue for the government - Tariffs allow governments to raise revenue , this
is particularly important for many developing countries such as the Caribbean which may
lack methods of raising revenue.
5. To prevent dumping- Dumping is a kind of predatory pricing on the international stage. It
occurs when manufacturers export a product to another country at a price below
charged in this market or even below the cost or production . For many small countries
this can have a devastating effect on the local firms ability to trade and compete. Hence
the imposition of a tariff can make the prices of these cheap foreign goods equal to the
prices of the more expensive domestic market.

Trade Ratios
Terms of trade
The terms of trade is a ratio of export prices to import prices. it can be calculated by the
following formula :

Terms of trade index = (Export price index/ Import price index ) x 100

The export price index is the weighted average of export prices while the import price index is
the weighted average of import prices.
The terms of trade show how much imports a given quantity of exports can buy .

When calculating the base year value for both export and import price index is 100 and data for
all other years are measured against the base year.

Year Export Prices Index Import Prices index Terms of trade

2010 100 100 (100/100) x100=100

2011 120 115 (120/115) x100=104

2012 130 110 130/110) x100=118

2013 125 130 126/130x100=96

Interpretation
1. For 2010 It can be interpreted as for every 100$ paid for imports, 100$ was received for
exports.
2. For 2011 -It can be interpreted as for every 100$ paid for imports, 104$ was received for
exports.
3. For 2012 It can be interpreted as for every 100$ paid for imports, 118$ was received for
exports.
4. For 2013 It can be interpreted as for every 100$ paid for imports, 96$ was received for
exports.
A rise in the value of the terms of trade index is described as a favorable movement of the TOT.
This means a given number of exports can now buy more imports, The terms of trade have
improved. A fall in the value of the terms of trade index is described a unfavorable. This means
a given number of exports can now buy fewer imports, The terms of trade have deteriorated.
Elasticity of Demand for Exports -

The elasticity of demand for exports is a measure of responsiveness for the demand of exports
to a general increase or decrease in their prices (change in price) .

Export elasticity of demand = % Change in quantity of exports / % Change in export prices(hint

use export price index)

Import elasticity of demand - This is a measure of the responsive menss for the demand of
imports to a general increase or decrease in their prices .
Import elasticity of demand =% Change in quantity of imports/ % change in import prices(hint
use import price index)

Importance of Import elasticity of demand and Export elasticity of demand

It is important to be cautious about using the Terms of trade to associate it with benefits and
improvements. If the price of exports of your country rises relative to the price of imports it
means the terms of trade have increased or improvised (however it does not account for
increase in the price of exports due to inflation or other negative factors).

The Terms of Trade do not tell the full story in terms of the gains for the country .

If the demand for exports is relatively elastic, your country will eventually sell fewer exports as a
result of the increase in export prices and will be worse off (despite there being an improvement
in terms of trade. On the other hand if the demand for export prices is inelastic the country may
prefer this since they are able to charge foreigners with higher prices. This is because the
quantity change in demand is less than any potential increase in export prices

We must also consider the import of elasticity. If demand for imports in your country is relatively
inelastic this means that citizens will still buy foreign products even if the price increases .Hence
it is also important to not only consider terms of trade but import elasticity of demand .

Eg n the following information was revealed for country A

 Year Export Index Import index Export (M)$ Import( M)$

1 100 100 500 600

2 120 105 400 580

Terms of trade year 1 = (export index /import index ) x 100

=(100/100) x100
=100

Terms of trade year 2 = (export index /import index ) x 100

= (120/105) x 100
=114

3. Export elasticity of demand = % Change in Exports/ % Change in export prices

(New Exports-Old Export/Old exports) x 100
= —---------------------------------------------------------
(New Price Index- Old Price Index/ Old Price Index) x 100

=( 400-500/500) x 100 = -20%

—-----------------------------------
(120-100/100) x 100 = 20%

=--20%/20%
=-1 -elastic

4. Import elasticity of demand = % Change in imporports/ % Change in import prices

(New Imports-Old Import/Old Imports) x 100
= —---------------------------------------------------------
(New Price Index- Old Price Index/ Old Price Index) x 100

=( 580-600/600) x 100 = -3.3%

—-----------------------------------
(105-100/100) x 100 = 5%%

=-3.3%/ 5%
= -0.66 -inelastic
Conclusion. According to the terms of trade Analysis the country should be in a better position
as terms of trade have improved. For every 100$ spent on imports the country receives $114 in
exports. However, when analyzing the elasticity of both import and export, it does not reflect the
same sentiment. The export elasticity is elastic meaning a larger percentage of foreigners will
desist from the home country’s product when the price increases. Additionally, import is inelastic
meaning foreigners will still buy imports.

N.B you’re using the index as prices for both imports and exports.