Part – B

Answer The Following Questions Each Question Carries 2 Marks.

Question 21.
What is International Economics?
Answer:

  1. International Economics is that branch of economics which is concerned with the exchange of goods and services between two or more countries. Hence the subject matter is mainly related to foreign trade.
  2. International Economics is a specialized field of Economics which deals with the economic interdependence among countries and studies the effects of such interdependence and the factors that affect it.


Question 22.
Define international trade?
Answer:
International Trade refers to the trade or exchange of goods and services between two or more countries. In other words, it is a trade among different countries or trade across political boundaries. It is also called as ‘external trade’ or ‘foreign trade’ or ‘inter-regional trade’.

Question 23.
State any two merits of trade?
Answer:

  1. Trade is one of the powerful forces of economic integration.
  2. The term ‘trade’ means exchange of goods, wares or merchandise among people.


Question 24.
What is the main difference between Adam Smith and Ricardo with regard to the emergence of foreign trade?
Answer:
Adam Smith Foreign Trade:

  1. According to Adam Smith the basis of International trade was absolute cost advantage.
  2. Trade between two countries would be mutually beneficial when one country produces a commodity at an absolute cost advantage.
  3. Adam Smith argued that all nations can be benefitted when there is free trade and specialisation interms of their absolute cost advantage.

Ricardo Foreign Trade:

  1. Ricardo demonstrates that the basis of trade is the comparative cost difference.
  2. Trade can take place even if the absolute cost difference is absent but there is comparative cost difference.
  3. According to Ricardo a country can gain from trade when it produces at relatively lower costs.

Question 25.
Define Terms of Trade?
Answer:
Terms of Trade:

  1. The gains from international trade depend upon the terms of trade which refers to the ratio of export prices to import prices.
  2. It is the rate at which the goods of one country are exchanged for goods of another country’.
  3. It is expressed as the relation between export prices and import prices.
  4. Terms of trade improves when average price of exports is higher than average price of imports.


Question 26.
What do you mean by balance of payments?
Answer:
Balance of Payments (BOP):

1. BoP is a systematic record of a country’s economic and financial transactions with the rest of the world over a period of time.

2. When a payment is received from a foreign country, it is a credit transaction while a payment to a foreign country is a debit transaction.

3. The principal items shown on the credit side are exports of goods and services, transfer receipts in the form of gift etc., from foreigners, borrowing from abroad, foreign direct investment and official sale of reserve assets including gold to foreign countries and international agencies.

4. The principal items on the debit side include imports of goods and serv ices, transfer payments to foreigners, lending to foreign countries, investments by residents in foreign countries and official purchase of reserve assets or gold from foreign countries and international agencies.


Question 27.
What is meant by Exchange Rate?
Meaning of Foreign Exchange (FOREX):

1. FOREX refers to foreign currencies. The mechanism through which payments are effected between two countries having different currency systems is called FOREX system. It covers methods of payment, rules and regulations of payment and the institutions facilitating such payments.

2. “FOREX is the system or process of converting one national currency into another, and of transferring money from one country to another”.

Part – C
Answer The Following Questions Each Question Carries 3 Marks.

Question 28.
Describe the subject matter of International Economics?
Answer:
Subject Matter of International Economics:
The subject matter of International Economics includes large number of segments which are classified into the following parts.

1. Pure Theory of Trade:
This component explains the causes for foreign trade, composition, direction and volume of trade, determination of the terms of trade and exchange rate, issues related to balance of trade and balance of payments.

2. Policy Issues:
Under this part, policy issues such as free trade vs. protection, methods of regulating trade, capital and technology flows, use of taxation, subsidies and dumping, exchange control and convertibility, foreign aid, external borrowings and foreign direct investment, measures of correcting disequilibrium in the balance of payments etc are covered.

3. International Cartels and Trade Blocs:
This part deals with the economic integration in the form of international cartels, customs unions, monetary unions, trade blocs, economic unions and the like. It also discusses the operation of Multi National Corporations (MNCs).

4. International Financial and Trade Regulatory Institutions:
The financial institutions like International Monetary Fund IMF, IBRD, WTO etc which influence international economic transactions and relations shall also be the part of international economics.


Question 29.
Compare the Classical Theory of international trade with Modern Theory of International trade?
Answer:
Classical Theory of International Trade:

  1. The classical theory explains the phenomenon of international trade on the basis of labour theory of value.
  2. It presents a one factor (labour) model.
  3. It attributes the differences in the comparative costs to differences in the productive efficiency of workers in the two countries.

Modern Theory of International Trade:

  1. The modem theory explains the phenomenon of international trade on the basis of general theory of value.
  2. It presents a multi – factor (labour and capital) model.
  3. It attributes the differences in comparative costs to the differences in factor endowments in the two countries.

