Economics

1MODULE – I INTERNATINAL TRADE (Q1- 15 MARKS)
1. Explain comparative cost advantage theory (Ricardian theory of international trade.

2. Critically explain comparative cost advantage theory
3. Explain modern theory/ factor endowment theory/heckscher-ohlin theory of international trade
4. What are terms of trade? Explain factors affecting it
5. Explain terms of trade and its types
6. What is gains of trade and state its importance
7. Critically explain modern theory/factor endowment theory/H-O theory
8. What are the factors affecting gains from trade
9. Explain gains of trade with offer curve.
Q1.Explain the Comparative Advantage Theory of International trade of Ricardo
Ans:-
 According to David Ricardo, it is not the absolute but the comparative difference in
costs that determine trade between two countries. Production costs differ in
countries because of geographical division of labour and specialization in production.
 Due to difference in climate, natural resources, geographical situation and efficiency
of labour, a country can produce one commodity at a lower cost than the other. In
this way, each country specializes in the production of that commodity in which its
comparative cost of production is the least.
 This is the basis of international trade, according to Ricardo. It follows that each
country will specialize in the production of those commodities in which it has the
greatest advantages or the least comparative disadvantages. Thus, a country will
export those commodities in which its comparative advantage is the greatest and
import those commodities in which its comparative disadvantage is the least.
In short ‘ According to comparative cost advantage theory of international theory, each

country exports the commodities in which it has cost advantage and imports that
commodity in which it has cost disadvantage.’
Assumption of the Theory
The Ricardian theory of comparative advantages is based on the following assumption:-

1. There are only two countries in international trade. (India and Nepal)
2. They produce the same two commodities which are same. (Clothe and Shoes)
3. There are similar tastes in both countries.
4. Labour is the only factor of Production. There is no capital factor
5. All units of labour are homogeneous and price of commodities is determined by labour cost
8. Commodities are produced under the law of constant costs or returns.
9. Technological knowledge is unchanged.
10. Factors of production are perfectly mobile within each country, but are perfectly
immobile between countries.
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DR. RAJESH BHOITE Page 1
PROF. BHALCHANDRA KARBHARI
11. There is free trade between the two countries
12. No transport costs are involved in carrying trade between the two countries.
13. All factors of production are fully employed in both the countries.
This theory is explained with the following example:
Country Clothe Shoe

( Labour) ( Labour)
Nepal 10 4
India 20 12
Ratio 10/20=0.5 4/12=0.33
It is observed from the above table that Nepal has advantage in producing both the
commodities i.e. Clothe and Shoe as the labour cost is minimum for both the commodities. In
Nepal, to produce the clothe only 50 percent cost is needed over the cost needed in India.
And to produce Shoe it needs 1/3rd cost of India. So it is able to produce both the
commodities. But in order to take advantage, it will prefer to produce only shoe as the labour
cost is even less than producing clothe. Thus it uses its total labour and produces only shoe
and exports to India. On the other hand India needs 12 labours to produce shoe, but if
imports from Nepal, it is more beneficial. So it prefers producing clothe using its total labour
and exports to Nepal. Thus both gain from the international trade due to cost differences. In
this way international trade takes place between these two countries.
Q2. Criticisms of Ricardian Theory OR Critically explain Comparative Cost advantage

theory OR
1. Unrealistic Assumption of labour Cost:-

The most severe criticism of the comparative advantage doctrine is that it is based on the
labour theory of value. In calculating production labour costs involved in the production
commodities. This is highly unrealistic.
2. No Similar Tastes:-
The assumption of similar tastes is unrealistic because tastes differ with different brackets in
a country. Moreover, they also with the growth on an economy and with the development of
its trade relations with other countries.
3.State Assumption of Fixed Proportions:-

The theory of comparative costs is based on the assumption that labour is used in the same
fixed proportions in the production of all commodities. Moreover, some substitution of
labour for capital is al-ways possible in production.
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4. Unrealistic Assumption of Constant Costs:-
The theory is based on another weak assumption that an increase of output due to
international specialization if followed by constant costs. But the fact is that there are either
increasing or diminishing costs.
5. Ignores Transport Costs:-

Ricardo ignores transport costs in determining comparative advantage in trade. This is
highly unrealistic because transport costs play an important role in determining the pattern
of world trade. Like economies of scale, it is an independent factor of production.
6. Factors not Fully Mobile internally:-

The doctrine assumes that factors of production are perfectly mobile internally and wholly
immobile internationally. This is not realistic because even within a country factors do not
move freely from one industry to another or from one region to another.
7. Two-Country Two-Commodity Model Unrealistic:-

The Ricardian model is related to trade between two countries on the basis of two
commodities. This is again unrealistic because in actually, international trade is among many
countries trading in many commodities.
8. Self-Interest Hinders its Operation:-

The doctrine does not operate if a country having a comparative disadvantage does not wish
to import a commodity from the other country due to strategic, military or development
considerations.
9. Neglects the Role of Technology:-

The theory neglects the role of technological innovations in international trade. This is
unrealistic because technological changes help in increasing the supply of goods not only for
the domestic market but also for international market.
10. One-Sided Theory:-

The Ricardian theory is one-sided because it considers only the supply side of international
trade and neglects the demand side. Whereas demand is also the most influencing factor in
international trade.
11. Impossibility of Complete Specialization:-

Prof. Frank Graham has pointed out that complete specialization will be impossible on the
basis of comparative advantage in producing commodities entering into international trade.
12. Incomplete Theory:-

It is an incomplete theory. It simply explains how two countries gain from international
trade. But it fails to show how the gains from trade are distributed between the two
countries.
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Q3. Explain Modern theory/Equilibrium theory/Factor endowment theory of Heckscher
Ohlin.
H-O theory is also known as Modern theory of international trade. It is advocated by Bertil
Ohlin and it is based on the General Equilibrium theory of Heckscher. So it is known as
Heckscher Ohlin theory of International Trade. It is well known as Factor Endowment
theory or Factor proportion theory because it considers two major factors in its explanation.
According to Ohlin, trade arises due to the differences in the relative prices of different goods
in different nations. The difference in commodity price is due to the difference in their factor
prices (or Costs). Factor is based on the factor endowment in that country. And as the factor
availability is different in the entire nation, there is difference in factor endowment. Thus this
model/ theorem states that
‘ The countries which are rich in labour (Labour intensive) will export labour intensive
goods only and the countries which are rich in capital will export capital intensive
goods only due to their factor endowment (abundance)’
Assumptions of the Theory:
1. There are two countries involved in the international trade. (USA and India)
2. There are two commodities produced by these countries. (Machine and Clothe
3. Both produce labour intensive and capital intensive goods
4. There are two factors of production i.e Capital and Labour
5. There is perfect competition in both commodity and factor markets
6. All production functions are homogeneous.
7. There is constant production to scale.
8. Both the countries differ in factor intensity
9. There is full employment of resources in both and countries
10. There is a free trade and no trade restrictions are observed
11. No transport cost is considered in trade.
Explanation of the theory:
Ohlin says that the country having abundant factor, will product and export goods with it
and will import the goods for which it has scarce resources. Thus it may be labour intensive
or capital intensive. To explain this theory Ohlin has adopted approach of considering factor
prices to know its abundance. But at the same time the abundance of the factors can be
considered in physical terms too.
Let assume that there is a trade between USA and India. Where USA is capital intensive and
India is labour intensive. Therefore, capital is cheap in USA and labour is Cheap in India. So
two commodities are produce i.e.machine and clothe. Machine is capital intensive and clothe
is labour intensive. Both are shown on the Iso-cost line representation the relative prices of
the two factors with possible combinations of the two factors producing a given level of
output.
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In both the diagram, the tangent point is E where AB cost line is Equal to Iso-quant IQ. In
USA curve it is seen that 30 capital unit is used with 10 labour units to produce 1 unit of
machine. Whereas in India curve, 30 units are used with 20 labour units to produce 1 unit of
clothe. Thus it is clear that USA is capital intensive and should produce and export Machine
whereas India being labour intensive should produce and export Clothe. Thus according to
Ohlin, USA will specialize on production of machine by using cheap factor capital
extensively while India specializes on commodity Y by using the cheap factor labour
available in the country.
Q4. Criticism/ Limitation of the H-O theory OR Modern Theory.
1. Unrealistic assumptions:
This theory is based on many unrealistic assumptions like two nations, two
commodities and two factors only. it assumes no transport cost, speaks about only
constant returns to scale production. Thus is it is highly assumptions based which
are not realistic.
2. One- sided theory:
According to Ohlin, supply plays an important role in determining the factor price.
He did not consider the demand factor. In fact demand forces are more significant in
international trade. Thus demand side has been ignored by Ohlin.
3. Static in nature:
This theorem is static in nature. It does not believe in dynamic economy and consider
the constant state of the economy with given production function. It is more
unrealistic today.
4. Leontief paradox:
American economics Leontief tested H-O theory in USA and got surprising result
that the country like USA which is more capital intensive, produces and exports
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labour intensive goods. Thus this finding falsifies the H-O theorem. That is why it is
called paradox of Leontief.
5. Wijnhold’s Criticism:
According to Economist Wijnhold’s, it is not factor price that determine the costs
and commodity prices but it is commodity prices that determine the factor prices.
Thus contradicts H-O gist.
6. Haberler’s Criticism:
According Haberler, Ohlin theory is not based on general equilibrium analysis but it
is based on partial equilibrium being incomplete, less comprehensive.
7. Other factors ignored:

