International Trade and Payments - Production Possibility Frontier for Ecuador - Assignment Example

Topic: International Trade and Payments Name: Student No. Institution: Tutor’s name Due Date Questions 1. a. Production possibility frontier based on the following data oil Coffee Ecuador 12 8 Columbia 20 4 I. Ecuador: The production possibility frontier will be as shown below. Figure 1. Production Possibility Frontier Curve for Ecuador. Adapted from Grath, A. (2012). The handbook of international trade and finance. London: Kogan Page. II. Columbia: The production possibility frontier will be as shown below Figure 2. Production possibility frontier curve for Columbia b. Autarky relative prices of oil for each Country This is summarized in the following table Oil Coffee Autarky Price ratio Ecuador 12 8 3O:2C or 1Oil: 0.67 Coffee Columbia 20 4 5 Oil:1 coffee or 1 Oil: 0.2 coffee c. Ecuador has an absolute advantage in the production of both commodities The relative price of oil in home market 2/3 for Ecuador while 1/5 for Columbia, thus Ecuador has a comparative advantage in both commodities than Columbia. However, Columbia has a comparative advantage in production of oil d. Autarky wages of workers in Ecuador in units per labor of: i. Coffee per unit of labor=4800/8=600 ii. Oil per unit of labor =4800/12=400 Autarky wages of workers in Columbia in units per unit of labor i. Coffee per unit of labor=3200/4=800 ii. Oil per unit of labor=3200/20=160 According to the above results, it is observed that Ecuador workers in oil sector are better off than those on Columbia while those in Coffee sector are better off in Columbia than in Ecuador. e. According to free trade assumption, it would be better if Ecuador specializes in production of oil while Columbia specializes in production of coffee since it will result into improved earning for workers in both countries. f. Gain from a 1.0 of Oil/Coffee price ration will be: Ecuador=0.67 Columbia=0.2 2. Questions based on the table below United States Canada Capital 40 machines 10 machines Labor 200 workers 60 workers a. According to the above table, United States labor-capital ratio is 200/40 50 while in Canada; labor-capital ratio is 60/10 or 6. Thus United States is labor intensive than Canada. United States capital-labor ratio is 40/200 or 0.2 while in Canada; capital-labor ratio is 10/60 or 0.167. Thus United States is capital-abundant than Canada. b. i. For production of 1 unit of steel, ratio of capital to labor is 2/8 or 0.25 while production of 1 unit of bread, ratio of capital to labor is 1/8 or 0.125. Thus production of steel is more capital intensive than production of bread. Furthermore, the two products are equally labor intensive because production of one unit requires 8 workers in both cases. ii. The country that would export bread is United States because there are more workers who will contribute to production of more units of bread for export. This is indicated by the fact that in USA, the total number of units produced will be given by 200/8=25 units at a time while in Canada, the total number of units will be 60/8=7.5 or 8 units at a time. c. Impact of moving from production of 20 loaves and 20 units of steel to production of 30 units of steel and 10 units of bread. According to the above changes, production of steel will be both labor and capital intensive because more workers will be required to produce additional units, while production of bread will be less labor intensive because fewer workers will be required to produce the reduced number of units of bread. d. The information given in parts (a) and (b) can be used to explain what would happen to returns to capital and labor after trade begins. This can be illustrated by the use of Heckscher-Ohlin theorem. According to this theorem, when there will be a change in production of units of bread and steel, there will be a rise in demand for labor for the United states than Canada while there will also be a rise in demand for capital for production of more units of steel. This factor demand changes will result into an impact in prices. Thus there will be a tendency of a fall in (w/r)1 for production of steel while a rise in (w/r)2 for production of bread. In this case (w/r) ratio represents a ratio of workers to machines. According to the assumption of Heckscher-Ohlin theorem, K/L ratio in production of steel will fall while the K/L ratio for production of bread will rise. In this case, K/L ratio represents the ratio of capital to labor. 