Q:

Trade and developmen

Trade is a key factor in economic development. A successful use of trade can boost a country's development. On the other hand, opening up markets to international trade may leave local producers swamped by more competitive foreign producers.

The current consensus is that trade, development, and poverty reduction are intimately linked. Sustained strong growth over longer periods is strongly associated with poverty reduction, while trade and growth are strongly linked. Countries that develop invariably increase their integration with the global economy, while export-led growth has been a key part of many countries successful development strategies. Continents, countries and sectors that have not developed and remain largely poor have comparative advantage in three main areas: natural resource exploitation, i.e. running down of natural capital such as rain forest timber; low-education labor-intensive manufacturing, due to high population densities and little suitable land per person; agriculture, due to low population densities and relatively large areas of suitable land per person. Crucially for poverty reduction, the latter two at least are laborintensive, helping to ensure that growth in these sectors will be povertyreducing. However, low value-added, price instability and unsustainability in these commodity sectors means they should be used only temporarily as stepping stones in the path to economic development.

Market access to developed countries

The issue of market access to high-income countries is a thorny but crucial one. The issues fall into three main groups: first, those relating to deliberately imposed barriers to trade, such as tariffs, quotas, and tariff escalation. Second, barriers to trade resulting from domestic and external producer support, primarily in the form of subsidies, but also including, for example, export credits. Third, those relating to indirect barriers to trade resulting from developing countries lack of institutional capacity to engage in the global economy and in multilateral institutions (e.g., the World Trade Organization) on equal terms. [edit] Barriers to trade

High tariffs are imposed on agriculture: in high-income countries, the average tariff rate on agriculture is almost double the tariff for manufactures. And more than one third of the European Union's agricultural tariff lines, for instance, carry duties above 15% [1]. Tariff peaks within agriculture occur most frequently on processed products and temperate commodities, rather than the major export crops of least developed countries (unprocessed fruits and vegetables and tropical commodities). However, many developing countries in temperate zones have the potential of competing as lower-cost producers in temperate commodities. Thus liberalization could open up new development-through-trade possibilities. Strong tariff escalation is typically imposed on agricultural and food products by high-income countries. This strongly discourages the development of high value added exports, and hinders diversification in particular as well as development in general. In high-income countries, tariffs on agricultural products escalate steeply, especially in the EU and Japan. Complex tariffs make it more difficult for developing country exporters to access industrialised-country markets because of the disadvantages developing countries face in accessing, and in their capacity to process, information. Not only are price signals distorted,

they are often unclear, subject to change (for example seasonally) and difficult to interpret. [2] Tariff-rate quotas (TRQs), introduced by the Uruguay Round with the aim of securing a minimum level of market access, have performed poorly. Average fill rates have been low and declining, from 67% in 1995 to 63% in 1998, with about a quarter of TRQs filled to less than 20%. The low fill rate may reflect high in-quota rates. Overall, the UR tariffication process which produced them has not resulted in the increased market access developing countries hoped for.

[edit] Producer support

Support to agricultural producers remains sizable, at about five times the level of international development assistance - $245 billion in 2000. Total support to agriculture, as defined by the OECD, reaches $327 billion - 1.3% of OECD countries GDP. To some extent these can be justified by multifunctionality arguments, but it remains a priority to find means of support which effectively meet the primary objectives without the negative developmental and environmental consequences that have been seen in the past. The dumping of unwanted production surpluses onto the world market through export subsidies has depressed prices for many temperate agricultural commodities, with EU surpluses of exportable wheat a prime example. (Despite several Common Agricultural Policy reforms, domestic support for wheat - as measured by OECD producer support estimates - declined only marginally from an average 52% of gross farm receipts in 1986-88, to around 48% in 1998-2000. [3]) The URAA has been relatively unsuccessful in disciplining export subsidies, with the proportion of subsidised exports in total exports increasing in many products of export interest for developing countries: for example for wheat, from 7% in 1995 to 25% in 1998. The cost to developing country production and exports is considerable, and only partially offset by the lower food prices available to NFIDC consumers. This form of transfer from highincome country taxpayers to low-income consumers is in any case rather inefficient, and the lower prices may harm production for local

consumption even in NFIDCs. Agricultural reform as a whole, including the removal of export subsidies, would only result in quite small price rises for developing-country consumers. The counter-cyclical nature of producer support is also harmful to developing-country producers. High-income farmers are insulated from changes in world prices, making production less responsive to swings in demand. As a result, world commodity prices are more volatile, and the burden of adjustment falls disproportionately on developing-country producers.

[edit] Lack of capacity This includes non-tariff barriers such as food regulations and standards, which developing countries are often not (or not effectively) involved in setting, and which may be deliberately used to reduce competition from developing countries. In any case, the lack of capacity to meet implement regulations and ensure compliance with standards constitutes a barrier to trade, and must be met by increasing that capacity. Researchers at the Overseas Development Institute have identified many capacity related issues that developing economies face aside from tariff barriers[1]: 1. Traders and potential traders must know about an agreement and its details, however, the interests and skills of good producers lie in production and not in legal rules, only the largest firms can afford policy advisers. 2. Markets and suppliers must share information - producer associations, industrial organisations, and chambers of commerce exchange information among their members and this information exchange must then take place across borders (as seen between Brazil and Argentina after Mercosur). 3. A successful agreement must be flexible and governments need to accept that it will need to evolve. 4. Trade agreements must generate relevant reforms in areas such as customs documentation, but also more fundamentally in relaxing rules for cross-border transportation.

