CBM-321 Module 2 Week 4-5 PDF

College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City...

College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 WEEK 4 – 5 TOPIC 5 :BASIC THEORY USING DEMAND AND SUPPLY IN TRADE UNIT LEARNING OUTCOME: At the end of the unit you are expected to: 1. Understand the underlying concepts of demand and supply 2. Identify the factors that influence market demand and supply 3. Explain the vital role of the basic concept of demand and supply on the international trade. METALANGUAGE In economics, the relationship between the quantity of a commodity that producers wish to sell at different prices and the quantity that consumers want to buy is the concepts of demand and supply. It is the primary model of price determination used in economic theory. In a market, the price of a commodity is determined by the interaction between supply and demand. The resulting price is called the equilibrium price and represents an agreement of the good between producers and consumers. The quantity of a good supplied by producers is in equilibrium equal to the quantity that consumers desire. Key Concepts and Terms 1. Law of Demand. The law of demand is the inverse relation between demand price and quantity demanded. 2. Demand. Demand is a fundamental aspect of market exchanges and economic activity. Even more, it is an essential feature of human existence. 3. Demand Curve. The demand relation between demand price and quantity demanded is commonly represented by a demand curve. A demand curve is nothing more than a graphical representation of the law of demand. 4. Supply. Supply is a fundamental aspect of market exchange and economic activity. Supply is based on the ownership and control of the scarce resources (labor, Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 1 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 capital, and, entrepreneurship and foreign exchange) which are used to produce the goods and services that satisfy wants and needs. 5. Law of Supply. The specific supply relation between price and quantity is termed the law of supply. The law of supply is the direct relation between supply price and quantity supplied. 6. Supply Curve. A supply curve is nothing more than a graphical representation of the law of supply. 7. Market Equilibrium. It refers to the state of equilibrium that exist when the opposing market forces of demand and supply exactly offset each other and there is no inherent tendency for changes. 8. Equilibrium Price. It refers to the price that exists when a market is in equilibrium. 9. Equilibrium Quantity. It refers to the quantity exchanged between buyers and sellers when a market is in equilibrium. ESSENTIAL KNOWLEDGE Topic 5.1: Demand Demand is an important component of business trade and economic development. Moreover it is an important feature of human life. People are seeking goods and services to fulfill their limitless needs and desires. The willingness and ability to buy a range of quantities of a goods at a range of prices, during a given time period. Demand is one half of the market exchange process; the other is supply. This demand side of the market draws inspiration from the unlimited wants and needs dimension of the scarcity problem. People desire the goods and services that satisfy our wants and needs. This is the ultimate source of demand. Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 2 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 Topic 5.1.1: The Law of Demand To understand the concept of law of demand watch this video: https://www.youtube.com/watch?v=QvGLcCTXk9o To read more go to this link https://courses.lumenlearning.com/wmopen-introbusiness/chapter/the-law-of- demand/ Topic 5.1.2: Demand Curve The demand relation between demand price and quantity demanded is commonly represented by a demand curve. A demand curve is nothing more than a graphical representation of the law of demand. The demand curve presented in this exhibit shows the relation between the demand price, measured on the vertical axis, and quantity demanded measured on the horizontal axis. The negative slope of the demand curve graphically illustrates the inverse law of demand relation between demand price and quantity demanded. As the demand price decline from D1 to D2, the quantity demanded increases from Q1 to Q2. Buyers are willing and able to buy more at lower prices. Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 3 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 For the discussion on determinants of demand go to this link; https://www.youtube.com/watch?v=6yjsiXAtSGE Topic 5.2: Supply Supply is a fundamental aspect of market exchange and economic activity. Supply is based on the ownership and control of the scarce resources (labor, capital, and, entrepreneurship and foreign exchange) which are used to produce the goods and services that satisfy wants and needs. Topic 5.2.1: Law of Supply The specific supply relation between price and quantity is termed the law of supply. The law of supply is the direct relation between supply price and quantity supplied. If, in other words, the supply price increases, then the quantity supplied increases. The law of supply, while important to the study of market and economics, has a number of important exceptions and is not as unwavering as other laws (like the law of demand) Topic 5.2.2: Supply Curve The supply relation between supply price and quantity supplied is commonly represented by a supply curve. A supply curve is nothing more than a graphical representation of the law of supply. The supply curve presented in this exhibit shows the Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 4 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 relation between the supply price, measured on the vertical axis, and quantity supplied measured on the horizontal axis. The positive slope of the supply curve graphically illustrates the direct law of supply relation between supply price and quantity supplied. As the supply price increase from S1 to S2, the quantity supplied increases from Q1 to Q2. Sellers are willing and able to sell more at higher prices. To discuss the determinants of supply that causes the shift of the supply cure go to this link: https://www.youtube.com/watch?v=Y9lN_T2eF5M Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 5 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 Topic 5.3: Market Equilibrium It refers to the state of equilibrium that exist when the opposing market forces of demand and supply exactly offset each other and there is no inherent tendency for changes. One achieved, a market equilibrium persists unless or until it is disrupted by an outside force. A market equilibrium is indicated by equilibrium price and equilibrium quantity. Topic 5.3.1: Equilibrium Price It refers to the price that exists when a market is in equilibrium. In particular, the equilibrium price is the price that equates the quantity demanded and quantity supplied, which is termed the equilibrium quantity. Moreover, the equilibrium price is simultaneously equal to the both the demand prices and supply price. In a market graph, like the one displayed here, the equilibrium price is found at the intersection of the demand curve and the supply curve. The equilibrium price is also commonly referred to as the market-clearing price. Topic 5.3.2: Equilibrium Quantity It refers to the quantity exchanged between buyers and sellers when a market is in equilibrium. The equilibrium quantity is simultaneously equal to both the quantity demanded and quantity supplied, which means that there is no shortage nor surplus in the market. This is, in fact, the prime criterion for market equilibrium. If buyers are able to buy all of the goods they’re willing and able to buy (no shortage) and sellers are able to sell all of the good they’re willing and able to sell (no surplus), then neither side of the market is inclined to change the existing term of trade. And that’s equilibrium. (Montaño, et., al 2015 p25-27, p30-31, p35) Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 6 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 Demand and Supply Equation Market Equilibrium: https://www.youtube.com/watch?v=qTRNU_b4iww Demand Function: https://www.youtube.com/watch?v=Ro-B0pfiXYM Supply Function: https://www.youtube.com/watch?v=nbVE5y6gg-c Topic 5.4: Demand and Supply Analysis of International Trade For the discussion go to this link; https://courses.lumenlearning.com/suny- microeconomics/chapter/reading-demand-and-supply-analysis-of-international-trade/ SELF HELP Please refer to the articles below to further deepen your understanding in demand and supply in trade. Read more: https://www.cfainstitute.org/- /media/documents/support/programs/cfa/prerequisite-economics- material-demand-and-supply-analysis-intro.ashx https://smallbusiness.chron.com/supply-demand-analysis-727.html https://opentextbc.ca/principlesofeconomics/chapter/3-1-demand- supply-and-equilibrium-in-markets-for-goods-and-services/ https://www.toppr.com/guides/general-awareness/economics-and- governance/theory-of-demand-and-supply/ Video clip: https://www.youtube.com/watch?v=g9aDizJpd_s https://www.youtube.com/watch?v=zPQyInnqvrI Demand and Supply Example: https://www.youtube.com/watch?v=GGNFaSadoJY Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 7 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 LET’S CHECK Congratulations! you just finished most vital concept in the study of international business and trade. Let us check your understanding of the important concept. Please proceed to the multiple choice. Select the letter that best describe your answer. 