Exchange Rate Manipulation-Balance of Payments

1. How does China continuing to undervalue its currency threaten the industrial economies of its largest trading partners?

China undervaluing its currency threatens the industrial economies of its largest trading partners in the following way. To devalue a currency means to simply lower the value of the currency. In other words, it means that other currencies, such as the USD, can purchase a larger quantity of RMB's per unit of USD. By undervaluing the RMB, China's exports become very cheap for global consumers, such as the US. This increases demand for Chinese exports in the global market from countries such as the US. In the US, for example, that would mean that demand for domestic goods would decrease, because they can import those goods from China at a lower price. This harms the domestic market in the US, and may lead to an increase in unemployment within the US.

Definitions:
-Export: a product or service sold abroad
-Unemployment: the number or proportion of unemployed people

The situation described above will be illustrated by figure 1.1 and 1.2:

Figure 1.1

Figure 1.2

Figure 1.1 represents a situation in which the US is not importing calculators from China. The domestic producers produce Q4 at P3 and the US imports Q4Q5 calculators at a price of P3 from the. In figure 1.2 we can see a situation in which the US is importing calculators from China. Since China's currency is undervalued, China is able to export its supply of calculators at a lower price than the rest of the world. In this situation the domestic producers produce Q2 calculators at a price of P2, while Q2Q3 is imported from China at a price of P2. From these graphs we can see exactly how China's cheap exports affect the calculator market in the US. Domestic producers get less revenue, and the domestic market for calculators has gotten smaller, therefore increasing unemployment. This is how it threatens the industrial economies of its larger trading partners.

Definitions:
-Import: bring (goods or services) into a country from abroad for sale.
-Revenue: income, especially when of an organization and of a substantial nature.

2. What is China’s purpose for maintaining the low value of the RMB relative to the currencies of other nations?

China's purpose for maintaining the low value of the RMB relative to the currencies of other nations is as follows. By maintaining a relatively low value of RMB, China's exports will be a lot cheaper than if the value of the RMB was relatively higher compared to currencies of other nations. A cheap RMB allows producers within China to keep production costs low. This makes their exports cheaper, and as such increases demand for them in the global market. Other nations, in this situation, will have higher production costs than China, and will be unable to set their exports at a price lower than that of China. This gives China a competitive advantage in the global market and increases the money entering the country. That is China's purpose for maintaining a low value of RMB relative to other nation's currencies.

3. What would be a unilateral protectionist measure the US government may advocate if the WTO refuses to take action against China’s currency manipulations? How would you advise president Obama on the issue of whether to take protectionist action against China in the context of the current economic crisis in America?

A unilateral protectionist measure the US government may advocate if the WTO refuses to take action against China's currency manipulation can be imposing a tariff on Chinese imports entering the US. A tariff is a tax or duty to be paid on a particular class of imports or exports. In the context of the current economic crisis in America, I would advise Obama to impose a tariff on Chinese imports entering the US to improve the US economy. A tariff on Chinese imports would decrease demand for them in the US, and would grant domestic producers a higher market share. What I mean by that is that they will be able to supply more goods at a higher price, which should help improve unemployment. It should help improve unemployment because if more goods are being produced domestically, through reason we can assume that that would require a larger workforce, therefore creating more jobs in the US. Unemployment and growth was one of the issues mentioned in worksheet 23.1, and due to reasons explained previously, a tariff on Chinese imports entering the US would improve the rate of unemployment, and also growth. It would improve growth because more goods are being produced in the US than before.

This situation can be illustrated with the following graph:

Figure 1.3

Without the tariff domestic producers produced Q1 marshmallows at a price of P1. Q1Q5 was imported from China. With the tariff imposed on China, domestic producers now produce Q2 marshmallows at a price of P2. Q2Q4 is now imported from China at a price of P2. Domestic producers receive a larger market share, which benefits the US in ways mentioned previously. While that may be true, welfare loss does occur represented by the triangles between Q1Q2 and Q4Q5. Freedom is not free.

