International Economics Concepts

Definitions

Theory of Reciprocal Demand

The theory of reciprocal demand is a concept of international trade that explains how demand for various commodities between nations creates equilibrium between the two countries. In this case, reciprocal equilibrium is created where one country’s demand for the products of another country matches its demand for the products of the other country (Krugman 468). For instance, Saudi Arabia demands machinery and vehicles from Germany while Germany demands oil products from Saudi Arabia.

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Ricardian Trade Model

The Ricardian Trade Model is a concept of international trade that was put forward by David Ricardo to explain how countries trade with each other. In this model, the concept of comparative advantage is applied where the differences between what countries produce or bring to the international market are determined by various factors such as technology. For instance, it is easier for a country such as Kenya to buy vehicles from Japan than to make them, as it does not have a technological advantage that can match the situation in Japan. On the other hand, it is easier for Japan to buy coffee and tea from Kenya than to produce it.

Comparative Advantage

In economics, comparative advantage indicates the ability of an individual, a firm, or a nation to produce and sell a commodity at a lower price than competitors do. For instance, Japan has a higher comparative advantage in producing cars relative to South Africa. Comparative advantage reveals why countries buy various products instead of producing them, even though they can produce theirs. In this case, it is easier and cheaper to buy from countries that have a higher comparative advantage in a specific commodity.

Factor Endowment Theory

The factor endowment theory that was developed by Heckscher-Ohlin holds that countries have different levels of endowment with various resources that can be exploited for manufacturing. Such resources include land, labor, entrepreneurship, and money. In this case, a country is likely to produce and export products that use more of the commodities that it is endowed with. For instance, Japan is endowed with money and technology to produce vehicles. However, it has small land to carry out agricultural production. Consequently, it is better to produce and export cars while at the same time importing agricultural products since it is not heavily endowed with land for such an activity.

Factor Price Equalization

In international trade, factor price equalization refers to a notion that as countries move towards free trade and the prices of output products are equalized, the prices of various manufacturing elements such as capital and labor will also be equalized. For instance, upon the introduction of free trade, workers are likely to move to a country that offers higher wages while capital will probably be transferred from the higher country to the lower one (Krugman 470). A good example is a change that occurred following the formation of the North American Free Trade Agreement (NAFTA) where the price of labor reduced greatly in the US while it rose almost in the same margin in Mexico towards equalization.

Stolper-Samuelson Theorem

In international trade, Stolper-Samuelson Theorem holds that free trade lowers the wage of a given scarce factor of production while protection through various methods such as tariffs raises the wages that relate to the given factor (Hornok 45). A good example of this concept is evident in the case of NAFTA where wages for the unskilled labor in a developed country such as the US have gone down drastically contrary to the situation in developing countries such as Mexico since unskilled labor is readily available. However, if restrictions were to be applied confining the move of unskilled labor from Mexico to the US, the wages for the same class of people in the US would rise.

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Inter-industry Specialization

Inter-industry specialization refers to the process where countries in international trade specialize in various industries where they have a comparative advantage concerning factors of production for that industry. For example, a country such as Switzerland has specialized in the production of high-end watches, owing to its long experience in the industry, which gives it a competitive advantage over its competitors. On the other hand, a country such as Kenya has specialized in the production of agricultural produce, owing to its comparative advantage in this sector.

Intra-industry Specialization

Intra-industry specialization is a concept in international trade that refers to the exchange or trade of similar commodities between nations. In this case, a country chooses to export and/or import similar commodities. For example, the United States produces and sells vehicles to other nations such as Germany and Japan. On the other hand, the nation also imports vehicles from Japan and Germany. This concept defies many theories of international trade since it does not adhere to the idea of comparative advantage, which has been the backbone of explaining international trade.

Domestic Production Subsidy

Domestic production subsidy refers to a payment that can be in the form of tax exemption relief or actual money payment that is offered to firms based on the level of output in a given commodity (Vernon 190). For instance, a country can offer domestic production subsidies to boost the production of a product that is deemed critical to the nation’s welfare such as security. A good example can be seen in developing nations, which offer domestic production subsidies to boost their few industrial production capacities whilst encouraging new entrants into the sector.

Tariff

Definition of a tariff and the various types of tariffs

In international trade, a tariff refers to a tax that a given nation imposes on imported goods and services as a way of restricting trade. Various types of tariffs exist in international trade. Firstly, specific tariffs refer to a fixed fee that is applied per unit of an imported good. (Krugman 473). The second tariff is known as an Ad Valorem tariff is applied as a percentage or a ratio of the value of an imported good or service. The third tariff is the prohibitive tariff, which is set high to ensure that nearly no one imports a certain kind of import. The fourth tariff is the protective tariff that is applied to artificially raise the prices of imports to protect domestic goods from international competition. The fifth tariff is referred to as the retaliatory tariff, which is imposed on goods of a country that has forced a given tariff for the retaliating country (Vernon 195). This duty is mainly used to force another country to drop unfavorable tariffs for the country’s products.

How each of the following elements may affect and/or lower the effective tariff rate

Offshore Assembly Provision (OAP)

Offshore Assembly Provision (OAP) refers to a provision where a country’s domestic goods that are assembled abroad receive preferential tariff treatment when they reenter the domestic market (Vernon 195). Offshore Assembly Provision affects tariffs of the covered products by eliminating or reducing the tariffs that might otherwise be imposed on such imports without the provision.

