Section 4: Test Reflection

In my response graded by Ms. Q, I had my ideas layed out and was able to say what I wanted to say, but it seems like I had a lot of generalizations. Because of that, it made my response more confusing to understand. Also the lack of explanation of some of the concepts/ideas/examples I used was a disadvantage for me and it is there that I lost points. I think that as long as I know these concepts well and can analyze situations given to me I can do well.

Something that helped me understand my flaws and advantages with this response was the comments and advice that Ms. Q gave me. With specific comments and leading questions, I think I can edit this well, and if given on the mock or final I’ll be able to respond well. Another thing was at the end of the essay she actually answered part of the question for me and that gave me a really good understanding of it.

p.s. Thank you Ms. Q :]

☀HAITI☀

GDP per capita in Haiti is $1,200 as of 2010 according to the CIA World Factbook. Its standing is 205th in comparison to the world.

The population growth rate is 0.787% and stands at 139th in comparison to the world.

“…widespread unemployment and underemployment; more than two-thirds of the labor force do not have formal jobs.”

Exports are at $559 million as of 2010 and are ranked 163rd in comparison to the world. Export commodities are apparel, manufactures, oils, cocoa, mangoes, and coffee. Imports are at $2.446 billion as of 2010 and are ranked 146th in comparison to the world. They are in a current account deficit of $781 million as of 2010.

Explain the principle of comparative advantage and the benefits which might arise from trade

Exam Review Blog Posts

1) Demands of the question

What is comparative advantage

Benefits of free trade

Significance of trading bloc membership regarding exports

2) Definitions

Comparative Advantage for a good exists where a country is able to produce a good at a lower opportunity cost of resources than another country.

Free Trade is international trade that takes place without any barriers, such as tariffs, quotas, or subsidies.

Trading Blocs include Free Trade Areas (FTA’s), Customs Unions, Common Markets, Economic Union

3) Triple A

Free trade

International trade is based on specialisation at a national level. Countries exchange goods with others and pay for imports from the revenues received from exporting. To work effectively, this system relies on few, if any, barriers existing to interfere with ‘free trade’.

The basic principle of free trade dates back to mercantilism and fed through to the early exponents of laissez-faire economics in the seventeenth century. Amongst the most famous early writers on economics was Adam Smith, who produced his ideas on absolute advantage. This was where one country concentrated on developing those goods in which its natural resource base allowed it to produce more than any other country with given resources. Later, David Ricardo developed comparative advantage theory which suggested that a country should exchange goods with another country as long as the domestic opportunity costs were different. As a result of this, production should increase and individual consumption should rise. In essence, these two early economic observations still underpin much of what we know about international trade.

Absolute and comparative advantage

Absolute advantage exists when one country is able to produce a good more cheaply in absolute terms than another country.

Comparative advantage exists when one country is able to produce a good more cheaply, in comparison to other goods produced domestically, than another country.

Comparative advantage is a principle of economics which states that trade between two countries will be mutually beneficial as long as their domestic opportunity costs of production differ.

Comparative advantage – example

Stage 1 – opportunity cost ratios

Let’s say that there are two countries – Utopia and Happyland. These countries produce two products – hardware and software. With one unit of their resources they can each produce as shown in Table 1 below.

Table 1 Potential production – Utopia and Happyland

	Hardware (units)	Software (units)
Utopia	200	1000
Happyland	100	1500

This means that the opportunity cost ratios for each country are as follows:

Utopia – for every 1 unit of hardware they produce the opportunity cost is 5 units of software.

Happyland – for every 1 unit of hardware they produce the opportunity cost is 15 units of software.

This means that Utopia has a comparative advantage in the production of hardware as for every unit of hardware they produce they give up less software. This makes them relatively more efficient at the production of hardware.

However, this also means that Happyland has a comparative advantage in the production of software as for every unit of software they produce they only give up one fifteenth of a unit of hardware, whereas Utopia have to give up one fifth of a unit.

