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NOTE CHAPTER 7 TERKINI
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CHAPTER 7 _ INTERNATIONAL ECONOMICS
DPB20033 - MACROECONOMICS
CHAPTER 7 INTERNATIONAL ECONOMICS LEARNING OUTCOMES At the end of this session, students should be able to: 1.
Explain the international trade
2.
Explain the protectionism policies
3.
Explain the concepts of balance of payments structure of Malaysia
4
Explain exchange rate
INTRODUCTION
Define International Trade International trade is the exchange of goods and services between the people across international borders or of two countries.
Define Domestic Trade Domestic trade is the exchange of goods and services within the political boundries of a country.
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Differentiate between Domestic Trade and International Trade DOMESTIC
INTERNATIONAL
TRADE
TRADE
Immobility of
Labour is free to move within the
Immobile (less mobile) to move
factors of
country
between countries.
production
This is due to financial constraints, language barriers and cultural differences.
Natural resources
Limited resources in domestic
Different countries are differently
only
gifted with production of different commodities. Examples: Malaysia can produce palm oil and rubber and Thailand can produce rice due to the availability of natural resources.
Monetary units
all transactions will be in Ringgit
There will be differences in
Malaysia
monetary units or currencies. Different countries have different currencies with different values.
National policies
laws and rules relating to taxation
there will be vast differences in the
or labors standard will be the
laws of different countries.
same within each country. Documentation
Involves fewer documents than
International trade involves greater
international trade
documentation as compared to domestic trade Examples: documentation that exist in international trade are import and export licences, traveller cheques, embargoes and non-tariff barriers.
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Protectionism
CHAPTER 7 _ INTERNATIONAL ECONOMICS
Not Practiced
Protectionism is practiced only in international trade where many countries want to protect their local industries from foreign competition. Examples: tariffs, quotas, embargoes and non-tariff barriers.
Size of market and
Limited size
total transactions
size of the market is relatively larger than the size in domestic trade.
Merit or Advantage of International Trade
Increases world output
Would output increases through specialization and trade. Varieties of goods and services Consumers can enjoy some of the goods which cannot be produced in their country due to geographical and other reasons. Examples: Malaysia cannot produce apples and grapes.
Relationship between trading partners Through trade fairs and economic co-operation (ASEAN, UE), the relationship between trading partners can be improved. Higher income and economics growth International trade can generate more income and this can also increase
the standard of living of a country. Sharing of knowledge and technology Through international trade, we can share the knowledge, information and technology with another country. Example: if Malaysia imports new technology-based machinery from Japan, then both countries can share the techonology.
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CHAPTER 7 _ INTERNATIONAL ECONOMICS
Demerit or
Depletion of country’s reserves
disadvantage
Continuous exports of raw materials can deplete the reserves in the long
of
run.
International
Example: oil exports from Malaysia will deplete reserves if there are too
Trade
many exports. Economics and political dependence This will disastrous especially when the political relationship between the trading partners have a problem.
Transportation costs The assumption in comparative advantage is that no transfortation costs are involved. But if transportation costs are too high, then international trade will not be a profitable venture for some countries.
ABSOLUTE ADVANTAGE AND COMPARATIVE ADVANTAGE
Assumptions
There are only 2 countries in the world Only 2 goods are produced No transportation costs are involved Production is under the law of constant costs
Identical production functions between trading countries
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Absolute Advantage Absolute advantage refers to the ability of a country to produce a goods or service efficiently than other country.
Examples: Table : Production before Specialization Country
Cotton
Rice
Malaysia
20
60
China
40
20
Total
60
80
These countries are dividing their resources equally (50% produce cotton and 50% produce rice). There for Malaysia can produce 20 cotton and 60 rice and China can produce 40 cotton and 20 rice. It can be seen that Malaysia has an absolute advantage producing rice while China in producing cotton. Specialization can take place where Malaysia will produce rice and China producing cotton using all it resources.
Table: Production after Specialization Country
Cotton
Rice
Malaysia
0
120
China
80
0
Total
80
120
Malaysia will channel all its resources to rice production and China will channel all its resources to cotton production. Total world output will increase after specialization.
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CHAPTER 7 _ INTERNATIONAL ECONOMICS
DPB20033 - MACROECONOMICS
Table: Production after International Trade (1C:1R) Country
Cotton
Rice
Malaysia
20
100
China
60
20
Total
80
120
Assume that there is an arrangement to trade 1 ton of cotton for 1 ton of rice.
Comparative Advantage Comparative advantage refers to the ability of one country to produce a particular good or service at a lower opportunity cost than another country.
