MFC-007: INTERNATIONAL. TRADE AND FINANCE Tutor Marked Assignment (TMA) Course Code: MEC-007 Assignment Code: MEC-007/AST/2022-23 Total Marks: 100 Note: Answer alll the questions. SECTION A Answer the following questions in about 700 words each. Each question carries 20 marks. 1. Critically discuss the Ricardian theory of Comparative Advantage. How is it differentfrom Adam Sinith’s theory of Absolute Advantage? 2. Explain the various concepts of terms of trade. Critically examine the behavior of termsof trade as explained by Prebisch. SECTION B Answer the following questions in about 400 words each. Each question carries 12 marks. 3. Explain multilateral framework of international trade. Explain its main features. 4. What are the various forms of economic integration? How is trade diversion differentfrom trade creation? Elucidate. 5. Describe the evolution of international monetary system. Examine the trends in theinternational monetary and financial systems. 6. Discuss the various instruments of trade protection, Differentiate between quotas andtariffs 7. Critically examine the relative metity and deuetrity of the fixed and flexible exchanyerates.SOLVED ASSIGNMENT Assignment Solution Guide (2022-2023) MLE.C.-07 International Trade & Finance Disclaimer/Special Note: These are just the sample of the Answers/Solutions to some of the Questions given in the Assignments. These Sample Answers/Solutions are prepared by Private Teacher/Tutors/ Authors for the help and guidance of the student to get an idea of how he/she can answer the Questions given the Assignments. We do.not claim 100% accuracy of these sample answers as these are based on the knowledge and capability of Private Teacher/Tutor. Sample answers may be seen as the Guide/Help for the reference to prepare the answers of the Questions given in the assignment. AAs these solutions and answers are prepared by the Private Teacher/Tutor so the chanees of ertor of mistake cannot be denied. Any Omission or Error is highly regretted though every care has been taken while preparing these Sample Answers’ Solutions. Please consult your own Teacher/Tutor before you prepare a Particular Answer and for up-to-date and information, data and solution, Student should must read and refer the official study material provided by the university ‘Note: Answer all the questions. SECTION-A Answer the following questions in about 700 words each. Each question carries 20 marks, Q. 1. Critically discuss the Ricardian theory of Comparative Advantage, How is it different from Adam Smith’s theory of Absolute Advantage? Ans. David Ricardo explains how a country can gain through International Trade even ifthe country doesnot have comparative advantage in any goods. In that situation, he demonstrates in his comparative advantage theory how a country would benefit by comparative advantage: ‘To explain this theory, he has taken the example of England and Portugal. In Portugal itis possible o produce both wine and cloth with less labour than it would take to produce the same quantities in Fngland. So Portugal has absolute advantage in the production of both, wine and cloth, So how can England gain from trade with Portugal? Both England and Portugal would gain from trade and one'can-understand through the concépts of the opportunity costs ‘manifested in comparative advantages. For example, the cost conditions in the two countries areas given inthe Table 11. So, Portugal hes advantage over both wine and cloth Table 1.1: Labour Cost and Opportunity Cost Comparisons ‘Country Labour cost of production (in hours) ‘Opportunity cost of production 1 unit of cloth Lunit of wine Lunit ofcloth [1 unit of wine England 100 120 1o00/120=0.83 | 120/100= 1.2 Portugal 90 80 ‘90780 = 1.12 3090= 0.89 If we calculate the opportunity costs, Portugal has lower opportunity costs (0.89) of the two countries in wine production, while England has lower opportunity costs (0.83) in cloth production. So, Portugal has comparative advantage over wine and England has ever cloth and both the countries would gain if they export these respective products tothe other country.‘Adam Smith’s theory of Intemational Trade is based on the concept of absolute advantage, while Ricardo’s theory is based on comparative advantage ‘Adam Smith says two countries can gain through international trade if they have absolute advantage in producing different goods. For instance, China ean produce 500 parts of product X with 100 workers. Japan can produce 1000 parts of product X with 100 workers. On the other hand, China can produce 1000 parts of product Y with 100 workers and Japan can produce 500 parts of product ¥ with 100 workers. Here China has the absolute advantage over Japan in producing product Y, while Japan has absolute advantage over China in producing product X. So, if China exports product ¥ to Japan and gets X from Japan, both the countries will gain. Ricardo says even ifa country does not have absolute advantage, and a country has absolute advantage in all the goods, they would gain if they have comparative advantage. To compare comparative advantage, we have to get the opportunity costs of the products. For example, India and Japan the cost conditions in the two countries are as given in following table, So, India has advantage over both rice and sugar. Labour Cost and