Chapter 3_International Trade

7/31/2019 Chapter 3_International Trade

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International Trade

The exchange of goods between citizens ofdifferent countries is called international Trade.

Technological improvements, improved

transport system, development of banking and

credit have been largely responsible for the

immense growth in international trade.

Goods are constantly transported from country

to country. Freights are cheap. It does not take

much time and money to send them from one

end of the world to another.2


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Basis of International Trade

DifferentCosts

Difference in costs of production in two countriesmake exchange of goods profitable.

Exchange will not be beneficial if goods are

produced at the same cost. A lower cost of production gives an advantage to

one country over the other, and vice versa. Nowthis advantage can be of one of the following

three types:(a) Absolute Differences in Costs

(b) Equal Differences in Costs

(c) Comparative Differences in Costs 3


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(a)Absolute Differences in Costs Suppose a country has a monopoly in the

production of a commodity. If othercountries need this commodity, the countryproducing it will have an absolute advantage

over them. Example: India has almost a monopoly of

manufactured Jute(with the exception ofBangladesh) and all other countries thatneed jute goods must buy them from India.Such absolute advantages are usually theresult of differences in climate or othernatural gifts.

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(b) Equal Differences in Costs

The differences in costs will be called equal,

when a unit of productive power produces.

Import of specie into country A will raise

prices there and export of goods to country B

will make things cheaper in B.

Thus, the difference between the price levels

of the two countries tend to equalise.

As a result, the trade between them will

cease.5


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Basis of International Trade(c) Comparative Differences in Costs It looks strange, but it is nevertheless true, that it may be

more profitable for a country to import some goods fromanother country even though it can produce them cheaperitself.

A country will do this when it finds that its labour and capitalcan be more profitably employed when used in producingsome other goods in which it enjoys a greater comparativeadvantage in production.

Suppose, Britain can produce both dairy products and steelcheaper than Holland, but she enjoys relatively greateradvantage in producing steel. In that case, she gains more byconcentrating on steel goods and exporting them to Hollandand importing dairy products from Holland.

Such a difference is called comparative difference and formsthe basis of permanent international trade. In thesecircumstances, the trade between the two countries will notonly start but will also continue. 6


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Modern theory of International Trade

This theory has been put forward by Bertil Ohlin, a

Swedish economist, and it has replaced thetraditional comparative cost theory.

Just as individuals specialise in economic activity in

which they have comparative advantages, similarlycountries specialise in the production of certain

commodities in which they have comparative

advantage on the basis of factor endowments.

Just as differences in individual capabilities is the

cause of exchange between individuals, similarly

differences in factor price is the cause of

international trade. 7


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Bertil Ohlin thus extends the analysis which is

applicable to a single market to thedetermination of values internationally i.e.,exchange between different countries.

Thus, Ohlin observes international trade is buta special case of inter-local or inter-regionaltrade. Hence, according to Ohlin, there is noneed to have separate theory of international

trade. He says that the same fundamental principles

holds good for all trade, whether it is internal

trade or international trade. 8


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The classical theory of comparative cost is

based on the assumption of comparative

immobility of the factors of production

between different countries.

But Ohlin points out that this immobility is tobe found even in different regions of the same

country.

According to Ohlin, the immediate cause ofinternational trade is the difference in

commodity prices which in turn is due to the

differences in factor prices. 9


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Goods are purchased because it is cheaper to buy

them from outside the country. The establishment of the rate of exchange

between the two countries facilitates thecomparison between the commodity prices

prevailing in the two countries. Thus, in Ohlins Opinion there are no fundamental

differences but only quantitative differencesbetween inter-regional and international trade.

Ohlins theory represents a departure from theclassical theory and marks a great improvementon it.

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Advantages of International Trade

(i) The productive resources of the world are utilised to the best

advantage. Every country concentrates on the production ofgoods for which it is best fitted. There is economy of effortand a consequent fall in prices. Thus, every country receivesthe highest return from its resources.

