QUESTION

Economic problem and Discuss gains from trade or the need for economic coordination argue what the best form of coordination eg central control v market system v other systems and use real life examples. This is 2500 hundred word assignment and needs to have real life examples as well as economic visual examples like graphs and tables. At least 1 graph every 2 pages and 3 real life examples per topic

Harvard style referencing

SOLUTION

1. Introduction

The paper evaluates the basis of trade between countries and the potential gains that occur to the economies as a result of the trade. The paper defines the existence of the economic problem and the scarcity of resources which give rise to the trade between two countries. The paper analyses the basis of trade through the comparative advantage theory and the absolute advantage. The free market trade and its advantages are also discussed in comparison to the distortions introduced like the tariffs as well as quotas. The shortages and the economic inefficiency lost from the distortions is also analysed and the comparisons are effectively made.

2. Existence of Economic Problem and the Comparative Advantage

Economics is defined as the allocation of scarce resources between competing wants. It is the simple economics which gives rise to the economic problem. The Economic Problem can be defined as the how the societies provide for their material reproduction which includes tradition, culture and the markets (Clark, 2012).  The scarcity of certain resources forms the basis of trade for some countries; the comparative advantage theory explains the economic problem which can be resolved using trade based on the strengths and the weaknesses of the country. The comparative advantage concept introduced in 1815 by Ricardo, The comparative advantage theory is based on specialization and the sacrifice of the opportunity cost to the producers and specialization. The comparative advantage theory in the trade implies when one country can sacrifice the production of a particular good for the good which has smaller opportunity costs of production, this can be explained as follows For Let us consider 2 countries Japan and US example Japan has a comparative advantage in the car production therefore Japan should produce cars for its own use as well as , export some of them to US , On the other hand US has a comparative advantage in the production of wheat , therefore US should produce as well as export some to Japan to gain from the trade , as it has a lower opportunity cost. Japan should not produce wheat but rather import has it would be more cost effective to import and the opportunity cost would be less, and Japan can concentrate on the specialisation of production in car. Comparative implies relative, according to the theory if one country is more than productive in producing a commodity then the other country should not absolutely produce the good, but rather engage in trade to gain maximum productivity both from the export and import of the good. This leads to understanding the concept of specialization. The term specialization implies a country should produce a good in which it has absolute productivity and comparative advantage. Specialization leads to concentration on the production of a particular product that can enable a country to gain the maximum from trade. This is the classical Ricardian Theory , which refers a country will produce and export those goods in which it has lower opportunity costs and will import those goods in which it has higher opportunity costs and low productivity(Mankiw 2009).

The comparative advantage theory can be explained using the following example:  Let us consider 2 country producing 2 specific goods, where country A has the comparative advantage in the production of both goods, while the other country has absolute advantage in the production of both the goods. Suppose Country’s produce 2 goods fish and coconuts the following is the production pattern of the country

(Source : volij.co.il  – accessed on 19/2/2012)

Country A’s opportunity cost is 3 coconuts per fish, and the other fish is 3 fish per coconut. The opportunity cost of County B is the cost of fish is 1 coconut per fish, and the opportunity Cost for coconuts in country B is 5 fish per coconut. Thus, Country A has an absolute advantage in the production of both the goods on the other hand Country B has a comparative advantage. Thus trade between both the countries would benefit the country’s trade balances, and would lead to maximization of benefits for both countries. On the other hand the trade can lead to specialization; Country B can specialize in the production of the goods in which it has comparative advantage it would lead to maximization of benefits for country B.

The comparative advantage theory offers some extensions to the basic model, the open economy gains from the trade even if the economy, even if the country does not change its production structure. The comparative advantage can be increased and full gains by concentrating on the products which are more productive. The comparative advantage theory has been identified as the as the most competent theory that can explain the growth and development of the open economy. The GATT and the WTO have also identified the comparative advantage theory that has led to the liberalization of the global trade policies to benefit specific countries from trade. The theory is relevant even in today’s times as the countries should trade and produce those goods in which it has economic efficiency. For example the OPEC countries have absolute advantage in the production of oil; therefore to gain the maximum the OPEC countries should trade oil to make productivity gains from it (OECD, 2006).