Opportunity Cost Comparisons. ‘Country Labour cost of production (in hours) Opportunity cost of productio 1 quintal of rice | 1 quintal of sugar | 1 quintal of rice 1 quintal of sugar Japan 100 120 083 120/100= 12 Tia 90 #0 12 8090-089 Tf we celeulae the opportunity costs, India has lower opportunity costs (0.89) ofthe wo counties lnvice production, while Japan has lower opportunity costs (0.83) in sugar production. So, India has comparative advantage over ice and Japan has over sugar. So India would gain if it exports rice to Japan and Japan would gain ift exports sugar to India, ‘Q.2. Explain the various concepts of terms of trade. Critically examine the behavior of terms of trade as explained by Prebiseh. ‘Ans. Terms of trade is the commodity terms of trade between the South and the North =the two regions. Terms of trade is (price exports) (price impors) or the rato ofthe prices of export commodities tothe prices of import commodities. or example, ifthe South exports 400 dollars worth of products and imports 200 dollars Worth of products, is terms of trade are 400/200 = 2. multiplied by 100, these calculations can be expressed as a percent (200%). If country’s tems of trade fll from say 100% to 70% (ftom to 0.7), thas experienced a 30% fll ints terms of trade “Terms of trade are sometimes used as a proxy for the relative social welfare of a Country dx Feb, i thié heuristic is technically questionable and should be used with exteme eaution, The increase ofthe ratio means an improvement in a nation’s terms of trade whichis good for that country in the sense that it can buy more imports for any given level of exports. The terms of trade is influenced by the exchange rate because @ rise in the value of a country’s currency lowers the domestic prices for its imports but does not directly affect the commodities it produces. “There are anumber of concepts elated to terms of trade. These concepts are wo types: those that relate to exchange between productive resources and those that relate to exchange ratios between commodities 1, Net Barter Terms of Trade (NBTT): This isthe price of exports to the price of imports, namely Pe/Pm =P, where Pe is the price of exports, and Pm is impor 2. Single Factorial Terms of Trade (SFTT): This isthe net barter terms of trade adjusted for the changes in productivity of exports. SFIT = POc where Oc is output per person in a country. The change in SFT measures the change in living standard ofan exporter in terms of imports. Suppose output rise but price declines andthe total changes is zero, i., 6°*60C-O, then the SFTT index will remain unchanged. ‘The Consumer Price index (CPD) will be P."P,* where a is share of imports in the consumption basket. ITF is money expenditure, then E/CPI i real expenditure when trade is balanced, So real expenditure will be: AldvertisementP.O PPt = QUP/Pm,)* AS P’falthe'real expenditure rose. But ifthere is no change in employment, there is @ one to one relation between an output index and a productivity index, and the index for real expenditure per employed person, P,Q, is the Weighted Single Factorial ‘Terms of Trade (WSFT). Double Factorial Terms of Trade (DFTT) is adjusted for both the productivity of imports and productivity of exports. DFTT is calculated to know the relative change in living standards, Thus, DFTT = (P/P,(0/0,) where O, is output per person in the North. This provides the relative value of the output of workers and combines relalive prices and relalive productivity, ‘Change in relative living standards can be decomposed into employment, productivity and TT changes. If we keep employment cout of the picture then the remaining two factors of productivity and TT can be combined into the DFTT. But the DETT gives an accurate measure of changes in the relative size of consumption baskets only in special cases (i) fraction of income spent on tradeable goods should be the same in the two regions (i) the relative price component is trendless. For the DET, relive rel income the South reatv tothe Note (P,P) BEAR Whe the expends in the North. When trade is balanced E =. P.Q. and E* ~ P.Q*. , and this expression becomes (Q./Q®,)P°"", Under constant employment assumption, this converts to kB*(Q./ Q_) where is the constant ratio of persons employed inthe two counties. k drops out when we view the last expression as an index. So, WDFIT=P "(9 /Q,) ‘The trade unweighted version corresponds to the case where ata* = 1 This condition is satisfied when the two countries have identical consumption patterns. 4. Income TT = (P./P,).0_.N, = ViP, Where Ne is employment in the production of commodity, so that V is value of primary production. The given value of ‘output measured in import prices. This is a useful measure as employment data to calculate O, is often not available. 5. Employment Corrected IT- As there is full employment in the North, in ease of increased output in one sector, there will bbe not be an inerease in total income as income in other Sectors falls, ) But this will not be the case in the South where due to unemployment output foregone elsewhere is zero, To take account of this, we can estimate the employment corrected DFTT, namely ECDFTT which equals: {P.