(ii) A country is able to consume goods which it cannot produce

at all, or only at an impossibly high cost. Thus consumers canenjoy a large variety of products. Commodities produced inthe tropics find their way to the temperate zone, and viceversa. This provides greater economic welfare and a higherstandard of living.

(iii) Violent price fluctuations are toned down. As the area ofmarkets is enlarged by trade, the effects of the disturbingfactors are spread over this large area and prices becomemore stable. If, at any time, the price of a commodity goes upabnormally, it can be imported from abroad and its pricebrought down.

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Advantages of International Trade(iv) Shortages in times of famine and scarcity can be met from imports.

Surplus produce can be sent out to needy countries. The world thus

tends to be united into one economic unit.

(v) Countries economically backward but rich in unused resources are able

to develop their industries. In the early stage, the industries of a

backward country have to be protected but once they develop, free trade

stimulates them still further.

(vi) Trade develops racial sympathies and creates common interests. Mangains culturally and the cause of world peace is promoted. Exchange of

goods is accompanied by exchange of ideas. This promotes international

understanding. Since a war is bound to interrupt international trade and

put the people to loss, every effort is made to avoid it.

(vii) The existence of international trade promotes peace. No country, howeverbig, can be self-sufficient. To achieve self-sufficiency, it will have to

undertake expensive wars, conquer free areas and convert them into

colonies. This is horrible. Free international trade supplies the essential

needs of nations, and thus checks their greed and desire to conquer.

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Disadvantages of International Trade(i) The worst effect of foreign trade on backward countries

is the destruction of their handicrafts and cottageindustries. In India such industries had reached a highstage of perfection. In recent times, Japan tried to crushour cotton industry by flooding Indian markets withcheap goods and protection had to be granted to save it.Industrially weak countries have to suffer like this.

(ii) The empire-builder follows the trader. The footholdgained by traders is used to complete a countrys politicalslavery. For example, the British came to India for tradeand stayed to rule. A powerful country can easily findsome excuse for attacking a weak country.

(iii) Dependence on foreign goods creates difficulties in timeof war when the country is cut off by enemy action. Indiahad to face great trouble in getting ordinary articles likeneedles, tools and medicines during the war.

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Disadvantages of International Trade(iv) Extreme specialization which makes a country depend on

one or two industries only is bad. This is like putting all eggs

in one basket. If a substitute is discovered or the industryotherwise suffers, the economic life of the people would beendangered.

(v) Countries which sell primary commodities and buymanufactured goods in return are losers. The standard of

living of the people in such countries remains low. Foreigntrade under such conditions leads more to discontent andunrest than to peace and goodwill. It is well known that thefeelings of the Indian people for the British before they leftIndia were very bitter.

(vi) Foreign trade may completely exhaust a countrys naturalresources like coal and oil which are irreplaceable. Thesegoods are exported for the sake of profit. But the countrysuffers in the long run when their source is dried upcompletely.

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Disadvantages of International Trade

(vii) Imports of harmful drugs and luxuries, as opium in

China, ruin the health of the nation. For the use of suchharmful articles, the blame must be put on internationaltrade which brings them into the country.

(viii) Through foreign trade, the economic troubles of onecountry are transmitted to others. The economic

disturbances in one country are transmitted to othersand their economy is upset. For example, the collapse ofAmerican markets in 1929 resulted in a world-widedepression.

(ix) Trade rivalry leads to war and friction. Germanys desireto secure markets for her goods was the most importantcause of the last two World Wars. Commercialcompetition often strains relations. Here also, India andPakistan find it difficult to come to an understanding due,to some extent, to a clash of trade interest.

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BALANCE OF TRADE A comparison of the total imports and exports of a

country is its balance of trade. The balance of trade is regarded as favourable or

active or positive when the value of exportedgoods exceeds that of imported goods.

