Notes on Trade

CHAPTER 17

INTERNATIONAL TRADE

WHAT IS TRADE?

It refers to the exchange of goods and services among the people, region and countries, often for exchange of money.

NEEDS / REASONS FOR TRADE

1.      To exchange the desired goods and services.

2.      To earn foreign exchange.

3.      To maintain and promote international cooperation/relations.

4.      For transferring various modern technologies.

5.      Specializing in the production of certain commodities.

TYPES OF TRADE

1.      Internal/Domestic Trade – The exchange of goods and services between individuals within the geographical boundary of a country.

2.      External/International Trade – The exchange of goods and services among the citizens of the different countries.

DIFFERENCES BETWEEN DOMESTIC AND INTERNATIONAL TRADE

Aspects / Areas	Internal Trade	External Trade
Political Boundary	Exchange of goods and services within the domestic territory of a country.	Exchange of goods and services outside the country
Nationals	People involved for trade are the citizens of the same country.	People involved for trade are the citizens of different countries.
Difference in Currency	Local Currency is used for all the transactions of goods and services.	Foreign Currencies are used for trade purposes.
Mobility of Resources	Factors of production are completely mobile.	Factors of production are completely immobile.
Restriction on Export & Import	There are no restrictions on the flow of trade between two regions of the same country.	There are restrictions on trade between two or more countries.

ADVANTAGES / MERITS OF INTERNATIONAL TRADE

1.      Varieties of Goods

Through international trade a country can be available with varieties of goods and services. This can bring an improvement in the quality of life and living standard of the people.

2.      Competition

International trade also promotes competition among countries in the international market for their existence. As a result there is an innovation of products in the market and it reduces the monopolistic exploitation of consumers.

3.      Specialization

Every country is able to focus in the production of the commodity of its greatest advantage (commodity that can be produced at the cheaper cost). 

4.      Cheaper Goods

Due to heavy competition and greater division of labour and specialization, goods will be cheaper in the international market.

5.      International Cooperation

Through international trade, side-by-side, countries are also able to maintain and strengthen the relations and come closer to each other.

DISADVANTAGES / DEMERITS OF INTERNATIONAL TRADE

1.      Economic Instability

International trade is the source of economic instability. Through international trade there is always the possibility of situations of booms and depressions present in one country being transmitted to other countries.

2.      Exploitation

There is always the possibility of advanced nations exploiting the underdeveloped countries as by charging high prices for their commodities.

3.      Dislodging of Domestic Industries

The import of cheaper goods from outside may affect the domestic industries producing similar goods. It may lead in dislocation and unemployment of resources.

4.      Unemployment

Under foreign trade, when a country tends to specialize in a few products, job opportunities available to people are curtailed leading to more unemployment problems.

5.      Dumping of old Technology

Through international trade, with the exchange of goods and services simultaneously there is also transmission of varieties of technological applications. Therefore, there is a chance of dumping old technology, especially in the underdeveloped and developing countries.

ADVANTAGES AND DISADVANTAGES OF INTERNAL TRADE

Advantages	Disadvantages
1.      High Demand for domestic commodities. 2.      Employment opportunities. 3.      Preservation of culture and tradition. 4.      No political interference.	1.      Slow pace of Development. 2.      Difficult to face Natural Calamities. 3.      Choice of Commodities will decrease. 4.      Exploitation of Consumer.

What is a Trade Union?

An organization of workers or employees formed mainly to negotiate with the employers on various employments related issues, improvement of terms and conditions of their workplace and enhance their status in the society.

What is Free Trade?

It is the unrestricted sale and purchase goods and services between the nations.

  

BASIS OF INTERNATIONAL TRADE - How does Trade take place?

There are TWO theories propounded to prove the basis of international trade:

1.      The Absolute Cost Theory

2.      The Comparative Cost Theory

THE ABSOLUTE COST THEORY

According to Adam Smith, the basis of international trade is the difference in absolute cost of production of commodities in different countries. The theory states that “a country will specialize and export those commodities which it can produce at a lower cost compared to other countries”. Thus, absolute cost differences arise when each of the two countries can produce some commodities at an absolutely lower cost than the other. This theory can be illustrated through a simple example as given below:

Production	Cost of Production (in US Dollar)
	Bhutan	Japan
Mushroom	1,500	2,000
Apples	2,000	1,000

The above table shows that Bhutan has an absolute advantage in the production of mushroom because cost of production is only 1,500 US $ and Japan has an absolute advantage in the production of apples (production cost is only 1,000 US $). Thus, Bhutan and Japan will specialize in the production of mushroom and apple respectively. Therefore, trade will take place by exchanging of the two goods, i.e, Bhutan exporting mushrooms and Japan exporting apples. It is called international trade due to absolute cost advantage.

THE COMPARATIVE COST THEORY

According to David Ricardo, international trade can still take place if one country possesses absolute advantage in the production of both the commodities, by considering their relative costs differences. So, his theory is called comparative cost theory. The theory states that “a country will specialize in the production of those goods which have lower comparative cost or goods which have greater comparative advantage”.

This theory can be explained using the concept of both opportunity cost and Production Possibility Curve (PPC) with the following example; suppose Bhutan and Japan are producing goods (say mushroom and apples). There are THREE stages through which trade will take place as per the comparative advantage theory. (Opportunity Cost Concept)

1.      Before Specialization

Production in KGs	Bhutan	Japan
Mushroom	12,000	4,000
Apples	8,000	6,000

Before specialization Bhutan is comparatively better in the production of both the commodities                  (mushroom and apples). But still Bhutan can specialize in the production of one commodity and Japan in the production of other commodity. However, Bhutan would not produce both the commodities but it would specialize in the production of one commodity (mushroom) which gives more advantage.

2.      Specialization

Production in KGs	Bhutan	Japan
Mushroom	24,000	0
Apples	0	12,000

During Specialization Bhutan would concentrate in the production of mushroom only (i.e 24,000) by using resources from apples. Similarly, Japan would produce more apples (12,000) by using resources from mushrooms as shown in the table.

3.      After Specialization

After specialization Bhutan would export mushroom to Japan and Japan would export apples to Bhutan. This theory is further elaborated by using Production Possibility Curve (PPC). PPC shows the combinations of two goods which can be produced with a given amount of resources.