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International Economics. Trade, The Balance of Payments and Exchange Rates. Trade. Buying and selling goods and services from other countries The purchase of goods and services from abroad that leads to an outflow of currency from the UK – Imports (M)

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international economics

International Economics

Trade, The Balance of Payments and Exchange Rates

  • Buying and selling goods and services from other countries
  • The purchase of goods and services from abroad that leads to an outflow of currency from the UK – Imports (M)
  • The sale of goods and services to buyers from other countries leading to an inflow of currency to the UK – Exports (X)
the flow of currencies
The Flow of Currencies:

Whisky sold to Italian hotel

Export earnings for UK

(Credit on Balance

of Payments)

€ changed to £

Map courtesy of

the flow of currencies4
The Flow of Currencies:

Oil from Russia


£ changed into Roubles

Export earnings for Russia

Import expenditure for the UK

(Debit on balance of payments)

Map courtesy of

specialisation and trade
Specialisation and Trade
  • Different factor endowments mean some countries can produce goods and services more efficiently than others – specialisation is therefore possible:
  • Absolute Advantage:
    • Where one country can produce goods with fewer resources than another
  • Comparative Advantage:
    • Where one country can produce goods at a lower opportunity cost – it sacrifices less resources in production
the terms of trade
The Terms of Trade
  • The Terms of Trade looks at the relationship between the price received for exports and the amount of imports we are able to buy with that money.

Average Price of Exports

Terms of Trade = ---------------------------

Average Price of Imports

the balance of payments
The Balance of Payments
  • A record of the trade between the UK and the rest of the world.
  • Trade in goods
  • Trade in services
  • Income flows

= Current Account

  • Transfer of funds and sale of assets and liabilities

= Capital Account

exchange rates
Exchange Rates
  • The rate at which one currency can be exchanged for another e.g.
  • £1 = $1.59
  • £1 = €1.15
  • Important in trade
exchange rates10
Exchange Rates
  • Determinants of Exchange Rates:
  • Exchange rates are determined by the demand for and the supply of currencies on the foreign exchange market
  • The demand and supply of currencies is in turn determined by:
exchange rates11
Exchange Rates
  • Relative interest rates
  • The demand for imports (D£)
  • The demand for exports (S£)
  • Investment opportunities
  • Speculative sentiments
  • Global trading patterns
  • Changes in relative inflation rates
exchange rates12
Exchange Rates
  • A depreciation in exchange rate should lead to a rise in D for exports, a fall in demand for imports – the balance of payments should ‘improve’
  • An appreciation of the exchange rate should lead to a fall in demand for exports and a rise in demand for imports – the balance of payments should get ‘worse’ BUT
exchange rates13
Exchange Rates
  • Floating Exchange Rates:
    • Price determined only by demand and supply of the currency – no government intervention
  • Fixed Exchange Rates:
    • The value of a currency fixed in relation to an anchor currency – not allowed to fluctuate
  • Dirty Floating or Managed Exchange Rate:

– rate influenced by government via central bank around a preferred rate

exchange rates14
Exchange Rates
  • Purchasing Power Parity (PPP)
  • The relationship between the exchange rate and the price level in different countries.
    • The price of £ in the foreign currency = Foreign Country price level/UK price level
  • Means by which trade between countries is restricted in some way – normally through measures to reduce the number of imports coming into a country
  • Main means are:
    • Tariffs
    • Quotas
    • Non-Tariff Barriers
  • Tariff: A tax on a good coming into a country
  • Increases the price of the good and makes it less competitive
  • Quota: Physical restriction on the number of goods coming into a country

Impact of a Tariff on Steel

S + Tariff

Price of Steel

(US $ per kg)


Amount of the tariff per unit






Quantity of Steel Bought and

Sold from Abroad


Impact of a Quota on Steel

Quota level

Price of Steel

(US $ per Kg)


The quota restricts the supply to a set amount (250 in the example) which is likely to result in a shortage of this good and a subsequent rise in its price.

Pre-trade position before a quota.






Quantity of Steel Bought and

Sold from Abroad

non tariff barriers
Non-Tariff Barriers
  • Any methods not covered by a tariff, most usually:
    • Rules
    • Regulations
    • Voluntary Export Restraints (VERs)
    • Legislation
    • Exacting Standards or Specifications
non tariff barriers20
Non-Tariff Barriers
  • Examples include setting exacting standards on fuel emissions from cars, the documentation required to be able to sell drugs in different countries, the ingredients in products – some of which may be banned in the destination country
  • NTBs are difficult to prove – when do you accuse a country of protectionism – could be a legal or cultural issue?
  • The main method involved in NTBs is not to prevent trade but to make the cost of doing so prohibitive to the potential exporter
reasons for protectionism
Reasons for protectionism
  • Protect domestic industries
  • Protect domestic employment
  • Strategic reasons
  • Political pressures
  • Protect culture?
  • Prevent ‘Dumping’ – selling goods in the destination country below cost to break into that market