ASSIGNMENT 1 –

QUESTION:

Write short notes on the following concepts:

1. Free trade and protectionism

a) Its meaning and form of protectionism (5mks)

b) Reasons for and against (10mks)

2. Money

a) Definition and its characteristics /attributes of money (5mks)

b) Functions of money (8mks)

Question 1:

Free trade

Free trade is a system of trade policy that allows traders to act and or transact without interference from
government. According to the law of comparative advantage the policy permits trading partners mutual
gains from trade of goods and services.

Under a free trade policy, prices are a reflection of true supply and demand, and are the sole determinant of
resource allocation. Free trade differs from other forms of trade policy where the allocation of goods and
services among trading countries are determined by artificial prices that may or may not reflect the true
nature of supply and demand. These artificial prices are the result of protectionist trade policies, whereby
governments intervene in the market through price adjustments and supply restrictions. Such government
interventions can increase as well as decrease the cost of goods and services to both consumers and
producers.

Interventions include subsidies, taxes and tariffs, non-tariff barriers, such as regulatory legislation and
quotas, and even inter-government

Most states conduct trade policies that are to a lesser or greater degree protectionist.[1] One ubiquitous
protectionist policy employed by states comes in the form of agricultural subsidies whereby countries
attempt to protect their agricultural industries from outside competition by creating artificial low prices for
their agricultural goods.[2]

Free trade agreements are a key element of customs unions and free trade areas. The details and differences
of these agreements are covered in their respective articles.

Features of free trade

Free trade implies the following features[citation needed]:

• trade of goods without taxes (including tariffs) or other trade barriers (e.g., quotas on imports or
subsidies for producers)
 • trade in services without taxes or other trade barrierThe absence of "trade-distorting" policies
(such as taxes, subsidies, regulations, or laws) that give some firms, households, or factors of
production an advantage over others
• Free access to markets
• Free access to market information
• Inability of firms to distort markets through government-imposed monopoly or oligopoly power
• The free movement of labor between and within countries
• The free movement of capital between and within countries

Reasons to Support Free Trade

Reasons to advocate free trade are as follows:

Economic Reasons:

• Economists with classic views propound free trade for economic growth.
• Their view is that free trade increases the level of output in the world economy by promoting
specialization.
• Free trade also lowers prices in an economy by encouraging competition.
• Moral Reasons:
• This is the libertarian view pertaining to some intellectuals belonging to the 18th and 19th century.
• Their view is based on moral grounds as they believe trade restrictions are immoral.
• Trade barriers also restrict consumer rights.
• Free trade between nations reduces vulnerability to wars.

Limitations of Free Trade

Limitations of free trade include:

The WTO is criticized for favoring large corporations.

Protectionism is apparent in some form or the other. Modern free trade policies are not entirely free from
barriers.

Many governments and bureaucratic agencies of different countries act as trade negotiators. They impose
heavy taxes and tariffs to increase their profitability.

A collective global movement towards free trade can propel great economic prosperity and global
cooperation for trading nations.

Protectionism

Protectionism is the economic policy of restraining trade between states, through methods such as tariffs
on imported goods, restrictive quotas, and a variety of other government regulations designed to discourage
imports, and prevent foreign take-over of domestic markets and companies.

This policy is closely aligned with anti-globalization, and contrasts with free trade, where government
barriers to trade and movement of capital are kept to a minimum. The term is mostly used in the context of
economics, where protectionism refers to policies or doctrines which protect businesses and workers
within a country by restricting or regulating trade with foreign nations.
Forms of protectionism

Protectionism comes in many forms. These include:

Currency manipulation: Artificially keeping a country's currency low to make its exports artificially cheap.
America has hinted that China is guilty of this practice without officially naming it as a currency
manipulator.

Non-tariff barriers: These can include using environmental and safety standards as a way of restricting
foreign imports. For example, America and others have argued that the European Union's restrictions on
genetically modified food are a form of agricultural protectionism. In the past, America has also
complained about EU restrictions on beef treated with hormones. The two sides …

What are some of the reasons given for trade restrictions?

