Archive for December, 2010

IA Commentary 3

ECONOMICS COMMENTARY COVERSHEET
Economics Commentary Number: 3
Title of extract: European Union and South Korea Sign Free Trade Agreement
Source of extract: International centre for trade and sustainable development. (2010). 14(35), Retrieved from http://ictsd.org/i/news/bridgesweekly/86983
Date of extract: November 4th, 2010
Word Count: 738
Date the commentary was written: November 8th, 2010
Sections of the syllabus to which the commentary relates: Section 4
Section: 4
Candidate Name: Sang Keun Kim
Candidate Number:

International Centre for Trade and Sustainable Development(ICTSD) reported that the European Union and South Korea signed a free trade agreement (FTA) on October 6th, 2010. Free trade agreement is an agreement to form a type of trade bloc between two or more countries to eliminate protectionism barriers such as tariffs and quotas. Tariff is a taxation imposed on any product when it is imported into a country. Also, quotas are limitation set on the number of imported good allowed in the country. In this commentary, the focus will be on the Korean side of the market, not the European market.

ICTSD reports that the FTA agreement will free almost all of the trade and eliminate 99% of European tariffs and 96% of Korean tariffs on imported goods. This elimination of tariffs will help markets between EU and Korea to eliminate dead weight loss, which is a cost caused by economic inefficiency.

By initiating free trade, EU and Korean markets will be able to get rid of the deadweight loss from the tariffs. Deadweight losses are costs that are caused by inefficient industries spending their resources inefficiently, and these costs are often passed on to the consumers. As EU and Korea initiate FTA, the prices of products will decrease from P(tariff) to P(world). Subsequently, the deadweight losses caused by inefficient industries are eliminated, getting rid of the burden off the consumers’ hands.


As EU and Korea get rid of the tariffs, there will be benefits for the consumers for several reasons. According to ICTSD, the Europeans will gain in chemicals, pharmaceutical, electronics, alcoholic beverages, and agricultural sectors. In other words, this means that the Europeans are efficient in these sectors and they have the ability to supply at the price of P(world), which is way cheaper compared to how Korean industries are supplying at P(domestic). Therefore, the Korean consumers benefit from a fall in price from P(domestic) to P(world) in these sectors. Also, the quantity demanded from the Korean consumers will increase from Q1 to Q2 due to its decreased price. So the consumers who could not buy the products from Q1 to Q2 now benefit from the EU-Korea FTA by the decrease in the price of the products. However, this will be especially bad for the Korean industries in these sectors. As it is illustrated in the diagram, their share of the market decreases from Q(domestic) to Q1 due to the EU-Korea FTA.

The efficient industries compared to other countries’ industries will benefit from gain in the share of other countries’ market by the FTA. These industries are most likely that they will not be badly affected by the FTA and will not lose any of the market shares within the domestic market. In the point of view of European industries in chemicals, pharmaceutical, electronics, alcoholic beverages, and agricultural sectors, these industries will not lose any of the market shares from the Korean industries in these sectors due to their competitiveness and efficiency. To illustrate, the Korean industries in these sectors will not be able to take away the European market due to its high price of P(world) compared to European industries’ price of P(domestic). Therefore, the supply curve will be above the equilibrium point and the Korean products in these sectors will not be appealing to the European consumers.

On the other hand, the Korean industries in automobiles, ships, and mobile communications sectors, they will not lose any of the market share from the European industries because of their cheap price of P(domestic) compared to P(world) of European industries.

In conclusion, the EU-Korea FTA will have a great impact and significance to both economies. There would be a losses and wins from both sides. However, the FTA is worth a try due to the elimination of deadweight losses caused by inefficient industries that are causing great burden on consumers. The elimination of deadweight losses mean the elimination of the inefficiency, and this will bolster the industries to be efficient as possible. Thus, this will benefit not only the consumers but also the industries because it will help them to be competitive in the global market. Increase in the competitiveness and efficiency will help the industries to export their goods and gain profit like how the other efficient foreign industries did. Also, the increase in the trade will greatly contribute to subside the ever-rising unemployment rate, which is troubling both the sides.