3. Gains from Trade

3.1 Gains From Trade with Exports

To analyse the gains from trade a small open economy is considered, the economy is a price taker in the economy, the world price prevails in the economy it is the price of the good of the good that prevails in the world market. Suppose the economy experiences a comparative advantage in the production of good a, this implies that price in the domestic economy is lower. Thus being a free economy the country accepts the price of Good A, that is available in the market. Therefore, the following figure explains the price and demand with trade in the world market.

Figure 1 Trade of a International Exporting Country (Mankiw, 2009).

Once the domestic undergoes the process of trade the domestic price increases to the world price. As the trade occurs the buyers would not like to accept the higher world price and no seller would accept the price lesser than the world price. The domestic price now equals to the world price, but the domestic quantity demanded is different from different from the quantity supplied. The consumers are forced to accept the world price which is higher than the domestic prices. To analyse the gains from the trade let us consider the following table.

The following is the surplus before trade,

Social Surplus with Trade

Thus the gains of trade have been realised by the suppliers, as the surplus of the producer increases , however the buyers are faced with a higher world price which effects the demand of the good(Mankiw 2009 , Reinert 2010)

3.2 Gains From Trade with Imports

Once the domestic undergoes the process of trade the domestic country’s price increases to the world price. As the trade occurs the buyers would not like to accept the higher world price and no seller would accept the price lesser to Pw. The domestic price now equals to the world price, but the domestic quantity demanded is different from different from the quantity supplied. The consumers are forced to accept the world price which is greater than the domestic prices. In the case of the import the domestic price (Pd) is greater than the world price (Pw) , with trade the domestic price reduces to the world price making the consumers better. To analyse the gains from the trade let us consider the following figure and  table.

Figure 2 : Gains from Trade with Imports (Mankiw , 2009)

With imports there is a change in the quantity demanded , The quantity demanded at price Pw is greater than the quantity demanded with trade , While on the other hand the suppliers are at a loss because they have to accept a price lower than the equilibrium price to supply goods which makes them worse off.

Gains from Trade

Thus , with the imports the buyers are better off because they are faced with a lower price for the goods , thus increasing their demand at a lower price, The domestic producer is however  worse off because he is forced to accept a lower price for the produce. Thus, however the trade has made the economy better off because the gains from trade are positive making offsetting the losses in the economy.

4. Distortions in Free Trade

When distortions are introduced in the free trade between countries it affects both the quantity demanded as well as supplied. Distortions are applicable to both imports as well as exports and occur in the form of tariffs or quotas.

4.1 Introduction of Import Tariff

A tariff can be referred as the tax on the good produced abroad and sold domestically. Such a tariff is referred to as an import tariff. In a free trade economy when the tariff is introduced it has the following effect. To analyse the gains from trade a small open economy is considered, the economy is a price taker in the economy, the world price in the economy is referred as the price of the good of the good that prevails in the world market. Suppose the economy experiences a comparative advantage in the production of good a, this implies that price in the domestic economy is lower. Thus being a free economy the country accepts the price of Good A, that is available in the market.

In the case of the import the domestic price (Pd) is higher than the world price (Pw) , with trade the domestic price reduces to the world price making the consumers better. The introduction of the tariff pushes the world price upwards but however it is still less than the domestic price. The introduction of the tariff further affects the quantity demanded, as the quantity demanded is reduced from Qd1 to Qd as the effect of higher prices. The suppliers also become slightly better off with the introduction of the tariff the quantity supplied increases from Qs1 to Qs .This also affects the surpluses in the economy as follows.

Figure 3: Imports With Tariffs (Mankiw , 2009)

The introduction of the tariffs introduces economic inefficiency in the system, thus leads to the introduction of the dead weight loss the dead weight loss in the figure is represented by triangle 4 (Mankiw , 2009, Kenneth 2012).

The import duties are used effectively by countries globally to insulate themselves from the world economies and protect domestic producers to boost the domestic economy. For example the in India import duty of 60-75% is applicable on cars priced above $40,000; this raises the price of the imported cars like Mercedes, Audi and BMW in India affecting the demand for these cars. These cars are sold at a rate which is much higher than the rates that prevail in some of the Western economies (Businessline.com – accessed on 19/5/2012).

