International Trade and Payment - Assignment Example

Student’s Name: Instructor’s Name: Course Code & Name: Date of Submission: Question 1: a. Possible Production Frontier curve b. Amount of cotton produced when country consumes 45 Million bushels of wheat. The country can produce 30 million bales of cotton if its consumption on wheat is 45 million bushels. The solution can be arrived at using graph above or calculation as shown below Gradient = = = -2/3 Y=-2/3x Y=-2/3x45 Y=-30 30 million Where y=cotton and X= Wheat c. Relative commodity price in absence of trade The relative commodity price is obtained by finding the gradient of the production possibility frontier as shown below. Gradient = = = -2/3 Y=-2/3X Therefore, for every 1 bushel of wheat consumed, the country reduces consumption of cotton by 0.667 thus the commodity price ratio; wheat to cotton is 1:0.67. d. Trade taking place at TOT 1 bale of cotton for 1 bushel of wheat The country has higher comparative advantage in producing wheat than cotton. Therefore, it will produce wheat for consumption and export but import cotton for domestic consumption (Solberg, 2006). Cotton Wheat Relative production 1 1.5 TOT 1 1 The effect of country importing 1 bale of cotton results to increase in allocation of resources to wheat production (Solberg, 2006). The increase in allocation to the wheat production results to increase in production of wheat by 1.5 bushels. e. Amount of cotton consumed when Country consumes 55 bushel of wheat The country produces wheat exclusively. Therefore, having consumed 55 bushels of wheat then cotton consumed can be arrived at as shown below; Remaining wheat for export = 90-55 = 35 Million Bushels Since term of trade is 1 bale of cotton for 1 bushel of wheat. Therefore, cotton consumed is equals to wheat exported. Thus cotton consumed is 35 million bales. f. Country gain from trade The gain represents comparative advantage the country has by deciding to produce goods that it can produce at a lower cost than others per unit (Shamah, 2003). Therefore, gain on trade for the country can be obtained as follows; Equation: Y=X Y= x 35 =23.33 Million bales Therefore, exporting 35 million bushels of wheat and importing 35 Million bales of cotton means the country is not producing 23.33 million bales of cotton. Gain in trade = 35,000,000-23,333,333 = 11,666,667 bales of cotton Question two a. Pre-trade production possibility frontier of two countries having different supply of labour and capital Australia Australia is capital-intensive country. Cloth is labour intensive while wheat is capital intensive. The graph is skewed to the left side since it produces more wheat than cloths (Salvatore, 2001). Kenya Kenya is labour-intensive country because it has high supply of labour than capital. Cloth is labour intensive while wheat is capital intensive. The graph is skewed to the right since the country can produce more clothing than wheat (Salvatore, 2001). The trade between the two countries exists since Australia can import cloths which are labour intensive i.e. scarce resource but export wheat since it produces in abundant because of excess capital. Kenya will export cloths since it has abundant labour but import wheat because capital factor is scarce. Therefore, interaction between the two countries is fostered by the differences in production factors (Salvatore, 2001). b. The level of specialization between the two countries. The graph below combines production possibility frontier of the two countries showing the level to which each country need to specialize in producing a commodity with high comparative advantage. The countries will specialize at point of intersection (E) of the two country’s production possibility frontier. Therefore, countries will specialize in producing cloths at point X and wheat at point Y. c. How factor mobility leads to price equalization According to the graph above, the interaction between production possibility frontier at point of intersection brings about the amount of goods each country need to specialize in producing the product with comparative advantage. The country with abundant factor to produce a given good needs to export excess product produced and import goods that have scarce factors of production (Ohlin, 1967). The trade between the two countries brings about factor mobility which reduces the price of goods with scarce factors of production and increase prices of the goods with abundant factors of production. The effect is illustrated in the example below; Before trade; Australia Pwht = 20 Pclth = 500 Kenya Pwht = 600 Pclth = 20 It is note that the relative prices are not equal when the prices in the two countries are compared. After trade; Australia Pwht = 50 Pclth = 400 Kenya Pwht = 500 Pclth = 40 Therefore, it can be noted that the relative prices between the two countries is the same i.e. Pwht/ Pclth = 100 This proves that factor mobility between the two countries brings price equalization. d. The effect of trade on real income of labour and real income to owners of capital Australia Australia produces more wheat which is capital intensive thus prices of wheat are low in a closed economy. Therefore, trade with Kenya increases demand for wheat due to increase in market size. The rise in demand increases commodity price thus increasing real income of the owners of capital. The real income for labour will reduce due to increase in cheap imports thus forcing clothing industries to