Chapter 1

An Introduction to International Trade

This chapter is devoted to answer some questions as: how

important is international trade to the nations of the world?

Which countries trade with other countries? What goods do

countries trade?

Question 1: Define the following terms:

1- Gross National Product (GNP)—value of final goods and

services produced by domestic factors of production.

- Refers to production by domestic factors, no matter

where they are located.

2- Gross Domestic Product (GDP)—value of final products

produced within a country.

- Refers to production within a country, no matter whether

the factors of production (labor and capital) are domestic

or foreign.

3- Exports—goods and services produced in one country and

sold to other countries.

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4- Imports—goods and services consumed in a country but

which have been purchased from other countries.

5- Trade Deficit—a country has a trade deficit if its imports

exceeds its exports.

6- Trade Surplus – a country has a trade surplus if its exports

exceed its imports.

7- Index of Openness—a measure of how much a country

participates in international trade; defined as the ratio of a

country’s exports to its GDP (or GNP).

- Open Economy—a country with a high value of the

index of openness.

- Closed Economy—a country with a relatively low index

of openness. International trade is only a small part of

their economic activity.

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Question 2: Why do the countries trade?

Answer:

1- Without trade, a country must be self-sufficient. It must

produce everything its citizens want to consume.

2- With trade, countries can specialize in the production of

goods that they can produce, and satisfy other needs by

trading.

3- Making a country more efficient, when it exports goods

which use abundant resources and imports goods which use

scarce resources.

4- Trade could increase competition.

5- Trade Creates new entrepreneurial opportunities, expands

the choice of goods and services, and creates jobs.

6- Enhances the domestic competitiveness.

7- The country will come up with new technology and

innovations will be taken place.

8- Access to cheaper raw-material.

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Question 3: compare between free trade &

protectionism.

Answer:

Free Trade:

Occurs when a government doesn't attempt to influence,

through quotas, duties or other means, what its citizens can

buy from another country or what they can produce and sell to

another country.

A- Advantage of free trade:

1. Free Trade means more jobs to go to other countries but

only jobs that required very little skills.

2- The aim of free trade is to analyze and refrain barrier in

order to customize easy exchange of specialized and skilled

labor force and division of labor, resulting enhanced

development.

B- Disadvantage of free trade:

1. Short term unemployment in relatively inefficient sectors

of the economy.

2. Other countries sometimes do not trade fairly and

difficulty in establishing infant industries.

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3. The government revenue will fall.

4. The domestic products will be neglected and the

consumers will switch to the other (foreign) products.

Protectionism:

Refers to policies, rules and regulations that help nation

place barriers in the form of tariffs while trading with any

other country.

A- Advantages of the trade protectionism are:

1. If a country’s local industry is not very strong, imposing

trade barrier would make foreign goods expensive and

this will provide a chance to the local firms to compete

on the font of price.

2. The increased duties result in tax revenue for the

government

3. The aims of protectionism are to preserve jobs.

B-disadvantages of protectionism are: 

1. The local firms are being protected and they are

competing on price not the quality

2. The artificial protection can work well for the products

inside the country , but when the products will be

exported; it’s a false sense of security.

3. It is against the principle of free markets.

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Chapter 2

International Trade Theories

This chapter is devoted for studying international trade theories

starting from the mercantilism trade theory till the alternative

theories.

Then we try to give you some questions to elaborate these

theories, which may help you.

Question 1: Explain the following theories:

1- Mercantilism Theory

Answer:

Theory of Mercantilism:

Nations should accumulate financial wealth, usually in the

form of gold,

Increasing exports and decreasing imports (through

imposing taxes on imported goods, ban on the

importation of other goods, and special laws and taxes

designed to favor certain industries at the expense of

others.

Importance of trade surplus because it leads to a net gold

inflow, and thereby to national wealth and power.

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Mercantilist countries practiced the so-called zero-

sum game, which meant that world wealth was

limited and that countries only could increase their

share at expense of their neighbors.

2- Absolute Advantage

Answer:

Absolute advantage theory (Adam Smith’s Model).

Absolute advantage theory a country can produce a good

using fewer productive inputs than is possible anywhere else in

the world, so each country should concentrate on the

production of those goods it produces most efficiently.

This theory based on the concept of an international division of

labor by the specialization of nations in the production of only

a few goods.

This specialization could lead to:

• level of world production exceed the sum of autarky

production levels.

• the surplus produced in this situation could then be

divided between countries through international trade,

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• so that all would have more than they would without

trade.

