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1. What is managed float of a country?
Answer: Managed float regime is the current international financial environment in
which exchange rates fluctuate from day to day, but central banks attempt to
influence their countries' exchange rates by buying and selling currencies. It is also
known as a dirty float.
The central bank under a managed floating exchange rate system (like the RBI)
intervenes in the foreign exchange market. Objective of this intervention is to
minimize the fluctuation in the exchange rate of rupee.
Since, the exchange rate is basically determined by market forces, the upward and
downward movement in the value of rupee are appreciation and depreciation.
2. Mention any two functions of WTO. How far the membership of India would be
beneficial for the country?
Answer:Functions:

The main functions of WTO are discussed below:

1. To implement rules and provisions related to trade policy review mechanism.

2. To provide a platform to member countries to decide future strategies related to

trade and tariff.

3. To provide facilities for implementation, administration and operation of

multilateral and bilateral agreements of the world trade.

4. To administer the rules and processes related to dispute settlement.

5. To ensure the optimum use of world resources.

6. To assist international organizations such as, IMF and IBRD for establishing
coherence in Universal Economic Policy determination.

BENEFITS TO INDIA

The GATT secretariat estimated that largest increase in the level of merchandise
trade in goods (in general, it would be US $ 745 billion .by the end of 2005) will be in
the areas of clothing (60 per cent), agriculture, forestry and fishery products (20 per
cent) and processed food and beverages (19 per cent). India's competitive advantage
lies in these fields. Hence, it is logical to believe that India will obtain large gains in
these sectors.
India's textile and clothing exports will increase due to the phasing out of Multi-fibre
An'angement (MFA) by 2005 .
The reduction in agricultural subsidies and barriers to export of agricultural products,
agricultural exports from India will increase .
The multilateral rules and disciplines relating to anti-dumping, subsidies and

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countervailing measures, safeguards and disputes settlement machinery will ensure
greater security and predictability of international trade. This would be favourable
environment for India's international business .
India along with other developing countries has the market access to a number of
advanced countries due to the imposition of the clauses concerning to trade without
discrimination.
3. Enumerate the main effects of devaluation.
Answer: Effects of a devaluation
1. Exports cheaper. A devaluation of the exchange rate will make exports more
competitive and appear cheaper to foreigners. This will increase demand for exports.
Also, after a devaluation, UK assets become more attractive; for example a
devaluation in the Pound can make UK property appear cheaper to foreigners.
2. Imports more expensive. A devaluation means imports, such as petrol, food and
raw materials will become more expensive. This will reduce demand for imports. It
may also encourage British tourists to take a holiday in UK, rather than US – which
now appears more expensive.
3. Increased aggregate demand (AD). A devaluation could cause higher economic
growth. Part of AD is (X-M) therefore higher exports and lower imports should
increase AD (assuming demand is relatively elastic). In normal circumstances, higher
AD is likely to cause higher real GDP and inflation.
4. Inflation is likely to occur following a devaluation because:

 Imports are more expensive – causing cost push inflation.

 AD is increasing causing demand pull inflation
 With exports becoming cheaper manufacturers may have less incentive to
cut costs and become more efficient. Therefore over time, costs may increase.

5. Improvement in the current account. With exports more competitive and imports
more expensive, we should see higher exports and lower imports, which will reduce
the current account deficit. In 2016, the UK had a near record current account deficit,
so a devaluation is necessary to reduce the size of the deficit.
6. Wages. A devaluation in the Pound makes the UK less attractive for foreign
workers. For example, with fall in the value of the Pound, migrant workers from
Eastern Europe may prefer to work in Germany than the UK. In the UK food
manufacturing industry, more than 30% of workers are from the EU. UK firms may
have to push up wages to keep foreign labour. Similarly, it becomes more attractive
for British workers to get a job in the US, because a dollar wage will go further.
4. Explain the concept of comparative cost advantage theory of international trade.
How acounty will again from such trade?

