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Portfolio
Definitions and diagrams from Section 4
FACTOR ENDOWMENTS
Factors of production that a country has available to produce goods and services
Real world example: Japan has people, China has land
SPECIALIZATION
Country specializes in the production of goods and services where they have a comparative advantage in production.
ABSOLUTE AND COMPARATIVE ADVANTAGE
Absolute: The ability to produce a particular good with fewer resources than another country.
Comparative: The ability to produce a particular good at a lower opportunity cost than another country.
Real world example: Japan makes technology and Thailand rice
Shoes (pairs)
Cloth (meter)
India
China
3
2
5 120
Figure 1: Production Possibilities Curves (PPCs) for India and China
PROTECTIONISM & FREE TRADE
Free trade: Absence of intrusions (subsidies) or barriers (tariff and quota) in the flow of goods and services between countries.
Protectionism: Presence of intrusions (subsidies) or barriers (tariffs and quotas) in the flow of goods and services between countries
TARIFF
Tariffs: taxes on goods imported into a country in order to protect local industries. They are a form of protectionism and are often used by governments to try to reduce the level of imports into a country.
Real world example: Brazil on US agricultural products
Pric
e of
ag
ricul
tura
l go
ods
Quantity of agricultural
goods
0 Q1
D
SBrazil
Tariff
SUS+TARIFF
SUS
P3
P1
P2
Q2 Q3Q4 Q5
Before tariff
After tariff
domestic imports
domestic imports
Government Revenue
Deadweight loss
QUOTA
Quota: limit on the quantity of goods that can be imported into a country in order to protect local industries.
Real world example: Japan
Pric
e of
ag
ricul
tura
l go
ods
Quantity of agricultural
goods
0 Q1
D
SBrazil
Quota
SUS+TARIFF
SUS
P3
P1
P2
Q2 Q3Q4 Q5
Before tariff
After tariff
domestic imports
domestic imports
Government Revenue
Deadweight loss
SUBSIDY
Subsidy: payment made to firms or consumers designed to encourage an increase in output in order to protect local industries.
Real world example: US to agricultural farmers
Pric
e of
ag
ricul
tura
l go
ods
Quantity of agricultural
goods
0 Q1
D
SUS
Subsidy
SWORLDP2
Q2 Q4Q3
Before subsidy
After subsidy
domestic imports
domestic imports
Cost to Government
SUS+SUBSIDIES
Size of subsidy
P1
VOLUNTARY EXPORTS RESTRAINT
Voluntary agreement between an exporting country and an importing country that limits the volume of trade in a particular product
Real world example: Japan and cars (reduced their exports to US)
DUMPING & ANTI-DUMPING
Dumping: selling of a good in another country at a price below its unit cost of production
Anti-dumping: legislation to protect an economy against the import of a good at a price below its unit cost of production
Real world example: Dumping US chicken in China (anti-dumping China on US chicken)
WORLD TRADE ORGANIZATION (WTO)
International body that sets the rules for global trading and resolves disputes between its member countries. It also hosts negotiations concerning the reduction of trade barriers between its member nations.
ECONOMIC INTEGRATION & GLOBALIZATION
Economic integration: A process whereby countries coordinate, link and harmonize their economic policies.
Globalization: The spread of economic, social & cultural ideas across the world, the result of increased economic integration through trade, investment and improving technology
TRADING BLOCKS
Countries agree to increase trade and cooperate.
Real world example: EU and ACP
FREE TRADE AREA
Countries remove trade barriers between themselves but trade in anyway with counties outside the group
Real world example: NAFTA
CUSTOMS UNION & COMMON MARKET
Countries adopt common trading policies. Countries adopt common regulations policies and the free movement of goods and service, capital and labor to form a common market.
Real world example: EU
ECONOMIC AND MONETARY UNION
Countries adopt a common market and currency.