Example:

we have two countries (A) and (B), and two products Soybeans

(S) and Textiles (T), the numbers in the table reflect the hours

it takes to make 1 unit of output of certain good in a certain

country, as follows:

Country

BA

123Soybeans

46Textiles

From the previous Example we see that workers in country

A can produce S in less time than workers in B , A is said to

have an absolute advantage in the production of S. while

workers in B can produce T in less time than workers in A, B

is said to have an absolute advantage in the production of T.

Criticism:- (on mercantilism)

1. there is a set of institutions, laws and regulations put by

governments to restrict international trade and hence the

international division of labor, so Smith attacks the

mercantilism system and to promote free international

trade

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2. Smith argued the opinion of mercantilists because this

system served to lower the wealth or standard of living of

a country,

2- comparative advantage theory

Answer:

Comparative advantage theory (David Ricardo’s Model).

Comparative Advantage Theory: A country has comparative

advantage in the production of a good if it can produce that

good at a lower opportunity cost relative to another country.

• Example : we have two countries (A) and (B), and two

products Soybeans (S) and Textiles (T), the numbers

indicate the amount of labor time required to produce 1

unit of output of a particular good in a particular country.

Country

BA

123Soybeans

86Textiles

From Example we see that:

country A has an absolute advantage in both goods.

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Country A is 4 times more efficient in the production of

good S relative to country B (compare 3 hours with 12

hours).

However, A is only 4/3 more efficient in the production of

T relative to country B (compare 6 hours with 8 hours).

Because A's greatest absolute advantage is in the production

of S, it is said to have a comparative advantage in S.

Likewise, because B's least absolute disadvantages in the

production of T, B is said to have a comparative advantage

in T.

If international trade takes place, A will export S, and B

will export T.

According to the law of comparative advantage, once trade is

allowed between the two countries, each country should move

to specialize in the production of its comparative advantage

good and then export the excess of the production of that good

to the other country in exchange for the other good.

Example:

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Per Unit Gains from Specialization According to

Comparative Advantage as Country A Produces More S, and

Country B Produces More T.

Per Unit Gain

In Production of T In Production of S

-1+2In A

+1.5-1In B

+0.5+1In World Country A:

If country A specialize its production in the direction of

comparative advantage, its output of S will rise.

The resources of this expansion must come from the T

industry, which means the output of T must fall by 1 unit, and

the 6 hours of labor time in T can be employed in the S

industry, and the result will be expansion of output of S by 2

units.

Country B:

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The output of S falls by 1 unit, and the 12 hours of labor time

in S can be employed in the T industry, and the result will be

expansion of output of T by 1.5 units.

And the gain from specialization in the world will be +1 unit in

S and +0.5 in T.

4- H-O Model

The Hecckscher-Ohlin Model.

Heckscher and Ohlin built their theory around two basic

characteristics of countries and products:

1. Countries differ from each other according to the factors

of production they possess.

2. Goods differ from each other according to the factors that

are required in their production.

The Direction of International Trade at HO Model:

The direction of international trade flows between two

countries is determined by:-

the endowment of the factors of production (labor &

capital).

that a country which is capital abundant will export the

capital intensive goods.

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And, the country which is labor abundant will export the

labor intensive goods.

Test of HO Model: The Leontief Paradox.

A test of HO model conducted by Leontief using input –

output data for the United States and the main finding is that

despite the fact that the United States was the most capital

intensive country in the world, it exported goods that were

relatively labor intensive and imported goods that were

relatively capital intensive, which is known as Leontief

Paradox.

alternative theories of international trade to explain

Leontief paradox

1- Human Skills theory, developed by Donald Keesing.

instead of focusing on differences in capital and labor

across countries, the emphasis should be on differences

in endowment of skilled and unskilled workers.

Country with large endowments of high skilled labor

will have comparative advantage in products that are

relatively intensive in skilled labor.

Keesing model provides an explanation of the Leontief

Paradox, because the United States has highly trained

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and educated workers, U.S exports tend to be skilled

labor intensive.

2- Product life Cycle theory.

by Raymond Vernon

The product life cycle is divided into three stages:

A- New product stage:

1. In this stage goods are invented mostly in the

developed countries.

2. And at this period there is no competition.

3. The invented company of the new product seeks to

export this product to other developed countries.

B- Maturity product stage:

During this stage, the company find the necessity to invest

abroad. 

C- Standardized product stage:

This is the final stage, where the company (country)

loses its comparative advantage in producing the product

and this advantage shifts to another country which could

produce this product with lower cost.

Vernon had explained Leontief paradox as when the United

States lose its comparative advantage in producing capital

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intensive goods and this comparative advantage switch to

another country, the U.S tend to import capital intensive goods

from this country, and that explains why the United States

imports are capital intensive goods.

