Managerial Economics Lecture 4 07 May 2016 AARIFAH RAZAK
Lecture outline International trade Balance of Payments Exchange Rates Application discussion of articles
International Trade Exchange of goods and services between countries Globalisation Degree of trade depends on openness Economists are concerned with efficiency - trade is good as long as resources are being used efficiently Idea of Specialisation
Theories of International Trade There is an unequal distribution of resources among countries Absolute advantage - Perfect specialisation - One country (X) may be able to produce the same product more cheaply (fewer inputs) than another country (Y) - Country X has an absolute advantage in the production of that product Comparative (or relative) advantage - Concerned with opportunity costs - One country (X) may be able to produce the same product at a lower opportunity cost than another country (Y) - Country X can specialise in the production of that product and export to country Y. - As long as the opportunity costs between two countries differ, international trade will benefit both countries - Country Y can allocate its resources to produce some other good in which it has a comparative advantage and that way consume more of each good
Gains from Trade - Globalisation Efficiency - increasing the amount produced for a given level of effort Increases quantity sold and profits realised Improves competitiveness of local business Technology gains Smoothens seasonal fluctuations in demand Faster growth Higher long run wage levels Capital mobility allows for better investment opportunities
Trade Policy Government may put trade barriers in place to: - protect infant domestic industries from foreign competition - encourage learning by doing - create and exploit a strategic trade advantage - protect domestic producers from dumping by foreign companies or governments - prevent loss of jobs Protectionism vs Free Trade Protected industries usually lag behind those that compete globally Inefficiency Trade tariffs increase the prices of goods - loss of welfare Imports are not necessarily bad for the economy
Main Barriers to Trade Tariffs - special tax on imported goods - makes imports more expensive and less competitive - source of revenue for government Quotas - limits the quantity of goods imported Embargos - complete prohibition of trade Subsidies granted to local businesses Non-tariff barriers Exchange controls limiting amount of foreign currency available Exchange rate policy movements in exchange rates impact imports and exports
Balance of Payments
The Balance of Payments Accounting Record Balance Sheet of the Country Record of all transactions occurring between South African households, firms and government and foreign households, firms and governments over a period of time (quarter / year)
Composition of the Balance of Payments Current account Exports less imports (mainly, but there are other components) Financial account Net capital inflows less net capital outflows Gold and other foreign reserves Change is the sum of current and financial accounts Unrecorded transactions errors and omissions
Excerpt from Quarterly Bulletin South Africa s annual trade deficit with the rest of the world halved between 2014 and 2015 despite a widening trend in the second half of 2015. The trade balance switched from a surplus in the second quarter of 2015 to deficits of R22 billion and R57 billion in the third and fourth quarters respectively. A contraction in merchandise export volumes alongside increased domestic demand for foreign-produced goods largely shaped developments on the trade account in the final quarter of 2015. Notwithstanding the widening of the trade deficit to 1,4 per cent of GDP in the fourth quarter of 2015, the trade deficit narrowed on an annual basis from 1,8 per cent of GDP in 2014 to 0,9 per cent in 2015. The traditional shortfall on the services, income and current transfer account with the rest of the world broadened slightly from the third to the fourth quarter of 2015, exacerbating the weakening of the trade balance over the period. The deficit on the current account of the balance of payments thus expanded from 4,3 per cent of GDP in the third quarter of 2015 to 5,1 per cent in the fourth quarter. On an annual basis, the deficit narrowed from 5,4 per cent of GDP in 2014 to 4,4 per cent in 2015. (Full Quarterly Bulletin, March 2016:32)
Exchange Rates
The Foreign Exchange Market Exchange rate: the price of one country s currency in terms of the currency of another country s currency Nominal vs Real exchange rate - inflation impacts the purchasing power of the rand and high inflation implies a decreasing currency value as its purchasing power relative to other countries worsens Demand and Supply of Currency determined in the FOREX market Consider the Rand-Dollar Forex market Demand for dollars determined by: - South African importers who require US dollars to pay for imports - South African citizens who wish to invest in US dollar-denominated assets Supply of dollars determined by: - SA exporters who earn dollars and exchange them for rands - Foreigners wishing to buy SA rand-denominated assets.
Equilibrium Exchange Rate Downward sloping demand curve quantity of dollars demanded increases as dollar becomes cheaper (price decreases) Upward-sloping supply curve as at a low dollar price, the quantity supplied of dollars will be low Putting the demand and supply of dollars together we see how the equilibrium rand-dollar exchange rate is obtained VAN SCHAIK PUBLISHERS
Shifts in Equilibrium The exchange rate will appreciate or depreciate in response to changes in demand and supply If the price of the dollar falls (fewer rands to buy 1 dollar) - dollar has depreciated but the rand has appreciated If the price of the dollar increases (more rands to buy 1 dollar) - dollar has appreciated but the rand has depreciated
Decrease in Supply of Dollars Perhaps agricultural exports decline due to drought South Africa exports less of these goods and earns fewer dollars Supply of dollars contracts Exchange rate increases Dollar appreciates Rand depreciates (weakens) Alternatively Nene sacking causes US investors to pull out
Changes in Demand and Supply of Dollars
Fixed and Floating Exchange Rates Monetary authority is responsible for monitoring the exchange rate Fixed exchange rate: Government intervenes in the foreign exchange market to ensure the exchange rate remains fixed Floating Exchange rate: Exchange rate is allowed to fluctuate freely based on market forces and government does not interfere Managed floating is a combination: exchange rate fluctuates with market forces but monetary authorities may intervene if necessary. In SA, the SARB intervenes using foreign reserves.
Economic effects of the Exchange Rate Assume the rand depreciates against the dollar Exports cheaper and imports more expensive (current account improves) It increases Aggregate demand and spending where people purchase more local goods which become relatively cheaper and pay more for imported goods. This drives up domestic prices (inflation) SARB increases interest rates to reduce inflation by reducing AD Price stability and higher interest rates, attract foreign investors The supply of dollars increases with increased investment in South Africa The exchange rate strengthens again
Discussion Nene sacking will plunge SA into recession next year A glimmer of hope for SA s battered currency
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