5. Selling to new markets requires adequate finance. 6. Poor or wrong infrastructure can restrict trade 7. Governments can support producers or traders in other ways. The benefits of trade agreements for developing countries are not automatic, especially for SMEs whether or not they are already exporting as the costs of entering a new market are greater for them than for large companies when compared to their potential revenue[1]. [edit]Market

access to developing countries

Average applied tariffs in agriculture are higher in developing countries (although most of the very high rates, over 100%, are found in developed countries). With an increasing share of agricultural exports directed toward other developing countries, high levels of tariff protection in the South may impede prospects for export-led growth. This may be particularly true for the export opportunities of low-income countries, which have increased export market share in agriculture . "Open regionalism" holds the potential to stimulate global trade and improve the efficiency of regional producers. But regional arrangements can also become a vehicle for protection, trade diversion, and unintended inefficiency. Agreements in particular between richer and poorer developing countries risk generating trade losses for the poorer ones when their imports are diverted toward the richer members whose firms are not internationally competitive. However, where regional arrangements lead to the reduction of nontariff barriers, trade creation is likely, and the dynamic benefits of effective regional integration in terms of improved governance and regional stability are likely to outweigh diversion concerns. The World Bank suggests that key conditions to benefit from expanded trade and investment include lowering common external trade barriers, stimulating competition, reducing transaction costs, and reinforcing nondiscriminatory investment and services policies. It should be noted that the greater structural differences between North and South economies mean that North-South arrangements hold the

greatest promise for economic convergence and trade creation, including in agricultural products, underlining the importance of links between South-South arrangements and northern economies. Trade liberalization. According to the World Bank, most analyses suggest that unilateral reduction in barriers can produce the greatest and the quickest gains. [4] Some countries, such as Chile, China and Costa Rica, have undertaken domestic policy reforms. Caution must however be employed: as the case of Haiti shows, liberalization when institutions and the economy are not strong enough to face risks and opportunities can be harmful (Rodrik 2001). And while reforms may be beneficial in the long run, for example by reducing possibilities for customs corruption, in the short run they create both winners and losers. Low-income consumers, unskilled workers in sheltered industries, and previously-shielded producers may suffer in the transition period as the economy adapts to changed incentive structures. Temporary safety nets can help cushion the blow and ensure trade-led growth is pro-poor. Specific assistance to meet costs of adaptation for example of switching to a different crop may be appropriate.

[edit]Market

access is vital, but not enough

It is important to recognise that the issues facing LDCs and middleincome developing countries differ significantly. For the middle-income countries, the primary issue is market access. Many of the worlds poor live in these countries, and so market access alone can have significant poverty-reducing effects in these countries. However, for the leastdeveloped countries, the principal problem is not market access, but lack of production capacity to achieve new trading opportunities. This is recognised by paragraph 42 of the Doha Development Agenda: We recognize that the integration of the LDCs into the multilateral trading system requires meaningful market access, support for the diversification of their production and export base, and trade-related technical assistance and capacity building.

So whilst the further development of middle-income countries, and in particular the tackling of rural poverty in these countries, can be achieved most importantly through increased market access in agriculture, lower-income countries need additional help, not only to take advantage of new opportunities, but to be able to adapt to changing conditions due to the loss of preferences. This additional help must take three main forms: support for developing-country agricultural production; support for participation in trade; and support for good policies and good governance. [edit]Support

for agricultural production

Support for agricultural modernization and development investment in productive capacity in agriculture and food processing. Support for agricultural-related development institutions which are not trade-distorting, eg research; eg risk-management of agricultural product price fluctuations; eg diversification.

[edit]Support

for participation in trade and the global economy

Cases such as Haitis post-1986 liberalization show that the opportunities thereby created will not be taken advantage of if macroeconomic policies, institutions, and the investment climate are not favorable. This includes

trade-related infrastructure: the cost of exporting must be low enough to ensure competitiveness in rapidly-expanding high-value agricultural markets where competition is stiff such as fruits and vegetables. It also includes related issues that are part of the general investment climate but can be particularly important for exports, such as a weak financial sector. Here, export finance is often a major constraint inhibiting exports in many low-income countries. Other issues are more specific to exports: developing countries and their exporters may have difficulty with both the implementation of,

and showing compliance with, international product standards and other multilateral agreements. Low-income developing countries need both technical and financial assistance in this area. Technical Assistance for negotiations is also needed to further developing-country interests in multilateral and bilateral arenas and ensure the success of future negotiations and agreements. Marketing of exports is also a challenge for low-income countries: product and country brands need to be built, and quality concerns met. Given the importance of agriculture for poverty reduction, additional policies and institutional capacity are needed to ensure an effective supply response to market incentives provide by better market access. Rural infrastructure is particularly important in enabling agricultural exports in developing countries. Sufficient credit at competitive conditions is important for private sector investment in storage, transportation and marketing of agricultural products. Investment in skills and education in rural areas is needed to bolster agricultural productivity. Trade policy reforms must address any remaining antiexport bias. Efficient land policies and land tenure institutions are needed to ensure the functioning of land markets, property rights, and efficient farm structures. [ediWorld

Trade Organization negotiations

The most recent round of World Trade Organization negotiations (the Doha "Development" Round) was promoted as being directed at the interests of developing countries, addressing issues of developed country protectionism. The introduction of the (investmentrelated)Singapore issues together with a lack of sufficient concessions to developing countries' interests has put the success of the negotiations in doubt.

Q:cost theory
Equal Difference in Cost :-

Adam Smith, in order to strengthen his argument in favour of absolute difference in cost pointed out that trade is not possible if countries operate under equal difference in cost instead of absolute difference.

The above table gives us the internal exchange rate 2x : 1y in both countries. Since the exchange ratio between X and Y in both countries is the same; none of them will benefit by entering into international trade. Based on this example, according to Adam Smith, for international trade to be beneficial countries must enjoy absolute difference in cost. Trade would not take place when the difference in cost is equal.

3. Comparative Difference in Cost :-

David Ricardo agreed that absolute difference in cost gives a clear reason for trade to take place. He, however, went further to argue that even that the country has absolute advantage in the production of both commodities it is beneficial for that country to specialise in the

production of that commodity in which it has a greater comparative advantage. The other country can be left to specialise in the production of that commodity in which it has less comparative advantage. According to Ricardo the essence for international trade is not the absolute difference in cost but comparative difference in cost.

