Studoc-International-Trade-notes 2[48].pdf

Economics 244 International Trade A1 Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward. ...

Economics 244 International Trade A1 Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  ECONOMICS 244: INTERNATIONAL TRADE PROBLEM 1 Trade and economic growth prospects in the era of Trumponomics and Global Trade Wars: good, bad or just plain ugly? What are the significant barriers to increased trade and economic growth? Trade wars refers to when trading partners continuously increase their tariffs on products against each other. It usually originates due to the initial introduction of tariffs against a country and then the corresponding retaliation that the other country implements. SESSION 1: What is the current state of the world economy with respect to trade and economic growth? Prior knowledge 1. What is economic growth? Economic growth refers to the increase in a country’s GDP. Absolute real economic growth refers to an increase in real GDP from one period to the next. Per-capita real economic growth refers to an increase from one period to the next in per-capita real GDP, which is real GDP divided by the population of the country. Economic growth is important as it determines the standard of living of the country’s population, which is essential, because imporiving the standard of living is essentially the end goal of each person. It is important to note that economic growth is a necessary condition for an increase in the standard of living, but not a sufficient condition, i.e. for the standard of living to increase, economic growth needs to be present; but, if economic growth is present, it does not always mean there is an increase in the standard of living. 2. How is economic growth measured? Economic growth can be measured either via the demand side of the economy or the supply side of the economy. From the demand side of the economy, real GDP (and accordingly ecnoomic growth) is measured according to the Keynesian equation, which is: Real GDP = AD = Y = C + I + G + (𝐄𝐗 − 𝐈𝐌) All these variables refer to specific items within the economy. These items are defined below. Private consumption expenditure, or simply consumption, denoted by C, refers to the goods and services purchased by consumers, which can range from food to airline tickets. Gross private investment, or simply investment, denoted by I, is the sum of private non- residential investment, which is when firms purchase new factories or machines, and private residential investment, which refers to when households purchase new houses or flats. In economic terms, investment refers to the purchase of any capital goods, as can be seen above. If investments refer to the purchase of gold or shares, it is specifically called financial investments. 1|Page Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  Government spending, denoted by G, refers to the purchases of goods, services and investment spending by the national, provincial and local governments. Government spending includes goods such as providing textbooks and medical services, but does not include government transfers, such as social grants or interest payments on government debt, because it might be government spending, but it does not purchase anything. Export, denoted by EX, refers to the purchase of South African consumption and capital goods and services by foreigners. Imports, denoted by Im, refers to the purchase of foreign goods and services by South African consumers, firms and governments. It is important to note that the net exports factor has a big influence on economic growth via the demand side of the economy. If the next exports is positive, i.e. the country exports more than what it imports, then this will lead to an increase in real GDP and will accordingly reflect economic growth. From the supply side of the economy, real GDP can be defined as a function of the factors of production and technology, i.e. Real GDP = 𝑓(N, K, L, t) 3. What are the sources of economic growth? The following factors can all lead to economic growth in a country: 1. Tangible factors a. Natural resources, including land, because the availability of natural resources make increased output possible. b. Capital, because capital investment increases output, which leads to an increase in labour productivity, and can accordingly affect economic growth and per-capita economic growth. This includes human capital, which refers to the knowledge and skills that a person acquires through education, training and experience. c. Labour, because an increase in labour (or labour productivity) leads to an increase in output, which leads to economic growth. Any of the abovementioned factors can lead to an increase (upward shift) in the production function, which leads to an increase in real GDP and accordingly in economic growth. Advancement in technology and inoovative idea, can also contribute towards economic growth by making firms (and countries) more cost effective and allowing them to increase their output and contribute towards the real GDP of the country. 2. Intangible factors a. Institutions, o Property rights structures that permit individuals to own property will be more conducive to production, and therefore economic growth, due to the incentive of ownership and the possibility of generating an income is present. o A legal system that dependable, honest and dedicated to enforcing legitmitate contracts and protecting private property reduces transacation costs of dealing with others and therefore providing individuals with an increased incentive to engage in activities that are conducive for economic growth. o Whether the country uses growth-promoting policies (increase the size of the economic pie) or transfer-promoting policies (increasing the size of the slices that groups receive relative to that of other groups). 2|Page Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  o Other institutions can also be conducive for economic growth, such as open and competitive markets, free (international) trade, policies that promote economic greedom, a stable monetary system, taxes and regulations that are not burdensome and a strong and effective educational system. Institutions, or the “rules of the game” as they are called, will also contribute to economic growth, because the institutions of a country outlines the norms and conventions of a country and accordingly how people behave and act towards one another. 4. The laws of demand and supply The Law of Demand refers to the inverse relationship between price and quantity demanded, i.e. when price increases, quantity demanded decreases, and when prices decrease, the quantity demanded increases. DETERMINANTS OF DEMAND Price When the price of a product increases, the quantity demanded by the consumers will decrease, which will lead to an upward movement along the same demand curve. Similarly, if price decreases, quantity demanded will increase and we will have a downward movement along the same demand curve. Factors that lead to a shift in the demand curve 1. The income of consumers a. Normal goods refer to goods with the property that the quantity demanded at every price level will rise as income rises, i.e. the demand curve will shift right. The opposite also applies, i.e. if income decreases, the quantity demanded at every price level will fall and the demand curve will shift left. b. Inferior goods refer to the goods with the property that the quantity demanded at every price level will fall as income rises, i.e. the demand curve will shift left. The opposite also applies, i.e. if income decreases, the quantity demanded at every price level will rise and the demand curve will shift right. 2. Consumer’s tastes (preferences) When the tastes of consumers change in favour of the company, i.e. they like a specific product more, it will lead to an increase in demand of the good, i.e. the demand curve will shift right, alternatively if the tastes of consumers change to the disadvantage of the company, the demand of the good will decrease, i.e. the demand curve will shift left. 3. Price of substitute and complement products a. Complements refer to any products that are usually consumed together (e.g. bread and butter), which means an increase in the price of one good decrease the demand for the complimentary good, i.e. the demand curve of the complimentary good will shift left, because if less bread is bought due to a price increase of bread, less butter will also be bought. Conversely, a decrease in the price of one good increase the demand for the complimentary good, which means the demand curve of the complimentary good will shift right. 3|Page Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  b. Substitutes refer to any products that perform the same task or satisfies the same human need (e.g. Coke and Pepsi), which means an increase in the price of one good increase the demand for the substitute good, i.e. the demand curve of the substitute good will shift right, because if Coke becomes more expensive, people will buy more Pepsi. Conversely, a decrease in the price of one good decrease the demand for the substitute good, i.e. the demand curve of the substitute good will shift left, because if Coke becomes cheaper, people will buy less Pepsi and more Coke. 4. Expectations about future income and/or prices If the expected future income increases, the demand of a good will increase in the present, i.e. the demand curve will shift right, because people know they will have more money in the future and will therefore be willing to buy more now. Similarly, with an increase in the expected future price, consumers will buy more in the present, because it is cheaper to buy them now, as opposed to buying the products later. Conversely, if the expected future income decreases, the demand of a good will decrease in the present, i.e. the demand curve will shift left, because people know they will have less money in the future and will therefore rather save in the present, than buy goods. Similarly, with a decrease in the expected future price, consumers will buy more in the future, because it will be cheaper to buy the goods later as opposed to buying the goods in the present. 5. Population If the population increases, the demand for goods will increase to reflect the increased needs of the larger population, i.e. the demand curve for the good will shift right, and conversely, the demand for goods will decrease when the population decreases, i.e. the demand curve of the good will shift left, because less products are needed to meet the decreased needs of the smaller population. The Law of Supply refers to the direct relationship between price and quantity demanded, i.e. when price increases, quantity demanded will also increase, and when price decreases, quantity demanded will decrease. DETERMINANTS OF SUPPLY Price When the price of a product increases, producers will be willing to sell more products because it will result in additional income for them, which will lead to an upward movement along the same supply curve. Similarly, if price decreases, quantity supplied will decrease, due to lowered profits, and we will have a downward movement along the same supply curve. Factors that lead to a shift in the supply curve 1. The state of technology Technological advancements lead to cheaper production processes, which will make the cost of production of goods cheaper and therefore suppliers will be willing to sell more and there will be an increase in supply, i.e. the supply curve will shift right. It will rarely happen, but in the case that the technology available to the producer deteriorates, the cost of producing goods will be more expensive and therefore suppliers will sell less, and supply will decrease, i.e. the supply curve will shift left. 2. The prices of the factors of production If the price of the factors of production, e.g. labour, capital or natural resources, increases, the cost of producing a good will increase, which will cause supply to decrease, i.e. the supply curve shifts left. 4|Page Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward. But, if the price of the factors of production decreases, supply will increase, i.e. the supply curve shifts right. 