It is unfavourable or adverse or negative whenimports exceed the value of exports.

In the Middle Ages, it was thought that a favourablebalance was the only way to make a country rich, as

it brought in gold and silver from outside. Now, however, this idea has been discarded, and it

is believed that, in the long run, exports andimports, including services of all kinds, should

balance. 16


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BALANCE OF TRADE

If, however, an unfavourable balance of trade

persists for a long time and is very large in

amount, gold shall have to be exported.

In that case, steps would have to be taken to

set it right. It should, however, be noted that

the visible unfavourable balance of trade

may be corrected by the export of invisible

items which do not enter into the account

books.

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BALANCE OF PAYMENTS

The balance of trade includes only the visible items

in foreign trade. They are material goods exported

and imported. Only these are entered in the port

registers maintained by the customs authorities.

But there are a large number of other items whichfall outside and are called invisible. The balance of

payments includes all visible and invisible items.

Hence, the balance of payments is acomprehensive record of economic transactions of

the residents of a country with the rest of the

world during a given period of time.18


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BALANCE OF PAYMENTS

Invisible Items:

ServicesIndia uses a good deal of foreign banking, shipping andinsurance services. She does not have enough of her ownships, insurance companies and exchange banks. Henceforeign agencies, like Lloyds Bank provided these

services. India has to pay for all such services. Tourists expenses

When Indian students and tourists purchase goods andservice Europe, it is like importing these goods andservices. The only difference is instead of goods comingto the consumers, the consumers have gone to them.They have to be paid for in goods exported from India. Inthe case of Indian students receiving education abroad,India is importing education and has to pay for it.

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BALANCE OF PAYMENTSInvisible Items:

Interest on borrowed capitalThe services of capital have to be paid for by the borrowingcountry. An investment made abroad is an export item andremains so till withdrawn. Ultimately all loans borrowed inforeign money markets have to be paid back and adjustedthrough exports.

Besides the above, there are various minor items like gifts,donations and money remitted home by foreign settlers;these are also invisible items.

All these invisible items produce exactly the same effect on a

country's account with the rest of the world as the export andimport of commodities. When they are added to the balanceof trade, we have a complete list of all the items which haveto be paid for or received by trading countries. Their sumtotal is called the balance of payments.

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BALANCE OF PAYMENTS Hence, the balance of payments is a comprehensive

record of economic transactions of the residents of acountry with the rest of the world during a givenperiod of time.

This record is so prepared as to provide meaning andmeasure to the various components of a countrys

external economic transactions. Thus, the aim is to present all receipts and payments

on account of goods exported, service rendered andcapital transferred by the residents of a country.

The main purpose of keeping these account is toinform the government of the country of itsinternational economic position and to help it inmaking decision on monetary and fiscal policies to bepursued as well as on the trade and payments issues.

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BALANCE OF PAYMENTS

Any item that typically gives rise to a purchase

of foreign currency is recorded as a debit item

in the balance of payments accounts and any

item that gives rise to a sale of foreign

currency is recorded as credit item.

The record of international transactions in

balance of payments always balances.

The BOP is divided in 2 parts:

1. Current Account.

2. Capital Account.

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BALANCE OF PAYMENTS

1. Current Account: The balance of payments on current

account includes items like imports and exports,expenses on travel, transportation, insurance,

investment, etc. These relate to current transactions. It

basically records all transactions in goods and services.

2. Capital Account: The capital account is made up of

capital transactions, e.g. borrowing and lending of

capital, repayment of capital, sale and purchase of

securities and other assets to and from foreigners

individuals, government and internationalorganisations.

When both current and capital accounts are taken, it is

called Overall Balance of Payments. It is overall balance of

payments which must balance. 23


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Theory of Protection Doctrine of Free Trade -

A policy of no restrictions on the movement of goodsbetween countries is known as the policy of Free Trade.