1. The Supply Curve is upward sloping because: a. As the price increases, so do costs. b. As the price increases, consumers demand less. c. As the price increases, suppliers can earn higher levels of profit or justify higher marginal costs to produce more. d. None of the Above 2. Part of the reason that Michael Jordan earns millions of dollars each year while school teachers may earn 30,000 is because a. The supply of superstar basketball players is very low, while the supply of competent teachers is much larger. b. Demand for Michael Jordan's talents is very high since he can generate so much revenue for a firm. c. Consumers enjoy basketball to the point that they are willing to spend lots of money and time attending games and watching commercials. d. All of the Above 3. When college students leave town for the summer, the demand for meals at the local restaurants declines. This results in a. a decrease in equilibrium price and an increase in quantity. b. an increase in equilibrium price and quantity. c. a decrease in equilibrium price and quantity. d. an increase in equilibrium price, and a decrease in quantity. e. None of the Above 4. All the following shift the demand curve for automobiles to the right except: a. the local factory gives a big raise to its employees. b. a brand-new automobile dealership opens in town. c. the price of gasoline falls. Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 8 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 d. None of the Above 5. If the cost of computer components falls, then a. the demand curve for computers shifts to the right. b. the demand curve for computers shifts to the left. c. the supply curve for computers shifts to the right d. the supply curve for computers shifts to the left 6. What happens in the market for airline travel when the price of traveling by rail decreases? a. The demand curve shifts left. b. The demand curve shifts right. c. The supply curve shifts left. d. The supply curve shifts right. e. We move along the supply curve. 7. If a sin tax is placed on sales of alcohol, a. the demand curve shifts to the left. b. the demand curve shifts to the right. c. the supply curve shifts to the left. d. the supply curve shifts to the right. 8. When a price ceiling is imposed above the equilibrium price, a. a shortage results b. a surplus result. c. the equilibrium outcome prevails. d. there is not enough information to determine the outcome. 9. If the demand curve shifts to the right, then we move up and to the right along our supply curve. a. True b. False 10. If the cost of making bicycles falls, the price goes down, causing the demand curve to shift to the right. a. True b. False Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 9 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 QUESTION AND ANSWER Question/s: Answer/s: 1. 1. 2. 2. 3. 3. 4. 4. 5. 5. KEYWORD INDEX A D Absolute advantage p7 Demand p2 C Demand curve p3 Commodities p3 E Consumer preferences p3 Economic activity p2 Cost of labor p5 Economic principle p3 Comparative advantage p7 Equilibrium price p6 Equilibrium quantity p6 R Equilibrium p6 Relationship p3 G S Graphically illustrated p3 Supply curve p4 H Slope p3 Horizontal axis p3 Seasonal effect p3 I Supply p4 Income p3 Surplus p6 International trade p8 Shortage p6 L Substitute product p5 Law of demand p2 T Law of Supply p4 Technology p5 M U Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 10 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 Market exchange p2 Unlimited wants and needs p2 Market equilibrium p6 V P Vertical axis p3 Prices p3 Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 11 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 TOPIC 6 : THEORIES OF INTERNATIONAL TRADE UNIT LEARNING OUTCOME: At the end of the unit you are expected to: 1. Explain why countries trade and the gains from trade 2. Understanding and apply specific trade models such as comparative advantage, factor endowment, and new models based on increasing returns. 3. Apply these trade models to explain patterns of international trade in goods and services. METALANGUAGE If you walk into a supermarket and are able to buy South American Bananas, Brazilian coffee and a bottle of South African wine, you are experiencing the effects of international trade. International trade allows us to expand our market for both goods and services that otherwise may not have been available to us. It is the reason why you can pick among s Japanese, German or American cars. As a result of international trade, the market contains greater competition and therefore more competitive prices, which brings a cheaper product home to the consumer. Key Concepts and Terms 1. International Trade. International trade is the exchange of goods and services among countries. One nation exports another nation import 2. Comparative Advantage. This ability of a firm or individual to produce goods and/or services at a lower opportunity cost than other firms or individuals. 3. Absolute Advantage. The ability of a country, individual, company or region to produce a good or service at a lower cost per unit than the cost a which any other entity produces that good or service. 4. Ricardian Model. Ricardian Model of international trade is developed on the theory of comparative advantage. 5. Heckscher-Ohlin Model. Heckscher-Ohlin model put stress on endowments of factors of production as basis for international trade. 6. Gravity Model of Trade. Provides an empirical explanation of international trade. According to this model, the economic sizes, and distance between nations are the Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 12 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 primary factors that determine the pattern of international trade. 