CHAPTER 7

INTERNATIONAL TRADE

The world has a long, rich history of international trade among nations that can be
traced back to early Assyrian, Babylonian, Egyptian, and even Phoenician civilizations. These
and other early civilizations recognized that trade can be tied directly to an improved quality of
life for the citizens of all trading partners. Today, the practice of trade among nations is growing
by leaps and bounds. There is hardly a person on earth who has not been influenced in some
way by the growing trade among nations.

Why International Trade?

International Trade is exchange of goods and services that is conducted beyond the
political boundaries of a country. It constitutes a vital element of international economics. The
proper allocation and efficient use of scarce resources are the fundamental activities of
economics. These do not apply to the operations of the national economy but also to the
international economy.

One of the most logical questions to ask is, why do industrialized countries trade with
one another? Some countries are deficient in critical raw materials such as coconut or gadgets.
To make up for these various deficiencies, countries must engage in international trade to
obtain the resources necessary to produce goods and services desired by their citizens. In
addition to trading for raw materials, nations also exchange a wide variety of processed food
and even finished products. Each country has its own specialties that are based on its economy
and the skills of its citizens.

Benefits of International Trade

1. Increases consumers’ satisfaction. When we talk of international trade means international

competition. The best goods and services are winners in the world markets. Those with the
lowest price and with best quality are in great demand.

2. Improves standard of living. People are given the chance to purchase all the goods and
services that money can purchase. With the presence of different goods and services coming all
parts of the world, people definitely enjoy a very comfortable and convenient life. Say for
examples, the best mentors, physicians, engineers, laptops, microwaves, cinematographic films,
gadgets, among other things, are available to people for their education, health care, recreation
and enjoyment.
3. Promotes product specialization. There is a very keen competition in the world markets,
particularly among less developed countries. To survive market competition, the best option is
to specialize in the production of goods and services based on natural comparative advantages.

4. Accelerates economic development. These benefits apply for the less developed countries.
These countries need better machines and proper technologies for their development projects,
like irrigation, communication, transportation, electrification and even industrialization. they
acquire these inputs for development from the industrialized countries like the Qatar,
Singapore, United States and those in Western Europe. As a matter of fact, we cannot even
produce rice, corn and other agricultural products without imported inputs like insecticides,
fertilizers and even pesticides.

5. Generates foreign exchange earnings. To a less developed countries like our country
Philippines, the availability of sufficient foreign exchange is significant for the attainment of
economic stability and growth. Foreign exchange, like dollars, marks, yens, pound sterling as
well francs, are used to import equipment, machines, oil products and other industrial
materials for our farms and factories.

6. Stimulates production. A profitable and large market is the best incentive for production.
People do not produce on a commercial scale if there are buyers for their products. To prove,
the existence of foreign markets encourages more local production of goods and services. Like
for example, we export raw materials and agricultural products to other countries, mostly the
industrial countries.

Bases of International Trade

Nations trade with one another for the same basic reasons that individuals engage in
the exchange of goods and services. The consumers, it is for maximum satisfaction while to
business, it is for maximum profit. They purchase from a place with the lowest price and sell to
another place with the highest price. Some of the more important determinants of
international trade:

1. Technological differences. All other things being equal, a country with a better technology
has definitely an advantage in production. Such technology helps a given business enterprises in
terms of lower unit cost, better quality and greater volume of output. This is a plus factor in
international trade.

2. Price differences. Countries with lower prices attract importers while countries with higher
prices attract exporters. For example, if the price of bananas is cheaper in Mexico, then
countries without bananas buy such fruits from Mexico. If the price of sugar is higher in
Malaysia than in the Singapore, it is better for the Philippines to export sugar to Malaysia.
Market price is a product of demand and supply relationship.

3. Distribution of natural resources. When a top Japanese government official saw the vast
natural resources of the Australia, he said that God was unfair. Japan is extremely very poor in
natural resources. Because of geographic differences, countries do not have the same natural
resources. Our own country is very rich in natural resources which are suitable for agricultural
production.