\f0, , ECDFIT. N=PV(P_O, GXod roF Where V = P.0,, is index of output of exportables valued at current prices ‘This exteiads ibe index to all three dimensions and also gots rid of troublesome Q.. which Gn often nat bé calculated because of lack of data ‘6) Because of unemployment in the South, analysts take interest over employment corrected WSFIT ECWSFIT= On.=270N, =2 PrONe = RON, The income terms of rade are PO,N, namely they correspond tothe case where a= 1, and so equal PX where X is quantily of exports, namely value of exports expressed in import prices. employment is not constant, then we calculate the ECWDFTT, employment corrected relative income double factor TT, OWNDO, Inhis analysis, Prebisch argued thatthe terms of ade of developing countries were deteriorating, He used the TT ofthe UK to conduct his study. His analysis however was criticised on several grounds 1. Cities argue thatthe UK’s TT cannot represent he TT of developing counties as the UK's NBT is not representative of industal countries as awhole, Therefore, it isinvalid to use the inverse of the UK's TT inthe analysis of TT of developing counties. POP; v PStudy® SOLVED ASSIGNMENT Badshah Assignment Solution Guide Baca of Ontine Sady Elearning (2022-2023) judybadshah.com js also argued that the UK's TT would not be appropriate data for study as the UK imported primary commodities from developed countries. 43. Other factors like transportation costs cause prices of imported products to fall. In the UK, the prices of imports might have fallen because of a decline in shipping costs since import prices include freight charges. So the decline in import prices in the UK could happen without a fallin the prices of commodities exported by developing countries. 4, The method of calculation of price indices may be biased as it does not take account of introduction of new goods and ‘quality differences, SECTION B Answer the following questions in about 400 words each. Each question carries 12 marks. Q.3. Explain multilateral framework of international trade. Explain its main features. ‘Ans. A multilateral framework of international trade facilitates member countries import and &Xport of goods and services. It is definitely a suitable platform for developing countries to join with. By becoming a member of a multilateral framework, a country will have opportunity to engage in import and export, ‘A multilateral framework also offers a better deal to @ country than any bilateral agreement for trade can provide. It also provides collective security to member countries, The platform gets mechanism for enforcement of rights and obligations and dispute settlement system to protect against unilateral actions of other countries ‘A member country gets the opportunity to learn from the experiences of other countries in the group and also influence the process to some extent. A county staying away from the group will get an image of an odd man out. So its better to be a part of such a framework which has been in existence for nearly six decades now. WTO is an example of a multilateral framework of international trade. ‘Q. 4. What are the various forms of economic integrati Elucidate. ‘Ans. Regional trading blocs are only one of the various forms of economic integration that existed in the World. There are five types of economic integration: (i) Free trade area, (ii) Customs union, (ii) Preferential trading area, (iv) Eeonomie and ‘monetary union, and (v) Common market. Ina free trade area, members move towards zero or neat-zero tariff levels among them ‘on substantially all trade, Members in a customs union have a common external tariff on products coming from outside the union, Ina preferential trading area, members grant tariff preferences among. Harmonization of various economic policies, including monetary policies; is effected in economicrand monetary union. In the case of common market; freer movement of factors of production isallowedeIf these stages of regional integration adopted in sequence, depict deeper economic integration processes. However, countries have formed regional groupings without following the strict sequence of different stages of integration. The key objective forregional trade integration is trade creation and trade diversion. ‘Trade Diversion: In Figure 1 it fs presented how trade diversion could reduce welfare in a country that enters into an FTA. Dand S are the demand and supply curves for county X. PY and PZ ate the fee trade supply prices of the product from countries Y and Z respectively, .? How is trade diversion different from trade creation? a » ee 2 : ss oo ¢ 1 Trade Diversion Advertisement: To get IGNOU Based Chapterwise Reference Books Including Many Solved Sample Question Papers for Various Courses Like B.A. B.Com B.A.Hons. M.A. M.Com MBA. BCA. M.C.A. M.RD. MS.W. M.T.M. B.Sc. BTS BIMC CTE DNHE B.lis etc. Visit www.neerajbooks.comStudy§ SOLVED ASSIGNMENT Badshah Assignment Solution Guide (2022-2023) Ttis assumed that X has a specific tariff, f, = f, = f* imposed on imports from countries ¥ and Z, The tariff increases the domestic supply prices to P,Y and P,, respectively. The size ofthe tariff is equal to P,” ~ PY = P,” PY, Iti quite clear that country X will import the produet from country Z and will not trade initially wth country Y. Imports would be to the order of D' -s ‘After countries X and Y form an FTA, X would impose zero tariff on import from country Y. Consequently, the domestic prices on goods from countries ¥ and Z would be PY and P,, respectively. Sine PY < P,7, country X would import only from country Y after the FTA. At the lower domestic price, PY, imports would rise to D?