Economics Econ International Trade Review Sheet

[chrezie]

These are some notes I made reviewing for midterms, thought I'd post it here.. maybe some people might find it useful : )

Cheers~

Protectionism

Positive:

1. Domestic employment
   

1. Sunrise or infant industries, give industries a chance to develop economies of scale, lower production prices and strengthen
   

1. Counteract tax differences (Value-added tax Vs. built-in tax burden)
   

1. Prevent dumping that could destroy domestic industries, making the country dependent on imports
   

1. Diversify production base, produce against comparative advantage so that the economy would not be as vulnerable to the price swings of a certain product
   
2. Raise government revenue
   

Negative:

1. Misallocation of resources, inefficient (the world would be able to produce more if all resources are allocated according to comparative advantage)
   

1. Escalation into trade war-->disputes, e.g. Great depression lead to world war
   

1. Corruption, many of these implemented policies are passes under the pressure of large players in the market for their own economic interest, to attain these goals, bribery and political alliances are often involved.
   

1. Domestic complacency, lack of incentive to decrease production costs and raise productive efficiency (laziness)
   

1. Higher price for domestic consumers
   

1. If import is used in production of other product, Harm downstream industries, harm exports, harm everyone..
   

Evaluating the impact of CAP

Positive

1. Benefits domestic producers, promotes employment in the agricultural sector, increased revenue can help those involved in the agricultural sector increase their life qualities.
   

1. Ensure the local supply of strategically important food sources. Agricultural goods are strategically important and crucial to people's basic needs. Agriculture must be promoted in case of failure to import, like cases of war etc.
   

1. Can enforce higher product quality, foreign goods difficult to control
   

1. Pushes down global food price, help impoverished population to meet basic necessities at a lower price
   

Negative

1. Tax payers must pay more money in order to support the large amounts of subsidies given to the agricultural producers
   

1. Foreign producers are hurt, as without subsidies, they are unable to compete with the artificially low prices caused by intensive subsidizing.-->hurt less developed nations, increasing the global inequity. The poor nations suffer as they are unable to profit from agricultural production even if they are more efficient in doing so and could produce at a lower price than European producers.
   

1. Decrease in production of other European products, as more resources are located. Inefficiency, over allocation of resources to the agricultural sector when they are able to produce goods of more value if they devoted resources to other areas of production
   

1. Inefficiencies in agricultural production, complacency, dependency on the government, has no incentive to lower production costs and become more efficient
   

Exchange Rate

Determinants of Exchange Rate:

1. Demand for goods and services
   
2. Demand for foreign direct investment
   

(opening a branch location, starting a new firm, or creating a joint venture in another country--> need the country's currency to buy capital equipment, rent space, pay salaries, purchase materials etc.)

1. Relative inflation rates
   

(inflation higher than that in other countries--> export prices are seen as higher, import prices lower, fewer people purchase the nation's products, thus demand for currency decrease. Also, domestic demand for foreign products and foreign currency increases, supply of currency increase, causing a depreciation of the currency. Also hurt trade balance.)

1. Speculation
   

( hold currency when expecting it to appreciate, sell when the currency is about to or is depreciating, they make their bets on economic factors such as the balance of payments situation, relative budget deficits and also on political events etc.)

1. Central bank intervention on the forex market
   

(central banks may buy or sell large amounts of foreign exchange to 1. prop up the value of their own currency by buying their own currency--> increase demand for their own currency, increase supply for other currencies.. 2. reduce the value of their currency, in order to increase exports and reduce the domestic consumption of imports

Effects of Appreciation

Advantage

1. Less expensive imports
   

-->cheaper consumer goods and services, increase life quality in the nation, able to consume more, and have a greater variety to choose from

--> decrease inflationary pressure when the nation is largely dependent on imports (demand for imports inelastic, e.g. energy)

-->cheaper cost of imported capital and raw material--> lower production cost--> more competitive in domestic and international markets, foreigners and domestic consumers both purchase more--> AD=NX+I+Cd+G, increased Cd and possible increase of NX (manufaactured products tend to me more expensive than raw materials and capital)