Word Count: [738 words]

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Diagrams: AD/AS + Section 4

The increase in the aggregate demand from AD1 to AD2 increases both price level and real output from P1 to P2 and from Q1 to Q2 respectively.

Aggregate demand could be increased by many factors. First of all, reduction in taxation could increase the consumption. Secondly, the reduction in interest rates will most likely shun away consumers to save their money but spend them. Also, due to the low interest rate, there will be less burden to borrow money. Therefore, this would both increase the consumption and the corporate investment. Thirdly, increase in government spending would increase the aggregate demand because it is one of the factors that comprises of the aggregate demand. The governmental spending boosts up the consumption in products and increases the earning/income in the sector. Finally, the improved competitiveness could also increase the aggregate demand as the opportunity cost in production would decrease. In addition, the increase in the competitiveness could also boost up the export, which also increases the aggregate demand.

The decrease in the aggregate demand from AD1 to AD2 decreases both price level and real output from P1 to P2 and from Q1 to Q2 respectively.

Decrease in aggregate demand is caused by many factors. First of all, the increase in the taxation could decrease the consumption. Secondly, the increase in the interest rate could allure consumers not to spend money but to save them. In addition, the high interest rate would attract lots of money in to the bank, draining the money out of the market. Also, the high interest rate decreases the corporate investment. Thirdly, decrease in the governmental spending would also decrease the aggregate demand. Finally, decrease in the competitiveness could also decrease the aggregate demand by increasing the opportunity cost associated with the production. In addition, loss in competitiveness could also lead to decrease in export, which also decreases the aggregate demand.

Increase in the aggregate supply from AS1 to AS2 increases real output from Q1 to Q2 but decrease the price level from P1 to P2. This is desirable as the price level is decrease and the real output has increased.

Increase in the aggregate supply could be caused by many factors. First of all, reduction in indirect taxation could lead to increase in the aggregate supply. As the taxation is reduced from the price of the product, the producer could manufacture products at much lower opportunity cost and gain price advantage. Secondly, the reduction in wages of the employees would lead to cut in the production cost and therefore gain price competitiveness. This way, the manufacturer could sell more products at much cheaper price, increasing the aggregate supply. Thirdly, the reduction in price of raw material also leads to the increase in the aggregate supply due to the cut in the production cost. Finally, favorable weather conditions could help industries that depend on the weather to produce more. Therefore, this would also increase the aggregate supply.

The decrease in aggregate supply from AS1 to AS2 decreases real output from Q1 to Q2 but increases the price level from P1 to P2. This is the worst scenario as the price level increase and the real output decreases.

There are many factors affecting the decrease in the aggregate supply. First of all, the increase in the indirect taxation could lead to increase in the cost of production. Therefore, the producer would only be able to produce less products than he/she used to produce. Secondly, the increase in the wages could also lead to the increase in the opportunity cost and the production cost. This would also increase the aggregate supply. Thirdly, the increase in the price of raw materials also increase the production cost that aggravates the decrease in aggregate supply. Finally, adverse weather conditions could ruin the production of industries that depend on the weather. So, this would also worsen the decrease in the aggregate supply.

Japan and China are in a comparative advantage to each other. Japan produces more automobiles at QA2 than what China’s producing at QA1. However, China produces more break pads at QB2 than what Japan is producing at QB1. In conclusion, Japan has a comparative advantage in automobiles over China, however, China has a comparative advantage in break pad over Japan. In these countries were to initiate FTA, they would both have loss and gains.

In this diagram, India is at absolute advantage over Fiji Island. India produces clothes at QC2 which is way more than what Fiji Island is producing at QC1. Also, India produces more hats at QH2 that is more than what Fiji Island is producing at QH1. In conclusion, as India produces more products in both items, India is in an absolute advantage over Fiji Island.