~ S*: Since the intial price in country Z.is lesser than the price in country Y, imports from ¥ are considered as diverted from a more efficient supplier Z.o a less efficient supplier Y. ‘Table 1 Welfare Effects of RTA: Trade Diversion Effects on Country X [Consumer Surplus = (mtner+9| Producer Surplus =m [Govt, Revenue ean [National Welfare Fone s=w ‘AS you see in the Table 1, the net national welfare effect can be either positive or negative, Trade diversion is generally considered to be welfare lowering as discussed earlier. However, in certain conditions the national welfare change could be positive under the trade diversion scenario, Ifthe free trade supply price (PY) offered by country Y is lower and closer to country Z's free trade supply price PZ, trade diversion still takes place after the FTA-formation. The welfare effects will be the same as far as the direction is concerned, However, they differ in magnitude. The consumer surplus gain becomes larger due to the larger fall in the domestic price. Hence, in such cases, formation of an FTA that causes trade diversion could have a positive welfare effect. Thus, trade diversion necd not necessarily be welfare lowering. ‘Trade Creation: Trade creation under an FTA means products are imported from a more efficient producer in the region, often involving a shift of imports away from the rest of the world. Such a move is welfare enhancing for a member country of the FTA. In Figure 1, country X enters into a FTA withthe more efficient supplier country Z, there will be only ifade creation arid no|diversion. Figure 2 presents another example of trade creation and its effects where country X forms an FTA with country’Y. Pp) aunty x 6 s Fa Ps 2 2 so a 2Trade Creation ‘Sand D represent the supply and demand curves for country X in the figure 2, The supply prices of the good from countries: Y and Z, respectively are by PY and P%, Assume that X has a specific tariff 1° ~ = imposed on imports from both countries Y¥ and Z. The tarif raises the domestic supply prices to PTY and PTZ respectively. The tariff size will be "= PTY -PY =P Advertisement To get IGNOU Based Chapterwise Reference Books Including Many Solved Sample Question Papers for Various Courses Like B.A. B.Com B.A.Hons. M.A. M.Com M.B.A. B.C.A. M.C.A. MRD. MS.W. M.T.M. B.Sc. BTS BIMC CTE DNHE B.Lis etc. Visit : www.neerajbooks.comStudy® SOLVED ASSIGNMENT Badshah Assignment Solution Guide tia Oe Soy «Fearne (2022-2023) wwwistudybadshahcom ®, Including the tariffs, the pre-FTA price in country X (P%) is less than both P,Y and P,? thus the product will not be imported. Country X will instead fulfil its domestic demand with its own supply at S' =D Suppose X and Y form an FTA and X full eliminates the tariff on imports from country ¥, the /, becomes zero but remains at. The domestic prices of products from countries ¥ and Z become PY and P.* respectively. As P¥ < P¥, country X would now {import the product from country Y after the FTA. At the lower domestic price P¥, imports would increase to D ~S*. Trade now is generated in the post-FTA scenario from an efficient source within the region. This is trade creation ‘Table: 3 Welfare Effects of RTA: Trade Creation Effects on ‘Country X, ‘Consumer Surplus =(m=n+r) Producer Surplus =m ‘Govt, Revenue. a National Welfare +aen) For the country X, the net welfare effect isthe total of gains and losses to consumers and producers. There are two po: dimensions: a positive consumption efficiency gain (r) and a positive production efficieney gain (n). An FTA that leads to trade creation implies net welfare gains. Thus, the gain would be even larger if country X entered into the FTA with the more efficient supplier country Z. ‘Trade creation and trade diversion analysis can be extended fo cover many markets and multiple countries of an FTA. The aggregate effects of an FTA can be obtained by totalling the effects across markets and across countries, The net welfare effects are measured by taking both trade ereation and trade diversion into account. Ifthe positive effects from trade creation outweigh the negative effects from trade diversion, the FTA under consideration is said to be welfare improving. Thus, both trade creation and trade diversion effects need to be added to assess the welfare-increasing effects of a customs union of RTA. Q. 5, Describe the evolution of international monetary system. Examine the trends in the international monetary and financial systems. Ans. International monetary system is part of the international financial system which is defined as a set of global financial markets, global financial institutions, official lenders such as the IMF, and global regulatory arrangements. These institutions facilitate cross border transactions in financial instruments, International monetary systems interdependent in the sense that balafices of payment are connected together. Ifone country. has a balance of payments surplus, the rest of the world has @ balance of payments deficit and vice versa. If one country has & balance of trade surplus, the rest ofthe world as.a balance of trade deficit. This