INTERNATIONAL

ECONOMICS
Prepared by:

SEVANDAL,
ROSEWIN L.
 INTERNATIONAL TRADE
focuses primarily in the real transactions in the
international economy , that is, on those transactions that
involve a physical movement of goods or a tangible
commitment of economic resources.
 THE BASIS FOR TRADE:
SPECIALIZATION
A. The Principle of Absolute Advantage (by Adam
Smith)
“When one nation is more efficient than (or has absolute advantage
over) another in the production of one commodity but is less
efficient than (or has absolute disadvantage with respect to) the
other nation can gain by each specializing in the production of the
commodity of its absolute advantage and exchanging part of its
output with the other nation for the commodity of its absolute
disadvantage” UNITED
Commodity / Country PHILIPPINES
STATES
Wheat (bushels/man-
6 1
hour)
Rice (kg/ man-hour) 4 5
US IS MORE EFFICIENT OR HAS ABSOLUTE ADVANTAGE
IN THE PRODUCTION OF WHEAT OVER THE PHILIPPINES
WHILE IT IS LESS EFFICIENT (OR HAS ABSOLUTE
DISADVANTAGE) IN RICE PRODUCTION. THEREFORE, IT
HAS TO SPECIALIZE IN THE PRODUCTION OF WHEAT AND
EXPORT PART OF IT TO THE PHILIPPINES IN EXCHANGE
FOR RICE.

Philippines is more efficient and has absolute advantage in rice over

the US but is less efficient (or has absolute disadvantage) in wheat
production. This implies that the Philippine has to specialize in the
production of rice and export part of it to US in exchange for
wheat.
B. THE LAW OF COMPARATIVE ADVANTAGE (DAVID
RICARDO)
According to Ricardo, even if one nation is less efficient than (or
has absolute disadvantage with respect to) the other nation in the
production of both commodities, there is still a basis for mutually
advantageous trade.
The first nation should specialize in the production of and export
the commodity in which its absolute disadvantage is smallest (this
is the commodity of its comparative advantage) and import the
commodity in which its absolute disadvantage is greatest (this the
commodity of its comparative disadvantage)

Commodity/country UNITED STATES PHILIPPINES

Wheat
6 1
(bushel/man-hour)
Rice (kg/man-hour) 4 2
the US absolute advantage is greater in wheat and so it has
comparative advantage in wheat.

The Philippines’ absolute disadvantage is smaller in rice so, it has a

comparative advantage in rice.

According to the Law of Comparative Advantage, both nations can

gain if the US specializes in the production of wheat and exports
some of it to the Philippines.

Note that in a two-nation, two-commodity world, once it is

determined that one nation has comparative advantage in one
commodity, the other nation necessarily has the comparative
advantage in the other commodity.
 FACTOR PROPORTIONS THEORY
“A nation relatively abundant in capital will export the relatively
capital-intensive goods for which domestic production requires
relatively large amounts of its relatively scarce factor, labor”

THE THEORY OF COMMERCIAL POLICY

Tariffs
are duties/taxes levied on imported goods either as a source of
revenue for the government or to protect the local
industries/sectors against import competition from the rest of
the world.
REASONS FOR IMPOSING TARIFFS

As a source of government revenue

Infant industry argument
Employment Argument

Types of Tariffs
Specific tariffs are levied as a fixed charged for each unit of
goods imported regardless of the value (i.e. $3/barrel of oil)

Ad Valorem tariffs are taxes imposed as a fraction of the

value of the imported goods (i.e. 25% of the value of imported
goods).
 THE COSTS AND BENEFITS OF TARIFFS
Consumer Surplus:
 measures the amount a consumer gains from a purchase by the
difference between the price he is willing to pay and what he
actually pays for the product.
 it is the area below the demand curve and above the
equilibrium price.
Producer Surplus
 refers to the gains derived by producer as measured by the
difference between the price he is willing to sell/dispose his
product and the accrual price he receives from the sale.
 is the area above the supply curve and below the equilibrium price
of the product.
EFFECTS ON THE DOMESTIC ECONOMY
(THE IMPORTING COUNTRY)
A tariff increases the price of the good in the importing country As
a result, the consumer lose in the importing country while the
producers gain since the consumer surplus declines while the
producer surplus increases
The government in the importing country gains revenue from the
imposition of the tariff

EFFECT ON THE FOREIGN COUNTRY

(THE EXPORTING COUNTRY)

If the importing country is a big country such that the volume of its
imports is large enough, there will be a decline in the price in the
exporting country since imports will decrease by so much causing
the demand to decrease. TABLE 1
WHAT ARE THE TWO EFFICIENCY LOSSES TO THE
NATION’S WELFARE OF A TARIFF?

1. Production distortion loss – results from the fact

that the tariff leads to domestic producers to produce
too much of a good which can be purchased more
cheaply abroad.

