International Economics Diagram
China has an absolute advantage in the production of both shoes and cloth. It can produce more of both than India with the same factor inputs. However, India has a comparative advantage in producing shoes, since they only give up 2.5 meters of cloth for each pair, whereas China gives up 4 meters of cloth. China should specialize in cloth and India in shoes.
Before trade, Qe corn is produced domestically at the price of Pe. When free trade takes place Q1Q2 of corn is imported at the world price of P1, and Q1 of corn is produced domestically.
When the government gives a subsidy to domestic producers, the domestic supply curve shirts to the right from Sdomestic to Sdomestic + Subsidy. The price consumers remains the same, but imports fall from Q1Q2 to Q3Q2 and domestic production increases from Q1 to Q3.
The imposition of a tariff upon imported corn means that the price will rise from P to P + Tariff. A tariff is a tax imposed on imports and is a type of protectionism. Initially the quantity of imports from other counties was Q1Q2, but with a tariff they both shifted in and it is now Q3Q4. Initially domestic supply was 0Q1 but it has shifted to 0Q3 after the tariff was imposed. With protectionism, it allows the country (domestic) to grow economically.
Evidence around the world suggests that the Marshall-Lerner condition does not hold in the short run, but does in the medium to long run. This is because in the short run, there will be few extra exports sold when prices fall – people overseas do not react immediately and so export demand will take time to change. However, extra money will have to be paid for imports immediately and so the current account will tend to deteriorate. In the medium term however, the lower export prices will start to lead to an increase in demand for them and so the current account will start to improve. The export elasticity of demand is therefore low in the short run, but will be higher in the long run.
This diagram shows an exchange rate regime where the value of a currency is allowed to be determined solely by the demand for, and the supply of the currency on the foreign exchange market. The price in terms of Euro of pounds is at point P and the quantity of pounds is at point Q.
Appreciation is an increase in the value of one currency in terms of another currency in a floating exchange rate system. When the value of the currency increases, the price of pounds in terms of euros increases from P to P1, and the quantity of pounds increases from Q to Q1.
Depreciation is a fall in the value of one currency in terms of another currency in a floating exchange rate system. When the value of the currency decreases, the price of pounds in terms of euros decreases from P to P1, and the quantity of pounds decreases from Q to Q1.