Question 30.
Explain the Net Barter Terms of Trade and Gross Barter Terms of Trade?
Answer:
1. Net Barter Terms of Trade:
This type was developed by Taussig in 1927.The ratio between the prices of exports and of imports is called the “net barter terms of trade’. It is named by Viner as the ‘commodity terms of trade’.
It is expressed as:
Tn = (P x /Pm ) × 100
Where,
Tn = Net Barter Terms of Trade
Px = Index number of export prices
Pm = Index number of import prices
This is used to measure the gain from international trade. If ‘Tn’ is greater than 100, then it is a favourable terms of trade which will mean that for a rupee of export, more of imports can be received by a country.

2. Gross Barter Terms of Trade:
This was developed by Taussig in 1927 as an improvement over the net terms of trade. It is an index of relationship between total physical quantity of imports and the total physical quantity of exports.
T = (Qm/Qx) × 100
Where,
Qm = Index of import quantities
Qx = Index of export quantities
If for a given quantity of export, more quantity of import can be consumed by a country, then one can say that terms of trade are favourable.


Question 31.
Distinguish between Balance of Trade and Balance of Payments?
Answer:
Balance of Trade:

  1. Balance of Trade refers to the total value of a country’s exports of commodities and total value of imports of commodities.
  2. Only export and import of commodities are included in the statement of Balance of Trade of a country.
  3. The Balance of Trade between the values of goods exchanged between two countries.
  4. Balance of Trade is a merchandise items or visible items only.

Balance of Payments:

  1. Balance of payments is a systematic record of a country’s economic and financial transactions with the rest of the world over a period of time.
  2. The principal items shown on the credit side are exports of goods and services, transfer receipts in the form of gift, etc.
  3. The Balance of payments between the values of goods and services changed between two countries.
  4. Balance of payments is a both visible and non – visible items.

Question 32.
What are import quotas?
Answer:
Import Control: Imports may be controlled by

  1. Imposing or enhancing import duties
  2. Restricting imports through import quotas
  3. Licensing and even prohibiting altogether the import of certain non-essential items. But this would encourage smuggling.


Question 33.
Write a brief note on flexible exchange rate?
Answer:
Flexible Exchange Rates: Under the flexible exchange rate (also known as floating exchange rate) system, exchange rates are freely determined in an open market by market forces of
demand and supply

Question 34.
State the objectives of Foreign Direct Investment.
Answer:
Objectives of FDI:
FDI has the following objectives.

  1. Sales Expansion
  2. Acquisition of resources
  3. Diversification
  4. Minimization of competitive risk.
    • FDI may help to increase the investment level and thereby the income and employment in the host country.
    • Direct foreign investment may facilitate transfer of technology to the recipient country.
    • FDI may also bring revenue to the government of host country when it taxes profits of foreign firms or gets royalties from concession agreements.
    • A part of profit from direct foreign investment may be ploughed back into the expansion, modernization or development of related industries.
    • It may kindle a managerial revolution in the recipient country through professional management and sophisticated management techniques.
    • Foreign capital may enable the country to increase its exports and reduce import requirements. And thereby ease BoP disequilibrium.
    • Foreign investment may also help increase competition and break domestic monopolies.
    • If FDI adds more value to output in the recipient country than the return on capital from foreign investment, then the social returns are greater than the private returns on foreign investment.
    • By bringing capital and foreign exchange FDI may help in filling the savings gap and the foreign exchange gap in order to achieve the goal of national economic development.
    • Foreign investments may stimulate domestic enterprise to invest in ancillary industries in collaboration with foreign enterprises.

Part – D
Answer The Following Questions Each Question Carries 5 Marks.

Question 35.
Discuss the differences between Internal Trade and International Trade?
Answer:
Internal Trade:

  1. Trade takes place between different individuals and firms within the same nation.
  2. Labour and capital move freely from one region to another.
  3. There will be free flow of goods and services since there are no restrictions.
  4. There is only one common currency.
  5. The physical and geographical conditions of a country are more or less similar.
  6. Trade and financial regulations are more or less the same.
  7. There is no difference in political affiliations, customs and habits of the people and government policies.

International Trade:

  1. Trade takes place between different individuals and firms in different countries.
  2. Labour and capital do not move easily from one nation to another.
  3. Goods and services do not easily move from one country to another since there are a number of restrictions like tariff and quota.
  4. There are different currencies.
  5. There are differences in physical and geographical conditions of the two countries.
  6. Trade and financial regulations such as interest rate, trade laws differ between countries.
  7. Differences are pronounced in political affiliations, habits and customs of the people and government policies


Question 36.
Explain briefly the Comparative Cost Theory?
Answer:
Ricardo’s Theory of Comparative Cost Advantage:

1. David Ricardo, the British economist in his ‘Principles of Political Economy and Taxation’ published in 1817, formulated a systematic theory called ‘Comparative Cost Theory’.

