Global Diagrams, gvy policy eval.

Absolute advantage

can produce a good with fewer resources, countries should specialize

Comparative Advantage

a country can produce a good with lower opportunity cost

Limitations of theory:

• unrealistic assumptions (free trade, fixed fop, full employment, perfect comp, no transport costs)

• risk of excessive specialization

• inability of developing countries to diversify manufacturing

Import Tariff

Pros:

• domestic producers gain revenue

• workers gain as domestic production increases

• gvt revenue

Cons:

• price goes up

• wellfare loss

• imported goods more expensive, domestic productions more expensive

• loss of export competitiveness as production price increases

• foreign producers lose

• global economy lose

• risk of retaliation

• potential corruption

Import Quota

Pros:

• domestic producers gain revenue

• workers gain as domestic production increases

Cons:

• price goes up

• wellfare loss

• imported goods more expensive, domestic productions more expensive

• loss of export competitiveness as production price increases

• foreign producers lose

• global economy lose

• risk of retaliation

• potential corruption

Subsidy (global)

Pros:

• domestic producers gain revenue

• workers gain as domestic production increases

Cons:

• gvt debt

• wellfare loss

• imported goods more expensive, domestic productions more expensive

• loss of export competitiveness as production price increases

• foreign producers lose

• global economy lose

• risk of retaliation

• potential corruption

Trade protection

Pros

• protect infant industries

• diversification of developing countries

• national security

• health, safety, env. standards

• gvt revenue

• overcoming trade deficit

• anti-dumping

• protect domestic jobs

cons

• difficult to select what industry to protect

• can be used to “protect’ unrelated industries

• when relying on tariffs for gvt rev. probabluy means theres a problem w the tax system

• retaliation is possible

• hard to prove dumping

Freely Floating Exchange Rate

Appreciation: occurs with excess demand. if Americans buy euros w dollars, the demand for euros increases, appreciating the currency

Deppreciation: osccurs with excess supply. the americans buying euros means theyre selling dollars, increasing supply of dollars, leading to depreciation

pros:

• allows for greater flexibilty in monetary policies

• allows for automatic adjustments to external shocks

Fixed Exchange Rate

fixed at partiy: 1 to 1 ratio, usually doesn’t happen

Appreciation: CB buys it on forex market to increase demand

deppreciation: CB sells it on forex, increase supply

revaluation: change where the exchange rate is fixed to higher price

devaluation: change where the exchange rate is fixed to lower price

pros:

• provides stability and predictability

• lowers speculative trading and currency volatility

cons:

• limits a country’s ability to conduct monetary policies as focus is on exhcange rate and not interest rate

Managed Exchange Rate

allowed to fluctuatie within a specific band, CB intervenes when exchange rate leaves band

Appreciation: CB buys it on forex market to increase demand

deppreciation: CB sells it on forex, increase supply

Consequences of curency depreciation

imports are more expensive, exports are cheaper. therefore net exports increase, shifting AD right

• cose push inflation as imported raw materials are more expensive

• demand pull inflation as AD increases

• unemployment falls as exports increase

Consequences of currency appreciation

imports are cheaper, exports are more expensive. net exports decrease, AD shifts left

• cost push deflation as imported raw materials are cheaper

• demand pull deflation as net exports fall

• unemployment may increase as less is exported

impact of currenccy depreciation on current account

depreciation → net exports increase → current account balance improves

the extent to which depends on Marshall-Lerner condition

impact of currency appreciation on current account

appreciation → net exports decrease → current account balance worsens

Marshall-Lerner condition / J-Curve

ML condition: extent to which a currency depreciation improves the current account balance, PED imports + PED exports > 1

Time lag between depreciation of a currency and an improvement in current account balance explained by J curve.

If a country’s currency depreciates, its good will become cheaper for other countries. However, it will take time before the other countries switch to that country’s goods as they aren’t sure whether the exchange rate my return in the short run

Poverty Cycle

A situation where poverty tends to perpetuate itself from one generation to the next.