This economy is in a free trade with the world without any trade barriers. The price dropped from Peq to Pworld.  Also, the quantity demand increased from Qe to Q2. This means that only consumers until Qe were able to buy a product, but now consumers until Q2 are able to buy the product they could buy before. From Q1 to Q2, it indicates the amount of imported goods and services. However, the domestic production decreases from Qe to Q1 to the price-competitive world providers. In conclusion, the consumers benefit the most from this situation.

In this economy, it imposes tariffs on imported goods. The tariff increases the price from Sworld to Stariff. This decreases the quantity demand for the product from Q2 to Q4. This means that consumers from Q4 to Q2 no cannot buy the product because of the increased price. Also, the deadweight loss occurs due to inefficient domestic producers entering the market. The amount of imported goods decreased from (Q2-Q1) to (Q4-Q3). This is a great loss for the world providers because they are losing the market share both ways from left and the right whereas the domestic providers are only gaining by one side from the left. The government also gains revenue from the tariff imposed on the imported goods.

In this economy, quota is imposed on the economy. The quota increase the price from Sworld to Stariff. This decreases the quantity demanded from Q2 to Q4. This decreases the imported good to the market from (Q2-Q1) to (Q4-Q3). Also, the foreign producers that avoided the quota benefits greatly by the windfall gain. However, there will be a deadweight loss caused by the inefficient producers. In addition, the government will gain nothing from this situation because they are not imposing a tariff.

In this diagram, the government is subsidizing the domestic industries to fight off the competitive foreign providers. The subsidy shifts the supply curve for the domestic providers from Sdomestic to Sdomestic+subsidy. This allows the domestic providers from Q1 to Q3 to re-enter the market. In the other hand, the imports decrease greatly by (Q3-Q1), which was taken from the domestic providers that are subsidized. The consumers are not hurt in this situation because there is no decrease in the quantity demanded, which means there was no increase in number of consumers who are not able to buy the product. Also, unlike the tariff and quota situation the importers do not lose by 2 ways but by only 1 way (from the left).

The fixed exchange rate could cause shortage of the quantity of the currency. As the demand for the imported goods increase, people would need more of the currency to buy another currency. This is why the supply curve should move from S1 to S2. However, due to the fixed exchange rate, the shortage in supply of the currency occurs.

Fixed exchange rate could cause the surplus in the supply of the currency in the market. As the demand for the exports increase overseas, the foreigners would demand more of the currency to buy the exports. This is why the demand curve should move from D1 to D2. However, due to the fixation in exchange rate, the surplus of currency occurs.

Floating exchange rate well suits the demand and the supply of the currency. Also, it does not have the problems of surplus/shortage of currency that fixed exchange rate systems have. The currency is demanded at the quantity of Q and the value of the currency in terms of another currency is at P.

Demand for the currency could be increased from the increased demand of exports. If foreigners are attracted to the exports, they would demand more of the currency to buy the exports. Therefore, this would increase the demand for the currency from Q1 to Q2 increasing the value of the currency in terms of another currency from P1 to P2. This is called appreciation of the currency as the value of the currency increased.

Demand for the currency could decrease by the lack of interest in exports. The foreigners would not demand less of the currency, decreasing the demand curve from D1 to D2. This decreases the quantity demanded for the currency from Q1 to Q2 and decrease the value of the currency in terms of another currency from P1 to P2. This is called the depreciation of the currency as the value of the currency has been decreased.

The increase in the supply of the currency could be caused by the increased interest in the imports. The consumers would need more of their currency to buy another currency to buy imports. This would increase the supply curve for the currency from S1 to S2. This increases the quantity demanded for the currency, however, it depreciates the currency from P1 to P2.

