1. PART ONE
INTERNATIONA TRADE THEORIES
AND POLICIES

2. MERCANTALISM
• Precious Metals
• Zero Sum Game : One gains, one losses
• Exports > Imports = Trade Surplus
• Policies : Monopoly rights, restrictions
• Economic System: manufacturing; rural, overseas
colonies
• Labor Theory of Value: Commodity is valued in
relation to the L

3. FAILURES OF MERCANTALISM
State Monopoly collapsed
Technology, market system
Views of Two Classical Writers
DAVID HUME ADAM SMITH
MERCANTALIST IDEAS VIEW CHALLENGED

4. DAVID HUME AGAINST MERCANTALISM
• Competitiveness Cannot Be Maintained At The Same Level
• Price Specific Flow Mechanism
• Two Countries
Country With A Surplus Country With A Deficit
(X>m) (X<m)
Inflow Of Gold Outflow Of Gold
Increase In Money Supply Decrease In Money Supply
Increase In Prices And Wages Decrease In Prices And Wages
Decrease Indemand For Exports Increase In demand For Exports
X , M X M
X=M X=M

5. ADAM SMITH AGAINST MERCANTALISM
• ROLE OF THE GOVERNMENT
• (NO GOVERNMENT INTERVENTION)
– NATIONAL DEFENCE AND JUSTICE
– PROVISON OF PUBLIC GOODS
– INTERVENTION IN TIMES OF MARKET FAILURES
THEORY OF ABSOLUTE ADVANTAGE

6. ABSOULTE ADVANTAGE THEORY
USE hypothetical EXAMPLEs when you are writing your answer;
1. Labor Hours 2. 200 labor hours: 100 hours Per Each commodity
3. Domestic Production ( After Trade)
Labor hours per unit
Food Cloth
Sri Lanka 5 2
India 4 10
Units of Good
Food Cloth Total
Sri Lanka 100/5=20 100/2=50 70
India 100/4=25 100/10=10 35
Units of Good
Food Cloth Total
Sri Lanka … 200/2=100 100
India 200/4=50 …… 50
What?
Assumptions?
Failures?

7. COMPARATIVE ADVANTAGE THEORY
(RICARDO)
LABOR HOURS
1 Cloth 1 wine
Sri
Lanka
50 60
India 45 40
Opportunity Cost
1 Cloth 1 wine
Sri Lanka 50/60=0.83 60/50=1.2
India 45/40=1.12 40/45=0.88
Cloth wine Price ratio
Sri Lanka 50 60 1 cloth:5/6 wine or
1 wine:6/5 cloth
India 45 40 1 cloth: 9/8 wine or
1 wine: 8/9 cloth
What?
Assumptions?
Failures?

8. PRODUCTION FUNCTION
isocost and isoquant
Q=F(K,L)
K
L
0
3
3
ISOQUANT
CURVE
ISOCOST
CURVE

9. LINEARLY HOMOGENEOUS
PRODUCTION FUNCTION
Constant Returns To Scale;
10 20 30
30
20
10
X=100
X=200
X=300
45 degree curve shows all the
equilibriums where Constant Returns to
Scale
Good X

10. K
L
K
L
Production points
of good X
Production points
of good Y Adding two graphs
together = edgeworth box

11. EDGEWORTH BOX
garments
software
S2
S2
S1
L
K

12. Factor Endowment Theory
• Basis of HO model is Factor Endowment
• Assumptions
– 2- countries,products,factors
– Technology, transportation cost, perfect competition,CRS, mobility,
Taste
• Ownership of different FOCs
• Different shapes of PPC

13. Factor endowments
garments
software
S2
S1
So
K
L
garments
software
S2
S2
S1
L
K
Country A
Country B
Capital Intensive country Labor Intensive country

14. H-O Theory
• Countries will tend to specialize in the production of
goods using relatively abundant factor. Comparative
advantage based on resource endowments.
• More demand for that factor will be created which
will increase price of that factor. Eventually they will
tend to equalize with the increase in trade.

15. H.O. Model Equilibrium
P1
P1
P0
P0
software
garments
P0P0 & P1P1 (price curves) show
different price ratios in autarky.
This is the basis for comparative
advantage.

16. Gains from trade after
specialization
• Country A • Country B
400
300
250
800
800
300
250 400
800
800
b
a
a
b
CONSUMPTION
POSSIBILITY C URVE
after trade
PPC before
trade
CONSUMPTION
POSSIBILITY
CCURVE after
trade
PPC before trade
GOOD Y
GOOD X
GOOD Y
GOOD X
COUNTRY A, SPECIALIZE GOOD Y COUNTRY B, SPECIALIZE GOOD X
PRODUCTION POINTS

17. INTERNATIONAL TRADE POLICIES

18. IS FREE TRADE INEFFICIENT?
• INFANT INDUSTRY ARGUMENT
• NATIONAL SECURITY
• DUMPING: CAPTURING,MC
• REVENUE
• DISCOURAGING LUXURIES
• DIVERSIIFICATION
• IMPROVING THE TERMS OF TRADE

19. TRADE RESTRICTIONS
• TARRIFFS
EXPORTS – TO STOP THE OUTFLOW OF RESOURCES
IMPORTS – TYPES,EFFECTS
• EFFECTS
S
World Price with Tariff
World Price
500 1800
45
40
30