Example: Table : Production before Specialization Country
Cotton
Rice
Malaysia
60
10
China
20
10
Total
80
20
According to David Ricardo, a country should specialize in goods in which it has a greater comparative advantage or lower opportunity cost than other countries.
To determine which country is to specialize in rice or cotton, the opportunity cost of production must be calculated.
Calculation of opportunity cost: Cotton: Malaysia
: 1 ton of cotton = rice/cotton = 10/60 = 0.17 *
China
: 1 ton of cotton = rice/cotton = 10/20 = 0.5
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Rice: Malaysia
: 1 ton of rice = cotton/rice = 60/10 = 6
China
: 1 ton of rice = cotton/rice = 20/10 = 2 * Table : Opportunity Cost Country
Cotton
Rice
Malaysia
0.17* (10/60)
6 (60/10)
China
0.5 (10/20)
2* (20/10)
** Indicates the lower opportunity cost
Malaysia has an comparative advantage producing cotton while China in producing rice.
Malaysia can produce cotton at a lower cost and China can produce rice at a lower cost. Table: Production after Specialization Country
Cotton
Rice
Malaysia
120
0
China
0
20
Total
120
20
The total world output of cotton increases after specialization (Malaysia specializing in production if cotton and China specializing in the production of rice)
Terms of trade
Terms of trade refers to the rate at which goods are exchange.
Formula: average price of exports x 100 Average price of imports
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Table: Production after International Trade (1R:4C) Country
Cotton
Rice
Malaysia
80
10
China
40
10
Total
120
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PROTECTIONISM POLICIES
Definition of Protectionism Policy
Protectionism policy is the economic policy of restraining trade between states through methods such as tariffs on imported goods, restrictive quotas, and a variety of other government regulations designed to discourage imports and prevent foreign take-over of domestic markets and companies.
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CHAPTER 7 _ INTERNATIONAL ECONOMICS
Purposes of
National security argument.
Protectionism
Production of goods for war and national defense should be produced by
Policies
the country itself and they should not be dependent on other countries for such goods.
Infant industry argument Infant or new industries should be protected from established foreign competitors. Example: Malaysia wants to develop the domestic automobile industry, Proton, and in order to protect proton, Malaysia has to impose high tariffs quotas on foreign- made cars.
Anti-dumping argument Dumping is the sale of goods abroad at a lower price or below the price
charged in the local market. Example: If Thailand sells its rice at a lower price than Malaysia, this will be referred to as dumping rice in Malaysia.
Domestic employment argument Many domestic producers will leave the industry if they cannot compete
with foreign competitors. This will lead unemployment. To avoid unemployment, country needs to practice protectionism and protect domestic employment by reducing imports and increasing exports
Low foreign wage argument If the wages in Malaysia are higher than those in Indonesia, many Indonesians personally moving to Malaysia. This can lead to unemployment for Malaysians if the entry is not controlled
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Tools of Protectionism
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Tariffs A tax imposed by the government on imported products (tax on import) The effect of tariffs is to increase the price of imports for domestic consumption (protect domestic producers) Tariffs also can increase government revenue 2 types of tariffs : a) Specific tariff A fixed tariff imposed on a unit of imported goods b) Ad-valorem tariff A tariff imposed on imported goods. Based on the value of the goods.
Quotas A legal limit on the number of units of a particular commodity that can be imported into the country.
Embargoes A law that bars trade with another country An embargo may include a ban on goods from countries with different ideologies. Examples; Malaysia bans goods from Israel Import license High license fees and delays in processing application forms may discourage producers from importing these goods and services. Exchange control Control on the amount of money that is allowed to be brought into and out of a country. In other words, exchange control refers to the government regulation of exchange rates as well as restriction on the purchase and sale of foreign currencies. Industry subsidies
Government provides subsidies to import-competing domestic firms or domestic firms producing export-based outputs (to protect the domestic firm and increasing the firm’s revenue)
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CHAPTER 7 _ INTERNATIONAL ECONOMICS
BALANCE OF PAYMENT STRUCTURE OF MALAYSIA Definition
Balance of payments (BOP) refers to the statement of systematic records of all economic transaction between one country and the rest of the world in a given period of time. The BOP also refers to the difference between the total values of goods and services imported and exported over period of time.
Refers the difference between the total values of goods and services imported and exported over a given period of time.
BOP account record both debit and credit. Debit – any transaction that supplies to country’s currency in the foreign exchange market. (- because
of the outflow of maney). Credit - any transaction that creates demand for the country’s currency in the foreign exchange market. (+ because due to inflow of money)
Structure of Malaysia balance of payments (BOP) The BOP has three major components The BOP in Malaysia complies according to the methodology set by the International Monetary Fund (IMF).
