Entries Tagged 'trade' ↓

Readers Question: Why isn’t trade among countries like a game with some winners and some losers?

Often in the political world, trade is seen as a game of tit for tat. e.g. US places tariffs on imports of Chinese chickens, China retaliates by placing tariffs on US cars e.t.c

However, the theory of comparative advantage and free trade suggests, that a country can increase its economic welfare by cutting tariffs – even if these tariff cuts are not reciprocated. In other words cutting tariffs is a win win situation.

The below example shows how reducing import tariffs leads to a net gain in economic welfare for the country (even if others don’t respond by cutting their import tariffs)

Diagram for Trade Creation

• The removal of tariffs leads to lower prices for consumers and an increase in consumer surplus of areas 1 + 2 + 3 + 4
• Imports will increase from Q3-Q2 to Q4-Q1
• The govt will lose tax revenue of area 3
• Domestic firms producing this good will sell less and lose producer surplus equal to area 1
• However overall there will be an increase in economic welfare of 2+4 (1+2+3+4 – (1+3))

However, it is not as simple as this.

There are some losers from free trade.

- Domestic firms protected by tariffs will lose out – these are often politically vocal. They will make more fuss than consumers who benefit from marginally lower prices.

It is true that countries benefit from cutting tariffs, but they would benefit even more if it is part of a mutual tariff reduction, helping to increase exports. Countries may not want to unilaterally cut tariffs, preferring to use them as a bargaining chip in trade negotiations.

Also, free trade can be damaging under certain circumstances. This is especially true for developing countries seeking to diversify their economy.

See:

Disadvantages of Free Trade

Benefits of Free Trade

Readers Question: hi, i just want to ask about the reasons behind the chinese current account surplus and the solutions that can be done.

Current Account Surplus

The Chinese current account surplus is very large. In 2007, $371 billion. Reasons for this Surplus

• High saving rate in China. Chinese consumers have a higher propensity to save than the rest of the world. This means they save rather than buy imports from abroad. The US has a very low savings rate and so US consumers have been buying Chinese imports
• Undervalued Yuan. It has been the policy of China to keep the value of the Chinese Yuan low. True it has appreciated but, less than if market forces had fully operated. The lower value of the Yuan keeps exports cheaper and imports more expensive.
• Shifting Comparative Advantage. China has developed a significant comparative advantage in manufactured goods which encourages a trade surplus.
• Continue reading →

Readers Question: Using the data and your own economic knowledge, evaluate the importance of rising productivity in bringing about an improvement in the UK balance of payment on the current account.

Productivity is defined as output per worker or output per input. Rising productivity implies that the economy is becoming more competitive and will be able to produce goods at a lower cost. If UK firms can produce goods at a lower cost this will make UK exports more competitive and therefore increase exports.

For example, if there is an improvement in labour productivity following better education and training, firms will be help to produce more for the same costs. This will help the UK compete and sell more exports.

Increasing exports will help improve the current account as exports will be rising relative to imports.

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Readers Question: Assess the view that supply-side reforms have enabled the UK economy to be ‘more successful in maintaining growth, despite an appreciation in the value of its currency’ (Extract 1, lines 5-6}. (From Edexcel unit 3)

An appreciation in the exchange rate would tend to reduce aggregate Demand and lead to lower economic growth. An appreciation makes exports less competitive, decreasing quantity of exports. An appreciation also  makes imports cheaper, increasing quantity of imports (and hence money leaving the economy). Therefore, the (X-M) component of AD will be lower. This will reduce Economic growth.

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Readers Question: When exchange rate goes down, what positive thing can happen?

• When there is a depreciation and the exchange rate goes down, the exports of a country will be cheaper and imports will become more expensive.
• e.g. a depreciation of the dollar makes US exports more competitive.
• Therefore there will be an increase in exports and decrease in quantity of imports. Therefore, domestic firms will benefit from increased sales. This may lead to job creation and lower unemployment, especially in exporting industries.
• The increase in X-M will help increase AD and therefore lead to economic growth Continue reading →

Readers Question: The Aussie dollar has appreciated strongly against the USD in recent times. Discuss the consequences of this rapid appreciation for Australia’s Balance of Payments?

The Australian Dollar has appreciated against the US Dollar because

• Large US current account deficit
• Australia has benefited from rising commodity prices, commodities which Australia produces a lot of.
• US interest rates are lower than Australia and the US economy has been weakening.

April 2008 $1 Aus Dollar = US 0.9300

Effects of AUS Dollar Appreciation

• It makes Australian exports more expensive. Therefore there will be a fall in demand for Australian exports.
• Imports into Australia will become cheaper, therefore there will be an increase in demand for imports.
• This is likely to worsen the current account deficit. However, this assumes that demand for exports and imports is relatively elastic. The Marshall Lerner condition states that if PED of exports + PED of imports > 1 then an appreciation will worsen the current account. Continue reading →

Readers Question: A huge current account deficit can seriously affect the economic well being of any country, big or small. Discuss this statement and offer some policy advises to the governemnts in countries which suffer from this.

Please see: Does a current account deficit matter?

I would add that some countries are better able to finance a current account deficit. E.g. the US could run a current account deficit because Chinese investors were willing to buy US assets. US debt was bought at a relatively low interest rates because of the dollar’s status as the reserve currency.

Some countries like the UK, may be an attractive destination for long term investment (Capital inflows) and this makes a current account deficit easier to finance. So it does depend on the size of the country and also the confidence people have in investing their. E.g. a developing economy may find it more difficult to attract capital flows.

 Policies to Reduce Current account deficit

• Solving UK current account deficit 
• Can government reduce current account deficit 
• Reasons for current account deficit 

Tomorrow, Monday, I am flying to New York, US. There might be a delay in answering some questions, but, I hope to be back quite soon.

I will be taking lots of dollars to take advantage of the discrepency in the dollar / sterling exchange rate.

Economists, often say there should be no ‘free money on the table’. But, buying a new Mac laptop in the US, could save me £500 due to the weakness of the dollar. I guess someone has to do well out of the declining dollar…

Readers Question: Evaluate the significance of the factors which have contributed to globalisation. You may use diagrams if you wish.

Globalization is not a new phenomena. The world economy has become increasingly interdependent for a long time. I have previously written various factors that have helped explained the rise in globalization here 

In evaluation I would make the following points.

• It is hard to precisely define globalisation there are different interpretations about what we actually mean, therefore, there are differing factors that explain it. Continue reading →

1)  You say depreciation causes inflation for the three reasons you mention, but later, that in the long run, a higher rate of inflation will cause depreciation.  So my first question is how are these two phenomena linked?  Is ‘long run’ the key; i.e. it takes a prolonged high inflation to cause a devaluation,  but devaluation causes inflation sooner? How long does it take for those three reasons to really kick in?

It depends, there is no straight answer. The two phenomena may occur simultaneously. Also it is complicated by the fact that many factors affect the exchange rate apart from just inflation. (e.g. short term interest rates)

2)  My next question is that I’m aware that factors such as rising commodity prices can exert upward inflationary pressure,  but are there any other factors that affect the devaluation of a currency – or is it purely down to inflation?

Many factors can affect exchange rates. These include:

• Interest Rates – lower interest rates cause less hot money flows and depreceation.
• Expectations – If investors expect a currency to devalue they will sell less. Confidence and market expectations are important in determining exchange rate
• Current account deficit. A large current account deficit may put downward pressure on exchange rates Continue reading →