H-O theorem only assumes factor endowment which influences the commodity price
and international trade. The H-O theory neglects other factors like technology,
techniques of production etc. which are the most influencing trade factors.
Q5. What is terms of trade? Explain its types in detail.
The international gain of the trade is known from terms of trade. So it is the most important
term in international economics. It is an analysis of international trade in short. It shows the
relationship between export price and import price. Thus it reveals whether trade is
favorable or unfavorable. It is true that it basically implies only barter transaction where
goods are exchanged for goods. It indicates how many quantities of domestic goods and
services (exports) are required to obtain a certain amount of foreign commodities (imports).
“Terms of trade are the rate at which the exports are exchanged for imports.”
According to Hanson
“By terms of trade we mean the rate at which one country’s products exchange for
those of another.”
Terms of trade is expressed as:
Terms of Trade = Px/Pm x 100
Where,
 PX refers to the price of Exports

 PX refers to the price of Imports
When Export price is more – Terms of trade is Favorable
When Import price is more -- Terms of trade is Unfavorable.
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A) Gross barter Terms of Trade ( GBT):
This concept is given by the economist Taussig. It considers the indices of physical
quantities imported and exported rather than considering prices as in commodity terms of
trade. So in short it is understood that instead of taking into account price index, quantity
indices are taken into consideration for known terms of trade. It is the superior measure than
NBT. Symbolically it is represented as:
Where,
 Tg refers to Gross barter Terms of Trade

 Qm refers to Quantity imported
 Qx refers to Quantity exported
It is also possible to measure the changes in GBT by comparing the current year indices with
those of the base year. If the index of current year is better or greater that of base year- Then
it’s favorable.
B) Net barter Terms of Trade (NBT):
This is the concept which compares the import price index with the export price index. The
ration of this two represents NBT. It is also known as the commodity terms of trade. It is
shown symbolically multiplied by 100. It is the most popular method used.
Where,
 NBT refers to Net barter terms of trade

 PX refers to export price index
 PM refers to import price index.
The changes in export price and import price over a period of time shows whether terms of
trade is favorable or unfavorable.
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C) Income Terms of Trade(Ty):
This measure was introduced by G.S. Dorrance. According to him this is the superior
and more useful method of Terms of Trade as it shown real improvement. This index
takes into account the volume of exports of a country and its export and import
prices (NBT). It shows import capacity of a nation by considering both the prices as
well as physical quantities traded. It is shown symbolically as:
D) Single Factoral Terms of Trade:

It is introduced by Prof. Viner which represents the ratio of export price index to the
import price index considering changes in the productivity of factors in the
production of exports. It is believed that when two commodities are exchanged,
indirectly, the factors used for the production of those commodities are exchanged.
E) Double Factoral Terms of Trade:

This overcomes the defect of Single Factoral terms of trade. This concept not only
considers the productivity of factors in the country’s exports but also the
productivity of foreign factors in the country’s imports.
F) Real Cost Terms of Trade (Tr)

It expresses to the total sacrifice of utility involved in the surrender of exports. It is
obtained by multiplying with the index of the amount of disutility per unit of
productive resources used in the producing exports.
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G) Utility Terms of Trade (Tu)
The defect of Tr is overcome in Tu. It is defined as the excess of total utility accruing
the imports over the total sacrifice of utility involved in the surrender of exports. The
benefit from imports must be greater than the sacrifice involved in producing
exports.
Q6. What are the factors affecting Terms of Trade (TOT
1. Size of Population:-
Growing population produces serious effects on terms of trade through import and
exports. Because the major part o the production is consumed within the nation. So
there is less left for the export. This effects the terms of trade unfavorably.
2. Variety of Products:-
A Country that has the potentials of offering a large variety of Products will obviously
enjoy favorable terms of trade. This is because exports are wide and substantial while
the import is negligible.
3. Technological change :-
Technological changes also affect the TOT of a country. If the technological changes
lead to the production of more export goods, their supply will increase, prices will fall
relative to its imports. It will export more than it imports. Therefore, its TOT will be
unfavorable.
4. Change in Tastes:-
Change in testes of the people of a country influence its TOT with another country. If
the tastes for the products of another country increase, it leads to increase in the
demand for the imported goods. Consequently, the TOT will become unfavorable,
and vice versa.
5. Economic Growth:-
Another factor is economic growth which increases the country’s productivity
capacity, welfare and income, given the taste and technology. Economic growth
affects TOT two ways.
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6. Tariffs and Quotas:-
An import tariff improves the TOT of the tariff-imposing country. As a result of be
imposition of tariff duties, imports will be reduced in relation to exports and its TOT
will improve.
7. Market Condition:-
A country which has got monopoly or oligopoly in the goods which it exports in the
world market is competitive; its TOT will be favorable. For it will sell its goods at a
high price in the world market.
8. Import Substitutes:-
If the country produces import-substitute goods in sufficient quantities its import
demand for such goods will be low. As a result, it will import less and its TOT will be
favourable, and vice versa.
10. Balance of Payments:-

Deficit in BOP brings improvement in TOT because the exchange rate falls. On the
hand, a surplus in BOP worsens the TOT by raising the exchange rate of the currency.
11. Inflation and Deflation:-

Inflation worsens the TOT because with the rise in domestic prices the demand for
imports goes up and for export declines. On the other hand, deflation improves the
TOT because the prices of domestic goods fall; the demand for exports increases and
for imports falls.
12. Nature of Goods:

If a country is producing and exporting only primary goods and importing
manufactured and capital goods, the terms of trade will be unfavorable.
Q.7What is the significance/ Importance of gains of trade?
Ans. Introduction:-
According to Adam Smith, the gains from trade resulted from the advantages of division of
labour and specialization both at the national and international level. They were due to the
existence of absolute differences in costs, that is, each country would specialize in the
production of that commodity which it could produce more cheaply than other countries
and import those commodities which it could produce dearly.
In modern analysis, the gains from international trade refer to the gains from exchange and
the gains from specialization based on the general equilibrium analysis.
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‘The gains from trade refer to net benefits or increases in goods that a country obtains
by trading with other countries.’
1. Division of labour:
International trade leads to international specialization. It enables a country to

specialize in the production of those commodities for which it is bests suited. It
possesses the necessary natural resources and facilitates for the production of those
goods. This leads to international division of labour or international specialization.
2. Increase in output:
International trade because of international specialization leads to an increase in the

world output of goods and services. It helps in expansion of trade to the larger extent.
3. Equal distribution of scarce resources:
Some nations are richly endowed with certain natural resources while such resources are
scarce in other countries. International trade helps in the equitable distribution of these
resources among all the countries of the world. Optimum utilization of the resources can
be done through it.
4. Equality in commodity and factor prices:
International trade results in the equalization of prices of goods and productive factors in
all the countries of the world which enter into international trade. Import and export of
scarce and abundant goods becomes possible this way. It is in this way that the prices of
factors of production will be equalized between different countries because of
5. Links Demand and Supply in different Nations:
International trade links demand and supply of product in one country with the supply
in another country and benefits both the countries. If there is difference in cost of
products in two countries then both counties can gain from this cost difference.
Specialization in one product becomes possible.
6. Standard of living improves:
International trade increases production and consumption in a country. This leads to

increase in national income and thus standard of living of people in the country also
improves.
7. Employment creation:
International trade increases employment opportunities. This leans to increase in

production in participating countries. Increase in production generates more
employment not only in production sector but also in distribution sector.
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Q8. What are the factors affecting Gains of Trade.
1. Differences in Cost Ratios:-

The gains from international trade depend on differences in comparative cost ratios in the
two trading countries. “A country gains by foreign trade, if and when the traders find that
there exists abroad a ratio of prices very different from that to which they are accustomed at
home. The size of the gain will depend on the cost of production of each commodity in both
countries.
2. Variety of goods:
A country which produces variety of goods, always gains because of supply factor. The scope
of exports is more for such countries.
3. Level of Income:-
 The level of money income of a country is another factor which determines the gains
and the share of trade. A country whose goods have a constant demand in other
countries will have a high level of money income.
 On the contrary, a country having high demand for foreign goods will have low
money incomes. As it will have high demand for foreign goods. Their prices will be
high.
4. Terms of Trade:-
The most important factor which determines the gains from trade is the terms of trade. The
terms of trade refer to the rate at which one commodity of a country is exchanged for another
commodity of the country.
5. Productive Efficiency:
 An increase in the productivity efficiency of a county also determines its gain from
trade. It lowers costs of production and prices of goods in the home country.
 As a result, the other county gains by importing cheap goods and its terms of trade
improve but that of the home country deteriorate.
6. Nature of Commodities Exported:-

Another factor is the nature of commodities exported by a country. A country which exports
mainly primary products has unfavorable terms of trade consequently; its gain from trade
will be smaller.
7. Technological Conditions:-
 A country which is technologically advanced and has an abundance of capital,its
volume of foreign trade will be large and so will be its gain from international, trade.
 On the hand, if a country is technologically backward with abundant labour its
volume of foreign trade will be small and so will be its gain from trade.