Answer: Comparative Costs Theory:

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The principle of comparative costs is based on the differences in production costs of

similar commodities in different countries. Production costs differ in countries
because of geographical division of labour and specialisation in production. Due to
differences in climate, natural resources, geographical situation and efficiency of
labour, a country can produce one commodity at a lower cost than the other.

In this way, each country specialises in the production of that commodity in which its
comparative cost of production is the least. Therefore, when a country enters into
trade with some other country, it will export those commodities in which its
comparative production costs are less, and will import those commodities in which
its comparative production costs are high.

This is the basis of international trade, according to Ricardo. It follows that each
country will specialise in the production of those commodities in which it has greater
comparative advantage or least comparative disadvantage. Thus a country will
export those commodities in which its comparative advantage is the greatest, and
import those commodities in which its comparative disadvantage is the least.

Assumptions of the Theory:

The Ricardian doctrine of comparative advantage is based on the following

assumptions:

(1) There are only two countries, say A and B.

(2) They produce the same two commodities, X and Y.

(3) Tastes are similar in both countries.

(4) Labour is the only factor of production.

(5) All labour units are homogeneous.

(6) The supply of labour is unchanged.

(7) Prices of the two commodities are determined by labour cost, i.e.. the number of
labour-units employed to produce each.

(8) Commodities are produced under the law of constant costs or returns.

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(9) Trade between the two countries takes place on the basis of the barter system.

(10) Technological knowledge is unchanged.

(11) Factors of production are perfectly mobile within each country but are perfectly
immobile between the two countries.

(12) There is free trade between the two countries, there being no trade barriers or
restrictions in the movement of commodities.

(13) No transport costs are involved in carrying trade between the two countries.

(14) All factors of production are fully employed in both the countries.

(15) The international market is perfect so that the exchange ratio for the two
commodities is the same.

Cost Differences:

Given these assumptions, the theory of comparative costs is explained by taking

three types of differences in costs: absolute, equal and comparative.

(1) Absolute Differences in Costs:

There may be absolute differences in costs when one country produces a commodity
at an absolute lower cost of production than the other.

The absolute cost differences are illustrated in Table 78.1

Table 78.1: Absolute Differences in Costs:

Country Commodity-X Commodity- Y

A 10 5
B 5 10
The table reveals that country A can produce 10 X or 5F with one unit of labour and
country В can produce 5X or 10К with one unit of labour.

In this case, country A has an absolute advantage in the production of X (for 10 X is

greater than 5 X), and country В has an absolute advantage in the production of Y
(for 10 Y is greater than 5 Y).

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This can be expressed as 10X of A/5X of B > 1 > 5 Y of A/10Y of B.

Trade between the two countries will benefit both, as shown in Table 78.2.

Country Production Production Gains

before Trade after Trade from
Trade
Commodity (1) (2) (2-1)
XY XY XY
A 10 5 20 — + 10 -5
В 5 10 — 20 -5 +10
Total Production 15 15 20 20 +5 +5

Table 78.2 reveals that before trade both countries produce only 15 units arch of the
two commodities by applying one labour-unit on each commodity. If A were to
specialise in producing commodity X and use both units of labour on it, its total
production will be 20 units of X. Similarly, if В were to specialise in the production of
Y alone, its total production will be 20 units of Y. The combined gain to both
countries from trade will be 5 units of X and Y.

Figure 78.1 illustrates absolute differences in costs with the help of production
possibility curves. YA XA is the production possibility curve of country A which shows
that it can produce either OXA of commodity X or OYA of commodity Y. Similarly,
country В can produce OXB of commodity X or 0YB of commodity Y. The figure also
reveals that A has an absolute advantage in the production of commodity X (OXA>
OXB), and country В has an absolute advantage in the production of commodity
Y(OYB > OYA).

Adam Smith based his theory of international trade on absolute differences in costs
between two countries. But this basis of trade is not realistic because we find that

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there are many underdeveloped countries which do not possess absolute advantage
in the production of commodities, and yet they have trade relations with other
countries. Ricardo, therefore, emphasised comparative differences in costs.

(2) Equal Differences in Costs:

Equal differences in cost arise when two commodities are produced in both
countries at the same cost difference. Suppose country A can produce 10 X or 5 Y
and country В can produce 8 X or 4 Y.

