Econ End of Unit Test: Q2 Reflection

Looking at the comments from Ms. Q about my end of unit test, I recognized that I need to pay more attention details and to go more in-depth with my explanations. I seem to have a lot of statements but I don’t explain enough. For example, I mention factors that affect exchange rate but I don’t explain how. I need to balance my time so I have the time to explain these concepts.

I also need to use more real life examples. Just mentioning China’s managed floating exchange rate with the US dollar is not enough; I have to go into detail. That is something I need to work on during review which is gathering real life information. I can continue to put some on my portfolio page on my blog.

Section 4 IB Paper 1: Explain the principle of comparative advantage and the benefits which might arise from free trade.

• 10 marks so about 10 minutes
• Define comparative advantage and free trade
• Comparative Advantage: The ability of a country to produce a good at a lower opportunity cost than another country
• Free trade: trade between countries without any government interference or protectionism in forms of tax, subsidies and quotas.

Free trade

International trade is based on specialisation at a national level. Countries exchange goods with others and pay for imports from the revenues received from exporting. To work effectively, this system relies on few, if any, barriers existing to interfere with ‘free trade’.

The basic principle of free trade dates back to mercantilism and fed through to the early exponents of laissez-faire economics in the seventeenth century. Amongst the most famous early writers on economics was Adam Smith, who produced his ideas on absolute advantage. This was where one country concentrated on developing those goods in which its natural resource base allowed it to produce more than any other country with given resources. Later, David Ricardo developed comparative advantage theory which suggested that a country should exchange goods with another country as long as the domestic opportunity costs were different. As a result of this, production should increase and individual consumption should rise. In essence, these two early economic observations still underpin much of what we know about international trade.

Absolute and comparative advantage

Absolute advantage exists when one country is able to produce a good more cheaply in absolute terms than another country.

Comparative advantage exists when one country is able to produce a good more cheaply, in comparison to other goods produced domestically, than another country.

Comparative advantage is a principle of economics which states that trade between two countries will be mutually beneficial as long as their domestic opportunity costs of production differ.

• Alternative explanations
• Macroeconomic goals
• Short term and long term

Extended Currency post

China has developed a large surplus with the US. Until August 2008, China has always maintained a “managed float” system after which they returned back to the fixed exchange rate system to stabilize their economy. Managed float system is when the government allows the currency to be influenced by market forces of demand and supply with some intervention. Along with this, because of the undervalued yuan, the US is accusing China of manipulating their currency since the low yuan is making exports cheaper, hurting the US economy and unemployment. A current account surplus is when demand for exports is larger than demand for imports due to the depreciation of a currency. Because of the low yuan, the US buys more imports from China than China buying US exports.

Because of China’s current account surplus, the US’s current account deficit is increasing and unemployment is increasing. One of the consequences of a current account surplus is high savings rates and little expenditure on imported goods and services. Because of the low exchange rate, imports are more expensive, therefore less people buy imported goods. On the other hand, domestic goods become more competitive in price or quality because the prices of imports are so high.

While the US has a current account deficit, China has a current account surplus. This surplus means that there is more money coming in from exports than money going out from imports due to the low currency exchange rate. One of the consequences of this is high savings rates and little expenditure on imported goods and services as mentioned above. Another is domestic goods are competitive in price or quality in the market. However, low exchange rates make imports expensive and exports cheap. Lastly, China also has to maintain domestic capacity to meet demand.

The Euro Chaining Spain Down?

According to Paul Krugman’s editorial on Spain economic condition, the Euro is major cause for it. In 1999 when Spain decided to adopt the Euro, the result was fabulous. Without the exchange rates, there were no losses of currency in imports and exports, European funds “poured” in “powering private-sector spending”. One other advantages includes increasing stability against speculation which would increase potential economic development. Also, businesses would be more secure as the currency wouldn’t fluctuate; it saves them a lot of trouble to not have to keep track of exchange rates. Single currencies could also lower interest rates, “locking in to German monetary credibility”. This would result in higher employment and more investment.

On the other hand, according to Spain’s situation, there are disadvantages to having  a single currency. One of the ways to combat a deficit would be to manipulate the exchange rate and devalue the currency to lower prices of exports, making them competitive in the market; however, with a single currency, they cannot do so. Currently, Spain is undergoing an “internal devaluation” which is where they cut wages and prices until the economy is stable again. This has lots of negative consequences, one of which is unemployment. An overarching disadvantage to all countries in the long run is that different countries have different economic performances and are at different stages in their cycles. One central bank cannot set one inflation level appropriate to all countries.

Although the Spanish were happy with their economic bubble in the beginning of the century, what once was their pair of golden wings is now their binding shackles urging them off the edge of the economic crisis.

A good article that explains pros and cons:

BBC Special Report: pros and cons