2. Consumption distortion loss – results from the fact

that a tariff leads consumers to consume too little of the
good due to high domestic prices.
What are the perceived/expected benefits
from a tariff?

• The offsetting gains of a tariff are represented

by the government revenue derived and the
terms of trade gains that arise because a tariff
lowers the foreign export prices.
• These gains depend on the ability of the tariff‐
imposing country to effectively use the
revenue and to drive the down foreign export
prices
What about tariff reduction?
Tariff reduction in agricultural products is one of
the commitments under the Final Act of the UR. That
is:

for industrialized countries, tariffs must be

reduced by 36% within six (6) years from the
year of GATT implementation
for developing countries, tariff reduction should
be 24% within ten (10) years and
for least developed countries, they are
exempted from tariff reduction
WHAT ARE THE EXPECTED EFFECTS OF
TARIFF REDUCTION?
The domestic price in the importing country declines and approach
the world price
There is a transfer of gains from producers back to consumers
Producer surplus or welfare gains of producers decline due to lower
prices
Welfare gains of consumers increase due to lower prices allowing
more demand and consumption
Tariff reduction eliminates production distortion losses because
there will be more efficient utilization or resources as these will be
redistributed according to the dictates of comparative advantage
Reduction in tariffs also eliminates the consumption distortion
losses because consumers can now enjoy more goods at lower
prices.
 NON – TARIFF BARRIERS TO TRADE
a) Import quota which limits the quantity of imports to some
specified level that is less than free trade quantity.
b) Limiting the amount of foreign exchange made available to do
importation of the good
c) Import ceiling is very similar to import quota. The government may
impose ceiling or maximum amount that an importer can buy from the rest
of the world.
d) International standards may be another way by which a
particular country can restrict importation from other countries.
Examples of these kinds include: ISO, HACCP, etc.

e) Sanitary and phyto – sanitary measures. This has something to do

with the country’s prerogative to protect human, animal and plant life and
health as well as the environment.
THE FOREIGN EXCHANGE AND FOREIGN EXCHANGE
MARKET
Foreign Exchange
 refers to the currency of the rest of the world rather than
one’s own currency
FOREIGN EXCHANGE MARKET
New York Foreign Exchange Market
London
Paris, Montreal
Tokyo and many others
Major Players in Foreign Exchange
Market
Commercial banks play a major role in
international transactions.
Corporations that are engaged in international trade and with
operations in several countries also receive and accept payments in
THE FOREIGN EXCHANGE AND FOREIGN EXCHANGE
MARKET

Foreign Exchange
refers to the currency of the rest of the world
rather than one’s own currency

FOREIGN EXCHANGE MARKET

institution for the exchange of one country's currency
with that of another country. Foreign exchange
markets are actually made up of many different
markets, because the trade between individual
currencies—say, the euro and the U.S. dollar—each
constitutes a market.
 Functions of the Foreign Exchange Market
a) International clearing
 The foreign exchange market provides services to its
clients in terms of converting one’s currency to another
to pay international obligations.
b)Hedging
 has something to do with the avoidance of foreign
exchange risks. It is a means of protecting oneself
against foreign exchange fluctuations.
c)Speculation
 is a process by which foreign exchange players/dealers
engage in the buying and selling of foreign currencies for
the purpose of gaining profits.
INSTRUMENTS OF FOREIGN EXCHANGE
Cable or telegraphic transfers.
 An importer in the Philippines with a payment to make
abroad would pay in pesos to the Philippine bank, which
would cable its branch or its foreign correspondent to
make the payment in foreign currency to the exporter
abroad
Bank Drafts
These are simply checks drawn by one bank on
another, sometimes used instead of telegraphic
transfers.
Letter of Credit (LC)
This may be denominated and make payable in the
currency either of the exporter or importer.
 THE EXCHANGE RATE SYSTEMS
1)Flexible ER is solely determined by the forces of supply and
demand for the foreign currency (i.e. US $)
2)Fixed/Pegged ER is a rate which is controlled by the Central
Bank (CB)
Changes in Exchange Rates
1) Changes in the supply and
demand conditions for US dollars.