In this case, with one unit of labour country A can produce either 10 X or 5 Y, and the
cost ratio between A” and Y is 2:1. In country B, one unit of labour can produce
either 8X or 4Y, and the cost ratio between the two commodities is 2: 1.

Thus the cost of producing X in terms of Y is the same in both countries. This can be
expressed as

10X of A/ 8X of B = 5Y of A/4Yof B = 1

When cost differences are equal, no country stands to gain from trade. Hence
international trade is not possible.

(3) Comparative Differences in Costs:

Comparative differences in cost occur when one country has an absolute advantage
in the production of both commodities, but a comparative advantage in the
production of one commodity than in the other. The comparative cost differences
are illustrated in Table 78.3.

Table 78.3 Comparative Differences in costs:

Country Commodity – X Commodity –

Y
A 10 10
B 6 8
The table reveals that country A can produce 10X or 10Y, and country В can produce
6X or 8X.

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In this case, country A has an absolute advantage in the production of both X and Y,
but a comparative advantage in the production of X. Country В is at an absolute
disadvantage in the production of both commodities but its least comparative
disadvantage is in the production of Y. This can be seen from the fact that before
trade the domestic cost ratio of X and Y in country A is 10: 10 (or 1:1), while in
country B, it is 6:8 (or 3:4). If they were to enter into trade, country A’s advantage
over country В in the production of commodity X is 10X of A / 6X of B or 5/3, and in
the production of Y, it is 10Y of A/8Y of B or 5/4. Since 5/3 is greater than 5/4, A’s
advantage is greater in the production of commodity X, A will find cheaper to import
commodity Y from country В in exchange for its X.

Similarly, we can know the comparative disadvantage of country В in the production

of both commodities. In the case of commodity X, country В’s position is 6X of B/10X
of A or 3/5. In the case of commodity Y, it is 8Y of B/10Y of A or 4/5.

Since 4/5 is greater than 3/5, B has least comparative disadvantage in the production
of Y. It will trade its Y for X of country A.

In other words, country A has a comparative advantage in the production of

commodity A’, and В has least comparative disadvantage in the production of Y.
Thus, trade is beneficial for both countries. The comparative advantage position of
both countries is illustrated in Figure 78.2.

Let PQ be the production possibility curve of country A and RS of country B. The

curve PQ shows that country A has an absolute advantage in the production of both
commodities X and Y respectively over country B. This is due to the fact that the
production possibility curves RS of country В lies below the production possibility

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curve PQ of country A. Country В produces OR units of commodity Y and OS units of

commodity X.

To show comparative advantage position in trade, draw a line RT parallel to line PQ.
Now country A has a comparative advantage in the production of commodity X only
because it exports ОТ (> OS) units relatively to country B. On the other hand,
country В has a comparative disadvantage in the production of commodity Y only.
This is because, if it gives up resources required to produce OS units of X, it would be
able to produce commodity Y by an amount less than OR. Thus country A has a
comparative advantage in the production of commodity X, and country В has a
comparative disadvantage in the production of commodity Y.

Its Criticisms:

The principle of comparative advantage has been the very basis of international
trade for over a century until after the First World War. Since then critics have been
able only to modify and amplify it. As rightly pointed out by Professor Samuelson, “If
theories, like girls, could win beauty contests, comparative advantage would
certainly rate high in that it is an elegantly logical structure.”

But the theory is not free from some defects. In particular, it has been criticised by
Bertin Ohlin and Frank D. Graham. We discuss some of the important criticisms as
under.

(1) Unrealistic Assumption of Labour Cost:

The most severe criticism of the comparative advantage doctrine is that it is based
on the labour theory of value. In calculating production costs, it takes only labour
costs and neglects non-labour costs involved in the production of commodities. This
is highly unrealistic be- cause it is money costs and not labour costs that are the basis
of national and international transactions of goods.

Further, the labour cost theory is based on the assumption of homogeneous labour.
This is again unrealistic because labour is heterogeneous—of different kinds and
grades, some specific or specialised, and other non-specific or general.

