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Semester 2 Indian System Of Business Luvnica Rastogi

What is Foreign Trade

Foreign trade is nothing but trade between the different countries of the world. It is also called as International trade, External trade or Inter-Regional trade. It consists of imports, exports and entrepot. The inflow of goods in a country is called import trade whereas outflow of goods from a country is called export trade. Many times goods are imported for the purpose of reexport after some processing operations. This is called entrepot trade. Foreign trade basically takes place for mutual satisfaction of wants and utilities of resources.

3 Types of Foreign Trade

Import Trade : Import trade refers to purchase of goods by one country from another country or inflow of goods and services from foreign country to home country. Export Trade : Export trade refers to the sale of goods by one country to another country or outflow of goods from home country to foreign country. Entrepot Trade : Entrepot trade is also known as Reexport. It refers to purchase of goods from one country and then selling them to another country after some processing operations.

Need and Importance of Foreign Trade

1. Division of labour and specialisation Foreign trade leads to division of labour and specialisation at the world level. Some countries have abundant natural resources. They should export raw materials and import finished goods from countries which are advanced in skilled manpower. This gives benefits to all the countries and thereby leading to division of labour and specialisation.

2. Optimum allocation and utilisation of resources
Due to specialisation, unproductive lines can be eliminated and wastage of resources avoided. In other words, resources are channelised for the production of only those goods which would give highest returns. Thus there is rational allocation and utilization of resources at the international level due to foreign trade.

3. Equality of prices
Prices can be stabilised by foreign trade. It helps to keep the demand and supply position stable, which in turn stabilises the prices, making allowances for transport and other marketing expenses

4. Availability of multiple choices Foreign trade helps in providing a better choice to the consumers. It helps in making available new varieties to consumers all over the world. 5. Ensures quality and standard goods Foreign trade is highly competitive. To maintain and increase the demand for goods, the exporting countries have to keep up the quality of goods. Thus quality and standardised goods are produced

6. Raises standard of living of the people
Imports can facilitate standard of living of the people. This is because people can have a choice of new and better varieties of goods and services. By consuming new and better varieties of goods, people can improve their standard of living.

7. Generate employment opportunities

Foreign trade helps in generating employment opportunities, by increasing the mobility of labour and resources. It generates direct employment in import sector and indirect employment in other sector of the economy. Such as Industry, Service Sector (insurance, banking, transport, communication), etc

8. Facilitate economic development

Imports facilitate economic development of a nation. This is because with the import of capital goods and technology, a country can generate growth in all sectors of the economy, i.e. agriculture, industry and service sector.

9. Assitance during natural calamities

During natural calamities such as earthquakes, floods, famines, etc., the affected countries face the problem of shortage of essential goods. Foreign trade enables a country to import food grains and medicines from other countries to help the affected people.

10. Maintains balance of payment position
Every country has to maintain its balance of payment position. Since, every country has to import, which results in outflow of foreign exchange, it also deals in export for the inflow of foreign exchange.

11. Brings reputation and helps earn goodwill

A country which is involved in exports earns goodwill in the international market. For e.g. Japan has earned a lot of goodwill in foreign markets due to its exports of quality electronic goods.

12. Promotes World Peace

Foreign trade brings countries closer. It facilitates transfer of technology and other assistance from developed countries to developing countries. It brings different countries closer due to economic relations arising out of trade agreements. Thus, foreign trade creates a friendly atmosphere for avoiding wars and conflicts. It promotes world peace as such countries try to maintain friendly relations among themselves.

The Advantages Of Foreign Trade.

There is an increasing demand for foreign trade because of the following reasons: The natural resources are unevenly distributed. The presence of specialization and division of labour. Different countries have difference in economic growth rate. The presence of the theory of comparative cost.


The following are some of the advantages of foreign trade: 1. Optimum use of Resources: Foreign trade helps in the optimum use of natural resources and avoid wastages of resources. 2. Stable Price: It ensures the presence of stable price by avoiding wide fluctuations in prices. It tries to equalise the world price. 3. Availability of all types of goods: It enables a country to import those goods which it cannot produce. 4. Increased Standard of living: It ensures more production to meet the demand of the people of different countries. By increased production, it becomes possible to increase income and the standard of living of its people. It also increase the standard of living by increasing more employment opportunities. 5. Large Scale production: It ensures large production because the production is carried on to meet the demand of its people as well as world market. Large scale production also ensures a great deal of internal economies which reduces the cost of production.

Foreign trade is not free from difficulties. The following are some of the important difficulties of foreign trade: 1. It is a long distance trade and as such it becomes difficult to maintain close relationship between the buyer and the seller. 2. Each country has its own language. As foreign trade involves trade between two or more countries, there is diversity of languages. This difference in language creates problem in foreign trade. 3. Foreign trade involves preparation of a number of documents which also creates difficulties in the way of foreign trade. 4. Some restrictions are imposed on export and import of commodities. These restrictions stands on the progress of foreign trade. 5. Foreign trade involves a great deal of risks because trade takes place over a long distance. Though the risks are covered through insurance, it involves extra cost of production because insurance cost is added to cost.

Scope of Foreign Trade

The aim of foreign trade is to increase production and to raise the standard of living of the people. Foreign trade helps citizens of one nation to consume and enjoy the possession of goods produced in some other nation.


I. Uneven Distribution of Natural Resources:

Natural resources of the world are not evenly divided amongst the nations of the world. Different countries of the world have different amount of natural resources and they differ with each other in regard to climate, minerals and other factors. Some countries can produce more of sugar like Cuba, some can produce more of cotton like Egypt, while there are some others which can produce more of wheat like Argentina. But all these countries need sugar, cotton and wheat. So they have to depend upon one another for the exchange of their surpluses with the goods are in short in their country and hence the need for foreign trade is natural.


II. Division of Labour and Specialization:

1. Due to uneven distribution of natural resources, some countries are more suitable placed to produce some goods more economically than other countries. 2. But they are geographically at a disadvantageous position to produce other goods. 3. They specialize in the production of such goods in which they have some natural advantage in the form of availability of raw material, labour, technical know-how, climatic conditions, etc., and get other goods in exchange for these goods from other countries.


III. Differences in Economic Growth Rate:

There are many differences in the economic growth rates of different countries. Some countries are developed, some are developing, while there are some other countries which are under-developed; these underdeveloped and developing countries have to depend upon developed ones for financial help, which ultimately encourages foreign trade.


IV. Theory of Comparative Cost:

According to the theory of comparative cost each country should concentrate on the production of those goods for which it is best suited, taking into account its natural resources, climate, labour supply, technical know-how and the level of development. Each country specializes in the production of those goods which it can produce at the lowest cost as compared to other countries which leads to international specialization and division of labour. This reduces the cost of production all over the world and improves the standard of living of the people in various countries. Hence the theory of comparative cost encourages foreign trade.

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