Depreciation occurs
when there is a fall in
the value of the Peso
relative to the US dollar
 APPRECIATION
OCCURS WHEN THE
VALUE OF THE PESO
INCREASES
RELATIVE THE US
DOLLAR

2) Central Banks’s action through

devaluation or revaluation
Devaluation is a Central Bank’s action to reduce the value of the Peso
against the dollar. This occurs when the CB’s official reserves are not
enough to support the exchange rate pegged at a certain level.
Revaluation is also a Central Bank’s action that increases the value of
the peso against the dollar. When there is excess supply of dollars in
the economy, the CB has to buy the excess dollars so that the
exchange rate is maintained at a certain desired level.
Effects of Devaluation/Depreciation on Imports and Exports
Both will result to a decrease in the value of the Peso relative to the
US$. This means that, it is now more expensive to buy the same one
dollar worth of goods before the devaluation or depreciation
occurred
 IMPORTATIONS WERE DISCOURAGED, IMPORTS WILL DECREASE
An opposite effect on exports will happen. The foreigners will need
less amount of dollars to buy the same amount quantity of goods
before the devaluation/depreciation occurred.
Exports therefore will be encouraged , exports will increase

Effects of Devaluation/Depreciation on the

Balance of Payments

Since export earnings will increase due to increased exports

and import expenditures will decrease because there will be less
importations, then the balance of payment will be improved eventually
 THE BALANCE OF PAYMENT (BOP)
 is the country’s record of all transactions between its residents
and the residents of the rest of the world. In the other words,
the BOP records all the payments made by domestic citizens
to foreigners.
The BOP account of a particular country is broken down into:
1. The Current Account
It includes the following components:
Exports and imports of goods
Export and imports of services
Investment income
Net Transfers
2. Capital Account
3. Official Reserves
Transactions Account
 BOP DEFICIT/SURPLUS

a) BOP deficit
 occurs when the nation’s payments to the foreigners exceed the
receipts from them. This means that the domestic economy is
borrowing or accumulating debts from abroad.

b) BOP surplus
 occurs when the nation’s receipts from the rest of the world
exceed the payments made to them. This means that there is
growing domestic claims on foreign wealth. In other words, the
foreigners are accumulating debts/loans from the domestic
economy.
PROBLEMS WITH EXCESSIVE BOP
DEFICITS/SURPLUS
Why is an excessive BOP deficit a problem to the government?

If the projects that the draw on foreign funds are not well
planned, it could not generate the profits as expected to repay
the loan;
Due to large BOP deficits, foreign creditors may become
reluctant to extend new loans to a particular country and may
even demand immediate repayment of the previous loans;
This then will lead to the “loss of foreign investors’ confidence”
which could further worsen the problem.
WHY IS BOP SURPLUS STILL A PROBLEM TO A
PARTICULAR COUNTRY?
For a given level of domestic savings, an increase in foreign
investment means lower domestic investments in plant and
equipment;
This implies lower capital stock accumulation in the domestic
economy and therefore lower productive capacity;
This leads to worsening unemployment problems and lower
national income;
Countries with large BOP surplus may also become the targets
of discriminatory protectionist measures by the trading
partners with external deficits.
 TRADE RELATED ISSUES
GATT – UR – WTO
 GATT stands for the General Agreement on Tariffs and
Trade.
 It was formed in 1947 in Geneva initially with 23 countries in
attendance to promote multilateral cooperation in trade and
investments.
 Seven more rounds of meetings have taken place since 1947
until finally the Uruguay Round of Multilateral Trade
Negotiations was launched in September 1986 at Punta del Este,
Uruguay.
 After eight years of negotiations, the final agreements were
reached resulting to the signing of the Final Act of the Uruguay
Round on April 15, 1994 in Marrakesh, Morocco by 111 countries
(90% of world trade members).
  It generally calls for a more liberalized trade, which is a
paradigm shift from past practices of restricted trade and
protectionism.

The economic framework , which has been formally defined by

GATT – WTO calls for the expansion and stabilization of world trade
through the following:
1. Tariffication of quantitative restrictions (QRs)
2. Reduction of tariffs on all agricultural products
3. Reduction of domestic price subsidies
4. Reduction of Export subsidies
5. Market access commitments, and
6. Harmonization of sanitary and phyto – sanitary measures
WHAT IS URUGUAY ROUND
(UR)?
is the eight most ambitious rounds of GATT
negotiations. It seeks to expand world trade
based on comparative advantage in four ways:
1.Wider and deeper tariff cuts
2.A strong and more effective GATT
3.Eliminating exceptions to GATT’s universal
coverage of goods
4.Expanding coverage to make more relevant to
the global trading environment
What are the provisions of the Agreement on
Agriculture?

• Conversion of all quotas and other quantitative

restrictions (QRs) into tariffs, a process called
“tariffication” in GATT parlance.
• Tariff cuts
• Reduction of domestic subsidies Reduction of
export subsidies
• Harmonization of sanitary and phytosanitary
measures (SPS)
• Continuation of the reform process.
 WHAT IS WTO?
•Stands for a WORLD TRADE ORGANIZATION. It is a
permanent institution to replace GATT which has existed on a
provisional basis.
•It has an effective capacity and stronger powers to enforce
GATT rules and discipline among member – countries.
•Specifically, it provides trade negotiations and settlement of
trade disputes among contracting countries and it also provides
for trade policy review mechanisms and global policy coherence.
Results of GATT – UR – WTO
1. Liberalized trade
2. Administrative Reforms
THE E N D .