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8. Size of the Country:-
 The gain trade also depends on the size of the country.
 As country which specializes in the production of those commodities in which it
enjoys a comparative advantage, exchanges them with a large country.
Q9 Explain the Gain from trade with offer curve OR

Reciprocal Demand Curve or International Demand curve.
Ans- In economics and particularly in international trade, an offer curve shows the quantity
of one type of product that an agent will export (“Offer”) for each quantity of another type of
product that it imports. The offer curve was first derived by English economists Edge worth
and Marshall to help explain international trade. The Offer Curves are also known as
‘Reciprocal demand curve’ or ‘international demand curve’.It is introduced by Marshall-
Edgeworth in geometrical way.
‘The offer curve of a country denotes the amount of commodity (X) it is willing to offer
for a given amount of some other commodity (Y). It is based on the relative price of the
two commodities.’
The offer cure of a country is based on the relative price of two commodities in that country.
The line has a limit beyond which the offer curve cannot go because; no country will export
goods for imports less than what it can produce domestically.
Assumptions:
1. Two countries and two commodity model is used

2. There is a perfect competition
3. There is free trade and no restrictions
4. All factors are mobile in nature
5. There is specialization and comparative costs advantage.
Offer curve is explained with the help of following diagram:
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MODULE –II BOP AND WTO (Que. 2 – 15 Marks)
1. Explain the structure of balance of payment

2. Explain the types of BOP disequilibrium
3. Explain causes of BOP disequilibrium
4. Explain measures to correct BOP disequilibrium
5. Explain recent trends of BOP
6. What is WTO? Explain its objectives and functions
7. What are the WTO agreements
TRIPS
TRIMS
GATS
Q.1 Explain the structure of Balance of Payments?
Balance of Payment is the comprehensive and wider term than BOT. it is the systematic
record of countries economic transaction of foreign trade with the world. It includes not only
the visible but also invisible goods. It means it does consider not only the merchandise goods
but also the services. Therefore it gives true picture of the economy. It is the difference
between the outflow of funds and inflow of funds (Payment and Receipt). Theoretically it
should get balance but practically it does not tally due to the chances of omission and errors
According to Charles Kindleberger“
The BOP of a country is a systematic recording of all economic transactions between

residents of that country and the rest of the world during a given period of time”
The following is the structure of BOP:
Receipts Payments
1) Exports of Goods 1) Imports of Goods
Trade account balance
2) Exports of services 2) Imports of Services
3) Interest ,profits and Dividends received 3) Interest, profits and Dividends paid
4) Unilateral receipts 4) Unilateral Payments
Current Account Balance (1 to 4)
5) Foreign Investments 5) Investments Abroad
6) Short term Borrowings 6) Short term Lending
7) Medium and long term borrowings 7) Medium and Long term Lending
Capital Account Balance (5 to 7)
8) Errors and Omissions 8) Errors and Omissions
9) Change in Reserves (+) 9) Change in Reserves (-)
Total Receipts = Total Payments
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The main elements of Balance of Payments are:
1) Trade Balance: It is the difference between export and import of merchandise goods. If the
exports are more than imports, there will be trade surplus, and if imports are more than
exports, there will be trade deficit. The trade balance forms a part of current account.
2) Current Account Balance: It is difference between the receipts and payments on account
of current account which includes trade balance. The current account includes export of
services, interest, profits, dividends and unilateral payments abroad. There can be either
surplus or deficit in current account. Unilateral trade is consisting of Foreign aid, Gifts and
pension.
3) Capital Account Balance: It is the difference between the receipts and payments on
account of capital account. The capital account involves inflow and outflows relating to
investments, short term borrowings/ lending, and medium term to long term borrowings/
lending.
4) Foreign Exchange Reserve: It includes the official reserves sold and purchased. The
credit side includes the official sales of gold abroad, and official sales of foreign currencies
abroad. The debit side includes the purchase of gold from abroad and official purchase of
foreign currencies.
5) Errors and Omission: From an accounting point of view, the BOP always balances on
account of the concept of double entry booking system. The double entry book keeping
principle states that for every credit, there is a corresponding credit, and therefore, there
should be a balance in BOP as well i.e., a balance between both the debit side and credit side.
Q.2 Discuss the types of disequilibrium of Balance of Payments
Ans: Disequilibrium refers to imbalance in the balance of payments. The imbalance can be
surplus or deficit. BOP surplus take place when the total credits (receipts) are more than
debits (payments), and deficit will take place when the total credits are less than the debits.
The surplus BOP may create a good situation for the country, whereas, deficit will create an
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adverse affect on the economy. Normally, the term “Disequilibrium” is interpreted from a
negative angle, and therefore, it implies deficit in BOP.
Types:
1. Cyclical Disequilibrium:When disequilibrium is caused due to changes in trade cycles,

it is termed as cyclical disequilibrium. It is possible that different phases of trade cycle like
depression,prosperity, boom, recession etc. it may disturb terms of trade and cause
disequilibrium in BOP. Trade cycles are not same for all the countries.
2. Structural disequilibrium: It may also be caused by structural changes in the economy.

Changes in fashion, tastes etc. maybring changes in demand and supply conditions. Such
changes may affect import export and thereby the balance of payment position. Arrival of
substitutes in the importing countries may seriously threaten the exporting countries. Even
the change in taste for foreign goods may increase imports. A war situation may also result in
structural changes causing BOP disequilibrium.
3. Short run disequilibrium: Disequilibrium caused on a temporary basis for a shorts period,
say one year is called short run disequilibrium. It does not pose a serious threat as it can be
overcome within a short run. It may be caused due to international borrowing and lending.
When a country goes for borrowing or lending it leads to short run disequilibrium. It is
justifies as they do not pose a serious threat.
4. Long term disequilibrium: When the disequilibrium is persistent and long run oriented,
it is called long run disequilibrium. It is the extension of short run disequilibrium. It is the
combinations of the short run Disequilibrium. It is the result of discrepancy in savings and
investments. It is observed in poor nations because they do not have habit of savings, but
need huge investments. If this gap is not filled by the foreign flows then it results in the long
run disequilibrium.
5. Fundamental Disequilibrium: The concept of it was originally introduced by

International Monetary Fund (IMF). It arises when disequilibrium turns chronic. In other
words it is a long run problem. Fundamental disequilibrium appears mainly on account of
persistent deficit, large inflow of capital and the subsequent adverse BOP. It indicates
persistent adverse balance of trade.
Q3. What are the causes of Balance of Payment disequilibrium?
1) Growing population: It is the unique feature of LDCs (less developed countries). Due to
ever increasing population, demand for consumption increases, to feed those need nation has
to import more with no exports. It results in BOP disequilibrium.
2) Natural calamities: Natural disasters like flood, earthquake, storms etc, destroy
agriculture and brings food crisis in the nation. In order to manage with the domestic
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demand of goods and services, the nation has to depend on imports. It adversely affects BOP
position.
3) Increase in income: With rise in income of the people, their purchasing power also
increases for the foreign or imported goods. Also It increases their domestic consumption so
export surplus becomes less. So increased income reduces surplus but increases deficit
causing BOP deficit.
4) Repayment of debts and interest: LDC’s nations take loans or financial assistance from
other nations. They have to pay interest thereon regularly. It increases payment side of BOP
statement. Even the repayments of old debt taken from IMF or WORD BANK, IDA etc are
paid by them. This all affect BOP position of the nation.
5) Demonstration effect: Due to globalization and open economy, today people have
started copying or imitating west. Demand for goods of MNC’s is on the height and imparted
items have become common. This imitation to foreign nations in consumption pattern
reduces exports and increases imports. It also brings BOP disequilibrium.
6) Inflation: Rapidly rising prices is common issue in almost all the countries but it is
particularly grave in the developing economies. Due to inflation they become good to sell in
but bad to buy from. It results in fewer exports and more imports affecting BOP
disequilibrium. A rise in the comparative price level certainly encourages imports and
discourages exports, resulting in a deficit balance of payments.
7) Trade barriers: Many countries impose tariff and non-tariff barriers to restrict free trade.
This reduces exports also and affects in BOP deficit. Putting restriction like quota, tariff
barriers, free flow of goods and services is restricted. It brings effects on the composition of
exports and imports resulting in BOP disequilibrium.
8)High developmental and Investment programmes: Huge development and investments

programmes in the developing economies are root causes of the disequilibrium in the balance
of Payments of these countries. Their propensity to import goes on increasing for want of
capital for rapid industrialization; while exports may not be boosted up to that extent as
these is the primary producing countries.
Q.4) Explain the methods of correction of disequilibrium in Balance of Payments.
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A) MONETARY MEASURES:
1. Devaluation: It refers to official reduction in the value of home currency.
 It is deliberate attempt by the central bank to increase the exports. Under fixed
exchange rate system, the government intervenes in exchange rate determination.
 When the country faces the problem of foreign exchange, the government will try to
encourage exports and reduce imports. This can be done through devaluation of the
domestic currency.
 In such a situation, the exports will become cheaper, and imports will become
expensive. This in turn will help to reduce imports and increase exports. Eg.
Devaluation of 1991.
2. Depreciation:In
 Under flexible exchange rate system, the government does not interfere in exchange
rate determination.
 The exchange rate gets adjusted depending upon market forces,i.e, demand for
and supply of foreign currency. If there is high demand for foreign currency than it
supply, it will appreciate, and vise-versa. It refers to the automatic way by which the
value of currency gets reduced by the market forces. It also makes exports cheap and
import costly.
3. Control of money supply:
 Central bank controls money supply to control inflation in the economy. When
inflation reduces, export increases and import gets reduced which helps to
correct BOP position.
 During both inflationary and deflationary trends, Central bank controls money
supply. This is considered to be the most important measures of correcting the
disequilibrium in the BOP positions.
4. Deflation:
The wages and salaries are lowered to cut the purchasing power of the people. The prices are
reduced for boost exports to correct the BOP position.
B) NON-MONETARY MEASURES
1. Tariff:
Tariff refers to tax or duties levied on imports which increase the import cost or makes
import expensive. This helps to reduce imports and thus helps in improving BOP position.
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2. Quotas:
 It is quantitative restriction on the volume of the goods.