influences the exchange,rate system. In a world of n countries with n currencies, there are n-bindependent exchange rates, No country ean fix exchange rates on its own. ‘As we learnt thatthe problem of what is widely known as the “impossible trinity” will be there with the prevalence of cross= border capital flows. Itis impossible to achieve simultaneously the objectives ofa fixed exchange rate, an open capital aceount and a monetary policy dedicated to domestic economic goals. ‘The fixed exchange rate system in various countries was dropped as an objective worth pursuing, The IMF had managed the anchored dollar system of fixed exchange rates. Since 1971 and especially after1973, the year the international monetary system. moved towards flexible exchange rates, the IMF lost its role as @ guardian of the international monetary system. The IMF was then shifted from its role a the centre ofthe international monetary system to a new role of ad hoc macroeconomic consultant and debt monitor. When the gold exchange standard broke down as a price-stabilization mechanism through the inter-dependence of the currency system, there was inflationary pressure witnessed worldwide, In results, the Articles of Agreement of the IMF were amended in 1978 with a focus how on price stabilisation as imbibed in the amended Article IV, In 1971, the US decided to de-link the dollar from gold. Regarding role of the Fund, itis amply clear that the intemational monetary system was being run by industrialized countries. The Fund had no coherent system for monetary stabilisation to offer. Advertisement: To get IGNOU Based Chapterwise Reference Books Including Many Solved Sample Question Papers for Various Courses Like B.A. B.Com B.A.Hons. M.A. M.Com M.B.A. BCA. M.C.A. M.RD. MS.W. M.T.M. B.Sc. BTS BIMC CTE DNHE B.lis etc. Visit www.neerajbooks.comStudy§ SOLVED ASSIGNMENT Badshah Assignment Selution Guide (2022-2023) In the strict sense, an international monetary system does not currently exist, Every nation has its own monetary system, The functioning of the IMF has been severely criticised. Its credentials have also been questioned with regard several issues including. IMF-supported programmes that impose austerity on countries in financial crisis. ‘There are various trends prevailing at present in the international monetary system, They are fragmented and there is no one- umbrella institution, which is said to be offering an international monetary and financial architecture. Some of the trends are summarised below: Deregulation and opening of domestic financial markets, Globalization of domestic financial markets and institutions. Firms and financial institutions raising funds through international capital markets, Investors collecting funds from abroad. Foreign corporations and financial institutions are allowed to issue bonds and stocks denominated in different currencies. They are also allowed to buy domestic securities Emergence of international financial centers in Europe and Asia. Growth of offshore money and capital markets ©. Globalization of insurance, banking and other intermediation businesses. These trends make the intemetional capital market as one market. International capital flows has been growing steadily in recent decades. However, this has negative effects on countries dependent on such flows. These countries became increasingly vulnerable to crises of confidence. Besides, the spreading of crises from one country to another has become a part of reality. This ‘was evident in various financial crisis including the Asian crisis of 1997, Latin America and Russia in 1998 and the 2008 crisis. Q. 6. Discuss the various instruments of trade protection. Differentiate between quotas and tariffs. ‘Ans. The tools of trade protection can broadly be divided into two types: (i) price-related measures or tariffs and (i non-price related or non-tarifT barriers (NTBs). Here we will discuss the both measures in detail. ‘Tariffs: A tariffs a tax on imported products including both final and intermediate goods, This is ealled import duty. It changes the prices of imported goods and domestic goods. Tariffmay be specific or ad valorem. Specific tariffs are fixed amount levied on a product, for example, Rs, 200 on 100kg of rice. Ad valorem are fixed percentage ofthe total value of the goods, for example, 20% tax on imported furniture. Pi 5 Pre pLieete to D. i. ooo a, a Fig. 1 Eftct of a Tari In Figure I, the impact of tariff on consumers, producers and the government is shown, Its a patial equilibrium framework, It is also assumed that the country is a small open economy that cannot affect world market prices. Tariffs only increase the prices in the domestic market. In Figure 1, D is the domestic demand and S is the supply curves of the imported product. , is the world market price of the product and this rate will be there in the domestic market under free trade. Q, isthe domestic production of the production, Q is the domestic demand and Q.