lower their prices (Ohlin, 1967). The reduction in demand and prices is translated to reduction in salaries and wages in order to fairly compete with Kenyan clothes. Kenya Kenya produces more cloths because the country has excess supply of labour factor and the production of cloths is labour intensive. The exportation of clothes to Australia opens up a new market which leads to increase in demand. The increase in demand results to rise in prices of the commodity thus translating to rise in the real income to labour. On the other hand, country imports cheap wheat from Australia since it is endowed with capital. The imports will lead to reduction prices of locally produced wheat since it needs to compete with Australia which has higher comparative advantage (Mikić, 1998). The reduction of demand and price leads to decrease in income to the owners of capital. Question Three: Demand vs Supply curve; The demand and supply is at equilibrium at point E. a. Pre-trade price and quantity equilibrium According to the graph above, the price and quantity will be at equilibrium when demand and supply intersect at E. Price = $2,500 Quantity =25,000 motorcycles b. Assuming the world price is $1,000 When the price is $1,000 the supply will be less than demand as shown by the line A above. Therefore, country will require to import. Domestic production = 10,000 Motorcycle Domestic consumption = 40,000 Motorcycle Quantity imported = 40,000-10,000 = 30,000 Motorcycle c. Effect of quotas on imports to 10,000 When domestic production of motorcycle is at 10,000 the country experience excess demand of 30,000 motorcycle but 15,000 to bring demand and supply to equilibrium. Therefore, the loss experienced from unsatisfied consumption given import quota is limited to 10,000 can be obtained as shown below; Total supply = 10,000 + 10,000 = 20,000 Price when supply is 20,000 = $2,000 Price at equilibrium = $2,500 Loss = 2,500-2,000 =$500 The loss arises from producer gain, government gain, deadweight loss due to low consumer consumption and increased cost of production (Mikić, 1998). =$500 on consumption Loss on production effect The introduction of quotas is a gain on domestic production since it reduces amount of imports to the country. This ensures high demand for the few motorcycles in the market thus priced high (Krugman & Obstfeld, 2000). Therefore, quotas do not cause loss to domestic production of motor cycle. Question Four: Tariff protection is important in shielding domestic industries from unfair competition from industries in other countries which enjoy economies of scale or low cost of production. Also, it provides a good mechanism in adjusting the prices of the commodity as a result of inflation or deflation since effective rate adjust with changes in prices (Krugman, 1996). The following shows calculation of effective rate of protection; a. Effective Rate Of Protection Price=$30,000 Steel =$15,000 Value add in free trade = $30,000-$15,000 = $15,000 Duty=$30,000*0.25=$7,500 Tariff protected price = 30,000+7,500 = $37,500 Value add for the tariff protection = $37,500-$15,000 = $22,500 Effective rate of protection = ERP= *100 =50% b. Effective rate of protection when import of steel tariff is set at 20% Value add from protection tariff Tariff protected price Car price =30,000+7,500 = $37,500 Steel price = $15,000 +$15,000*0.2=$18,000 Value add from protection = $37,500 - $18,000 = $19,500 Effective rate of protection = VA = 15,000 ERP= *100 =30% Question five: Country A Country B Country C Price of X $20 $16 $12 Non-Discriminatory 100% Custom Union Custom union Non-discriminatory tariff Country A will stop producing and imports goods consumed from country C. The granting of 100% ad valorem by country A will lead to increased competition between the country producers with country B and C. Due to economies of scale in country B and C, consumers in country A will prefer to consume imports than domestically produced goods. The reduction in demand of the domestically produced goods will lead to collapse of domestic producers (Krugman, 1996). Therefore, Country A will import goods that are consumed domestically than produced due to low comparative advantage in production compared to country B and C. Custom union The country will produce good X and bridge shortages from Country B. The custom union enables the trading blocks to impose common tariffs to the external trading nations. The member bloc countries might have different imports quotas among themselves but common tariffs to non-member. The bloc will enable country A to import good X when it is facing shortage i.e. ensuring that the quota compensate the shortage that arises from low production from domestic industries (Krugman, 1996). The custom union will result to creation of trade between country A and B since it will ensure free movement of factors of production, competition and stimulate investment. Also, it allows control of country C since it produces cheaply compared with country A and B i.e. they might increase tariffs to make the good more costly thus competing fairly with the good X produced in the bloc (Hartmann, 1998). On the other hand, divert trade between bloc countries and country C since tariff imposed might not favour imports thus country C will venture into other markets. Question Six: a. Intra-trade index for each product in respective countries Country A Good X Intra-trade index for Good X =1- =1- =0 Good Y Intra-trade index for Good Y=1- =0.667 