International Trade and Exchange Rate Economics
1. Terms of Trade (ToT)
Meaning: Terms of Trade refers to the rate at which a country’s exports exchange for imports; it indicates the purchasing power of exports in terms of imports.
Formula: ToT = (Export Price Index / Import Price Index) × 100
- ToT > 100: Favorable (more imports for same exports)
- ToT < 100: Unfavorable
Types of ToT
- Net Barter ToT: Ratio of export prices to import prices (Px/Pm)
- Gross Barter ToT: Ratio of quantity of imports to exports (Qm/Qx)
- Income ToT: Net ToT × Volume of exports; shows import capacity
- Single Factoral ToT: Net ToT adjusted by productivity in export sector
- Double Factoral ToT: Adjusted by productivity in both export and import sectors
Determinants and Importance
Determinants: Demand and supply of exports/imports, exchange rate changes, trade policies, inflation rates, and technological progress.
Importance: Measures economic welfare, affects Balance of Payments, and helps policy formulation.
2. Free Trade vs. Protectionism
Free Trade
Meaning: International trade without restrictions such as tariffs, quotas, or controls.
Features: No barriers to trade, based on comparative cost advantage, and free movement of goods and services.
Pros and Cons: Promotes efficient resource allocation, lower costs, and innovation, but may harm domestic industries and increase import dependence.
Protectionism
Meaning: Government policy to restrict imports to protect domestic industries.
Methods: Tariffs (tax on imports), quotas (quantity restrictions), subsidies (financial aid), and import licensing.
Pros and Cons: Protects infant industries and national security, but often leads to higher consumer prices and inefficiency.
3. Fixed and Flexible Exchange Rates
Meaning: Exchange rate is the price of one country’s currency in terms of another currency.
Fixed Exchange Rate
Meaning: Rate determined and maintained by the government or central bank.
Features: Stability in currency value, controlled fluctuations, and requires foreign exchange reserves.
Flexible (Floating) Exchange Rate
Meaning: Determined by the demand and supply of foreign exchange in the market.
Features: No direct government control, fluctuates continuously, and is market-driven.
Exchange Rate Concepts
- Appreciation: Increase in value of domestic currency
- Depreciation: Decrease in value
- Devaluation: Official reduction (fixed system)
- Revaluation: Official increase
4. Balance of Trade (BoT) and Balance of Payments (BoP)
Balance of Trade (BoT)
Meaning: Difference between exports and imports of goods only.
Formula: BoT = Exports – Imports
Balance of Payments (BoP)
Meaning: Systematic record of all economic transactions between a country and the rest of the world during a period.
Components: Current Account (goods, services, income, transfers), Capital Account (FDI, loans, portfolio investments), and Official Reserves Account.
5. International Institutions
International Monetary Fund (IMF)
Established: 1944 (Bretton Woods). Objectives: Exchange stability and global monetary cooperation.
World Bank (WB)
Established: 1944. Objective: Economic development and poverty reduction through long-term loans and infrastructure financing.
World Trade Organization (WTO)
Established: 1995. Objective: Promote free and fair international trade by reducing barriers and settling disputes.