We can see this clearly if we plot the production possibility frontiers for the two countries.

Figure 1 PPF’s for Happyland and Utopia pre-trade

Let’s say that they choose to use half their resources on the production of each good. In this case, their consumption (pre-trade) will be as shown in table 2 below.

Table 2 Pre-trade consumption

	Hardware (units)	Software (units)
Utopia	100	500
Happyland	50	750
Total consumption	150	1250

Stage 2 – specialisation

If each country now specialises where they have a comparative advantage, then we will get production as shown in Table 3.

Table 3 Specialisation

	Hardware (units)	Software (units)
Utopia	200	0
Happyland	0	1500
Total production	200	1500

We can see straight away that world production is greater, but each country has now only produced one good and, so once they have specialised, they will want to trade to get some of the other good. The terms of trade (or exchange rate) that they trade at will be determined by the opportunity cost ratios we worked out in stage 1. The terms of trade will settle somewhere between the two opportunity cost ratios to ensure that both countries benefit.

Let’s say they settle on an exchange rate of 1 unit of hardware = 10 units of software and that they agree to trade 75 units of hardware for 750 units of software. The position now will be as shown in table 4.

	Hardware (units)	Software (units)
Utopia	125	750
Happyland	75	750
Total production	200	1500

If we now draw the pre-trade and post-trade PPF’s for each country we can clearly see as in Figure 2 below how they are better off from specialisation and trade as they can now reach higher levels of consumption of both goods than was possible before specialisation.

Figure 2 Production – post specialisation and trade

So, consumption increases through specialisation and trade compared to a situation of self-sufficiency. It remains the basic idea behind modern free trade. Despite these advantages, many countries still protect their domestic trade-why? You therefore need to know both the advantages that arise from free trade and the reasons why protectionism still exists (see section 4.2 for details on protectionism).

Limitations of comparative advantage theory

We need to be careful, as comparative advantage theory does not explain all changes in trade patterns. It is an important explanation, but you also need to take into account that:

Transport costs and tariffs will change the relative prices of goods and may therefore ‘blur’ the impact of comparative advantage.

Exchange rates do not always relate exactly to what comparative advantage theory suggests as they have many other determinants – this may also negate the theory.

Imperfect competition may lead to prices being different to opportunity cost ratios. Imperfect competition may also lead to the exploitation of economies of scale which may adjust to what comparative advantage theory suggests should happen.

Comparative advantage theory is a static theory and does not take account of some of the more dynamic elements determining world trade. In particular, the factor of production capital is not a natural resource, and so may come outside the scope of the theory.

 

5) Insert relevant PPT slides

6) Diagrams

 

7) Evaluation suggestions

Causes and Consequences, Pros and Cons, Macroeconomics goals, Short and Long Term effects.

Spain: Euro

Spain is in a deficit, and they cannot fix that because their currency is the Euro, which is the only fixed currency in the world. Although there are advantages to this single currency, there are also disadvantages. When Spain first embraced the euro, the country grew economically and there was a large inflow of money. Yet, recently it has been holding Spain back from growing even more because how Spain’s economy acts depends on how this single currency appreciates and depreciates. Consequently, there is little competition in the market and cannot deal with the problems they have independently. As seen in the article, Spain is troubled with “internal devaluation”, and this could result in greater costs for consumers and producers. Having read this article, it does not seem favorable to stick to the Euro right now.

Diagrams: International Economics

China has an absolute advantage in the production of both shoes and cloth. It can produce more of both than India with the same factor inputs. However, India has a comparative advantage in producing shoes, since they only give up 2.5 meters of cloth for each pair, whereas China gives up 4 meters of cloth. China should specialize in cloth and India in shoes

Before trade, Qe corn is produced domestically at the price of Pe. When free trade takes place Q1Q2 of corn is imported at the world price of P1, and Q1 of corn is produced domestically.