7. Imports. Imports are goods (or services) produced by the foreign sector and purchase by the domestic economy. These are goods (or services) that flow into the domestic economy. 8. Exports. Exports are goods (or services) produced by the domestic economy and purchased by the foreign sector. These are goods that flow out of the domestic economy. 9. Net Exports. Net exports are the difference between exports and imports. This is the difference between goods flowing out of the domestic economy and goods and services flowing into the domestic economy. 10. Balance of Trade. The balance of trade of a nation is the difference between values of its exports and import. 11. Foreign Exchange Rate: Foreign exchange is the currency and other financial instrument used to conduct transaction and make payments in the foreign sector of a given country. 12. Fixed Exchange Rate: A fixed exchange rate is an exchange rate that is established at a specific level and maintained through government actions (usually through monetary policy actions of a central bank). 13. Managed Flexible Exchange Rate: A managed flexible exchange rate, what is also termed a managed float, is an exchange rate that is generally allowed to adjust due to the interaction of supply and demand in the foreign exchange market, but with occasional intervention by government. ESSENTIAL KNOWLEDGE Topic 6.1: International Trade International trade is the exchange of goods and services among countries. One nation exports another nation import. International trade abides by the same by the same basic economic principles as standard exchanges, such as those analyzed by the market model. The unique feature of international trade is the that buyers and sellers reside in different countries. Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 13 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 International Trade Theory deals with the different models of international trade that have been developed to explain the diverse ideas of exchange of goods and services across the global boundaries. The theories of international trade have undergone a number of changes from time to time. The basic principle behind international trade is not very much different from that involved in the domestic trade. The primary objective of trade is to maximize the gains from trade for the parties engaged in the exchange of goods and services. Be it domestic or international trade, the underlying motivation remains the same. The cost involved and factors of production separate international trade from domestic trade. Topic 6.1.1: Comparative Advantage This ability of a firm or individual to produce goods and/or services at a lower opportunity cost than other firms or individuals. A comparative advantage gives a company the ability to sell goods and services at a lower price than its competitors and realize stronger sales margins. Having a comparative advantage or disadvantage can shape a company’s entire focus. For example, if a cruise company found that it had a comparative advantage over a similar company, due to its closer proximity to a port, it might encourage the latter to focus on other, more productive, aspects of the business. It is important to note that a comparative advantage is not the same as an absolute advantage. The latter implies that one is the best something, while the former relates more to the costs of the particular endeavor. Comparative advantage is an economic law that demonstrates the way in which protectionism (mercantilism, at the time it was written) is unnecessary in free trade. Popularized by David Ricardo, comparative advantage argues that free trade works even if one partner in a deal holds absolute advantage in all areas of production – that is, one partner makes products cheaper, better and faster than its trading partner. The essence of this law can be illustrated with a simple example. Imagine that you are a Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 14 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 skilled cabinet maker as well as a gifted painter. It takes you days to build a cabinet or days to paint a picture. In the local economy, paintings sell for P400 and cabinets go for P350. Your neighbor also shares the same skill sets, but it takes him a more day to build a cabinet and three days to complete a painting. You have an absolute advantage over your neighbor in both areas, so you should try to out produce him across the board, right? It’s Wrong. Why? – here’s why: if you flip between painting and cabinet making over a six- day work week, you would produce three paintings and three cabinets worth P2,250. If your neighbor embarked upon the same work schedule, he would produce one painting and two cabinet worth P1,100. There would be a total of four paintings and five cabinet producers: a total of nine production units. If, however, you were to choose to focus on painting, the area where you have the greatest comparative advantage