 The government may impose quotas on imports, so as to restrict the imports, which
in turn would improve the BOP position. There are various types of quotas such as
tariff quota, multilateral quota, and bilateral quota.
3. Export Promotion Measures:
 The government may introduce a number of export promotion measures to encourage

exporters to export more so as to earn valuable foreign exchange, which in turn
would improve BOP situation.
 In India, the following are some of the export promotion measures such as duty
drawback, excise exemption, fright concession, octroi refund etc.
4. Import Substitution:
 Governments, especially, that of the developing countries may encourage import

substitution so as to restrict imports and save valuable foreign exchange.
 The governments may encourage domestic producers to produce goods which
were earlier imported. The domestic producers may be provided with several
incentives such as Tax holiday, Cash subsidy etc. This can guarantee the removal
of adverse Balance of Payment.
Q5. What are the objectives and Functions of World Trade Organization?
 The World Trade Organization started functioning form 1st January; 1995.WTO is
the result of the Uruguay Round of negotiations (8th Round).
 It is the successor to the General Agreement on Tariffs and Trade (GATT). GATT
ceased to exist as a separate institution and has become part of the WTO..WTO is
wider in scope as compared to GATT.
 In addition to the regulation of global trade in goods, it also regulates trade in
services, intellectual property rights and investment. It is a permanent body and it
acts as the watchdog of international trade. .
 It is the result of the evolution of the multilateral trading system since the
establishment of GATT in 1947.
OBJECTIVES OF WTO:
1. To promote Free trade without discrimination

The main objective of WTO is to promote trade without trade discrimination. Not tariff and
non-tariff barrier is encouraged within the functioning of WTO. No member country should
break Most Nations Clause (MFN). Not trade restrictions are expected in free trade.
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2. To Grow the LDC’s
The failure of GATT itself revealed that the developing nations were exploited in trade and
were not given trading status. The establishment of WTO aims to provide equality of status
to these nations in trade. The development of LDC is the prime objective of WTO.
3. To protect environment.
Seeing the environment degradation worldwide, WTO aims to protect the over exploitation
of natural resources. The sustainable development is appealed to all the members so that the
future generation should not face resource scarcity.
4. To eliminate or remove the Trade barriers:

WTO either eliminates or removes trade barriers to promote free trade worldwide. The
protection policies are not supported by WTO. In-fact it is believed that without removing
tariff and non-tariff barriers fair trade can never is carried.
5. To Raise standard of living

It is one of the objectives of WTO. It is expected that every country should enjoy equal
standard of living. The gap between rich and poor nations should be removed.
6. To Settle trade disputes

It is obvious that the dispute may arise in multilateral trade. So WTO tries to settle this
dispute by its mechanism. Unlike GATT, WTO has strong dispute settlement mechanism by
which trade related issues are settled as and when the grievances received from any country.
7. To monitor Multilateral Trade:

The main purpose behind the establishment of WTO is to monitor the world trade with
framing common rules and regulations for fair trade. It makes trade relations good and
smoothen trade with less barriers among the trading nations. It is a watchdog of the
multilateral trade.
Q6. Functions of WTO

1. Forum for negotiations: It provides the forum for negations among its members
concerning their multilateral trade relations. It provides the platform where the free
trade is carried with mutual consent.
2. Trade without discrimination. WTO supports and follows fair trade. There is no
scope for trade discrimination under WTO. The principle of WTO is to carry trade
without trade discrimination among advanced and Less Developing countries.
3. Monitors agreements: WTO monitors the world trade by framing rules and
regulations to be followed by the member nations. It monitors its agreements and its
implementations. It is a administrative body for Multilateral trade among the world
nations. It also administers the ‘Trade Review Mechanism’
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4. Policy review mechanism: The members have to undergo a periodic review of their
policies. This is done with a view to promoting mutual understanding of the need,
significance and the impact of these policies which would promote transparency and
fairness.
5. Governs the settlementdisputesWTO has strong trade dispute settlement

mechanism to solve the disputes arising from the trade. It has systematic procedure
for settlement of dispute among nations dealing only with trade. The disputes
occurred duet to discrimination done by any member county with trading country, is
solved by panel of experts.
6. Co-operation with other International institutions:WTO cooperates with IMF,

IBRD and its affiliated agencies to achieve better place in global economic policy
making. Every international institute is engaged with area of its functioning. WTO
coordinates with them towards the universal welfare.
Q.7. What are the Major Agreements of WTO?
A) Intellectual Property Rights?
Twenty first century is the century of knowledge. New ideas and inventions are being
discovered every day being the outcome of human mental activity. The resulting outcome of
human intelligence is known as intellectual property. These properties are intangible
having great commercial potential. So there is need to protect them making others not to
enjoy the fruits of somebody’s efforts. In short IP can be defined as intellect possessing
commercial value. IPR is the rights given to the people over the creation of their minds. They
give right to the creator of his or her creation. It includes patents, copyrights, indusrial
designs, trademarks, geographical indications, trade secrets and layout design of
integrated circuits.
1. Copyrights: A copyright is basically the right to copy and make use of literacy and
artistic works, dramatic a musical creation, published edition of works, sound
recording, broadcasts, computer programs and soft ware’s, films etc. It offers
protection to original works of authorship in any tangible medium of expression. It is
normally an automatic right of authors and creators.
2. Patents: These are exclusive rights granted to owners for new inventions employing
scientific and technical knowledge. They are granted for product, compositions,
process including improvements that renew, inventive and industrially applicable.
3. Trademarks: Trademarks are visual signs, symbols, logos, names, letters and
combinations of colors used to enable the public to identify the suppliers of goods or
used to distinguish the goods and services of one organization from those of other
organization. They can be registered, which give the holder right to use them. e.g
Coca Cola in soft drinks and Sony in electronic goods.
4. Geographical indications: These are the locations of the originality of goods. It
indicates quality, reputation or other characteristic of the goods which are essentially
attributable to its geographical origin.E.g. Basmati rice (India and Pakistan),
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Darjeeling tea and Kancheepuram sari, Scotch whisky (Scotland), Champagne
(France) etc.
5. Industrial Designs: A design is an idea or conception as to the features of shape,
configuration, pattern or composition of lines or colors applied to any article. Owners
of protected design have rights to prevent manufacture, sale or importation of article.
E.g.; Designs as applied to shoes, TV and textiles.
6. Trade secrets: Trade secrets are defined as formula, pattern, device or compilation of
information used in ones business and gives an opportunity or an advantage over
competitors who do not know the use of it. In India there is no separate legislation
dealing with trade secrets.
Impact of TRIPS:
1. Impact on Drug prices: The patent regime will have adverse effects on the drug prices.
India is able to supply drugs at low prices under Indian Patent Act 1970. It is argued that
prices of drugs will increase in India due to TRIPS
2. Impact on patent protection: It gave monopoly in manufacturing as well as import to
patent holder. The patent holder would resort to imports only & national government
would not be able to exercise any price control on the imported products.
3. Impact on Agriculture: Indian Agriculture is troubled due to TRIPS. TRIPS extended
IPRS to agriculture through patenting of plant varieties. This has serious implications on
Indian Agriculture. Patenting of plant varieties would transfer all gains to MNC’s who
may go for controlling food production. It may be problems for our farmers.
HIGHLIGHTS:-
 India would have to fight for the protection of its plants such as Neem, Basmati Rice,
Tulsi (Basil) etc.
 Protection is also needed for India’s herbs.
 In India, the general opinion is not favorable to TRIPS.
 The threats of TRIPS are in the field of agriculture & pharmaceuticals in India.
 TRIPS are mainly needed for the promotion of technological innovation.
 The transition period given to all developing countries is five years.
Tenure of protection of IPR’s in India.
 Copyright 60 years
 Patent 20 years
 Industrial design 10 years
 Layout design 10 years
 Trade Mark 7 years
B) Trade related Investment Measures (TRIMS)

TRIMS will protect the interests of foreign investors. The capital and the profits will be
protected and the investee countries will have the obligation to allow the repatriation of
capital and profits. The foreign companies will enjoy the same rights as enjoyed by the local
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or domestic companies. This is expected to increase the flow of FDI (Foreign Direct
Investment) and FPI (Foreign Portfolio investment) many rights have been given to the
foreign investors. This will provide unfettered rights the big corporations and many
developing countries having less income than the companies will not have any control over
the companies. The TRIM was introduced by USA in the eighth round of GATT at Uruguay.
Features:
 All restrictions on FDI should go

 The foreign investors should be treated as domestic investors
 There should not be any discrimination against the foreign investors.
 Foreign investors should not be compelled to buy the local materials
 They should not be compelled to export as part of their production
Effects of TRIMS
 The power of MNC and TNC has been increasing. They almost have taken command
over the sales of their goods and services in LDCs.
 Competition for domestic firms have increased due to the well set MNC,s
 The money transfer is observed as outflow earned in the form of profit in our nation
by foreign investors.
 The key personnel have been attracted abroad. The units or subsidiaries of MNC
freely move them form one unit to other unit regardless their nationality. It has
resulted in brain drain.
 TRIMS provide for strong and effective protection for investors against
nationalization and expropriation.
 No code conduct has been seen so for TNC’s but they have been protected all the
time.
C ) GENERAL AGRREEMENT ON TRADE IN SERVICES (GATS):
GATS are based o the fact that there is growing importance of Trade in Services for growth
and development of the world economy. It aims at establishing a multinational framework of
trade in services like banking, insurance, telecom, air-transport etc. With regards to GATS,
and services are defined as the supply of services from the territory of one member nation to
the territory of any other member. It includes obligation of all member countries on
international trade in services like telecommunication, audio visual, tourism and professional
services. Objective of GATS are:
 To create rules for trade in services

 Ensuring non-discriminatory treatment
 Promoting liberal trade.
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Positive impact of GATT:
 It provides an opportunity not only to avail services from other member countries
 It helps increase the quality of its own services due to competition.
 Foreign firms are allowed in number of service sectors. It is allowed through joint
venture and collaboration.
 It helps to develop professionalism and expertise in the service sector. E.g Education
sector, hotel and hospitality, insurance, communication, Travel and tour sectors.
Negative impact of GATT:

 Most of the developing countries have opened up their service sectors but finds
difficult to face competition from the well developed countries.
 They lack professional skills and resources to face the global service competition.
 They do not utilize their resources properly
 There is brain drain of educate population to other countries
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MODULE – III FOREGIN EXCHANGE MARKET (Q.N 3 – 15)
1. What is foreign exchange market? Explain its functions in brief.

2. What are the participants/players/components/ dealers of foreign exchange market
3. Explain spot and forward exchange rates
4. What is fixed exchange rate? Explain its merits and demerits
5. What is flexible or fluctuating exchange rate? Explain its merits and demerits
6. Write explanatory notes on
Arbitrate
Hedging
Speculation
Q 1. MEANING AND FUNCTION OF FOREIGN EXCHANGE MARFKET.