Exchange Rate Regimes Worksheet - Real World Situations

Worksheet-ExchangeRateDeterminants

1.

Determinant: US economic growth

Price of Peso in terms of USD

Supply of Peso from Mexico

Demand for Peso in US

Quantity of Peso in US

Demand line shifts right because more Pesos are demanded from the US

2.

Determinant: Political turmoil in Syria

Price of SP in terms of euros

Supply of SP

Demand for SP

Quantity of SP

Demand line shifts left

3.

Determinant: Investors sweeping in to Romania

Price of RON in terms of euros

Supply of RON

Demand for RON

Quantity of RON

Demand line shifts right because investors are demanding RON

4.

Price of CHE in terms of euros

Supply of CHE

Demand for CHE

Quantity of CHE

Demand line shifts right because europeans will want to save their money in Switzerland to get a higher return on their investment

5.

Price of Indian Rupee in terms of euros

Supply of Indian Rupee

Demand for Indian Rupee

Quantity of Indian Rupee

Demand line shifts left because demand for Indian Rupee falls.

6. 

Price of Krone in terms of Euro

Supply of Krone

Demand for Krone

Quantity of Krone

Demand line shifts left because europeans will demand less Krone due to higher prices in Norway. They will demand less goods/services from Norway, and therefore Krone.

Worksheet-ManagedExchangeRatesinSingapore

1. What are the advantages and disadvantages of a floating exchange rate?

There are a number of disadvantages and advantages of a fixed exchange rate. The following sentences provide advantages of a floating exchange rate. Interest rates can be used to control inflation since the exchange rate does not have to be kept at a certain level. Another advantage is that ff the Marshall-Lerner condition is satisfied, the exchange rate should adjust itself to keep the current account in balance. Another advantage is that high reserves of foreign currency and gold do not need to be stored in order to control the value of the currency. For example, China keeps high amounts of foreign currency, such as USD, in order to keep their currency pegged to the USD. When they need to appreciate their currency, they increase demand for it by exchanging their high amounts of foreign currency into their currency. If they had a floating exchange rate, this hassle would be unnecessary.
Disadvantages

Now let us go over the disadvantages. International markets become uncertain with a floating exchange rate. Businesses will have difficulty predicting their future costs and revenues. For example, the tech company Apple would be unable to accurately predict future costs and revenues with floating exchange rates affecting their endeavors. This could significantly harm the company and would cause many repercussions. Another disadvantage is that a floating exchange rate can make inflation even worse. High inflation will lead to exports becoming more expensive and imports becoming cheaper. The exchange rate will fall to save the current account from a deficit. However, a lower exchange rate will cause imports to become more expensive, which will worsen the inflation.

2. What are the advantages and disadvantages of a fixed exchange rate?

There are a number of disadvantages and advantages of a fixed exchange rate. The following sentences provide advantages of a fixed exchange rate. Businesses will be able to predict future costs and revenues with a fixed exchange rate, because it is more predictable. Another advantage is that a fixed exchange rate ensures reasonable government policies on inflation, because a fixed exchange rate can lead to harmful effects on the demand for exports and imports. Another advantage is that speculation in foreign exchange markets are reduced, however, attempts to destabilize the fixed exchange rate have been made to profit financially.

Now let us go over the disadvantages. The government has to keep the exchange rate fixed. For example, if the exchange rate was in risk of depreciating, the government would increase interest rates to get the currency to appreciate. The issue, however, is that that will lead to increased unemployment. Another disadvantage is that the government has to keep high amounts of foreign currency in order to keep the exchange rate fixed. Another disadvantage is that finding the right value for the exchange rate can be very difficult, and if it is not set correctly firms may feel as if they are not competitive enough in foreign markets.

3. What is the common tool used by many governments to control inflation. Why can’t all countries use the Singapore approach?