Ricardo's Theory of Comparative Advantage

David Ricardo stated a theory that other things being equal a country tends to specialise in and exports those commodities in the production of which it has maximum comparative cost advantage or minimum comparative disadvantage. Similarly the country's imports will be of goods having relatively less comparative cost advantage or greater disadvantage.

1. Ricardo's Assumptions :-

Ricardo explains his theory with the help of following assumptions :1. There are two countries and two commodities. 2. There is a perfect competition both in commodity and factor market. 3. Cost of production is expressed in terms of labour i.e. value of a commodity is measured in terms of labour hours/days required to

produce it. Commodities are also exchanged on the basis of labour content of each good. 4. Labour is the only factor of production other than natural resources. 5. Labour is homogeneous i.e. identical in efficiency, in a particular country. 6. Labour is perfectly mobile within a country but perfectly immobile between countries. 7. There is free trade i.e. the movement of goods between countries is not hindered by any restrictions. 8. Production is subject to constant returns to scale. 9. There is no technological change. 10. 11. 12. Trade between two countries takes place on barter system. Full employment exists in both countries. There is no transport cost.

2. Ricardo's Example :-

On the basis of above assumptions, Ricardo explained his comparative cost difference theory, by taking an example of England and Portugal as two countries & Wine and Cloth as two commodities. As pointed out in the assumptions, the cost is measured in terms of labour hour. The principle of comparative advantage expressed in labour hours by the following table.

Portugal requires less hours of labour for both wine and cloth. One unit of wine in Portugal is produced with the help of 80 labour hours as above 120 labour hours required in England. In the case of cloth too, Portugal requires less labour hours than England. From this it could be argued that there is no need for trade as Portugal produces both commodities at a lower cost. Ricardo however tried to prove that Portugal stands to gain by specialising in the commodity in which it has a greater comparative advantage. Comparative cost advantage of Portugal can be expressed in terms of cost ratio.

Cost ratios of producing Wine and Cloth

Portugal has advantage of lower cost of production both in wine and cloth. However the difference in cost, that is the comparative advantage is greater in the production of wine (1.5 0.66 = 0.84) than in cloth (1.11 0.9 = 0.21). Even in the terms of absolute number of days of labour Portugal has a large comparative advantage in wine, that is, 40 labourers less than

England as compared to cloth where the difference is only 10, (40 > 10). Accordingly Portugal specialises in the production of wine where its comparative advantage is larger. England specialises in the production of cloth where its comparative disadvantage is lesser than in wine.

Comparative Cost Benefits Both Participants

Let us explain Ricardian contention that comparative cost benefits both the participants, though one of them had clear cost advantage in both commodities. To prove it, let us work out the internal exchange ratio.

Let us assume these 2 countries enter into trade at an international exchange rate (Terms of Trade) 1 : 1. At this rate, England specialising in cloth and exporting one unit of cloth gets one unit of wine. At home it is required to give 1.2 units of cloth for one unit of wine. England thus gains 0.2 of cloth i.e. wine is cheaper from Portugal by 0.2 unit of cloth. Similarly Portugal gets one unit of cloth from England for its one unit of wine as against 0.89 of cloth at home thus gaining extra cloth of 0.11. Here both England and Portugal gain from the trade i.e. England gives 0.2 less of cloth to get one unit of wine and Portugal gets 0.11 more of cloth for one unit of wine.

In this example, Portugal specialises in wine where it has greater comparative advantage leaving cloth for England in which it has less comparative disadvantage. Thus comparative cost theory states that each country produces & exports those goods in which they enjoy cost advantage & imports those goods suffering cost disadvantage.
Q: Heckscher Ohlin's H-O Theory

According to Bertil Ohlin, trade arises due to the differences in the relative prices of different goods in different countries. The difference in commodity price is due to the difference in factor prices (i.e. costs). Factor prices differ because endowments (i.e. capital and labour) differ in countries. Hence, trade occurs because different countries have different factor endowments. The Heckscher Ohlin theorem states that countries which are rich in labour will export labour intensive goods and countries which are rich in capital will export capital intensive goods.

Assumptions of Heckscher Ohlin's H-O Theory

Heckscher-Ohlin's theory explains the modern approach to international trade on the basis of following assumptions :-

1. There are two countries involved. 2. Each country has two factors (labour and capital). 3. Each country produce two commodities or goods (labour intensive and capital intensive). 4. There is perfect competition in both commodity and factor markets. 5. All production functions are homogeneous of the first degree i.e. production function is subject to constant returns to scale. 6. Factors are freely mobile within a country but immobile between countries. 7. Two countries differ in factor supply. 8. Each commodity differs in factor intensity. 9. The production function remains the same in different countries for the same commodity. For e.g. If commodity A requires more capital in one country then same is the case in other country. 10. 11. 12. There is full employment of resources in both countries and Trade is free i.e. there are no trade restrictions in the form of tariffs There are no transportation costs. demand are identical in both countries. or non-tariff barriers. Given these assumption, Ohlin's thesis contends that a country export goods which use relatively a greater proportion of its abundant and cheap factor. While same country import goods whose production requires the intensive use of the nation's relatively scarce and expensive factor.

Understanding The Concept of Factor Abundance

In the two countries, two commodities & two factor model, implies that the capital rich country will export capital intensive commodity and the labour rich country will export labour intensive commodity. But the concept of country being rich in one factor or other is not very clear. Economists quite often define factor abundance in terms of factor prices. Ohlin himself has followed this approach. Alternatively factor abundance can be defined in physical terms. In this case, physical amounts of capital & Labour are to be compared.

Price Criterion for defining Factor Abundance

A country where capital is relatively cheaper and labour is relatively costly is said to be capital rich country. Whereas a country where labour is relatively cheaper and capital is relatively costly is said to be labour rich country. Price of the factor can be symbolically measured as follows :-

In above relation, 1. P refers to price of the factor, 2. K refers to Capital, 3. L refers to Labour, 4. E stands for England, and 5. I stands for India. Note:- In reality, England is not a country else a part of United Kingdom (U.K). England is called a country in this article just for the sake of learning example. The above analysis highlights a fact that in England capital is cheap, and hence it is a capital abundant country. Whereas in India, Labour is cheaper, and thus it is a labour rich country. Now lets understand how such a pattern of trade will necessarily emerge.

