Economics /Grade 12 TOPIC 4 Notes Nkangala District/2024

ECONOMICS NOTES
TOPIC 4: INTERNATIONAL TRADE
GRADE: 12

YEAR: 2024

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 Economics /Grade 12 TOPIC 4 Notes Nkangala District/2024

TOPIC 4: INTERNATIONAL TRADE

International trade involves importing and exporting goods and services across countries.

REASONS FOR INTERNATIONAL TRADE (possible essay)

- There are two main reasons for international trade namely, demand reasons and
supply reasons.

Demand reasons
 Size of population
 An increase in population creates a need for more goods and services.
 Local suppliers may not able to satisfy the needs and wants for the growing population.
 As a result, members of the population can import some of the goods and services from
other countries.
 Income levels
 An increase in people`s income often increases the demand for goods and services.
 This can also result in the demand for goods and services, some of which may not be
produced locally.
 This means such goods should be imported to satisfy such demand
 Change in the wealth of the population
 An increase in wealth of the population leads to greater demand for goods and services.
 People who have access to more money can spend more on luxury goods.
 Countries that cannot supply these luxury goods often import them.
 Preferences and taste
 Tastes and preferences differ from person to person.
 People need a variety of goods and services.
 If some goods and services are not available in their home country, international trade
will develop as such goods will be imported.

 The difference in consumption patterns

 Consumption patterns differ from country to country.
 People in well-developed countries have a higher demand for luxury goods some of
which they can easily buy even from other countries.
 Poor people in all countries have a high demand for basic goods and services, and those
not available locally can also be imported.

Supply reasons
 Natural resources
 Natural resources are not evenly distributed across the earth.
 They vary from country to country and can only be exploited in places where there are
such resources.
 Each country has its own unique mix of natural resources that makes it possible for them
to produce certain goods and services more efficiently and at a relatively lower price.

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 Economics /Grade 12 TOPIC 4 Notes Nkangala District/2024

 If a country without a particular natural resource needs that resource it has to import the
resource from the country that has it e.g. South Africa export its minerals but has to import
oil because it has no oil wells.
 Climatic conditions
 Countries have different climates and certain crops can only grow in certain climatic
conditions.
 Some countries cannot grow agricultural products that they need, as a result, those
countries have to import these products from countries that can grow them abundantly. For
example, Brazil is one of the big producers of coffee due to its tropical climate, South
Africans are importers of coffee.
 Labour resources
 The quality, quantity, and cost of labour also differ between countries.
 Some countries have highly skilled labour with high productivity rates.
 This enables them to produce goods and services at a lower price than they are produced
in other countries.
 Certain individuals have greater ability and aptitude for certain tasks.
 It is a worldwide phenomenon that some countries have developed a skill and aptitude for
the production of certain commodities, for example, The Swiss are known for watch-
making.
 Capital
 In some countries capital is more easily available than in others.
 Developed countries usually enjoy an advantage over underdeveloped countries.
 Due to a lack of capital some countries cannot produce all the goods they require.
 In many developing countries there is a lack of physical infrastructure and this hampers
local production of goods and services.

 Specialisation
 Some countries specialise in the production of certain goods and services.
 By specialising in the production of certain goods and services, a country is able to take
advantage of economies of scale and therefore produce the goods at a comparatively
cheaper unit cost, for example, Japan has specialised in the production of certain electronic
goods and they sell such goods at a much lower price than they can be produced in other
countries.
 This often results in mass production because of division of labour automation and
mechanisation.
 Cost differences occur because goods and services can be produced at lower costs in one
country than another because of the theory of comparative advantage.
 Technological resources
 Some countries have access to technological resources that enable them to produce
certain goods and services at a low unit cost.
 Improved production processes, the availability of equipment and m achinery, and other
technological factors all influence the supply of goods and services and thereby contribute to
cost differences between countries.
 E.g. Japan has been producing more of electronic products because they have good
technology for such production.