Real world example: Euro zone
TRADE CREATION
Entry of country into a customs union leads to the transfer of production from a high cost producer to a low cost producer
Real world example: Spain joined the EU
A
B
C High cost Producer
BLow Cost Producer
Tariffs
Trading Bloc
Before trade creation
After trade creation
A
B
C High cost Producer
BLow cost Producer
TRADE DIVERSION
Entry of country into a customs union leads to the transfer of production from a low cost producer to a high cost producer
AC
High cost Producer
B
DLow cost producer
Before trade diversion
After trade diversion
A
C High cost Producer
B
Trade Barriers
DLow cost producer
BALANCE OF PAYMENTS
Record of the value of all the transactions between the residents of a country with the residents of all other countries over a given time periodCurrent account + capital account
CURRENT ACCOUNT
Visible Trade+ Invisible Trade+ Net Transfers
VISIBLE TRADEExports of goods minus imports of goods over a given time period
INVISIBLE TRADEExports of services minus imports of services over a given time period
NET TRANSFERS
Net payments of interest, profits and dividends from investments and transfers of money
CAPITAL ACCOUNT
Net Transfers of Capital + Net Investment and loans+ Changes in National Reserves
EXPENDITURE-SWITCHING POLICIES
Policies implemented by the government that attempt to switch the expenditure of domestic consumers away from imports towards domestically produced goods and services
EXCHANGE RATE SYSTEM
Exchange Rates express the value of one currency in terms of another currency.
FLOATING EXCHANGE RATE SYSTEM
Supply and Demand determine the exchange rate
Real world example: US
Price of US dollars in terms of Yuan
Quantity of US dollars
D
S
0
P
Q
Supply and demand for US dollars
Ep
MANAGED EXCHANGE RATE
Exchange rate generally allowed to float but governments intervene to avoid sudden fluctuations
Real world example: China now, Japan
FIXED EXCHANGE RATE SYSTEM
Government intervention to maintain a fixed exchange rate
Real world example: China before
Price of Yuan in terms of Dollars
Quantity of Yuan
D
S
0
P
Q
Fixed exchange rate (devaluated: shortage)
Ep
Shortage
Fixed exchange rate
P*
Q1 Q2
Price of Yuan in terms of Dollars
Quantity of Yuan
D
S
0
P
Q
Fixed exchange rate (surplus)
Ep
Surplus
Fixed exchange rate
P*
Q1 Q2
APPRECIATION
Increase in the value of one currency un terms of another currency in a floating exchange rate system
Real world example: Chinese Yuan
S1
EP1
EP2
Price of currency A in terms of currency B
Quantity of currency A
P2
P1
Q1 Q2
0
Increase in demand
D2
D1
S1
D
S2
EP1
EP2
Price of currency A in terms of currency B
Quantity of currency A
P2
P1
Q2 Q1
0
Decrease in supply
DEPRECIATION
A fall in the value of one currency in terms of another currency in a floating exchange rate systemReal world example: US Dollars
S1
EP1
EP2
Price of currency A in terms of currency B
Quantity of currency A
P2
P1
Q2 Q1
0
Decrease in demand
D1
D2
S1
D
S2
EP1
EP2
Price of currency A in terms of currency B
Quantity of currency A
P1
P2
Q1 Q2
0
Increase in supply
DEVALUATIONDecrease in the value of a currency in a fixed exchange rate system
Price of Yuan in terms of Dollars
Quantity of Yuan
D
S
0
P
Q
Devaluation
Ep
Shortage
Rate #2P2
Q1 Q2
Rate #1P1
REVALUATION
Increase in the value of a currency in a fixed exchange rate system
Real world example: US want Chinese Yuan to be revaluated
Price of Yuan in terms of Dollars
Quantity of Yuan
D
S
0
P
Q
Revaluation
Ep
Surplus
Rate #2P2
Q1 Q2
Rate #1P1
MARSHALL-LERNER CONDITION
PED of Exports + PED of imports > 1Reducing the currency exchange rate will only reduce the Current Account deficit when the PED of Exports together with the PED of imports is greater than one i.e. elastic.
J-CURVE
Though policy makers may hope that a currency depreciation will improve the Current Account deficit in the short-run the Current Account Deficit will worsen even when the Marshall-Lerner Condition is meet.
Current account balance
Time0
J-curve
+
-
TERMS OF TRADE
Relationship between the price received for exports and the amount of imports a country is able to buy with that money.