Diagram Explaining Heckscher Ohlin's H-O Theory

Let us take an example of same two countries viz; England and India where England is a capital rich country while India is a labour abundant nation. In the above diagram XX is the isoquant (equal product curve) for the commodity X produced in England. YY is the isoquant representing commodity Y produced in India. It is very clear that XX is relatively capital intensive while YY is relatively labour incentive. The factor capital is represented on Y-axis while the factor labour is represented on the horizontal X-axis. PA is the price line or budget line of the country England. The price line PA is tangent to XX at E. The price line PA is also tangent to YY isoquant at K. The point K will help us to find out how much of capital and labour is required to produce one unit of Y in England. P1B is the price line of the country India, The price line P1B is tangent to YY at I. The price line RS which is drawn parallel to P1B is tangent to XX

at M. This will help us to find out how much of capital and labour is required to produce one unit of commodity X in India. Under the given situations, the country England will choose the combination E. Which means more specialisation on capital goods. It will not choose the combination K because it is more labour intensive and less capital intensive. Thus according to Ohlin, England will specialise on production of goods X by using the cheap factor capital extensively while India specialises on commodity Y by using the cheap factor labour available in the country. The Ohlin's theory concludes that :1. The basis of internal trade is the difference in commodity prices in the two countries. 2. Differences in the commodity prices are due to cost differences which are the results of differences in factor endowments in two countries. 3. A capital rich country specialises in capital intensive goods & exports them. While a Labour abundant country specialises in labour intensive goods & exports them.

Limitations of Heckscher Ohlin's H-O Theory

Heckscher Ohlin's Theory has been criticised on basis of following grounds :1. Unrealistic Assumptions : Besides the usual assumptions of two countries, two commodities, no transport cost, etc. Ohlin's theory also

assumes no qualitative difference in factors of production, identical production function, constant return to scale, etc. All these assumptions makes the theory unrealistic one. 2. Restrictive : Ohlin's theory is not free from constrains. His theory includes only two commodities, two countries and two factors. Thus it is a restrictive one. 3. One-Sided Theory : According to Ohlin's theory, supply plays a significant role than demand in determining factor prices. But if demand forces are more significant, a capital abundant country will export labour intensive good as the price of capital will be high due to high demand for capital. 4. Static in Nature : Like Ricardian Theory the H-O Model is also static in nature. The theory is based on a given state of economy and with a given production function and does not accept any change. 5. Wijnholds's Criticism : According to Wijnholds, it is not the factor prices that determine the costs and commodity prices but it is commodity prices that determine the factor prices. 6. Consumers' Demand ignored : Ohlin forgot an important fact that commodity prices are also influenced by the consumers' demand. 7. Haberler's Criticism : According to Haberler, Ohlin's theory is based on partial equilibrium. It fails to give a complete, comprehensive and general equilibrium analysis. 8. Leontief Paradox : American economist Dr. Wassily Leontief tested H-O theory under U.S.A conditions. He found out that U.S.A exports labour intensive goods and imports capital intensive goods, but U.S.A being a capital abundant country must export capital intensive goods

and import labour intensive goods than to produce them at home. This situation is called Leontief Paradox which negates H-O Theory. 9. Other Factors Neglected : Factor endowment is not the sole factor influencing commodity price and international trade. The H-O Theory neglects other factors like technology, technique of production, natural factors, different qualities of labour, etc., which can also influence the international trade.

Q: Gains from trade

Gains from trade in economics refers to net benefits to agents from allowing an increase in voluntary trading with each other. In technical terms, it is the increase of consumer surplus[1] plus producer surplus[2] from lower tariffs[3] or otherwise liberalizing trade.[4] It is commonly described as resulting from: specialization in production from division of labor, economies of scale, scope, and agglomeration[5] and relative availability of factor resources in types of output by farms, businesses, location[6] and economies a resulting increase in total output possibilities trade through markets from sale of one type of output for other, more highly valued goods.[7] Market incentives, such as reflected in prices of outputs and inputs, are theorized to attract factors of production, including labor, into activities according to comparative advantage, that is, for which they each have a low opportunity cost. The factor owners then use their increased income from such specialization to buy more-valued goods of which they would otherwise be high-cost producers, hence theirgains from trade. The concept may be applied to an entire economy for the alternatives of autarky (no trade) or trade. A measure of total gains from trade is the

sum of consumer surplus and producer profits or, more roughly, the increased output from specialization in production with resulting trade.[8] Gains from trade may also refer to net benefits to a country from lowering barriers to trade such astariffs on imports.[9] David Ricardo in 1817 first clearly stated and proved the principle of comparative advantage,[10] termed a "fundamental analytical explanation" for the source of gains from trade.[11] But from publication of Adam Smith's The Wealth of Nations in 1776, it was widely argued, that, with competition and absent market distortions, such gains are positive in moving toward free trade and away from autarky or prohibitively high import tariffs. Rigorous early contemporary statements of the conditions under which this proposition holds are found in Samuelson in 1939 and 1962.[12] For the analytically tractable general case of Arrow-Debreu goods, formal proofs came in 1972 for determining the condition of no losers in moving from autarky toward free trade.[13] It does not follow that no tariffs are the best an economy could do. Rather, a large economy might be able to set taxes and subsidies to its benefit at the expense of other economies. Later results of Kemp and others showed that in an Arrow-Debreu world with a system of lump-sum compensatory mechanisms, corresponding to a customs union for a given subset set of countries (described by free trade among a group of economies and a common set of tariffs), there is a common set of world' tariffs such that no country would be worse off than in the smaller customs union. The suggestion is that if a customs union has advantages for an economy, there is a worldwide customs union that is at least as good for each country in the world.[14]

Measurement of gains from trade

Classical Economist there are two methods to measure the gains from trade;- 1) international trade increases national income which helps us to get low priced imports. 2) gains are measured in terms of trade. To measure the gains from the trade comparison of cost of production between domestic and foreign countries is required. But it is very difficult to acquire the knowledge of cost of production and cost of

imports in domestic country. Therefore terms of trade method is preferable to measure the gains from trade.