THEORY OF COMPARATIVE ADVANTAGE

Comparative Advantage refers to the ability of a party to produce a particular good or

service at a lower marginal and opportunity cost over another. Even if one country is more
efficient in the production of all goods (absolute advantage in all goods) than the other, both
countries will still gain by trading with each other, as long as they have different relative
efficiencies.
For example, if, using machinery, a worker in one country can produce both pants and shirts at
8 per hour, and a worker in a country with less machinery can produce either 2 pants or 4 shirts
in an hour, each country can gain from trade because their internal trade-offs between pants
and shirts are different. The less-efficient country has a comparative advantage in shirts, so it
finds it more efficient to produce shirts and trade them to the more-efficient country for pants.
Without trade, its opportunity cost per pants was 2 shirts; by trading, its cost per pants can
reduce to as low as 1 shirt depending on how much trade occurs (since the more-efficient
country has a 1:1 trade-off). The more-efficient country has a comparative advantage in pants,
so it can gain in efficiency by moving some workers from shirt-production to pants-production
and trading some pants for shirts. Without trade, its cost to make a shirt was 1 pant; by trading,
its cost per shirt can go as low as 1/2 pants depending on how much trade occurs.
Forms of Trade Protection

Protection refers to an advantage given to domestic producers in competing against

foreign goods in the domestic market.

1. Quotas. It refers to a quantitative restriction in limiting imports of a particular product to a

specified number of units, or to a certain value in a given period of time.

2. Tariffs. It refers to a tax imposed on imports as they enter a country. It is commonly levied as
a specified as valorem percentage of the value of imports.

3. State trading. Governments, especially those with socialist and communist economies,
sometime grant monopoly importing rights to state enterprises. Thus, private companies
cannot import goods.
4. Exchange controls. The Bangko Sentral ng Pilipinas restricts the sale of foreign exchange like
for example US dollars to importers. Only those with permission from the BSP to buy foreign
exchange have the ability to import.

5. Government regulations. These constitute a sort of protection for the domestic protection
for the domestic products. Safety and health standards for imported goods are an example of
government regulation.

PHILIPPINE EXPORT-IMPORT POLICY GUIDELINES

Classification of Imports

Before any importation into the Philippines can be made; the particular item or sub-item is
identified within the Philippine Standard Commodity Classification Manual (PSCM) as to where
the imported goods belong to. This commodity classification is the general basis for
determining whether the item is freely importable, prohibited, or regulated.

a. Freely Importable. These are commodities, which importation is neither regulated nor
prohibited. The importation may be effected without prior approval of or clearance from any
government agency.

b. Regulated Commodities. These are commodities which importation requires

clearances/permits from appropriate government gencies including the Bangko Sentral ng
Pilipinas (BSP).

c. Prohibited or Banned. These are commodities which importation is not allowed under the
existing laws.

Absolutely Prohibited:

 Those specifically listed under Section 101 of the Tariff and Customs Code of the
Philippines
 Used Clothing and Rags under Republic Act (RA) 4653, dated 06 June 1966
 Toy Guns under LOI 1264, dated 31 July 1982
 Right-Hand Drive Vehicles under RA 8506 dated 13 February 1998
 Laundry and Industrial Detergents containing hard surfactants under RA 8970 dated 31
October 2000

Conditionally Prohibited:

 Ammunitions, firearms
 Cinematographic films, photographs, paintings, drawings or other representation of any
obscene/immoral character
 Heroin or other synthetic drugs
 LETTER OF CREDIT

Letter of Credit is a letter from a bank guaranteeing that a buyer's payment to a seller
will be received on time and for the correct amount. In the event that the buyer is unable to
make payment on the purchase, the bank will be required to cover the full or remaining
amount of the purchase.

Letter of Credit, simply defined, is a written instrument issued by a bank at the request
of its customer, the Importer (Buyer), whereby the bank promises to pay the Exporter
(Beneficiary) for goods or services, provided that the Exporter presents all documents called
for, exactly as stipulated in the Letter of Credit, and meet all other terms and conditions set out
in the Letter of Credit. A Letter of Credit is also commonly referred to as a Documentary Credit.

NO DOLLAR IMPORT

No Dollar Import is a special privilege given by the government to returning residents and
other qualified individuals to bring motor vehicles into the country for personal use under
certain conditions.

A. Basic Requirements

Importer

 Has resided abroad for at least one (1) year (accumulated within 3 year period of his/her
stay abroad up to the date of filing of the application)
 Immigrants holding 13g or 13a visa or Dual Citizen
 SRR Visa Holder under the Philippine Retirement Act
 47(a)(2) Visa Holder under the Balik-Scientist Program

Motor Vehicle

 Left Hand Drive

 Not to exceed 3,000 kgs GVW
 Registered under the name of the qualified importer for at least six (6) months prior to
the submission of the application to the Bureau of Import Services (BIS)
 Certificate of Emission Compliance (CEC) from country of origin duly authenticated by
the Philippine Embassy abroad (under CAA RA 8749)