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 Economics /Grade 12 TOPIC 4 Notes Nkangala District/2024

EFFECTS OF INTERNATIONAL TRADE

 Specialisation
 International trade enables countries to specialise in producing goods and services in
which they have comparative advantage.
 Specialisation allow a country to produce for the local and export market.
 The revenue earned from such exports is used to pay for imports.

 Mass production / increase in production

 Firms produce goods and services in larger quantities in order to satisfy local and
international demand.
 Mass production has an advantage of reducing production costs, therefore leading to
high profits.

 Efficiency
 International trade increases competition among producers.
 For firms to compete successfully they have to be efficient by eliminating (removing)
wastage of resources.
 This efficiency can lead to lower costs of production.
 Therefore, consumers can benefit by paying lower prices.

 Greater variety of goods and services

 Consumers have access to goods and services produced in other countries.
 This allows consumers to choose products that suit their taste better.

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 Economics /Grade 12 TOPIC 4 Notes Nkangala District/2024

BALANCE OF PAYMENTS
 Balance of Payment is a country’s systematic record of transactions with the rest of
the world over a specific period.
 It consists of THREE main accounts/components namely: current account, financial
account and the capital transfer account.

There are 3 components of the BOP (see the 2021 examination guideline)

1. CURRENT ACCOUNT
Merchandise exports
+ Net gold exports
+ Services receipts
+ Income receipts
(-) Merchandise imports
(- ) Payment for services
(-) Income payments
Current transfers (net receipts)
Balance on Current Account
Memo item: trade balance
2. CAPITAL TRANSFER ACCOUNT

NET LENDING TO (+) OR BORROWING FROM (-) REST OF THE

WORLD

3. FINANCIAL ACCOUNT
Net direct investment
Net portfolio investment
Net financial derivatives
Net other investments
Reserve assets
Balance on financial account
Memo item: balance on financial account excluding reserve assets
Unrecorded transactions
Memo item: Balance on financial account excluding reserve assets including
unrecorded transactions

1. CURRENT ACCOUNT
 It is a component that records transaction related to production, income and expenditure.
 Merchandise (goods) exports and merchandise (goods) imports: record transaction
on all visible goods (raw materials and intermediate goods, final goods) that South Africa
export and import.
 Net gold export: shows the record of the income earned from the exportation of gold.
While gold is a physical good it is recorded separately because of the high amount of

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money that it earns as an individual product; and South Africa relies heavily on it as an
earner of income.
 Services: record money earned or spend on services such as insurance, transportation,
recreational, professional.
 Income: Income earned by South African citizens from non- citizens and vice versa (non
-South African citizens earning income from South African).
 It consists of two components which are compensation of employees e.g. salaries and
wages and investment income e.g. dividends and profits.
 Current transfer (net): Items transferred from residents to non-residents (and vice-
versa) without any counter-performance required e.g. gifts/donations.

 CURRENT ACCOUNT

2019 2020

Merchandise exports 1 235 964 1 286 047

Net Gold exports 67191 108 299

Service receipt 212 721 121 073

Income receipt 116 781 122 120

(Less) merchandise imports 1 263 824 1 109 459

(Less) service payments 226 494 160 422

(Less) income payment 259 944 216 319

Current transfers (net) -35 561 43 135

Balance on current account -153 166 194474

Memo item: trade balance 39 331 ?

 A negative balance on the current account indicates a deficit in the account. This means
the money outflow (capital outflow) was higher than the money (capital) inflow.
 A positive balance indicates a surplus which means money inflows was higher than money
outflows.

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1.1 Trade account

 It is part of the current account that reflects the transactions involving exports and imports
of goods (merchandise) only.
 This means only merchandise exports; net gold exports and merchandise imports are
part of trade account.
 The trade balance is obtained by subtracting merchandise imports from the sum total of
merchandise export and net gold exports.

TRADE ACCOUNT 2019 2020

Merchandise exports 1 235 964 ?

Net gold exports 67 191 ?