Chapter 3

Tariffs and Nontariff Barriers

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We have focused our discussion on the causes and

consequences of international trade. We have seen that

international trade leads to the redistribution of production in

an economy. It also affects the returns paid to factors of

production. For both of these reasons, some individuals in

every society favor government policies aimed at affecting the

volume and composition of international trad

Question 1: Define the following terms.

1- Commercial policy is known as actions taken by a

government to influence the volume and composition of trade

flows (into or out of a country).

2- Tariff : A tax imposed by a government on either exports or

imports.

3- Quota : A government imposed limit on the value or

quantity of an import or export goods.

4- Subsidies : Payments by a government to an industry to

encourage exports or discourage imports.

5- Nontariff barriers : A wide range of government policies

than tariffs designed to affect the volume or composition of a

country's international trade

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6- Consumer surplus: is the difference between the amount

consumers are willing to pay to purchase a given quantity of

goods and the amount they have to pay to purchase those

goods.

7- Producer surplus: is the difference between the price paid

in the market for a good and the minimum price required by an

industry to produce that good.

8-Embargo—complete ban on import of a certain good.

9- Tariff Rate Quota (TRQ)—allows a certain quantity of a

good into a country at low or zero tariff rates, but applies

higher tariff to quantities exceeding the quota.

10- Voluntary Export Restraint (VER)—an indirect quota

resulting from an exporting country “voluntarily” limiting

its exports.

Question 2: Illustrate the following with discussion.

1- The gains from free trade (import side).

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Say country A in equilibrium, the price of grapes would be

PA And the quantity produced would be QA.

Now, suppose we introduce international trade into this model.

We assume that the world price of grapes Pw is lower than PA.

This will cause Consumption to expand to Q2 and

domestic production to fall to Q1

The difference between domestic consumption and

domestic production will comprise imports.

What are the economic impacts of these changes in the

grape market in country A?

consumers are better off; they are able to purchase this

product at a lower price than before trade. Domestic

producers are worse off; the lower price leads some

suppliers to reduce the quantity supplied.

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- The welfare effects in the import market of a move to

free trade.

2- The gains from free trade export side.

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Suppose this represents the market for honey (H), in autarky

before trade the price of H is PA, and would equal QA .

Suppose that the world price of H is equal to PW.

Then, after international trade is introduced, domestic

suppliers would move to expand output in response to the

now higher price.

At the same time, the domestic quantity demanded would

fall, and the new quantity supplied would be Q4 , while the

new quantity demanded would be Q3 units.

The difference represents exports of H to the rest of the

world.

The welfare effects in the export market of a move to free

trade.

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Because the price has increased, consumer surplus falls.

The total reduction of consumer surplus would be $(e + f).

The higher price, however, raises producer surplus. The

increase is equal to $ (e + f +g). The net impact for national

welfare to rise by $g.

3- The effect of an import tariff.

Suppose the government of A imposes a tariff on imports of

grapes of t dollars.

Let's consider the effect of the tariff on production and

consumption.

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Under free trade, domestic production was Q1 units, while

consumption was Q2 units. Imports represented the difference

between these two amounts.

After the tariff, production rises from Q1 to Q3units.

- When considering the effect of the tariff on price, once the

tariff is imposed, it is passed through to the economy in the

form of higher prices for the foreign product. Since domestic

producers are selling an identical product, they raise their

prices as well.

- Total consumption of grapes falls. This is due, to the higher

price consumers must pay for the product. Hence, quantity

demanded falls from Q2 to Q4.

- Tariff causes a reduction in imports for two reasons:

First: domestic output expands.

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Second: domestic consumption falls.

Finally, tariffs lower the standard of living of a country

relative to free trade, because they hurt consumers more

than they help producers.

4- The economic effects of quota.

The curve DM is the domestic demand curve, and the curve

SM is the supply curve of domestic producers. The world price

is assumed to be $1000.

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Under free trade:

Residents of this country would consume 50,000 units, 10,000

of these would be produced locally, and 40,0000 would be

imported.

The government imposes a quota on imports:

A quota that limits imports to 20,000 units. Because of

the reduction in imports, the prices of the product M will

start to rise and this will encourage local producers to

expand their output levels.

These market forces will bring about new equilibrium;

prices continue to rise until desired imports fall to the

quota level of 20,000 units (the price must raise until the

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difference between domestic demand and supply equals

20,000 units).