3. Impacts of changes in events on the volume of trade and trade for various economic units between the US and EC using offer curves for a) The United States and Portugal Figure 3. Offer curve for changes in trade between United States and Portugal or Spain If Portugal or Spain changes their demand for the US agricultural products, there will be a shift in the offer curve from OC1 to OC1’ as shown in the above figure. This is as a result of unwillingness of Portugal or Spain to trade with the United States. b) Spain/Portugal and the rest of EC Figure 4. Offer curve for changes in trade between Portugal/Spain and the rest of EC There will be willingness of Portugal and Spain to trade with other member of EC thus the offer curve will shift from OT1 to OT2. This is as a result of better terms of trade between them. c) United States and the rest of EC. Figure 5. Offer curve for changes in trade between United States and the rest of EC According to the above offer curve, there will be a shit in the curve from oC1 to OC1’’ as a result of unwillingness of the rest of EU to trade with the United States due to imposition of tariffs by the United States. 4. a. Calculation of effective rate of protection (ERP) for the steel industry Percentage ad valorem Cost per tonne ($) tariffs Steel 30% 600 180 Coal 15% 240 36 Iron 40% 160 64 Free trade value of steel industry per tonne of steel= 600- (240+160)=600-240-160=$200. Under protection: tariff protected price Price of Steel=$600+ (0.3*600) =$780 Price of Coal=$240+ (0.4*240) =$276 Price of iron=$160+ (0.4*160) =$224 Value added under protection=$780-(224+276) =$280 There is an increase in value added due to protection. ERP= ((280-200)/200*100) = 40%. b. Impact on ERP if tariff on iron ore is increased to 40 per cent while on coal is reduced to 10 per cent Price of steel will remain $780, price of iron will also remain $224, while price of coal will be $240+ (240*0.1) =$264. Therefore, value added under protection will be given by $(780-224-264) =$292 ERP= ((292-200)/200*100)) =46%. There will be an increase in ERP from 40 per cent to 46%. c. Impact on ERP is tariffs on coal and iron ore are both abolished while tariffs on steel are increased to 50 per cent In this case, the price of steel will be =$600+ (0.5*600) =$900 Price of coal=$240 Price of iron=$160 Value added under protection=$(900-240-160)=$500 New ERP will be (500-200)/200*100=150%. Thus there will be an increase in ERP by 150 per cent. 5. Comparison of free trade situation and tariff situation in domestic market supply and demand diagram. a. Before the introduction of tariffs, there will be increased demand and reduced supply while when the tariffs are introduced; there will be reduced demand in the domestic market and reduced supply due to high costs of motorcycles. Figure 6. Costs and benefits as a result of introduction of tariffs on the production of motorcycles in Australia. b. From the above table: Change in consumer surplus is given by (200-150)= 150 Change in producer surplus is given by (125-100)=25 Tariff revenue is given by=$(4000-3400)=$600 Welfare cost if the tariff is the sum of areas b and d =1/2*25*600+1/2*50*600=7500+1500=9000 c. Cost of creation of 700 jobs in the motorcycle industry for an Australian consumers and the economy. For the consumers, it will be 700*600/150=$ 2800 For the whole economy, it will be 4000*700/600=$4666.7 d. Quantity of import licenses that would be issued to achieve the same price and quantity effects as the tariffs. This s indicated by equilibrium quantity which according the diagram above =138 motorcycles. 6. When country A joins the free trade area in commodity X and competes with countries that have joined the groups, there will not be trade creation. This is because country A will use its own policies to influence trade with other countries while other countries that have joined the groups will be inclined to comply with the regulations of the groups. In addition, there may be trade diversion among members of other groups who will prefer to use policies developed by country A to trade in similar goods. For instance, some countries will be willing to sell product X at a reduced rate of $10 plus import duty to counteract competition from countries that have joined trade groups. Furthermore, the act of imposing a tariff will result into a reduction in volume of trade but an improvement in terms of trade. There will be a general improvement of welfare by improving volume of trade and terms of trade. 