When the government gives a subsidy to domestic producers, the domestic supply curve shirts to the right from Sdomestic to Sdomestic + Subsidy. The price consumers remains the same, but imports fall from Q1Q2 to Q3Q2 and domestic production increases from Q1 to Q3.

The imposition of a tariff upon imported corn means that the price will rise from P to P + Tariff. A tariff is a tax imposed on imports and is a type of protectionism. Initially the quantity of imports from other counties was Q1Q2, but with a tariff they both shifted in and it is now Q3Q4. Initially domestic supply was 0Q1 but it has shifted to 0Q3 after the tariff was imposed. With protectionism, it allows the country (domestic) to grow economically.

Evidence around the world suggests that the Marshall-Lerner condition does not hold in the short run, but does in the medium to long run. This is because in the short run, there will be few extra exports sold when prices fall – people overseas do not react immediately and so export demand will take time to change. However, extra money will have to be paid for imports immediately and so the current account will tend to deteriorate. In the medium term however, the lower export prices will start to lead to an increase in demand for them and so the current account will start to improve. The export elasticity of demand is therefore low in the short run, but will be higher in the long run.

This diagram shows an exchange rate regime where the value of a currency is allowed to be determined solely by the demand for, and the supply of the currency on the foreign exchange market. The price in terms of Euro of pounds is at point P and the quantity of pounds is at point Q.

Appreciation is an increase in the value of one currency in terms of another currency in a floating exchange rate system. When the value of the currency increases, the price of pounds in terms of euros increases from P to P1, and the quantity of pounds increases from Q to Q1.

Depreciation is a fall in the value of one currency in terms of another currency in a floating exchange rate system. When the value of the currency decreases, the price of pounds in terms of euros decreases from P to P1, and the quantity of pounds decreases from Q to Q1.

Definitions: International Economics

Factor Endowments are the factors of production that a country has available to produce goods and services.

Specialization exists where a country specializes in the production of goods and services where they have a comparative advantage in production. They will then trade to get the goods and services in which they do not specialize.

Absolute Advantage for a good exists where a country is able to produce more output than other countries using the same inputs of factors of production.

Comparative Advantage for a good exists where a country is able to produce a good at a lower opportunity cost of resources than another country.

Free Trade is international trade that takes place without any barriers, such as tariffs, quotas, or subsidies.

Tariff is a tax that is imposed on imports to protect domestic industries from foreign competition and to raise revenue for the government.

Quota is an import barrier that set upper limits on the quantity or value of imports that may be imported into a country.

Subsidy is an amount of money paid by the government to a firm, per unit of output, to encourage output and to give the firm an advantage over foreign competitors.

Voluntary Export Restraint is a voluntary agreement between an exporting country and an importing country that limits the volume of trade in a particular product.

Infant Industry Argument proposes that new industries should be protected from foreign competition until they are large enough to compete in international markets.

Dumping is the selling of a good in another country at a price below its unit cost of production.

Anti-dumping is legislation to protect an economy against the import of a good at a price below its unit cost of production.

An FTA (free trade area) exists when an agreement is made between countries, where countries agree to trade freely among the members of the group, but are able to trade with countries outside the free trade area in whatever ways they wish, for example, the North American Free Trade Agreement between the US, Canada, and Mexico.

Customs union is an agreement made between countries, where the countries agree to trade freely among themselves, and they also agree to adopt common external barriers against any country attempting to import into the customs union, for example, the Switzerland-Liechtenstein customs union.

Trade Creation occurs when the entry of a country into a trading bloc leads to the production of a good moving from a high-cost producer to a low-cost producer. If, for example a country joins the EU, its car producers are no longer subject to the EU common external tariff and it can export more cars to EU member countries.

Trade diversion occurs when the entry of a country into a customs union leads to the production of a good moving from a low-cost producer to a high-cost producer. When the UK, for example, joined the EU, it had to impose a common external tariff on butter from the low-cost produver NZ, and start to import butter from high-cost EU producers.