20. PART TWO
EXCHANGE RATE AND BALANCE OF
PAYMENTS

21. EXCHANGE RATE
THEORY
what?
Determinants?
D and S of F. Currency?
Factors?
Regimes?
Appreciation?
Depreciation?
YEAR RUPEE PER
DOLLAR
1960 4.77
1970 5.96
1980 18.00
1990 40.24
2000 80.06
2010 110.95

22. Exchange Rate – Sri Lanka2.0
2.2
2.4
2.6
2.8
1980 1985 1990 1995 2000 2005 2010
4.2
4.3
4.4
4.5
1
0.8
1.2
1.6
2.0
2.4
2.8
3.2
1
2.4
2.8
3.2
3.6
4.0
4.4
4.8
5.2
1980 1985 1990 1995 2000 2005 2010
NOMINAL ER
Rupee has been hepreciated overtime

23. CAUSES OF DEPRECIATION
3 CAUSES
1. PERSON VISITS ANOTHER COUNTRY
2. IMPORT FROM ANOTHER COUNTRY
3. INVEST IN ANOTHER COUNTRY
CAUSES FOR APPRECIATION ARE THE OPPOSITE
OF THESE 3

24. DEPRECIATION
• Depreciation (weaker currency)
Advantages
• Producers will sell more exports
• It becomes cheaper for foreigners to travel into the country
• Foreign investment in domestic assets will become cheaper
• There is less foreign price competition for domestic producers
Disadvantages
• Domestic consumers pay more for imports
• It becomes more expensive to travel outside the country
• It becomes more expensive to invest in foreign assets
• There is less foreign competition for domestic pricing

25. CURRENCY APPRECIATION
Appreciation (stronger currency)
Advantages
• Consumer can buy more imports at a lower price
• Travelers abroad can get more foreign currency
• Investors can buy more foreign assets
• The competition from foreign suppliers keeps domestic prices down
Disadvantages
• Producers will sell fewer exports
• Foreigners traveling into the country will find it more expensive
• Foreign investment of domestic assets will be more expensive
• Domestic suppliers will have more price competition

26. BALANCE OF PAYMENTS
A systematic record of all economic transactions with the world
• Components
– Trade Account
– Invisible Trade
– Transfers
– Current Account
– Capital Account
– The Overall Balance
– Monetary movements
– Credit and Debit Transactions
– Double Entry Book Keeping

27. BOP IN SRI LANKA (2012 DATA)
2.0
2.2
2.4
2.6
2.8
3.0
3.2
3.4
3.6
1980 1985 1990 1995 2000 2005 2010
REER
4.2
4.3
4.4
4.5
4.6
4.7
4.8
1980 1985 1990 1995 2000 2005 2010
RER
0.8
1.2
1.6
2.0
2.4
2.8
3.2
1980 1985 1990 1995 2000 2005 2010
NEER
2.4
2.8
3.2
3.6
4.0
4.4
4.8
5.2
1980 1985 1990 1995 2000 2005 2010
NOMINAL ER
5
6
7
8
9
10
1980 1985 1990 1995 2000 2005 2010
DEFICIT
4.0
4.4
4.8
5.2
5.6
6.0
6.4
1980 1985 1990 1995 2000 2005 2010
TOT
Debit (-) Credit (+) Balance
Trade Account
Total Exports
Total Imports
Trade Balance
2440,899
1245,531
-1195,368
Services
Receipts
Payments
Service Balance
324,181
483,502
159,321
Net Transfers 6,899
Current Account Balance -495,853
Capital Account Balance 630,769
OVERALL BALANCE 72,638
SOURCE: CBSL ANNUAL REPORT 2012
SEE THE OVERALL BALANCE OVER TIME ( 2000 TO 2012)
2.0
2.2
2.4
2.6
2.8
3.0
1980 1985 1990 1995 2000 2005 2010
4.2
4.3
4.4
4.5
4.6
1980 1985 1990 1995 2000 2005 2010
0.8
1.2
1.6
2.0
2.4
2.8
3.2
1980 1985 1990 1995 2000 2005 2010
NEER
2.4
2.8
3.2
3.6
4.0
4.4
4.8
5.2
1980 1985 1990 1995 2000 2005 2010
NOMINAL ER
5
6
7
8
1980 1985 1990 1995 2000 2005 2010
4.0
4.4
4.8
5.2
5.6
6.0
6.4
1980 1985 1990 1995 2000 2005 2010
TOT
1977 2012
0
-10
0
-15
-20
-5

28. CONSEQUECES OF UNFAVOURABLE BALANCE OF TRADE

29. PART THREE
INTERNATIONAL TRADE
ORGANISATIONS

30. THEORY OF INTEGRATION
Free Trade Area : No Trade Restrictions
Custom Union : No Restrictions + Common Policies With
Non Members
Common Market : No Restrictions + Common Policies With
Non Members + Free Mobility Of Factors
Of Production
Economic Union : No Restrictions + Common Policies With
Non Members + Free Mobility Of Factors
Of Production + Monetary , Fiscal And
Other Policies

31. THEORY OF CUSTOM UNION
D
S
S(partner Country)
S(world)
S(world + tax=15)
500 1600900 1800
45
40
30
50

32. TRADE ORGANISATIONS
• UNCTAD
• GATT
• WTO
• ROUNDS OF TALKS (URUGUA ,TOKIO)

33. THANK YOU