B. Documentary Requirements
For Philippine Passport Holders

 Completely filled-out and notarized BIS Application Form

 Completely filled-out and notarized Affidavit of Undertaking
 1 copy of 2X2 picture with signature
 Original or authenticated copy of complete pages of old and new passport (for time
period refer to I.A.1)
 Original or authenticated copy of Car Title or Registration with English translation if
necessary
 Processing fee of One Thousand Five Hundred Pesos (P1,500.00) for cars and Nine
Hundred Pesos (P 900.00) for motorcycle

Methods of Payment in International Trade

To succeed in today’s global marketplace and win sales against foreign competitors, exporters
must offer their customers attractive sales terms supported by the appropriate payment
methods. Because getting paid in full and on time is the ultimate goal for each export sale, an
appropriate payment method must be chosen carefully to minimize the payment risk while also
accommodating the needs of the buyer. As shown in figure 1, there are five primary methods of
payment for international transactions. During or before contract negotiations, you should
consider which method in the figure is mutually desirable for you and your customer.
New Payment Risk Diagram – To Be Created by Designer

Least Secure Less Secure More Secure Most Secure

Exporter Consignment Open Documentary Letters of Cash-in-

Account Collections Credit Advance

Importer Cash-in- Letters of Documentary Open Consignment

Advance Credit Collections Account

FOREIGN EXCHANGE MARKET

The exchange of one currency for another or the conversion of one currency into another
currency. Foreign exchange also refers to the global market where currencies are traded
virtually around-the-clock. The term foreign exchange is usually abbreviated as "forex".

The markets, in which participants are able to buy, sell exchange and speculate on currencies.
Foreign exchange markets are made up of banks, commercial companies, central banks,
investment management firms, hedge funds, and retail forex brokers and investors. The forex
market is considered to be the largest financial market in the world.

The Bangko Sentral ng Pilipinas (BSP) maintains a floating exchange rate system. Exchange rates
are determined on the basis of supply and demand in the foreign exchange market. The role of
the BSP in the foreign exchange market is principally to ensure orderly conditions in the market.
The market-determination of the exchange rate is consistent with the Government’s
commitment to market-oriented reforms and outward-looking strategies of achieving
competitiveness through price stability and efficiency.

Exchange Rates and Supply and Demand

4.2 Supply and Demand

Prices of goods, commodities and exchange rates are determined on open markets under the
control of two forces, supply and demand.

The laws of supply and demand show that:

 High supply causes low prices, and high demand causes high prices.
 When there is an abundant supply of a given commodity then the price should fall.
 When there is a scarce supply of a given commodity then the price should increase.
 Therefore, an increase in the demand for a commodity would cause it to appreciate in value,
whereas an increase in supply would cause it to depreciate.

The value of a nation’s currency, under a floating exchange rate, is determined by the
interaction of supply and demand. We will work through some charts and an example to show
how these forces work, from a theoretical point of view.

Demand Curve
Figure 1 shows the demand for Philippine peso in the United States. The curve is a normal
downward sloping demand curve, indicating that as the peso depreciates relative to the dollar,
the quantity of peso demanded by Americans increases. Note that we are measuring the price
of the peso-the exchange rate-on the vertical axis. Since it is dollars per peso (US$/Php), it is the
price of a peso in terms of dollars and an increase in the exchange rate, R, is a decline in the
value of the dollar. In other words, movements up the vertical axis represent an increase in
price of the peso, which is equivalent to a fall in the price of the dollar. Similarly, movements
down the vertical axis represent a decrease in the price of the peso.

For Americans, Philippine goods are less expensive when the peso is cheaper and the dollar is
stronger. At depreciated values for the peso, Americans will switch from American-made or
third-party suppliers of goods and services to Filipino suppliers. Before they can purchase goods
made in Philippines, they must exchange dollars for Philippine peso. Consequently, the
increased demand for Philippine goods is simultaneously an increase in the quantity of
Philippine peso demanded.

Supply Curve

Figure 2 shows the supply side of the picture. The supply curve slopes up because Filipino firms
and consumers are willing to buy a greater quantity of American goods as the dollar becomes
cheaper (i.e. they receive more dollars per peso). Before Filipino customers can buy American
goods, however, they must first convert peso into dollars, so the increase in the quantity of
American goods demanded is simultaneously an increase in the quantity of foreign currency
supplied to the United States.
Equilibrium Price

Suppliers and consumers meet at a particular quantity and price at which they are both
satisfied. Figure 3 combines the supply and demand curves. The intersection determines the
market exchange rate and the quantity of dollars supplied to United States. At the exchange
rate R, the demand and supply of Philippine peso to the United States is Q.

This is known as the equilibrium or the market’s clearing point.

