Economics Chapter 16 Flashcards
Foreign sector
Globalisation
World has become a global village in which individuals, businesses and governments must think, act and plan globally
Openness or Degree of Integration
The extent of a country’s involvement in international trade and finance is referred to as the openness of its
economy or its degree of integration into the international economy, and this differs from country to country
Why do countries trade?
The notion of self-sufficiency (or autarky) used to be popular among politicians and citizens who wanted to be independent from other countries. But countries, like individuals, are economically interdependent. In microeconomics it is explained that it is better for an individual to specialize in the activities that he or she does best, rather than to attempt to do everything (even if he or she can do everything better than anyone else).
Other reason for international trade
Is the fact that factors of production (natural resources, labor, capital and entrepreneurship) are not evenly distributed among the nations of the world
Why do countries trade? Absolute advantage
Countries trade because some countries have an absolute advantage in the production of certain goods
Why do countries trade? Comparative(relative) advantage
Trade may also be beneficial when one country is more efficient in production of both goods
Law of comparative advantage
According to the theory (or law) of comparative advantage, each country will tend to specialize in and export those goods for which it has a comparative advantage
When will international trade occur?
Opportunity costs between countries differ
Both countries will gain only if trading/exchanging ratio lies somewhere between opportunity cost ratios in two countries
Trade policy
Trade leads to greater world production of traded goods, by implication leads to an increase in economic welfare
Steps are taken to open economies to international trade and reap the benefits of such trade
Governments take steps to protect domestic firms against foreign competition and to control the volume of imports entering the country
Measures used to protect domestic use
Import tariffs
Import quota
Subsidies
Non-tariff barriers
Exchange controls
Exchange rate policy
Import tariffs
are duties or taxes imposed on products imported into a country. They are generally used to protect domestic industries or sectors from foreign competition, but it can be shown that they result in a net loss
of welfare to the domestic society
Two categories of tariffs
Specific-A fixed amount levied on each unit of imported commodity
Ad valorem-A percentage of the value of the imported good
Revenue tariffs
Usually imposed on goods that are not produced domestically
Protective tariffs
Imposed on goods that are produced domestically to protect local producers from foreign competition
Import qouta
Import quotas seek to control the physical level of imports and are therefore a form of direct intervention in the market mechanism. They have much the same economic consequences as import tariffs.
Aim to influence the price of imported items
The seller benefits from the price due to limited supply of good unless government auctions import licenses to the highest bidder
Subsidies
Subsidies granted to home producers also have essentially the same economic impact as taxes on imported goods
The support comes indirectly from tax payers which is preferable to tariffs where consumers are forced to pay a higher price than they would have paid in the absence of tariffs
Non-tariff barriers
Non-tariff barriers have become increasingly significant in recent years. They take the form of, for example,
discriminatory administrative practices, such as deliberately channeling government contracts to domestic
firms, insisting on certain technical standards or specifications that may be difficult for foreign firms to meet,
special licensing requirements or, simply, unnecessary red tape.
Exchange controls
Exchange controls can also be used to restrict imports by limiting the amount of foreign currency available for their purchase
Exchange rate policy
movements in exchange rates may have significant effects on exports and imports(may be more effective than traditional instruments)
Arguments for the use of trade barriers
Protection benefits a few greatly, free trade benefits a lot of people a little.
Those few beneficiaries go at great lengths to acquire protection while majority cares less
Balance payments
Strategy to correct deficit in the BoP however dependent on the elasticity of demand for imports and possible retaliation
Dumping
Closely related to BOP arguments
Trade barriers to counter dumping
Selling a product in the foreign or in other export markets at a lower price than domestic markets
Simple price discrimination OR expand output and achieve economies of scale
Predatory dumping
Part of the proceeds of higher price is used to subsidize exports to under competitors.