3. The number of suppliers in the market If the number of suppliers increase, the quantity supplied will be able to increase and therefore the supply curve will shift to the right. Conversely, if the number of suppliers decrease the quantity supplied will consequently decrease and the supply curve will shift to the left. 4. Expectations about future prices Because suppliers want to maximise their profits, they will want to sell at the highest possible price. Accordingly, if they expect the future price to increase, they will prefer to sell in the future, rather than in the present, and will therefore decrease their quantity supplied in the present, which will lead to the supply curve shifting to the left. Conversely, if it is expected that the future prices will decrease the suppliers will benefit from the higher prices in the and increase quantity supplied in the present, which will lead to an increase in supply, which means the supply curve will shift to the right. 5. Weather conditions The weather can have significant effects on the quantity supplied of a product. In the case that the weather has an adverse effect on the quantity supplied, such as during a drought, the quantity supplied will decrease and we will see a leftward shift in the supply curve. But, if the weather has a beneficial effect on the production of a good, it will increase the quantity supplied and we will see a rightward shift in the supply curve. QUESTION 1 – 4 marks Explain with the aid of the Keynesian equation in Macroeconomics, what the role of trade is in generating economic growth. Economic growth is measured as the increase in real GDP. Real GDP can be determined by the following Keynesian equation, as used in Macroeconomics, Real GDP = AD = Y = C + I + G + (𝐄𝐗 − 𝐈𝐌) Net exports, or the trade balance, refers to the difference between exports and imports. If net exports is positive, which means exports exceed imports, then there is a trade surplus. If net exports is negative, which means imports exceed export, then there is a trade deficit. The net exports (EX – IM) portion of the Keynesian equation is the part that represents international trade. Net exports is the primary source of trade in South Africa as it contributes approximately 40% of South Africa’s GDP. This means that we have a quite open economy, i.e. we participate in international trade to a large extent. International trade will also have an effect on investment, especially regarding the uncertainties that go hand-in-hand with certain trade decisions made by our country’s trading partners. This is because investment does not only rely on interest rates, but also on confidence and expectations, e.g. the investments of individuals are halted due to the uncertainty of what Donald Trump might potentially do. They will rather wait with their investments as they are scared that whatever he does has an adverse effect on their investments. 5|Page Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward. Additional questions associated to Question 1 What do global trade prospects look like? World merchandise trade growth is expected to remain strong in 2018 & 2019, but its continued expansion depends on robust global economic growth and governments pursuing appropriate monetary, fiscal and trade policy. The expected growth of the world merchandise trade volume is 4,4% for 2018 with strong growth in developing economies in both exports (5,4%) and imports (4,8%) (slightly down from the 4,7% in 2017, which was mainly driven by increase investment and consumption expenditure). Developing countries will also see fairly strong growth on both the export side (3,8%) and the import side (4,1%). It is expected to more in 2019 to 4,0%, which is lower than the average rate of 4,8% that has been seen since 1990, but it is still good as it is above the post-crisis growth rate of 3,0%. 2019 will still see developing economies outpacing developed countries in both exports (5,1% compared to 3,1%) and imports (4,4% compared to 3,3%). Strong trade growth → Economic growth → Job creation This can be quickly undermined if governments decide to implement restrictive trade policies, especially if the global economy falls into a cycle of retaliation between the trade partners. It is expected that escalating trade tensions may be affecting business confidence and investment decisions, which could compromise the current outlook on future trade prospects. The WTO suggests that these problems need to be tackled through dialogue and serious engagement before governments resort to restrictive (and protectionist) policies. Fast monetary tightening by central banks could also trigger fluctuations in exchange rates and capital flows that can be very disruptive for trade flow. The worsening geopolitical tensions could also lead to reduced trade flows. Lastly, technological change can lead to conflict that are increasingly taking on the form of cyber-attacks, which can impact trade in services, as well as the trade of goods. There are some factors that weigh negatively on trade that are still present, such as the rebalancing of the Chinese economy away from investment toward consumption, which will dampen imports slightly in the short-run, but will produce stronger, sustainable growth over the long term; as well as the reduced pace of global trade liberalization (short-run and long-run) will still affect global trade. What do global economic growth prospects look like? The economic growth over the short-term also looks very positive, but again, the longer-term forecasts are very uncertain. This expected growth of the world merchandise trade volume will be accompanied by a GDP growth of 3,2% in 2018; and 3,1% in 2019. These brighter prospects reflect investment and employment gains, but also improved business and consumer confidence. These outlooks are quite uncertain due to the considerable risks involved with the increased possibility of disorderly financial market volatility (due to elevated corporate debt since the global financial crisis, which makes firm more vulnerable to rising borrowing costs) and the vulnerability of some emerging markets and developing economies to these disruptions. Trade protectionist sentiment has also mounted, which means policy decisions remain uncertain and geopolitical risks (which will reduce trade flows, although the impact thereof is very unpredictable) are elevated. The forecasts for long-term growth has finally stabilized, which can be a signal that the global economy is finally emerging from the 2008/2009 financial crisis, but historically, these long-term forecasts are 6|Page Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward. generally overly optimistic and probably overlooked potential growth and structural drags on economic activity. The unanticipated increase in inflation in one or more countries, could cause monetary authorities to increase interest rates, which can cause economic growth to slow down, which has negative consequences for global trade. What can be done? Policymakers need to implement reforms that can lift long-term growth prospects. Furthermore, the importance of supporting skill acquisition and boosting competitiveness and trade openness is being emphasised by a rapidly changing technological landscape. Improving basis numeracy and literacy could also yield substantial development dividends (returns). Lastly, promoting comprehensive trade agreements can strengthen long-term growth prospects by addressing growth in global trade first. South Africa’s forecasted to expand (economic growth) 1,4% in 2018 and 1,8% in 2019 as a pickup in business and consumer confidence supports stronger growth in investment and consumption expenditures. Sold on StudentSummaries.co.za. All Rights Reserved. Not for resale/distribution. Report unauthorised use to [email protected] for a reward. 7|Page Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  SESSION 2: What are the most significant barriers to freer interenational trade? Prior knowledge 1. Consumer and producer surplus Consumer surplus occurs when consumers are paying less than what they are willing to pay for a product. Accordingly, consumer surplus refers to the difference between the price that the consumer is willing to pay and the price they are actually paying, i.e. the price a consumer is willing to pay minus the price they are paying. The consumer surplus refers to the area enclosed by the demand curve above the equilibrium level (as illustrated by the area of the blue triangle in the figure to the right). Producer surplus occurs when producers receive more than what they are willing to accept for a product. Accordingly, producer surplus refers to the difference between the price that they are receiving for their product and the price they are willing to accept, i.e. the price a producer is receiving minus the price they are willing to accept. The producer surplus refers to the area enclosed by the supply curve below the equilibrium level (as illustrated by the area of the grey triangle in the figure above). 2. Tariffs and the impact of tariffs A tariff is a tax on an imported good, which means it costs exporters more in their country to get their products into the importing country, which accordingly makes products more expensive for consumers. The most common tariff is an import tariff. Tariffs can exist on any good and/or service and the rates at which these tariffs are set are often quite ridiculous. Tariffs can cause problems for producers, consumers and societies at large. The effect of a tariff will fully be discussed in Question 2 on the next page. 3. Quotas and the influence of quotas A quota is a legal limit that is imposed on the amount of a good that is allowed to be imported, i.e. enter the country. Very similar to the effects of a tariff, quotas result in a decreased consumer surplus, an increased comsumer surplus and a gain for importers. Because the loss to consumers is greater than the increase in producer’s surplus plus the gain to importers, there will always be a net loss associated with the implementation of a quota. 