(2) No Similar Tastes:

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The assumption of similar tastes is unrealistic because tastes differ with different
income brackets in a country. Moreover, they also change with the growth of an
economy and with the development of its trade relations with other countries.

(3) Static Assumption of Fixed Proportions:

The theory of comparative costs is based on the assumption that labour is used in
the same fixed proportions in the production of all commodities. This is essentially a
static analysis and hence unrealistic. As a matter of fact labour is used in varying
proportions in the production of commodities. For instance, less labour is used per
unit of capital in the production of steel than in the production of textiles. Moreover,
some substitution of labour for capital is always possible in production.

5. Explain the concept of absolute cost advantage theory.

Answer: Adam Smith is generally ignored as a trade theorist in text books of

international economics because of the common belief that he only confirmed the
rule of absolute advantages to explain the structure of foreign trade.

However, his vent-for-surplus approach may be interpreted as a pioneering study

which stresses the importance of economies of scale in explaining the structure of
trade.

Economists recognize the undeniable influence of Smith’s concepts such as “extent

of the market”, “division of labour”, “improved dexterity in every particular
workman”, and “simple inventions coming from workman” on trade theory.

Adam Smith propounded the theory of absolute cost advantage as the basis of
foreign trade; under such circumstances an exchange of goods will take place only if
each of the two countries can produce one commodity at an absolutely lower
production cost than the other country.

Suppose, there are two countries I & II and two commodities A and B. For example,
country can produce a unit of commodity (A) with 10 and a unit of commodity (B)
with 20 labour units, and that in country II, the production of a unit of (A) costs 20
and a unit of (15) 10 labour units. Now country I has absolute cost advantage in tin-
production of (A) and it will confine itself to the production of (A) and country II in

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the production of (B). Exactly the same would happen if I and II were two regions of
one country. We speak of an absolute- differences in costs because each country can
produce one commodity at an absolutely lower cost them the other. Thus, in such a
situation, a division of labour between them must lead to an increase in total output.

6. State the indicators of economic development. Why is planning needed in under

development economics. What do you mean by vicious circle of poverty.

Answer: Measurement of economic development and express in definite index is

very difficult task in economics. So many opinions are found to indicate level of
economic development of a nation. However, some common and popular indicators
that used to measure development are discussed below:

Volume of Per Capita Income

Per Capita Income is first and most important indicators of economic development
of a nation. It is commonly used by all nations in the world along with UN while
measuring economic position of the nation. The PCI of Least Developed Countries
(LDCs) is less than $400. There are 49 countries LDCs across the globe.

Rise in Factor Productivity

Development means rise in production and productivity of factors of production.

Productivity implies increased per unit of production of factors of production land,
labor, capital and organization in terms of rent, wages, interest and profit.

Rise in Living Standard

Another indicator of development is living standard of common people which should

go on rising to higher levels. The very objective of development is to provide better
life to people. It refers to increase in average consumption level of individual and
society.

Physical Quality of Life Index

Physical Quality of Life Index is a common indicator of development. It is computed

from life expectancy at birth, infant mortality rate and literacy rate of a country. If
people live longer and are literate, PQLI value will be high. It is measured in scale of 1
to 100.

Human Development Index

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The Human Development Index as an indicator was introduced by UNDP in the

World Human Development Report in 1990. Since then, it has been the most popular
indicator of development. Its range of measurement is in between 0 to 1.

Poverty Alleviation and Inequality Reduction

As a nation develops, poverty must be reduced and the gap between the rich and
poor must be narrowed down . Poverty limits opportunities of common people to
uplift their life. It weakens their income earning capability. Their access to health,
education and skill development is most essential to minimize poverty rate.
NEED FOR PLANNING:
n UDCs’ planning is necessitated due to following reasons:

(1) Weak, Private Sector:

In an underdeveloped country, private enterprise is weak and may fail to take the
necessary risks of pioneering those industries which are necessary for rapid
economic development of the country.

Therefore, the State must come to the forefront action. The underdeveloped
countries have remained almost stationary.