The common tool used by many governments to control inflation is the manipulation of exchange rates. An increase in interest rates will lower inflation due to money being less accessible to investors, businesses, and consumers. A decrease in interest rates will have the opposite effect. A decrease in interest rates will lower demand for the currency, since saving in that particular country has become less attractive, which will depreciate the currency. That will make exports cheaper and imports more expensive. Not all countries use the Singapore approach, because not all countries have exports making up over 100% of their GDP. For Singapore this approach is very effective, however, for other countries it may not be.

4. Can a country use both Monetary Policy and a managed exchange rate to control inflation? Do trade-offs exist?

Monetary policy is used to control the amount of money in an economy, interest rates, and the buying/selling of government bonds. As mentioned before, interest rates may be manipulated in order to control demand for a currency. The level of demand for a currency can affect inflation, and therefore we can use monetary policy and a managed exchange rate to control inflation.

5. Evaluate the effects on the Chinese economy of an appreciation of the yuan.

The Chinese economy has a gigantic export industry. The appreciation of the yuan would have devastating consequences on the Chinese economy, and the world. An appreciation of the yuan would make their exports more expensive, and therefore less competitive in foreign markets. This would raise costs for many foreign businesses if they were relying on China as a supplier. Lower sales of exports will lead the current account to a deficit, which will have a major impact on China's economy. In conclusion, the effects of the appreciation of the yuan would be felt all around the world.

Non-price Determinants-Supply & Demand

Non-price determinants of supply and demand:

• These are the following non-price determinants of demand: branding, market size, demographics, seasonality, available income, complementary goods, and future expectations.
• These are the following non-price determinants of supply: costs of production, productivity, government intervention in the form of taxes and subsidies, price of related goods, and supply side shocks.

What would cause a demand or supply shift within a market for currency exchange?
A change in any of the non-price determinants of demand will cause the demand curve to shift either left or right. A change in any of the non-price determinants of supply will cause the supply curve to shift either left or right. If the demand curve shifts to the right, then the equilibrium quantity and price will increase. The producers will supply more and will charge higher prices due to increased demand for their good/service. If the supply curve shifts to the right, then the equilibrium quantity will increase whilst the equilibrium price will decrease. With an increase in supply producers are able to supply more. The price will decrease because the good/service is now more abundant. These non-price determinants of supply and demand can affect supply and demand for goods and services, and thus can cause changes in the exchange rate because countries supply and demand goods/services from one another.

Foreign Exchange Market and Exchange Rate Determination

Definitions:-Exchange rate: the value of one currency for the purpose of conversion to another.
-Inflation: a general increase in prices and fall in the purchasing value of money.

-Prospect: the possibility or likelihood of some future event occurring.

1. Exchange rates are like prices, in that they are determined by supply and demand. But not all exchange rates are allowed to float freely, since the governments or central banks of some countries actively intervene in the market for their currency to manipulate its value. Identify one policy a government or central bank could use to strengthen the value of its currency and one policy that could weaken the value of a currency.
One policy a government or central bank could use to strengthen the value of its currency is the policy in which they use their reserves of foreign currency to purchase its own currency. This will lead to an increase in demand for the currency which will strengthen the value of their currency.

One policy a government or central bank could use to weaken the value of its currency is the policy in which they lower the level of interest rates in their country. By doing so domestic interest rates will be relatively lower than interest rates in other countries, which will lead to less foreign financial investment in the domestic country. This is because financial investment in other countries will be more attractive. Investors that will be investing in other countries will need to exchange the domestic currency for foreign currency, which will increase the supply of the domestic currency in the foreign exchange market. This usually weakens the value of the domestic currency.

2. What are the benefits of having a stronger currency?
The benefits of having a stronger currency are: downward pressure on inflation, more imports can be bought, and improved domestic efficiency. A stronger currency will make imports cheaper, which will increase competition and put pressure on domestic producers to decrease their prices. They can lower prices due to cheaper imports. Cheaper imports reduce their production costs. The increased competitiveness will also lead to increased domestic efficiency so that domestic producers can remain competitive in their industries.