The WTO is an international body that sets the rules for global trading and resolves disputes between its member countries. It also hosts negotiations concerning the reduction of trade barriers between its member nations.

The balance of payments is a record of the value of all the transactions between the residents of a country with the residents of all other countries over a given time period.

The balance of trade is a measure of the revenue received from the exports of tangible goods minus the expenditure on the imports of tangible goods over a given time period.

The invisible balance is a measure of the revenue received from the exports of services minus the expenditure on the imports of services over a given time period

Current account is a measure of the flow of funds from trade in goods and services, plus net investment income flows (profit, interest, and dividends) and net transfer of  money (foreign aid, grants, and remittances)

Capital account is a measure of the buying and selling of assets between countries. The assets are often separated to show assets that represent ownership and assets that represent lending.

Current Account Surplus exists where the revenue from the export of goods and services and income flows is greater than the expenditure on the import of goods and services and income flows over a given time period.

Current Account Deficit exists where revenue from the export of goods and services and income flows is less than the expenditure on the import of goods and services and income flows over a given time period.

Expenditure-switching policies are policies implemented by the government that attempt to switch the expenditure of domestic consumers away from imports towards domestically produced goods and services.

Expenditure-reducing policies are policies implemented by the government that attempt to reduce overall expenditure in the economy, including expenditure on imports.

Marshall-Lerner condition states that a depreciation or devaluation, of a currency will only lead to an improvement in the current account balance if the elasticity of demand for exports plus the elasticity of demand for imports is greater than one.

J-Curve theory suggests that in the short term, even if the Marshall-Lerner condition is fulfilled, a fall in the value of the currency will lead to a worsening of the current account deficit, before things improve in the long term.

Exchange Rate is the value of one currency expressed in terms of another currency.

Fixed Exchange Rate is an exchange rate regime where the value of a currency is fixed or pegged, to the value of another currency, or to the average value of a selection of currencies or to the value of some other commodity such as gold.

Floating Exchange Rate is an exchange rate regime where the value of a currency is allowed to be determined solely by the demand for, and the supply of the currency on the foreign exchange market.

Depreciation is a fall in the value of one currency in terms of another currency in a floating exchange rate system.

Appreciation is an increase in the value of one currency in terms of another currency in a floating exchange rate system.

Devaluation is a decrease in the value of a currency in a fixed exchange rate system.

Revaluation is an increase in the value of a currency in a fixed exchange rate system.

Purchasing Power Parity (PPP) Theory states that under a floating exchange rate system, exchange rates adjust to offset differential rates of inflation between countries that are trading partners in order to restore balance of payments equilibrium.

Terms of Trade is an index that shows the value of a country’s average export prices relative to their average import prices.

Deteriorating (Adverse) Terms of Trade exists when the average price of exports falls relative to the average price of imports.

Elasticity of Demand for Exports is a measure of the responsiveness of the quantity demanded of exports when there is a change in the relative price of exports.

Elasticity of Demand for Imports is a measure of the responsiveness of the quantity demanded of imports when there is a change in the relative price of imports.

China’s Artificially Low Currency

From a fixed currency exchange rate, China has moved on to be a managed currency exchange rate. The fixed currency exchange rate is when the value of a currency is fixed to the value of another currency or to the value of other commodities. On the other hand, a managed exchange rate is when the exchange rate is floating between a floor and a ceiling limit that the government assigns. With this being said, China deeply relies on the supply and demand in the market to set their exchange rate. In the end, China’s economic state regarding currency and exchange rate relies greatly on the demand from other countries, namely the United States. With China maintaining a high currency account surplus, they are having a hard time maintaining a good relationship with others countries. Other countries think that they are being taken advantage of and that China is “cheating”.

“Some US lawmakers and industry groups allege that China keeps its currency at artificially low levels against the dollar to gain advantages in trade.”