Bonded Warehouse

A bonded warehouse refers to a secured warehouse that is managed by authorities where dutiable imports are stored for a period before the owner/importer can pay the required duties (Hornok 56). Bonded warehousing does not eliminate a tariff. Instead, it postpones the time it is paid to the government as a way of giving importers the ability to import more products while paying their respective tariffs later. Once the duty is paid, the goods are then released or re-exported depending on the intentions of the importer.

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Foreign Trade Zone

Foreign Trade Zone is a specially designated area where foreign goods can be landed, unloaded, repacked, or manipulated for reshipment without the involvement of customs authorities of the nation where the zone is located. Consequently, goods that are in the zone are exempted from tariffs except when they are taken to the consumers of the given nation. The effect of Foreign Trade Zones is that the tariffs for the covered goods are eliminated. Hence, the government does not earn anything from such goods.

The effects of a tariff using the large-nation model

Tariffs play a major role in international trade. In this case, tariffs lead to gains for some parties and losses for others as explained in the large-nation model. One can consider the coffee market in the United States where coffee is a commodity that is not domestically produced. Looking at its demand and supply curve at equilibrium and without restrictions, the following graph is can be evident:

Coffee market in USA

From the above graph, the market equilibrium stands at $4 per pound and 200 million pounds in the US. Assuming that a tariff of $2 is imposed for every pound of coffee that goes to the US, the consumer ends up paying $2 more for every pound relative to what foreign sellers receive. Hence, with a $2 tariff per pound, the new equilibrium should be as follows:

Coffee market in USA

With the new equilibrium shift, losers and winners are evident as depicted in the graph below:

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With the new equilibrium shift, losers and winners are evident

In the above green area, coffee will be more expensive than before. Hence, customers will be the first major losers. However, foreign producers will lose $175 million as represented by the light blue triangle region. However, the government gains $300 million through the $2 tariff on the 150million pounds that now enter the market.

An Optimal Tariff: is it achievable?

An optimal tariff is the level of tariff imposition that can maximize the welfare of a given country in international trade (Krugman 471). However, it is not possible to achieve optimal tariff since it is only possible in large country economies on the condition that other countries will not retaliate by increasing their tariffs. Since each country seeks to maximize its benefits in international trade, it is with almost surety that any tariff increment towards the optimal tariff will lead to retaliation.

How tariffs are burdens to exporters? Effect on consumers’ discretionary income

In an ideal situation, tariffs should effectively lead to increased prices for consumers who cushion the exporter from the increased tariff. However, in some instances, tariffs do not translate into increased prices. The implication is that exporters must cushion the burden of the tariff. The overall situation leads to low profits. Tariffs affect consumers, especially when they result in an increased cost of essential goods and services. This observation means that consumers have less to save for future spending on non-essential goods.

Quota

How a quota differs from a tariff

Quotas are statistical restrictions and limits that are obligatory to any commodities that are introduced into a country from another. For instance, a nation may be restricted from importing more than 5000 vehicles. Quotas affect consumers since they lead to increased commodity prices. The situation benefits producers.

How a quota differs from a tariff

As shown in the above graph, without the imposition of a quota, Japan exports 8 million cars into the United States where the price of the cars stands at $20,000 as indicated by the equilibrium between demand and supply curve S1. However, upon imposition of the Quota of 5 million cars, the price of cars increases drastically to $27,000. In this case, sellers are the winners. Despite them being willing to sell at $16,000, customers are willing to pay $27,000 due to the reduced supply. Hence, customers are the biggest losers.

On the other hand, tariffs affect foreign importers since they lead to fewer quantities of commodities that are brought and bought by the domestic market.

How a quota differs from a tariff

As shown in the graph above, a tariff of $11,000 on Japanese cars would have the same effect as a quota as described previously. The tariff reduces the number of Japanese car imports to 5 million while increasing the price from $20,000 to $27,000. However, the revenue of $11,000 in the form of tariff goes to the government. In this case, consumers and the importers are losers while the government is the biggest winner.

Policies that may be passed to protect domestic production

To protect domestic production, the government may put in place various kinds of policies (Hornok 66). These policies may be in the form of duties where the government levies any introduced commodities to augment their value to give home manufacturers a competitive advantage in terms of outlays and earnings. The second policy is through import quota, which restricts the number of commodities that are introduced into a nation. This plan protects the local production by ensuring that the market is not flooded with cheap imports. The third policy that the government may impose is in the form of subsidies where local industries and companies are offered financial assistance or tax relief to ensure their products are set below the market price to beat the competition. The fourth policy is export funding where local producers are accorded monetary aid to export more to the international market. These policies protect and boost the production of local industries. They also protect them from competition from international industry players.

How international trade may be a substitute for labor migration

International trade may be a substitute for labor migration. Through free trade, the factors of production tend to move towards equalization (Krugman 475). For instance, when two trading countries that have different factors of production engage in trade, there is a tendency to have increased wages in the country that initially had lower wages. In other words, free trade, which involves also free factor mobility, allows countries to move towards a level playing ground, which eliminates the need to move between the two countries. Labor is less likely to move where the two countries have few barriers to the free movement of factors of production.

Works Cited

Hornok, Cecılia. International Trade Barriers. Budapest, Hungary: Central European University, 2011. Print.

Krugman, Paul. “Increasing returns, monopolistic competition, and international trade.” Journal of international Economics 9.4(1979): 469-479. Print.

Vernon, Raymond. “International investment and international trade in the product cycle.” The quarterly journal of economics 1.1(1966): 190-207. Print.

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