4. Other non-tariff restrictions There are a variety of other non-tariff restrictions that a country’s government can decide to implement. The general problem with any form of trade restriction is that it takes away the gains that countries get from free trade (i.e. international trade with any trade barriers). These gains originate from countries that specialize in the production of goods in which they have a comparative advantages in relation to other goods, but regardless, the gains are nullified due to these trade restrictions. 8|Page Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward. Question 2 – 8 marks Explain with the aid of a graph, what the impact on the South African economy will be when the government levies an import tariff on chicken wings. Suppose, we are in the market for chicken wings. In the world market for chicken wings, the price will be determined by international demand and supply and will settle at a price of Pw. At this price level local suppliers are willing to produce and supply Q1, but local buyers are willing to buy Q4, which means that there will be an import of (Q4 – Q1) units. Under these circumstances the consumer surplus will be the area of blue triangle; and the producer surplus will be area of the green triangle. Suppose that an import tariff of t is introduced on chicken wings. This will mean that the new price to import chicken wings will be (P w + t) at which local suppliers are willing to produce and supply Q2 (quantity supplied increases) and local buyers are willing to buy Q3 (quantity demanded decreases). This means that the amount imported by South Africa will decrease to (Q3 – Q1) units. This will have the effect of the consumer surplus reducing by area 1, 2, 3 and 4 to now become the area of the orange triangle. The producer surplus, however, will increase with area 1 and now become the area of the red triangle. Area 3 will be a benefit to the government in the form of a tax revenue. The tax revenue will be equal to (Q 3 − Q 2 ) × 𝑡. And the loss of area 2 and 4 will be imposed on society in the form of a deadweight loss. This means that the economy is currently operating under inefficient conditions. The effect of levying a tariff on an imported good leads to import inflation, because the prices of goods and services are artificially increased, and we generally find that have an effect on other firms, as well, e.g. If the tariff was imposed on a raw material, the tariff will have an effect on the market for that specific raw material, as well as any industry/market that uses that raw material in their production process. Furthermore, it also has an effect on complementary products and substitutes, in the case where the tariff is not imposed on a raw material. Question 3 – maximum of 10 marks Name and describe briefly five non-tariff restrictions. Non-tariff bariers are any measures that restricts trade, but that are not tariffs, which means it does not raise revenue for the government. They can be deliberate or unintended, but regardless they restrict trade or reduce the ease in which products can imported or exported. Any form of trade barriers leads in an economic loss, because it limits standard trading. 9|Page Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward. The following schematic outlines the different forms of non-tariff restrictions and the different forms that can be found in each of these categories. Quotas Import Licensing requirements Specific limitations on Local content requirements trade Minimum import price limits Embargoes Valuation systems Customs and Antidumping practices Administrative Entry Tariff classifications Procedures Fees Standard disparities Sanitary and phytosanitary measures Standards Intergovernmental accpetance of testing methods and standards Packaging, labeling and marking standards Government procurement policies Government Export subsidies participation in trade Countervailing duties Domestic assitance programs Prior import deposit subsidies Administrative fees Special supplementary duties Charges on imports Import credit discriminations Variable levies Border taxes Voluntary export restraints Other non-tariff barriers Orderly marketing agreements SPECIFIC LIMITATIONS ON TRADE Quotas A quota is a specific limit for goods and services that are allowed to be imported/exported. These quotas are usually set for a specific timeframe. If the quota is reached, the country/business needs to wait until the timeframe has elapsed before commencing with trade activities. Import Licensing requirements Countries may use licenses to limit imported goods to specific business. A business is only permitted to import goods if they have been granted a trade license, alternatively, the import of that good (or goods in general) was restricted. Using licenses is a form of direct regulation of imports because the government ensures that only business that are approved by them are allowed to participate in trade activities as specific documentation is required for trade. 10 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  Proportion restrictions of foreign to domestic goods (local content requirement) When a foreign company makes products in a country, the materials, parts etc that have been made in that country rather than imported. A minimum level of local content is sometimes a requirement under trade laws when giving foreign companies the right to manufacture in a particular place. Minimum import price limits Minimum import prices are the minimum price per tonne that the importing firm has to pay while importing products into their country. By setting a minimum import price limit high enough, governments can discourage importing companies/firms to import goods. Embargoes Embargoes are when the trade of specific goods or services are restricted. This is a measured used by governments generally for specific political or economic reasons. Sanctions Sanctions are threatened penalty for disobeying predetermined laws or rules or the need for express permission or approval for an action. CUSTOMS AND ADMINISTRATIVE ENTRY PROCEDURES Valuation systems It is possible to avoid taxes and import duties, by making a deal with the exporting company to undervalue the product on the receipt. SARS prevents this of happening by specifically requesting the original proof of payment to verify the amount that the product was purchased for. If SARS finds you guilty of this form of fraudulent behaviour, you can be charged with a penalty. This tries to discourage companies to import by increasing the actual price that they need to pay artificially with other non-tariff barriers, such as import levies and border taxes. Anti-dumping practices Dumping occurs when an exporting country sells product in the importing country at a price that is lower than the price that is charged in the domestic market (sometimes lower than cost). The WTO allows governments to implement anti-dumping practices (i.e. to prevent the exporting country of selling their products locally) when they can show that there is material injury to the competing domestic industry. The government therefore has to be able to calculate the extent of dumping, i.e. how much lower the product’s export price is, as opposed to the local price in the exporting country’s market and then show that the dumping is causing injury or threatening to cause material injury. Tariff classifications The tariff classification assigns a customs nomenclature code that uniquely identifies the goods. The customs nomenclature code may be 6, 8 or 10 digits long. The different nomenclature codes are commonly called customs codes, customs tariffs, tariff positions, customs classification codes, customs nomenclatures, commodity codes, goods codes, etc. The tariff classification determines the import customs duties rate, the existence of prohibitions and/or restrictions (licenses and/or authorization for goods subject to restricted trade), application of anti- dumping duties, existence of quotas, etc., other agricultural measures, including those from the common agricultural policy, safety standards and the existence of health or phytosanitary procedures. 11 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  Documentation requirements This refers to administrative restrictions such as adherence to certain documentary procedure are adopted to regulate imports. These measures impede the free flow of trade to a large extent. Large number of countries demands that shipping documents must accompany the consular documents such as a) Certificate of origin, b) Certified invoices, c) Import certificates etc. Sometimes, it is also insisted that such documents should be drawn in the language of importing countries. In case the documentation is faculty and is not drawn in the language of the importing country heavy penalties are imposed. Fees charged for such documentation are quite heavy. Fees All costs associated with being allowed to bring the imported good and/or service into the country. These fees are generally set high and acts as an artificial way of increasing the price and in turn incentivising local consumers to make use of local goods and services instead of importing them. STANDARDS Standard disparities Standard disparities refer to the differing standards that countries have for similar goods and/or services. The government can then implement measures to prohibit the import of goods that do not adhere to the standards of the importing country. Sanitary and phytosanitary measures Sanitary and phytosanitary measures may be defined as those measure implemented in order to protect human, animal and plant lives from the risks associated with toxins and other nefarious products present in foodstuff and to prevent the proliferation of diseases in a country. It encompasses the hygienic requirements, storage and transport conditions, testing requirement and certification of products. Intergovernmental acceptances of testing methods and standards Packaging, labelling and marking Governments try and prevent the importing of goods that make use of certain forms of packaging or labelling, or goods that do not use of specific packaging or labelling. This could be done for a variety of reasons, e.g. if the government wants to prohibit certain harmful materials to enter a country’s border. GOVERNMENT PARTICIPATION IN TRADE Government procurement policies Government procurement or public procurement is the procurement of goods, services and construction on behalf of a public authority, such as a government agency. Government procurement policies therefore refer to laws and government rules that favour local products when the government is the buyer. 