International Trade
International Trade
Introduction
International trade refers to the purchase and sale of goods and services between different countries. In a free trade regime a country exports a good which is relatively abundant and can be produced at a comparatively lower cost in that country. It imports the goods and services that is relatively scarce and costly in the home market. Free trade has a number of advantages as it allows for production efficiency. It allows the good to be produced by the country which is relatively more efficient in producing it. Moreover, the exchange of goods allows a country to consume more of the good that was scarce in the home market. There are a number of issues associated with trade like the exchange rate, prices of inputs of production, welfare and such others. We are going to discuss a few issues in this paper.
Free trade has a number of benefits for the trading nations. In spite of the gains from trade countries tend to restrict trade of some goods and services. The country may impose restriction on imports to protect its nascent industries. Giving protection at the initial stage allows the industry to reach its optimum scale. Often trade restrictions are set on goods or services that are of strategic importance to the country.
There are two ways in which a country can impose restriction on trade. One is import tariff . An import tariff is a tax on import. This tax increases the price of the imported good in the domestic market. Thus the price in the domestic market is higher than in the international market. The tariff rate is set at such a rate so that the tariff included price of import is higher than the price of the import substitute in the domestic market, so that the people tend to purchase the relatively cheaper domestic good rather than the imported good. Thus import of the good is reduced.
Another way of trade restriction is a quota. A quota is a quantitative restriction. The government restricts the import of the good beyond a certain quantity. In a quota system the government issues trading licenses for the given amount to be imported and distributes the license among the importers. Only the license holders can import the good. Thus only a specified amount of the good can be imported and not more than that. A quota also leads to the increase in price of the imported good as supply is low.
Trade restrictions prove to be beneficial for the domestic producers. They remain protected from external competition. They gain more market power, hence producer surplus increase with the increase in price . The government also benefits. Imposition of tariff results in revenue earning for the government by way of import tax collection. In case of quota also the government earns revenue from the sale of licenses. The consumers are losers due to the rise in price and fall in supply. Consumer surplus falls. The overall welfare also declines due to trade restrictions as production efficiency is lost.
Lower Input Prices and Trade
Wage rates are lower in Africa as Africa is labor abundant. But the US is capital abundant which makes capital cheaper in the US. If the corporate in the US move to Africa for cheaper labor inputs they will lose out on the cheaper and abundant capital they enjoyed in the US. But they can remain in the US and reap the benefit of cheaper African labor by importing the labor services from Africa. Thus, they will save up on cost and the African workers will also be benefitted as they will have better paid jobs in the US. This is the benefit of free trade.
Foreign Exchange Market
The foreign exchange rate is the price of the foreign currency in terms of the domestic currency. The demand and supply of foreign exchange determines the foreign exchange rate. Here we consider the price of US dollars in terms of the Japanese Yen. Let us consider the following situations:
The interest rate in Japan is lowered: A reduction in the interest rate in Japan results in greater capital inflow in the Japanese market. Thus supply of Yen increases. If the interest rate is lower than that in the US capital will flow out to US. There will be a higher volume of capital outflow from Japan. With greater outflow of US dollars, supply of US dollar decreases. The supply curve shifts to the left leading to the rise in the price of the US dollar. Thus dollar appreciates.
Prices are lower in the US: Lower prices in the US market makes US goods cheaper. Thus US exports rise. There is more import of US good in the Japanese market. Thus demand for US dollar increases due to increased import. This raises the price of US dollar. So in this case US dollar appreciates.
Higher US interest Rates: If the Interest rate in the US is raised there will be inflow of capital in the US. Thus, there will be outflow of capital from Japan reducing the supply of US dollar n Japan. Thus the price of US dollar increases. US dollar Appreciated in this situation.
Exchange Rate and Export-Import
When the exchange rate of a country appreciates that is the exchange rate increases the price of the domestic currency becomes higher than the foreign currency. In such a situation the domestic goods will be more expensive in the foreign market as more have to be paid for the goods in terms of the foreign currency. As price of the domestic goods increase in the world market the demand for exports decrease. Thus appreciation of the domestic currency reduces exports of the domestic goods.
On the other hand, as the domestic currency appreciates imports become cheaper. The appreciation of the domestic currency implies that the foreign currency is cheaper than the domestic currency. Thus imported goods will require less domestic currency as the exchange value is low. The lower price of imports will increase the demand for imports. Thus appreciation of the domestic currency increases imports.
So we conclude that as the domestic currency appreciates exports decrease and imports increase. Similarly, when the domestic currency depreciated exports rise and imports fall. Thus a higher exchange rate, that is, a higher price of foreign exchange leads to lower price of exports and so increases exports. Import prices are higher with a higher exchange rate. So imports fall.
Conclusion
In this paper we have discussed the methods and impact of trade restrictions. We have also discussed how cheaper inputs in another country can help businesses in the domestic country through trade. We have also devoted a part of our discussion on analyzing the effect of various factors on the foreign exchange rate. Finally, we analyzed the impact of change in the exchange rate on export and import for the country.
References
Chacoliades, Miltiades. International Economics. McGraw Hill, 1990.
Sodersten, Bo and Geoffrey Reed. International Economics. U.K.: Pulgrave-Macmillan, 1994.