Factors affecting gains from trade

There are several factors which determine the gains from international trade: 1.Differences in cost ratio: The gains from international trade depends upon the cost ratios of differences in comparative cost ratios in the two trading countries.If the difference between exchange rate and cost of production is lesser than lesser will be the gains from trade and viceverse. 2. Demand and supply: If a country has elastic demand and supply it gives more gains from trade vice-verse with inelastic demand and supply. 3. Factor availability: International trade is based on the specialization and a country specializes depending upon the availability of factors of production. It will increase the domestic cost ratios and so the gains from trade. 4. Size of country: If a country is small in size its easy for them to specialize in the production one commodity and export the surplus production to a large sized country and can get more gains from international trade. Whereas if a country is large in size then they have to specialize in more than one good because the excess production of only one commodity can not be exported fully to a small sized country as the demand for good will reduce very frequently. so smaller the size of the country larger is the gain from trade. 5. Terms of Trade: Gains from trade will depend upon the terms of trade. If the cost ratio & terms of trade are closer to each other more will be the gains from trade of the participating countries. 6. Productive Efficiency: An increase in the productive efficiency of a country of a country also determines its gains from trade as it lowers the

cost of production and price of the goods.as a result the country importing gains by importing cheap goods.

Static and dynamic gains from trade

The gains from trade can be classified into static and dynamic gains from trades. Static Gains means the increase in social welfare as a result of maximized national output due to optimum utilization of country's factor endowments or resources. Dynamic gains from trade, are those benefits which accelerates economic growth of the participating countries. Static gain's are the result of the operation of the theory of comparative cost in the field of foreign trade. On this principle countries make the optimum use of their available resources so that their national output is greater which also raises the level of social welfare in the country. When there is an introduction of foreign trade in the economy the result is called the static gains from trade. Dynamic gains from trade relate to economic development of the economy. Specialization of the country for the production of best suited commodities which result in a large volume of quality production which promotes growth. Thus the extension of domestic market to foreign market will accelerate economic growth.

Advantages and Disadvantages of International Trade:

Advantages:

The main advantages of international trade to a country are as follows: (i) Economy in the Use of Productive Resources: Each country tries to produce those goods in which it is best suited. As

the resources of each country are fully exploited, there is thus a great economy in the use of productive resources. (ii) Wider Range of Commodities: International trade makes it possible for each country to enjoy wider range of commodities than what is otherwise open to it. The commodities which can be produced at home at relatively higher cost can be brought from the cheaper market from abroad and the resources of the country thus saved can be better employed for the production of other commodities in which it is comparatively better fitted. (iii) Scarcity of Commodities: If at any time there is shortage of food or scarcity of other essential commodities in the country, they can be easily imported from other countries and thus the country can be saved from shortage of commodities and low standard of living. (iv) Promotes Competition: International trade promotes competition among different countries. The producers in home country, being afraid of the foreign competition, keep the prices of their products at reasonable level. (v) Speedy Industrialization: International trade enables a backward country to acquire skill, machinery; and other capita! equipment from industrially advanced countries for speeding up industrialization. (vi) Fall of Prices: A country can export her surplus products to a country which is in need of them. The home prices are, thus, prevented from falling. (vii) Extension of Means of Transport: When goods are exchanged from one county to another, it leads to an extension of the means of communication and transport.

(viii) Economic Inter-Dependence: International trade offers facilities to the citizens of every country to come in contact with one another. |t makes them realize that no country in the world is self-sufficient. It thus pro motes peace and goodwill among nations. Disadvantages: International trade has its own demerits/disadvantages. These, in brief are as follows: (i) Exhaustion of Resources: In order to earn present export advantages a country may exploit her limited natural resources beyond proper limits. This may lead to exhaustion of essential material resources like iron, coal, oil, etc. The future generation thus stands at a disadvantage. (ii) Effect on Domestic Industries: If no restrictions are placed on the foreign trade, it may ruin the domestic industries and cause widespread distress among the people. (iii) Effect on Consumption Habits: Sometimes it so happens that the traders in order to make profits import commodities which are very harmful and injurious to the people For instance, if opium, wine, etc., are imported, it will adversely affect the health and morale of the people. (iv) Times of Emergency: If each country specializes in the production of those commodities in which it has comparative advantage over other countries, it may prove very dangerous rather fatal during times of emergency tike war. The country may not be able to get essential supplies Thus the whole economy may be crippled.

(v) Provides Foothold to the Foreigners: Foreign trade provides foothold to the foreigners in the country. It is in fact a pretext for a thorough political and economic subjugation of the weak by the powerful country Pakistan and India cannot forget as to how the Britishers came under the garb of traders here. We cannot deny this fact that international trade has certain evil consequences but if it is properly controlled, it can prove very beneficial for all the countries of the world.

Q: terms of trade
In international economics and international trade, terms of trade or TOT is (Price Exports)/(Price Imports). In layman's terms it means what quantity of imports can be purchased through the sale of a fixed quantity of exports. "Terms of trade" are sometimes used as a proxy for the relative social welfare of a country, but this heuristic is technically questionable and should be used with extreme caution. An improvement in a nation's terms of trade (the increase of the ratio) is good for that country in the sense that it can buy more imports for any given level of exports. The terms of trade is influenced by the exchange rate because a rise in the value of a country's currency lowers the domestic prices for its imports but does not directly affect the commodities it produces (i.e. its exports). Two country model CIE economics In the simplified case of two countries and two commodities, terms of trade is defined as the ratio of the total export