1. Competitive pressure on domestic exporters
   

-->have a disadvantageous price compared to previous levels. increase in efficiency, cut costs, innovation, more competitive in the long run

Disadvantage

1. Decreased exports
   

-->NX decrease-->NX is component of AD-->AD decrease--> diagram--> real GDP decrease--> unemployment increase

1. Increased import
   

--> NX decrease…

--> harm industry in the nation (both domestic and exporting), eventual dependency on foreign imports--> long term unemployment (structural unemployment

Effects of Depreciation

Advantage

1. Expansion of domestic industries
   

• increase in export
  
• decrease in imports
  
• improve trade balance
  

Disadvantage

1. Imported Inflation
   

• higher import price, can cause significant rise in price level as imported consumer products become more expensive, and domestic production cost increase as raw materials become more expensive
  

Government intervention to control exchange rate

Prop up currency/ maintain high fixed exchange rate

1. Buy their own currency with official Reserves
   

Problems: unsustainable--> puts large pressure on foreign exchange reserves

1. Increase interest rate
   

(attract foreign depositors, capital inflow, increase demand and price of currency)

Problems: limits monetary policy's effect of managing domestic money supply, and correspondingly, domestic employment and inflation

1. Exchange controls: Gov. policies to limit domestic purchase of foreign currency
   

Limit the supply of the currency in the international market, reducing downward pressure

Problems:

• frustrate domestic consumers and producers who wish to seek opportunities in foreign markets, cannot invest abroad
  
• Discourage investors and speculators from purchasing the currency in fear that they would not be able to sell it when necessary
  

Depreciate currency/ maintain low fixed exchange rate

1. Buying up foreign currency and supplying extra domestic currency with Official reserves
   

Problems:

• may lead to inflation due to the overall increase in money supply
  
• Accumulate large amounts of foreign reserves
  

1. Policy to promote export
   

Problems:

• Protectionism lead to resentment among importing countries
  
• Possible inefficient allocation of resources (poorer countries may be more efficient, but cannot support protectionism measures like those taken by China)
  

1. Exchange controls: restrict the amount of domestic currency that can be held by foreign enterprises--> bureaucratic and economic barrier to foreign firms operating in country and limit FDI
   

• Limit demand for currency
  

Problem of managed/fixed exchange rates

--> see the evaluation of appreciation/ depreciation

Evaluation of Fixed Exchange Rate

Advantages

1. Stability
   

• Foreign investors do not have to take into account possible exchange rate changes, simplifying business plans and reduce calculating costs
  

1. Inflation Control
   

• With exchanged rates fixed, exports prices are directly linked to domestic inflation, and thus, Gov. has greater incentive to manage inflation in order to keep export prices competitive
  

1. Protection against heavy influence of speculation
   

• Speculators have less incentive to
  

Disadvantages

1. Limitations of using monetary policy to control domestic economy
   

1. When faced with external shocks, may have to resort to measures such as protectionism and import controls etc.
   

e.g. When products in other countries rise in price, nation would have to pay more import money… as compared to increasing the value of its currency

1. Need to hold foreign reserves that could have been used to buy and sell needed resources
   

1. Speculators may aggravate problems
   

• e.g. if a country is trying to maintain high rate, and is running low on reserves, speculators may bet against the currency, believing that it will necessarily devalue, and thus create a run on the currency, dramatically causing its depreciation
  

1. Difficult to set suitable rate
   

1. Vulnerable to charges of unfair competition
   

• Poor trade relations, trade sanctions or protectionist policies may be levied against it
  

Current Account Deficit

Effect of Current account deficit

1. Low domestic production (high imports, low exports)
   

• Higher unemployment than that would otherwise exist if there wasn't a current account deficit)
  

1. Upward pressure on foreign currency and downward pressure on domestic currency
   

Demand more foreign currency to purchase foreign goods and services, larger supply of domestic currency in international market (move in direction that encourages output and decrease deficit)

1. Surplus in capital and financial accounts
   

• foreign ownership of domestic assets--> DISADV: potential threat to a nation's economic and political sovereignty as foreigners have more control over a nation's economy
  

(Foreign direct investment in domestic firms

Increased portfolio investment by foreigners in the domestic economy

Increase in foreign ownership of domestic government debt)

• build up of foreign reserves of the deficit nation's currency--> currency exchange rate vulnerable to the actions of other nations.
  