(Less) merchandise imports 1 263 824 ?

Trade balance 39 331 ?

 A surplus balance indicates that South Africa exported more physical goods than it
imported.

2. CAPITAL TRANSFER ACCOUNT

 It contains small amounts that move between countries as a result of the transfer of fixed
assets and also grants of money from a foreign charity and money that migrants move.
 For example, when a foreign foundation gives a grant for HIV research, it is a transfer
receipt (inflow). When a South African emigrates to Australia, the money she/he takes
out of the country is a transfer payment (outflow).

3. FINANCIAL ACCCOUNT
The financial account consists of the following sub-accounts:
[Link] investments
 An investment in fixed property in a foreign country or the acquisition of a significant
share (10 %+) in a business in a foreign country.
 In cases where an individual acquires more than 50% of the business the aim of the
investment is to take control of such a business.
 The investments into South Africa by foreigners represents incurrence of liability by
South Africa. However, it (liability) is recorded as a credit (+) because money enters the
country (it is a money inflow)
 Investment by South Africans in foreign countries e.g. buying of 10% or more of shares
in a company in foreign country represents acquisition of asset.
 However, it (asset) is recorded as a debit (-) because money leaves the country for that
investment to take place (it is a money outflow).
 The difference between the assets and liabilities represents Net direct investments.

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3.2. Portfolio investment.

 The purchase of financial assets such as equity security assets e.g. minority shares on
a stock market of another country. The percentage of such share is very small and the
aim is just to make more money (unlike in the case of direct investment where the aim of
buying shares is to get control of the business). Portfolio investments are regarded as
“hot money” because they can be quickly converted into cash.
 People can also invest in debt security assets such government bond. Government
bond involve government borrowing money from people over a period of time.
 The investor then earn interest which will periodically be paid into his/her account while
the principal amount invested is still with the borrower (government). At the end of the
term the government will pay back the initial amount invested to the investor (buy back
the bond).
 These assets are recorded as debits when south Africans invest in other countries while
they are recorded as credit when other countries citizens invest in South Africa i.e.
incurrence of liabilities represents money inflow and acquisition of financial assets
represents money out flow.
 Financial derivatives
 An investment made in a specific asset with a fixed future value that is paid out on a
specific date.
 Other investment
 Transactions that do not fall under direct, portfolio and financial derivatives, are classified
as other investments e.g. short term loans
 Reserve assets
 Financial capital held by the monetary authorities such as the central bank to finance the
trading disequilibrium.
 Reserve assets includes foreign currency that is held by the SARB.

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FINANCIAL ACCOUNT 2014 2015

Net direct investments (inflows (+) , outflows (-) [1] -20 607 ?
(Net incurrence of) liabilities 62 627 22 065
(Net acquisition of financial) assets -83 234 -73 282
Net portfolio investments [2] 49 132 69 568
(Net incurrence of) liabilities 73 386 ?
Equity securities 26 826 89 824
Debt securities 46 560 16 189
(Net acquisition of ) assets -24 254 ?
Equity securities
-14 721 -17768
Debt security
- 9 533 -18677
Net financial derivatives [3] 16 409 ?
(Net incurrence of) liabilities 211 251 325 738
(Net acquisition of) assets -194 842 -320 856
Net other investments [4] 121 821 ?
(Net incurrence of) liabilities 148 133 72 273
(Net acquisition of) assets - 26 312 - 46 769
Reserve assets (decrease (-) increase (+) [5] -16 602 9071

BALANCE ON FINANCIAL ACCOUNT (1 +2+ 3+ 4+ 5) 150153 160 242

Memo item: Balance on financial account excluding reserve assets 166 755 ?
(1 +2 +3 +4)

Un recorded transactions 51 298 22 709

Memo item: Balance on financial account excluding reserve assets
including unrecorded transactions (1 +2 +3 +4 +6) 218 053 ?

