CHAPTER 5 The Foreign Sector Globalisation Characterised

CHAPTER 5: The Foreign Sector

Globalisation Characterised by… expansion of trade between countries capital markets sprung up in developing and former centrally planned economies tourism has increased new technologies have linked the farthest corners of the world

HOMEWORK Read Box 5 -1 on pages 102, 103

Why countries trade Self-sufficiency (or autarky) used to be popular among politicians and citizens who wanted to be independent. Countries gain if every country specialises and exports surplus not consumed domestically and import goods which not produced domestically.

Extract from Adam Smith’s ‘Wealth of Nations’ (1776) “It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy. . . What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage. ”

More reasons to trade… SA has… but no…

Trade between countries But what if both countries produce both wool and rubber? Will trade still be desirable or possible under such conditions? Assumptions… only two countries each of which producing two goods are exchanged directly for goods (ignore exchange rates)

Absolute and Comparative Advantage Example You’re given the following info. about a newlywed couple and the time it takes each of them to do different chores: vacuuming a room or washing a load of dishes.

Absolute Advantage: The person, firm, or nation with a higher level of productivity compared to that of another. Who has the absolute advantage in vacuuming? Debbie Who has the absolute advantage in washing dishes? Neither

Q: What is Debbie’s opportunity cost Q; What is. Mike’s opportunity cost of What Mike’s Q: What is. Washing opportunitycost ofof Q: A: Washing 1 1/3 opportunity cost of Ais Debbie’s 2/3 of dishes. : loads a room. of dishes. A: Vacuuming ¾ of vacuumingdishes in of washing in terms of washingin termsof washing vacuuming dishes inroom. of washing Vacuuming 1½ terms dishes? vacuuming? OC of vacuuming= Time spent vacuuming a room Time spent washing dishes

Comparative Advantage: the person, firm, or nation with the lower opportunity cost vs. that of another. Who has the comparative advantage in vacuuming? Debbie Who has the comparative advantage in washing dishes? Mike

Shirts (per worker/week) Cellphones (per worker/week) 50 100 150 10 5 15 Absolute advantage between countries South Africa Zimbabwe TOTAL Zimbabwe has an absolute advantage in the production of _______ South Africa has an absolute advantage in the production of _______

Gains from specialisation and trade What would happen if both countries specialised ? Shirts (per worker/week) South Africa Zimbabwe TOTAL (prev. total) Cellphones (per worker/week) 0 200 (150) 20 0 20 (15)

Comparative (relative) advantage All that is required for both countries to benefit from trade is that the opportunity costs of production differ between the two countries. David Ricardo (1772– 1823)

Comparative Advantage Example Cars (per day) South Africa Germany Barrels of wine (per day) 1 2 6 8 Germany has an absolute advantage over South Africa in the production of _____.

Cars (per day) Barrels of wine (per day) 1 2 6 8 Gains from trade South Africa Germany has a relative or comparative advantage in the Has Germany got anything to gain from trading with South production of _______ Africa? ? ? South Africa has a relative or comparative advantage in the Lets look at the OC of production… production of _______ OC of producing 1 Car Barrel of wine South Africa Germany 6 4 1/6 1/4

OC of producing 1 Car OC of producing 1 Barrel of wine South Africa 6 1/6 Germany 4 1/4 Terms of trade South Africa will shift resources into wine production if it can exchange fewer than 6 barrels of wine for a car from Germany will shift resources into car production if it can obtain more than 4 barrels of wine for every car it sends to South Africa. Beneficial if 1 car is exchanged for more than 4 but fewer than 6 barrels of wine.

Gains From Trade Suppose 1 car exchanges for 5 barrels of wine: Germany receives 5 barrels of wine for each car sent to SA. Beneficial for Germany to shift resources from wine to car production and trade the excess cars. Without trade: 4 barrels of wine for each car sacrificed. After trade: 5 barrels of wine for each car given up.

Gains From Trade Suppose 1 car exchanges for 5 barrels of wine: South Africa receives 1 car for 5 barrels of wine it sends to Germany. Beneficial for South Africa to shift resources from car to wine production and trade the excess. Without trade: 1 car for 6 barrels of wine sacrificed. After trade: 1 car for 5 barrels of wine given up.

Trade policy International imports can hurt local firms. Gov. policies to protect domestic firms include… Import tariffs: duties or taxes imposed on products imported into a country. Import quotas: control number of imports Subsidies: lowers the cots of domestic producers.

Non-tariff barriers discriminatory administrative practices, for example… Deliberately awarding government contracts to domestic firms insisting on technical standards difficult foreign firms to meet special licensing requirements unnecessary red tape. Exchange rate policy: movements in exchange rates may have significant effects on exports and imports

Exchange rates SA importers pay in foreign currencies for goods/services and exchange SA rand foreign currencies. SA importers demand foreign currencies. Other countries, pay in rand for SA exports and exchange foreign currencies for rand SA exports lead to a supply of foreign currency. Rate at which currencies are exchanged = rate of exchange or exchange rate.

Exchange rates simply represents the price of one currency in terms of another. Increase in the value of one currency in terms of another (appreciation) implies a decrease (depreciation) in the value of the other currency.

$ per £ S£ 1. 90 1. 85 The rise in initial Assume an in the Investing demand creates exchange rate of UK would now a shortage in£ £ 1 = $1. 85. be more and price There are of attractive and £ 1(exchange rumours that the demand for £ rate) going UK is would to would rise increase interest rates D£ 1 Shortage D£ Q 1 Q 3 Q 2 Quantity on For. Ex Markets