• Current Account • Capital Account • Official Reserve Account
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CURRENT ACCOUNT
Current Account The current account has 4 components: The first section of BOP is a
Contains receipts and payments a) Merchandise Trade Balance
Current account.
on goods and services
b) Service Balance c) Net Income d) Current Transfer
a) Merchandise trade balance is the difference between export and import of physical goods (also referred as visible goods). Merchandise trade balance = value of merchandise export - value of merchandise import if export > import = trade surplus if export < import = trade deficit
b) Services balance is the difference of receipts and payments from services. Tourists to Malaysia and overseas students studying in Malaysia are included under these services. Items services: 1) Transportation 2) travel 3) Other service 4) Government transaction Service balance = value of service export - value of service import
if services export > service import = trade surplus if service export < services import = trade deficit
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Therefore:
Merchandise trade balance
Balance of Goods and Services
Service balance
c) Net Income Refers to the difference between investment income flows into and out of a country. Consists of: Compensation of employees, Investment income in form of Direct investment, Portfolio investment and Other investment
d) Current Transfer Includes gifts, military aid and financial aid by the government, private individuals and organization to foreign countries and inflow from other countries into Malaysia. Example: Malaysian government provided financial aids to Tsunami victims in Acheh and at the same time Australia provided aid to Malaysia Therefore Balance in current account = Merchandise trade balance + Service balance + Net income + current transfer
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CAPITAL ACCOUNT
Capital Account
Record the payment flows on The second section of the
purchases of foreign assets
BOP.
by Malaysian or Malaysian assets by foreigners.
Consists of capital transfer and non produced and non – financial assets.
OFFICIAL RESERVED ACCOUNT Official Reserve Account
consists of government gold and foreign currency reserves as well as government
reserves with the IMF and special Drawing Rights (SDR)
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CHAPTER 7 _ INTERNATIONAL ECONOMICS
The Way to overcome the deficits in the balance of payments (disequilibrium) Export
The main purpose of the exports promotion is to increase the value of
Promotion
exports of the country in order to reduce the deficit in the balance of payments. Government can encourage exports by giving subsidies or granting tax holidays
At the same time, the government can promote local products in international markets and provides information to local exporters on how to market their products globally.
Discourage
The government can restrict imports of consumer products and
imports
substitute them with locally manufactured products (imposing tariff rates for imported products) Through campaigns, the government can increase the sense of loyalty among local consumers to buy locally manufactured products. For examples, Belilah Barang Buatan Malaysia.
Inflation
In order to solve the deficit in the BOP, the government should control the inflation problems. Government can impose tight monetary policies and fiscal policies or both to control inflation.
Using the
The government’s reserve in the form of gold and foreign currencies are
government’s
used to balance the deficit in the BOP (can be used for a short period
reserves
only)
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CHAPTER 7 _ INTERNATIONAL ECONOMICS
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Devaluation
Devaluation is the government’s policy of lowering the par value of the country’s currency compared to the currencies of other countries by an official announcement. Reducing the par value of the currency, will reduce the value of the home currency and increase the value of foreign currencies Exports will increase and imports will decrease (foreign goods will become more expensive)
This method will be used only as a last resort.
EXCHANGE RATE Define exchange rate
The exchange rate can be defined as the price of one currency in terms of another currency.
Fixed exchange rate and floating exchange rate Fixed
Exchange rate of one currency with another currency is set by the
Exchange Rate
government Fixes exchange rate may vary in the minimum limits
The government would set the par value of the currency relative to
.
foreign currencies
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Floating
Foreign currency exchange rate is determined by supply and demand of
Exchange Rate
foreign currency in the foreign exchange market.
Need not involve the government in saving foreign currency reserves
Able to achieve continuous equilibrium label despite changes in factor
affecting demand and supply
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CHAPTER 7 _ INTERNATIONAL ECONOMICS
TUTORIAL EXERCISES Essay Questions 1. Explain TWO (2) disadvantages of having international trade. 2. Define the Balance of Payments and list THREE (3) major components in the BOP 3. Differentiate between a fixed exchange rate and a floating exchange rate. 4. International trade brings advantages to the individual countries as well as to the world. State only FOUR (4) advantages of international trade. 5. Differentiate between domestic trade and international trade 6. Differentiate between absolute advantage and comparative advantage theory. 7. Explain FIVE (5) purposes of protectionism policies. 8. Explain FIVE (5) tools of protectionism. 9. Differentiate the following terms: a.
International trade and domestic trade
b.
Absolute advantage and comparative advantage
c.
Quotas and tariffs
10. Describe FIVE (5) reasons why a country should impose protectionism policies on international trade
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