~ Q, isthe quantity of imported products Advertisement To get IGNOU Based Chapterwise Reference Books Including Many Solved Sample Question Papers for Various Courses Like B.A. B.Com B.A.Hons. M.A. M.Com M.B.A. B.C.A. M.C.A. MRD. MS.W. M.T.M. B.Sc. BTS BIMC CTE DNHE B.Lis etc. Visit : www.neerajbooks.comStudy® SOLVED ASSIGNMENT Badshah Assignment Solution Guide tia Oe Soy «Fearne (2022-2023) wwwistudybadshahcom ‘The tariff imposed on the product is ¢. Thus, the cost after the tariff is (P,+ 0). In consequence, domestic production rises from Q, is Q,, while consumption declines from Q, is Q, ‘Because ofthe tariffs, domestic consumers suffer a loss in consumer surphis equal tothe area (a-+ b+) compared to free trade, The loss occurs as consumers must now pay more (P, + #) forthe good and they now consume Q,Q, amount less of the good than with fre trade. ‘The domestic producers however gain from the rise in prices. The area a in the graph is the increase in the producer's surplus. The government also makes gains from the tarif. The tariff revenue is given by the area c Itis clea that te loss to consumers is more than the gain to both producer and the government. This is shown inthe graph’s band d. This i also called a net social loss to society ‘The loss in social welfare from the production distortion due tothe tariffs area 6. Iti the higher costs of producing Q,Q, domestically instead of importing this amount. ‘The welfare loss due to the consumption distortion created by the tariffs area , NS eost of RONBBENing Q, Q, an amount whose value to consumer exceeds the cost of importing it. In this analysis, impact on terms of trade, BOP and factor markets are not considered, It also does not attach any weight to ‘employment in the sector being granted tariff production. Effective Rate of Protection: The Effective Rate of Protection (ERP) is a measure of the total effect of the entre tariff structure on the value added per unit of output in each industry, when both intermediate and final goods are imported Is used to measure the real amount of protection afforded to a particular industry by import duties. ERP of final product F = (VT= VWYV, 'V, is the value added in the production’of F afte tariff and V., is the value added in the production of F at world market prices, i. V, isthe value added under free trade. Value added is the difference between the price ofthe final product produced by an indust, less the eost of inputs required per unit of produetion ofthe final product. ‘The following example will further clarify the ERP: Suppose the world market price of final product F is Rs. 10000, The world market price of one unit ofan intermediate good is Rs. 5,000, Thus, Vw here will be Rs. 5,000 (10,000 ~ 5,000), ‘Case 1: A tariff of 10% is levied on the final product F, while there is no tariff on the intermediate, I. Pos tariff, the price of F inthe domestic market rises by 10% to Rs, 11000 and VT is Rs. 6,000 (11,005,000). Thus ERP is (6,000-5,000)/5,000 = (1 5100 = 20%, ‘Case 2: Consider a tariff of 10% is imposed on the intermediate | and that there is no tariff on the final good F. So its domestic prige will increase by’ 10% to Rs. 5,500..Thus, V_ will be Rs, 500 (5,500-5,000). Thus, ERP is (500-5,000)/1000 = 100100 10008. ‘The following points should be clear to you while calculating ERP: 1. World niarket pices of te fal good aiid imported inputs determine the valve adkled th the domestic industry under free trade; 2. Domestic prices ofa final product can surpass the world market price after the tariff is levied, How this affects domestic value added would depend on the extent of price rise in the final good vis-a-vis that of intermediates and on te importance of the intermediates in the production process; 3. In case intermediate is not required in the production of the final good, then the ERP will be equal to the nominal rate of tariff on the final good; 4. In case the tariff on final goods is higher than that on intermediates, then the ERP would be higher than the nominal rate of production; 5. When tariffs on imports are too high compared to the tariff on the final good, ERP will be negative. Negative ERP indicates that trade protection could actualy lower domestic value added as compared to free trade, Advertisement: To get IGNOU Based Chapterwise Reference Books Including Many Solved Sample Question Papers for Various Courses Like B.A. B.Com B.A.Hons. M.A. M.Com M.B.A. BCA. M.C.A. M.RD. MS.W. M.T.M. B.Sc. BTS BIMC CTE DNHE B.lis etc. Visit www.neerajbooks.comStudy§ SOLVED ASSIGNMENT Badshah Assignment Selution Guide (2022-2023) It may be difficult to calculate of ERP if different inputs used by a single industry may be subjected to differential rates of tariff and also because of the difficulty of getting reliable ‘free trade" prices ofthe final and intermediate goods. ‘There are some limitations in the concept of ERP. In the calculation of ERP, fixed co-efficients of production (i.e. input needs per unit of output are taken to be fixed) is assumed, which do not allow for factor substitution possibilities. Secondly, the underlying assumption of a small open economy that cannot affect world market prices, may not apply in practice. ‘Non-Tariff Barriers: Non-tariff barriers are trade barriers that restrict imports but are notin the usual form ofa tariff. Some common examples of NTBs are import quotas and export restrictions, Some of the NTBs are discussed below: ‘Quotas: An import quota is type of protectionist trade restriction that sets a physical limit on the quantity of a good that can be imported into a country ina given period of time. Quotas are applied through a system of