12 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  Export subsidies Subsidies that are granted to producers of goods that are produced with the purpose of being exported to other countries. It reduces the cost and accordingly makes the firm more competitive on the foreign market. Countervailing duties Countervailing duties, also known as anti-subsidy duties, are trade import duties imposed under WTO rules to neutralize the negative effect that subsidised can have on the competitive position of local firms. Countervailing duties can only be implemented after an investigation finds that a foreign country subsidizes its exports, injuring domestic producers in the importing country. Domestic assistance programmes CHARGES ON IMPORTS Prior import deposit subsidies A prior import deposit is a deposit required by a government of a specific sum, in either the domestic or foreign currency, usually corresponding to a certain percentage of the value of the imported products. These deposits are characteristically held without interest from the time that the order was placed until the transaction is completed. This will especially be a useful measure to decrease the imports of luxury goods with high values, because the consumer might not have cash available to the sum of the import deposit, which will disallow them from making the import. Administrative fees Special supplementary duties Import credit discriminations Import credit refers to credit which is opened by an importer with a bank in his own country and upon which the exporter he deals with may draw bills of exchange. A creditor can discriminate against you by doing any of the following: offer you credit with unfavourable terms compared to someone else with similar qualifications; refuse to you extend you credit if you qualify for it; keep you from applying for credit or closes your account. Variable levies Variable import levy is a levy on imports that raises their price to a level at least as high as the domestic price. Such levies are adjusted frequently (hence variable) in response to changes in world market prices and are imposed to defend administered prices set above world market prices. Border taxes A border-adjustment tax (also known as a border-adjusted tax, destination tax, destination-based cash flow tax or a border tax adjustment) is a tax on goods based on location of final consumption rather than production. It allegedly eliminates incentives for companies to reduce their tax bills through tax inversion and intangible asset relocation. 13 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward. OTHERS Voluntary export restraints Voluntary export restraints set a limit on the number of goods and services that a country will export to specified countries. These restraints are typically based on availability and political alliances. Orderly marketing agreements The term “orderly marketing agreements” (OMA) refers to an agreement by which the national government agrees among themselves, that an exporting country will restrain its exports targeted toward an importing country with which it is negotiating. These agreements are restrictive and commonly affect prices, international relations and free trade. Sold on StudentSummaries.co.za. All Rights Reserved. Not for resale/distribution. Report unauthorised use to [email protected] for a reward. 14 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  SESSION 3: Why are there restrictions on trade? Question 4 – up to 6 marks Explain three justifications for restrictions on trade with the aid of real world examples. Economic reasons Raising revenue for the government Low foreign wages argument Some argue that country’s producers cannot compete with foreign producers, because they have to pay too high wages and foreign producers pay low wages. They therefore insist that international trade must be restricted, or they will be ruined. High productivity and high wages are usually linked, and the opposite is true, as well. A country high-wage disadvantage may be offset by its productivity advantage, and a country’s low- wage advantage may be offset by its productivity disadvantage. High wages do not necessarily mean high costs when productivity and the costs of non-labour resources are included. Foreign export subsidies argument Some governments subsidize firms that export goods. If a country offers a below market loan to a company, it is often argued that the government subsidizes the production of the good the firm produces. If, in turn, the firm exports the good to a foreign country, the country’s producers of substitute goods call foul. They complain that the foreign firm has been given an unfair advantage that they should be protected against. Others say that consumers should not turn their backs on a gift (lower prices). If foreign governments want to subsidize their exports and thus give a gift to foreign consumers at the expense of their own taxpayers, then the recipients should not complain. The complainers are the domestic producers who cannot sell their goods at as a high price because the so-called gift that domestic consumers are receiving from foreign governments. Preventing unemployment (saving domestic jobs) Critics: if a domestic producer is being outcompeted by foreign producers and if domestic jobs in an industry are being lost as a result, the world market is signalling that those labour resources could be put to better use in an industry in which the country holds a comparative advantage. Protecting infant industries Young, emerging firms often need help against bigger, mature firms until they have found their feet and are in a position in which they are able to compete with the bigger firms. This can cause a problem, because the smaller firms become dependent on the help and will always claim that they are “not big enough yet” in which case this argument starts to be abused. Arguments to prove that the protection of infant industries is not always helpful to a countries economy are as follows: 1. Often infant industries fail to mature, proving to be inefficient and uncompetitive in global market economies creating inefficient domestic producers, low quality but high cost goods and rent seeking; 2. Often infant industries never grow up, and thus continue to seek protection today e.g. clothing in SA; 15 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  3. A problem revolves around deciding which industries should be encouraged; 4. Because these industries are not exposed to competition, they were under no pressure to improve efficiency and so lower the process of their goods resulting in the rich getting richer and the masses paying for necessities because they could not get them from elsewhere. It is important to understand the infant industry argument is the one that governments most often use, regardless of its flaws. Real world example: One of the first acts of the US Congress was to impose tariffs on a variety of imports including cotton, leather, and various forms of clothing, in an effort to protect the American textile industry. Promoting industrialization Improving comparative position Anti-dumping argument Selling a product in a foreign country at a price that is lower than the price that is being charged in the domestic market. Firms are allowed to accuse countries of dumping, in which case they need to be able to prove that it caused damage and injury by consulting economists and lawyers. When anti-dumping does in fact occur, the WTO will levy the country with dumping duties. Argue that domestic consumers benefit from lower prices. This is an impractical strategy, because they often dump in the aim of driving out local competition, after which they will raise their prices, incentivising the local competition to come back, and their string of losses incurred would have been in vain. The problems that can occur regarding the anti-dumping argument is as follows — Domestic producers seek protection against imports, mobilizing public opinion with allegations that imports are dumped; — Designed to protect consumers from cheaper imported products that are harmful. Real world example: Ron Chernow points to the example of regional oil monopolies in Titan: The Life of John D. Rockefeller, Sr. where lining an approved strategy where oil in one market, Cincinnati, would be sold at or below cost to drive competition's profits down and force them to exit the market. In another area where other independent businesses were already driven out, namely in Chicago, prices would be increased by a quarter. This occurred in the early 1900’s. On November 18, 1906, the federal government filed suit in Missouri to dissolve Standard Oil under the Sherman Antitrust Act, naming as defendants Standard Oil of New Jersey, sixty-five companies under its control, and a pantheon of chieftains, including John and William Rockefeller, Henry Flagler, Oliver Payne, John Archbold, and Henry Rogers. They were charged with monopolizing the oil industry and conspiring to restrain trade through a familiar litany of tactics: railroad rebates, the abuse of their pipeline monopoly, predatory pricing, industrial espionage, and the secret ownership of ostensible competitors. Non-economic (political) reasons Maintaining essential industries Dealing with unfriendly countries To prevent trade agreements and interactions with unpleasant countries that the local government might not want to deal with. 16 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  Maintaining control (over resources) To ensure that resources are not abused and overexerted through exports in which case a local country can lose its controlling share over the country’s natural resource. Preserving national identity (security) – National defence argument Certain industries, such as aircraft, petroleum and weapons, are necessary to the national defence. Suppose the US has a comparative advantage in the production of wheat and country X has a comparative advantage in weapons. Many Americans feel that the US should not specialize in the production of wheat and then trade wheat to country X in exchange for weapons. Leaving weapons production to another company, they maintain, is too dangerous. Than national defence argument may have some validity, but even arguments may be abused. Industries that are not really necessary to the national defence may maintain otherwise. In the past, the national defence argument has been used by firms in industries such as pens, pottery, papers, candles, thumbtacks, tuna fishing and pencils. Look at the Canada-wash-pegs situation going in with South Korea. It is necessary to protect certain industries with a tariff, to ensure the continued domestic production of said products during times of war, e.g. agriculture and weapons. Real world example: The legal basis cited in Trump's tariff order on steel and aluminium against countries such as India, Australia, China and Canada, is Section 232 of the Trade Expansion Act of 1962 which under certain circumstances allows the president to impose tariffs based on the recommendation from the U.S. Secretary of Commerce if "an article is being imported into the United States in such quantities or under such circumstances as to threaten or impair the national security." To prevent the abuse of human rights This can be done by prohibiting products to enter the country’s borders in an attempt to protect its citizens. Fair trade versus free trade argument Through fair trade, tariffs or other restrictions can be imposed in the name of fairness in order to reduce competition and put prices up. However, arguments have been put forward to show that fair trade is just a nicer way of implying protection of economies, where local domestic producers are protected unlawfully at the consumer’s detriment. Note that free trade is trade without restrictions whereas fair trade is where “fair” prices are paid to producers (occurs between developed and developing countries). Sold on StudentSummaries.co.za. All Rights Reserved. Not for resale/distribution. Report unauthorised use to [email protected] for a reward. 