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 Economics /Grade 12 TOPIC 4 Notes Nkangala District/2024

UNIT 3: FOREIGN EXCHANGE MARKETS

Foreign exchange
 Foreign exchange market is the market in which currencies are bought and sold.
 Foreign exchange is the process of changing one currency by another country’s
currency.
 Exchange rate is the price of a country’s currency in terms of another country’s
currency
 Exchange rate can be quoted as the domestic price of one unit of a foreign currency
e.g. $1 = R14.00 (direct quote).
 It can also be quoted as the foreign price of the domestic currency e.g. R1 = 0.07
(indirect quote).

NATURE OF DEMAND AND SUPPLY OF CURRENCIES

 The market forces of demand and supply determines the value of a currency.
 The higher the price of a currency the lower the demand tend to be but, the higher
the price of a currency the higher the supply tend to be. This shows that the law of
demand and the law of supply also appl with currency trading.

Reasons for the demand of foreign exchange by South Africa

 Payments for imports.
 Payment for services received from foreign countries.
 Payment of interest and dividends on foreign capital invested in South Africa.
 Repayments of overseas loans.
 Transferring capital to foreign countries.
 South African spending money in foreign countries e.g. tourism

 Reasons for the supply of foreign exchange by South Africa / (South Africa
supplying its currency to foreign countries)

 Receiving earnings for goods exported

 Receiving earnings for services rendered to foreign countries
 Receiving interest and dividends on capital invested in foreign countries.
 Repayment by foreign countries on loans made in South Africa.
 Investments made by foreign countries
 Foreign tourists’ spending money in South Africa.

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THE DETERMINATION OF THE EXCHANGE RATE

D S
Excess supply of dollars
Exchange rate

$1 =14

$1=12

$1 = 10
E Excess demand for
dollars
S D

100

Quantity of dollars in billions

 The exchange rate is determined by the market forces of demand and supply.
 The interaction of demand and supply sets the equilibrium exchange rate at $1 = R12
 At any exchange rate above the market equilibrium exchange rate e.g. $1 =R14 there
will be excess supply of dollars.
 At an exchange rate below the market exchange rate e.g. ($1 = R10) there will be
excess demand for dollars.

APPRECIATION AND DEPRECIATION OF A CURRENCY

Appreciation: is the increase in the value of a currency because of market forces.
 If the dollar appreciates against the rand, it means South Africans need more rands
than before to buy one dollar.
Depreciation: is the decrease in the value of a currency due to market forces of
demand and supply.
 If the dollar depreciates against the rand, it means South Africans will need fewer
rands than before to buy one dollar

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INCREASE IN DEMAND FOR DOLLARS

D1 S
D

$1 =R14

$1 = R12

D1
S
D

100 120

Quantity of dollars in billions

 An increase in the demand for dollars causes the demand curve to shift to D1D1 and
a new equilibrium exchange rate of $1 = R14 is reached.
 This means the dollar appreciated (increased in value) while the rand has depreciated
(decreased in value). South Africans need to pay R2 more for a dollar while Americans
receives R2 more for their dollar than before.

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INCREASE IN SUPPLY OF DOLLARS

S1

$1 =R12
$1 = R10

100 120

Quantity of dollars (billions)

 An increase in supply of dollars will result in the supply curve shifting to S1S1.
 The new equilibrium exchange rate of $1 = R10 is reached. At this point the dollar has
depreciated and the rand has appreciated.
 Depreciation of the dollar means that the amount needed to buy a dollar has
decreased by R2.
 The equilibrium quantity of dollars traded increases from 100 to 120 billion.

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EXCHANGE RATE SYSTEM

There are three types of exchange rates namely:

 Free floating exchange rate system

 The value of the currency is determined purely by the forces of the market, which are
the demand and supply of the currency
 South Africa uses the free-floating exchange rate system which means the reserve
bank does not intervene to influence the value of the currency.

