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I’m Awesome January 20, 2011

Posted by Avu in Section 4.
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Using an appropriate diagram, explain who gains and who loses from the introduction of a tariff January 20, 2011

Posted by Avu in Section 4.
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1. Demands of the Question: Being a Paper 2 question, I do not have to do any evaluation. I have to use a diagram to illustrate the winners and losers of the introduction of a tariff. Along with this, I need to define tariff, and specify the stakeholders who will be effected by the tariff. I will then need to use the diagram to illustrate why those stakeholders gain or lose from the tariff’s imposition.

2. Definition: A tariff is a tax on imports used in order to reduce import quantity and increase domestic quantity. It results in a higher price and lower quantity.

3. Triple A: A tariff is a tax on imports, which can either be specific (so much per unit of sale) or ad valorem (a percentage of the price of the product). Tariffs reduce supply and raise the price of imports. This gives domestic equivalents a comparative advantage. As such, tariffs are distorting the market forces and may prevent consumers from gaining the benefit of all the advantages of international specialization and trade. The tariff has the effect of shifting the world supply curve vertically upwards by the amount of the tariff. The level of imports will fall from QaQd to QbQc. The government will also raise revenue, shown by the blue shaded area. The level of domestic production will increase from 0Qa to 0Qb.

4. Bullet Points:

  • Tariff is a tax on imports
  • Tax can be specific or ad valorem
  • Reduce supply and raise price
  • Domestic suppliers get comparative advantage of exporters
  • Distort market forces and reduce consumer benefit
  • Effectively shifts world supply up

5. PowerPoint Slides

6. Diagrams

7. Evaluation Suggestions: Don’t evaluate.

Diagrams – Section 4 January 20, 2011

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J-Curve: Even if the Marshall-Lerner condition is fulfilled, depreciation will result in a deficit economy's deficit increasing before, over time, recovering and becoming a surplus.

Comparative Advantage: With the same resources, Germany can produce more beer than Russia. Therefore it has comparative advantage when it comes to beer. However, Russia can produce more vodka, and therefore has a comparative advantage in vodka.

Tariff: With the imposition of a tariff, the tax drives price up from P1 to P2. The higher price allows more domestic suppliers to compete, increasing domestic supply from Q1 to Q3. However, the lower quantity demanded due to higher prices results in fewer world suppliers from competiting, lowering overall supply from Q2 to Q4.

Subsidy: The imposition of a subsidy shifts supply from S to S+Subsidy, which maintains the same price, but effects quantity. Domestic quantity increases from Q1 to Q2, while import quantity decreases from Q1Q3 to Q2Q3

Exchange Rate Appreciation: A high interest rate leads to investment in the US dollar by Japanese, meaning the demand, quantity, and price for US dollars in terms of Yen increase.

Exchange Rate Depreciation: Due to higher demand for US dollars, Japanese yen floods into the international market. Supply increases from S to S2, leading to lower prices and higher quantities of yen.

Manipulating Children, Working Hours, and Currency January 20, 2011

Posted by Avu in Section 4.
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For several years there has been tension between the Chinese and American economies due to allegations of the Chinese currency being manipulated.

Beginning in 2005, China switched from a fixed exchange rate system to a managed floating exchange rate system. This allowed China to integrate into a market economy further, by not having the value of its currency pinned onto the US dollar, as it was in a fixed exchange system. With a floating exchange system, the value of currency is solely determined by the supply and demand of the currency on the international market. The government could, however, intervene if necessary.

The overwhelming opinion during the switch was positive, on both Chinese and American sides, as both believed a commitment to let market forces move currency was best for all parties.

However, since the switch, tensions have escalated due to American allegations that China has been manipulating its currency through forced depreciation, which allows China to create a surplus. The effect of this on the United States is limited growth and destroyed jobs, along with the compounding of its already painfully large deficit. The issue, however, with China’s surplus is that it behaves out of rhythm with economic theory.

It is suggested that a surplus leads to increased demand of a currency and overall appreciation. Appreciation in turn leads to more expensive exports and cheaper imports, which self-corrects the balance of payments with more reliance on imports than exports. However, in China’s anomalous state, the surplus has not led to appreciation, rather, the currency continues to depreciate and marked values. This maintains a system in which China has cheap exports and expensive imports, and thus is more reliant on exports, selling them heavily with high foreign demand.

