Modern Economics and Comparative Advantage Models - Essay Example

MGMT410 Mock Exam Q1 a) The notion of comparative advantage has become one of the fundamental aspects of modern economics. Two major comparative advantage models have emerged: the Ricardian model and the Heckscher Ohlin Model. The fundamental difference between the Ricardian comparative advantage model and the Heckscher Ohlin Model are that the former explains trade patterns on the basis of different technologies, whereas the latter suggests that the basis of trade patterns depends upon “factor endowments”. Such divisions can be further understood as with the progression of modern society technology became more evenly distributed (Labib 2009). The Heckscher Ohlin Model argues that this does not preclude the process of comparative advantage from occurring as capital endowments, such as infrastructure and an educated workforce, retain specific production advantage varieties (Labib 2009). b) The basic assumptions of both of these models is that even if a country can produce goods at a cheaper cost than another country, the most effective means of production will be to concentrate on the goods they produce to the greatest advantage (Labib 2009). The understanding is that by exporting these goods and importing goods that are the key product of other countries the nation will gain its greatest productive wealth (Labib 2009). One of the most recent remedies of this situation is New Trade Theory. This theoretical perspective shifts the focus from the comparative advantage paradigm to one more internally focused. While comparative advantage largely neglected nascent industries in favour of established industries of greatest advantage, new trade theory considers the importance of establishing networks or clusters among industries. Through this process the country is encouraged to impose tariffs as a means of allowing emerging clusters of industries to grow, as the understanding is that these clusters will ultimately lead to a significant competitive advantage (Labib 2009). One considers Silicon Valley as a major example of such clustering. 2. The notion of free trade has long been a notion that has sounded good among individuals, but when considered both in practice and theory has a number of prominent drawbacks. Indeed, there are a number of arguments justifying exceptions to free trade. As noted above the establishment of nascent industries oftentimes necessitates tariffs be implemented (Ravenhill 2005). Another reason against free trade is the general support of industry in the country, as tariffs protect against foreign competition (Ravenhill 2005). Another reason for tariffs is to protect consumers. Oftentimes tariffs are placed on goods and services that can be deemed potentially harmful to the general public (Ravenhill 2005). The tariff then represents a tax on the import as a means of deterrence. A forth reason is national security, as tariffs have oftentimes been implemented as a means of protecting the defence industry (Ravenhill 2005). A final reason for tariffs is retaliation against other countries, as the tariffs can function as a means of restricting specific trade to a region as forcing political action (Ravenhill 2005). 3. a) While trade between nations can occur without tariffs or other such interference, the notion that ‘free trade’ can ever be ‘fair trade’ is highly problematic. The main understanding in these regards is that countries are imbued with different endowments and natural resources that allow them a competitive trade advantage with other countries. While the trade may be ‘free’ in the sense that there are no tariffs it is not fair as the countries involved in the trade have different resources available to them. b) Ultimately it is better to have the World Trade Organization (WTO) than not. While Doha revealed significant conflict between developed and third world countries the very process by which a global discourse could be established regarding more equitable global trade relations is clearly a step in the right direction. Extraneous to Doha, the WTO has also contributed meaningfully to various dispute settlements. 4. a) The company in question is a United Kingdom firm based in Africa. The chart demonstrates the currency exchange rate between the British Pound Stirling and the South African rand over a multiple year period. A general analysis of the chart reveals great fluctuations that are perhaps attributable to the Western financial crisis. One considers that after the 2008 period the British Pound Stirling gained great value in South African rand relation to the. Since this pre-recession period spike the British Pound has steadily lost value to the South African rand such that it currently rests below 2006 levels. There are a variety of hedging mechanisms that the organization could implement. Of course the most direct method would be to become involved in FOREX exchange. Still, another method would be to participate in the derivatives markets. While there may be short-term reasons for such an approach it seems clear that currently the British pound is undervalued, as the market has over-compensated for the pre-recession bubble; the most logical hedging move would then be to simply retain British pound until it regains it’s pre bubble level. b) The forward exchange rate is 1.7722. 5. a) Within a narrow band China has tied its currency to the dollar. It has done this through high amounts of government interventions, including tariffs and other measures that have led many Western leaders to claim the Chinese are unfairly manipulating their currency. This currency manipulation occurs as the monetary system has switched from the earlier Bretton Woods to Bretton Woods II (Matap 2000). The difference between the two systems is that the first system is international currency was pegged to the dollar, which in turn was on the gold standard (Matap 2000). In Bretton Woods II the gold standard was abandoned leaving the United States currency a floating system (Matap 2000). This change is reflected with China, as they have been able to artificially depreciate the Chinese currency as a means of gaining manufacturing advantages over Western firms (Van Dormael 2009) b) In a freely floating exchange rate regime the determinants driving bilateral exchange rates include the balance of trade between the countries. In this instance the country was the greatest imbalance will witness a depreciating currency (Murphy 1999). Other prominent areas that affect the exchange rate include the levels of inflation, as well as foreign direct investment (Murphy 1999). References Labib, Subhi Y. (2009). "Capitalism". The Journal of Economic History (Wilmington, DE: Economic History Association) 29 (1): 79–86. Matap, Edward (2000). The World Bank Since Bretton Woods. Washington, D.C.: The Brookings Institution. pp. 105–107, 124–135. Murphy, John. (1999) Technical Analysis of the Financial Markets. New York Institute of Finance. Ravenhill, John (2005). Global Political Economy. Oxford University Press. Van Dormael, A (2001).; Bretton Woods : birth of a monetary system; London MacMillan Read More