International Economics Answer 2022

Running head: INTERNATIONAL ECONOMICS
International Economics
Name of the Student:
Name of the University:
Author note:

INTERNATIONAL ECONOMICS 1
Table of Contents
Answer 1..........................................................................................................................................3
Answer i).....................................................................................................................................3
Answer ii & iii)............................................................................................................................4
Answer 2..........................................................................................................................................6
Answer i).....................................................................................................................................6
Answer ii)....................................................................................................................................7
Answer 3..........................................................................................................................................8
Answer i).....................................................................................................................................8
Answer ii)....................................................................................................................................9
Answer 4........................................................................................................................................11
Answer i)...................................................................................................................................11
Answer ii)..................................................................................................................................11
Answer iii).................................................................................................................................12
Answer 5........................................................................................................................................13
Answer i)...................................................................................................................................13
Answer ii)..................................................................................................................................14
Answer iii).................................................................................................................................15
Answer 6........................................................................................................................................16
Answer i)...................................................................................................................................16

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Answer ii)..................................................................................................................................16
Answer iii).................................................................................................................................17
Answer 7........................................................................................................................................19
Answer i)...................................................................................................................................19
Answer ii)..................................................................................................................................19
Answer iii).................................................................................................................................20
Answer 8........................................................................................................................................21
Answer i)...................................................................................................................................21
Answer ii)..................................................................................................................................21
Answer iii).................................................................................................................................22
References......................................................................................................................................23

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Answer 1
Answer i)
Tariff is defined as the tax that the government imposes on the goods and services that
are imported from other nations to raise the price of the imported goods for making those less
desirable or less competitive in comparison to the domestic goods and services. The tariff rates
are sometimes different for imports from different countries or for specific types of goods or
services which indicates the trade preference of the importing country (Feenstra et al., 2019).
Trade policy refers to the collection of different rules and regulations related to the
international trade. These policies are imposed to achieve growth and development in the
economy through international trade and gain mutual benefits with the trading partners. There
are various instruments that can be used under trade policies, such as, tariffs, subsidies, import
quota, voluntary export restraints, anti-dumping duties etc. (Yotov et al., 2016). Import tariff is a
very significant trade policy instrument, which represents a tax imposed on imported goods and
services. There are two types of import tariffs, namely, specific tariffs and Ad valorem tariffs. As
stated by Orefice (2017), specific tariffs are those that are imposed as a fixed rate on each unit of
the goods, such as, a specific tariff of $10 is imposed on each unit of an imported branded
handbag with international price of $100. This tax raises the price of the imported bag to $110 in
the domestic market and the government collects the revenue of $10 per unit of the imported
bag. Secondly, ad valorem tariffs are imposed as a fraction of the value of the imported goods
and services. Such as, when a 20% ad valorem tariff is imposed on an imported handbag with an
international price of $100, then the tariff imposed price in the domestic economy becomes $120
and the government gets a revenue of $20 on each of the imported handbag.

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SDomest
ic
Quantity
Price
PTariff
PWorld SWorld
SWorld +
Tariff
PDomestic
QDomest
ic
QST QDT
DDomes
tic
Qs QD
BA
FG
Tariff revenue
Answer ii & iii)
Positive effect of tariff is enjoyed by the government in terms of increased revenue, and
the domestic producers as the tariff is imposed to provide them protection against the foreign
competitors by raising the price of the imported goods and services. The negative effect of
import tariff is borne by the consumers as they have to pay higher price for enjoying the
imported products (Orefice, 2017).
Figure 1: positive and negative effect of import tariff
As seen from the above image, in no trade situation, the domestic demand for quantity is
QDomestic and corresponding price is PDomestic. In case of trade, supply increases at world price,
PWorld, which is lower than domestic price. At this price, domestic demand also increases for
cheaper imported goods. Without tariff, the import quantity is Qs – QD. Hence, to protect the
domestic sellers and raise revenue, the government imposes tariff on the imports, and that raises
the price to PTariff. At higher price, import supply reduces from Qs to QST, and demand also falls

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from QD to QDT, and the import volume is QST – QDT, which is less. The rectangle ABFG
represents the revenue of the government. It can be seen that the positive effect of tariff goes to
the government and to the domestic sellers, while the negative effect falls on the consumers in
terms of higher price and less supply of imported goods.