(1) Protecting the infant industry. This is the most traditional excuse & is often used by developing
countries. They claim that they have many sunrise industries with great potential to be transformed into
international business. However, at the meantime they yet to realise the cost advantages from economies of
scale. They need time to enlarge their market share, trained their labors & learn to produce via the most
cost-efficient method. As such they need ‘temporary’ protection from low-cost foreign producers until they
are able to compete on equal footing. So tariffs are put up, making the once-cheap foreign goods to be
artificially expensive. Local producers can now raise the price of their goods & thus enable them to enjoy
some profits

Evaluation: However, there problems appear to be bigger than the solution. Firstly, once protectionist
measures are erected it is so politically unpopular to remove it. People with special interests will always
convince policymakers that further protection is justified. Secondly, it is very difficult for a government to
decide which industries that really have the potential comparative advantage & therefore merit protection.
If the industry turns out to be not having a good chance, then this is an enormous waste of financial
resources. Lastly, this argument is not that relevant to developed nations like US, Germany & Japan where
most of its industries have reached maturity stage.

(2) Protecting jobs. At any given time in an economy, there will also be some industries which are
declining (sunset industries). Normally firms in this industry have reached maturity stage but yet
inefficient. Let’s consider US. In 2002, President Bush imposed the controversial 8-30% steel tariffs after
mounting pressure from industry leaders & increasing number of steel mills that went under administration.
If there was no further action taken, probably structural unemployment would have increased even more.
Let’s not forget that there are many industries that are steel related. So bankruptcy of mills have negative
spill over onto others

Evaluation: However, we can also argue that jobs protection in steel mills is at the expense of other
businesses. First, think of the US producers of cars, bikes & other goods which are forced to use more
expensive US steel. They’ll see an increase in the production costs which will force them to raise prices,
thus losing customers. This will cause reduction of jobs in those industries. Or, to mitigate sudden increase
in costs firms often resort to downsize its workforce. So whose job is more important, the steelworker’s or
auto producer’s?

(3) Revenue. In many developing countries, it is quite difficult to earn sufficient revenue from income tax
& corporation tax. This is because, the level of unemployment is usually high & there are very few large
firms around. Therefore the governments impose tariffs onto foreign goods in order to raise the desired
revenue.
Evaluation: However it is worth to take that not all developing nations have the freedom to impose tariffs.
Consider those Sub Saharan African economies. Many of them have considerable comparative advantage
in agriculture sector & production of minerals like diamonds, gold, copper etc. Their economic & political
will are somehow tied due to the high level of debts to IMF. They are forced to undergo strict Structural
Adjustment Policies (SAP) which among require them to liberalise their economy

(4) National security. Some governments admit that although they may not have comparative advantage in
the production of a good, protectionist measures must be maintained to ensure their survival. Agriculture &
steel industries can become strategically important especially in time of crisis or war where they are easily
cut off. In Japan, very high restrictive quotas & tariffs are placed on rice. The farmers need to be protected
so that they can grow enough food to feed the Japanese in crisis. The same reason for US which wants
protection for its steel industry so that they can produce sufficient tanks & munitions during an
international conflict

Evaluation: However, this argument is often overstated. In many cases, it is unlikely that a country which
goes on war or in crisis be cut off from all supplies. It is merely an excuse to erect protectionism

(5) Protect consumers from unsafe products. Very often consumers are unaware of the quality & safety
of the products they consume. Therefore we have the government stepping in to act as an agent
guaranteeing consumers product safety. Cars must pass safety inspection, rules are made regarding types of
chemicals that can be used onto food etc. Having said so, different countries have different standards that
might not conform to other beliefs about product safety. For instance, the famous EU ban on US beef &
dairy products claiming that the cattle have been injected with hormones to increase its size & milk
production. The US government defends itself by saying that this does not pose a risk to consumers & EU
medical authorities have no hard evidence for this

Evaluation: However, it is believed that there is no safety issues involved here. What EU did was actually
to protect its inefficient beef & dairy producers like France & Spain. Also this form of ‘obvious’
protectionist measure often invite retaliation. This was the case as later in 1999, US retaliated by imposing
trade sanctions against dairy goods from EU worth more than $117 million. In return, it harmed those EU
farmers as much as it hurt those in US