3. What are the benefits of having a weaker currency?
The benefits of having a weaker currency are: increased employment in export and domestic industries. Increased employment in export industries due to a weaker currency occurs because a weaker currency will make exports relatively cheaper. This will increase their competitiveness and will lead to employment in the export industries.

A low exchange rate will make imports more expensive, so domestic producers will be more inclined to purchase goods and services from domestic producers. This will increase demand for domestic good and services, which will lead to an increase in employment.

4. Which determinant of exchange rates presented in the video do you think are most attributable to the fluctuating values of currencies on foreign exchange markets, and why? Relative incomes, relative interest rates, relative inflation rates, speculation or simply the tastes and preferences of global consumers?
I think that the most attributable determinant of exchange rates presented in the video is "relative inflation rates". Inflation rates determine a whole country's price levels, which can have a significant impact on exchange rates. Relatively lower inflation rates than in other countries will increase foreign demand, because the goods/services in the country with the lower inflation rates will be relatively cheaper.

-Lastly, pick one world currency (besides the Euro of the US Dollar). List and explain the factors that might lead to a fall in the supply of the selected currency in relation to the Euro market.

Chosen currency: GBP. In the following text please assume that when I say "other EU countries", I mean all EU countries except: Bulgaria, Croatia, Czech Republic, Denmark, Hungary, Poland, Romania, Sweden, and England.

There are several factors that might lead to a fall in the supply of GBP in relation to the Euro market. If British people decrease their demand for goods and services from other EU countries, they will be exchanging less GBP for Euros, which will lead to a decrease in the supply of GBP. British demand for goods/services from the EU can decrease if incomes in England decrease, if British people change their tastes in favor of non-EU goods/services, and if inflation rates in England are lower than in other countries in the EU. Relatively lower inflation rates in England means that goods/services in other EU countries will be more expensive.

Another factor to consider is the following. If investment prospects worsen in EU countries (except England), the supply of GBP will decrease. Worse investment prospects will make British people less inclined to invest in other EU countries.

Another factor to consider is the following. If interest rates in other EU countries decrease, British people will be more attracted to save in England, which will decrease the supply of GBP.

Another factor to consider is the following. If British people speculate that the value of GBP will increase, they won't convert their GBP's into other currencies to make a financial gain. This will reduce the supply of GBP.

Next, draw a diagram to illustrate the fall in the supply of the the Euro and its effect upon the exchange rate of your selected currency in terms of the euro.

A fall in the supply of the Euro will have the following effect on GBP. For every quantity of GBP, less Euros can be bought. The exchange rate will increase from a fall in the supply of the Euro. The euro will appreciate while GBP will depreciate.

Marshall-Lerner Condition/J-Curve

The J-Curve is a curved line in which it decreases, reaches a point of inflection, and then increases in a manner that resembles the letter "J". Usually, the line increases to a point that is higher than the original starting point. The J-curve shows the effects of policies and investments: they lead to a loss, and then a gain that's usually larger than the loss.

A professional illustration of the J-curve can be found in proximity to this sentence.

In order to explain the main ideas of a J-curve, we can use an example such as the effects of a currency's depreciation. The x-axis represents time. The y-axis below 0 represents a current account deficit, while the y-axis above 0 represents a current account surplus. If a country's currency was to depreciate, the current account would encounter a greater deficit than before. This is true, in theory, because imports will become more expensive, while exports will become cheaper. In the short term, demand for imports is inelastic, because businesses are likely to continue importing the same amounts as before due to contracts or habit. Demand for exports in the short run is inelastic as well, because the world will take some time to notice the price difference. For these reasons, a currency's depreciation will lead to a current account deficit until the point of inflection.

In the long run the current account will rise towards a surplus, and hopefully will rise above it. Demand for imports will become elastic in the long run, because contracts will expire and businesses will find cheaper domestic alternatives. Demand for exports will become elastic in the long run, because the international market will find out about the cheaper exports and will make use of them. Hopefully, through this example, the main ideas of the J-curve have become clear.