Changes in Demand and Supply

In figure 4, an increase in the US demand for the peso (rightward shift of the demand curve)
causes a rise in the exchange rate, an appreciation in the peso, and depreciation in the dollar.
Conversely, a fall in demand would shift the demand curve left and lead to a falling peso and
rising dollar. On the supply side, an increase in the supply of peso to the US market (supply
curve shifts right) is illustrated in Figure 5, where a new intersection for supply and demand
occurs at a lower exchange rate and an appreciated dollar. A decrease in the supply of peso
shifts the curve leftward, causing the exchange rate to rise and the dollar to depreciate.
Increase in Demand Increase in Supply.
When the forces between supply and demand change, the market moves in ways to clear itself
through a change in price.

In international finance markets, if many investors are selling a particular currency, they are
making it more readily available and increasing its supply. If there is not an equal amount of
buyers, or demand, for that currency, its price will go down in order to strike a new balance
between supply and demand.

The direction in which the value of a currency is heading can cause cash to flow into or out of
that currency. A currency that is appreciating can cause money to flow into its country’s assets
as investors and Forex traders want to benefit from buying or taking “long” positions on the
currency as the currency’s price rises.

BALANCE OF PAYMENTS

Balance of payments (BoP) accounts are an accounting record of all monetary transactions
between a country and the rest of the world.[1] These transactions include payments for the
country's exports and imports of goods, services, financial capital, and financial transfers. The
BOP accounts summarize international transactions for a specific period, usually a year, and are
prepared in a single currency, typically the domestic currency for the country concerned.
Sources of funds for a nation, such as exports or the receipts of loans and investments, are
recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign
countries, are recorded as negative or deficit items.

When all components of the BOP accounts are included they must sum to zero with no overall
surplus or deficit. For example, if a country is importing more than it exports, its trade balance
will be in deficit, but the shortfall will have to be counterbalanced in other ways – such as by
funds earned from its foreign investments, by running down central bank reserves or by
receiving loans from other countries.
 CHAPTER EXERCISES

Name: ___________________________ Score:_________________

Course/Year/Section: ________________ Schedule: ______________

I- Multiple Choice: Read the following statements carefully and select the correct answer from
among the alternatives given. Write only the letter/s on the space provided before each
number.

1. It refers to a quantitative restriction in limiting imports of a particular product to a specified

number of units, or to a certain value in a given period of time.
A. Tariff C. Quota
B. State Trading D. Government Regulation
2. It is a letter from a bank guaranteeing that a buyer's payment to a seller will be received on
time and for the correct amount.
A. Letter of Credit C. Sales Invoice
B. Official Receipt D. Collection Receipt
3. It refers to a tax imposed on imports as they enter a country. It is commonly levied as
specified as valorem percentage of the value of imports.
A. Prohibited Import C. Quota
B. Tariff D. Excise Tax
4. It is a special privilege given by the government to returning residents and other qualified
individuals to bring motor vehicles into the country for personal use under certain conditions.
A. No Dollar Import C. Prohibited Import
B. Anti-Dumping Duty D. Countervailing Duty
5. It is an exchange of goods and services that is conducted beyond the political boundaries of
a country. It constitutes a vital element of international economics.
A. Trade C. International Trade
B. Domestic Trade D. State Trading
6. It restricts the sale of foreign exchange like for example US dollars to importers. Only those
with permission from the BSP to buy foreign exchange have the ability to import.
A. International Monetary Fund C. World Bank
B. Bureau of Customs D. Bangko Sentral ng Pilipinas
7. It refers to the ability of a party to produce a particular good or service at a
lower marginal and opportunity cost over another.
A. Comparative Advantage C. Bill of Lading
B. Efficiency D. Productivity
8. It constitutes a sort of protection for the domestic protection for the domestic products like
Safety and health standards for imported goods.
A. Import Prohibition C. Government Regulation
B. Quota D. Tariff
9. It is a form of trade protection especially those with socialist and communist economies,
sometime grant monopoly importing rights to state enterprises. Thus, private companies
cannot import goods.
A. Government Regulation B. State Trading
B. Import Prohibition D. Anti-Dumping Duty
10. It is a classification of import wherein importation requires clearances/permits from
appropriate government agencies including the Bangko Sentral ng Pilipinas (BSP).
A. Freely Importable Import C. Liberalized Import
C. Regulated Import D. Prohibited Import

II- ESSAY
Answer the following questions: (10 pts. each)

1. Are you in favor of free trade in the Philippines? Why or Why not? Prove your stand.

2. How does a nation solve its balance of payments problems?

3. In your own point of view, what happens to a country which excludes itself from
international trade?