Restrictions placed with a view to safeguarding homeindustries constitute the policy of protection.

Free trade, however, does not require the removal of

all duties on commodities. It only insists that they shallbe imposed only for revenue and not at all forprotection. As a practical policy, free trade is based onthe theory of international trade.

Protection aims at helping some industries againstforeign competition. This is done either through dutieson imported goods, or bounties to domestic producers.An import duty makes the foreign articles sell at higherprice and so helps the home manufactures.

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ADVANTAGES OF PROTECTION(I) To help Infant industries

An infant has to be protected till it grows to manhood, Nurse the baby

feed the infant and free the adult is a well-known maxim. Protectiveduties are crutches to teach new manufacturers to walk. The

advantage thus gained often greater than the cost paid by consumers

in the shape of higher prices. India extended protection to some

important industries on the basis of this argument.

(II) To keep money at home

When we purchase swadeshi goods, we are keeping purchasing

power in our own country. It is possible that we are paying more for

the goods than we may have to pay for foreign goods of the same

quality, if allowed to come in freely. But we do not mind paying more

and feel a glow of pride, when making a little sacrifice.

(Ill) To get an In flow ofgold

When you send goods to others and close your doors to other goods,

you may have to be paid in gold. This will be possible, however, only

when our goods have an inelastic demand and the others either

cannot or do not retaliate. 25


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ADVANTAGES OF PROTECTION(iv)To develop key Industries

Key industries are keys to further industrial expansion. They provide

machines and materials for other industries. Chemical andmetallurgical industries are of this type. They serve as a base for the

national economy. They are essential for the defence of the country

in war and its prosperity in peace.

(v) To attain self-sufficiencyWhen the government wants to make the country independent of

foreign supplies, protection is necessary. Complete self-sufficiency,

however, is impossible and even a partial one is costly. Therefore, a

self-sufficiency should be sought for only essential industries.

(vi) To secure diversification of occupationsThe greater the number of openings for the people of a country, the

better it is for their material progress. Too much reliance on any

single industry is risky. Therefore, it may be necessary to encourage

some industries with the artificial aid of protection.26


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ADVANTAGES OF PROTECTION(vii) To prevent dumping of foreign goods

When a foreign country plans to crush our industry by selling goods at a priceeven below the cost of production, it is a case of dumping. Such a supply of

cheap goods might be welcome if it were permanent; but it is usuallytemporary. It is done to kill competition and then to make up all losses bycharging higher prices. Anti-dumping duties are, therefore, justified to savethe home industry.

(viii) To create employmentProtection helps to develop industries, and it creates more employment.There is no doubt that the development of sugar and other Indian industriesunder protection provided a large volume of employment.

(ix) To correct adverse balance of paymentsSometimes, protection is given with a view to correcting an adverse balance ofpayments. Protection reduces imports, and the balance of payments situationcan thus be improved, although temporarily.

(x) For the countrys defence

Certain industries which produce defence materials and equipment such asarms, ammunition, tanks must be protected.

(xi) To safeguard the Interest of high-wage labourSometimes it is argued that in the absence of protection, the highly-paidlabour of the industrially advanced countries would he exposed to thecompetition of cheap foreign labour, and that the products of their high-wagelabour can be under sold by those of pauper labour from abroad.

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DISADVANTAGES OF PROTECTION(I) When foreign competition is removed, the home

manufacturers become lethargic. Protection acts like an

opiate. It sends the home producer to sleep. All improvementsare neglected. There is no incentive to cut down the costs orto improve the quality. Technical progress thus comes to astandstill.

(II) Another disadvantage is that there is a loss in public revenues.If high protective duties are imposed, imports will shrink andrevenue from customs will fall.

(III) Burden on consumers. The most important objection toprotection comes from the consumers. The burden ofprotective duties does not fall on the foreign manufacturers.The burden is on the home consumer because he has to pay a

higher price than before on account of the imposition ofimport duties. It is said that it does not look fair that a poorconsumer should be penalised to enrich the already richmanufacturer. Thus, inequalities of wealth distribution arefurther aggravated.