and the most profit, and leave cabinet making to your neighbor, something magical would happen. You would produce six painting worth P2,400 per week, while your neighbor would produce four cabinets worth P1,400, bringing the total to 10 production units. In real terms, both you and your neighbor would be richer for specializing and the local economy is one production unit the better for it. Topic 6.1.2: Absolute Advantage The ability of a country, individual, company or region to produce a good or service at a lower cost per unit than the cost a which any other entity produces that good or service. Entities with absolute advantages can produce a product or service. Entities with absolute advantages can produce a product or service using a smaller number of inputs and/or using a more efficient process than another party producing the same product or service. The United State produces 700 million gallons of wine per year, while Italy produces 4 billion gallons of wine per year. Italy has an absolute advantage because it produces many more gallons of wine (the output) in the same amount of time (the input) as the United States. Lisa can sew a sweater in 5 hours, while Kate can sew a sweater in 3 hours. Kate has an absolute advantage over Jane, because it takes her fewer hours (the input) to produce a Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 15 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 sweater (the output). An entity can have an absolute advantage in more than one good or service. Absolute advantage also explains why it makes sense for countries, individuals and businesses to trade with one another. Because each has advantage in producing certain products and services, they can both benefits from trade. For example, if Liza can produce a comparable painting in 5 hours while Kate needs 9 hours to produce a comparable painting, Lisa has an absolute advantage over Kate in painting. Remember Kate has an absolute advantage over Lisa is sewing sweaters. If both Liza and Kate specialize in the products, they have an absolute advantage in and buy the products they don’t have an absolute advantage in from the other entity, they will both be better off. Topic 6.1.3: Three Famous International Trade Theories Among the different international trade theories, the Ricardian model, the Heckscher- Ohlin model and the Gravity model of trade are worth mentioning. Ricardian Model. Ricardian Model of international trade is developed on the theory of comparative advantage. According to this model countries involved in trade, specialize in producing the products in which they have comparative advantage. Heckscher-Ohlin Model. Heckscher-Ohlin model put stress on endowments of factors of production as basis for international trade. As per this theory countries will specialize in and export those products, which make use of the domestically abundant factors of production more intensively than those factors, which are scarcely available in the home country. Gravity Model of Trade. Provides an empirical explanation of international trade. According to this model, the economic sizes, and distance between nations are the primary factors that determine the pattern of international trade. Topic 6.1.4: Trading Flows: Exports and Imports Trading globally gives consumers and countries the opportunity to be exposed to goods Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 16 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 and services not available in their own countries. Almost every kind of product can be found on the international market: foods, clothes, spare parts, oil, jewelry, wine, stocks, currencies and water. Services are also traded: tourism, banking, consulting and transportation. A product that is sold to the global market is an export, and a product that is bought from the global market is an import. Imports and exports are accounted for in a country’s current in the balance of payments. Imports. Imports are goods (or services) produced by the foreign sector and purchase by the domestic economy. These are goods (or services) that flow into the domestic economy. Exports. Exports are goods (or services) produced by the domestic economy and purchased by the foreign sector. These are goods that flow out of the domestic economy. Net Exports. Net exports are the difference between exports and imports. This is the difference between goods flowing out of the domestic economy and goods and services flowing into the domestic economy. Topic 6.2: International Trade and Balance of Payment Topic 6.2.1: Balance of Trade The balance of trade of a nation is the difference between values of its exports and import. When exports are greater than imports, the nation is said to have a balance of trade surplus. On the other hand, if imports are greater than exports, the nation is said to have a balance of trade deficit. Exports and imports that figure in the balance of trade concept arise in the context of trade with other countries. Exports are the value of goods and services produced in the Philippines and sold to other countries in other