import licenses. Firms which have license are permitted to import specified quantities of the imported good into the domestic market. With a quota the domestic price ofan imported good will always be higher than its world market pice. Firms buy the product, at world price and sell them at higher price in the domestic market. ‘Here we will discuss the impact of quota under different market structures in the damestie economy. @ Import Quotas with Perfeet Competition: The impact of import quotas in a perfectly competitive market is presented in Figure 2. Dis the demand curve and Sis the supply curve for the good before quota imposition. The world price ofthe product, is P_ and the total domestic production is Q,, demand is Q, and Q,Q, amount of products is imported. S vs | & — P, a. oe Fig. 2 Effects of mport Quota with Perfect Competition "Now suppose an import quota is imposed and imports restricted at Q,, After the quota imposition, domestic demand falls sor of total domestic production and imports. The prices in the damestic market rise on excess domestic demand. Domest supply curve shifted toS" on quota effects. isthe new equilibrium. P'Is the new price. New domestié producti has increased to Q, while domestic demand is fallen from Q, to.Q,. Here we should know that Q,Q, = Q.Q.= import quota —P, is tariff equal tothe quota. ‘These'are of (a + b+ c+ d) isthe arca representing the loss in consumer Surplus. A isthe rise in producer surplus. The area is the quotatent; Ifcacerues 16 the license holders and is counted as part of social gas. The area’b +s the soeial loss from quota ‘c would accrues to foreigners if they have sold the product directly in the domestic market, It would be social loss forthe domestic country Sometimes, quota rent may not acerue tothe firms involved. It may be dissipated in rent-secking activites like paying bribe to acquire import licenses and so on. In that case, ¢ would be social loss. The area (b-+ c+ d) would be the total cost imposed by ry has auctioned the licences, the bidding process would drive the price of licence up to P!—P_ per unit of imports and the government would earn revenue equal to the area. (Gi) Import quotas with Monopoly: An import quota causes greater loss in social welfare in monopoly compared to perfect. competition, From the social welfare point of view, an important tariff should be preferred to a quota in monopoly. In case of a tariff, say ¢, the price of imports will be P, + , So the monopolist cannot charge a higher price than this level. Ifease he charges Advertisement To get IGNOU Based Chapterwise Reference Books Including Many Solved Sample Question Papers for Various Courses Like B.A. B.Com B.A.Hons. M.A. M.Com M.B.A. B.C.A. M.C.A. MRD. MS.W. M.T.M. B.Sc. BTS BIMC CTE DNHE B.Lis etc. Visit : www.neerajbooks.com 10Study® SOLVED ASSIGNMENT Badshah Assignment Solution Guide Sonataeeanret (2022-2023) judybadshah.com higher price, consumers would go for imports and the monopolist would suffer loss. Thus, a tariff would effectively impose a ceiling. Incase of quota, the monopolist will charge higher than the import price because the consumers will have no option asset by the quota limit. Me P Py @ Od a oa —% Fig. 3 Effects of import Quota with Monopoly In Figure 3, D is the demand curve under fiee trade, P, isthe world market price ofthe produet. Now an import quota is Q,Q,. When the quota is imposed, the demand curve facing the monopolist moves inwards, at all prices above P, because imports have reduced the monopolists market by Q,Q,. After quota imposition, MR is the relevant marginal revenue curve facing the ‘monopolist, corresponding to the new demand curve. Here the monopolist will optimize profits by producing an output of Q.,.where the marginal revenue equals marginal cos. ‘The product will be sold at the price P., Here (P,,—P,.)is the quota rent eafned by the monopolist firms. In perfectly competitive market, the MC curve could have been the supply curve, and the market price would have been P! and output Q'. It shows the outcome in a monopoly is more inefficient compared with perfect competition. In monopoly, the ‘output is lower andthe price is higher. Thus, it leads to greater welfare losses For this reason, tariffs are preferred to quotas, particularly when the domestic producer has monopoly power. ‘Other Non-Tariff Barriers: Some of the NTBs commonly used by countries across the world are mentioned below: Exchange Controls: Foreign exchange restrictions occupy a special place among the non-tariff regulatory instruments ‘Countries central bank regulates the foreign exchange restretions. It puts limits on residents acquiring foreign currency. For example, a resident needs central bank’s permission to old foreign cutrefey bank account Import Deposit Scheme: Another example of foreign trade regulations is import deposits. Import deposits is a form of deposit, which the importer must pay the bank for a definite period of time (non-interestbeating deposit) in’an amount equal to all or part ofthe cost ofimported goods. Thisrule is imposed by the coumtry’s Central Banks to restrict imports by making them more expensive. ‘Health and Safety Standards: Importing countries usualy inipose health and'saféty staidards On th products they import. This increases the costs for the exporting