revenue[clarification needed] a country receives for its export commodity to the total import revenue it pays for its import commodity. In this case the imports of one country are the exports of the other country. For example, if a country exports 50 dollars worth of product in exchange for 100 dollars worth of imported product, that country's terms of trade are 50/100 = 0.5. The terms of trade for the other country must be the reciprocal (100/50 = 2). When this number is falling, the country is said to have "deteriorating terms of trade". If multiplied by 100, these calculations can be expressed as a percentage (50% and 200% respectively). If a country's terms of trade fall from say 100% to 70% (from 1.0 to 0.7), it has experienced a 30% deterioration in its terms of trade. When doing longitudinal (time series) calculations, it is common to set a value for the base year[citation needed] to make interpretation of the results easier. In basic Microeconomics, the terms of trade are usually set in the interval between the opportunity costs for the production of a given good of two countries. Terms of trade is the ratio of a country's export price index to its import price index, multiplied by 100 The terms of trade measures the rate of exchange of one good or service for another when two countries trade with each

limitations Terms of trade should not be used as synonymous with social welfare, or even Pareto economic welfare. Terms of trade calculations do not tell us about the volume of the countries' exports, only relative changes between countries. To understand how a country's socialutility changes, it is necessary to consider

changes in the volume of trade, changes in productivity and resource allocation, and changes in capital flows. The price of exports from a country can be heavily influenced by the value of its currency, which can in turn be heavily influenced by the interest rate in that country. If the value of currency of a particular country is increased due to an increase in interest rate one can expect the terms of trade to improve. However this may not necessarily mean an improved standard of living for the country since an increase in the price of exports perceived by other nations will result in a lower volume of exports. As a result, exporters in the country may actually be struggling to sell their goods in the international market even though they are enjoying a (supposedly) high price. In the real world of over 200 nations trading hundreds of thousands of products, terms of trade calculations can get very complex. Thus, the possibility of errors is significant.

Q: tarrifs A tariff may be either tax on imports or exports (trade tariff), or a list or schedule of prices for such things as rail service, bus routes, and electrical usage (electrical tariff, etc.).[1] The word comes from the Italian word tariffa "list of prices, book of rates," which is derived from the Arabic ta'rif "to notify or announc A protective Tariff is often used by governments to attempt to control trade between nations to protect and encourage their noncompetitive or undeveloped local industries, businesses, unions etc. giving them time to become competitive. In addition

it was thought under the theory ofmercantilism generally believed by many countries in this era that exclusive trade with the colonies should be nearly all on ships of the parent country and all advanced industries etc. should be restricted to the mother country. Raw materials should be exported to the parent country and finished goods exported to the colonies. The United States starting out as a colony had these and other handicaps. The advantages they had were a free, independent, innovative and lightly taxed populace with close ties to the British Industrial Revolution. The reasons for an industry or business being noncompetitive are basically four: Their average wages may be higher than is typical in the competitor's country. They do not have the innovations or inventions that their competitors have. They do not have the skill sets or organization their competitors have. They lack raw materials needed to make some product. In the U.S. all these conditions applied except for the lack of raw materials. The new textile producing machines (the start of theIndustrial Revolution) developed by Britain were prohibited to be imported to what would become the United States (and elsewhere), skilled mechanics and engineers knowledgeable about these machines were prohibited from emigration and the U.S. had significantly higher wages due to the lack of people one of the main reasons people immigrated to the U.S.. A protective tariff was proposed by Secretary of Treasury Alexander Hamilton to help overcome these handicaps while

knowledge and organization skills were accumulated to build competitive industries and to allow higher wages to be paid in these industries. These protectionist ideas were essentially ignored for many years as Federal tariff revenue was the main goal of tariffs. More imported goods could easily be paid for by exporting more raw products. Major problems occurred in this state of affairs starting in the Napoleonic Wars when both France and Britain tried to interfere with each other's trade by blockading U.S. (and other) shipping. In 1807 imports dropped by more than half and some products became much more expensive or unobtainable. Congress passed the Embargo Act of 1807 and the NonIntercourse Act (1809) to punish British and French governments for their actions; unfortunately their main effect was to reduce imports even more. The War of 1812 brought a similar set of problems as U.S. trade was again restricted by British naval blockades and Congress needed additional funds to expand the U.S. Army and rebuild the U.S. Navy which had largely been disbanded after the Revolutionary War. Tariffs were adjusted and the excise tax on whiskey reinstated to cover most of these costs. The lack of imported goods relatively quickly gave very strong incentives to start building several U.S. industries. Slowly but surely many of the initial handicaps were overcome as knowledge about the machinery and/or the organization of industries were released by Britain or "emigrated from" the British isles, the Netherlands or wherever they were more developed. Many new industries were set up and run profitably during the wars and about half of them failed after hostilities ceased and normal imports resumed. Industry in the U.S. was

advancing up the skill set, innovation knowledge and organization curve. Tariffs soon became a major political issue as the Whigs and later the Republicans wanted to protect their mostly northern industries and constituents by voting for higher tariffs and the Democratic Party (United States), dominated by Southern Democrats, which had very little industry but imported many goods voted for lower tariffs. Each party as it came into power voted to raise or lower tariffs under the constraints that the Federal Government always needed a certain level of revenues. The United States public debt was paid off in 1834 and President Andrew Jackson, a strong Southern Democrat, oversaw the cutting of the tariff rates roughly in half and eliminating nearly all federal excise taxes in about 1835. Tariffs within technology strategies When tariffs are an integral element of a country's technology strategy, the tariffs can be highly effective in helping to increase and maintain the country's economic health. As an integral part of the technology strategy, tariffs are effective in supporting the technology strategy's function of enabling the country to out maneuver the competition in the acquisition and utilization of technology in order to produce products and provide services that excel at satisfying the customer needs for a competitive advantage in domestic and foreign markets. In contrast, in economic theory tariffs are viewed as a primary element in international trade with the function of the tariff being to influence the flow of trade by lowering or raising the price of targeted goods to create what amounts to an artificial competitive advantage. When tariffs are viewed and used in this

fashion, they are addressing the country's and the competitors' respective economic healths in terms of maximizing or minimizing revenue flow rather than in terms of the ability to generate and maintain a competitive advantage which is the source of the revenue. As a result, the impact of the tariffs on the economic health of the country are at best minimal but often are counter-productive. A program within the US intelligence community, Project Socrates, that was tasked with addressing America's declining economic competitiveness, determined that countries like China and India were using tariffs as an integral element of their respective technology strategies to rapidly build their countries into economic superpowers. It was also determined that the US, in its early years, had also used tariffs as an integral part of what amounted to technology strategies to transform the country into a superpower.