17 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  PROBLEM 2 What are the options for Africa to improve growth prospects through increased trade? What does International Trade Theory suggest? Intra-industry trade refers to trade that occurs within the same industry between different countries, e.g. the trading of cellular technology among different countries. Inter-industry trade, however, refers to trade that occurs between different industries, such as trade between the agriculture sector (flour) and the industrial sector (ovens). Trade patterns describes what is imported and exported, by whom and to whom. In the past, colonies would provide raw materials and the empires would refine and then trade those. A country’s pattern of trade is determined by relative factor endowments, i.e. a country will export (and specialise) goods that embody factors of productions that are generally abundant, while they will import goods that have relatively scarce factors of production will be imported. Factor endowments refer to the natural resources allocated by location and structure of the country in question. SESSION 4: What policy advice could Africa derive from International Trade Theory? Prior knowledge 1. Why do nations trade? – Absolute and comparative advantage All nations have different sets of resources to their availability and accordingly, due to this resource constraint, they cannot produce all of the goods and services needed to satisfy their population’s needs. Accordingly, nations will partake in trade in order to obtain goods and/or services, which they cannot produce, or produce at the lowest possible cost, and they can then supply other nations with goods and/or services that they require. In order for a nation to determine which goods and/or services they will need to export or import, the following two concepts become important. Absolute advantage refers to the ability of a country to produce a good and/or service at a lower cost per unit than all other countries, e.g. tropical countries where their climate is beneficial to fruit production and accordingly offers them cost advantages. Comparative advantage refers to the ability of a country to carry out a particular economic activity more efficiently than another activity, which means that they can produce the particular good or service at a lower opportunity cost than their competitor. 2. Production possibility frontiers The production possibility frontier (PPF) is the boundary between those combination of goods and services that can be produced and those that cannot, i.e. a graph that shows the combinations of goods and services that can be produced given the available factors of production and the available production technology, as illustrated in the figure on the next page with good X and good Y. Because of this, every choice along the PPF involves a trade-off, because to produce more of good Y, you have to produce less of good X. 18 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward. In the figure to the right, the y-axis displays the quantity of good Y produced and the x-axis displays the quantity of good X produced. Any point on or below the PPF (the blue line) is where production of the combination of goods is possible, i.e. attainable points. Any point outside of the PPF, e.g. point D, is unattainable, which means that without an increase in the factors of production or the production technology, that specific combination of goods is impossible. Any point below the PPF, e.g. point C, is attainable, but it is an ineffective position, i.e. more can be produced with what the available resources. Production efficiency is achieved if goods and services are produced at the lowest possible price, which is illustrated by any point on the PPF. At any point below the PPF, resources are either unemployed or misallocated or both. At any of these points, we will say that the economy is production inefficient. When resources are unemployed it means they are left idle, while they could be working, while if resources are misallocated, it means resources are assigned to tasks for which they are not the best match. Productive inefficiency implies that gains are possible in one area without losses in another. Different forms of the PPF 1. If the PPF is a straight line, it represents an economy with production that occurs under conditions of constant opportunity costs. 2. If the PPF is bowed-outward (concave-downward), as in the figure above, it represents an economy with production that occurs under conditions of increasing opportunity costs. This means the opportunity cost of a good increases the more you move to the right of the PPF. Bowed-outward PPF = Increasing opportunity costs A simple two-person PPF model A person who can produce a good at a lower opportunity cost than another person has a comparative advantage in the production of the good. Individuals can make themselves better off by specializing in the production of the good in which they have a comparative advantage and then trading some of that good for other goods, which will allow them to achieve production combinations that were previously unattainable. 3. Indifference cures An indifference curve, e.g. I3, refers to a set of bundles among which the consumer is indifferent (has no preference), which can be represented graphically (like the figure on the next page). This also means that the total utility remains the same along the entire indifference curve. An indifference curve will be mapped on an axis where two different goods and/or services are on the horizontal and vertical axis. The combination of all the consumer’s indifference curves is called an indifference map. Within an indifference map, a higher indifference curve is preferred as it leads to larger levels of satisfaction. It is important to note that there are infinitely many indifference curves that can exist within in an indifference map in order to represent the preferences of all possible combinations 19 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward. of goods and services that can be produced. We generally only use a limited amount of indifference curves in an indifference map in order to carry out simple indifference curve analyses. Properties of indifference curves Indifference curves are ubiquitous, i.e. there is an indifference curve passing through every single possible bundle, which is ensured by the completeness property of preference ordering. Indifference curves are downward sloping, which is an extension of the “More-is-better” property of preference ordering. Indifference curves cannot cross, because, as Food (kg/wk) can be seen on the figure to the right, the utility received from bundle D is the same as the utilitiy received from bundle F (as they are on the same indifference curve) and similarly the utility received from bundle D is the same as the utilitiy received from bundle E, which by logical inference means the utilitiy received from bundle D F E should be equal to the utility received from I2 bundle F, which is not true because F is in fact preferred to E as it has a higher level of E I1 Shelter consumption of both goods. (m2/wk) Shelter (m 2/wk) Indifference curves become less steep due to the convexity property of preference ordering, which is a result of the marginal rate of substitution. Trade-off between goods and/or services The marginal rate of substitution (MRS) refers to the rate at which the consumer is willing to exchange the good measured along the vertical axis for the good measured along the horizontal axis, without changing the total satisfaction that the consumer receives. The MRS is equal to the absolute value of the slope of the indifference curve, as illustrated in the figure to the right. The MRS is subject to diminishing marginal rate of ∆FA MRSA = ฬ ฬ substitution, which means that the MRS declines ∆SA as we move downwards (to the right) on the indifference curve, which can be logically explained as follow: if you only have one unit of food left, you would need to be offered a very large amount of shelter to give up that last unit of food. However, if you had 1 000 units of food left, you would quite easily give up one unit of food. 4. Opportunity cost Implicit costs (opportunity cost) of an activity refers to the value of all things that must be sacrificed to partake in a particular activity. Since every choice on the PPF involves a trade-off, there is an opportunity cost involved. Opportunity cost is a ratio: It is the decrease in the quantity produced of one good divided by the increase in quantity 20 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward. produced of another good, e.g. if 5 units of X must be given up to produce 1 more unit of Y, then the opportunity cost of Y is 5X. The opportunity cost of X is the inverse of the opportunity cost of Y, i.e. 1/5 Y. The opportunity cost of a good increases as more of it is produced, i.e. when very little of good Y is produced, e.g. none on the x-axis, the opportunity cost of producing more Y is very small, while if a lot of good Y is produced, e.g. at point A in the figure to the right, the opportunity cost of producing more Y is very high. The reason why opportunity cost of a good increases as more of it is produced is because all resources are not equally productive in all aspects, i.e. moving resources that are more efficient at producing good X to produce good Y will decrease productivity and increase opportunity cost. Because opportunity cost increases as more of a good is produced, the PPF is concave, as we see in the figure to the right. This is the most general form of the PPF that one will encounter, as most economies face production that take place under conditions of increasing opportunity cost. Question 1 What are the key elements of mercantilist thought on trade? Mercantilism was an economic school of thought, which emerged in the period between 1300 and 1500 when Europe was experiencing an acute shortage of gold and silver bullion for use as money in domestic and international transactions. Due to the origin of this school of thought, the main aim of their school of thought was to protect the gold and silver reserves of the country at all costs, even if this were to be at the expense of their trading partners. The mercantilist view on trade exhibited the following characteristics: First of all, there was extensive regulation of imports and exports. The regulation was so severe that certain imports were restricted completely, while others were heavily discouraged by the use of import duties. The mercantilists were therefore extreme advocates for protectionist policies in order to discourage imports in order to preserve their gold and silver reserves. They did, however, try and export as much as possible in order to increase their gold and silver reserves. Secondly, trade monopolies formed and flourished. When trade monopolies formed (usually by means of extensive government control) in specific goods and/or services, it meant that there was no competition in the market, which allowed them to sell goods and services at higher prices in order to increase their gold and silver reserves. Furthermore, smuggling flourished, because those that were willing to take the risk and trade goods and/or services that were prohibited, could reap very large profits and again, increase their gold and silver reserves. 