The decrease in the supply of the currency could be caused by the decrease in the interest for the imported goods. As consumers would demand less of their currency, the supply curve would shift from S1 to S2 decreasing the quantity demand for the currency but increase the value of the currency in terms of another currency. This causes the currency to appreciate.

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Diigo Contributions

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List of Definitions for Section 4

This is the list of economic definitions used in Section 4 (International Economics) with real world examples to have better understanding of the definitions. It would be faster if you use command-F (Mac) or control-F (PC) to find the definitions.

1. Trade – is an exchange involving goods, services, or currency.

2. Reasons for Trade – There are several reasons for why countries trade with each other.

  1. Different Factor Endowments – There are some economies that are rich in natural resources while others have comparatively little resources. Trade enables economies to specialize in the exports in resources and money to buy imports of other goods that they need but lack.
  2. Increased Welfare – specialization and trade allow countries to gain a higher level of consumption than they would do domestically and this leads to increased welfare and higher living standards.
  3. To gain Economies of Scale – with specialization and production on a larger scale than may be possible domestically, a country may be able to gain more economies of scale. This will lead to lower average costs and benefit consumers through lower prices.
  4. Diversity of Choice – trade enables people to access and approach diverse and variety of goods and services that may not be available only in the domestic market.
    • Real World Example: Korean consumers are able to buy Apple products from US and have wide variety of choice along their own electronics manufacturers Samsung and LG.
  5. Increased Competition – Increased competition helps domestic industries to have improvements in productivity and efficiency. In addition, it gives domestic firms better incentive and improve their products to compete against foreign firms.
    • Real World Example: As Apple introduced the iPhone, Korean phone manufacturers such as Samsung and LG began to make their own smart phones to counter the increasing Apple influence on Korean domestic market. Warc: iPhone threatens LG and Samsung in Korea
  6. Engine for Growth – increased trade helps domestic economies to grow and make improvements in living standards of the people.

3. Free trade – It is international trade free from any restrictions like tariffs, quotas or other protection.

  • Real World Example: Korea and EU signed the agreement to initiate FTA that will eliminate all the trade barriers imposed on the trade. ICTSD: EU-Korea FTA

4. Protectionism – it is a policy to protect domestic industries from fierce foreign competitions. It includes tariffs, quotas, embargo, and voluntary export restraints.

  • Real World Example: Japan has a heavy protectionism on their domestic rice industry. Japan imposes 341 yen per kilogram tariff on all imported rice. This raises the price of the imported rice to be way higher than the quota, effectively prohibiting the imported rice from hurting domestic rice industry. In addition, Japan subsidizes the rice industry and the taxpayers paid $2.8 billion in 1999 alone. Japan-101: Japanese Rice Trade Policy

5. Tariff – it is a tax on imports in order to protect domestic industries by increasing the price of the imports. This gives domestic industries equivalent comparative advantage to the foreign industries.

  • Real World Example: Japan imposes a tariff of 341 yen per kilogram on imported rice.

6. Quotas -it restricts the maximum amount of imports allowed into an economy. This reduces the amount of imports into the economy and increases the equilibrium price within the market.

7. Exchange Control – it limits the amount of foreign currency available for paying for imports. This reduces the amount of imports in the economy to protect domestic industries.

  • Real World Example: China has exchange control to regulate not only the value of their currency but also to regulate the amount of imported goods to be in Chinese domestic market. CABC: Chinese foreign exchange control system

8. Export Subsidies – it is a subsidy offered to domestic industries to allow exporters to export more products than the natural equilibrium point would allow. The benefits the foreign consumers with increased economic welfare and the decrease in the price of the imports. Tax payers would have to bear the burden, however, the domestic industries would enjoy more wages and job security. However, this could reduce the domestic exporters’ interest in domestic market and disregard the market. This could lead to an increase in domestic prices.

9. Voluntary Export Restraints (VER’s) – it is the voluntary quota set by the manufacturer.

10. Administrative Obstacles – governments could set trade barriers such as long, slow paperwork. This makes it hard for foreign firms to to compete with the domestic firms.