Again, the issue for the United States in this case is that the fact that China maintains such low export prices, presumably through the constantly depreciating currency, American businesses must import Chinese products for price reasons. This, however, is not conducive to attempting to salvage to US economy from its already unprecedented deficit. Due to the tension and widespread allegations, the American government has formally accused China of artificially depreciating its currency in order to keep its exports relatively cheap.

Neither country is apparently willing to concede their stance on the issue, and the political relations between the two nations are becoming increasingly strained. It appears that the weak Yuan is tragically painful to the US economy as it only expands China’s already large surplus, with cheap exports, that are far more attractive to buyers, who will now not purchase exports from the United States. With a relatively strong dollar, the American trade deficit continues to expand, as exports are far too unattractive to purchase. Thus, goods that aren’t competitive from the United States will not be sold in domestic or international markets, leading to further deficit.

Now, to evaluate the decision, first one must validate it. It’s clearly valid that China has been artificially manipulating its currency to keep it weak and prevent its export prices from rising overly high for international competitiveness. It is also notable that the United States used similar policies in the earlier part of the 20th century in order to bolster their own economy. For that reason, it is hypocritical and inappropriate for the United States to attempt to accuse China of such an act.

In economic terms, however, it is irresponsible for China to forcibly manipulate its currency, as it results in market forces not being genuinely implemented in a floating exchange system. This results in unfair market dominance for an undeserving nation.

In laymen’s terms, it boils down, unfortunately, to international cooperation. Despite the economic evidence that may prove otherwise for either nation, a compromise must be reached that is acceptable to both, else the political fabric will unravel leading to problems far worse than economic inefficiency.

Defintions – Section 4 January 19, 2011

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Factor endowments – factors of production available to a country
Specialization – situation in which a country devotes more resources towards making that which their factor endowments give an advantage to produce
Absolute advantage – a situation where a country is indefinitely able to produce more than another country with the same FOPs
Comparative advantage – a situation where a country is able to produce a good at a lower opportunity cost than another country
Free trade – international trade that takes place without any trade barriers
Tariff – a tax that is placed upon imported goods to protect domestic companies from foreign competition that raises government revenue
Quota – a limit that is placed on the quantity of goods and services that may be imported into a country
Subsidy – money paid by a government to a firm which is done to increase the per unit output of the firm and also to give it an advantage against firms from overseas until it can compete with foreign competitors
Dumping – selling a good to another country at a price below unit production cost
Balance of payments – the record of the value of all payments made between the residents of one country with the residents of all other countries over a given period of time
Balance of trade – the net revenue from exports and imports of products over a period of time
Current account – measure of the flow of funds from trade in goods and services, net investment income flows, including profit, interest, and dividends, and net transfers of money, including foreign aid, grants, and remittances
Capital account – measure of the buying and selling of assets between countries. Assets either show ownership or represent lending
Current account surplus – a situation that exists when the revenue from exports and included income flows is greater than the expenditure on imports and included income flows over a given period of time
Current account deficit – a situation that exists when the revenue from exports and included income flows is less than the expenditure on imports and included income flows over a given period of time
Marshall-Lerner condition – theory that the depreciation of a currency will result in an improvement in the current account balance only if the elasticity of demand for exports plus the elasticity of demand for imports are elastic, or greater than one
J-curve – a theory that suggests that even if the Marshall-Lerner condition is fulfilled, depreciation of a currency will lead to a further worsening of the current account deficit before improvement occurs in the long term
Exchange rate – the value of a currency in terms of another currency
Fixed exchange rate – exchange rate system in which the value of a currency is fixed to either the value of another currency, the average value of a group of currencies, or a commodity like gold
Floating exchange rate – exchange rate system in which the value of a currency is determined by the demand and supply of the currency on international markets
Depreciation – a fall in the value of a currency in terms of another currency in a floating exchange rate system
Appreciation –  a rise in the value of a currency in terms of another currency in a floating exchange rate system
Devaluation – a fall in the value of a currency in a fixed exchange rate system
Revaluation – a rise in the value of a currency in a fixed exchange rate system