Comprehension and Discussion Questions. 2. Does an exporter or importer agree to ship under a letter of credit?

1. What is the first step involved in the typical transaction?

2. Does an exporter or importer agree to ship under a letter of credit?

3. What does the bank of New York advice the US exporter?

4. What is the term of the time draft of the US exporter?

5. What bank notifies the French importer of the arrival of the draft?

6. When does the Bank of Paris have funds to pay the maturing draft?

7. What is the last step in the typical transaction?

 

Text IV. EXPORT AS AN IMPORTANT PART OF FOREIGN TRADE

    Every country, regardless of size, ideology, or state of development, participates in international trade. Trade theorists have tried to explain why states trade and how they benefit from it largely under assumptions of static conditions that hold all domestic factors of production (land, other natural resources, labor, and capital) in fixed supply. The resulting theory of comparative advantage is rich in its implications about the gains from trade, the following among them: (1) Any country can increase its income by trading, because the world market provides an opportunity to buy some goods at relative prices that are lower than those which would prevail at home in the absence of trade. (2) The smaller the country the greater this potential gain from trade, but all countries benefit to some extent. (3) A country will gain most by exporting commodities that it produced, using its abundant factors of production most intensively, while importing those goods whose production would require relatively more of the scarcer factors of production.

    The theory of comparative advantage is posed here in the very simple form developed by David Ricardo during the nineteenth century: two countries, two goods, and only one factor of production, labor. Some of the complexities of the real world can be incorporated into the theory, however. A trading world of many countries can be handled by taking the home country, say Kenya, and treating the rest of the world as its trading partner. The Swedish economists Eli Heckscher and Bertil Ohlin during the first half of the twentieth century expanded the theory to deal with two factors, such as labor and capital.

    Before trade, a country both produces and consumer at a point like A. With trade, a country produces at a point like B and can increase its consumption of both goods and move to a higher indifference curve at C.

    We divided the economy into production of X goods and Y goods, without being specific about the nature of those goods. In Figure 1, the economy of our home country is divided instead into exportable goods, such as rice, that are produced using relatively land- and labor-intensive methods, and importable goods, such as cloth, produced using relatively capital-intensive methods. As shown in the diagram, the home country is relatively well-endowed with land and labor, so the production frontier is skewed to the right; this depicts the country’s greater capacity to produce rice than cloth. The country’s collective utility in consuming these goods is represented by the community indifference curves.

    Without trade, the home country achieves its greatest utility by producing and consuming at point A, the tendency of the indifference curve I and the production frontier. The slope at A determines the domestic relative price of rice in terms of cloth. Assume that the rest of the world is better endowed with capacity than with labor and land relative to the endowments of the home country and that world consumers have tastes broadly similar to those of the home country. Then on world markets the relatively higher production of cloth compared with the demand for cloth will drive its price lower than in the home country. Since only relative prices matter, these two statements mean the same thing: in world markets the price of rice in terms of cloth will be higher than in the home country.

 

TEST I

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