What is the Marhsall-Lerner condition? The Marhsall-Lerner condition is a concept that can be used to determine whether a depreciation or a devaluation of a currency will lead to an improvement in the balance of payments. If the PED of imports and the PED of exports add up to a value that is greater than 1, an improvement in the balance of payments will occur in the long run after a depreciation or devaluation of a currency.

The consequences of the falling Euro on Latvia's Current account will be evaluated using relevant concepts and knowledge in economics. In the table above, we can see that the current account in Latvia is negative. We can also see that imports exceed exports. A fall in the Euro will lead to imports becoming more expensive in the short run. Exports will become cheaper. Since PED for imports and exports in the short run is inelastic, this situation will lead to a higher current account deficit. 

However, in the long run the situation should improve. PED of imports will become elastic due to contracts expiring and businesses finding cheaper domestic alternatives. This will lower the county's expenses on imports. The low price of exports will be noticed in the long run in the international market, therefore making PED for exports elastic. This will increase the inflow of money from exports in Latvia, effectively improving the current account in terms of bringing it closer to a surplus. An improved current account will assist the balance of trade to react a surplus.

Balance of Payments Activity

1.       Distinguish:

a.       Import and export:

                                                              i.      An import is a good or service brought in from abroad for sale (money out, good/service in). An export is a product or service sold abroad (money in, good/service out).

b.      Visible and invisible trade:

                                                              i.      Visible trade accounts for imports and exports of physical merchandise. Invisible trade accounts for business transactions that occur with no exchange of tangible goods. That includes customer service, intellectual property and patents.

2.       State whether the following are:

a.       A HK toy sold in UK

                                                              i.      Export

                                                            ii.      Visible

b.      French cheese sold in HK.

                                                              i.      Import

                                                            ii.      Visible

c.       A HK tourist holidaying in Thailand

                                                              i.      Import

                                                            ii.      Invisible

d.      Cathay Pacific buying planes from Airbus

                                                              i.      Import

                                                            ii.      Visible

e.      The HK Police Force buying Russian weapons

                                                              i.      Import

                                                            ii.      Visible

f.        An Australian tourist staying at HK Disneyland

                                                              i.      Export

                                                            ii.      Invisible

3.       In which part of the HK Balance of Payments account would the following transactions be recorded:

a.       A US company buying shares on the HK stock market

                                                              i.      The financial account: direct investment

b.      HK citizen sending wages earned in UK back to HK

                                                              i.      Current account: income

c.       A HK company selling prawns direct to France

                                                              i.      Financial account: direct investment

d.      An Italian firm investing in a chain of restaurants

                                                              i.      Financial account: direct investment

e.      HK company paying dividends to US shareholder

                                                              i.      Current account: income

4.       Which of the above transactions are inflows of money to HK (and are therefore credits on the balance of payments account) and which are outflows (and thus debits)?

a.       Credits: a, b, c

b.      Debits: e

5.       The fictitious figures below refer to HK’s balance of payments for 2007, 08, 09 and 2010 Calculate for each year

a.       Balance on trade in goods

                                                               i.      2007

1.       42345 – 57600 = -15255

                                                             ii.      2008

1.       123000 – 245786 = -122786

                                                            iii.      2009

1.       56363 – 66666 = -10303

                                                           iv.      2010

1.       853970 – 900000 = -46030

b.      Balance on trade in services

                                                               i.      2007

1.       654000 – 124000 = 530000

                                                             ii.      2008

1.       12789 – 9876 = 2913

                                                            iii.      2009

1.       46879 – 38945 = 7934

                                                           iv.      2010

1.       345876 – 200000 = 145876

c.       The balance of trade

                                                               i.      2007

1.       530000 – 15255 = 514745

                                                             ii.      2008

1.       2913 – 122786 = -119873

                                                            iii.      2009

1.       7934 – 10303 = -2369

                                                           iv.      2010

1.       145876 – 46030 = 99846

d.      The current account balance

                                                               i.      2007

1.       514745 – 12500 – 34000 = 468245

                                                             ii.      2008

1.       -119873 + 123765 + 47987 = 51879

                                                            iii.      2009

1.       -2369 + 100000 – 99999 = -92368

                                                           iv.      2010

1.       99846 + 34987 = 134833

Fed Chairperson Recommendation

US economy: statistics at a glance: http://ig.ft.com/sites/us/economic-dashboard/