Meaning of foreign exchange:
Foreign exchange refers to foreign currencies possessed by a country for making payments to
other countries. It includes all claims upon foreign currencies. It is a mechanism to the
international payments through which payments are made between two counties having
different currency systems. This mechanism converts domestic currencies to foreign
currencies. According to Withers
“ Foreign exchange is a art and science of internationally monetary exchange.”
Foreign exchange market is a medium through which foreign currencies are
bought and sold. Foreign exchange market is the place where currencies are bought and
sold. Institutions like the Treasury, Central Bank, Foreign exchange banks etc are .involved
in the purchase and sale of foreign exchange currencies constitute the foreign exchange
market.
According to Kindleberger
“Foreign Exchange Market is a place where foreign money or currencies are bought and
sold.”
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1. Clearing Functions:
 It is the primary function of the foreign exchange market. The foreign exchange
market helps to transfer the purchasing power between countries.
 This transfer is done by converting domestic currency into foreign currencies
and vice-versa. It helps to carry out international payments and transactions. It is
also known as money changing function of a foreign exchange market. I
 t helps in transferring purchasing power between two countries.
 This function plays an important role in promoting international trade along with
international capital flow.
2 .Credit Function:
 The foreign exchange market provides national and international credit to promote
foreign trade. International payments may be delayed as exporters and importers may
not be able to fulfill their obligations immediately.
 Bills are discounted for this purpose.Credit function has been the main drive
behind the success of foreign trade.
 While importing goods time is required for the actual delivery of the goods because of
shipment and transportation of goods. So the credit is foreign exchange markets.
3 .Hedging Functions:
 Hedging means covering foreign exchange risks arising out of fluctuations in
exchange rates. An importer who has to make payments to a foreign country may lose
if he expects the price to rise in future.
 To cover the risk, he may deposit his own funds in the foreign country or buy
forward the foreign exchange.
 It leads to spot markets and forward markets. Hedging will give rise to a supply of
and demand for forward exchange.
 It is important, especially in a market with flexible exchange rates, as it permits
exporters and importers to protect themselves against risks connected with exchange
rate fluctuations. It is needed for carrying pure trading functions.
Q2. PARTICIPANTS OR DEALERS OR PLAYERS OF FOREIGN EXCHANGE

MARKET.
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1. Commercial banks:
 They carry out buying and selling orders from their clients. They deal with other
commercial banks and also through foreign exchange brokers.
 Being more in number these banks provide good services for these markets. Their role
is important in the success of these markets.
 Commercial banks help in assisting foreign trade and foreign exchange transactions.
The main role in this regards is played by foreign exchange brokers.
2.Acceptance house:
 They also participate in foreign exchange transactions.
 They accept bills of exchange on behalf of the clients and increase the scope for such
market transactions.
3.Retail clients;
 These include people, international investors, multinational corporations and others
who need foreign exchange.
 They deal through commercial banks and authorized agents.
 They are large in numbers. Demand and supply of foreign exchange is influenced by
retail clients.
4 Brokers:
 They are the authorized brokers acting as intermediaries between buyers and
sellers.
 They are middlemen who get commission and save time of banks.
 They do not sell or buy currencies themselves.
 Their role is major in the success and spread of foreign exchange market.
5.Central banks:
 It is the main official player of this market having power to control the transactions
of foreign exchange markets.
 They authorize commercial banks and other financial institutions to deal in foreign
exchange.
 They are so called ‘Authorized Dealers’ Under the fluctuating or flexible rate
system, the central bank of the nation normally does not interfere in the exchange
market.
 But now they are interfering in the same to influence the rates in order to keep
economy unaffected by the trade. The initiative is needed for controlling inflationary
and deflationary trends.
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6. Non-bank financial institutions:
 Due to deregulation and liberalization of financial markets during recent years, non
banking institutions are getting to scope to participate and provide services in these
markets.
 Foreign exchange transactions are handled by these institutions on a large scale.
 They are: Wholesale market known as inter-bank market has size of transactions
very large. It includes highly professional dealers and MNC banks.
 Brokers who act as middlemen between the prices makers. They are appointed by
banks because they possess more knowledge or information about the market. Etc.
Q3. SPOT AND FORWARD EXCHANGES

The term spot exchange refers to the price of foreign currency in terms of domestic
currency payable for the immediate delivery of the foreign currency. It is the class of foreign
exchange transaction which requires the immediate delivery, or exchange of currencies on
the spot. This rate is agreed upon the demand and supply forces in the currency market. In
practice, the settlement takes place within two days in most markets.
The rate of exchange effective for the spot transaction is known as the spot rate and the
market for such transactions is known as the spot market.
It is day to day rate of exchange which is charged on the delivery of goods on spot.
The forward transaction is an agreement between two parties, requiring the delivery
at some specified future date of a specified amount foreign currency by one of the parties,
against payment in domestic currency by the other party, at the price agreed upon in the
contract. The rate of exchange applicable to the forward contract is called the forward
exchange rate and the market for forward transactions is known as the forward market.
These contracts usually have maturities of 30, 60 or 90 days or may be for a year (180 days).
Forward exchange facilities, obviously, are of immense help to exporters and importers as
they can cover the risks arising out of exchange rate fluctuations by entering into an
appropriate forward exchange contract. They are different than spot exchange rate because
it may either be at premium or discount or par:
At par: If the FER quoted is exactly equivalent to the spot rate at the time of making the
contract, the forward exchange rate is said to be at par.
At premium:If the forward rate is above the present spot rate, the foreign rate is said to be at
a premium. The FER for a currency, say a dollar, is said to be at a premium with respect to
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the spot rate when one dollar buys more units of another currency, say rupee, in the forward
that in the spot market.
At discount: If the forward rate is below the present spot rate. The foreign exchange rate is
said to be at a discount.
 Naturally, when the demand for forward exchange exceeds its supply, the forward
rate will be quoted at premium
 And, conversely, when the supply of forward exchange exceeds the demand for its,
the rate will be quoted at discount.
 When the supply is equivalent to the demand for forward exchange, the forward rate
will tend to be a par.
Q4. Write a note on Arbitrage

Arbitrage means:
“ The purchase of securities on one market for immediate resale on another market in
order to profit from a price discrepancy (discrepancy).
Arbitrage involves buying and selling of foreign currency in low markets in order to
gain profit from the price differences between the two markets. Those who deal with
arbitrage are called Arbitrageurs’. They purchase currency in a low price market and sell in
higher price market immediately without involving any risk. He enjoys the difference of
same currency values existing in different countries. Arbitrageurs’ may be banks, the grab
opportunities immediately because the difference in exchange rates in tow markets may be
for a short period of time due to the difference in demand and supply faced by different banks
or traders in foreign exchange. It is also true that arbitrage never deals with such operations
if the profit margin is low. It is possible within the country or within the local market where
two banks offer two different bids and asking rates.
Example:
Suppose if the rate of exchange is 1US $ = 50/- in US market and 1 US $ = 55/- in Indian
markets. Then arbitrageurs buy dollars in US dollars from US market and sell it in the Indian
market and gets profit of Rs 5/- per dollar.
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Types of Arbitrage:
 Geographical Arbitrage:
In trading practice of buying a currency in once geographical market and selling it in
another in which the price is higher. It consists of buying currency where it is the cheapest
and selling it where it is the dearest so as to make a profit from the difference in the rates.
 Triangular Arbitrage:
The process of buying and selling foreign exchange between three different currencies in
order to profit from a discrepancy in cross rates. It occurs when three currencies are
involved. It has scope in International banking and finance.
Q5 Write a short not on -HEDGING:-

 The exchange rates frequently fluctuate and the exporters may suffer loss. When
the rates become favorable, exporter may gain. If the payments are to be made in
future then it may be a great loss to the exporter or the importer.
 So foreign exchange market provides hedges against such fluctuations.
 They guarantee payments of foreign exchange at a fixed rate, even if the
exchange rates might have gone down or up.
 It is an important function of foreign exchange market.
 It is the risk management technique against the fluctuations observed in the foreign
exchange rates. Hedgers are the agents, usually the firms who enter the forward
exchange market to protect themselves against the risk arising out of exchange rate
fluctuations. Let understand its function.
Suppose an Indian importer who imports goods from America worth $50,000 has to
make the payments in three months time. The spot rate at the moment is Rs. 40=$ 1. Then he
has to pay Rs. 20,00,000. But due to certain uncertainty of the market situation, if the
importer fears a depreciation of rupee. He will have pay more than spot rate determined. So
he may enter into buying dollar forward today, through an agreement with commercial
banks or authorized agents. This is called hedging.
The strategy of hedging involves increasing hard currency which is likely to
appreciate and decreasing soft currency which is likely to depreciate and at the same time
decreasing hare currency liabilities and increasing soft currency liabilities. E.g. If
depreciation of Indian rupee is expected the basic hedging strategy would be: reduce the
level of cash rupees, decrease accounts receivables, increase local currency borrowing, delay
accounts payable and sell weak currency forward, speed up remittance of dividend to the
parent company, speed up all the payments to be done in hard currency and delay al the
receivables from abroad.
If the local currency is expected to appreciate, then the hedging strategy would be to
increase the stock of local currency, speed up the collection, buy currency forward, reduce
imports of soft currency goods, reduce local currency borrowing, delay remittance.
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Importance:
1. It is the risk management technique.
2. It is forward contract.
3. It saves importer as well as exporter from the risk going to arise due to the
fluctuations in the exchange rate.
4. It is good for the firms who have large amounts receivables or commitments to pay
in foreign currencies.
Types:
1. Long hedge or Anticipatory hedge :
An investor is protected against adverse price movements of an asset that will be
purchased in the future. It is also called buy hedge or purchasing hedge. It provides at
least partial protection for securing future supply at a fixed ceiling price.
2. Short hedge :
An investor already owns a spot asset and engages in a trade to sell its associated
future contract. . It is also called selling hedge. It provides at least partial protection
an order at a fixed price.
Q5. Speculation and its types
 The supply of and demand for forward exchange market is also the result of
speculation. Speculation means “taking of foreign exchange risk or an open position
in the hope of making profit. It is based on the expectations about the future rate of
the foreign currency. It is observed in the forward market.
 Suppose a speculator who expects the spot rate of a foreign currency to increase in
relation to his home currency in say 3 months, and then he buys the foreign currency
in the forward market. He sells it’s at the spot exchange rate after 3 months. If his
expectations are correct, he earns a profit or he may incur a loss or break even.
 Speculation in a foreign currency depends on domestic and foreign interest rate
differentials and on expectations about future movements in the exchange rate.
Suppose the interest rate in the foreign market is higher than in home nation.
Speculation may be.
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1. Stabilizing :
When speculators buy a foreign currency with a fall in its exchange rate in the
expectation that it will soon rise and thus earn a profit. In contrary, when they sell a
currency with a rise in its exchange rate in the expectation that it will soon fall,
thereby earning a profit. The effect of such speculation is to smooth out fluctuations
in the exchange rate.
2. Destabilizing :
When speculators buy a foreign currency with a rise in the exchange rate in the
expectation that it will rise further. On the other hand, when speculators sell a
foreign currency with a fall in the exchange rate in the expectation that it will fall
further. Thus they get no profit and may stop speculative business.
Q6. WHAT IS FIXED EXCHANGE RATE? ITS MERITS AND DEMERITS:

