Final Reflection

My mock exams turned out pretty good. I actually think that the tests on definition and diagrams helped a lot before the mock exams. Through those tests, I saved up time studying. Instead of going through the definitions and diagrams once again, I just went through some details that were important to know (details that could help me with the evaluation). Thus, I did not waste time thinking of ways to answer the questions on the exam. Thoughts just came up my mind quickly mainly because I was comfortable with the topics already.

As for the revision, I would go through definitions and diagrams once again (including the ones for international and development economics). Once I’ve mastered them already, I’ll dig in to the details until I get comfortable explaining different ideas already. I will try answering past papers and see how well I do on them.


Test Reflection Section 4

Although I did not do so well in this exam, I am not very disappointed since this section was not my strongest. I would say that was overwhelmed by the number of questions that were given to us, so I did not end up studying for every single question. Unfortunately, I did not get the questions I studied for. Thus, I ended up having troubles organizing my ideas since the ideas were very vague in my mind.

Although I defined the key terms for the question, my biggest issue was that, I was not very focused on the prompt. I talked about the question in general terms. This was another reason why my ideas were disorganized. Also, I did not use much real world examples.

Ms. Q has done a great job correcting our exam. Her comments are really helpful for my future exams. Thank you, Ms. Q!


Zimbabwe Statistics

The country’s GDP is $5,010,452,000.00, while its GDP per capita is $382.88. The income inequality is relatively high since it is 50.1

The country’s HDI is 0.505 which is comparatively low.

Zimbabwe’s unemployment rate is 80%, which is much more than half of the country’s population.

The life expectancy of the Zimbabweans is only 44.28, but 75% of the nationals have access to sanitation.

 


Using the principle of comparative advantage, explain why economic theory suggest that countries should specialize and trade with each other.

Demands of the question:

  • Explain the reasons why countries should specialize and trade with each other.

Definition:

  • International trade is the process of exchanging goods and services between countries. It involves the buying and selling of imports and exports.
  • Specialisation means to focus on the production of a single good or service or a particular activity in the production of that good or service.
  • A country has a comparative advantage when they can produce a good or service at a lower opportunity cost than another country. If countries specialise where they have a comparative advantage then the level of output and therefore world welfare will be increased.
  • 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.


Country D has a comparative advantage on Product B, while Country C has a comparative advantage on Product A.

Reasons for trade:

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.

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

 

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.

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.



Exchange Rates (DD)

An exchange rate is the price of one currency expressed in terms of another. An exchange rate system is the way in which the exchange rate is determined. These come in three types. They are:

Fixed – this is an exchange rate system where one currency is fixed in value against another. It involves the government working to keep the parity via intervention on the currency markets. These give certainty but can cost vast sums of foreign exchange from national reserves.

Floating – this is an exchange rate which accepts that market forces will determine rates based on how they view a country’s trade performance and its economic and political stability. These systems cost less to maintain but can result in vast swings and changes in currency values. This can seriously affect trade performance and confidence.

Managed or dirty float – which is where the rate is floating but between upper and lower limits that the domestic government keeps it to. It brings more stability but at less cost to the national reserves.

Appreciation – this describes an upward movement in a freely floating exchange rate. This may occur day by day or perhaps even minute by minute.

Revaluation – this also describes an upward movement in an exchange rate, but in a fixed exchange rate system. This will be a very infrequent event (if ever) and means the government has deliberately changed the fixed value of the exchange rate upwards.

Depreciation – this describes a downward movement in a floating exchange rate.

Devaluation – this means that the government has changed the fixed rate of a fixed exchange rate downwards.

The Marshall-Lerner condition looks at the overall impact of a depreciation on the current account of the balance of payments. This will be the sum of the effects we identified above on imports and exports. The condition states that the current account will improve after a depreciation if the sum of the price elasticities of demand for imports and exports is greater than 1.

J-Curve – 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.


Balance of Payments (DD)

World Trade Organization (WTO) is the organisation that organised the first eight rounds of trade liberalisation was called GATT – the General Agreement on Tariffs and Trade, and in the Uruguay Round a new organisation was formed to organise trade between countries and oversee the negotiations.

The balance of payments accounts measure the international trade performance of an economy and show how well it is managing to match imports and exports of goods and services and the flows of investment in and out of the country.

The current account records imports and exports of goods (sometimes known as the ‘balance of trade’ or ‘visible trade’) and imports and exports of services (sometimes known as ‘invisible trade’). It often also records income flows (flows of interest, profits and dividends that may have arisen from investment flows) and transfers of money.

The capital account of the balance of payments records the flows of money into and out of a country for investment and other purposes.


Economic Integration (DD)

Economic Integration: Improved productivity, technological development (e.g. e-commerce) and better transport infrastructures are all contributing to globalisation. This increased interdependency makes trade issues and trade performance even more important.

Globalisation essentially means a trend towards much more global production and a greater degree of interdependence between the various countries of the world.

Trading Blocs:

  1. Sovereign countries belonging to a free trade area trade freely amongst themselves but have individual trade barriers with countries outside the free trade area.
  2. In a Customs Union, countries have free trade amongst themselves, as in an FTA, but they are no longer fully sovereign over trade policy. There will be some degree of standardisation of trade policies. They will have a common external tariff (CET) which is applied to all countries outside the customs union.
  3. Common market is a customs union, which has, in addition, the free movement of factors of production such as labour and capital between the member countries without restriction.
  4. Economic Union is a common market where the level of integration is more developed. The member states may adopt common economic policies, such as common currency (such as the Euro).

Trade creation will mean that consumption shifts from a high-cost producer to a low-cost producer and trade therefore expands.

Trade diversion means that trade shifts from a lower cost producer outside the union to a higher cost producer inside the union.