Deemed unfair, trade barriers warranted-countervailing duties
Dumping is difficult to prove what may look
like dumping might be comparative advantage
Infant industries
Older economic argument
Government protection infant industries with potential comparative advantage ,however has its flaws(domestic monopoly)
Employment
Most common argument
Protection of jobs and local industries
Mostly driven by trade unions
May delay structural changes which may render industry competition
Inefficient way of stimulating employment/lowering unemployment
Government revenue
Effective means and crucial source of government revenue
National security
Governments prefer not to be entirely dependent upon foreign suppliers for essential products
Industries producing essential products during war or international crisis should be protected
Arguments against trade barriers
Retaliation by trade partners(Tit for tat trade war)
Welfare cost to society-increases in prices fall in consumer surplus, deadweight loss
Inefficiency-less incentive to reduce cost and increase efficiency
Exchange rate
The rate at which currencies are exchanged is known as the rate of exchange or exchange rate
Foreign exchange market
A foreign exchange market is the international market in which one currency can be exchanged for other currencies
Rate of exchange
Is the ratio, the price of one currency in terms of another currency It can be explained/analysed using demand and supply curves
Appreciation
The value of one currency has increased in terms of another(If one needs less rands to get a dollar)
A fall in the exchange rate means that the domestic currency has appreciated
Depreciation
The value of one currency has decreased in terms of another(if you need more rands to get a dollar)
A rise in the exchange rate means that the domestic currency has depreciated
Demand for dollars
Suppliers for dollars are holders of dollars seeking to exchange them for rands
A first source is South African
importers who import goods and services for which they pay in US dollars. A second source is South African residents who wish to purchase dollar denominated assets, such as shares of American companies. Another example is
American investors who sell their South African assets (eg shares, bonds) and wish to convert the proceeds into
US dollars. A fourth source is South African tourists who buy dollars or dollar denominated travellers cheques.
Another important source is speculators who anticipate a decline/rise in the value of the rand relative to the dollar
Supply for dollars
Those who supply dollars are holders of dollars seeking to exchange them for rand. The supply of dollars comes from
various sources. A first source is South African exporters who export goods and services. The foreign buyers of South African exports whose prices are quoted in dollars supply dollars which are then exchanged for rand. A second source is foreign holders of dollars who purchase South African assets (eg shares on the
JSE or government stock). They also supply dollars. Another example is South African investors who sell foreign assets
denominated in dollars and convert the proceeds back into rand. Further sources include foreign tourists in South Africa who
exchange dollars or dollar denominated travellers’ cheques for rand, and speculators who anticipate a rise in the value of the rand relative to the dollar
Why do exchange rates fluctuate?
exchange rates tend to fluctuate quite considerably, since the demand for and supply of foreign exchange are not synchronised on a day-to-day basis
a freely floating exchange rate is also subject to speculation. Because of the potential volatility of exchange rates, and because the authorities often wish to use the exchange rate to pursue particular policy objectives, exchange rates are often managed or manipulated to some extent by central banks. This is called managed floating
When can the central bank intervene
Central bank may only intervene to stabilize a depreciating currency if it has sufficient foreign exchange reserves to do so
How does SARB intervene
if an excess supply of dollars develops at the original exchange rate (eg because of a decrease in the demand for dollars, ie a decrease in the supply of rand), and the SARB wishes to avoid a depreciation of the
dollar (ie an appreciation of the rand), it will purchase the excess dollars at the ori ginal exchange rate and add them to the foreign exchange reserves
In other words, the rand will depreciate against the dollar. Suppose that the SARB wishes to avoid such a depreciation of the rand (eg because it may result in
inflationary pressure). What can it do?
If it has the necessary reserves, the SARB can supply $1 billion to the market.
Exchange rate policy
Exchange rates are among the most important prices in the economy. Movements in exchange rates can have a significant impact on economic growth, employment, inflation and the balance of payments as well as on the wellbeing of individuals
With a floating currency, there are basically only three policy options:
With a floating currency, there are basically only three policy options:
Do nothing, that is, allow market forces, including the actions of currency speculators, to determine exchange
rates.
Intervene in the foreign exchange market by buying or selling foreign exchange, that is, practise managed
floating. However, as explained above, such a course of action is subject to severe limitations, especially in
view of the large turnover in the foreign exchange market
Use interest rates to influence exchange rates. For example, if the SARB wishes to avoid a depreciation of the
rand against the major currencies, it can raise interest rates relative to the rates in the rest of the world
encourage an inflow of foreign capital and will also raise the costs of speculators who want to speculate
against the rand
Terms of trade
Total value of country’s exports=total volume of exports x prices of exports
Total value of country’s imports=total volume of imports x prices of imports
What happens when export prices decline
Volumes produced and sold needs to increase to keep total export earninngs constant
When the prices of a country’s exports are falling relative to the prices
When the prices of a country’s exports are falling relative to the prices of the goods and services it imports, the country actually becomes poorer. Why? Because the country has to sell more of its export products and use more of its scarce factors of production just so that it can afford the same volume of imports as before
Terms of trade expressed in words
Economists have a special name for the ratio between export prices (expressed as an index) and import prices (also expressed as an index). This relationship is called the terms of trade, which is normally expressed as an index
Effects of TOT
An increase in TOT means that welfare of nation has increased
A fall or weakening of TOT indicates welfare loss
SA’s TOT is highly driven by gold prices and subsequently experienced significant fluctuations in the past