21 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  Lastly, there was significant incentives for European governments to establish colonial empires. This was a common occurrence due to the fact that colonies could feed Europe with cheap labour, which allowed them to drive down their production costs and accordingly reap larger profits. From the aforementioned characteristics, it is clear that the mercantilist school of thought does not place high importance on morals. They were completely committed to increasing their gold and silver reserves and would go to drastic measures to ensure this. Additional question How does Adam Smith prove the Mercantilists wrong? Adam Smith believed that the mercantilist school of thought enabled merchants to enrich themselves by exploiting monopolistic concessions and other extraordinary privileges granted to them by the government, and accordingly, did not enrich the welfare of society. Adam Smith favoured a free market without state regulation, monopolies and privileges, because it would discourage entrepreneurs to behave in a competitive, efficient and dynamic manner. Adam Smith’s main critiques on the mercantilist school of thought, is contained within the Wealth of Nations, and the essence can be extracted as follows A nation’s wealth depends on its productive capacity, not merely the gold and silver reserves. Smith argued that if reserves were used to purchase materials and tools, or to employ labour, the productive capacity of the nation would increase, and future wealth could be assured. He believed that a laissez-faire approach is the best way to increase productive capacity, i.e. Smith believed that governments should remove all restrictions and special privileges in order for the expansion of industries and trade, such that social harmony and economic progress can triumph. Lastly, he believed that international trade is mutually beneficial for all trading countries, and accordingly there should be no protectionist policies, because if nations export products which they can produce relatively efficiently and import products that they produce relatively inefficiently, all parties involved in trade will be “gainers”; nobody is “losers” in free trade. The essential is therefore that the gains of international trade, ceteris paribus, can only exceed the losses thereof if there is free trade that prevails in the global economy. Question 2 – 15 marks Explain David Ricardo’s theory of Comparative Advantage with the aid of a graph so that the gains from trade and the implied policy advice is clear. David Ricardo’s theory of Comparative Advantage states that every country will produce the commodities that are the most suited to its natural factor endowments. David Ricardo’s theory is that both countries gain even if one produces everything more cheaply than the other. If country A (that has the absolute advantage) produces one good more efficiently than it produces the other, country A should produce only that good. Country B should then produce the other good as this will result in the maximum combined output of each good. 22 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward. The trade pattern that is perpetuated by Ricardo’s theory is that of inter-industry trade across country borders. For Africa to take advantage of Ricardo’s theory of Comparative Advantage is to find innovative ways to become more efficient in their production processes. David Ricardo’s theory of Comparative Advantage is based on the following assumptions: 1. There are two countries and two commodities. 2. There is perfect competition in both the commodity and factor market. 3. Labour is the only factor of production, other than natural resources. 4. Labour is perfectly mobile domestically, but immobile internationally. 5. There is free trade. 6. There is no technological change. 7. Full employment exists in both countries. 8. There is no transport cost, i.e. it does not increase as the distance travelled increases. Under these assumptions, we can explain international trade with the following graph. Suppose we have two countries, A and B, that produce two commodities, wheat and cloth. The axes is very important in this question, as every point on this curve is a combination of the value on both axes – you therefore have to always give axes titles. When a country exists in isolation, they are limited to their physical (and institutional) constraints and therefore the best a country can do is to reach a point on the PPF. Any point on the PPF shows that you are efficiently utilizing all resources. Because we are efficient, we will be producing at e - the autarky equilibrium (achieved without trade), where the slope of PPF = slope of PP’ = (MRS) slope of II’ and we currently produce the optimal output of, suppose, Ow units of wheat and Oc units of cloth. This will also lead to a maximum level of real income in this country. Any point beyond the PPF is unattainable under the current conditions. PP’ – the domestic terms of trade (or domestic price line) TT’ – the international terms of trade In autarky, an equilibrium that is achieved without trade, production will be equal to consumption, indicated by pre-trade equilibrium of e on the graph – the point where the slope of the indifference curve (the marginal rate of substitution) is equal to the slope of the budget line, as well as the slope of the budget line (the marginal rate of transformation). Absolute advantage refers to the ability of a country to produce a good and/or service at a lower cost per unit than all other countries, e.g. tropical countries where their climate is beneficial to fruit production and accordingly offers them cost advantages. If one country has the absolute advantage in both countries (Adam Smith): the country that does not does not have an absolute advantage will have no gains to trade. 23 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward. When referring to international trade, we prefer to have comparative advantage, which is the advantage that one country has over another if it can produce a product at a lower opportunity cost than another country. The opportunity cost is therefore the value of one product in terms of another, e.g. the quantity of food that must be sacrificed to produce one more unit of clothing. Choosing to focus on the comparative advantage, instead of the absolute advantage, allows a country to specialize in the good in which it has a maximum comparative advantage, to export the surplus and import the good in which it has a comparative disadvantage. Now, if we introduce foreign trade into this model, the theory of Comparative advantage suggests that the country will want to produce the product in which it has the maximum comparative advantage (the lowest opportunity cost), suppose in this hypothetical that the country will specialize in cloth. Should both countries produce the maximum for the relative goods we have then that both countries will be able to consume more than they can individually produce of each good, thus they are consuming at a higher indifference curve, which is beyond their PPF. The slope of TT’, called the terms of trade budget line (the relation of the export price to the import price), becomes steeper, because we assume that the export and import price is not the same. Now, because we have opened up the country’s borders to international trade, we move to the highest indifference point that we can achieve, e´. On the graph, the prospect of trade leads to the production and consumption points to be split and a higher indifference curve can be reached, i.e. beyond the PPF (more of both goods are consumed), which means a higher level of satisfaction for the consumers. Hence, the nation is better off after trade, because it can now reach a point that was previously unattained. From the graph above, we can determine the following gains that arise from international trade: A higher level of real income can be achieved due to the fact that if the surplus goods are exported, they will receive higher earnings that could have been received if it was sold domestically. A higher level of production (and consumption) can be achieved than what was possible under autarky, i.e. we can now produce (and consume) at a point that is beyond the PPF due to the international trade. The theory of comparative advantage implies a policy of free trade – a laissez-faire approach. Question 3 – 2 marks What is the basis for Ricardo’s Comparative Advantage theory? The basis of David Ricardo’s Comparative Advantage theory focuses on the relative cost of products, i.e. it implies to us that countries will specialise in the products in which it has the lowest relative cost (therefore, the product in which they have a comparative advantage), which they will then export. The inverse will therefore also apply – the country will have to import the commodities in which they relative cost disadvantages. Even in the event that a country has an absolute advantage in more than one good, it will still specialize in the good for which they have the maximum comparative advantage. 24 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  SESSION 5: Could African countries that are less well-endowed with resources still gain from international trade? Question 4 – 10 marks Explain the Heckscher-Ohlin (H-O) model of comparative advantage, indicating what they believe the basis for comparative advantage is. The H-O model is an explanation for the basis of comparative advantage that explores the distinction between capital rich and labour rich countries. The H-O theory focuses on the difference in the relative abundance of factors of production in various nations as the most important determinant of the difference in relative commodity prices and comparative advantage. When Africa implements the H-O model, we need to focus on the following to ensure that we receive the benefit that the model can contribute Use abundant resources more efficiently Focus on the factor endowments, intensity and value added of the country. The H-O model is based on the following assumptions: 1. It is a 2 X 2 X 2 (2 by 2 by 2) model, i.e. there is 2 countries that trade in 2 products and there are 2 factors of production, which are capital and labour. 2. There is perfect competition in the factor and commodity market. 3. There are constant returns to scale, i.e. there is a linear homogenous product function. 4. People in different countries have similar tastes and preferences. 5. There is an immobility of resources across borders, but it is perfectly mobile within domestic markets. The reason for this is because trade will lead to an unreal reflection of the value of the product. 6. There is no transport cost, i.e. it does not increase as the distance travelled increases. The two propositions of their model consist of: 1. Relative availability of factors of production differs between countries. Capital-abundant or capital-rich countries vs. labour-abundant or labour-rich countries. 