2. Ricardo demonstrates that the basis of trade is the comparative cost difference. In other words, trade can take place even if the absolute cost difference is absent but there is comparative cost difference.

3. According to Ricardo, a country can gain from trade when it produces at relatively lower costs. Even when a country enjoys absolute advantage in both goods, the country would specialize in the production and export of those goods which are relatively more advantageous.

Assumptions:

  1. There are only two nations and two commodities (2 × 2 model)
  2. Labour is the only element of cost of production.
  3. All labourers are of equal efficiency.
  4. Labour is perfectly mobile within the country but perfectly immobile between countries, (v) Production is subject
  5. To the law of constant returns.
  6. Foreign trade is free from all barriers.
  7. No change in technology.
  8. No transport cost.
  9. Perfect competition.
  10. Full employment.
  11. No government intervention.

Illustration:
Ricardo’s theory of comparative cost can be explained with a hypothetical example of production costs of cloth and wheat in America and India.



It is evident from the example that India has an absolute advantage in production of both cloth and wheat.

However, India should concentrate on the production of wheat in which she enjoys a comparative cost advantage. (80/120 < 90/100). For America the comparative cost disadvantage is lesser in cloth production. Hence America will specialize in the production of cloth and export it to India in exchange for wheat. (Any exchange ratio between 0.88 units and 1.2 units of cloth against one unit of wheat represents gain for both the nations).

With trade, India can get 1 unit of cloth and 1 unit of wheat by using its 160 labour units. In the absence of trade, for getting this benefit, India will have to use 170 units of labour. America also gains from this trade. With trade, America can get 1 unit of cloth and one unit of wheat by using its 200 units of labour. Otherwise, America will have to use 220 units of labour for getting 1 unit of cloth and 1 unit of wheat.


Question 37.
Discuss the Modern Theory of International Trade?
Answer:
Modern Theory of International Trade:
Introduction:
The modem theory of international trade was developed by Swedish economist Eli Heckscher and his student Bertil Ohlin in 1919. This model was based on the Ricardian theory of international trade. This theory says that the basis for international trade is the difference in factor endowments. It is otherwise called as ‘Factor Endowment Theory’.

The Theory:
The classical theory argued that the basis for foreign trade was comparative cost difference and it considered only labour factor. But the modem theory of international trade explains the causes for such comparative cost difference. This theory attributes international differences in comparative costs to:

  1. Difference in the endowments of factors of production between countries, and
  2. Differences in the factor proportions required in production.

Assumptions:

  1. There are two countries, two commodities and two factors. (2 × 2 × 2 model)
  2. Countries differ in factor endowments.
  3. Commodities are categorized in terms of factor intensity.
  4. Countries use same production technology.
  5. Countries have identical demand conditions.
  6. There is perfect competition in both product and factor markets in both the countries

Explanation:
According to Heckscher – Ohlin, “a capital – abundant country will export the capital – intensive goods, while the labour-abundant country will export the labour – intensive goods”. A factor is regarded abundant or scare in relation to the quantum of other factors. A country can be regarded as richly endowed with capital only if the ratio of capital to other factors is higher than other countries

Illustration:


Question 38.
Explain the types of Terms of Trade given by Viner?
Answer:
Terms of Trade related to the Interchange between Productive Resources:

1. The Single Factoral Terms of Trade:
Viner has devised another concept called “the single factoral terms of trade” as an improvement upon the commodity terms of trade. It represents the ratio of export – price index to the import – price index adjusted for changes in the productivity of a country’s factors in the production of exports. Symbolically, it can be stated as
Tf = (Px / Pm ) Fx
Where, Tf stands for single factoral terms of trade index. Fx stands for productivity in exports (which is measured as the index of cost in terms of quantity of factors of production used per unit of export).

2. Double Factoral Terms of Trade:
Viner constructed another index called “Double factoral terms of Trade”. It is expressed as
Tff = (Px / Pm )(Fx / Fm)
which takes into account the productivity in country’s exports, as well as the productivity of foreign factors.
Here, Fm represents import index (which is measured as the index of cost in terms of quantity of factors of production employed per unit of imports).


Question 39.
Bring out the components of balance of payments account?
Answer:
Components of BOPs:
The credit and debit items are shown vertically in the BOP account of a country. Horizontally, they are divided into three categories, i.e.

  1. The current account,
  2. The capital account and
  3. The official settlements account or official reserve assets account.

1. The Current Account:
It includes all international trade transactions of goods and services, international service transactions (i.e. tourism, transportation and royalty fees) and international unilateral transfers (i.e. gifts and foreign aid).

