Module 5

Foreign Trade
Trade means buying and selling of goods and services.
Foreign Trade means trade between countries. The branch of economics which
deals with foreign trade is called International Economics.
Advantages of Foreign Trade.
1 Optimum use of natural resources
Foreign Trade ensures optimum utilisation of resources.
2 Availability of all type of goods
Availability of wide variety of goods produced all over the world.
3. Specialisation
Foreign Trade leads to specialisation, as the country produces those goods,
where the production process has certain advantages. Country can enjoy
division of labour.

4. Advantages of large scale production.

Due to international trade goods can be produced for home consumption as
well as for exports. This Helps the country to enjoy the benefits of large scale
production.
5 Stability in prices – Foreign Trade helps to avoid fluctuations in prices by
making the goods available all over the world.
6 Establishment of new industries – The importing of machinery and
Technology enables the country to start new industries.
7 Increase in Efficiency – When there is international competition, the producers
of a country attempt to produce better quality goods at least cost. This
increases efficiency and productivity.
8 Development of means of Transport and Communication - Foreign Trade
requires the best means of communication. Due Turn this the countries develop
better transport and communication facilities
9 international cooperation and understanding. The people of different
countries come in contact with with each other. Commercial integration among
nations of the world encourages exchange of ideas and culture. It creates
cooperation, understanding, and cordial relations among nations.
10 Discouragement in Monopoly – If certain units raise the prices through
monopoly the govt. Imports these goods to bring down the prices in the home
country.
11 Better Employment Opportunities – Foreign Trade provides employment
opportunities both inside and outside the country.
Disadvantages of Foreign Trade
1 A threat to Domestic industry -Due to foreign competition and
unrestricted imports the upcoming industries may suffer.
2 Economic Dependence – Underdeveloped nations have to rely on
developed countries for their economic growth.
This could lead to economic exploitation of the dependent country.
3 Misuse of natural resources – Excessive exports can exhaust the natural
resources of our country. If not controlled the country may suffer in the
long run.
4 Endangers Indepedence- Foreign Trade encourages slavery. It. ( impairs)
weakens the economic independence of the poor nations.
5 Import of harmful goods - Through Foreign trade harmful goods may be
imported and it may adversely affect health and well – being of the
people.
6 Evil Effects of Dumping – In order to cheapen the value of the other
country's goods a country may dump their goods on some other country.
7. Against National Defence - A nation which depends on foreign sources
of supply lacks defence during war. During war they may not be able to
import goods. In some cases if we depend too much on other countries
they may deny help during an emergency.
(4 Theories of international trade in next document.)
Balance of payments
Balance of payments is a systematic record of all economic transactions of a
nation with the rest of the world for a specific period of time. Usually time
period is taken as one year. The main purpose of balance of payments is to
inform the government regarding the international currency position of the
nation and to help in the formulation of policies accordingly. It is also useful
to banks, firms and individuals who directly or indirectly involve in
international trade and finance.
Balance of Trade and Balance of payments.
Balance of trade includes only those transactions which are involved in the
exporting and importing of visible items or goods.
It does not include the various kinds of services like shipping ,banking
insurance, payment of interest , dividend etc
Balance of payments include both visible and invisible items. Balance of
payments gives a better picture of the countries external balance.
Components of balance of payments
Usually international transactions are classified under the following heads
that is the components of balance of payments
1 Current account
2 Capital account
3 Unilateral payments account
4 Official Reserves Asset Account.
1 Current Account -It includes both visible and non – visible items of imports
and exports.
2 Capital account- Capital account includes short term and long term capital
transactions. The following are the major items in the capital account.
a) Loans and Borrowings.
 b) Investments
3 Unilateral transfers account
Unilateral transfers means the one way transfer of an item from one person
to another. Such one way transfers are without any expectations of anything
in return. This is an important item of balance of payments. The following
are the important items which come under unilateral transfers are
a) Payments or remittances from immigrants to their home country.
b) Humanitarian aid
by one country to the other
c) Contribution to charitable institutions
d) Membership payments to international agencies
e) Gifts from one country to the other. The gift could be from a person
business or government.
4 The official reserve account
The official reserve account is an account where the foreign currency and
securities held by the government usually by central bank is used to balance
the payments from year to year.
Balance of payments is in disequilibrium because of deficit. When there is
excess of imports over exports it is called a deficit or disequilibrium in the
country's Balance of Payments position.
There are a number of factors responsible for a disequilibrium or a deficit in
the balance of payments. The following are the economic factors that lead
to balance of payment disequilibrium.
Economic Factors
1 Development Disequilibrium – Large scale development expenditure may
increase the purchasing power of the people and they may import capital
goods like machinery and equipment for their economic development. This
may increase the import bills and result in a deficit.
2. Cyclical Disequilibrium-
Cyclical fluctuation creates Boom and Depression. When there is Boom
import may increase more than export and it creates a Deficit in the Balance
of Payments.
3 Secular Disequilibrium – In developed countries disposable income and
aggregate income will be very high. Wages may increase and production
costs also increases. This may result in higher prices. Higher demand and
higher price leads to larger imports and deficit in the Balance of Payments.
Social Factors
Change in taste, fashion etc. may change competition habits of the people
and this may affect exports and imports as well as balance of payments.
Correction of Disequilibrium.
1 Automatic correction – Economy corrects the disequilibrium automatically
with the help of demand and supply. Exchange rates will get adjusted and
there will be fall in external value of domestic currency. It will increase the
exports and correct the deficit.
2 Deliberate measures
Deliberate measures may be further divided into 3. They are Monetary
measures, Trade measures and Miscellaneous measures.
Monetary Measures
1 Monetary expansion and contraction
When there is a deficit a contraction of money supply decreases purchasing
power of the people and hence aggregate demand as well as price level falls.
This reduces imports.
2 Devaluation - Devaluation is the deliberate reduction in the value of
currency by reducing the official rate at which it is exchanged. When there is
a deficit. Devaluation encourages export and discourages import. It makes
goods cheaper for foreigners and foreign goods expensive in the their home
country.
3 Exchange control
 Government keeps control on the foreign exchange earnings of the country.
Govt. may not give foreign earnings for public expenditure. This will help to
control import.
Trade Measures
a) Export Control -Exports are encouraged by abolishing export duty giving
export subsidy facility for export oriented production
b) Import control- Imports are discouraged by increasing import duties
through import quotas and import licensing etc.
c) Miscellaneous measures- Miscellaneous measures include
encouragement of foreign investment , promotion of tourism etc.

Devaluation
Devaluation means the deliberate reduction in the value of domestic
currency in terms of foreign currency. A country which faces a serious
problem of deficit in the balance of payments may resort to devaluation.