The Economic Effect of Tariffs

To protect fledgling domestic industries from foreign competition. To protect aging and inefficient domestic industries from foreign competition. To protect domestic producers from dumping by foreign companies or governments. Dumping occurs when a foreign company charges a price in the domestic market which is "too low". In most instances "too low" is generally understood to be a price which is lower in a foreign market than the price in the domestic market. In other instances "too

low" means a price which is below cost, so the producer is losing money.
The cost of tariffs to the economy is not trivial. The World Bank estimates that if all barriers to trade such as tariffs were eliminated, the global economy would expand by 830 billion dollars by 2015. Theeconomic effect of tariffs can be broken down into two components: The impact to the country which has a tariff imposed on it. The impact to the country imposing the tariff. In almost all instances the tariff causes a net loss to the economies of both the country imposing the tariff and the country the tariff is imposed on.

mpact to the economy of a country with the tariff imposed on it. It is easy to see why a foreign tariff hurts the economy of a country. A foreign tariff raises the costs of domestic producers which causes them to sell less in those foreign markets. In the case of the softwood lumber dispute, it is estimated that recent American tariffs have cost Canadian lumber producers 1.5 billion Canadian dollars. Producers cut production due to this reduction in demand which causes jobs to be lost. These job losses impact other industries as the demand for consumer products decreases because of the reduced employment level. Foreign tariffs, along with other forms of market restrictions, cause a decline in the economic health of a nation.

The next section explains why tariffs also hurt the economy of the country which imposes them.

Q: quota,
in international trade, government-imposed limit on the quantity, or in exceptional cases the value, of the goods or services that may be exported or imported over a specified period of time. Quotas are more effective in restricting trade than tariffs, particularly if domestic demand for a commodity is not sensitive to increases in price. Because the effects of quotas cannot be offset by depreciation of the foreign currency or by an export subsidy, quotas may be more disturbing to the international trade mechanism than tariffs. Applied selectively to various countries, quotas can also be a coercive economic weapon. Tariff quotas may be distinguished from import quotas. A tariff quota permits the import of a certain quantity of a commodity duty-free or at a lower duty rate, while quantities exceeding the quota are subject to a higher duty rate. An import quota, on the other hand, restricts imports absolutely. If the quantity imported under a quota is less than would be imported in the absence of a quota, the domestic price of the commodity in question may rise. Unless the governmentmaintains some system of licensing importers in order to capture as revenue the difference between the higher domestic price and the foreign price, the importing of such commodities can prove a lucrative source of private profit. Quantitative trade restrictions were first imposed on a large scale during and immediately after World War I. During the 1920s quotas were progressively abolished and replaced by tariffs. The next great wave of quota protection came during the Great Depression in the early 1930s, with France leading the European countries in introducing a comprehensive quota system in 1931. After World War II, the western

European countries began a gradual dismantling of quantitative import restrictions, but the United States tended to make more use of them.

Ans 2

Goals

The primary goal of import quotas is to reduce imports and increase domestic production of a good, service, or activity, thus "protect" domestic production by restricting foreign competition. As the quantity of importing the good is restricted, the price of the imported good increases, thus encourages consumers to purchase more domestic products. In general, a quota is simply a legal quantity restriction placed on a good imported that is imposed by the domestic government. [edit]Effects Because the import quota prevents domestic consumers from buying a imported good, the supply of the good is no longer perfectly elastic at the world price. Instead, as long as the price of the good is above the world price, the license holders import as much as they are permitted, and the total supply of the good equals the domestic supply plus the quota amount. The price of the good adjusts to balance supply (domestic plus imported) and demand. The quota causes the price of the good to rise above the world price. The domestic quantity demanded falls and the domestic quantity supplied rises. Thus, the import quota reduces the imports. Because the quota raises the domestic price above the world price, domestic sellers are better off, and domestic buyers are worse off. In addition, the license holders are better off because

they make a profit from buying at the world price and selling at the higher domestic price. Thus, import quotas decrease consumer surplus while increasing producer surplus and licenseholder surplus. While import quotas and other foreign trade policies can be beneficial to the aggregate domestic economy they tend to be most beneficial, and thus most commonly promoted by, domestic firms facing competition from foreign imports. Domestic firms benefit with higher sales, greater profits, and more income to resource owners. However, by increasing domestic prices and restricting accessing to imports, foreign trade policies also tend to be harmful to domestic consumers. [edit]Other effects[3] Domestic Employment: Decreasing imports and increasing domestic production also increases domestic employment. Low Foreign Wages: Restricting imports produced by foreign workers who receive lower wages "levels the competitive playing field" compared to domestic goods produced by higher paid domestic workers. Infant Industry: If foreign imports compete with a relatively young domestic industry that is neither mature enough nor large enough to benefit from economies of scale, then import quotas protect the "infant industry" while it matures and develops. Unfair Trade: The foreign imports might be sold at lower prices in the domestic economy because foreign producers engage in unfair trade practices, such as "dumping" imports at

prices below production cost. Import quotas seek to prevent foreign producers such activity. National Security: Import quotas can also discourage imports and encourage domestic production of goods that are deemed critical to the security of the national economy. Corruption: Import quotas can lead to administrative corruption in countries with import quotas as the importers chosen to meet the quota are the ones who can provide the most favors to the customs officers. Smuggling: Import quotas are more likely to cause smuggling. It's likely that people will try to sneak the bats into the country illegally if the import quota is only a small fraction of the demand for the product. So governments have to set the import quota at a reasonable level. [edit]Types[4] Quotas are established by legislation and Presidential proclamations issued pursuant to specific legislation and provided for in theHarmonized Tariff Schedule of the United States (HTSUS). United States import quotas may be divided into two types: absolute quota and tariff-rate quota. Once a quota has been reached, goods may still be entered, but at a considerably higher rate of duty. [edit]Absolute quotas Absolute quotas limit the quantity of certain goods that may enter the commerce of the United States during a specific period. Once the quantity permitted under an absolute quota is

