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Country should specialize in the production of commodities which it can produce most efficiently Lower Cost of Production.
India should specialise in Rice production. As India has to sacrifice 2 Qtl of Rice for 1 Qtl of Jute. It can import jute from Bangladesh 1Qtl of Rice = 1.5 Qtl of Jute (30/20) Per Quintal Labour Cost (Man- hour) Country India Bangladesh Rice 30 50 Jute 60 20
Ricardo's Insight
What if one country has absolute advantage in both the commodities? Is trade possible? As long as countries have comparative advantage in the production of both the commodities specialisation and trade would always be possible. Per Quintal Labour Cost (Man- hour) Country India Bangladesh Rice 30 50 Jute 60 80
India It can produce both the goods efficiently. It has comparative advantage in rice production. It can produce Rice at 60% (30/50) cost then Bangladesh. It has comparative disadvantage in jute because cost of jute production is twice the cost of rice production.
Bangladesh It has comparative advantage in jute production Relative cost of jute production ( 80/50 = 1.6 Qtl of rice) is less than Indias(60/30= 2Qtl of rice).
Rice 30 50
Jute 60 80
1
50/80
0.625
1
It depends upon the determination of commodity exchange rate between two countries. Indias exchange rate ranges between 500Kg to 625 kg of Jute for 1 Qtl of Rice. Bangladesh it ranges between 1.6 to 2 Qtl of Rice for 1 Qtl of Jute. If Exchange rate in foreign trade are same as internal rates then both the country gain.
The comparative advantage in the cost of production is due to the difference s in the factor endowment of the nations. It refers to the overall availability of usable resources in the country. A country tends to specialise in the export of a commodity whose production requires intensive use of its abundant resources and imports a commodity whose production requires intensive use of its scarce resources.
Balance Of Payments
Definition
It is a systematic record of a countrys economic and financial transactions with the rest of the world, over a period of time.
Transaction of goods and services and income between an economy and the rest of the world.
Purpose
It provide data for the Economic analysis of the countrys as the partner in International trade. It reveals the changes in composition and magnitude of foreign trade. It predicts future performances on past trade performances. It also revels the weak and strong points in the countrys foreign trade and thereby Govt intervention for corrective measures.
Balance of Trade : It refers to the difference in value of Imports and Exports i.e Visible Items
X>M X< M
Balance of Payments: Includes both Visible and Invisibles items ( Such as Services by shipping, banking and insurance, interest payment, dividend, expenditure of tourist, foreign investment, external lending and borrowing, NRI deposits etc)
Components of BOP
BOP
Current A/C
Merchandise / Visible Invisible Export / Import
Capital A/C
Short Term Capital Movement
Unilateral Transfers
Current Account
It includes all transactions which give rise to or use up National Income. Credit : Value which are receivable Debit: Value which are payable. a) Merchandise / Visible Exports and Imports Merchandise Exports : Sales of Good abroad Merchandise Imports: Purchase of Goods from aboard b) Invisible Items Invisible Exports: Sales of Services Invisible Imports: Purchase of Services
c) Unilateral Payments
Capital Account
Which increase or decrease countrys total stock of capital.
a) Short Term Capital Movement Purchase of short term securities Speculative Purchase of Foreign Currency Cash balances held by foreigners Net balance ( + /- ) of current account
b) Long Term Capital Movement Direct Investments in Shares, bonds and in real estate and physically assets which investors hold a controlling power. Portfolio investments in stocks and bonds Repurchase and resale of securities Direct export and import of capital goods c) Gold and Foreign Exchange reserves They are maintained to stabilize the exchange rate of the home currency and to make payments to the creditors in case of deficit.