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Answer 2
Answer i)
Arguments supporting free trade
i. Free trade enables the nations to practice specialization according to their comparative
advantage over the trading partners. Hence, it provides opportunities for efficient and
optimized resource allocation and utilization.
ii. Increased economic growth can be achieved for the countries under free trade agreement.
The economies can exchange goods and services without trade and tariff restrictions
which helps in the growth of the domestic production through transfer of advanced
technology and knowledge, and it also increases competitiveness of local industries to
enter the global market.
iii. Reduced or zero trade barriers lead to increased trade for the countries, as low cost
production is possible, resulting in higher output by the nations (Jungherr et al., 2018).
There are many free trade zones in the world, established with the aim of achieving economic
growth and development of the member countries through trade creation. NAFTA is one such
free trade agreement. It stands for North American Free Trade Agreement, which is a trilateral
trade bloc among the USA, Canada and Mexico. It is of the biggest trade blocs of the world in
terms of GDP. Due to NAFTA, the trade between the three member countries quadrupled from
$290 billion to $1.23 trillion between 1993 and 2019 (Doran & Marchildon, 2019). This boosted
economic growth and development, income and employment generation, and also lowered prices
of imported goods between the member nations due to reduced tariff, which in turn benefitted the
trade through increase of exports and imports.

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Answer ii)
Arguments against free trade
i) Free trade is not capable of bringing all-round development to the industries as by
applying the comparative advantage principle, a nation can specialize in few goods
and services only. The inefficient industries remain neglected in such cases and thus,
all over development is not possible. Furthermore,
ii) Chances of domestic industries being left out are much higher under free trade. Due
to lack of tariff, the imported goods are cheaper and hence, there may be increase in
the demand for imported goods, while the demand for domestic goods fall
substantially. This affects the domestic industries negatively.
iii) The scopes of raising revenue from import taxes reduce significantly under free trade.
Many small nations rely heavily on the import tariffs for raising revenue, however, if
there is reduced trade tariffs and taxes, then revenue is also reduced (Jungherr et al.,
2018).
Regarding NAFTA, there are some criticisms of this free trade agreement. While USA has been
taking the advantages of cheap labor in Mexico for manufacturing and in other labour intensive
industries, NAFTA is criticized for the powerful influential nations taking advantage of the poor
country. The local governments are undermined while implementing laws beneficial for their
own economy as NAFTA prevents them to impose those laws that might affect the NAFTA
benefits. Thus, even though trade volume between the member countries has increased,
individual development are not much significant or attributable to the free trade, such as,
Mexico’s GDP and GDP per capita are lower than that of Brazil and Chile. Many inefficient

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businesses survived due to free trade agreement lowering down the overall development level
(Doran & Marchildon, 2019).
Answer 3
Answer i)
Uruguay Round represents the 8th round of the Multilateral Trade Negotiations (MTN)
that was conducted within the framework of the General Agreement on Tariffs and Trade
(GATT). It spanned from 1986 to 1993 and included 123 nations as contacting parties (Wto.org,
2020). This round covered almost all types of trade that included every type of products and
services, such as, toothbrushes to automobiles, banking services to healthcare,
telecommunications to knowledge transfer, and from genes of genetically modified agricultural
products to the treatment for AIDS. The Uruguay Round is considered to be the largest trade
negotiation in the history and of any kind (Wto.org, 2020).
The Uruguay Round were successful as it brought the biggest reform of the trading
system of the world since GATT was established at the end of World War II. Despite its early
failure, it took painstaking negotiation processes for seven years and included every aspect of
trade and every type of goods and services to be traded, and addressed all types of tariff policies
to be imposed. The major success of the Uruguay Round was the creation of World Trade
Organization (WTO) and GATT remained an integral part of the WTO agreements (European
Commission, 2013). The other success factors are:
 Trade-weighted average tariff cut of 38%
 Inclusion of new economic sectors like services under international trading system, that
is, adoption of General Agreement of trade in Services (GATS)

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 Inclusion of Agriculture trade under full GATT disciplines
 Agreement achieved on Trade-Related Aspects of Intellectual Property Rights (TRIPS)
 Establishment of a unified dispute settlement system, known as Dispute Settlement Body
(DSB)
 Agreement is reached on Trade-Related Investment Measures (TRIMS)
 Establishment of trade Policy Review Mechanism (TPRM) (European Commission,
2013)
The guidelines were accepted by the participating countries over the
years, such as, within only two years from 1986, the participants agreed on a
package of cuts in the import duties on the tropical products, which are
primarily exported by the developing countries, and this was a huge benefit
for the developing countries. The agricultural trade and services trade were
two major success points. Prior to this round, the trade of agricultural
products were decreasing due to increased subsidies, falling world prices,
rising support cost and build-up of stocks and after this round, the terms
have been made favorable for agricultural trade (Caldas, 2018). These factors
are still being followed in today’s international trade. Under WTO regulations
as per the Uruguay Round agreements, the international trade on all types of
goods and services, such as, from consumer products to banking services
are carried on today also.
Answer ii)
The Uruguay round has been criticized for not paying sufficient attentional to the
developing countries. Moreover, the agreements made to protect the intellectual property and the