This is the system where the exchange rate is fixed and found rigid irrespective of changes in
the demand and supply of exchange. This rate is fixed by the government by means of
pegging operations. (Buying and selling exchange at a particular rate).Government follows
exchange control to keep the rates stable. It helps to reduce the exchange reserves. It is the
feature of IMF agreement. Under this system, the rate is not determined by the market forces
but it is pegged/fixed.
MERITS:
1. Promotes trade:
As the exchange rates are stable, international trade is promote without any speculation and
forcasting.The fixed exchange rates creates certainty and assurance in the trade.
2. FDI:
Fixed exchange rates ensure the regular flow of the international capital movements. Since
investors are assured of regular returns, FDI is encouraged. It also supports the growth of
money and capital markets.
3. No speculation:
Being fixed in nature, there is no chance to speculate the fluctuations in the exchange rates.
Certainty in the rates is highly featured in this method.
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4. Stability.
A stable exchange rate helps to achieve internal economic stability and avoids problems of
hoarding, decline in investment and unemployment. It would be very difficult in the
fluctuating exchange rate system.
5. Simple and systematic:

The economic transactions between nations have become too complex that it is
advantageous to follow a fixed exchange rate system. it systematized the worlds monetary
system.
6. Good for small countries:

Fixed exchange rate system is good for the small nations as their transactions are small and
need highly certainty and surety. It minimizes risk.
7. Controls inflation:
Fixed exchange rate helps to maintain the external value of the currency stable and thus
controls inflation.
DEMERITS:
1. Lacks adjustment mechanism:

The greatest defect of the system is that it lacks adjustment mechanism. This puts a great
strain on the reserves of participating countries.
2. Difficult in real sense:

This system has to be supervised by an authority of the national government and
international authority. There is also a problem of division of power between the two
authorities to maintain fixed exchange rates.
3. Problem of liquidity:
It creates problem of liquidity. Hence there had to be variations in exchange rates. It is found
in the flexible exchange rates.
4. Not permanent:
It is not possible to keep exchange rate fixed because it may deter the long term investment.
It is difficult to respond to temporary shocks. For example an oil importer may face a balance
of payment deficit if oil price increase but in a fixed exchange rate there is little chance to
devalue.
5. Rigidity:
This exchange rate has been found more rigid and thus may create problem in promoting
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6.Discourage Foreign Investment:
Fixed exchange rates are not permanently fixed or rigid. Therefore, such a system
discourages long-term foreign investment which is considered available under the really fixed
exchange rate system.
Q7 . Explain the flexible exchange rate system? Its merits and demerits.
In this system exchange rate go on fluctuating according to the demand and supply of it in
the world market. Exchange rate is determined according to the free forces of demand and
supply of foreign currencies. This system is quit suitable for the countries like USA.This rate
is set where the demand for exchange and supply of exchange is in equilibrium. If there is a
high demand for a particular currency, its exchange rate relative to other currencies
increases, on the other hand, if there is less demand, its value decreases.
MERITS:
1. Smooth adjustment:
Flexible exchange rate brings smooth adjustment in BOP position automatically. When
there is deficit in the BOP, the external value of the currency’s fall. It encourages export and
discourages imports and thus automatically brings equilibrium in the BOP.
2. Automatic:
This system is quite simple. The exchange rate changes freely to equate demand and supply
and the problem of scarcity or surplus are automatically solved.
3.Easen liquidity problem:

As exchange rate moves freely, there is no need to maintain large scale reserves. The flexible
exchange rate system solves the problem of international liquidity automatically.
4. Avoids prolonged Disequilibrium:

The flexible exchange rate system facilitates continues adjustments. So a prolonged
disequilibrium is automatically avoided.
5. Free trade:
Flexible exchange rate promotes free trade. It does not require the use of exchange control
which may be necessary under the fixed exchange rate system. It is good under the
multilateral trade system.
6. Full employment:
Flexible exchange rates reflect the true cost-price structure relationship. They are more
suitable to countries seeking to follow a policy a full employment.
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DEMERITS:
1. Instability and uncertainty:

The flexible exchange rates lead to instability and uncertainty. This reduces the volume of
investments and international trade. Due to increasing risks, long-term investments are
curtailed.
2. Speculation:
Under this exchange system there will be more speculation causing further fluctuations.
3. Inflationary:
This exchange increase in inflationary pressures on the domestic price level causing further
depreciation. On the other hand, the fixed exchange rate system prevents inflation and
maintains the external value of currency.
4. BOP problem:
Due to uncertainty in the rates, elasticity’s of demand also get affected in the foreign market.
It leads to BOP problems in the country if the value of currencies rises externally.
5. Unsuitable:
This exchange rate is unsuitable if the factors are immobile. It is also not good during the war
situation and political instability.
6.Adverse Effect on Economic Structure:
The system of flexible exchange rates has serious repercussion on the economic structure of
the economy. Fluctuating exchange rates cause changes in the price of imported and exported
goods which, in turn, destabilize the economy of the country.
7.Unnecessary Capital Movements:
The system of fluctuating exchange rates leads to unnecessary international capital

movements. By encouraging speculative activities, such a system causes large-scale capital
outflows and inflows, thus, seriously disturbing the economy of the country.
8.Factor Immobility:
The immobility of various factors of production deprives the flexible exchange rate system of
its advantages arising from the adoption of monetary and other policies for maintaining
internal stability. Such policies produce desirable effects on production and employment only
when supply of factors of production is elastic.
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MODULE- IV EXCHANGE RATE MANAGEMENT (Q. n.4- 15 marks)
1. Explain the determinants of foreign exchange rate? Or factors affecting exchange rat
2. Explain Purchasing Power Parity theory? (PPP theory)
3. Critically explain PPP theory
4. Explain the role of central bank (RBI) in foreign exchange determination
5. Explain managed flexibility (LERMS) OR central bank intervention in exchange rate.
Q What is Foreign exchange Rate? Explain its determinants. OR Explain the factors
affecting exchange rate.
The foreign exchange rate is the rate at which the currency of a country is exchanged
against the currency of another country. It is the price or one currency in terms of another
currency. It expresses one currency in terms of another currency. Say 1$=45/-Rs. The
exchange rate is determined by the interaction of demand and supply of particular currency.
Determinants:
A) Demand for exchange:
1. Import of goods:
It is the major part of total imports. Capital goods and consumer goods are imported from
other countries. Therefore the exchange is demanded by the people who import these
goods. Demand for such exchange depends on the prices of the imports. Higher the prices of
imports lesser the demand for foreign exchange and vice versa.
2 Import of services:
Nowadays the service sector is booming worldwide. Therefore the services are in great
demand in worldwide. Services rendered by the other countries which include insurance,
banking, communication, transport tourist services and educational services demands
foreign exchange. So the demand has been continuously increasing for the same.
3.Unilateral payments:
Sometimes rich nations do support LDC’s with foreign aid so the payments such as gifts,
donations are to be made in foreign exchange. So the demand for the same has been
increasing nowadays. Such payments may be a part of foreign aid or social help.
4.Export of capital:
Foreign exchange is required for the repayment of debt, purchase of assets in foreign
countries, investment in financial assets or direct investment. So exchange is needed to fulfill
the same requirements.
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5. Remittances:
Most of the foreign firms or individual investors (Foreign Portfolio Investment) are investing
in India. So they are paid Interest, Dividend and Profit in their currencies. It creates the
demand for foreign exchange. It is also needed to make the payment of external borrowings.
B) SUPPLY OF FOREIGN EXCHAGE:
1. Export of goods:
This is a major source of supply of foreign exchange. The supply of foreign exchange is
influenced by size and price of exports .Both the size and price of exports depends on
demand of elasticity for exports. The supply sterling pounds depends on the Britain’s
demand for India’s goods.
2 Export of services:
Exports of services are also the source of supply of foreign exchange. This source is gaining
importance in recent years. Expert services in various fields, tourists coming from other
countries, transport, Communication, finance and insurance are some of the important
services which supply the foreign exchange.
3 Unilateral receipts:
It includes payments received in the form of remittances made by domestics working