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DISADVANTAGES OF PROTECTION(iv) Tariff is said to be the mother of trusts. As soon as protection has

removed foreign competition, the home manufacturers are induced

to form combinations of their own in order to remove the internal

competition also. In lndia, the sugar factory owners formed the Indian

Sugar Syndicate to eliminate competition among themselves, and to

charge a monopoly price from the consumers.

(v) There is also the danger ofcorruption. It is very well known that in

America the legislators used to be offered bribes by industrialists. The

object was that no legislative measure may be adopted which might

adversely affect them, and legislation which suits them may be

passed.

(vi) Misdirection of resources. Protection diverts labour and capital andother factors of production into set channels. They are prevented

from seeking their most remunerative employment. This is bound to

decrease the national dividend. Misallocation of the available

resources into unsuitable channels cannot be economically justified.

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DISADVANTAGES OF PROTECTION(vii) Vested interests are created which refuse to give up

protection. The infants refuse to admit that they are grown

up. They start kicking at the slightest indication of withdrawal

of protection.

(viii) There is a danger of retaliation from abroad. As a result,

some home industries might suffer.

(ix) Choice limited. Protection limits the choice of consumer

goods. Through tariffs, quotas and exchange control, the

availability of foreign goods is severelylimited. The various

protective policies drastically cut down the availability of

foreign movies, books, magazines, pictures, clothing, food,etc. Goods imported from other countries also bring with

them ideas and styles and other ways of living. Indeed, they

enrich life.

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Reason for Protection for


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Reason for Protection for

Underdeveloped CountriesIn spite of all the objections and dangers enumerated above, there is yet a

strong case for protection, especially in the case of under-developed

countries:

(i) Protection in these countries brings about a fuller utilisation of the

unutilised or under-utilised natural resources.

(ii) Protection would also restrict imports and create demand for thehome products, thereby giving a fillip to investment, employment and

income.

(iii) Further, since in under-developed countries, there is an excessive

dependence on agriculture, diversification is very much needed in these

countries. Protection helps to bring about diversification in industries, andhence gives economic stability to them.

(iv) Above all, the protection of infant industries is an absolute necessity

in these countries.

(v) The economies of most the under-developed countries are

unbalanced, and there are strong reasons for a protectionist policy to

support industrialization in them.31


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TARIFFS AND SUBSIDIES

The import duties (tariffs) and export subsidies

affect the prices and quantities of goods andgovernment revenue.

Tariffs: Tariff is an important tool of protectionused mainly to cut imports as imposition of

import duties increases the prices of importedgoods.

It diverts the demand from imported goods toindigenous goods providing promotionalenvironment for indigenous industries.

Tariff is also useful for reducing the wide deficit inbalance of payments as it discourages import

reducing the burden on BOP. 32

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TariffsThe main effects of imposition of tariffs are:

1. Protective EffectTariff reduces the imports of competing goods thus affordingprotection to the domestic producer. Domestic production isincreased as a result of the imposition of tariff. This is known asProtective effect.

2. Consumption EffectWhen tariff is imposed, price of the commodity rises and

domestic consumption is reduced. This is called the Consumptioneffect.

3. Revenue EffectThe government derives revenue from the tariff which ismeasured by the quantity of the imports multiplied by the rate oftariff. This is the Revenue effect.

4. Redistribution EffectThe imposition of the tariff increases the price of the commodityand thus reduces the consumers surplus. In this way, someincome is transferred from the consumers to the producers. Thisaffects distribution of income. It is called Redistribution effect.

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TariffsThe main effects of imposition of tariffs are:

5. Terms of Trade EffectTake the case of two countries A and B with different factorendowments giving comparative advantage to each in theproduction of a certain commodity. Tariff will reduce the volume oftrade and the terms of trade will improve for the country imposingthe tariff.

