Effect of Economic Integration on Industrial Firms in Australia and China - Case Study Example

Name of the Student] [Name of the institution] [Course] [Date] Effect of economic integration on industrial firms Introduction The need to exchange goods and services amongst people with different wants has necessitated advancements in trade, both regionally and internationally. Different companies in different industries in every country compete in an effort to supply the products that can satisfy the diverging and insatiable wants every day. Firms trade with each other across borders of the country to strengthen, borrow and look for competitive advantages in terms of quality, quantity, price and other technological advancements. However, there are certain constraints to doing this trade rather than normal costs. The constraints in this case are those that are related to government through its intervention in trade. According to Dee (2005), government policies across borders affects trade in various ways and this directly affect the firms in any industry in a country. Nevertheless, there have been calls by economists, majorly, for nations to embrace free trade in order to boost economies and further consumer satisfactions in the product market. One of the ways for free trade is integration of countries economically. This paper seeks to describe the economic impacts on industries upon integration of countries. With reference to a particular industry in Australia and China, the paper will ascertain the effects of integration of the two countries on the industry. This will include well illustrated implications to the particular industry where Australia is importing products. Finally, the paper will adopt a reliable conclusion which can form the basis for future analysis and information. Discussion Economic integration is the process whereby two or more countries from a region or different regions come together to make some economic arrangements to eliminate and/or reduce trade barriers. It also involves making arrangements of coordinating both the monetary and fiscal policies within the integrating countries. The most important aim of integration is to reduce the cost of trade that exists between the countries coming together. In this case, both governments try to reduce the costs for producers and for the consumers as well in an effort to increase trade between the countries involved in this arrangement (Tinbergen, 1965). This paper focuses on Australian-Chinese increased relationship in the past two decades. The trade relationship between Australia and China has eventually seen them considering forming a Free Trade Agreement between them. When this happens, trade between the two countries will be free and industries in both countries will benefit largely through an open economy in the two countries. Removal or reduction of trade barriers in any merging economies have the positivity of no control of the goods and services that crosses the borders of each country thereby increasing rate of exchange of goods and services. The principles of Free Trade Agreement state that countries under this agreement remove tariffs on member’s products, but each member country maintains its independence in making policies of trade with non members (Fratianni, 2006). In this case, the original trade policies in terms of trade barriers with other countries in the world which are not in the trade agreement still holds. More clearly, firms in the member countries of this agreement enjoys free movement of goods and services, with reduced or/ and eliminated barriers, while the non-member countries do trade normally with existing barriers. There are different effects of either the two cases on an industry supplying goods and services across the border. This study wants to ascertain these effects with respect to electronic industry, an Australian industry, in the event Australia and China economically integrate through formation of Free Trade area. The importation of electronic products is one of the highly affected by the imposed tariffs among nations. The market prices of these products are largely a dependant factor on the amount of tax levied upon the imported ones, since the country cannot entirely rely on the domestic products alone. More importantly, consumers and the producers in this industry are the affected in either way. This study goes ahead to determine the effects of free trade area on both consumers and producers in the same industry. Effects of integration on imports Consider electronic industry in Australia importing electronic goods and services from China, maybe due to relationship existing between the two countries or due to the reduced costs of importing Chinese products. The market price of the imported products has the tax implications on them due to existing tariff as shown. In this case, there is a demand shown on quantity of the products given the prevailing market price. The graph below shows the relationship that exists between the quantity demanded and the quantity supplied in the industry before the two counties form free trade agreement (integration). Before formation of the free trade area, importing electronic products from China is accompanied by some tax, thus making the standard price of the product is the price in China plus the tax (P+tax) as shown in the graph below. The overall quantity of the products imported is Q2-Q1. Firms in this industry will (assuming homogeneity) therefore compete each other depending on where it sources its products, through domestic production or importations. Price is the determining factor in this case, which will also depend on the amount of tax on Chinese products and the elasticity of demand in Australia. Graph of quantity and price of imports in Australia before forming a free trade area with China S Price Pe P+tax D Q1 Q2 In a competitive market, each of the firms can sell their products as much as they can at the prevailing market price without the pressure of lowering their price so as to attract customers. Each firm will maximize its profit at the point where marginal cost equals the marginal revenue (Metcalfe, 2002). Price Marginal cost ATC P* g Marginal Revenue= Demand pl k Quantity With the tax on imported products of the industry, firms the prevailing price will be set by the reliability of the tax on imports. Increase or decrease in that tax will affect the prevailing price in a similar way. According to the graph above, the, marginal revenue of an individual firm equals to the prevailing market price. With the aim of profit maximization, the firm can make the profit at the point of intersection of the MC curve and the MR curve. The prevailing market price is higher