abroad, donations given and all types of receipts.
4Import of capital:
Foreign Direct investment ( FDI) and Foreign Portfolio Investment (FPI) , repayment of
debts by the foreigners, all constitutes and increase the supply of foreign exchange.
Supply from all these sources add up to aggregate supply of foreign exchange
Determination of exchange rate where demand and supply of currencies are same.
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5. Remittances:
Investment done by Indian firms or individual investors brings foreign exchange. Inflow of
foreign exchange is the result of such investment in the form of dividend received, interest
received and profit earned. Even income earned on lending constitutes supply of foreign
exchange.
EQUILIBRUIM EXCHANGE RATE
The exchange rate is determined where demand for and supply of foreign exchange becomes
equal. The rate is fixed where quantity demanded for foreign exchange get equal to quantity
supplied of foreign exchange.
DIAGRAM
Q PURCHASING POWER PARITY THEORY.
This theory has been restated by the Swedish economist Gustav Cassel in 1916, exactly in
the years following the First World War, when the exchange rates were free to fluctuate, the
rate of exchange between two currencies in the long run would be determined by their
respective purchasing powers. According to him “ the rate of exchange between two
currencies must stand essentially on the quotient of the internal purchasing powers of
these currencies.”Thus, according to the purchasing power parity theory, the exchange rate
between one currency and another is in equilibrium when their domestic purchasing
powers at the rate of exchange are equivalent. E.g. if in India 45 Rs are spent for
purchasing 1 kg of apples and in America for the same kg of apples if one dollar is needed to
spend, then it is clear that the purchasing power of both currencies is different in their
respective nations. In order to make equivalent these currencies with each other’s units
purchasing power will be 1$ = 45Rs.
So’ the relative purchasing power of the two currencies is the main determinant of the
exchange rate between them.’
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Once the equilibrium is established, the market forces will operate to restore the equilibrium
if there are some deviations. E.g. if the exchange rate changes to 1$ = 42Rs when the
purchasing power of these currencies remain stable, dollar holder will convert dollars into
rupees because, by doing so, they save Rs. 2 when they purchase a commodity worth $ 1. A
change in the purchasing power of currencies will be reflected in their exchange rates. For
this purpose the price index is made. It is the parity (equality of the purchasing powers of
the currencies which determines the exchange rate.
If there is a change in prices (purchasing power of the currencies), the new equilibrium rate
of exchange can be found out by the following formula;
ER = Er X Pd/Pf
Where,
ER = Equilibrium exchange rate
Er =Exchange rate in the reference period
Pd = Domestic price index
Pf = Foreign country’s price index
Two versions of PPP:
1. Absolute Version:
Under this version, the exchange rate between the currencies of two nations is established
at the point where their purchasing power is equal. It reflects their domestic purchasing
power too. It is calculated as:
Rate of exchange = PI / PA
Where,
 PI = Prices of certain goods in India or domestic currency

 PA = Prices of same goods in another country or foreign currency, say USA.
Thing to note is that, the changes in internal price level cause changes in the exchange rate. If
inflation is India, then the purchasing power of rupee in terms of dollars would decline. It is
not easy to measure the value of money in absolute terms.
2. Relative version:
It is brought over improving absolute version which is not good measure due to neglect ion
of transport cost and trade restrictions. In this method the changes in the purchasing power
can be measured by the changes in the indices of domestic pricesof the countries
concerned. Hence the changes in the equilibrium rate can be measured by the ration of the
price indices of the respective countries. In this new equilibrium rate of exchange can be
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calculated by multiplying the base period of rate exchange by the relative changes in the
price levels in the two countries with the help of index numbers.
Q.3) Explain the limitations/ Critical Evaluation of the purchasing power theory.
Ans:-The PPP Theory has the following limitations-
1) Limited Application to large Countries:
The PPP theory is applicable mainly to the small countries and not large countries. It is
applicable to countries where major portion of their national income comes from
2) Ignores Specializations in International Trade:
This theory ignores the effect of specialization in international trade. Normally countries
specialize in those items in which they enjoy superior cost a vantage, and accordingly
produce for goods for domestic consumption as well as exports.
3) Direct not possible:
In the PPP Theory we assume that the changes in price levels results in changes in the
exchange rate. But in practical sense direct link between price change and exchange rate may
not exist.
4) Ignores Government Intervention in Exchange Rate:
The theory assumes free trade and absence of exchange control for a steady rate based on
PPP.
5) Transfer of Capital is neglected:
The applicability of this theory is limited. It considers only the trade in merchandise. Trade
in service, capital transfer, and unilateral transfers are excluded. All such items also create a
demand for and supply of foreign exchange.
6) Long Run Application:
This theory ignores the effects of economic variables in the short- run. Therefore the theory
holds good only in the long run. But in reality, Short run applicability is more significant.
7) Ignores the Quality of Goods:
The quality of goods in different countries may not be the same. There is a difference I the
quality of goods. But this theory does not consider this difference in quality of goods .
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8) Not a Dynamic Theory:
This theory I applicable to a static world. Today’s world has become highly dynamic. It is the
movement of capital and speculative activities which have a deep impact on the exchange
rate, Hence the theory s not dynamic in nature.
9) Elasticity o Reciprocal Demand is Ignored:
This Theory does not consider the elasticity of a commodity in two countries. Due to some
factors the demand for a commodity in the domestic market may be highly elastic.
Q Role of Central bank or RBI in controlling foreign exchange in India.
According to Foreign Exchange Regulation Act (FERA) was passed in 1947 the role of RBI
toward intervening foreign exchange market operations is
1. Authorized dealers:
Under the supervision of Central Government, RBI has appointed to authorize to
issue licenses to those who wish to get involved in foreign exchange transactions. It is
the administrative authority for exchange control in India.
2. Rate fixation:
RBI has the right of fixing the value of home currency which is known as the official
rate of exchange. And every one dealing with it is expected to follow it
unconditionally. The norms related to it have been given in FERA now replaced with
FEMA.
3. Regular directions:
RBI issues direction through “Exchange Control Manual’ time to time regarding
Imports and Exports, Foreign Travel remittances, Transfer of Investment incomes
and transfer of capital. These directions are very useful for currency control.
4. Restricting Imports:
There are norms and proper rules which are to be followed while importing goods
from out. Imports are only permitted against proper licenses and according to FERA,
all payments for imports have to be made only through authorized dealers. This way
RBI regulates import trade.
5. Controlling Exports:
The RBI also controls export trade with the help of custom authorities. The items like
Gold can only be exported with proper due permission of RBI. Even the negative list
of exports is prepared by Government Of India.
6. Return submission:
Authorized dealers must report all foreign exchange transaction to the RBI enabling
to keep an eye on it regularly. Exchange stability objective of RBI only can be
achieved when reported with each and every economic transaction carried by dealers.
7. Controlling FDI and FPI:
Investment in India can only be done by Non-residents after obtaining the permission
of RBI. It is covered under the scope of Industrial Policy of the Government of India.
Nowadays in order to attract more Foreign Direct Investment and Foreign Portfolio
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Investment, Government has been framing liberal policies where flow of Investment
is permitted in particular sectors. Even outflow of capital has been allowed through
Joint Venture.
Q.4 Explain RBI’s intervention in exchange rate management in India.
India adopted exchange rate of IMF up to 1971. Between the periods of 1971 -1992, Indian
Rupee was pegged to dollar and basket currencies of India’s major trading partners. In 1992,
RBI introduced LERMS- Liberalized Exchange Rate Management System. Under it dual
exchange rate was- 40% of foreign exchange earnings to be surrendered to RBI at official
exchange rate and 60% of foreign exchange earnings to be converted into Indian Rupees at
market determined exchange rate. From 1994, LERMS was withdrawn and all transactions
of goods and services were converted at market rate with no restrictions. The main objective
of RBI in Indian Foreign Exchange market:
1. To maintain stability in exchange rates

2. To promote economic development by the way of import substitution and export
promotion.
3. To conserve the foreign exchange reserves which is scarce in nature?
RBI’s Role:
1. Administrative Authority:
The RBI is the administrative authority for exchange control in India. The RBI has
been given powers to issue licenses to those who are involved in foreign exchange
transactions.
2. Issue of Directions:
The ‘Exchange Control Manual’ contains all directions and procedures given by RBI
to Authorized dealers from time to time.
3. Import Trade:
RBI regulates import trade. Import is permitted only against proper licenses. The
items of imports that can be imported freely are specified under open general license.
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4. Export Trade:
The RBI controls export trade. The special permission of RBI is needed for exporting
Gold and Jewellery. Nowadays relaxation has been provided on such exports.
Managed Flexibility:
Developing countries initially followed fixed exchange rate system under IMF condition. But
after they allowed the market forces to determine the exchange rate, which means they
adopted the flexible exchange rate. These rate was determined by the market forces
ofdemand and supply of currencies.
It was automatic operation. Normally central banks do not interfere in such determination.
Under this system if the demand for foreign currency is more than that of its supply, foreign
currency appreciates and domestic currency depreciates and vice-versa. There are
disadvantages of such system also so the nation like India has adopted Managed Flexible
Exchange Rate(MFER).
Under managed flexibility the central bank intervenes to bring stability in the exchange rate.
The central bank intervenes in exchange rate determination. RBI intervene by purchasing
foreign currency form the market or sale of foreign currency in market, it helps to bring
exchange rate stability.
 Suppose there is much demand for foreign currency say US dollar in the Indian
market, dollar will appreciate too much and Indian Rupee will accordingly
depreciate. Depreciation of Rupee adversely affects Indian importers and the problem
of excess demand for dollars, RBI releases the dollars from its reserves in the market
so as to stabilize the exchange rate of Rupee-dollar.
 Suppose if there is less demand for foreign currency say US dollar in Indian
market, dollar will depreciates and Indian Rupee will appreciate too much, too much
appreciation of Indian Rupee adversely affects exporters. Therefore RBI, purchases
the dollars from the market so as to bring about stability in the Rupee-dollar rate.
Significance of managed flexibility:
1. Economic adjustment:
Frequent change in exchange rate may create a problem in Balance of Payment
position. Therefore intervention of RBI in stabilizing exchange rates helps to
improve the condition of the same or avoid such disturbances.
2. Appropriate rate:
The RBI goes on collecting market information or keeps an eye over the foreign trade
and currency issues. If central bank expects increase in demand for foreign exchange,
it may accordingly plan to intervene to release more foreign exchange reserves in the
market so as to influence the exchange rate.
3. Proper control:
Change in exchange rate may affect imports or exports unfavorably. So RBI needs to
intervene when there is inflationary or deflationary trends market. Attempt is
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made not to save importers and exporters form the risk arising from the fluctuations
exchange rates. It helps monetary authorities like RBI to bring control over economic
activities.
SEMESTER- 6
OBJECTIVES
(FOR INTERMAL MODULE 1 and 4) & FOR FINAL EXAM ALL)