6. Effect on National Income

If a country is facing unemployment problem, imposition of tariffwill increase employment and thus increase national income. Thishappens because with the imposition of tariff consumers demandsare diverted to the domestically produced goods. To meet thisincreased demand new production units will be set up. As a resultlot of employment will be created and national income increased.

Optimum TariffA tariff is said to be optimum when its rate maximises the welfareof the country i.e. when the rate is considered best from all pointsof view; it is neither high nor low. It is the ideal rate.

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S b idi


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Subsidies

Subsidies are provided to the exporting industries

so that they can compete in the world market. Goods that are exported are usually lower priced

and abundant in the country that exports it.

Exports is thus encouraged to utilise the surplusand avoid the further fall in prices of such

exportable commodities.

This encouragement to such industries is given

with the view to earn more foreign exchange as

well as protect the interest of such export

industries having excess capacities.

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Foreign Exchange Control


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Foreign exchange controls are various forms of

controls imposed by a government on thepurchase/sale of foreign currencies by residentsor on the purchase/sale of local currency bynonresidents.

Such control is used to restore equilibrium inthe Balance of Payments.

If a country finds that its balance of trade hasbeen persistently unfavourable, then it must do

something to set it right. The various ways of foreign exchange control

include devaluation of currency, over valuationof currency.

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Obj i f h C l


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Objectives of Exchange ControlThe object of controlling exchange is to fix it at a leveldifferent from what it would be if the economic forceswere permitted free interplay. The objectives of exchangecontrol may be :

(a) To correct a serious imbalance in the economy of thecountry relatively to the outside world.

(b) To conserve the countrys gold reserves which arebeing depleted

(c) To correct a persistently adverse balance of payments

(d) To prevent a flight of capital from the country

(e) To conserve foreign exchange reserves for largepayments abroad

(f) To maintain stable exchange rate

(g) To ensure growth with stability.

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There are three possible course that a country

adopting exchange control may like to pursue,

considering the economic situation in which it

may find itself.(1) It may like to undervalue or depreciate

currency

(2) It may decide on over-valuation(3) It may decide to avoid fluctuations and

maintain a stable rate.

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F i E h C t l


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Foreign Exchange ControlUnder Valuation

Undervaluation is advocated for curingdepression.

When a country decides on undervaluation ordepreciation, i.e., fixing a rate lower than it wouldbe in a free exchange market, exports arestimulated and imports are discouraged.

It will give stimulus to export industries anddomestic industries will also benefit becauseimports have been discouraged.

Thus, undervaluation will increase economicactivity in the country, add to the total output(GDP) and will create more employment.

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F i E h C t l


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Foreign Exchange ControlOver Valuation

The second object of exchange control may be overvaluation or

fixing the value of its currency at a level higher than it would be ifthere was no intervention in foreign exchange.

This course is indicated in the following situations:(i) When there is a serious imbalance in the countrys traderelationship. As a consequence, the supply of national currency mayfar exceed the demand for it.

(ii) The country may be in great need of foreign goods either forprosecution of a war or for reconstruction after the war or foreconomic development.(iii) If a country is suffering from inflation, the exchange value of thenational currency will go down when exchanges are left free tomove. If foreign trade plays a very important part in the economy of

the country, this downward trend must be arrested by overvaluingthe domestic currency, otherwise imports will become very dearand the exporters will have windfall profits.(iv) A policy of overvaluation is also in the interest of a countrywhich has to meet a large debt payments expressed in foreigncurrency.

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M th d f E h C t l


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Methods of Exchange ControlInfluencing Exchange Rate Exchange control is exercised either by regulating international

movements of goods through various devices or by the purchaseand sale of foreign currency at specified rates in order to maintain aparticular range of exchange fluctuations.

Exchange control can be exercised by influencing demand for, andsupply of, currencies in the exchange market.