7. The table below shows the percentage rates of appreciation or depreciation of Australian Dollar against other currencies. a. Percentage changes in exchange rates between Australia and other countries Country   Exchange Rate Percentage rate of appreciation(+ve) or depreciation(-ve) against other currencies   2009   (May) 2011   (May) Japan ¥   63.81 = $A1  ¥   100.90 = $A1 (100.90-63.81)/63.81*100=58.12% USA $US 0.6433 = $A1 $US 1.0367=   $A1 (1.0367-0.6433)/0.6433*100=61.15% UK £ 0.4545 =   $A1 £ 0.6668 = $A1 (0.6668-0.4545)/0.4545*100=46.71% NZ $NZ   1.2812 = $A1 $NZ 1.2084 = $A1 (1.2084-1.2812)/1.2812*100=-5.69% SG $SG 0.9985=$A1 $ SG 1.2766=$ A1 (1.2766-0.9985)/0.9985*100=27.85% China $4.9916 $8.0450 (8.045-4.9916)/4.9916*100=61.17% Hong Kong Renminbi 4.3963=$ A1 Renminbi 6.3913=$ A1 (6.3913-4.3963)/4.3963*100=45.38% Total 294.69 Average 42.1% Comment: There was appreciation in the Australian currency agains all the currencies except against New Zealand currency which had a depreciation of -5.69%. b. Trade weights that can be used in the effective exchange rates (EER) estimation. This is demonstrated in the table below. Country Exports (A$million) Export weight Imports (A$million) Import weight Total Trade weights for each partner country Japan 51,171 31 20,300 17 71471 25 US 9,854 6 30,317 24 40171 14 UK 8,009 5 6,918 6 14927 5 NZ 7,668 5 7,511 5 15179 5 SG 6,558 4 14,872 12 21430 7 China Hong Kong 76,824 2,839 47 2 43,405 1,132 35 1 120229 3971 42 2 TOTAL 162923 100 124464 100 287387 100 Exports and Imports weights 0.57 0.43 The weight for each partner country is obtained by applying the formula below In the above equation,wim and wix represent a partner country’s imports and exports respectively and m and X represent total imports and exports of the country. By substituting the respective values for each partner country into the above equation, the values for each partner’s trade weight were obtained as shown in the right column. The trade weight for Australia in general is obtained by the average of individual trade weights with partner countries. This gives a value of 14.28%. The effective appreciation for Australia is lower compared to the result obtained in the first section which resulted into a value of 42.1% appreciation. 8. The data for consumer price index for various trading partners with Australia Country Consumer Price Index   2009 2013 Bilateral exchange rate or REER for each partner country Japan 100 98.9 156.38 USA 100 109.1 175.82 UK 100 114.5 168.27 New   Zealand Singapore China Hong Kong 100 100 100 100 109.2 114.6 101.0 114.5 103.00 146.52 146.83 184.54 Australia 100 110.7 110.7 Total 1192.06 Average 149.00 i. Bilateral exchange rate is determined as follows The following formula is used to determine bilateral exchange rates in various partner countries with respect to Australia. In the above equation, ER represents exchange rates in the following period while ERB represents exchange rates in the base period. CPI represents consumer price index in the subsequent period while CPIB represents consumer price index in the base period. ii. Rate of change in real bilateral exchange rates is calculated by substituting the values into the equation, the results for each country are obtained as shown on the right column. iii. From the information above, real effective exchange rate is calculated by finding the average of the real bilateral exchange rates with partner countries. This results into a real effective exchange rate of 149.00 iv. According to the above information, it is observed that real effective exchange rate of Australia is higher when consumer price index is used compared to when weighted imports and exports are used. This shows that there has been an increase in Australia’s competitiveness over the period. This has the effect of improving trade between Australia and its partners and result into improved economy for the country and improved living standards for Australian citizens. 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