Components of BOP
Current Account Balance
Credit (Receipts)
Export of Goods Export of Services Interest profits and Dividend Received
Debit (Payments)
Import of Goods Import of Services Interest profits and Dividend paid
Unilateral Payments
Components of BOP
Capital Account Balance
Credit (Receipts)
Foreign Investment Direct, Portfolio Short Term Borrowings Long Term Borrowings Foreign Exchange Reserves (+)
Debit (Payments)
Investment Aboard Direct, Portfolio Short Term Lending Long Term Lending Foreign Exchange Reserves (-)
BOP is based on double entry book keeping in which both sides of a transactions, receipt and payment are recorded. Export: Outflow of goods / Inflow of foreign currency
Indias BOP
Capital A/C
Indias BOP
Bop Disequilibrium
BOP Equilibrium : Total Receipt = Total Payment Demand for foreign Exchange = Supply BOP Disequilibrium : Demand > Supply : Demand < Supply :
Deficit Surplus
Deficit in Current A/C is offset by Surplus in Capital A/C Surplus in Current A/C is offset by a deficit in capital A/C
( By loans / borrowings or depleting its gold /foreign exchange reserves)
a) Price Change Change in Price level causes BOP disequilibrium. The change in price level may be inflationary or deflationary. Inflation makes import cheaper and export costlier. Increase in imports as domestic prices become higher than import prices Decrease in exports as domestic price rises. Deficit in BOP
b) Development Disequilibrium Large scale development expenditure increase the purchasing power Increases demand and prices Increases in large imports. Its common in developing countries as large scale import of capital goods.
Business cycle fluctuations causes disequilibrium. The countrys which are dependent upon Imports faces large deficit during inflation Moderate deficit or surplus during depression.
d) Structural Disequilibrium
Depletion of Natural Resources Changes in Technology Alternative source of Supply Development of better substitute
Political Factors
Political Instability may experience large capital outflow and inadequacy of domestic investment and production. War and changes in trade route can also cause disequilibrium.
3)
Other Factors Disturbances or crop failure Rapid growth in population leads to large scale imports of foodgrains. Changes in taste preferences and fashion causes change in export and import.
Correction of Disequilibrium
Correction Of BOP
Automatic Measures
Deliberate Measures
Monetary Measure
Trade Measure
Miscellaneous
Correction of Disequilibrium
A) Automatic Measures
BOP disequilibrium may be automatically corrected If the market forces of demand and supply are allowed to have a free play, in course of time equilibrium would be restored. For ex If there is deficit in BOP Demand for Foreign exchange exceeds its supply This result in increase in exchange rate Fall in value of domestic currency Exports cheaper and import costlier Increase in Exports and fall in imports Equilibrium in BOP
Correction of Disequilibrium
1) Monetary measures
a) Monetary Contraction / Deflation
Contraction or Expansion of money supply For Example: Deficit in BOP Contract the Money Supply Reduces purchasing power Decrease the demand Reduces domestic prices Decrease in imports and increase in exports
Correction of Disequilibrium
b) Devaluation
Reduction of the official rate at which the currency is exchanged for another currency Devaluation is done to improve its BOP Export prices fall, Export increases Import prices goes up, import reduces Deficit of BOP reduces
Elastic demand for imports and exports Structure of Imports and Exports Domestic Price stability ( Should not lead to Price rise) International co-operation Hike in import duties, reduction in export duties, export license, export promotion programme
Correction of Disequilibrium
c) Exchange Control
Central Govt has complete control over foreign exchange reserves. Exporters surrender foreign exchange in exchange of domestic currency. Govt release foreign exchange only for essential imports.
Its not a permanent solution to long run disequilibrium because it suppresses demand for Imports and not cure Deficit.
Correction of Disequilibrium
2) Trade Measures
Correction of Disequilibrium
3) Miscellaneous Measures Obtaining foreign loans Development of tourism Incentives to enhance inward remittances Encouraging foreign investment.
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91 -9 2 -9 3 -9 4 -9 5 -9 6 -9 7 -9 8 -9 9 00 92 93 94 95 96 97 98 -2 0
19 19 19 19 19 19 19 19 99
Exports Imports
20 00 01 20 20 20 20 02 03 04 05 20
F Invest
-0 1 -0 2 -0 3 -0 4 -0 5 -0 6