This can be done indirectly by devices like tariffs, quotas, bounties,changes in interest rates, etc.

Imposition of import duties and of import quotas will reduceimports, cut down the demand for foreign currency, lower its valueor raise the value of the domestic currency.

Export duties, which are not so common, will have the opposite

effect. Bounties affect the other way about. Export bounty will raiseand import bounty (which exists nowhere) will lower the value ofthe home currency.

A rise in the interest rates attract funds from abroad, increasesdemand for domestic currency and raises its value, and vice versa.

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M th d f E h C t l


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Methods of Exchange ControlControlling Exchange Rate

There are two methods generally adopted for controlling

exchange:

(a) InterventionIn this case, the government enters the exchange market eitherto purchase or to sell foreign exchange in order to bring the rate

up or down to the desired level. This method has been calledintervention and leads to exchange pegging.

(b) RestrictionIn this case, the government can prevent the existing demandfor, or supply of, the currency, in which they are interested, fromreaching the exchange market. This method as been calledrestriction. The second method has been more popular becauseintervention proved a weak weapon and was also expensive.

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Methods of E change Control


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Methods of Exchange Control

Exchange Control Proper

Exchange restriction is exchange control proper. For thisthree things are done:

(a) All foreign dealings are centralised, usually in the central

bank.

(b) The national currency cannot be offered for exchangewithout previous permission.

(c) It is made a criminal offence to enter into an unauthorised

foreign exchange transaction.

The usual procedure isto order all exporters to surrender

claims in foreign currency to the central bank and ration the

foreign exchange made so available among the licensed

importers. Exchange control thus involves import control. 43

D l ti


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Devaluation

A very common method of correcting an adverse

balance of payments is the devaluation of thehome currency.

The devalued currency falls in value againstforeign currencies so that the foreigners have to

pay less in terms of their own currencies for ourgoods.

The importers in the country, on the other hand,have now to pay more in terms of the devalued

currency for foreign goods. Hence, they (i.e., foreigners) are induced to

import more from such a country. Thus importsdecrease and exports increase, and the balanceof payments is corrected.

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D l ti E l


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Devaluation Example

India, following the U.K. devalued her currency

in terms of the dollar in September 1949. Her trade balance had been very unfavourable.

There used to be a big gap between her

exports and imports. After the devaluation, however, her balance of

payments was set right.

In June 1966, again, India had to devalue therupee. This resulted in some improvement inthe balance of payments position.

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Obj ti f D l ti


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Objectives of Devaluation

1. Correction of Balance of Payments: when the

country is faced with chronic deficit in thebalance of payments, it becomes essential forher to devalue her currency. The purpose is toeliminate the deficit in BOP completely or reduce

it to the maximum possible extent.

2. Prevention of dumping: It means that preventingthe sale of a product by one country in another

country at a price lower than its cost ofproduction. A country dumping goods wants tocapture the market and thus in the beginning itsells at almost throw-away prices.

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Merits of De al ation


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Merits of Devaluation

1. Lowers external value: Devaluation of currency

implies lowering of external value of currencyagainst foreign exchange as a deliberate policyadopted by the government or the monetaryauthority under exchange control system.

2. More evasion of foreign exchange: Devaluationprovides more and more evasion of foreignexchange to black marketing of foreign exchanges

due to the smuggling of restricted importedgoods, which makes foreign exchange controldifficult.

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Limitations of Devaluation


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Limitations of Devaluation

1. Elasticity of supply & demand: The policy of

devaluation is likely to get successful only whenthe elasticity of supply & demand are morethan one. This situation is rarely foundespecially in a country like India.

2. Devaluation is limited: The effectiveness ofpolicy of devaluation is limited when thedemand for imported goods is inelastic. It

implies that even though prices of importedgoods may go up, demand may not get reducedto extent of devaluation of rupee.

Chapter 3_International Trade

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