(6) Discourage unethical practices. Sometimes a country might wish to impose trade restrictions to force
a change in other countries. For instance, tariffs are placed onto shoes & textile from East Asia to exhibit
dissatisfaction & a form of ‘boycott’ against the working practices there. In China employees have to
endure long working hours & yet ill-paid. Also in many instances, these employers fail to comply with
compulsory health & safety legislations thus giving them artificial cost competitiveness. Also trade
restrictions are a method to show dissatisfactions with some like African nations as the money is used to
finance civil war & terrorism within Africa

(7) Protection from dumping. Dumping is an act of selling large quantities of a good in another country at
price below its production costs. For example, EU has large surpluses of butter & milk. Therefore it
decided to sell these at a very low price in another developing economy. If that particular country does not
have any form of protection onto its local dairy industry, very soon all those dairy farmers will be driven
out of job

Evaluation: However, it is very difficult to distinguish whether the case of dumping is purely done with
intention to drive out local industries or the exporting countries really enjoy significant EOS

(8) Narrowing BOP deficit. One of the arguments for protectionist measures is also to fix the deficit in
balance of payments particularly current account. It is hoped that with more expensive foreign goods, its
demand will fall in relation to exports. As such over the time current account deficit will be narrowed. The
IMF actually allows member countries to impose temporary trade restrictions to get their BOP fixed

Evaluation: However, this is more like a short run solution. To seek for long run remedy, it is best if the
particular country identifies the root cause for deficit. Is it due to lack of commitment onto education &
healthcare sector? Could it be accrued to low level of investment onto capital equipments? Chances to
narrow the deficit will increase if solutions to boost exports & cut imports are both taken simultaneously.
Also a government will have to be careful not to impose excessive import tariffs onto intermediate goods.
Or else, production costs will increase & exports fall at a faster rate than imports. BOP deficit worsens

(9) Cultural preservation. This is a non-economic reason. In some countries like Canada, various forms of
restrictions such as 80% tax are put onto US sales of publications, magazines & textbooks. In 1990s this
cultural protectionism was expanding to kill off US ‘intruders’. Critics argued that without media
protection, US magazines like Time & Business Week could soon deprive Canadians of the ability to read
about themselves. In short, to filter the cultural imperialism
Arguments against protectionism

Protectionism is frequently criticized[by whom?] as harming the people it is meant to help. Most mainstream
economists instead support free trade.[1][4] Economic theory, under the principle of comparative advantage,
shows that the gains from free trade outweigh any losses as free trade creates more jobs than it destroys
because it allows countries to specialize in the production of goods and services in which they have a
comparative advantage.[11] Protectionism results in deadweight loss; this loss to overall welfare gives no-
one any benefit, unlike in a free market, where there is no such total loss. According to economist Stephen
P. Magee, the benefits of free trade outweigh the losses by as much as 100 to 1.[12]

Most economists, including Nobel prize winners Milton Friedman and Paul Krugman, believe that free
trade helps workers in developing countries, even though they are not subject to the stringent health and
labour standards of developed countries. This is because "the growth of manufacturing — and of the
myriad other jobs that the new export sector creates — has a ripple effect throughout the economy" that
creates competition among producers, lifting wages and living conditions.[13] Economists[who?] have
suggested that those who support protectionism ostensibly to further the interests of workers in least
developed countries are in fact being disingenuous, seeking only to protect jobs in developed countries.[14]
Additionally, workers in the least developed countries only accept jobs if they are the best on offer, as all
mutually consensual exchanges must be of benefit to both sides, else they wouldn't be entered into freely.
That they accept low-paying jobs from companies in developed countries shows that their other
employment prospects are worse.

Alan Greenspan, former chair of the American Federal Reserve, has criticized protectionist proposals as
leading "to an atrophy of our competitive ability. ... If the protectionist route is followed, newer, more
efficient industries will have less scope to expand, and overall output and economic welfare will suffer."[15]

Protectionism has also been accused of being one of the major causes of war. Proponents of this theory
point to the constant warfare in the 17th and 18th centuries among European countries whose governments
were predominantly mercantilist and protectionist, the American Revolution, which came about primarily
due to British tariffs and taxes, as well as the protective policies preceding both World War I and World
War II. According to Frederic Bastiat, "When goods cannot cross borders, armies will."

