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Macroeconomics : International Trade and Balance of Payments : Chapter 19

International trade plays a major role in the economic development of a country. There are two schools of thought as regards trade. One school favors free trade while the other advocates protectionism. According to the theory of absolute advantage, if a country can produce a good cheaper than other countries, it would have absolute advantage in the production of that good. Countries should produce and export surpluses of goods in which it has absolute advantage and buy whatever else they need from other countries.

According to the theory of comparative advantage, each country should produce a good in which it has a comparative advantage. The Heckscher-Ohlin model states that there are two types of products – labor intensive and capital intensive. The labor-rich country is likely to produce labor-intensive goods, while the country rich in capital is likely to produce capital-intensive goods.

The two countries will then trade in these goods and reap the benefits of international trade. Imitation Gap theory considers the possibility of trade between two countries having the same factor endowments and consumer tastes. The International Product Life-Cycle (IPLC) theory, explains various stages in the life of a product and the resultant international trade. A closed economy is an economy which has minimal interaction with other economies in the world.

An open economy is an economy which interacts with other nations to exchange goods, services, and investments. Trade between open economies can be strengthened by economic integration.

To protect domestic industries from competition, government imposes barriers. The barriers can be both tariff and non-tariff. Tariff barriers include advalorem duties, specific duties and compound duties. Non-tariff barriers include quotas, subsidies, licensing, administered protection, and health and safety standards.

The world is becoming an integrated market place and trade equations are changing rapidly. Realizing the importance of private capital inflow for the development of a country, many countries are taking numerous measures to attract foreign investors. Balance of Payment (BoP) can be defined as a systematic record of all economic transactions between the residents of the reporting country and the residents of the rest of the world.

Disequilibrium in the BoP can be corrected with the help of both monetary and non-monetary measures. Monetary measures include deflation, exchange rate depreciation, devaluation and exchange control. Non-monetary measures include tariffs (import duties), import quotas and export promotion polices and programmes.

Exchange rate means the price of one currency in terms of another. Exchange rates are either fixed by governments or determined by the market forces. The two basic exchange rate regimes are the fixed exchange rate and the floating/flexible exchange systems.

Chapter 19 : Overview


Basis Of International Trade
Theory of Absolute Advantage
Theory of Comparative Advantage
Heckscher-Ohlin Theory Imitation-Gap Theory
International Product Life Cycle Theory

Barriers To International Trade
Tariffs
Non Tariff Barriers

Trends In International Trade
Closed Economy
Open Economy
Role of WTO
Economic Integration
Forms of Economic Integration

Balance Of Payment And Its Components
Causes And Types Of Disequilibrium In Bop
Measures To Correct Disequilibrium
Monetary Measures
Non Monetary Measures

Exchange Rate Policy
Historic Perspective of Foreign Exchange Rate System
Types of Exchange Rate System

India's Balance Of Payment And Trade Policy
The Crisis of the Early 1990s
Trade Policy