The Sino-US trade is an important relationship in the trading industry, and any controversy stirred up with these countries is a big deal. The US claims that China’s currency (RNB) is kept artificially low against the U.S. currency (USD), to gain advantages in trade. These unfair advantages which are gained by the Chinese is a result of dumping. Dumping is when an economy sells its products and services at a price lower than its unit cost of production. By keeping their currency low, and lowering it even more, they are devaluating their currency which is called depreciation. With a depreciated currency, exports are cheaper and imports are more expensive.

China is in a surplus right now, and they are manipulating their currency to stay in a surplus. By having a depreciated currency, countries demand more of China’s goods, and the inflow of currency into China stays large. In simple terms, when a country has a current account surplus, they have a high number of exports and a low number of imports. Because they have a surplus, this should cause the currency to appreciate, so they start to import more, and thus they self correct their currency to have a more balanced one.

When we think of and look at countries in terms or deficit and surplus, when one country is in surplus another was is in deficit. Due to this, specifically in the US, the manipulation of the currency is “destroying jobs and limiting growth in the U.S.”. One way that China is manipulating its currency is through putting their money on the market. By having an excess amount of exports on the market, it will depreciate its currency and thus keep the exports high and its imports low. A depreciating currency is when there is a “fall in the value of one currency in terms of another currency in a floating exchange rate system”.

If the yuan is weak, theie exports will increase and the imports will decrease because the yuan is cheap from the perspective of other currencies. With the yuan decreasing, other countries, such as the US will experience an appreciating currency in relation to China. However, if the yuan were to get stronger and China was in surplus when this happens, then the exports would decrease and the imports would increase. Since China’s currency would appreciate in this case, other currencies such as the US will experience a depreciating currency and thus exports will decrease because Americans have less purchasing power. This would thus decrease the surplus and shift the current account balance closer.

Over all, China’s currency is artificially in a surplus right now and has been for a while. If China were to stop keeping their currency artificial, their exports would decrease and imports would increase which would lead to an increase in unemployment.

Australia’s Current Account Deficit (via Hiroko’s Econ Blog)

AMAAAAAAZING! Nice blog post!

Through looking at the above graph, it is evident that Australia has been in deficit for at least the past 20 years. There are great fluctuations which show that there are periods of time in which Australia's current account balance has moved closer to 0 however, it is still in the negatives meaning it is still in a deficit. Also, when looking at the IMF's predicted current account balance figures, it can be seen that they are predicting Australi … Read More

via Hiroko's Econ Blog

JAPAN. SURPLUS or DEFICIT?

1) Historical Trends: In 1980 Japan was in a deficit of 10.75 billion dollars. Yet from 1981, the currency came out of the deficit and started to balance out, but gradually kept going into a surplus. In 1986 it reached nearly 90 billion dollars. From then on, there were contractions and expansions on the graph, but overall the country is more in a surplus than in a deficit.

 

 

 

 

2) In terms of GDP,since 1981, the country has been in surplus, but as you can see there are ups and downs of the graph. One of the largest contractions of surplus you can see here is from 1986 to 1990 where it went from 4.299 to 1.45. Since then the surplus has gradually been increasing until 2007, but since then the surplus has been contracting.

 

 

 

 

 

3) This article from Reuters explains how Japan’s current account surplus fell 8.1 percent since May of 2009.

Reflection on Section 4 Data Response

Compared to the graded formative response which I got a 10/20 on, I did well on this summative response and got a 17/20. I did well with the definitions and the first diagram, which was the tariff diagram, but did not do as well on the second diagram and the evaluation. With the second diagram, I got the concept correct but could not fully explain the diagram. I should have thought about the determinants of demand, and it this case I should have talked about consumer tastes and preferences. For the evaluation, I needed to wrap it up by discussing if China was right in imposing a tariff. Not necessarily taking sides, but talking about if China was correct, why? Also if China was not correct in imposing a tariff, why? I should talk about the WTO, because they deal with these kinds of disputes between member nations of the WTO.