2. Technology determines different combinations of factors of production for different products. A product could be produced in capital- or labour-intensive way (factor intensity). The predictions that can be made from this model is that countries specialise in those products that use their abundant factor of production intensively. Predictions This model can provide us with a general equilibrium solution which explains why it occupies a central place in the pure theory of trade (how the invisible hand determines what export should be produced, how they are to be produced and how the gains from trade are distributed among the different factors of production in the trading countries), and why economists have found it so useful in stimulating further theoretical work. The theory of comparative advantage implies a policy of free trade – a laissez-faire approach. 25 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward. Question 5 – 2 marks What are the trade patterns that will arise if countries followed the H-O model’s policy message? The H-O model postulates that a nation will export the commodity whose production requires the intensive (labour- or capital intensive) use of the nation’s relatively abundant and cheap factor and import the commodity whose production requires the intensive use of the nation’s relatively scarce and expensive factor. The trade pattern as suggested by the H-O model is that of inter-industry trade. Sold on StudentSummaries.co.za. All Rights Reserved. Not for resale/distribution. Report unauthorised use to [email protected] for a reward. 26 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  SESSION 6 & 7: How can we make sense of modern-day trade patterns, such as intra- industry trade? Question 6 – 10 marks How does the notion of economies of scale contribute to comparative advantage? Explain. Economies of scale means that it becomes cheaper per unit of output as the amount of output produced increase. This occurs due to international trade, because international trade allows for the increase in output volumes due to the existence of larger markets. We know that international trade leads to a mutually beneficial situation for the two trading partners. This does however extend to two countries that face identical production and demand conditions, i.e. an identical relative price for both nations, due to the existence of increasing returns to scale (they do not have to have identical conditions, though). Increasing returns to scale refers to the production situation where an increase in input leads to a proportionally bigger increase the output, e.g. if the output more than doubles due to a doubling in the inputs. Increasing returns to scale potentially occurs due to the larger scale of operation a greater division of labour and specialization becomes possible, which was not possible at a small scale of operations. This means that each labourer specializes in a specific repetitive task, which will increase labour productivity. When an economy faces increasing returns to scale, the PPF becomes convex (inward-bending), as can be seen in the figure to the right (or on page 92 of Salvatore, Chapter 4). This means that if a country specializes in a product, the relative price diminishes, rather than increases, as usual. In the figure to the right, we find the autarky at point A where both countries produce 40 units of good X and of good Y, as this is where the budget line is tangential to the PPF and the indifference curve, I. This is an unstable point, though, as any movement from A will result in a drop in the relative price of the good until the country specializes, i.e. if country A moves to the right of point A, the relative price of good X will drop and continue to drop until country A completely specializes in good X. With trade, however, the countries will start to specialize (it is irrelevant which country specializes in which good) in either good X or good Y, in which case they will move to the extreme points of B (if they specialize in good X) and B’ (if they specialize in good Y). This will result in an equilibrium point at point E after they have exchanged 60X for 60Y, which will mean that each person will gain 20 units of each good (from 40 at point A to 60 at point E). These gains will arise due to the economies of scale in the production of only one commodity, which is due to specialization. Economies of scale can result from — Internal factors, which arise from efficient production inside of the firm and are those which are open to a single factory, or a single firm independently of the action of other firms. These result from an increase in the scale of output of a firm and cannot be achieved unless output 27 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  increases, i.e. when you are producing at the minimum point of the average cost curve, which is called the minimum efficient scale. — External factors that come from outside of the firm, e.g. from a group of firms in an industry or from a group of industries. — Natural economies of scale can also arise due to where the firm is based, which can give a comparative advantage, as well as the nature of the industry that it operates in. — International economies of scale, which refers to increased productivity due to the firm’s integration of its entire system of manufacturing operations around the world. This is most commonly classified by firms that are starting to increasingly trade in parts and components with countries that might have comparative advantages in just those parts or components, as well as from establishing production facilities in countries other than the firm’s main place of operation. These economies of scale then provide a basis for comparative advantage – the firm is able to maintain lower per unit costs as the production volume increases due to trade, which then leads to efficient production of scale occurs, which can explain the existence of comparative advantage. Economies of scale provides an economic theory to explain the trade pattern of intra-industry trade. Economies of scale and product differentiation: Product differentiation refers to the fact that products from different manufacturers in the same industry is slightly different. Product differentiation does however increase the unit cost of products, but it disallows for the use of standardised machinery and production possibilities. Due to the existence of international trade, it allows firm to only specialize in one variety of a product and give domestic users larger choices by importing different varieties from overseas. This specialization again will lead to economies of scale, and accordingly comparative advantage, which becomes the basis of intra-industry trade. Question 7 – 10 marks How can we explain trade patterns on the basis of overlapping demand? The theory of overlapping demand refers to a hypothesis that was advanced by Linder in 1961, that states that a nation will export the manufactured products for which a large domestic market exists, i.e. products that appeal to the majority of the population. When the economy continuously satisfies this market, they acquire the necessary experience and efficiency that will enable the countries to export these products to other countries, usually their neighbour countries, with similar GNP per capita (income) levels and similar tastes and preferences. Conversely, countries will import the products that appeal to their low- and high-income minorities. When the countries start to specialize and export these products, they are able to achieve economies of scale. Overlapping demand results in countries with similar needs trading with each other so as widen their choice and encourage competition as well as to access larger markets. The trade pattern that originates due to the overlapping demand, is that of intra-industry trade, because industries from different countries with similar income levels and taste, will engage in the trade of goods and services, that are slightly differentiated between the countries. 28 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward. This theory tries to explain trade from the demand side, as opposed to from the supply side, as we have been doing thus far. Question 8 – 8 marks Is technological change an important cause of differences in comparative advantage? Explain. As much as the relative availability of factor endowments and the existence of economies of scale and product differentiation plays a role on international trade, so does the dynamic changes in technology. The role of the dynamic changes in technology is explained by the technological gap and the product cycle models. Sine time is involved in these models in a fundamental way, we can consider them to be a dynamic extension of the static (non-changing) H-O model, not a replacement of the trade theory. It is important to note that these changes are dynamic, which means that the changes occur continuously, i.e. there is not only one change and then it stops. In the following two models, trade is originally based on new technology developed by relatively abundant factors in industrialized nations. In short, both of two theories below aims to explain dynamic comparative advantage for new products and new production processes, as opposed to the basic H-O model, which explains static comparative advantage. They act as extensions of the basic H-O model into a technologically dynamic world, rather than as alternative trade models. 1. The technological gap model This model believes that a great deal of trade that occurs among industrialized countries is based on the introduction of new products and production processes. Generally, there will be a sole producer of these products, which means that the innovating firm and nation has a temporary monopoly, which is generally based on patents and copyrights that are used to encourage further inventions. The reason how it encourages invention is in the sense that is disallows others from exactly copying products and therefore forces them to be innovative and invent something new. This country will therefore have a technological advantage, which allows for economies of scale to develop, which will lead to the initiation of foreign trade. As other countries acquire new technology, the foreign producers can eventually start to conquer the markets abroad, and even the domestic market, because of their lower labour costs, seeing as they were previously more labour-intensive and therefore more productive and efficient. In the meantime, the domestic producers may have introduced even newer products and production processes, which will again give them the advantage and allow them to export these products based on the technological gap that was established and which advantage is being taken of. From this, we can see that comparative advantage originally exists in the country that is innovative and later on shifts to the country that has the lower cost. A shortcoming of this model is that It does not explain the size of the technological gap between countries and industries; It does not explore the reasons why technological gap exists in the first place, nor how to eliminate the technological gap. 29 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  2. The product cycle model The product cycle model is a