As you may or may not know, an upcoming interest rate decision concerning the FED is about to occur. A decision to increase or decrease the interest rates is one that consists of many factors. Factors such as GDP, employment rate, and the rate of inflation will be affected by a increase or decrease in the interest rates.

Definitions:

• GDP: The broadest quantitative measure of a nation's total economic activity. More specifically, GDP represents the monetary value of all goods and services produced within a nation's geographic borders over a specified period of time.
• Employment rate: Indicates the percentage of persons of working age who are employed.
• Inflation: A general increase in prices and fall in the purchasing value of money.
• Interest rate: The proportion of a loan that is charged as interest to the borrower, typically expressed as an annual percentage of the loan outstanding.
• Multiplier effect: Refers to the increase in final income arising from any new injection of spending. The size of the multiplier depends upon household's marginal decisions to spend, called the marginal propensity to consume (mpc), or to save, called the marginal propensity to save (mps).

Dear Janet Yellen, chair of the Federal Reserve, as an economics student I would like to assist you with your decision to increase or decrease the interest rate. According to US economy statistics, the annualized Q2 GDP growth was 3.7%. That is a rather high percentage. A healthy rate of growth is 2%-3%. With that being true, I suggest that you decide to increase interest rates. By increasing the interest rates, several things will occur. Monthly mortgage payments will increase, granting consumers less disposable income on goods and services. This will decrease consumption, therefore lowering GDP.

An increase in interest rates will have another effect. Borrowing will become more expensive, and as such consumers will be less encouraged to borrow money and consume. Firms will be less encouraged to invest, therefore decreasing investment. A decrease in consumption and investment has a direct effect on GDP.

According to another statistic from the US economy statistics, the effective interest rate has been very low (0.25%) since 2009. By raising the interest rates, the FED will gain more money. In this situation of higher interest rates, the "winners" would be the FED and savers. Savers would also be "winners", because with the higher interest rates, they will get more money for saving their money. The "losers" in this situation would be the consumers and firms, due to reasons stated previously.

In conclusion, the interest rates have been very low since 2009. The GDP is a little too high, therefore a consideration of raising interest rates should take place. Raising interest rates will lower the GDP growth in the long run.

Country Specific Protectionist Policies

http://www.computerworld.com/article/2874816/us-to-impose-big-tariffs-on-china-and-taiwan-for-dumping-solar-panels-on-market.html

The U.S. ITC (International Trade Commission) and DOC (Department of Commerce) have found that China and Taiwan have been saturating the market for solar panels, and plan to impose a tariff of 70% on Chinese solar panels entering the U.S. A tariff ranging from 11.45% to 27.55% will be imposed on Taiwanese solar panels. In 2012, tariffs between 31% to 250% were imposed on Chinese solar panels, however, the current situation will be discussed.

Just to be clear, the product market is solar panels. The country of interest is the United States. The form of protectionism is a tariff. According to Google, a tariff is a tax or duty to be paid on a particular class of imports or exports.

Here's an illustration of the solar panel market in the U.S:*

*Diagram not to scale.

As we can see on the graph to the left, before the tariff on Chinese solar panels imported in the U.S, domestic suppliers supplied a quantity of Q1 at a price of PC (Price of Chinese solar panels before tariff). The Chinese supplied a quantity of Q2 solar panels at a price of PC.

