Chapter 11

International Trade and

Balance of Payment
 Chapter Objectives
 Define the advantages of international trade
 Explain reasons and tools for protectionism
policies.
 Explain on the components of in the balance of
payments structure .

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 International Trade
 Refers to the exchange of goods and
services between the people of two
countries.
 also refers to the exchange of goods and
services within the political boundaries of a
country.

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 Objectives of International Trade
 It will increases world production and gives consumers a
greater variety of products.
 Specialization is the reason for every country to involves
itself in international trade. When countries specialize,
total world output increases and world consumption also
increase.
 Through international trade, a country can consume a
combination of goods that lie outside the boundary of
that industry.

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Merits and Demerits of International
Trade
Advantages/Merits Demerits /Disadvantages
1. Increase world output 1. Depletion of country’s reserves
2. Varieties of goods and services 2. Economics and political
3. Relationship between trading dependence
partners 3. Transportation costs
4. Higher income and economic
growth
5. Sharing of knowledge and
technology

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 Reasons for Protectionism
1. National security argument
2. Infant industry argument
3. Anti-dumping argument
4. Domestic employment argument
5. Low foreign wage argument

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 Reasons for Protectionism
1. National security argument
 Based on the assumption that a country should be self
sufficient in certain industries such as the manufacture of
aircraft and weapons and the production of petroleum.

2. Infant industry argument

 Based on the assumption that infant or new industries should
be protected from established foreign competitors until such
time they have developed sufficient efficiency and economies
of scale for them to compete on the equal basis.

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 Reasons for Protectionism
3. Anti-dumping argument
 Dumping is the sale of goods abroad at a lower price or price below the
price charged in the local market.
 Dumping is unfair trade practice since it disadvantages domestic
producers of the substitute goods.
4. Domestic employment argument
 If domestic producers cannot compete with foreign competitors, then
many domestic producers will leave the industry. This will lead to
unemployment.
5. Low foreign wage argument
 Countries need to impose trade restrictions because wages in one
country can be higher than those in other country. This overcome the
threat of cheap labour.

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 Tools of Protectionism
1. Tariff
a. Specific tariff
b. Ad valorem tariff
2. Quotas
3. Embargoes
4. Import licence
5. Exchange control
6. Industry Subsidies

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 Tools of Protectionism
1. Tariff – a tax imposed by the government on imported
products.
a. Specific tariff – a fixed tariff imposed on a unit of imported
goods.
b. Ad valorem tariff – a tariff imposed on imported goods based
on the value of the goods.
2. Quotas – A legal limit on the number of units of a particular
commodity that can be imported.
3. Embargoes – A law that bars trade with another country

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 Cont’
4. Import license – control the number of importing
firms and the volume of imports
through the requirement of import
licenses.
5. Exchange control – Control on the amount of money
that is allowed to be brought into
and out of a country.

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 Balance of Payment (BOP)
1. Refers to the statement of systematic record of all
economic transaction between one country and the
rest of the world during a given made by period of
time.
2. It shows the details of total payments made by a
country to other nations and also the total receipts
received by it.
3. The BOP also refers to the difference between the
total value of goods and services imported and
exported over a given period of time.

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 Balance of Payment (BOP)
 The BOP account records both debits and credits.
1. A debits is any transaction that supplies the
country’s currency in the foreign exchange
market. It is indicated by a minus(-) sign because
of the outflow of money.
2. A credit is any transaction that creates demand
for the country’s currency in the foreign
exchange market. It is indicated by a plus (+) sign
due to inflow of money.
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 Structure of Balance of Payment
 The international transactions has three major
components:
1. Current account
a. Merchandise trade balance
b. Service balance
c. Net Income
d. Current Transfer
2. Capital account
3. Official Reserve account

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 a. Current Account
1. Merchandise trade balance
- The difference between export and import of physical goods.
Merchandise Trade Balance = Value of merchandise export-Value of merchandise Import

a. Trade Surplus-Merchandise exports greater than

merchandise imports.
b. Trade Deficit – Merchandise exports less than merchandise
imports.
2. Service balance
- The difference between receipts and payments from services.
Service Balance = Value of service exports-Value of service imports

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 a. Current Account
3. Net Income
- The difference between investment income flows into and out of a
country. Such incomes include compensation paid to employees,
investment income in the form of direct investment, portfolio investment
and other investment.
- Income inflow into Malaysia are from investments made by Malaysians
oversea.
- Income Outflow from Malaysia will be investment by foreigners in
Malaysia.
4. Current Transfer
- gifts, military aid and financial aid by the government, private
individuals and organizations to foreign countries.

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 b. Capital Account
 Records the payment flows on purchases of foreign assets by
Malaysians or Malaysian assets by foreigners.
 Examples of capital account: capital transfers and non-
produced and non-financial assets.
 Examples of financial accounts include the purchase of shares
or bonds, extending loans, buying government securities or
purchasing property, direct investment, portfolio and other
investments.
 Private transactions- all types of investment: direct, portfolio
and short-term.
 Government or official transactions consists of loans to and
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 Cont’
a. Errors and Omissions
 A balancing item that enables credits and debits equal.

b. Official Reserve Account

- Consist of government gold and foreign currency reserves as
well as government reserves with the International Monetary
Fund (IMF) and Special Drawing Rights (SDR)

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 Basic Calculation of the BOP
Item Calculation
Merchandise trade balance = Merchandise export-merchandise import
Service balance = Services export –services import

Balance in current account = Merchandise trade balance + Service balance + Net Income +
Current Transfer
Balance on capital account = Capital account + Financial Account

Overall balance = Balance in current account + balance in capital account + errors

and omissions
Reserve assets = - (overall balance)

Basic balance = Balance in current account + Long Term capital account

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 Disequilibrium in Balance of Payments
 Occurs when there is a deficit or surplus in the
balance of payments
 Factors that contribute to the disequilibrium such as
development programs, income and price effect,
elasticity of demand for exports and imports and
population growth

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