generalization and extension of the technological gap model, which has been developed by Vernon in 1966. According to this model, when a new product is introduced, it generally requires highly skilled labour to be able to produce the product. As the product matures and acquires mass acceptance by the public, it becomes standardized, and it can therefore by produced by mass production techniques and less skilled labour. This means that the comparative advantage will shift from the more advanced country that originally introduced the product to less advanced nations that has relatively cheaper labour This is generally also accompanied by foreign domestic investment from the innovating nation to nations with cheaper labour. According to this theory, products goes through five different stages, for which the effect on imports and exports can be graphically illustrated by the figure to the right. The five stages through which products go, is given below: 1. The introduction of the product into the market; 2. The expansion of production to accommodate the possibility of exports; 3. The product starts to become standardized and we see the beginnings of production through imitation of other countries; 4. Foreign imitators start to undersell the nation in third markets, i.e. they start selling the product at a lower price in their third markets due to the comparative advantage that they have based on their relatively cheaper labour costs; 5. Foreigners start to undersell the innovating firms in their home markets, as well, for the same reason as mentioned above. Vernon pointed out that high-income and labour-saving products are most likely to be introduced into rich countries, because the opportunities for doing is greater in these countries; the development of these new products require close interaction with markets as to benefit from consumer feedback in terms of modifying products; and because there is a need in rich countries to provide services. Sold on StudentSummaries.co.za. All Rights Reserved. Not for resale/distribution. Report unauthorised use to [email protected] for a reward. 30 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  SESSION 8: What will happen in theory if the barriers to free trade are removed? Question 9 – 6 marks Show graphically what the impact on the domestic economy of a small country will be when an import tariff is removed. Suppose, we are in the market for chicken wings. In the world market for chicken wings, the price will be determined by international demand and supply and will settle at a price of RPw, but because there is currently an import tariff levied on chicken wings the price will artificially be set at (Pw + t). At this price level, import levy taken into account, local suppliers are willing to produce and supply Q2, but local buyers are willing to buy Q3, which means that there will be an import of (Q3 – Q2) units. Under these circumstances the consumer surplus will be equal to the area of the orange triangle; and the producer surplus will be equal to the area of the red triangle. The tax revenue of the government will be equal to area 3 and will be equal to (Q 3 − Q 2 ) × t. And there will be a dead weight loss to society equal to the sum of the areas 2 and 4. Suppose that this import tariff of t on chicken wings is removed. This will mean that the global market for chicken wings will return to the equilibrium price of Pw. At this price local suppliers are willing to produce and supply Q1 (quantity supplied decreases) and local buyers are willing to buy Q4 (quantity demanded increases). This means that the amount imported by South Africa will increase to (Q4 – Q1) units. This will have the effect of the consumer surplus increasing by area 1, 2, 3 and 4 to now become equal to the area of the blue triangle. The producer surplus, however, will decrease with area 1 and now become equal to the area of the green triangle. And the deadweight loss to society that was equal to the sum of area 2 and 4 will be redistributed to an increase in consumer surplus and there will therefore no longer be a deadweight loss to society. Because of the removal of the tariff barrier, international trade will be stimulated due to the increase of imports in certain countries (and the increase in exports in the corresponding country), which will lead to accelerated growth in these countries, The tax revenue that the government received will, however, have decreased, which will generally be a source of concern for the government, but they have different methods to counteract this. These methods include They can redeem these taxes due to higher personal income tax that will be collected, because the accelerate growth of the country, will trickle down to higher income for individuals, as well, which will then lead to increase higher personal income. Furthermore, the removal of the import tax will lead to the increased consumption of certain goods on which the government can also receive tax revenue in the form of VAT, as in South 31 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  Africa and other countries, or in the form of a general sales tax, that nearly all countries impose on their products. Sold on StudentSummaries.co.za. All Rights Reserved. Not for resale/distribution. Report unauthorised use to [email protected] for a reward. 32 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward.  SESSION 9: Barriers to trade are removed under the auspices of the World Trade Organization. How could Africa benefit from the participation in the World Trade Organization? Prior knowledge What are multilateral trading systems? A multilateral trading system is a self-regulated financial trading venue that facilitates the exchange of financial instruments between multiple parties. It cats as an alternative to the traditional stock exchanges where a market is made in securities, typically using electronic systems. Multilateral trading systems can be operated by a market operator or an investment firm whereas the operation of a regulated market is not considered an investment service and is carried out exclusively by market operators that are authorised to do so. What is the WTO, its purpose and functions? The World Trade Organization (WTO) is an international forum for governments to negotiate trade agreements. A place where governments can settle trade disputes and attempt to open country borders up for global trade. The purpose of the WTO is ensuring smooth trade flows, i.e. that goods and/or services can cross borders as easily as possible. The function of the WTO is to provide a place where members can set the rules for trade, negotiate the rules for trade and help to settle any trade disputes regarding international trade between WTO members. What is globalization? Globalization is a phenomenon by which economic agents in any given part of the world are more affected by events elsewhere in the world then they were before. Furthermore, it refers to the growing integration of the national economies of the world to the extent that we may be witnessing the emergence and operation of a single worldwide economy. We know that globalization is occurring when the following starts to happen: — Countries in the world start opening up their borders to more global trade. — People start investing more money in countries other than where they reside. — Companies start hiring more employees in countries other than where their main basis of operations is. Question 10 What is the current status of the WTO’s Trade Facilitation Agreement and how can African economies benefit from it? What is the WTO and the TFA? The WTO’s attempts to open up country borders for global trade by implementing the Trade Facilitation Agreement (TFA), which aims to make the international flow of goods more seamless by easing border delays and transit bottlenecks between countries and by cutting the red tape associated with international trade. 33 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report unauthorized use to [email protected] for a reward. Some feel that the WTO is not democratic or transparent and they may be unfair to small developing countries because, for example, if SA is in dispute with USA, it is like a mouse against an elephant. The agreement might be in the favour of the richer/bigger country. The current status of the WTO’s TFA The TFA entered into force on the 22nd of February 2017, after two-thirds of the current 164 WTO members ratified the TFA and deposited their instruments of acceptance with the WTO Secretariat. The world has 195 countries of which 164 are currently members of the WTO, 23 countries are only observers of the WTO and only 8 countries are not a part of the WTO. 137 of the WTO members have ratified the TFA. Of these 137 members, 60,7% have assessed their capacity to implement the TFA as Category A, 8,2% has assessed their capacity to implement the TFA as Category B, 11,5% assessed their capacity to implement the TFA as Category C and 19,6% of the members have not assessed (or made it known) their capacity to implement the TFA yet. Observer status is given to governments to allow them to better acquaint themselves with the WTO and its activities, and to prepare and initiation negotiations for accession to the WTO Agreement. The status of the 54 African countries specifically indicate that 44 are members of the WTO o 29 have ratified the TFA o 15 have not ratified the TFA 9 are observers to the WTO Eritrea is the only African country that is not apart of the WTO. A possible reason for this is due to the ongoing war that has been raging between Eritrea and Ethiopia that has recently come to an end. The WTO and the TFA’s purpose The TFA aims to simplify, modernise and harmonise import and export processes by reduction of trade barriers, such as the documentation and time required to make exports and imports more accessible. It sets out measures for effective co-operation between customs and all other authorities. Section 1 contains provisions for expediting the movement release and clearance of goods including goods in transit. Section 2 contains special differential treatment provisions that allow developing and least developed countries (LCDs) to determine when they will implement individual provisions of the agreement and to identify provisions that they will only be able to implement on the receipt of technical assistance and support for capacity building. Section 3 contains provisions that establish a permanent committee on trade facilitation and requires members to have a national committee to facilitate domestic coordination and implementation of the provisions of the agreement. In terms of the agreement itself, the TFA does the following The TFA aims to remove bureaucratic delays and red tape – which refers to excessive government regulation that delay processes – that pose a burden for moving goods across borders for traders. o The implications thereof for Africa: Africa will find trade with other countries easier, increasing their choice in products and their supply of products, lowering prices and increasing the buying power of their money. 34 | P a g e Copyright {site_name}. This summary has been sold to {first_name} {last_name} with email {email}. Any resale illegal. Report un