words, exports are expenditures on Philippine goods and services by the residents of foreign countries. Imports, on the other hands, are the value of goods and services produced in other countries and bought by the United State in other words, imports are expenditures by the Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 17 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 residents of the Philippines on goods and services produced by foreign countries. Since the balance of trade arises in the context of foreign trade, the balance of trade deficit is also called the foreign trade surplus and the balance of trade deficit is also called the foreign trade deficit. Also, since the balance of trade surplus or deficit is defined as the difference between exports and imports, it as also called net exports. The foreign trade surplus or deficit is considered to play an important part in the economic growth of a nation, and thus it has implications for jobs created within the country or jobs lost to other nations. Topic 6.2.2: Determinants of Balance of Trade. There are three major determinants of the trade balance or net exports; Foreign exchange rates, national incomes, and domestic and foreign price level. Foreign Exchange Rate: Foreign exchange is the currency and other financial instrument used to conduct transaction and make payments in the foreign sector of a given country. The foreign half of the term infers that the currency is part of a given country’s’ foreign sector, that is, everything beyond the political boundaries of a country. The exchange half of the term infers that these foreign instruments are used to make payments, that is, to facilitate trades, and more to the point that domestic currency is traded for foreign currency to engage international transactions. Domestic and Foreign Incomes: Changes in national income in foreign countries as well as in the Philippines have an important effect on net exports. If national income in foreign countries rise foreign residents demand greater amounts of goods and services, some of which can be bought from the Philippines. As a result, an increase in income in foreign countries leads to an increase in Philippine exports, causing the foreign trade deficit to rise (assuming other factors do not change). If national income in foreign countries falls, Philippines exports to these countries will decline, leading to a decline in the foreign trade deficit as well. Foreign Price Level: Even if the foreign exchange rate and the domestic and foreign Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 18 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 economic growth rates remain unchanged, changes in price levels can affect Philippines net exports, in general, an increase in Philippines price levels will hurt Philippines exports. On the other hand, an increase in Philippines price level will also affect Philippines imports of foreign goods and services. The price increases serve as a double-edged sword that reduces exports to decline that is, the foreign trade deficit become worse of the magnitude of the foreign trade surplus declines. Topic 6.2.3: Foreign Exchange Rate Policies Flexible Exchange Rate: A flexible exchange rate, also termed floating exchange rate, is an exchange rate determined through the unrestricted interaction of supply and demand in the foreign exchange market. A flexible exchange rate means that a country is NOT trying to manipulate currency prices to achieve some change in the exports or imports. This policy is based on the presumption that the free interplay of market forces in most likely to generate a desirable pattern of international trade. Fixed Exchange Rate: A fixed exchange rate is an exchange rate that is established at a specific level and maintained through government actions (usually through monetary policy actions of a central bank). To fix an exchange rate, government must be willing to buy and sell currency in the foreign exchange market in whatever amount are necessary to keep the exchange rate fixed. A fixed exchange rate typically disrupts the balance of trade and balance of payments for a country. But in many cases, this is exactly what a country is seeking to do. Managed Flexible Exchange Rate: A managed flexible exchange rate, what is also termed a managed float, is an exchange rate that is generally allowed to adjust due to the interaction of supply and demand in the foreign exchange market, but with occasional intervention by government. Most nations of the world currently use a managed flexible exchange rate policy. With this alternative an exchange rate is free to rise and fall, but it is subject to government control if it moves too high or too low. With managed float, the government steps into the foreign exchange market and buys or sells whatever currency Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 19 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 is necessary keep the exchange rate within desired limits. Topic 6.3: Balance of Payments The balance of payments provides a country with a record of international payment