model answers international trade Flashcards
addition of a traffi
Under the conditions of free trade, the market for steel is initially in equilibrium where Q4 steel is bought and sold at price Pw. Q1 quantity of steel is supplied by domestic producers and Q4 – Q1 quantity of steel is produced by foreign producers. A tariff is an indirect specific tax on imported goods and services, which shifts S(world) up to S(world) + tariff. The market is now in equilibrium where Q3 steel is bought and sold at a higher price of Pw+t. Domestic producers benefit as they now produce the higher quantity Q3 of steel and receive the higher price Pw+t. Domestic producer surplus rises by the area A. Foreign producers are negatively impacted as they now sell the lower quantity Q3-Q2 of steel at the same price Pw. Consumers are negatively affected as they now pay a higher price and buy a lower quantity of the good, losing [ABCD] of consumer surplus; in the case of steel this is likely to affect all manner of goods in which steel is a factor of production. The government gains C of tariff revenue, while B and D are deadweight welfare loss as a result of inefficient domestic production and a smaller market size.
Explain how a fall in the UK base interest rate affects the UK exchange rate
The market for the pound is initially in equilibrium where Q pounds are traded at exchange rate E/R. Due to a fall in the UK base interest rate, international savers receive a lower reward to saving in the UK, therefore demand fewer pounds. Demand shifts left from D to D1. The market is now in equilibrium where Q1 pounds are traded at a lower exchange rate E/R1. This is called a depreciation. As a result, exports will become cheaper and imports more expensive, increasing exports and decreasing imports, shifting AD to the right and increasing economic growth and demand pull inflation.
explain how a currency depreciation causes cost push inflation
The economy is initially in equilibrium where real output is Y and the average price level is P. If there is a depreciation of the pound, import prices rise. If firms import factors of production, costs rise for firms across the economy, meaning they can produce less. This causes SRAS to shift to the left to SRAS1. The new equilibrium is where real output has fallen to Y1 and the average price level has increased to P1. The increase in the average price level due to increased costs is cost-push inflation.
Evaluation of a depreciation – the J curve answer
Initially the economy has a current account deficit, where the value of imports exceeds the value of exports, plus net primary and secondary income. Due to a depreciation of the currency at point A, exports become cheaper and imports become more expensive. In the short term, the demand for imports and exports is relatively inelastic and thus the Marshall Lerner Condition is not met. This may be due to companies having inflexible contracts with suppliers or customers. As a result, export revenue falls and import expenditure rises, worsening the current account deficit, as shown from point A to B. Over time, export and import demand become more elastic as contracts run out and firms switch to cheaper suppliers; as a result, export revenue increases and import expenditure falls, improving the current account deficit after point B. The Marshall Lerner Condition is met where PEDx + PEDm ≥ 1 at point B.
Explain the impact of improved international competitiveness on an economy. Refer to unit labour costs and give the example of improved education (T-levels).
The UK economy is initially in equilibrium where the average price level is P and real output (Y) is less than potential output (Yf). T-levels improve the quality of labour which is a factor of production. Improved labour raises international competitiveness because a higher supply of skilled labour lowers unit labour costs and raises the productivity. As a result, exporters’ costs fall and the quality of products rises. If the demand for exports rises as a result, AD will shift right to AD1, as exports are a component of AD. As the quality and quantity of factors of production improve, LRAS will also shift right to LRAS1, as the economy’s potential output rises. The economy is now in equilibrium where the average price level is still P and real output has risen to Yf1. An improvement in international competitiveness has resulted in non-inflationary long run growth and an improvement to the country’s trade balance.
However, whether this is the case depends on the change in the UK’s unit labour costs and productivity relative to other countries. If other countries’ unit labour costs fall more quickly, the price of their exports may also fall more quickly, meaning they may have lower relative prices, lowering the demand for UK exports.
Using opportunity cost to evaluate supply side policies
- State what the next best alternative is for the country you are discussing
- Future interest repayments
- Future credit ratings
- Return on investment and future growth linking to corruption and government failure
Evaluate the decision for Bangladesh to invest in news road
The decision to invest in new infrastructure in Bangladesh will result in a significant opportunity cost (what is foregone as a result of a decision). This could be cutting spending in other areas, such as education; given that Bangladesh has significant gender inequality, it is likely that there is also a pressing need for government spending in this area as well. In addition, if the money is borrowed, this will result in a future opportunity cost, where taxpayers in the future will have to pay higher taxes or forego other types of spending. If the debt is large, future credit ratings may fall and interest rates may rise (although current interest rates are low). The opportunity cost is justifiable if the investment results in higher future economic growth, leading to higher incomes and profits, and therefore tax revenues. Future tax revenues may be used to pay back the interest and debt, but also fund further projects like education.
Prebisch–Singer hypothesis
terms of trade - index of export prices divided by index of import prices times 100
driven by the wealth effect and yed. globalisation and what this has done is driven price of manfucred goods as incomes have risen and what this has done is risen the price relative to primary products which has stayed fairly low and stable. import prices likely to increase in the long term compared to export prices therefire they need to export more. Not good for well being and quakity of life they have to export more to get the same they used to. in the short run exports may increase in which case devloping countries need to use that reveuve to diverisfiy the economy. by producing semi finished good sor finished good along with manfucting goods.
