Equilibrium and Disequilibrium in
International Trade and Finance
Week Two (A)
Equilibrium and Disequilibrium in the
Balance of Payment
and
Risk of International Trade
Equilibrium and Disequilibrium in
the Balance of Payment
Balance of Payment represent balance in
current account, capital account will
always be equal if receipt and payment are
equal.
If receipt and payment are equal, we could
say Balance of Payment is in equilibrium
state in international trade. If there any
surplus or deficit is know as
disequilibrium in international trade.
Equilibrium and Disequilibrium in
the Balance of Payment
the emphasis in this class is in the
export and import domain in the
current account.
Firstly, we need to review some basic
concepts in the foreign exchange
the Balance of Payment
key definition
Equilibrium: The state in which market supply
and demand balance each other and, as a result,
prices become stable.
In other words
The equilibrium price is the price at which the
supply of goods matches demand.
Equilibrium and Disequilibrium in
the Balance of Payment
A causes of the disequilibrium in the balance of
payment is
- Price fluctuation
- Huge development and investment programs
in the developing economic
- A vast increase in the domestic production of
foodstuffs, raw material, substitute good. Etc.
- International borrowing and investment
Equilibrium and Disequilibrium in
the Balance of Payment
Nominal Exchange Rate: The rate at
which a person can trade the currency
of one country for the currency of
another.
For Example: if you go to bank, you
might see a posted exchange rate of 80
yen per dollar. If you give the bank one
U.S dollar, it will give you 80 Japanese
yen
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Equilibrium and Disequilibrium in
the Balance of Payment
Appreciation: an increase in the value of a
currency as measured by the amount of
foreign currency it can buy.
For Example: a dollar buys more foreign
currency, that change is called an
appreciation of the dollar.
Equilibrium and Disequilibrium in
the Balance of Payment
At times you may have heard the
media report that the dollar is either
“strong” or “weak.” These
descriptions usually refer to recent
changes in the nominal exchange
rate. When a currency appreciates, it
is said to strengthen, because it can
then buy more foreign currency.
Similarly, when a currency
depreciates, it is said to weaken.
Equilibrium and Disequilibrium in
the Balance of Payment
Real and nominal exchange rates are
closely related. To see how, consider an
example. Suppose that a bushel of
American rice sells for $100, and a bushel
of Japanese rice sells for 16,000 yen. What
is the real exchange rate between
American and Japanese rice? (Assume
nominal exchange rate is one dollar=80
yen)
Equilibrium and Disequilibrium in
the Balance of Payment
Depreciation: a decrease in the value of a
currency as measured by the amount of
foreign currency it can buy.
For example: a dollar buys less foreign
currency, that change is called a
depreciation of the dollar.
Equilibrium and Disequilibrium in
the Balance of Payment
• Real Exchange Rate
The rate at which a person can trade the
goods and services of one country for the
goods and services of another.
Real Exchange Rate =
Nominal Exchange Rate * Domestic Price
Foreign price
Equilibrium and Disequilibrium in
the Balance of Payment
The solution:
Real exchange rate=
Nominal exchange rate * domestic price
foreign price
= 80*100
16,000
= 1/2
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Equilibrium and Disequilibrium in
the Balance of Payment
Why does the real exchange rate matter?
The real exchange rate is a key determinant of
how much a country exports and imports
Now let denote p = price index in domestic
country. P* = price index in the foreign country. e
= nominal exchange rate
Real exchange rate = (e*p) / p*
Equilibrium and Disequilibrium in
the Balance of Payment
a nominal exchange rate appreciation of
domestic country lead to real exchange
rate appreciation, and the country’s export
decrease. The balance of payment of the
country will be deficit.
an increase in domestic prices result in
real exchange rate appreciation, and the
country’s export decrease. The balance of
payment of the country will be deficit.
Equilibrium and Disequilibrium in
the Balance of Payment
Measure to correct the Disequilibrium
- Trade measure
- Monetary measure
- Current devaluation
- Money contraction
- Exchange control
- Encouragement to foreign investment
- Incentive to foreign tourist
Equilibrium and Disequilibrium in
the Balance of Payment
A country’s real exchange rate is a key
determinant of its net export of goods and
services. A depreciation in the U.S real exchange
rate means that U.S goods have become cheaper
relative to foreign goods. This change
encourages consumers both at home and abroad
to buy more U.S goods and fewer goods from
other countries. As a result, U.S export rise, and
import fall. Conversely, an appreciation in the U.S
real exchange rate means that U.S goods have
become more expensive compared to foreign
goods so U.S. net export fall.
Equilibrium and Disequilibrium in
the Balance of Payment
an increase in foreign prices result in real
exchange rate depreciation, the country’s
export increase, and import decrease. The
balance of payment of the country will be
surplus.
Risk of International Trade
• The risks that exist in international trade can be divided into two major
groups:
Economic risks
• Risk of insolvency of the buyer,
• Risk of protracted default - the failure of the buyer to pay the amount due
within six months after the due date, and
• Risk of non-acceptance
• Surrendering economic sovereignty
•
Political risks
Risk of cancellation or non-renewal of export or import licenses
• War risks
• Risk of expropriation or confiscation of the importer's company
• Risk of the imposition of an import ban after the shipment of the goods
• Transfer risk - imposition of exchange controls by the importer's country
or foreign currency shortages
• Surrendering political sovereignty