This occurs at a price of $1,500, at this price 44,000 units

will be purchased, 20,000 of these will be imported, and

the remaining 24,000 will be produced locally.

As with tariff, quotas serve to limit trade and raise prices.

The welfare effects of quotas:

the imposition of the quota raises the domestic price and

therefore lowers consumer surplus.

Consumers lose the amount $(a + b+ c+ d), producer

surplus represents higher profits by $a, and the triangles

$(b + d) represents the cost of society of imposing the

quota (deadweight costs).

Area c is the value of quota rent: Profit that accrues to

whoever has the right to bring imports into the country

and sell these goods in the protected market.

Consider the rectangle that defines area c. The base of the

rectangle represents the amount of imports allowed into

the country (20,000 units); the height of the rectangle is

the difference between the world price ($1000) and the

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domestic price ($1,500). The difference between these

two prices reflects the per unit (additional) profit that can

be earned by whoever has the right to sell the imported

product.

Q: Who gets the quota rent?

-Government

-Domestic producers or importers

-Foreign producers.

Question 3: Compare between tariff & quota.

QuotaTariff

They are similar in their effects on prices, output, and imports.

They are similar in their effects on prices, output, and imports.

quota rent depends on who gets the license.

Tariff revenue goes to government

with a quota, no new imports are allowed in.

With a tariff, an increase in demand will be met by a rise in imports

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Change in consumer surplus - $a - $b - $c - $d

Change in producer surplus $a Change in government revenue $c 

Net Welfare Cost - $b - $d

Question 4: there is a relationship between trade &

economic growth. Discuss.

Answer:

Trade enhances economic growth through imports of capital

goods.

- Trade enhances international diffusion of technology.

- Trade expands market size.

- Trade can enlarge the pool of savings necessary for

investment spending.

Question 5: there are arguments for protectionism. Elaborate.

Arguments for Protectionism:

There are some arguments for protection, we discuss them as

follows.

1- Balance of Payments Problems:

If a country exports less than its imports, the balance of

payments deficit will result.

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2- Government revenue.

All governments need tax revenues, and Tariffs produce

government revenue.

3- Income Redistribution.

Trade policy can be used to redistribute income from one

sector of society to another.

In some countries, one of aims of commercial policy is to tax

the rich so as to aid the poor.

4-Protection of Infant Industries.

New industries may need protection until they have mastered

the production.

5- Protect Jobs.

Foreign imports are cheaper and consumers are going for the

cheapest product which is also with a good quality.

By restricting imports and making imports more expensive,

Countries can help their domestic industries and protect its

jobs.

6. To Prevent Dumping.

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When selling products/goods overseas for a lower price than

production costs.

Chapter 4An Introduction to International

Finance

This chapter is devoted to study the trade in financial assets.

Such trade may be related to the financing of goods and

services trade, but it may also be related to investors altering

their portfolios, multinational firms transferring assets from

one subsidiary to another, government buying and selling

different currencies to change exchange rates.

Question 1: Define the following terms.

1- The Balance of Payments (BOP): is a record of a

nation's transactions with the rest of the world, in other

words the BOP reflects the country's international

trading performance.

2- A country with a trade surplus: exports more goods

than it imports.

3- A country with a trade deficit imports more than it

exports.

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4- Balance of payments deficit: BOP debit items

exceed the credit items in value.

5- Balance of payments surplus: BOP credit items

exceed the debit items in value.

6- Foreign Exchange Market (FEM)—the market

where monies of different countries are traded.

7- Exchange rate—price of one country’s money in

terms of another.

8- Foreign exchange risk—the risk

of an unexpected change in the exchange rate.

9- International investment—portfolio investment and

direct investment.

10- International monetary systems— history of

international financial systems.

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Chapter Five

The Balance of Payments

This chapter is devoted for studying the balance of payment,

practically after studying this chapter you can solve the

following problems.

Question 1: Discuss the followings:

1- The features of the balance of payment.

Features of the BOP

BOP follows the accounting procedure of double-entry

bookkeeping (debits & credits).

A credit entry records an item or transaction that brings

foreign exchange into the country.

A debit entry represents a loss of

foreign exchange.

BOP will always balance.

A BOP deficit (surplus) means that the debit entries

exceed (are less than) the credits. This imbalance applies

only to a particular account or component of

the BOP.

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2- Double entry accounting in the BOP.Is an accounting method which records each transaction as

both a credit and a debit.

Credit entries represent the source of financing and the debit

entries represent the uses of that financing.

A- Credit transactions result in receipt of payment from

foreigners,

Merchandise exports.

Transportation and travel receipts

Income received from investments abroad

Gifts received from foreign residents

Aid received from foreign governments.

