CHAPTER ONE INTERNATIONAL TRADE AND THE BALANCE OF PAYMENTS Trade is simply a buying and selling of goods and services from one to other. International trade is a trade between residents of two countries.

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Import is the purchase of goods and services from foreign countries leading to outflow of foreign currency. Export is the sale of goods and services to foreign countries leading to inflow of foreign currencies.

Why do countries trade? Without trade, A country must be self-sufficient. It must produce everything its citizens want to consume. With trade, Countries can specialize in the production of goods that they can produce, and satisfy other needs by trading.

There are two classic international trade theories explained why the countries trade, Adam Smith's theory of absolute advantage Ricardo's theory of comparative advantage Which explained the causes and gains from international trade.

Absolute advantage theory Theory of absolute advantage demonstrates that: international trade will be beneficial when One nation has an absolute advantage in one good and the other nation has an absolute advantage in the other goods

One country is said to have: an absolute advantage when it can produce more of the good than another country, by the same quantity of resources.

Assumptions: (a)There are two countries in the world (b)Labor is only one factor of production (c)The cost of a good depends on the amount of labor (d) No transportation cost exists.

Example JapanEgyptNations 20 units10 units Cars 15 Yards20 Yards Clothes

It can be seen that: The Egypt has an absolute advantage in clothes production, as its workers' productivity in cloth is higher than that of the Japan. Similarly, Japan has an absolute advantage in cars production.

Principle of Absolute Advantage Each nation benefits by specializing in the production of goods that it produces at a lower cost than the other nation, while importing the goods that it produces at a higher cost.

Comparative advantage theories What If Egypt has absolute advantage in both goods While Japan has disadvantage in both goods????

JapanEgyptNations 10 units30 units Cars 5 Yards30 Yards Clothes 3 times 6 times 1 2 Example

Egypt is six times as efficient in clothes production but only thrice as efficient in cars production Egypt has a greater absolute advantage in clothes than in cars, while Japan has a smaller absolute disadvantage in cars than clothes

Each nation specializes in and exports that good in which it has a comparative advantage Egypt in clothes, Japan in cars. Trade enables both countries to have gain from trade.

EgyptJapan onion100 units75 units watches200 units150 units Define the advantage and specialization in the next case: Case 1 Egypt has In producing and exporting………………….While Japan has…………………in producing and exporting……………………

Balance of Payments balance of payments is defined as the record of transactions between residents and non-residents over a specified period. Three main components : The current account, The capital account The official statements b

The Current Account (CA); The current account is subdivided into 4 sections The merchandise trade account (Exports or imports of goods.), The services account ( tourists ’ expenditures, and shipping fees) investment income account (International interest and dividend payments and the earnings of domestically owned firms operating abroad). the transfer payments account (unilateral current transfers (like gifts and foreign aids).

The Capital Account: The Capital Account includes the purchase and sale of financial and non-financial assets. The Official Account: Includes the net change in foreign exchange reserves and official government borrowing.

FOREIGN EXCHNGE MARKETS AND EXCHANGE RATE The foreign exchange market is the market in which individuals, firms, and banks buy and sell foreign currencies or foreign exchange. The foreign exchange market for any currency is composed of all the locations (such as London, Paris, Zurich, Frankfurt, Singapore) where currencies are bought and sold for other currencies.

Exchange Rate The exchange rate between the dollar and the Egyptian pound is equal to the number of pounds needed to purchase one dollar. For example, if 1$=6LE this means that six pound are required to purchase one dollar.

EQUILIBRIUM FOREIGN EXCHANGE RATES The exchange rate is determined, just like the price of any commodity, by the intersection of the market demand and supply curves for dollar

E D D S Surplus Deficit Exports Imports