Questions to be studied:
 Explain comparative cost advantage theory of Ricardo OR Ricardian theory
 Critically explain comparative cost advantage theory
 Explain modern theory/factor endowment theory/factor abundance theory or
Hechshcher Ohlin theory of international trade
 Critically explain modern theory of international trade.
 What is a term of trade? Explain factors affecting it
 Explain the types of Terms of Trade in detail
 Explain Gains from trade and factors affecting it(determination)
 Explain importance of Gains from trade ( with Offer curve)
 MODULE-I INTERNATIONAL TRADE
question Answerers
Absolute cost theory is given by  Adam Smith (Specialization)
 Model is: 2x1x1
 Two nations, one good, one factor LABOUR
Comparative cost theory  Ricardo (Comparative cost benefit over one
(Classical theory) commodity

Model: 2x2x1

Two nations, two goods, one factor LABOUR
Factor Endowment theory 
Heckscher-Ohlin ( based on Two factors with intensity)
(Abundance theory/ Modern 
Model is: 2x2x2
theory) 
Two nations, two goods, two factors LABOUR AND
CAPITAL
Terms of trade Shows Relationship between Export price and Import price
Gross barter Terms of Trade Given by TAUSSIG. It only conserved QUANTITY exported and
concept imported
Net Barter Terms of Trade It only considers PRICE of goods exported and imported
concept
Income Terms of Trade concept Given by DORRANCE. It considers both PRICE AND
QUANTITY
Theory of Reciprocal demand is J.S. Mill showing equilibrium rate of exchange.

advocated by
Reciprocal demand curve (Offer Advocated by Marshall and Edge worth
Curve)/International demand
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curve
Offer curve is based on PRICES of two commodities/
\
MODULE – II BOP AND WTO
Questions to be studied:
 What is BOP? Explain its structure

 What are the types of BOP disequilibrium
 What are the cause of BOP certificate
 Explain the measures for BOP disequilibrium
 Explain BOP trends after 1991.
 What is WTO? Explain its objectives and functions
 Explain WTO agreements:
 TRIMS
 TRIPS
 GATS
Balance of trade shows  Only VISIBLE AND merchandise goods

 It shows deficit or surplus
Balance of trade shows  Visible + invisible goods(Services)
 It shows either omission or Error
 It is based on Double entry book keeping system
Current account shows Goods and services exported and imported
Capital account shows Capital flows (FDI/ FPI/ investments)
Unilateral account shows Receipt and payments of Donations, Foreign aid, Gifts
Reserve Account shows Gold sold or purchased
What is BOP disequilibrium? Surplus or Deficit
When Import >Export = Deficit
Export>Import =Surplus
Cyclical disequilibrium Due to trade cycle phases like recession, depression, prosperity
Short run disequilibrium Due to excess borrowing
Long run disequilibrium Due to discrepancy between savings and investments
Structural disequilibrium Due to change in taste and economic sectors
Fundamental or Chronic Defined by IMF for serious BOP problem

Disequilibrium
Monetary Measure of correcting 1. Depreciation : ( automatic fall in currency value by market
BOP forces)
2. Devaluation: (currency value is deliberately reduced by
monetary authority(RBI)
3. Deflation( fall in prices)
Non-monetary measures Quantitative restrictions imposed ( Volume restricted)
General Agreement on Tariff and  Ad-hoc agreement for trade for multilateral trade
Trade (GATT)  Year- 1947 set up
 Replaced with WTO in 1995
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World Trade Organization  Replaced GATT in 1995, 1st January
(WTO)  Encourage multilateral trade
 Tariff and quota reduction
 Dispute settlement mechanism
Trade Related Intellectual Under this agreements KNOWLEDGE is protected by Patents,
Property Rights (TRIPs) copyrights, industrial designs, layouts, trade secrets etc.
Trade related Investment Under this agreements INVESTMENTS encouraged
measures’ (TRIMs)
General Agreement on Trade in Under this agreement services are liberalized.
services (GATS)
MODULE – III FOREIGN EXCHANGE MAREKT
 What is foreign exchange market? Explain its functions

 What are the players or components or elements or dealers of foreign
exchange market
 What is spot and forward exchange rate system
 Explain merits and demerits of fixed exchange rates system
 Explain merits and demerits of flexible exchange rate system
 Explain in detail
 Arbitrage
 Hedging
 Speculation
Foreign exchange Currencies dealt in trade

Foreign exchange market Place where exchanges are bought and sold
Clearing function Transferring purchasing power (Currency conversion
Speculation Anticipating changes in currency values
Hedging Provides Risk cover arising due to currency value
fluctuations
Arbitrage Function of earning profit by selling currencies from
low price markets to high price markets.
Spot rate The rate at which immediate delivery of foreign
exchanges take place
Forward rate The rate which future transactions are carried on
agreed rate of exchange.
Fixed exchange rate  Traced to Gold standard later stage
 Rigid and certain
 Brings pressure on reserves
 Good for small nations
 Role of monetary authorities is important
Flexible exchange rate  Floating or fluctuating rate system
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 Rate is determined by market force s of demand
and supply factors
 No intervention of RBI
 It does not put pressure on reserves
MODULE – 4 FOREIGN EXCHANGE RATES
 Explain the determination of foreign exchange rate? OR How foreign exchange rate
is determined – explain with diagram
 Explain PPP theory in detail with its types
 Criticism of PPP theory.
 Explain role of RBI in controlling foreign exchange rate
 Explain intervention of RBI in exchange rate or Managed flexibility OR LERMS
Exchange rate It is a rate at which currencies are exchanged

Managed Float system  Hybrid of fixed and flexible rate system.
 RBI intervenes by selling or buying exchanges
 India has adopted this rate system
Who propounded PPP theory Gustav Cassel

What PPP theory says? Parity/ equality of purchasing powers of the currencies
determines exchange rates
Foreign exchange Regulation Act Passed in 1947 to control foreign exchange transactions
Foreign Exchange Management Act Replaced FERA in 1999
Liberalized Exchange Rate management Brought in 1992 for dual exchange rate system
System( LERMS)
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1MODULE – I INTERNATINAL TRADE (Q1- 15 MARKS)

1. Explain comparative cost advantage theory (Ricardian theory of international trade.

Q1.Explain the Comparative Advantage Theory of International trade of Ricardo

In short ‘ According to comparative cost advantage theory of international theory, each

Assumption of the Theory

The Ricardian theory of comparative advantages is based on the following assumption:-

This theory is explained with the following example:

Country Clothe Shoe

Q2. Criticisms of Ricardian Theory OR Critically explain Comparative Cost advantage

1. Unrealistic Assumption of labour Cost:-

3.State Assumption of Fixed Proportions:-

5. Ignores Transport Costs:-

6. Factors not Fully Mobile internally:-

7. Two-Country Two-Commodity Model Unrealistic:-

8. Self-Interest Hinders its Operation:-

9. Neglects the Role of Technology:-

10. One-Sided Theory:-

11. Impossibility of Complete Specialization:-

12. Incomplete Theory:-

Assumptions of the Theory:

Explanation of the theory:

Q4. Criticism/ Limitation of the H-O theory OR Modern Theory.

7. Other factors ignored:

Q5. What is terms of trade? Explain its types in detail.

Terms of trade is expressed as:

Terms of Trade = Px/Pm x 100

 PX refers to the price of Exports

When Export price is more – Terms of trade is Favorable

When Import price is more -- Terms of trade is Unfavorable.

 Tg refers to Gross barter Terms of Trade

B) Net barter Terms of Trade (NBT):

 NBT refers to Net barter terms of trade

D) Single Factoral Terms of Trade:

E) Double Factoral Terms of Trade:

F) Real Cost Terms of Trade (Tr)

Q6. What are the factors affecting Terms of Trade (TOT

10. Balance of Payments:-

11. Inflation and Deflation:-

12. Nature of Goods:

Q.7What is the significance/ Importance of gains of trade?

International trade leads to international specialization. It enables a country to

International trade because of international specialization leads to an increase in the

3. Equal distribution of scarce resources:

4. Equality in commodity and factor prices:

5. Links Demand and Supply in different Nations:

6. Standard of living improves:

International trade increases production and consumption in a country. This leads to

International trade increases employment opportunities. This leans to increase in

1. Differences in Cost Ratios:-

6. Nature of Commodities Exported:-

Q9 Explain the Gain from trade with offer curve OR

1. Two countries and two commodity model is used

Offer curve is explained with the help of following diagram:

1. Explain the structure of balance of payment

Q.1 Explain the structure of Balance of Payments?

According to Charles Kindleberger“

The BOP of a country is a systematic recording of all economic transactions between

The following is the structure of BOP:

Q.2 Discuss the types of disequilibrium of Balance of Payments

1. Cyclical Disequilibrium:When disequilibrium is caused due to changes in trade cycles,

2. Structural disequilibrium: It may also be caused by structural changes in the economy.

5. Fundamental Disequilibrium: The concept of it was originally introduced by

Q3. What are the causes of Balance of Payment disequilibrium?

8)High developmental and Investment programmes: Huge development and investments