than the average total cost therefore firms in this industry will be making economic profit represented by the rectangle p*g pl k. However, after formation of free trade area, various policies regarding importations from China will be abolished. In this case, there will be a lot of changes on the production levels, prices and the competitiveness of the firms in this industry. The quantity that will be imported will be higher comparatively because there will be no tax on these products. In this case, the prevailing market price will reduce in the industry thereby affecting the profit maximization points of firms in this industry (Tinbergen, 1965). After the formation of the Free Trade Area between Australia and China, tariff is removed and the level of imports in Australian industry increases to Q4-Q3 as shown in the graph below, higher than the previous Q2-Q1 before the tariff is removed. The increase in quantity imported is as a result of the reduction of price by removal of the tax. Quantity, Q1-Q3 , will be imported at the expense of home production and the customers of the firms will increase their demand for the products by Q4-Q2 because their price has reduced from (P+t) – (P-t) . A graph of quantity and price of imports in Australia after forming free trade area with China Price Supply Pe P+t P-t Demand Q3 Q1 Q2 Q4 Quantity The removal of the tariff automatically create a reduction in price which alternately make the average total cost of production for an individual firm in this industry higher than the prevailing market price as shown in the graph below. MC Price ATC Pl m P* n MR Q* Quantity The reduction of price of imports due to the removal of tariff makes the average total cost of production for an individual firm become higher than the prevailing price (Fratianni, 2006). In this case, the firm starts making negative economic profit. This is represented by rectangle P1 mnP* in the graph. Although the firms in this industry make loses, the can still maximize profit by minimizing its losses at the point where the marginal cost curve meets the marginal revenue curve or by importing where the price equals to the marginal revenue and produce at q*. At the initial stages of the removal of the tariff, firms will actually be producing at a price equal to marginal revenue, marginal cost and the average total cost at its minimum. At this point, economic profit will be zero. With time, and the persistency of the low price firms will be making losses and most probably many firms will be scared and exit the market (Dee, 2005). Result Free trade area makes the prices of imported products to decrease thereby causing an increase in the domestic demand and a decrease in domestic supply. Imports increase marginally thereby creating trade and efficiency between the integrating countries. As the market price goes up, the quantity produced by the firms goes up and conversely makes the profit made by these firms to be high. However, when the prices go down, due to the removal of tariff, the quantity produced by firms goes down and makes the profit to decline. Moreover, domestic supply declines which further affects the demand for imports positively. In this case therefore higher prices are good for firms in the competitive market since it is associated with economic profits. Low prices on the other hand affect these firms negatively because they reduce the average revenue thereby making these firms operate at lower profit. In the long run they make losses and exit the industry. Free trade area affects the consumers of the Australian industry in a positive way. In this case, there is reduction of the domestic price of both the imported and the domestic substitute products. When prices are reduced, consumer spending spirit is naturally uplifted and this increases demand. This finally alleviates the consumer surplus (welfare) in the market, but this has a reverse effect on the firms (Jones and Kings, 1992). Firms in the industry are affected negatively upon the formation of free trade area. In this case, they suffer losses on their productions. The decrease in price of their products on the domestic market reduces the producer surplus in the industry. They make negative profits in the industry and this may scare some forms. This decrease in price also induces a decrease on output of the existing firms in the industry, thereby making some firms to reach a shutdown points in the industry. Only the firms with higher competitive edge in the industry will survive and eventually take advantage of the reduced number of firms in that industry and the efficiency in the industry in the long run. Efficient firms enjoy free access to national markets of the foreign country while the inefficient firms lose markets and exit the market. In this case, employment opportunities will be lost and many workers will be moving to other industry, thereby making the industry to loose workers. This scenario also affects therefore the labor market (Dee, 2005). There will be low prices and the surviving low cost firms will compete in the market for the already increased demand. This competition will encourage product innovations in the industry thereby improving quality of the products and their efficiency. Conclusion It is therefore true to conclude that free trade area as a means of economic integration have both ends of positivity and negativity for the countries intending or already in an agreement. Coming together in a close economic relationship between these countries have beneficial repercussions in terms of increased volume of trade and efficiency. It also improves the quality and quantity of products as well as the consumer welfare. However, it has some negative components in the sense that it hurts industrial firms which cannot withstand the tests of low production, low profit, and therefore lower market prices. Such situation demoralizes economic growth of a country especially if the country is on the receiving ends of the imports implications. References: Dee, P. S. (2005). Quantitative methods for assessing the effects of non-tariffs measures and trade facilitation. River Edge, NJ: World scientific pub. Fratianni, M. (2006). Regional economic integration. Amsterdam: Elsevier JAI. Jones, R., and king, R.G. (1992). The Chinese economic area; economic integration without a free trade agreement. Paris: OECD, Dept. of economics and Statistics. Metcalfe, J. S. (2002). Market relations and the competitive process. New York: Manchester University Press. Pelkimans, J. (1997). European integration: methods and economic analysis. Harlow, Essex, England: Longman. Tinbergen, J. (1965). International economic integration (2nd ed). Amsterdam: Elsevier Read More