B- Debit transactions involve to payments to foreigners,

Merchandise imports.

Transportation and travel expenditures.

Income paid on investments of foreigners.

Gifts to foreign residents.

Aid given by home government.

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Overseas investments by home country residents.

Each credit transaction has a balancing debit transaction,

and vice versa, so the overall balance of payments is always

in balance.

Question 2: What happens if the country has a

current account deficit?

The country must borrow (sell domestic securities)

to the rest of the world to finance the current

account deficit.

As foreigners accumulate domestic securities, the

domestic currency value falls which, in turn, raises

net exports and consequently income.

What happens if the country has a current account

deficit?

In addition, domestic interest rates rise which, in

turn, lowers consumption and investment spending.

The increase in national income relative

to spending will reduce the current

account deficit.

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Chapter Six

WTO & its Dimensions

This chapter is expanded upon discussion by focusing on recent trade policy initiatives, and we also discuss in some details the role of international organizations and agreements, such as the World Trade Organization (WTO).

Question 1: What's the role of the following

institutions?

A- World Bank: "Development Assistance".

Provides loans to developing countries and the official goal are

the reduction of poverty. Established by the Bretton Woods,

1944.

B- International Monetary Fund (IMF): Financial

Assistance. Established by the Bretton Woods, 1944.

C- World Trade Organization (WTO):Trade Policy

Regulation and Negotiation, 1995.

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Question 2: Explain the main principles of GATT.

The principles of GATT:-

1- Most Favored Nation (MFN).

Under WTO agreements, countries cannot normally

discriminate between their trading partners. Which means

grant someone a special favor such as lower customs duty rate,

and do the same for all other WTO members, that’s all

members are equal under GATT.

2- Non discrimination.

Which means not discriminate between national and foreign

economic units giving them national treatments.

3- Reciprocity.

Under the WTO agreements, members must reciprocate the

reduction in tariff & nontariff barriers. The exception of that

are the infant industries in developing countries to enable it to

compete in international markets.

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4- Ratification.

This principle allows countries to protect their local or

national industries through tariff as a tool to protect infant

industries.

5- Preferential treatment for developing countries.

That developed countries must provide preferential treatment

for developing countries and to aid these developing countries

in conducting the development programs which include open

their markets in front of developing countries products.

6- Transparency.

Which means depends only on tariffs as a protection tool not

on nontariff barriers as quotas because of the lack in

transparency in nontariff barriers.

7- Multilateral negotiations.

That means negotiation is the basic tool to solve commercial

dispute under GATT.

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Question 3: Uruguay Round of Multilateral Trade

Negotiations has several important results.

Elaborate.

A- Agreement on trade in goods, include agreements

such as:

1- Agriculture Agreement.

2- Agreement on manufactured goods including agreement on

textiles and clothing.

3-Agreement on Trade Related Investment Measures

(TRIMS).

4- Trade Related Aspects of Commodity Measures.

B- General Agreement on Trade in Services (GATS).

The agreement covers all internationally traded services, for

example: banking, information technology and

telecommunication, tourism, consultants…..etc.

C- Trade Related Aspects of Intellectual Property

Rights (TRIPs).

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Areas covered by the TRIPs Agreement:

1- Copyright and related rights.

2- Trademarks.

3- Geographical indication.

4- Industrial design.

5- Patents.

6- Layout designs of integrated circuits.

7- Undisclosed information, including trade secrets.

Question 4: Regionalism versus Multilateralism.

Explain in details.

It is important to remember that regional trade liberalization is

very much different from the process of multilateral

liberalization that is the corner stone of the WTO.

In regional trade arrangements, countries lower their trade

barriers only for a small group of partner countries and

discriminate against the rest of the world.

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Within the WTO, trade liberalization by any one member

country is extended to all other members on an unconditional

MFN basis, here there is essentially no discrimination.

Regional agreements facilitate the work at the WTO, for the

following reasons:

1. Regional integration is a tool to overcome national trade

barriers and to boost competitiveness.

2. Big bilateral deals can remove obstacles on certain topics

and be much more comprehensive than the commitments

that a given country can make in multilateral rounds.

3. Bilateral agreements are essential to improve the WTO

negotiations especially in the periods of freezing of the

relations in the WTO.

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Review Questions:

1-According to chapter Two , summarize the international

trade theories.

2-According to chapter three, illustrate the impacts of

tariff & Quota, then compare between them.

3- According to chapter 4 & 5, discuss the balance of

payment.

4- According to chapter 6, discuss the WTO & its

dimensions.

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