This reading will cover:
|Terminology used in international trade|
|Term||What it means|
|GDP||The market value of all new goods and services produced within a country/economy during a given period of time, usually a year or a quarter, by domestic factors of production (labor, land, and capital). So long as it is produced within the country, it does not matter who produced the good and service, i.e., it includes foreigners within the country. Resold products within that period are not included.|
|GNP||The market value of all new goods and services produced during a given period of time, usually a year or a quarter, by factors of production (labor, land, and capital) supplied by the residents of the country, irrespective of where they are located. It excludes goods and services produced by foreigners within the country, but includes those produced by citizens residing out of the country.
For countries, such as Pakistan, with large differences between GDP and GNP, it is implied that a large number of its citizens are working abroad.
|Imports||Goods and services that a domestic country (i.e., households, firms, and government) purchases from other countries. Any good/service that crosses the border into a country for commercial purposes (for consumption by the domestic country). Ex: The U.S. imports cloth from India. India imports several processed foods from the U.S., olive oil from Italy, and motorcycles from Europe.|
|Exports||Goods and services that a domestic country sells to other countries (crosses the border). Ex: China exports clothing to the European Union, South Korea exports cell phones to other countries.|
|Terms of trade||Ratio of the price of exports to the price of imports. For instance, if the terms of trade increase from 1.1 to 1.3, it means the terms of trade have improved because the country will be able to purchase more imports for the same amount of exports.|
|Net exports||Net Exports = Value of a country’s Exports – Value of its Imports
Trade balanced if value of Exports = Value of Imports.
Trade surplus if value of Exports > Value of Imports.
Trade deficit if value of Exports < Value of Imports.
|Autarky||A country that is self-sufficient and does not engage in international trade. All goods and services are produced and consumed domestically; it does not import from or export to other countries.
For example, North Korea. Before India opened up to international trade in 1991, it was close to an autarkic state. Price of a good or service in such an economy is called autarkic price.
|Closed economy||An autarkic economy is also known as a closed economy as it does not trade with other economies.|
|Open economy||In contrast, an economy that trades with other countries with no restrictions on trade is called an open economy.|
|World price||The price of goods and services in the world market; the prevailing price outside the domestic country.|
|Free trade||No government restrictions on a country’s ability to trade. The country freely exports to and imports from the rest of the world. For a similar product, free trade assumes domestic price and world price must be equal. Global demand and supply determine the equilibrium price for exports and imports.|
|Trade protection||Government imposes certain trade restrictions such as tariffs and quotas that prevent market forces from determining the equilibrium price and quantity of imports and exports. Ex: India imposes custom duties of 100% on import of completely built unit luxury cars such as Porsche and BMW. To restrict the amount of iron ore exported, it imposes an export duty on iron ore pellets.|
|FDI/MNC/FPI||FDI stands for foreign direct investment. In FDI, a firm in any country (source country) invests in a foreign country (host country). Unlike financial investments, these are investments in productive assets of the host country (that involves a certain amount of infrastructure). For example, Ikea/Walmart setting up stores in China and India is an example of FDI. Volvo setting up a bus plant in India is an example of FDI. Typically, a multi-national corporation makes an FDI. There can be FDI in real estate where the foreign country is developing a residential project in the domestic country. There are rules governing what percentage of FDI is allowed based on the sector. For example, it may be 49% in banking, but less than 10% in retail.
FPI stands for foreign portfolio investment. If an investment management company in the U.S. invests in financial assets of another country such as the Indian stock market, then it would be an example of FPI.
Note: There is a lot of data covered in this section in the curriculum. But, only certain testable points are highlighted here.
The following exhibits are reproduced from the curriculum. The main points are summarized below:
The exhibit below shows trade and FDI as a percentage of GDP for select countries from 1980-2007. Trade increased from 37.2% to 50.7% from 1980 to 2006.
Trade Openness and GDP Growth
|Trade as Percent of GDP
(averaged over the period)
|Average GDP growth (%)|
|Low and Middle Income:|
Note: Averages indicate the average of the annual data for the period covered
Source: World Bank
Benefits of international trade:
Note: The term “gains from trade” implies that the overall benefits of trade outweigh the losses from trade. It does not mean that all stakeholders (producers, consumers, government) benefit (or benefit equally) from trade.
Costs of international trade: