The UK Economy and International Trade - Essay Example

 MONOPOLISTIC COMPETITION vs OLIGOPOLY The term monopolistic competition was first coined by E.H. Chamberlin and Joan Robinson. The intention was to define markets that had both the characteristics of competitive markets and monopolies – competitive markets, in which many firms proliferate; and monopolies, wherein a single firm dominates in delivery of a single, differentiated product (or one that appears to be so). Monopolistic competition has the following elements: 1. “Large number of buyers and sellers” (Hirshey, 2006); or more specifically, “a few dominant firms, with a large number of competitive fringe firms” (McGuigan et al., 2008, p. 394); 2. Product heterogeneity, wherein the output of the dominant firms are viewed to be different from those of the other firms, whether the differentiation is real, perceived, or just imagined, although the products of competitive firms are still deemed comparable; 3. Ease of entry into and exit out of the market in general, although there may be substantial barriers to effectively enter the market catered to by the leading brands; 4. Perfect dissemination of information as to cost, price, and product quality, both for sellers and buyers; and 5. Independent decision making by competing firms – that is, the actions taken by one firm do not materially influence those of the other firms. Monopolistic competition is clearly seen in industries such as banking, electronics, fashion and garments, food manufacturing, fast food retail, and almost all personal and professional service industries like hair styling and grooming. For these industries, there are many suppliers whose products are easily substituted for each other; and although differentiation is created in the mind of the buyer, the difference is not so insurmountable that another brand more conveniently accessible could not substitute for the other, first choice. In contrast, an oligopoly exists where only few competitors operate. Unlike in monopolistic competition, wherein the actions of competitors do not influence the others, in oligopoly, output decisions of individual firms have a decisive influence on the course of action the other firms decide to take. In an oligopoly, the following elements are present: 1. Few sellers dominate the market, unlike the many competitors in monopolistic competition. 2. Homogeneous or unique products, compared to monopolistic’s product heterogeneity; 3. Blockaded entry and exit, opposite to that of monopolistic competition; 4. Imperfect dissemination of information, because of control exerted by the few individual firms; and finally 5. Decisions of individual firms influence each other, which is contrary to the freedom of decision-making in monopolistic competition. A good example of an oligopoly is the market for diamonds, which is dominated by De Beers, which corners 60% of the market, and other, relatively recently established, diamond firms in Canada, Russia and Australia. De Beers had once monopolized the diamond trade by buying out all its competitors and controlling the price. As more diamond deposits were discovered, De Beers was compelled to try a new tact, veering away from the diamond cartel, and instead embarking on brand strategy. Other oligopolies exist in the industries that produce automobile, cigarettes, cruise ships, and aluminum. Wordcount = 500 INFLATION In the past year, inflation had, for the first three quarters, risen sharply to a high of 5.2% in September. The skyrocketing of prices was mainly due to the increase in food and energy prices. During that period, energy and household bills was estimated at 15%, the highest fate in 20 years, according to the Office for National Statistics (ONS). The worldwide increase in the prices of petroleum products last year was the most significant cause of the escalation in energy prices and other basic commodities. Clothing, footwear, toys an games were, according to the ONS, relatively more expensive and partially accounted for the increase in the cost of living, together with the price of foodstuffs like milk and meat. (BBC News, Oct 2008). Moderate inflation is not undesirable; in fact, a 2-percent inflation rate is a healthy sign that the economy is growing at a healthy pace. However, both extreme highs and lows of inflation are highly undesirable and, in fact, may signal the onset of an economic crisis. High inflation indicates that the prices of goods are rising too quickly, indicating the purchasing power of money is falling too fast. It may signal excess liquidity, causing government to consider raising interest rates, which would in turn be disastrous for businesses that require credit availability to operate. Deflation, on the other hand, means that demand is dropping and goods are not getting sold fast enough, causing businesses to consider cutting down production and reducing capacity. Either way, when businesses fail the tendency is for people to lose their jobs and rely on the state for welfare. This simultaneously decreases the state’s tax revenue and increases its public expenditure, contributing further to a growing budget deficit. In the case of either hyperinflation or deflation, the end result is