flows. While the balance of trade is one important part of the balance of payments account it is only part. The balance of payments as a comprehensive set of accounts that track all sorts of payments coming in to and going out of a nation for a wide variety of reasons. Specifically, the balance of payments is the difference between all payments coming into a nation and those going out of the nation. It is the balance of international monetary transactions for a nation Topic 6.3.1: Measuring of Balance of Payments The balance of payments is a summary of all the international transactions of a country and its citizens during a specified period of time. This period is usually of one year, though many countries have now started preparing the quarterly accounts for the purposes of forecasting. Harvey and Johnson have defined these accounts in these words. The balance of payments accounts for a country set out, in summary form, all the current and capital transactions which have taken place between the residents of that country and the rest of the world in a given period of time. The word residents does not only mean the persons, but also business firms, governments, and international agencies located in a particular country. The residents are not necessarily always citizens of the country. The balance of payments of a country may be expressed through the following relation: B=R–P Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 20 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 Here B denotes the balance of payments; R, total receipts; and P, total payments. Both total receipts and payments can be subdivided into domestic and foreign receipts and payments. Assuming that domestic receipts and domestic payments are equal, the balance of payments can be stated as: B = Rf – Pf If Rf > Pf, there will be a balance of payments surplus. If Rf < Pf, it denotes a deficit in international payments. An equality between receipts and payments (Rf = Pf) signifies equilibrium in international payments. Is Balance of Payments Always in Balance? The balance of payments is a statement of international transactions expressed in terms of debits and credits based on double entry system of book-keeping. If all the entries are made correctly, the total debits must be equal to total credits. It happens because each transaction is expressed through entries of equal amounts on the opposite sides of the BOP account. So if the BOP of a country is considered strictly from the accounting sense, there must be identity between the total credits and total debits and therefore the statement that ‘balance of payments is always in balance’, seems to be true. In the accounting sense, the BOP remains always in a state of balance. This can be shown on the assumption that an economic system is in a state of equilibrium and the aggregate income (Y) is exactly equal to the aggregate expenditure. Alternatively, it may be assumed that the total injections are exactly equal to total withdrawals in the system. Total injections include investment (I), government expenditure (G) and exports of goods, services and capital (X). Total withdrawals, on the other hand, include savings (S), taxes (T) and imports of goods, services and capital (M). I+G+X=S+T+M (X – M) = (S -I) + (T – G) Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 21 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 If the budget is balanced so that (T – G) = 0 and the domestic saving and investment are exactly balanced so that (S – I) = 0, it will follow: (X – M) = 0 Topic 6.3.2: International trade has both winners and losers. Winners: The winners in an international trade are the consumers in the buying (or importing) nation and the producers in the selling (or exporting) nation. The buyers receive consumer surplus and the sellers acquire producer surplus Losers: However, the losers in an international trade are the producers in the buying (or importing) nation and the consumers in the selling (or exporting) nation. The producers in the buying nation face greater competition for their products, which inevitably means lower prices and profits. The consumers in the selling nation also face greater competition for this domestic production, which is bound to cause higher prices. SELF HELP Please refer to the articles below to further deepen your understanding in theories of international trade. Read more: https://www.econlib.org/library/Topics/HighSchool/BalanceofTradeandBalance ofPayments.html https://courses.lumenlearning.com/wmintrobusiness/chapter/reading-the- globalization-of-business/ http://www.levyinstitute.org/pubs/wp_635.pdf LET’S CHECK Congratulations! you just finished most vital concept in the study of international business and trade. Let us check your understanding of the important concept. Please proceed to the multiple choice. Select the letter that best describe your answer. Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 22 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 1. Transportation cost of trade affects: a. Pattern of trade c. boundaries between tradable and non- tradable goods b. Global supply chains d. All of the above 2. A no-trade world will have which of the following characteristics: a. Countries will have same relative endowment of production factor b. Consumers across countries will have identical and homogenous tastes c. There will be no distortions or externalities d. All of the above 3. In the 2-factor, 2 goods Heckscher-Ohlin model, the two countries differ in a. Military capabilities c. relative availabilities of factor of production b. Labor productivities d. tastes 4. According to Ricardo, a country will have a comparative advantage in: a. Industries in which there are neither import nor export b. Import competing industries c. Industries that sell to domestic and foreign buyers d. Industries that sell to only foreign buyers 5. Nations conduct international trade because: a. Some nation prefers to produce one thing while others produce other things. b. Resources are not equally distributed among all trading nations. c. Trade enhance opportunities to accumulate profits. d. Interest rates are not identical in all trading nations. 6. Which of the following is a determinant of trade? a. Tastes c. Technological change b. Per capital income d. All of the above 7. International Trade is most likely to generate short-term unemployment in: a. Industries in which there are neither import nor export b. Import-competing industries c. Industries that sell to domestic and foreign buyers d. Industries that sell to only foreign buyers 8. According to the theory of comparative advantage, which of the following is NOT a reason why countries trade? Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 23 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 a. Costs are higher in one country than in another b. Prices are lower in one country than in another c. The productivity of labor differs across countries and industries d. Exports give a country a political advantage over other countries that export less. 9. The reasons why international trade has strong effects on distribution of income because: a. Resources cannot move immediately or without cost from one industry to another b. Industries differ in the factors of production they demand c. Trade has no effect on distribution of income d. Bothe A and B 10. Which of the following is not a benefit of international trade? a. High wage level for all domestic workers b. Lower domestic prices c. Development of more efficient methods and new products d. A greater range of consumption choices. 11. Bangladesh is relatively abundant in labor, while Canada is relatively abundant in capital. In both countries the production of shirts is relatively more labor intensive than the production of computers. According to the factor endowment theory (Heckscher-Ohlin model), Bangladesh will have a(n): a. Absolute advantage in production of shirts and computers b. Absolute advantage in production of computers c. Comparative advantage in production of shirts d. Comparative advantage in production of computers. 12. Free traders maintain that an open economy is advantageous in that it provides all of the following except: a. Increased competition for world producers b. A wider selection of products for consumers c. The utilization of the most efficient production methods d. Relatively high wage levels for all domestic workers. 13. A closed economy is one in which? Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 24 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 a. Imports exactly equal exports, so that trade is balanced. b. Domestic firms invest in industries overseas. c. The home economy is isolated from foreign trade d. Saving exactly equals investment at full employment. 14. Ricardian trading principle emphasis the; a. Demand side of the market c. Role of comparative advantage b. Supply side of the market d. Role of absolute advantage 15. Under Heckscher-Ohlin Model, international trade can lead to increase in: a. Consumer welfare only if output of both products is increased b. Output of both products and consumer welfare in both countries c. Total production of both products, but not consumer welfare in both countries d. Consumer welfare in both countries, but not to all production of both products. QUESTION AND ANSWER Question/s: Answer/s: 1. 1. 2. 2. 3. 3. 4. 4. 5. 5. KEYWORD INDEX A D Absolute Advantage p15 Domestic Income p18 B E Balance of Trade p17 Export p17 Balance of Payments p20 F C Foreign Exchange Rate p18 Comparative Advantage p14 Fixed Exchange Rate p19 Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 25 of 26  College of Business Administration Education 2nd Floor, SS Building Bolton Street, Davao City Telefax: (082)227-5456 Local 131 Foreign Income p18 I Foreign Price Level p18 International Trade p13 Flexible Exchange Rate p19 International Trade Theories p16 G Import p17 Gravity Model of Trade p16 M H Mercantilism p14 Heckscher-Ohlin Model p16 Managed Flexible Exchange Rate p19 N Net Export p17 R Ricardian Model p16 Course: CBM 321 – International Business and Trade Prepared by: Jesson Rey F. Sabado Reviewed by: CMC Page 26 of 26