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industrial tariffs have been found to be putting many constraints on the policy making and actual
needs. It has been observed that the developing nations lacked experience in regards to the WTO
negotiations and guidelines, and hence these economies were affected by the developed
industrial nations (McDorman, 2019). For example, the USA became major power of the GATT
and WTO, ad hence, it started showing mercantilist attitude and in today’s international trade
also, USA is a dominating force, placing embargos on various countries, such as, on Cuba, on
the basis of their political relationships in the past two decades. These aspects negatively affect
the developing nations’ growth and development through international trade and also create
imbalances in the global market. The Uruguay Round did not focus on such potential issues at
the time of creation (Finger & Nogues, 2002).

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Answer 4
Answer i)
The aim of import substitution policy is to encourage the national production. The
strategy of import substitution under the trade policy is meant to abolish the import of foreign
goods and encourage the domestic production. As stated by Cherkesova et al. (2019), the
purpose of import substitution policy is changing the economic structure of a nation by
decreasing the dependency on the foreign goods through increasing production of domestic
goods. The protection measures for the domestic producers include high tariffs and duties on
imports, restrictions through quotas, and these are applied to the fundamentally high-cost
industries. This policy is majorly adopted by the developing countries in order to boost the
domestic economic growth as well as collect higher revenue from imported goods and services.
Answer ii)
The positive effects of import substitution policy include higher self-reliance and
increased efficiency of the domestic producers. When a country imposes import substitution
policy, then the domestic manufacturers can increase their productivity, efficiency and quality of
their production which results in increased competitiveness in the global market. This also leads
to increased employment scopes for the local people and domestically produced goods are
available at a lower price. For example, Sri Lanka, the South-Asian developing economy
implemented import substitution policy in 1977 and it resulted in poverty reduction to some
extent. The garment industry benefitted mostly from import substitution policy and today, many
major economies outsource their clothing manufacturing to Sri Lanka for reducing their cost of

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production. Thus, garment industry brings a high amount of foreign exchange to the economy
(Zobov et al., 2017).
Answer iii)
The negative effects of import substitution include the chances of domestic industries
remaining inefficient as those are protected from foreign competitors and hence, they have no
incentive for increasing their efficiency. Moreover, implementation of import substitution
strategy on the entire industrial sector for a long time can generate a sub-optimal production
level. Avoidance of foreign competition often makes the domestic industry highly inefficient,
generating less than full potential output, and less jobs for people. Thirdly, government also loses
their share of revenue that is generated from imports. For example, after World War II, Brazil
like many other LDCs applied import substitution strategy and enjoyed a short period of success,
however, in long run, this led to stagnant growth and at the same time, left many industries
inefficient and many other remained infants (Adewale, 2017). Countries that abandoned the
import substitution policy such as, Taiwan and Korea, experienced much faster growth and are
almost developed.

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Answer 5
Answer i)
Balance of payments (BOP) is the statement or record of all the monetary transactions
occurred between the residents of a nation and the rest of the world at any given period. BOP
includes all the transactions, incoming or outgoing, by individuals, corporate organizations, and
the government and the record is useful for measuring the flow of funds required for economic
development. The BOP is presented in a double entry book keeping system, under the headings
credits and debits and after all the elements are recorded correctly, the total is summed up to
zero. However, when the total credit does not equal to total debits, BOP imbalance occurs and it
indicates whether the country has funds surplus or deficit. When the exports of a country are
higher than its imports, the BOP is in surplus as credits are higher than debits. In case of BOP
deficit, the imports are higher than exports (Heijdra, 2017).
The components of BOP current account (goods and services), capital account (assets)
and financial account (Investments and intangibles). These are entered in the following
classifications, exports and imports of goods (visible items), exports and imports of services
(invisible items), unilateral transfers (gifts, indemnities, remittances, etc. received from and paid
to the foreigners) and capital receipts (borrowings from/lending to foreigners, capital repayments
by/to foreigners, or sale of assets to or purchase of assets from foreigners) (Uribe & Schmitt-
Grohé, 2017). Thus, all these components are critical for BOP as these indicate which elements
are creating deficit for the economy and which are boosting the economic growth. Current and
capital accounts are the dominating elements due to their large volume of transactions.