economic crisis. Wordcount = 300 FACTORS THAT HAVE SLOWED ECONOMIC GROWTH At the same time that inflation was rising, economic growth was slowing down. Looking back at the analysts’ evaluation at that time, the slowdown in growth was due to several factors – the slowdown in manufacturing (BBC News, Mar 2009), rising unemployment (Chamberlin, Jan 2009), a decrease in demand for products and services (BBC News, Mar 2009), and a worsening trade deficit (The Cabinet Maker, Jan 2009) coupled with the financial sub-prime crisis that spilled over from the United States financial markets (Datamonitor, Mar 2009; Chamberlin, Jan 2009). Chamberlin’s economic review of January 2009 has specifically attributed the third quarter drop in growth to a drop in household consumption and fixed investment, with the latter being the main contributor to the downslide. Fixed investment includes investment in dwellings and business investment. It was investment in dwelling that fell sharply, in reaction to the collapse of the credit derivatives market across the Atlantic. These derivatives were, after all, based on sub-prime mortgage loans, majority of which were, to start with, high risk, and eventually defaulted. As property values fall rapidly in the States, it is little wonder that the spillover shock in the UK would push the market for dwellings increasingly downward. Wordcount = 200 BENEFITS OF TRADE AND SPECIALISATION Trade pertains to the exchange of goods and services; international trade, to the exchange of capital, goods and services across country borders. While domestic and international trade are essentially the same when considering the motives and actions of the trading parties, international trade has developed special implications and involves special costs not normally found in domestic trade. When persons trade, it is essentially a private transaction dependent solely upon the will of the parties. When countries trade, the transaction takes on a public character because trading repeatedly in significant quantities have repercussions that affect the lives and livelihoods of the rest of the nation. Furthermore, countries would tend to trade in goods and services for which they have comparative advantage. Comparative advantage refers to the ability of a country to more efficiently produce a good or service than other countries – stated in economic terms, a country has a comparative advantage when it can produce a good or service at a lower marginal cost (as contrasted with absolute cost) than that at which other countries can produce the good. As an example, in its trade with the United States, UK’s leading exports to this country fall within the categories of medicinal preparations and passenger cars; on the other hand, its fastest growing imports from America are fuel oil and precious metals. (Workman, 2007) In the normal scheme of things, countries which can produce a good (or service) easily and cheaply will not be importing this good from another country, but rather produce it internally. Likewise, a country that could not produce a good (or service) within its borders, or could do so only at a high cost, would find it more cost-efficient to import this good (or service) from abroad. Thus, UK has comparative advantage over the United States in the manufacture of medicinal preparations and passenger cars. On the other hand, it has a comparative disadvantage to the US in the production of fuel oil and precious metals. There are economic benefits involved in international trade. According to Wiens, these fall within two aspects: (1) comparative advantage (as developed by David Ricardo), and (2) economies of scale (as expounded on by Adam Smith). Under the theory of comparative advantage, when countries trade with each other, they get the benefit of each other efficiencies and forego producing that particular good internally, saving itself the higher costs involved. This redounds to a more efficient deployment of ecological resources, while at the same time being able to gain access to products of superior quality. In this sense, specialization in those areas where the country has comparative advantage is the natural tendency, enabling the country to avail of potential benefits of specialization such as higher output, greater variety, a bigger market, and lower prices due to greater competition (Riley, 2006). As to economies of scale, this was first expounded on in the Wealth of Nations, the monumental work written by 18th century economist Adam Smith. Under this theory, “firms can obtain cost advantages of expanding output if by increasing its fixed costs it shifts its short-run average total cost curve down and to the right along its long-run average cost curve.” (Wiens, 2008) The diagram that follows, also sourced from Wiens (2008), shows the relationships among short-run average cost (SRAC) curves, the long-run average cost (LRAC) curve, and short-run marginal cost (SRMC) curves. According to the theory successive SRACs are tangent to the LRAC at the point of intersection with its corresponding SRMC. Successive points of intersection describes the LRAC, and the point where LRAC is lowest and at which it intersects with the SRAC would be the point of economies of