ECS 1601

Learning Unit 4: The foreign

sector

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part B.
economy.

Content
In this study unit you will learn
more about:
Why countries trade
The balance of payments
Exchange rates
Terms of trade

Read section
16.1 and
16.2 in
textbook
pp 300 - 304

4.1 Why countries trade

The worlds economies have become

increasingly integrated; this process
is called globalisation.
The extent of a countrys
involvement in globalisation is called
openness, or the degree of
integration into the international
economy.
The South African economy is
described as an open economy.

Continued
A country is self-sufficient (autarky) if it makes
everything it consumes within the borders of the country.
But Adam Smith said it is better to specialise in a couple
of goods and services and trade with other countries
because countries have different resources
Factors of production are not equally distributed amongst
countries
For example, South Africa has a lot of gold and platinum
(natural resources) but not a lot of computer factories.
Therefore, South Africa specialises in mining gold and platinum,
exporting the surplus and importing computers (capital) from
America and Japan.

But both countries could also be endowed with the same

factors of production
Therefore countries can have an absolute or a
comparative advantage in a particular resource

Absolute advantage
Catching
fish

Climbing
trees for
coconuts

Man

20
10

6
3

Woman

8
4

10
5

A
man
and
woman
isabetter
at
IfThe
they
do
trade
The
man
is anot
better
climbing
trees.
In one
woman
are
swimmer
and
catches
and
each
spend
30
hour
she
gets
10 The
20
fishon
in catching
an
hour.
stranded
on
an
min
coconuts.
The
man
woman only catches only
8.
island.
They
need
fish
and
30has
min
on
gets
6.
She
an
He has an absolute
coconuts,
they
will
fish
and coconuts
absolute
advantage
advantage
in
catching
in survive.
getting
have
the coconuts.
following:
to
fish.

Absolute advantage
If
they
each
Now
they
can
Lets
write
in the
Compare
how
specialise
and
the
trade
their
goods,
corner
how
much
much
they
have
if
man
only
fishes
and
then
they
will
each
they
will
have
if
theywoman
trade
to the
the
only
have
more
they
do
values
innot
thetrade
picks
coconuts,
they
coconuts
and
more
(just
to
corners!
will
have
fish
than the
remember).
following after an
previously!
hour:

Man

Catching
fish
(Not
trade=10)

10
20

(Not
trade=4)

Woman

Climbing
trees for
coconuts

(Not
trade=3)

(Not
trade=5)

10
5

Comparative (relative)
advantage
Trade can also be beneficial when one individual or
country has an absolute advantage in both goods.
All that is required for both to benefit is that the
opportunity costs differ.
According to the theory of comparative advantage
each country will tend to specialise in and export
those goods for which it has a comparative advantage.
If both countries or persons have the same
opportunity costs for the same quantities of the same
goods there is an equal advantage and no basis for
trade.
Lets take a look at our example again ...

Comparative advantage
A year later the

Now
the
woman
The
man
has
a at
higher
Now
the
man
has
a
Yes!
Lets
look
thehas
man
became
ill
In
theabsolute
time itcost.
takes
the
an
(opportunity)
costIn
in
opportunity
the
COMPARATIVE
man
to
catch
fish,
and
was
able
getting
fish.not
Itone
will
be
advantage
in
both
time
it
takes
the
woman
advantage
in
he
could
gotten
better
forhave
the
man
to 3
to
catch
one
fish,
she
to
swim
any
more.
fishing
and
getting
coconuts.
coconuts
get
thehave
coconuts
and
could
gotten
1.25
Now
he
could
only
coconuts.
Do you
for
the woman to fish.
coconuts.
think they
catch
2 fishshould
in a
still trade?
hour.

Man

Woman

Catching
fish

20
2

Climbing
trees for
coconuts

8
1

=3

10

= 1.25

Read
section
13.6 in the
textbook on
pp 249 252

4.2 The balance of payment

Exports and
imports

Current
account

Surplus =
exports>
imports

The balance of payments is a record

each Balance
country keeps on its transactions
of
with
the
rest
of
the
world.
Paymen
Deficit =
exports<
imports

ts

Financia
l
account
Capital
transfer
account

Unrecorded
transactions

Financial flows
between
countries
Surplus = net
inflow of
foreign capital
Deficit = net
outflow of
foreign capital

4.2 The balance of

payments
Current account
An important good traded in South Africa is gold
Services traded included transport, construction,
etc.
Income receipts are shown separately. That is
income earned by South Africans in other
countries.
Income payments are money earned by nonSouth Africans in South Africa.
Current transfers: money, gifts, services,
etc traded for nothing in return.

4.2 The balance of

payments
Financial account
Direct investment
Investments made in order to gain control of the
management of the enterprise.
Portfolio investment
Purchasing assets such as bonds or shares.
Other investments (residual category)
All investments that are not classified as either a
direct or portfolio investment.
Unrecorded transactions
Used to balance the financial account.

Gold and foreign reserves

Exports = the country GETS foreign currency.
Imports = the country PAYS foreign currency.
If EXPORTS < IMPORTS (meaning the country
pays more foreign currency than it earns) then
foreign reserves decrease.
If EXPORTS > IMPORTS (meaning the country
gets more foreign currency than it pays) then
foreign reserves increase.
A portion of South Africas foreign reserves are
held in gold.

You have now

finished part A of the
slides for Learning
Unit 4. Take a break,
then continue with
Part B.