This task of their development is a big task. These countries need a big push. It is
only possible through a comprehensive planning. Thus the Government should
follow comprehensive planning for the development of underdeveloped countries.

(2) Inequalities of Income:

Inequalities of income and wealth exist in underdeveloped economies. Private
enterprise system does not secure an equal distribution of the benefits of economic
development among different classes of the community. The developing social
conscience of the people cannot tolerate the existence of such grave inequalities.
This would secure a better distribution of national income among all classes of
people in the country.

(3) Problem of Unemployment:

Another reason why the underdeveloped countries need a plan is that the working
of pricing system has failed to solve the problem of mass unemployment. The mass
unemployment which existed during 1930’s was horrible. No country wanted to
experience such as mass unemployment again. There is also the acute problem of
disguised unemployment in under-developed countries. The mass unemployment,

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particularly disguised unemployment, which exists in underdeveloped countries
cannot be dealt with unless a comprehensive economic plan for development is
formulated.

(4) Change in Attitude:

All underdeveloped countries have become development-minded. Now they want to
pack the development of centuries into a few years. They like to raise the standard
of living of their people. Therefore, these countries require quick economic
development.

(5) Need of More Capital:

Higher rate of growth of development requires huge capital investment. It involves a
considerable degree of central planning and control. Among the underdeveloped
countries, higher rates of growth have been registered in those countries where
there is a planned development. In the last 15-20 years, the rate of growth of income
in poor countries has been on the whole, higher than it was before they adopted
planned development.

(6) Foreign Aid:

In modern economic activities the progress of one nation is related directly or
indirectly to the progress of other nations. Thus, the detailed plan, mentioning
specific output projects and investment projects, is very useful in creating favourable
atmosphere for bilateral and multi-lateral agreements of foreign aid. Thus, carefully
designed plan outlay is essential for increasing foreign trade and thereby improving
development prospects.

(7) Structural Changes:

ADVERTISEMENTS:

In an un-developed or under- developed country, the main economic sector is

predominantly agriculture. The secondary and tertiary sector are substantially less
developed. This results into structural dis-equilibrium. Thus, for increasing the
overall productivity, it is very essential that optimum labour force be diverted and
employed on secondary and tertiary sectors of the economy. This is possible only by
proper planning in different sectors of the economy.

(8) Economies of Scale:

The structured changes encourages and facilitate the setting up of new industrial
units, which invariably created external economies. But these newly create
economies are not usually taken into account by the private entrepreneurs under
the market system. In case of external economies, role of public sector along with
planning is essential.

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Thus, the overall gains are maximized by making proper plan adjustments. Thus a
specified investment can be best utilized taking a macro-economic view to have
appropriate social as well as private gains. This strongly favours a planned
development specially in case of less developed countries.

(9) Future Requirements:

In an attempt to maximize the current profit, the producers exploit the natural
resources without considering the future requirement. Therefore, it is evident that if
exhaustible natural resources are not properly utilized, less will be available for
future generations. To conserve the natural resources carefully it is important to
make and execute proper plans.

VICIOUS CIRCLE OF POVERTY:

In economics, the cycle of poverty is the "set of factors or events by which poverty,
once started, is likely to continue unless there is outside intervention".
The cycle of poverty has been defined as a phenomenon where poor families
become impoverished for at least three generations, i.e. for enough time that the
family includes no surviving ancestors who possess and can transmit the intellectual,
social, and cultural capital necessary to stay out of or change their impoverished
condition. In calculations of expected generation length and ancestor lifespan,
the lower median age of parents in these families is offset by the shorter lifespans in
many of these groups.
Such families have either limited or no resources. There are many disadvantages that
collectively work in a circular process making it virtually impossible for individuals to
break the cycle. This occurs when poor people do not have the resources necessary
to get out of poverty, such as financial capital, education, or connections. In other
words, impoverished individuals do not have access to economic and social
resources as a result of their poverty. This lack may increase their poverty. This could
mean that the poor remain poor throughout their lives. This cycle has also been
referred to as a "pattern" of behaviors and situations which cannot easily be
changed.

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