scale, where the firm experiences optimum cost advantage. Economies of scale emanate from certain sources: for instance, lower distribution cost due to investment in specialized machinery and production lines, and spreading this cost over the greater output; skilled and specially trained labor force; research and development enabling the technological innovations; managerial innovations; lower per unit marketing costs, since advertising costs are distributed over a greater output; and lower cost of financing for being able to avail of prime interest rates. The implementation of international trade could be complicated, because of controversial issues of political and humanitarian natures. Traditionally, trade between two countries was regulated by bilateral treaties between them. Under the mercantilist theory, most states imposed restrictions and tariffs on their international trade. By tariff is meant the tax imposed by a country on goods entering (or leaving) its boundaries. The tariff is imposed in order to restrict trade, particularly on goods entering the country. This is a protectionist policy, firstly to generate revenues for the coffers of the state, and secondly to elevate the cost of the good and allow for local goods a greater opportunity to compete with these imported goods. Imposing tariffs discourages the entry of foreign goods and allows for local goods to benefit from a lower cost regime than the imports. In the 19th century, a new school of thought in international trade, known as “free trade” was born in Europe, particularly in the UK. This replaced mercantilism as the prevailing theory governing international trade. The theory of free trade involved the reduction and eventual removal of tariffs and protective regulations, in order to better benefit consumers with lower costs for better quality goods. After World War II, together with the establishment of the World Trade Organization (WTO), the General Agreement in Tariffs and Trade (GATT) came into being. The GATT called for multilateral treaties among member countries that would gradually reduce tariffs in international trade. Today, the push towards free trade has sparked political protests, as charges of unfairness were hurled at the regulations. However, recent studies have shown that full trade liberalization tended to benefit the poor. In one study, it was estimated that 72 million to 440 million people could be lifted out of poverty as a direct result of trade liberalization. (Bouet, 2008) One may conjecture the debate will not die anytime soon. Wordcount = 1,000 REFERENCES Anonymous 2009, “UK trade deficit up,” Cabinet Maker, Jan. 23, 2009, Manning Publishing Ltd. Anonymous 2009, “Government minister admits UK in worst recession in 100 years”, MarketWatch: Financial Services pp. 19-20, March 2009, Datamonitor Plc Bouet, A 2008, The Expected Benefits of Trade Liberalization for World Income and Development: Opening the “Black Box” of Global Trade Modeling, International Food Policy Research Institute, Washington D.C. Chamberlin, G 2009, “Economic Review, Office for National Statistics, January 2009”, Economic & Labour Market Review, vol. 3, no. 2, pp. 6-14, Office of Public Sector Information. Chamberlin, G 2009, “Economic Review, Office for National Statistics, February 2009”, Economic & Labour Market Review, vol. 3, no. 2, pp. 6-13, Office of Public Sector Information. Chamberlin, G 2009, “Economic Review, Office for National Statistics, March 2009”, Economic & Labour Market Review, vol. 3, no. 2, pp. 6-13, Office of Public Sector Information. “Consumer inflation reaches 5.2%”, BBC News, 14 October 2008. Available from: [May 4, 2009] Deardorff, A 2003, Introduction to Comparative Advantage (manuscript) “GDP Growth. UK output decreases by 1.9%” National Statistics Online. Available from [May 4, 2009] Hirscheym, M 2006, Basic Economics for Managers, Thomson South-wester, Mason, OH “Inflation: CPI down to 2.9%, RPI down to -0.4%” National Statistics Online, 21 April 2009. Available from: [May 4, 2009] McGuigan, J R, Moyer, R C, & Harris, F H deB 2008, Economics for Managers, 11th ed., Thomson South-western, Mason, OH Mumtaz, H & Surico, P 2009, “The Transmission of International Shocks:A Factor-Augmented VAR Approach”, Journal of Money, Credit and Banking, Supplement to Vol. 41, No. 1, Feb 2009 “Recession fear as economy shrinks”. BBC News, 24 October 2008. Available from: [May 4, 2009] Riley, G (2006) Market & Market Systems: Specialisation & Trade, Eton College. Available at [May 4, 2009] “UK recession is 'gathering pace'”, BBC News, 11 March 2009. Available from: “UK manufacturing shrinks further”, BBC News, 10 Marcy 2009. Available from: [May 4, 2009] “UK recession is 'gathering pace'”, National Statistics Online, 11 March 2009. Available from [May 4, 2009] “UK recession likely, says Brown”, BBC News, 22 October 2008. Available from: [May 4, 2009] Wiens, E G 2008, “International Trade and International Finance,” Egwald Economics: International Economics, Microeconomics, and Macroeconomics. Available from [May 4, 2009] Workman, D 2007, “Top UK Exports & Imports: Most Popular Products Traded Between Britain & America”, Suite 101.com, Aug 27, 2007. Available from [May 4, 2009] Read More