Presumably due to dumping, China was able to supply solar panels at a price of PC, and as such had a lot of market power. According to Google, dumping is to send (goods unsaleable in the home market) to a foreign market for sale at a low price.

After a tariff of 70% on Chinese solar panels imported in the U.S, domestic suppliers supply a quantity of Q3 at a price of PC+tariff 70%. Chinese solar panel suppliers supply a quantity of Q4 at a price of PC+tariff 70%.

The winners in this situation are domestic producers in the U.S. and the U.S. government. The domestic producers win, because they are now able to supply an amount (Q3-Q1) more than before the imposition of the tariff. Their price goes from PC to PC+tariff 70%, increasing domestic producer's revenue from g to g+h+b+a. The government wins because the 70% tariff revenue will go to them. According to Google, revenue is income, especially when of an organization and of a substantial nature. The government will receive a tariff revenue of d+e.

The losers in this situation are the consumers and foreign producers. The consumers lose because solar panels became more expensive for them (from PC to PC+tariff 70%). Foreign producers lose because due to the 70% tariff, they are able to supply less. c+f represent the overall dead-weight loss in this situation. According to Wikipedia, deadweight loss (also known as excess burden or allocative inefficiency) is a loss of economic efficiency that can occur when equilibrium for a good or service is not achieved or is not achievable.

Argument for and Against Free Trade Activity

August 31 Workpoint 22.5

Domestic producers win by the imposition of the quota, because the amount that they supply has risen from Q1 to Q1 + (Q4-Q3). They also win because they are now selling at PQuota, which is more than the previous price (Pw). Why does this make them winners? Because their revenue increased from a to a+c+d+f+i+j.

Importers lose by the imposition of the quota, because they used to supply (Q2-Q1), but now only supply (Q3-Q1) due to the quota. Even though they charge more per unit, their revenue has gone from b+c+d+e to b+g+h. If this is a decrease in revenue, which it appears to be, then importers qualify to hold a position in the losers column. 

Consumers lose by the imposition of the quota, because they have to pay PQuota for textiles, as opposed to Pw if there was no quota. Thus, the consumers lose, because they need to spend more money on textiles.

The world loses by the imposition of the quota, because the area labeled as j represents the inefficiency of the domestic producers. This is a loss of world efficiency, because more resources are being used than are necessary to produce textiles in Europe. Inefficient use of the world's resources, in this situation, make the world one of the losers.

Xiaomi to Export Cheap Smartphones to Emerging Markets

This article relates to section 3 chapter 21 of the Economics book.

A Chinese smartphone firm by the name of Xiaomi is expanding into 10 new countries after successfully outselling Samsung and Apple in its domestic market during Christmas. The company was founded four years ago by Lei Jun, known as the Chinese Steve Jobs. The company aims to dominate its market by offering high-end smartphones at low costs.

Link to article: LINK

Figure 1.1

Figure 1.1 represents the smartphone market of one of the 10 countries Xiaomi is expanding into. In one of those countries, before Xiaomi's smartphones were available, the price per smartphone used to be PE, and the number of smartphones consumed was QE. With Xiaomi offering cheap high-end smartphones in their country, a world price PW is introduced to the consumers in that country. Since no one will want to pay PE for smartphones, the price will decrease to PW. Domestic industries will produce at a price of PW and a quantity of Q1. A domestic industry is one that operates in the country itself. A quantity of (Q2-Q1) will be supplied by non-domestic industries, such as Xiaomi, to match the demand of Q2 smartphones in the country. Consumers will now be able to consume (Q2-QE) more smartphones at a lower price of PW.

If the country wanted to support domestic firms, they could introduce a tariff. A tariff is a tax that is charged on imported goods. This would raise the world price up, increase the price and quantity at which domestic firms produce, and decrease the amount that is imported. As a result, domestic firms will have greater market power.