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Trade plays a very crucial role in BOP. The record of the transactions containing the
import and export of visible and invisible items is known as Balance of Trade (BOT). Since,
BOP is the statement of all the monetary inflow and outflow of the nation, hence, international
trade is a major source of monetary transactions with other nations. The value of exports and
imports determines the position of an economy whether it is in surplus or deficit (Minford &
Peel, 2019).
Answer ii)
Figure 2: Current account deficit of New Zealand, 2016-2020
(Source: Tradingeconomics.com, 2020)
New Zealand has been facing current account deficit for maximum time in the last 5
years. In February 2020, New Zealand recorded NZ $594 million surplus in the trade balance,
which was NZ $94 million in February 2019. The exports increased 4.5% year-on-year to NZ
$4920 million while imports fell 9.9% to NZ $4330 million due to lack of domestic demand in
all categories (Tradingeconomics.com, 2020).

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The current account deficit of New Zealand for the year ended in September 2018
reached around NZ $10.5 billion (Stats.govt.nz, 2018). This was the biggest annual current
account deficit in New Zealand since 2009. It remained stable in 2019. The seasonally adjusted
current account deficit remained unchanged at NZ $2.6 billion in Q1 of 2019 from Q4 of 2018.
In the last 5 years, the country has experienced current account deficit, among which it was
slightly less in 2016. The data implies that New Zealand spends more than it earns from the rest
of the world, which also says that the level of imports has been higher in the last 5 years than its
exports. According to Stats NZ (2019), New Zealand made more investments in other countries
than the return to the foreign investors in New Zealand, which contributed in lessening the BOP
deficit in 2019. It has been observed that investment level was comparatively higher for New
Zealand in the last five years than the exports and imports of goods, which led to much volatility
and deficit in BOP (Tibshraeny, 2019).
Answer iii)
The annual trade deficit in New Zealand in 2018 was at 11-year high, reaching at NZ
$5.9 billion (Stats.govt.nz, 2019). The increase in fuel imports pushed up the trade deficit. The
continuous trade deficit over the five years implies higher imports and lower exports of goods
and services. Rising value of imported crude oil and petrol were major reasons for widening the
deficit gap. Thus, international trade significantly affected BOP deficit of New Zealand.

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Answer 6
Answer i)
Foreign exchange or Forex refers to the trading of one currency for another (Cavallino,
2019). In other words, conversion of the currency of one country into that of another country is
called foreign exchange. For example, exchanging USD for NZD or AUD in the Forex market is
called as foreign exchange.
Foreign exchange market is similar to any other market for goods and services
transactions. The global trading of currencies take place in the foreign exchange market. The
rates or price of forex depends on the market demand and supply. Its rates fluctuate on the basis
of market demand and supply and on the global sentiments related to a particular nation and its
currency. Hence, the chances of fluctuation of forex price are quite high. Without any market
place, it is extremely difficult to determine the price of the currencies and trade those during
international trade, commerce and investments (Cavallino, 2019).

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Answer ii)
Figure 3: Equilibrium in Forex Market
In the foreign exchange market, the price of the currency is knows as exchange rate, that
is, exchange rate refers to the price of one currency in terms of another. Supply of domestic
currency is assumed to be fixed in an economy and hence, the supply curve is vertical. The
demand curve is downward sloping, indicating higher exchange value for a currency leads to
lower demand. In the above image, equilibrium is achieved at point B, however, if there is excess
demand for dollar in the forex market (Point C), then it price or exchange rate rises, and
similarly, if there is excess supply of dollar in the market against Euro (Point A), then dollar
value falls. The current USD-Euro exchange rate is 1 Euro = 1.10 USD, which indicates the
forex equilibrium between these two currencies.

18INTERNATIONAL ECONOMICS
Answer iii)
Figure 4: NZD – USD exchange rates, 2013 – 2019
(Source: Macrotrends.net, 2020)
Exchange rate plays a very crucial rate in a country’s import and export volume. When
the currency of a country is strengthening, that is, demand for the currency is higher in the
market, appreciating the currency value, then imports become cheaper and exports become more
expensive. Hence, export volume falls and import rises. Similarly, when the currency of a nation
is cheaper, or depreciates in value, due to excess supply in the global market, the currency
becomes weaker, and in this situation, exports of the country becomes cheaper and thereby
export volume increases, while imports become more expensive, resulting in falling imports
(Corsetti, Dedola & Leduc, 2018). As seen in case of New Zealand’s BOP in the last few years,
the volume of imports was higher than exports resulting in current account deficit. This implies
that value of NZD has been appreciating which increased import volume than the export volume.