Free trade promotes equal access to domestic resources (human, natural, capital, etc.) for domestic
participants and foreign participants alike. Some thinkers[who?] extend that under free trade, citizens of
participating countries deserve equal access to resources and social welfare (labor laws, education, etc.).
Visa entrance policies tend to discourage free reallocation between many countries, and encourage it with
others. High freedom and mobility has been shown to lead to far greater development than aid programs in
many cases, for example eastern European countries in the European Union. In other words visa entrance
requirements are a form of local protectionism.

Money

From Mike Moffat, former About.com Guide

Definition:

Money is a good that acts as a medium of exchange in transactions. Classically it is said that money acts as
a unit of account, a store of value, and a medium of exchange. Most authors find that the first two are
nonessential properties that follow from the third. In fact, other goods are often better than money at being
intertemporal stores of value, since most monies degrade in value over time through inflation or the
overthrow of governments.

A medium that can be exchanged for goods and services and is used as a measure of their values on the
market, including among its forms a commodity such as gold, an officially issued coin or note, or a deposit
in a checking account or other readily liquefiable account.

The official currency, coins, and negotiable paper notes issued by a government.

Characteristics of money

 These Characteristics are:

o Durability

o Portability

o Divisibility

o Uniformity

o Limited Supply

o Acceptability
 Durability

• Durability means that the item must be able to withstand being used repeatedly.

• Items that are considered Currency, coins and paper bills used as money meet this requirement.

 Portability

• Portability means that individuals are able to carry money with them and transfer it easily to other
individuals.

• This is why coins and paper money have historically proved popular.

 Divisibility

• Divisibility means that the money can easily be divided into smaller units of value.

• Today, different coins and notes convey these fractional values.

 Uniformity

• Uniformity means that all versions of the same denomination of currency must have the
purchasing power.

• As an example, a 1928 $2 bill will still buy $2 worth of goods or services today.

 Limited Supply

• Limited Supply means that restrictions on the amount of money in circulation ensure that values
remain relatively constant for the currency.

• The responsibility for maintaining an adequate money supply falls on the Federal Reserve System.

 Acceptability

• Acceptability means that everyone must be able to use the money for transactions.

• In the United States this is indicated on our paper bills by the notation: “This note is legal tender
for all debts, public and private”.

Functions / uses of money

• These uses are:

o a Medium of Exchange

o a Unit of Account

o a Store of Value
 o
o a Standard of deferred payment

 …a Medium of Exchange

• By definition, a Medium of Exchange is anything that is used to determine value during the
exchange of goods and services.

• Money allows us to use systems of trade beyond the Barter System.

o Bartering is directly trading one good or service for another.

• Your money acts as a common ground for determining value.

 …a Unit of Account

• Money can be used as a means to compare the values of goods and services.

• You can use the monetary value assigned to a specific good or service to compare it to one offered
by a different provider.

• Money allows us to compare similar offers for goods and services to determine the best value.

 …a Store of Value

• Money is used to maintain the value of a transaction over time.

• If you receive monetary compensation for a good or service, the actual amount that your received
does not change if you do not use it immediately.

o You can spend, or exchange, your money at a later time without penalty.

• However, the functional value of the stored money may change over time due to other factors.
• Again, this is something that people keep in order to maintain the value of their wealth. Again,
while it would usually be the same as the medium of exchange, in inflationary times other media
might be substituted, such as jewelry, land or collectable goods. In this sense, money is "set aside"
for the future.

• Standard of deferred payment

This is the unit in which debt contracts are stated. Deferred payment means a payment made in
the future, not now. Here, again, it is usually the same as the medium of exchange, but not always.
During periods of inflation, people may accept paper money for immediate payment, but insist on
some other medium, such as real goods and services or gold, for deferred payment -- because the
medium of exchange would lose much of its value in the meanwhile.