countries. These standards are sometimes entered under the pretext of protecting the safety and health of local populations. However, these standards are often used by developed nations to put barriers on imports originating from low-wage developing countries. ‘Customs valuation procedure: Under a system of ad valorem tariffs, the importing nations increase the value of the imported goods under some pretext, which would raise the duty on it, This practice is called customs valuation procedure. For «example, in the post-war period, the US was valuing certain chemical imports at the American selling price rather than at the ‘world market price. This system was scrapped since the Tokyo Round of negotiations. Local content requirements: Importing countries puts certain terms and conditions that some stipulated portion of a final ‘good be produced domestically. Another condition may be that a certain specified fraction of the final goods price must represent domestic value added. The reason behind this regulation isto promote local production of certain intermediate goods. ‘The instruments of trade protection can be divided into two types: (tariffs and price-related measures and (4) Non-Tari Barriers (NTBs) or non-price related. Advertisement: To get IGNOU Based Chapterwise Reference Books Including Many Solved Sample Question Papers for Various Courses Like B.A. B.Com B.A.Hons. M.A. M.Com MBA. BCA. M.C.A. M.RD. MS.W. M.T.M. B.Sc. BTS BIMC CTE DNHE B.lis etc. Visit www.neerajbooks.comStudy§ SOLVED ASSIGNMENT Badshah Assignment Selution Guide (2022-2023) ‘Tariffs: A tarfT sa tax on imported products. This is called import duty. TarfTs imposed on both inal and intermediate goods. It changes the prices of imported goods and damestic goods. Tariff are two types - specific or ad valorem. Specific tris ae fixed amount levied on a product, for example, Rs. 500 on 100kg of rie. Ad valorem are fixed per centage ofthe total value ofthe goods, for example, 10% tax on imported vegetables. [Non-Tariff Barriers: Nonelarff barriers are trade barviers that restrict imports. They are different from a tariff: Some common examples of NTBs are import quotas and export restrictions. Some of the NTBS are diseussed below: ‘Quotas: An import quota i type of protectionist rade restriction that sets a physical limit on the quantity ofa good that can be imported into a country in a given period of time. Quotas are applied through a system of import licenses. Firms which have license are permitted to import specified quantities ofthe imported good int the domestic market. With a quota the domestic price of an imported good will always be higher than its world market price. Firms buy the product at world price and sell them at higher price in the domestic market. ‘Other Non Tarif Barriers: Some ofthe NTBs commonly used by countries across the Word are foreign éXthange restrictions, import deposit scheme, health and safety standard, customs valuation procedure and local content requirements ‘Q. 7. Critically examine the relative merits and demerits ofthe fixed and flexible exchange rates. Ans. On the basis ofthe experiences on the Bretton Woods system and the managed or ditty floating rat system since 1973, ‘we will see the merits and demerits ofthe fixed and floating rates systems, Monetary Policy Autonomy: The Central Banks under fixed exchange rate system are obliged to intervene inthe foreign exchange market to keep the rate fixed. Such obligation is not there under floating rate regime. Thus, the government uses ‘monetary policy to get internal and external balance ‘Symmetry: The US was abe to set world monetary conditions aby itself under Bretton Woods regime. Under floating rate system, itis different, All the countries have the same opportunity to influence its exchange rate against foreign currencies Exchange rates as automatic stabilises: For any rate alignment, there used to be long periods of speculation under Brotton Woods system. Under floating rate system, policy-induced exchange rates were sought to stabilise the economics. Under floating rate, no long-period speculation is needed Diseipline: Under the floating rte system, the Central Banks might engage in inflationary policies as they have the freedom to fix their exchange rates. This is not possible under fixed exchange rate regime. Speculation: Speculation in change is rate unde floating rate system may result in tremendous instability in foreign exchange market, effecting infernal and external balance of countries, International Trade and Investment: The exchange rate under floating ric regime make intemal prices more unpredictable and thus it ternational trade and investment. ‘Uncoordinated Economic policies: There willbe competitive currency practices undef floating Fate system. This may harm the world economy. Countries may adopt polices without taking into account the position of other counties. Uncertainty: In floating rate the exchange ate Volatility increases, Floating exchange rate fuels greater Uncertainty in the economy than the fixed exchange rate Advertisement To get IGNOU Based Chapterwise Reference Books Including Many Solved Sample Question Papers for Various Courses Like B.A. B.Com B.A.Hons. M.A. M.Com M.B.A. B.C.A. M.C.A. MRD. MS.W. M.T.M. B.Sc. BTS BIMC CTE DNHE B.Lis etc. Visit : www.neerajbooks.com 2