4.2 Impact of Import Quotas

Unlike a tariff which affects the price of a good produced abroad and is sold domestically , the import quotas stipulates the quantity of good that can be sold in the country. Like the tariff the import quotas also affect the efficiency in the economy and reduce the economic surplus in the economy. Let us consider the example again of the small open economy, Suppose the economy experiences a comparative advantage in the production of good a, this implies that price in the domestic economy is lower. Thus being a free economy the country accepts the price of Good A, that is available in the market.

In the case of the import the domestic price (Pd) is higher than the world price (Pw), with trade the domestic price reduces to the world price making the consumers better, with the introduction of the quota the price though world Price (Pw) remains unaffected, but the domestic supply curve shifts to the right exactly by the amount of the quotas implemented. But however the quantity supplied increases from Q1 to Qs , at the same price this causes the rightward shift of the supply curve at the prevailing world price , which is still less than the price in the domestic economy (Pd).  The domestic quantity demanded is reduced from Qd1 to Qd.

Figure 3: Imports with Quota (Mankiw , 2009, Kenneth 2012).

The introduction of the Quotas introduces economic inefficiencies in the system, therefore the gains from trade are adversely affected, and the following comparison is made from the gains of trade with imports and the imports with quota.

Thus the introduction of the quota clearly reduces the surpluses of the consumer, which is evident from the areas in the diagram, the consumer demand is affected as the demand cannot be fulfilled because of the implementation of the quotas. Thus the deadweight loss in this case which is an indicator of economic inefficiency is represented by triangle 6.

The quota system is also effectively used by the policy makers to adopt protectionist policies to help the domestic producers and increase domestic output and productivity. In 1959 the US established a mandatory import quota effective from oil imports from OPEC countries. Preferences were given to the import of oil from countries like Canada, Venezuela as well as Mexico to some extent. This was done to avoid the high prices charged by the OPEC countries in the time. The import quotas continue to be popular even today; the US has raised its import quota of sugar from 120,000 tonnes including 1,421 tonnes from India. The increase in the quota has been done to avoid the short falls in the US markets (Economic times- accessed on 19/5/2012)

5. Conclusion

It would thus not be incorrect to say that both tariff and quota have a similar impact on the economy , i.e. they both cause effective distortion in the welfare and the availability of the social surplus to both consumers and producers. The import quotas and the duties continue to be popular forms of protectionist policies being adopted by countries to safe guard their domestic economies. However it is argued by most economists that an import duty is a better form of distortion, as with the payment of the import duty the effective quantity can be easily imported, On the other hand the quota tends to curb even the existing demand of the product. The ideal situation would be free trade, but it cannot be permitted in a real world with interests of domestic economies at stake.

6. References

• Mankiw, N. Gregory. Principles of economics. 5. ed. Mason, Ohio: South-Western ;, 2009. Print.
• Volij, Oscar . “Comparative Advantage and Gains from Trade Two Instructive Numerical Examples.” volij.co.il/. N.p., n.d. Web. 19 May 2012. <http://volij.co.il/publications/papers/p
• Globalisation, comparative advantage and the changing dynamics of trade. Paris: OECD, 2011. Print.
• Reinert, Kenneth A.. An introduction to international economics: new perspectives on the world economy. New York: Cambridge University Press, 2012. Print.
• “Business Line : Companies News : Praful Patel adds voice to protest against duty cut for European cars.” Business Line : Home Page News & Features. N.p., n.d. Web. 21 May 2012. <http://www.thehindubusinessline.com/
• title. “OPEC: The Concise Encyclopedia of Economics | Library of Economics and Liberty.” Library of Economics and Liberty. N.p., n.d. Web. 21 May 2012. <http://www.econlib.org/library/Enc/OP
• “US raises India’s sugar import quota – The Economic Times.” The Economic Times: Business News, Personal Finance, Financial News, India Stock Market Investing, Economy News, SENSEX, NIFTY, NSE, BSE Live, IPO News. N.p., n.d. Web. 21 May 2012. <http://economictimes.indiatimes.com/markets/commodities/us-raises-indias-sugar-import-quota/articleshow/8960371.cms>.

LE06

But you can order it from our service and receive complete high-quality custom paper.  Our service offers Economics  essay sample that was written by professional writer. If you like one, you have an opportunity to buy a similar paper. Any of the academic papers will be written from scratch, according to all customers’ specifications, expectations and highest standards.” Please  Click on the  below links to Chat Now  or fill the Order Form !