 Managed floating exchange rate system

- The value of the currency is determined by the market forces of demand and supply
up to a certain limit that is set by the central bank.
- If the currency depreciates too much, the central banks of those countries often
intervene by buying their own currencies in the foreign exchange market. This help to
increase the demand for the currency and therefore the currency will appreciate.
- If the local currency appreciates too much, the central banks often sell their currency
on the foreign exchange market, therefore increasing the supply of the currency and
therefore reducing its value (depreciation).
- Majority of countries use this exchange rate system as very few countries have free
floating or fixed exchange rates.

 Fixed exchange rate system

 The value of the currency is fixed or pegged to another country’s currency usually the
US dollar.
 This is often to avoid uncertainties with regard to exchange rates.
 If the government decide the amount of its currency that will be equal to one dollar.
 The government of these countries can increase the value of its currency when it sees
fit and this is called revaluation.
 When the government feel that their currency is too strong it can decide to decrease
its value, and this is called devaluation.

TERMS OF TRADE

 Another important indicator of how a country is performing in international trade is an

index called terms of trade.
 Terms of trade is the ratio of index export prices to index import prices.
 This shows whether the country can afford to pay for its imported goods with the
amount of money earned from its exports over the same period. Every country aims
for index of export prices to be more than index of import prices.

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 Formula = index of export prices x 100

Index of imports prices

Year Index of Index of imports Terms of trade

exports
2005 100 100 100 ÷100 x 100 = 100 (1)
2010 105 101 105 ÷ 101 x 100 = 104
*year x 95 102 95 ÷ 102 x 100 = 93
*year x is used for example purposes only to show a situation where export prices are lower than
import prices.

 In the above example in 2005, the terms of trade indicate that the country ‘s earnings
from exports were exactly the same as what it paid for its imports (no improvement, no
deterioration/ no decline in welfare)
 In 2010, the country’s situation improved, because it earned more money from its exports
than what it paid for its imports (improvement in welfare)
 In year X, the terms of trade indicate a decrease in welfare as the amount of money
earned from exports was less than the amount paid for exports (decline in welfare/
decrease in standard of living)

CORRECTION OF BALANCE OF PAYMENT DISEQUILIBRIUM

The following measures can be used to correct the deficit on the balance of payment.
 Interest rates
 Domestic demand can be changed by increasing the interest rates payable on credit.
 If interest rates are increased, spending including on imports can decrease.
 Foreign savers often try to take advantage by increasing their investment in the country
with the higher interest rate. This will result in money inflow, therefore reducing the deficit
on the BoP.
 Borrowing and lending
 Countries with surpluses often lend money to countries with deficits.
 Countries with deficits often borrow from countries with surpluses.
 In the event of fundamental disequilibrium, member countries may borrow from the IMF
 Borrowing is nevertheless not a long-term solution for a fundamental balance of
payments disequilibrium.
 Fundamental disequilibrium is when the disequilibrium especially the deficit is persistent
and long-term with no indication of it ending.

 Change in demand
 Change in demand is either domestic or foreign
 An increase in domestic demand cause imports to increase and this has a negative effect
on the balance of the Balance of Payments.

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 A decrease in domestic demand can reduce even the demand on imports. This can
reduce the deficit on the Balance of Payment.

 Export promotion
 Export promotion is applied to encourage the production of goods that can be exported,
 Exports result in money inflow, and this can reduce the deficit on the Balance of payment.

 Import substitution
 Government pays incentives to produce goods domestically rather than to import them.
 This can result in less money flowing out of the country, therefore reducing the deficit on
BoP.

 Change in exchange rates

 The three systems of controlling exchange rates have different effects:
 Free-floating exchange rates. They work automatically. If imports increase, the
demand for foreign exchange increases. The currency depreciates as a result of the
working of market forces. Depreciation makes imports more expensive in the
depreciating country and exports cheaper in the foreign country. Imports decrease and
exports increase, and the currency appreciates.
 Managed floating exchange rate. Central banks use their reserves to effect
depreciations and appreciations. Over the long term, currencies have to find their
equilibrium levels.

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