11. Health and Safety Standards – high health and safety standards for imported goods can make it difficult for foreign firms to compete in domestic market. This protects the domestic industries.

  • Real World Example: Japan only allows US beef that are aged below 20 months in fear of mad cow disease. Japan considers beef aged over 20 months as ‘highly dangerous’ of mad cow disease and prohibits them from the domestic beef market. Bloomberg: Japan-US Beef, Mad Cow Disease Concerns

12. Environmental Standards – high environmental standards also makes the foreign firms to compete in the domestic market. This protects the domestic industries.

13. Downward Multiplier Effects – protectionism could reduce the level could affect the country’s exports to be less competitiveness and decrease the exports due to decreased amount and the increased price of imports.

  • Real World Example: Korea has tariffs on imported chicken and this may have been the cause to the high price of domestic chicken in Korean market. The high price in chicken reduces the competitiveness of industries that rely on chicken as part of their production. For example, KFC’s would have great decrease in the competitiveness in the price of their chicken due to the high price caused by the protectionism.

14. Globalization -it is the integration of national economies into international economy trough trade, commerce, investments, and capital flows.

  • Real World Example: China is a communist country, but it has realized that it could benefit from the globalization and trade. So, China opened up its market and economy to the world and became an enormous part of the global economy.

15. Types of Trading Blocs

  1. Free Trade Area (FTA) – it is an area where there are no trade barriers. Sovereign countries must not implement trade barriers on the member countries of FTA.
  2. Customs Union – it is similar to FTA in that it is free from trade barriers. However, it is different in that countries are no longer fully sovereign over the trade policies. There is standardized trade policies that the countries must abide by to.
  3. Common Market -it allows free movement of factors of production such as labor and capital between the member countries without restriction.
  4. Economic Union – it is a developed trading bloc in the level of integration. The member states may have common economic policies, common currency, and common monetary policies.
    • Real World Example: EU is an economic and political union that has common economic policies and common currency as Euro.

16. World Trade Organisation (WTO) – it is an organization that intends to supervise and liberalize international trade. It penalizes countries implementing illegal trade barriers on the other country.

17. Balance of Payments – it measures the international trade performance of an economy and shows how well it is managing to match imports and exports of goods and services and the flows of investment in and out of the country.

18. Current Account – it records imports and exports of goods and services.

19. Capital Account – it records the flow of money into and out of a country for investment and other purposes.

20. Exchange Rate – it is the price of one currency expressed in terms of another.

  1. Fixed– the exchange rate of one currency is fixed in value to other currencies.
    • Real World Example: North Korea has a fixed exchange rate. However, the fixed exchange rate does not accurately reflect the market value of the currency as the market value for the currency is often 20 times lower than the fixed value for the currency.
  2. Floating – the exchange rate of one currency is completely dependent on the market mechanism of supply and demand of the currency.
    • Real World Example: Japan has a floating exchange rate. The government does not intervene with the exchange rate.
  3. Managed or Dirty Float – the exchange rate that is based on floating exchange rate, however, has maximum and minimum limits managed by the government.
    • Real World Example: China is implementing dirty float system for the exchange rate. It sets the maximum value to the exchange rate in order to artificially depreciate its currency and therefore export more to the world.

21. Dumping – It is to sell a product in another country at a price below its unit cost of production in order to decimate the domestic industry of that country.

  • Real World Example: Philippines once had a competitive agricultural industry. It was once famous for its efficiency to harvest crops 3 times a year whereas other agricultural industries could only harvest 1 time. However, as it opened up its market to the world, foreign agricultural industries started dumping their crops in Philippines domestic market. The domestic agricultural industries soon collapsed, and the foreign agricultural industries raised the price of the crops. Philippines’ economy significantly shrank and gave its title of Asia’s 2nd developed nation to other countries like South Korea, Taiwan, Hong Kong, etc.

