Free Trade and Protectionism (DD)

Free trade is trade that occurs between countries without any barriers or hindrances.

A tariff is a tax on imports, which can either be specific (so much per unit of sale) or ad valorem (a percentage of the price of the product).

Tariff diagram:

The tariff has the effect of shifting the world supply curve vertically upwards by the amount of the tariff. The level of imports will fall from QaQd to QbQc. The government will also raise revenue, shown by the blue shaded area. The level of domestic production will increase from 0Qa to 0Qb.

Quotas have the effect of restricting the maximum amount of imports allowed into an economy.

Export subsidies allow exporters to supply the market with more product than the natural equilibrium would have allowed.

Costs of Trade:

Adjustment costschanges in comparative advantage may require adjustments in the structure of industry and these may take some time. While they are taking place there may be employment costs from the changeover.

Environmental costs – free trade may lead to firms relocating to where environmental and other regulations are most lax. This could cause long-term environmental problems.


Reasons for Trade Definition and Diagram

Reasons for trade:

  • Different factor endowments – some economies are rich in natural resources while others have relatively little. Trade enables economies to specialise in the export of some resources and earn revenue to pay for imports of other goods.
  • Increased welfare – specialisation (where countries have a comparative advantage) and trade allow countries to gain a higher level of consumption than they would do domestically and this leads to increased welfare and higher living standards.
  • To gain economies of scale – with specialisation and production on a larger scale than may be possible domestically, a country may be able to gain more economies of scale. This will lead to lower average costs and benefit consumers through lower prices.
  • Diversity of choice – trade enables us to access goods and services that we may not be able to produce ourselves.
  • Political / historical reasons – some trade takes place for political and other reasons relating to history and tradition, though this is generally diminishing in importance.
  • Increased competition – increased global competition may help to spur domestic productivity improvements and give domestic firms a better incentive to innovate and improve their products. This will benefit consumers.
  • Trade may be an ‘engine for growth’ – increased trade may help to spur greater domestic economic growth and drive further improvements in living standards.

Absolute advantage exists when one country is able to produce a good more cheaply in absolute terms than another country.

Comparative advantage exists when one country is able to produce a good more cheaply, in comparison to other goods produced domestically, than another country.

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.

US $ vs. Chinese 元

There is currently a tension between the American currency and the Chinese currency. The Americans claim that the Chinese manipulate their currency to have more advantages in the trade. The Americans believe that the Chinese devalue their currency to benefit more in the trade. Devaluing of currency means that the Chinese sell their products to the Americans at a very low price, but they sell American products in China at a high price.

The Americans argue that the Chinese have devalued their currency about 20% to 40% against the dollar. Thus, making the Chinese much more advantageous in the trade. The US’ trade deficit with China is currently the biggest deficit US has compared to any other countries. On the other hand, China has a very high surplus with the U.S., which is currently 250 billion dollars, which is the largest among any other countries.

Surplus occurs when a country exports more than it imports. China is currently in surplus simply because most of the products in every country are imported from China. Because there is greater demand for Chinese products, the Chinese yuan would appreciate. Appreciation is the rise in value of a currency in terms of another currency in a floating exchange rate system. When a currency appreciates, it would cause the situation to switch – the exports would drop, wile the import would rise since appreciation would cause the Chinese yuan to become more expensive for foreigners.

The idea is that surpluses and deficits tend to self-correct over time. However, China has been in surplus for a long time, so the U.S. claims that China devalues its currency to keep the country in surplus. Countries, of course would rather be in surplus than in deficit. A problem with that though, is that if one country is in surplus, another country is in deficit, which is the situation of China and the U.S. right now. With China’s actions, the U.S. is very much affected since the U.S. have to cut down some jobs, thus causing unemployment and slow economic growth. Instead of helping the U.S. which is currently in deficit, the Chinese is making the U.S.’ situation worse. Countries in surplus are supposed to help countries in deficit by investing their money to them.

Instead of letting the Chinese yuan appreciate, the Chinese devalue their currency by making their currency depreciate. Depreciation is the lowering of the value of a currency in terms of another currency in a floating exchange rate system. One way that the Chinese could depreciate their Chinese yuan is by supplying more of their currency. The Chinese need to supply more of their currency since they keep their currency low and weak to make foreigners demand for it. If the Chinese yuan is relatively cheaper than other currencies, foreigners tend to buy them.

The graph above shows how the Chinese yuan depreciates. Since the RMB is weak and the dollar is strong, more RMB is put in the foreign currency market, so the Chinese supplies more of their currency. An increase in supply of currency causes it to depreciate.

Thus, China’s decision to devalue their currency is very selfish since other economies are affected by the decision. One country’s surplus is another country’s deficit. This is an unfair movement since countries in surplus are supposed to help countries in deficit.

France Balance of Payments (via Manon’s Econ Blog)

This is a good example of deficit.

France Balance of Payments Historical trends It has been in deficit since 2004. Current account deficit 2.67% of GDP Current account -56.13 billion $ GDP 2.097 trillion $ … Read More

via Manon's Econ Blog

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.