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For example, as seen from the graph above, since 2013, the exchange rate between NZD and
USD has been falling, that is, price of USD in terms of NZD has been depreciating and therefore,
it led to higher imports from the USA than exports from New Zealand to USA (Macrotrends.net,
2020).

20INTERNATIONAL ECONOMICS
Answer 7
Answer i)
International capital market refers to the system for the governments, organizations and
people where they can borrow, invest, or can do both across the national boundaries. Thus,
someone can access the international capital market either through debt or equity (Phelan &
Toda, 2019). Every nation has a domestic capital market, which is a major part of financial
sector. Similarly, in the international capital market, the governments of different countries
engage in capital transactions, through borrowing or investing.
International capital markets provide benefits like higher returns and cheaper cost of
borrowing and risk diversification (Phelan & Toda, 2019). Through this market, countries can
borrow from another country with lower borrowing cost or invest in others for higher rate of
returns. Moreover, as they can access more opportunities for investing or borrowing, the risk is
reduced, as not all economies would face turbulence at the same time.
Answer ii)
The structure of the international capital market consists of two sections, primary and
secondary. In the primary market, new securities, that is, bonds and stocks are issued, and in the
secondary market, maximum number of capital transactions take place. The latter one includes
all the stock exchanges, such as, the London Stock Exchange, the New York Stock Exchange,
and the Tokyo Nikkei etc., future and options markets, and bond markets (Flandreau, 2017).
These markets make dealings in security trading. The products include bonds, securities, stocks,
and the key components of the international capital markets are International Equity Markets,
International Bond Markets, Euro Currency Markets, and Offshore Centers (Phelan & Toda,

21INTERNATIONAL ECONOMICS
2019). In the past decade, the international capital markets have been more controlled and
regularized due to increased effects of globalization. The participants of these markets are the
International Banks, Securities Firm, Global Financial Firms and Investment Firms (Flandreau,
2017).
Answer iii)
International trade has strong connection with international flows of the financial capital.
Unbalanced trade between countries can trigger financial crisis and that can lead the economies
into recessions. Large trade deficits are the causes of these type of financial crisis as foreign
investors lose their confidence on the economy and move their investment in other economies.
This leads to a massive fall in the real GDP and causes recession. For example, in 1995, Mexico
faced similar situation and its GDP fell 8.1%. Similarly, in 1997-98, South Korea, Thailand,
Indonesia and Malaysia, faced this economic downfall, known as Asian Financial Crisis (Hsieh,
2017). In all the cases, the crisis started with large trade deficits. Hence, if trade balance is
positive, the international capital flow will remain favorable for the economic growth of the
country.

22INTERNATIONAL ECONOMICS
Answer 8
Answer i)
Money is a universally accepted medium of exchange. It can be defined as an economic
unit used for transactional purposes. Hence, in a market, for any type of transactions, like, buying
or selling of a product or service, money is used for exchange. The roles of money in an
economy include medium of exchange, measure of value, store of value, and standard of
deferred payments (Goodhart, 2019).
Answer ii)
Money was introduced to avoid the problems of barter system. In the barter system, there
were many difficulties, such as, double coincidence of wants, no standard of measuring value of
a product or service, absence of subdivision of products or services, such as, selling a house in
exchange for some land and some livestock, and difficulty of storage (Graziani, 2016). Thus,
with the progress of civilizations all over the world, the concept of money was introduced.
There are four stages of international monetary system, namely Gold Standard (1875-
1914), Inter-war period (1915-1944), Bretton Woods system (1945-1972) and Present
International Monetary system (1972-present). In Gold standard, the countries fixed the currency
value in terms of gold, and it had a fixed exchange rate. In the inter-war period, gold standard
was abandoned and currencies were depreciated and it introduced competitive devaluation and
fluctuating exchange rate (Eichengreen, 2019). Bretton Woods system was the foundation of the
international monetary system. It created a dollar based fixed exchange rate system, where only
US fixed their currency against gold and other countries pegged their currencies to USD. After

23INTERNATIONAL ECONOMICS
this system collapsed in 1971, the present system was introduced with flexible exchange rate
(Eichengreen, 2019).
Answer iii)
International monetary system has exchange rates, which influences the trade and
investment volume. Countries with appreciating currency value will attract more investment due
to higher returns for the investors, and trade inflow will rise, while when a country is facing
currency depreciation, and exchange rate is rising, then investors would not be investing in the
country and trade outflow will increase. Hence, the chances of trade deficit is higher in case of
appreciating currency and trade surplus has a higher probability of occurrence in case of
depreciating currency (Shelton, 2018).

24INTERNATIONAL ECONOMICS
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