Good Z Intra-trade index for Good Z =1- =0 Country B Good R Intra-trade index for Good R =1- =1- =0 Good S Intra-trade index for Good S=1- =0.795 Good T Intra-trade index for Good T =1- =0.74 Country C Good M Intra-trade index for Good R =1- =1- =0.785 Good N Intra-trade index for Good S=1- =0.788 Good O Intra-trade index for Good T =1- =0.722 b. Intra-trade index for total trade in the country Country A Country intra-trade index = Average index for the goods = = = 0.22 Country B Country intra-trade index = = = 0.512 Country C Country intra-trade index = = = 0.765 c. Trade pattern explanation Grubel–Lloyd index measure is the theory behind explanation of the intra and inter-industry trade. The measure ranges from zero to one. The theory shows that there is exists of intra-industry trade and no inter-industry when the index is equal to one (Hartmann, 1998). On the other hand, there is existence of inter-industry trade and no existence of intra-industry trade when index is equal to zero. Therefore, we can conclude the following from the trade in the following product and country index; Country A According to the calculation above, we can note that for; Good X there is no intra-industry trade while inter-industry trade exist since index is zero Good Y there is intra-industry trade of index 0.333 (1-0.667) and inter-industry trade of index 0.667. Therefore, both forms of trade between industries exist. Good Z there is no intra-industry trade while inter-industry trade exist since index is zero The total trade index between industries for Country A is 0.22 meaning that the country has high intra-industry trade of 0.78 and inter-industry trade of 0.22. Country B According to the calculation above, for; Good R there is no intra-industry trade while inter-industry trade exists since index is zero. Good S there is intra-industry trade of index 0.205 (1-0.795) and inter-industry trade of index 0.795. Therefore, both forms of trade between industries exist. Good T there is intra-industry trade of index 0.26 and inter-industry trade of index 0.74. Therefore, both forms of trade between industries exist in the industry. The total trade index between industries for Country B is 0.512 meaning that the country has fairly balanced intra-industry trade of 0.488 and inter-industry trade of 0.512. Country C According to the calculation above, it can be noted that there exist intra-industry and inter-industry trade within the industry for all the products. The proportion of the trade is as shown below; Good M: Intra-industry trade = 0.215 Intra-industry trade = 0.785 Good N: Intra-industry trade = 0.212 Intra-industry trade = 0.788 Good O: Intra-industry trade = 0.278 Intra-industry trade = 0.722 The total trade index within industries is at 0.765. Therefore, there is high inter-industry trade (0.765) in country C economy than intra-industry trade (0.235). Question Seven: Country ER-2008 ER-2014 R index Trade(X+M) Wi NEER (∑Rindex x Wi) Japan 91.58 98.04 1.071 66415 0.228 0.244 US 0.9180 0.8202 0.893 36261 0.124 0.111 UK 0.4608 0.5271 1.144 10054 0.034 0.039 NZ 1.1557 1.0462 0.905 14800 0.051 0.046 SG 1.2665 1.0836 0.8556 18592 0.064 0.055 CHINA 6.4393 5.0859 0.790 141905 0.486 0.384 Hong Kong 5.3693 6.362 1.185 3829 0.013 0.015 Total 291,856 NEER =0.894 The Nominal Effective Exchange rate for Australia is 0.894. Therefore, Australian dollar has appreciated by 10.6%. Question eight: Country CPI-2014 ER-2000 ER-2014 RER () Wi Rind() REER=∑WiRind Australia 110.5 Japan 102.8 91.58 98.04 105.383 0.228 1.15 0.262 US 108.6 0.9180 0.8202 0.835 0.124 0.91 0.113 UK 111.8 0.4608 0.5271 0.521 0.034 1.13 0.038 NZ 107.6 1.1557 1.0462 1.074 0.051 0.93 0.047 SG 113.3 1.2665 1.0836 1.057 0.064 0.83 0.053 CHINA 113.3 6.4393 5.0859 4.960 0.486 0.77 0.374 Hong Kong 119.4 5.3693 6.362 5.889 0.013 1.097 0.014 Total REER= 0.901 The real effective exchange rate is 0.901. Therefore, Australian dollar has depreciated by 9.9%. The depreciation of the currency shows that the exports have reduced due to decreased competitiveness of Australian exports in foreign market (Bhagwati, 1996). On the other hand, imports might have increased with constant exports this is due to decreased competitiveness of Australian products in the domestic market. This increases the demand of foreign currency with decreased demand of local currency. Therefore, results to decrease in real effective exchange rate. Reference: Bhagwati, J. (1996). International trade. Cambridge, Mass.: MIT Press. Chrystal, A. (1981). Principles of international economics. Journal Of International Economics, 11(4), 605-606. doi:10.1016/0022-1996(81)90038-6 Harrod, R. (1958). International economics. Chicago]: University of Chicago Press. Hartmann, P. (1998). Currency competition and foreign exchange markets. Cambridge, U.K.: Cambridge University Press. Krugman, P. (1996). Rethinking international trade. Cambridge, Mass.: MIT Press. Krugman, P., & Obstfeld, M. (2000). International economics. Reading Mass.: Addison-Wesley. Mikić, M. (1998). International trade. New York: St. Martinʼs Press. Ohlin, B. (1967). Interregional and international trade. Cambridge, Mass.: Harvard University Press. Salvatore, D. (2001). International economics. New York: John Wiley. Shamah, S. (2003). A foreign exchange primer. Chichester, West Sussex, England: J. Wiley. Solberg, C. (2006). Relationship between exporters and their foreign sales and marketing intermediaries. Amsterdam: Elsevier JAI. Read More