1. Inflation
   

• When domestic currency depreciates Imports become more expensive, PL increases
  

1. Nation tighten money supply and raise domestic interest rates
   

• Prevent massive depreciation and inflation
  
• Attract foreign investors with higher interest rate to maintain high demand for nation's currency
  

• Also attract domestic savings and purchasing of gov. bonds, decrease Cd and I, decrease AD--> slow down economic growth, cause GDP to decrease, increase in unemployment
  

1. Interest must be paid to foreign interests
   

• Taxpayer money spent without contributing to AD, or improving the nation's life quality--> could otherwise be spent by the gov. through gov. spending, improved infrastructure, education, healthcare, improvement of workforce--> higher AS, also AD increase--> GDP increase, lower unemployment
  

1. Lower international credit rating
   

• Questioned ability to pay back debt
  
• Must offer higher interest rates to foreign lenders
  

Ways of Correcting current account deficit

1. Expenditure-switching policies/ Protectionism
   

• Reduce domestic spending on imports and Increase domestic spending on domestic products
  

1) Lower exchange rate

• Increase amount of domestic currency in international market
  

• Imports more expensive, and exports to foreign markets more attractive to foreigners
  

2) Protectionism

• Tariffs, quotas or subsidies
  

1. Expenditure-reducing policies
   

• Reduction of overall expenditure to reduce import spending
  

• Adverse effects on domestic output and employment (last resort)
  

1) Contractionary fiscal policies

• Reduction in government spending--> reduction of disposable income in the economy--> lower rate of employment--> discourage demand for imports
  

• Deflation--> products cheaper--> exports more attractive to foreigners
  

2)Contractionary monetary policies

• Raise interest rates--> discourage consumption and investment in imported goods/capital
  
• Deflationary effect--> products cheaper-->exports more attractive
  

1. Expansionary supply -side policies
   

• Increase the nation's long-run competitiveness
  

1)Investment in education and healthcare

2)Public funding for scientific research and development

3)Investment in modern transportation and communication infrastructure

*Marshall-Lerner condition and the J-curve

• Devaluation of currency may harm current account balance in short run (low elasticity in short run), but would benefit in long run, as the
  

Effect of Current account Surplus

1. Upward pressure on domestic currency and downward pressure on foreign currency
   

Demand more domestic currency to purchase foreign goods and services, larger demand of domestic currency in international market (move in direction that encourages output and decrease deficit)

1. Low domestic consumption
   

Economic Integration

Preferential trade agreement:

When two or more countries reduce or remove tariffs on particular G & S produced in participating countries, or make other agreements reducing the barriers to free trade between the nations.

Free trade area:

Formed when two or more nations make and agreement to completely eliminate tariffs on most (if not all) G & S traded between the member nations.

Customs Union:

Agreement between nations through which tariffs on all goods and services produced by member nations are traded tariff free, while the member nations agree on common tariff rates on imports from all non-member countries.

Common market:

Similar to the customs union, but all four factors of production (labour, land, capital resources and entrepreneurial talent) flow freely between member nations.

Monetary Union:

Trading bloc in which member states eliminate all barriers to trade between them, allow for the free flow of the factors of production, adopt common tariffs on non-member states and use a common currency managed by a shared central bank. (But nations can still maintain their fiscal sovereinty, control their own fiscal policies)

Complete Economic integration

Advantages

• Greater efficiency of resource allocation
  
• Higher real income as imports become cheaper--> increase life-standard, greater variety of G & S
  

• Larger export market, increase output, higher employment/ income etc.
  

Disadvantages

• Fall in employment in less competitive industries
  
• BLAH BLAH BLAH…. See protectionism
  
• Loss of economic sovereignty
  

[Purplelily8]

Hey.

This is really helpful, plus we r currently learning it mock exams coming up.

Thanks for the help.