filled, no further entries or withdrawals from warehouse for consumption of merchandise subject to the quota are permitted for the remainder of the quota period. Importers may hold shipments in excess of a specified absolute quota limit until the opening of the next quota period by entering the goods into a foreign trade zone or bonded warehouse. The goods may also be exported or destroyed under U.S. Customs and Border Protection (CBP) supervision. [edit]Tariff-rate quotas Tariff rate quotas permit a specified quantity of imported merchandise to be entered at a reduced rate of duty during the quota period. There is no limitation on the amount of merchandise that may be imported into the United States, however quantities entered in excess of the quota limit during that period are subject to a higher duty rate. If the importer has not taken possession of the goods, and elects not to pay the higher rate of duty, they may enter the goods into a foreign trade zone or bonded warehouse until the opening of the next quota period, or export or destroy the goods under CBP supervision. Once CBP determines the date and time a quota is filled, field officers are authorized to make the required duty rate adjustments on the portion of the merchandise not entitled to quota preference. Under the North American Free Trade Agreement (NAFTA), there are trade-preference levels (TPL), which are administered like tariff-rate quotas. The U.S. Customs Service administers the majority of import quotas. The Commissioner of Customs controls the importation of quota merchandise, but has

no authority to change or modify any quota. The Department of Commerce, in conjunction with the Office of the United States Trade Representative, determines and fixes quota limits. Quota merchandise is subject to the usual Customs procedures applicable to other imports. No import licenses are currently required for quotas administered by the Commissioner of Customs. Q:ppp

According to PPP theory, when exchange rates are of a fluctuating nature, the rate of exchange between two currencies in the long run will be fixed by their respective purchasing powers in their own nations.

Foreign currency is demanded by the people because it has some purchasing power in its own nation. Also domestic currency has a certain purchasing power, because it can buy some amount of goods/services in the domestic economy. Thus, when home currency is exchanged for any foreign currency, in fact the domestic purchasing is being exchanged for the purchasing power, because it can buy some amount of goods/ services in the domestic economy. Thus, when home currency is exchanged for any foreign currency, in fact the domestic purchasing power is being exchanged for the purchasing power of that foreign currency. This exchange of the purchasing power takes place at some specified rare where purchasing of two currencies nations gets

equalized. Thus, the relative purchasing power of the two currencies determines the exchange rate. The exchange rate under this theory is in equilibrium when their domestic purchasing powers at that rate of exchanges are equivalent e.g., Suppose certain bundle of goods/ services in U.S.A. costs U.S. $ 10 and the same bundle in India costs, Rs. 450/- then the exchange rate between Indian Rupee and U.S. Dollar is $1 = Rs. 45. Because this is the exchange rate at which the parity between the purchasing power of two nations is maintained. A change in the purchasing power of any currency will reflect in the exchange rates also. Hence under this theory the external value of the currency depends on the domestic purchasing power of that currency relative to that of another currency.

Gustav Cassel has presented the PPP theory in two versions.

Absolute Version of the PPP Theory

According to the absolute version of the purchasing power parity (PPP) theory, the exchange rates between two currencies should reflect the relation between the international purchasng powers of various currencies. In simple words the exchange rate would be determined, at the point where the internal purchasing power of the respective currencies gets equalized. Let us take an example to illustrate the point.

Suppose particular basket of goods cost Rs. 1000/- in India and $ 100 in the U.S.A. That means the exchanges rate would be Rs. 10 = $1. The exchange rate an be determined with the following equation.

In this equation 'P' i.e. prices are related to the respective bundle of goods with same weights assigned in both the countries. Thus, the above equation explains that the equilibrium exchange rate is determined by the ratio of the internal purchasing power of foreign currency and domestic currency in their own countries. Thus, to conclude the absolute version of this theory maintains the the absolute version of this theory maintains that the absolute purchasing power of respective currencies does play a vital role in determining the equilibrium exchange rate.

Criticism of Purchasing Power Parity (PPP) Theory

1.

Limitations of the Price Index : As seen above in the relative version the PPP theory uses the price index in order to measure the changes in the equilibrium rate of exchange. However, price indices suffer from various limitations and thus theory too.

2. Neglect of the demand / supply approach : The theory fails to explain the demand for as well as the supply of foreign exchange. The PPP theory proves to be unsatisfactory due to this negligence. Because in actual practice the exchange rate is determined according to the market forces such as the demand for and supply of foreign currency. 3. Unrealistic Approach : Since the PPP theory uses price indices which itself proves to be unrealistic. The reason for this is that the quality of goods and services included in the indices differs from nation to nation. Thus, any comparison without due significance for the quality proves to be unrealistic. 4. Unrealistic Assumptions : It is yet another valid criticism that the PPP theory is based on the unrealistic assumptions such as absence of transport cost. Also it wrongly assumes that there is an absence of any barriers to the international trade. 5. Neglects Impact of International Capital Flow : The PPP theory neglects the impact of the international capital movements on the foreign exchange market. International capital flows may cause fluctuations in the existing exchange rate.

6. Rare Occurrence : According to critics, the PPP theory is in contrast to the Practical approach. Because, the rate of exchange between any two currencies based on the domestic price ratios is a very rare occurrence. Thus, the PPP theory is criticized on the above grounds.

Conclusion On Purchasing Power Parity Theory

Despite these criticisms the theory focuses on the following major points. 1. It tries to establish relationship between domestic price level and the exchange rates. 2. The theory explains the nature of trade as well as considers the BOP (Balance of Payments) of a nation.