2. The Capital Account:
Financial transactions consisting of direct investment and purchases of interest-bearing financial instruments, non-interest bearing demand deposits and gold fall under the capital account.

3. The Official Reserve Assets Account:
Official reserve transactions consist of movements of international reserves by governments and dfficial agencies to accommodate imbalances arising from the current and capital accounts.

The official reserve assets of a country include its gold stock, holdings of its convertible foreign currencies and Special Drawing Rights (SDRs) and its net position in the International Monetary Fund (IMF).
Balance of payment (BOP) Account Chart
Credit (Receipts) – Debit (Payments) = Balance [Deficit (-), Surplus (+)]
Deficit if Debit > Credit

Question 40.
Discuss the various types of disequilibrium in the balance of payments?
Answer:
Types BOP Disequilibrium:
There are three main types of BOP Disequilibrium, which are discussed below.

  1. Cyclical Disequilibrium,
  2. Secular Disequilibrium,
  3. Structural Disequilibrium.

1. Cyclical Disequilibrium:
Cyclical disequilibrium occurs because of two reasons. First, two countries may be passing through different phases of business cycle. Secondly, the elasticities of demand may differ between countries.

2. Secular Disequilibrium:
The secular or long-run disequilibrium in BOP occurs because of long – run and deep seated changes in an economy as it advances from one stage of growth to another. In the initial stages of development, domestic investment exceeds domestic savings and imports exceed exports, as it happens in India since 1951.

3. Structural Disequilibrium:
Structural changes in the economy may also cause balance of payments disequilibrium. Such structural changes include development of alternative sources of supply, development of better substitutes, exhaustion of productive resources or changes in transport routes and costs.


Question 41.
How the Rate of Exchange is determined? Illustrate?
Answer:
Determinants of Exchange Rates:
Exchange rates are determined by numerous factors and they are related to the trading relationship between two countries.
Factors determining Exchange Rate:

  1. Differentials in Inflation
  2. Differential in Interest Rates
  3. Current Account Deficits
  4. Public Debt
  5. Terms of Trade
  6. Political and Economic Stability
  7. Recession
  8. Speculation

1. Differentials in Inflation:

  1. Inflation and exchange rates are inversely related.
  2. A country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies.

2. Differentials in Interest Rates:

  1. There is a high degree of correlation between interest rates, inflation and exchange rates.
  2. Central banks can influence over both inflation and exchange rates by manipulating interest rates.
  3. Higher interest rates attract foreign capital and cause the exchange rate to rise and vice versa.

3. Current Account Deficits:

  1. A deficit in the current account implies excess of payments over receipts.
  2. The country resorts to borrowing capital from foreign sources to make up the deficit.
  3. Excess demand for foreign currency lowers a country’s exchange rate.

4. Public Debt:

  1. Large public debts are driving out foreign investors, because it leads to inflation.
  2. As a result, exchange rate will be lower.

5. Terms of Trade:

  1. A country’s terms of trade also determines the exchange rate.
  2. If the price of a country’s exports rises by a greater rate than that of its imports, its terms ‘ of trade will improve.
  3. Favorable terms of trade imply greater demand for the country’s exports and thus BoP becomes favorable.

6. Political and Economic Stability:
If a nation’s political climate is stable and economic performance is good, its currency value will be appreciated by attracting more foreign capital.

7. Recession:

  1. Interest rates are low during the recession phase.
  2. This will decrease inflow of foreign capital.
  3. As a result, a currency will be depreciated against other currencies, thereby lowering the exchange rate.

8. Speculation:

  1. If a country’s currency value is expected to rise, investors will demand more of that currency in order to make a profit in the near future.
  2. This results in appreciation of the exchange rate.
  3. Beside the above determinants, relative dominance in the global politics and the power to announce economic sanctions over other countries also determine exchange rates.


Question 42.
Explain the relationship between Foreign Direct Investment and economic development?
Answer:
Foreign Direct Investment (FDI) and Trade:

  1. FDI is an important factor in global economy.
  2. Foreign trade and FDI are closely related. In developing countries like India
  3. FDI in the natural resource sector, including plantations, increases trade volume.
  4. Foreign production by FDI is useful to substitute foreign trade.
  5. FDI is also influenced by the income generated from the trade and regional integration schemes.
  6. FDI is helpful to accelerate the economic growth by facilitating essential imports needed for carrying out development programmes like capital goods, technical know-how, raw materials and other inputs and even scarce consumer goods.
  7. FDI may be required to fill the trade gap.
  8. FDI is encouraged by the factors such as foreign exchange shortage, desire to create employment and acceleration of the pace of economic development.
  9. Many developing countries strongly prefer foreign investment to imports.
  10. However, the real impact of FDI on different sections of an economy.