*End of article*

The date the article was published: 23 April 2014

The date the commentary was written: 30.08.2015

Word count of commentary: ~258 words

The section of the syllabus to which this article relates: "Why do countries trade?" and "Free trade and protectionism"

August 26, 2015

Advantages that occur from opening a market to free trade:

• Increased production:
• A firms market becomes a lot bigger, which lowers average costs and increases productivity.
• Consumer benefits.
• Greater variety of goods and services, as well as lower prices due to competition.
• Employment.
• Higher employment in exporting industries.
• Production efficiency.
• Increased competition promotes new innovations and technologies for producers to produce more with the resources they have.
• Economic growth.
• Living standards and real incomes increase due to competitive industries.
• Foreign exchange gains.
• Can get other country's currency by selling goods to then import goods.

Disadvantages that occur from opening a market to free trade:

• International trade cycles can cause domestic economic instability as economies become dependent on global markets.
• International markets are not a level playing field.
• Countries with a surplus of a product may offer it for a very small price which other countries might not be able to compete with.
• Developing/new industries might have difficulty competing with global competitors.
• Pollution
• As industries compete with the market price they might not include certain production costs.

Student Workpoint 21.2 (Why do countries trade? p263)

1. (See table)

2. (See figure 1.1)

3. Yes, trade should occur between China and Pakistan. China has an absolute advantage in producing both goods, however, it only has a comparative advantage in producing rice. For China the opportunity cost of producing 1 kilo of rice is 4/5, while for Pakistan it's 1. Pakistan has a comparative advantage in producing meters of cloth. For Pakistan the opportunity cost of producing 1 meter of cloth is 1, while for China it's 5/4. If a comparative/absolute advantage is present, then mutual benefit will occur through trade between the two countries.

4. Since China has a comparative advantage in producing rice, it should specialize in producing rice. China is more efficient at producing rice than Pakistan. As for Pakistan, it has a comparative advantage in producing meters of cloth, and therefore it should specialize in producing meters of cloth. The exact opportunity costs can be seen on the table and in the preceding sentences (#3).

UK retail sales volumes rise by 0.1%

The original article can be found here: LINK

This article from BBC relates to chapter 12 section 12.2 of the Economics book. One of the components of aggregate demand is consumption. "Aggregate demand (AD) is the total demand for the goods and services of a nation at a given price level and at a given period of time." (Maley, 258) Now that you know what aggregate demand is, let's define consumption. "Consumption measures all spending by domestic households on goods and services during a particular period of time." (Maley, 259). The primary determinant of consumption is the level of national income. I'm sure you can guess what that means. In the article, Ian Geddes says "With wages increasing, falling fuel prices and with a low interest rate environment, discretionary spending has been boosted by rising real incomes". To summarize, people in the UK have more money to spend because their wages are increasing faster than inflation. "People tend to increase their spending when their income improves" (Maley, 32). This increase in demand can be seen on the graph (figure 1.1)

Figure 1.1

In figure 1.1, we can see that the aggregate demand and aggregate supply lines shifted to the right. This resulted in Q1 moving to Q2, x representing the retail sales volume rise of 0.1%. Why this happened is explained in the article, as well as in the preceding paragraph.

So what does this retail sales volume rise of 0.1% mean for the future? What are the implications? The biggest growth in sales were in electrical goods and furniture. We can deduce that electrical goods and furniture are normal goods, because demand for them increased as consumer income increased. With this information, people that sell those goods could look into making their goods more affordable, since the demand is evident. That way, when consumer income is not as high there will still be a much higher demand (article mentioned a sales increase of almost 20% in both departments).

What would you do with your extra income?

*End of article*

The date the article was published: 20 August 2015

The date the commentary was written: 22.08.2015

Word count of commentary: 327 words

The section of the syllabus to which this article relates: aggregate demand and aggregate supply

References

Maley, Sean, and Jason Welker. Economics: Developed Specifically for the IB Diploma. Harlow: Pearson Education, 2011. Print.

"UK Retail Sales Volumes Rise by 0.1% - BBC News." BBC News. BBC, 20 Aug. 2015. Web. 23 Aug. 2015.