22. Anti-Dumping – It is a legislation to protect an economy against imported goods that are sold at a price below its unit cost of production.

  • Real World Example: World Trade Organization (WTO) monitors firms dumping maliciously on foreign markets and penalize them as soon as they spot them on the action.

Resources:

  • Triple A Learning
  • Economics Glossary
  • Wikipedia

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Spanish Currency in Jeopardy (via Bobby’s Blog)

I thought that this blog post had an insightful analysis on the Spanish currency exchange rate and how the exchange rate is affecting the current account of the Spanish economy. According to the blog post, Spanish are experiencing double-digit deficit in their current account. In addition, the author analyzes the Spanish dilemma over whether they should stay or defect from Euro.

Spanish Currency in Jeopardy At this time, Spain, as part of the PIGS, countries that have double digit deficits in terms of current account in GDP, is suffering greatly. According to the article by Paul Krugman, the only solution Spain has formulated in order to recover from the deficit is to abandon the euro currency. By doing so, they will be free from Germany, a country that is doing relatively well in light of the current recession. Unlike Spain, it is currently experie … Read More

via Bobby’s Blog

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U.S. vs. China: Currency and Trade Dispute

Historically, China used the fixed exchange rate for their currency Yuan over almost 50 years. Of course, China has discontinued its inflexible practice from the start of July of 2005. Instead of the fixed exchange rate, they employed a flexible exchange rate system. However, it wasn’t 100% flexible or floating because of the Chinese government’s intervention in the currency exchange market. What the government would do is that they would use their reserves of currencies to ‘manipulate’ or manage the currency exchange rate to be at a certain level. Exchange rate is a ratio between the value of two currencies and it is a method to translate the value of one currency into another.

China armed with undervalued currency and its huge industrial factories and infrastructures, it gains enormous amount of surplus in current account against United States. The surplus in current account means that the country is exporting more than it is importing. Therefore, China is gaining lots of US dollars from the trade. If you look this at the American point of view, US is losing in terms of current account against China. US is importing more than it is exporting. The imbalance in the current account in both cases (surplus and deficit) could create some problems. For deficit in current account, the country will experience in large amounts of payments losing to the foreign country. So US will be losing lots of its payments and interests to China. For surplus in current account, it is considered ‘desirable’ compared to the deficit in current account, however, it could mean that the country is not experiencing the highest possible standards of living. Also, it could be seen as economy’s under-performing. Also, it exerts pressure on the exchange rate to appreciate the currency of the country.

As you could see, the fixed exchange rate could cause a problem of shortage in the currency supply. This would generally push the exchange rate upwards, but the fixed rate block this. Therefore, the shortage in the supply of the currency occurs.

What would have happen if the Yuan got stronger and appreciated? It would decrease the exports of China dramatically. Conversely, it would increase the imported goods to China. This will ‘fix’ the imbalance and lower the surplus in current account against United States. In the point of view of Americans, this will increase their exports to China and decrease the imports due to increase in the price. This would be beneficial for both countries’ balance of payment, however, China refuses to appreciate their currency. It is because the weak Yuan stimulates exports to US and this is the key engine for China’s enormous economic growth. They think that the surplus in the current account is a good thing, however, as it was mentioned there are problems with it also.

In conclusion, China’s currency policy is creating an imbalance in the trade between United States and China. Also, it is creating the imbalance in the balance of payment. It would be idealistic if China gave up their under-evaluation policy. However, it will increase the unemployment rate in China as the exports decrease and the number of workplaces in China decreases. Conversely, this will be beneficial for United States for it will lower the unemployment rate by the increase in exports and increase in the number of workplaces.

Resources:

Council of Foreign Relations – Confronting the China-US Economic Imbalance

Wikipedia – Fixed Exchange Rate

Graph from Triple AAA Reading – Fixed Exchange Rate

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