Category Archives: Section 4

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!


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.



Hope might be in sight for the UK: The Marshall-Lerner Condition and the J-Curve


The article is a good example of a country, experiencing a Marshall-Lerner condition. The Marshall-Lerner condition examines the price elasticities of demand for exports and imports of a certain country. The Marshall-Lerner condition states that PED of exports + PED of imports > 1. If a country’s currency depreciates, while the demand for their imports and exports are elastic, then the currency will change its current account to surplus.

The article states that the UK pound has depreciated, making it more expensive for the importers. However, the imported products has been having more demands. This shows that the UK pound has depreciated, while their imports and exports are price elastic. Thus, the country is hoping for a boost in their economic growth. Although the country is in a greater deficit, the Marshall-Lerner condition states that in the long run, a situation they are currently encountering would lead to surplus or contracts their deficit.

The J-curve is illustrated with the country’s situation since the J-curve shows that a country has to undergo economic turbulence before achieving growth. UK’s deficit would perhaps only happen in the short-run, and the country would continue growing in the long-run.


The Spanish Prisoner

The Spanish currency has suffered recently against the U.S. dollars. Spain used to have its own currency, peso, but after joining the Euro Area, the country has adopted euro as well. As Spain joined the Euro Area, they chose to have single currency, where every country part of the Euro Area uses the same currency. Lately, the Spanish economy has not been doing well since they are in big deficit in terms of U.S. dollars. When the country used to have its own currency, they were able to manipulate the value of their currency. However, since Spain uses a single currency as other European countries, they cannot do anything about their problem. They cannot adjust the value of Euro since the economies of the other countries part of the Euro area are doing well, unlike them.

One solution that the Spanish people can do is to leave the Euro Area — let go of the euro. If the Spanish had a choice to manipulate their “own” currency, their economy would have been much better right now. However, since Spain is in such a big deficit now, they do not have enough money to cover the expenses of dropping out from the single currency. Most consequences Spain is going to face is going to be in the long run since they just have to wait and see how their economy is going to be in a few years time.


Philippines Current Account Balance

The current account of the Philippines is currently in surplus. The surplus of the country in terms of GDP is 3.5%. It is expected to reach 0 by 2013. Right now, the country is in good condition since it’s better off in surplus rather than in deficit.


Data Response Reflection

In the last data response, I actually did better than I expected. However, I had a little trouble with the evaluation. I tried to write as much as possible on the evaluation, such as pros and cons and the stakeholders. However, I did not have enough time to talk about other things, such as the decrease in supply of poultry. Hence, I should have better time management.

It took me a pretty long time to find the reason why the supply of the US poultry increased. I had to reread the article, which took me a while, so I didn’t have much time to write on my evaluation.


Free Trade vs. Protectionism

International Economics consists of both free trade and protectionism. Free trade is the exchange of goods and services between nations without any barriers against imports, while protectionism consists of trade barriers such as tariffs, quotas and subsidy. Both have pros and cons for countries, but which is better among the two?

In my opinion, countries could develop their economies easier with free trade. International economics is supposed to be about different nations, sharing labor with each other. If others think that different domestic industries should specialize  on different domestic products to get more revenue, the same would apply internationally. Industries can specialize on products where they have comparative and absolute advantage than other countries. Through specialization, the country would actually get more revenue for greater welfare and better standard of living. The whole country benefits, rather than just certain people who work in domestic industries.

It is said that barriers to imported products, such as by keeping imports more costly or by lessening the amount of imports that enter the country, will increase the market share of domestic companies as well as enhance employment opportunities at home. However, protectionism damages the economy of a country; it worsens the country’s standard of living. Only some people get rich, while others do not benefit from anything.

Although I think that free trade is better than protectionism, protectionism can help protect domestic industries against “cheap” imported products. The government should implement whichever as long as they don’t hurt most of the people of the society.