Q1 (a) Definition of free trade

Free trade is a system in which goods, capital, and labour flow freely between nations, without barriers which could hinder the trade process. Many nations have free trade agreements, and several international organizations promote free trade between their members. There are a number of arguments both for and against this practice, from a range of economists, politicians, industries, and social scientists. A number of barriers to trade are struck down in a free trade agreement. Taxes, tariffs, and import quotas are all eliminated, as are subsidies, tax breaks, and other forms of support to domestic producers. Restrictions on the flow of currency are also lifted, as are regulations which could be considered a barrier to free trade. Put simply, free trade enables foreign companies to trade just as efficiently, easily, and effectively as domestic producers. The idea behind free trade is that it will lower prices for goods and services by promoting competition. Domestic producers will no longer be able to rely on government subsidies and other forms of assistance, including quotas which essentially force citizens to buy from domestic producers, while foreign companies can make inroads on new markets when barriers to trade are lifted. In addition to reducing prices, free trade is also supposed to encourage innovation, since competition between companies sparks a need to come up with innovative products and solutions to capture market share.

Q1 (a) Forms of free trade

Bilateral trade or clearing trade is trade exclusively between two states, particularly, barter trade based on bilateral deals between governments, and without using hard currency for payment. Bilateral trade agreements often aim to keep trade deficits at minimum by keeping a clearing account where deficit would accumulate. Multilateralism is a term in international relations that refers to multiple countries working in concert on a given issue. International organizations, such as the United Nations (UN)

and the World Trade Organization are multilateral in nature. The main proponents of multilateralism have traditionally been the middle powers such as Canada, Australia, Switzerland, the Benelux countries and the Nordic countries. Larger states often act unilaterally, while the smaller ones may have little direct power at all in international affairs aside from participation in the United Nations (by consolidating their UN vote in a voting bloc with other nations, for example). Multilateralism may involve multiple nations acting together as in the UN or may involve regional or military alliances, pacts, or groupings such as NATO. Unilateralism is any doctrine or agenda that supports onesided action. Such action may be in disregard for other parties, or as an expression of a commitment toward a direction which other parties may find agreeable. Unilateralism is a neologism, (though already in common use) coined to be an antonym for multilateralism the doctrine which asserts the benefits of participation from as many parties as possible.

Q1 (b) Reasons for free trade

1. The theory of comparative advantage. This explains that by specialising in goods where countries have a lower opportunity cost, there can be an increase in economic welfare for all countries. 2. Reducing Tariff barriers leads to trade creation Trade creation occurs when consumption switches from high cost producers to low cost producers

The removal of tariffs leads to lower prices for consumers and an increase in consumer surplus of areas 1 + 2 + 3 + 4 Imports will increase from Q3-Q2 to Q4-Q1 The govt will lose tax revenue of area 3 Domestic firms producing this good will sell less and lose producer surplus equal to area 1 However overall there will be an increase in economic welfare of 2+4 (1+2+3+4 - (1+3) The magnitude of this increase depends upon the elasticity of supply and demand. If demand elastic consumers will have a big increase in welfare

3. Increased Exports. As well as benefits for consumers importing goods, firms exporting goods where the UK has a comparative advantage will also see a big improvement in economic welfare. Lower tariffs on UK exports will enable a higher quantity of exports boosting UK jobs and economic growth. 4. Economies of Scale: If countries can specialise in certain goods they can benefit from economies of scale and lower average costs, this is especially true in industries with high fixed costs or that require

high levels of investment. The benefits of economies of scale will ultimately lead to lower prices for consumers. 5. Increased Competition. With more trade domestic firms will face more competition from abroad therefore there will be more incentives to cut costs and increase efficiency. It may prevent domestic monopolies from charging too high prices. 6. Trade is an engine of growth. World trade has increased by an average of 7% since the 1945, causing this to be one of the big contributors to economic growth. 7. Make use of surplus raw materials Middle Eastern counties such as Qatar are very rich in reserves of oil but without trade there would be not much benefit in having so much oil. Japan on the other hand has very few raw material without trade it would be very poor. 8. Tariffs may encourage inefficiency If an economy protects its domestic industry by increasing tariffs industries may not have any incentives to cut costs.

Q 1(c) Reasons against free trade

1. Infant Industry Argument. If developing countries have industries that are relatively new, then at the moment these industries would struggle against international competition. However if they invested in the industry then in the future they may be able to gain Comparative Advantage.
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This shows that comparative advantage can change over time Therefore protection would allow them to progress and gain experience to enable them to be able to compete in the future.

2. The Senile industry argument. If industries are declining and inefficient they may require large investment to make them efficient again. Protection for these industries would act as an incentive to for firms to invest and reinvent themselves. However protectionism could also be an excuse for protecting inefficient firms 3. To diversify the economy Many developing countries rely on producing primary products in which they currently have a comparative advantage. However relying on agricultural products has several disadvantages that are Prices can fluctuate due to environmental factors and Goods have a low income elasticity of demand. Therefore with economic growth demand will only increase a little 4. Raise revenue for the govt. Import taxes can be used to raise money for the govt however this will only be a small amount of money 5. Help the Balance of Payments Reducing imports can help the current account. However in the long term this is likely to lead to retaliation 6. Cultural Identity This is not really an economic argument but more political and cultural. Many countries wish to protect their countries from what they see as an Americanisation or commercialisation of their countries 7. Protection against dumping The EU sold a lot of its food surplus from the CAP at very low prices on the world market. This caused problems for world farmers because they saw a big fall in their market prices 8. Environmental

It is argued that free trade can harm the environment because LDC may use up natural reserves of raw materials to export. Also countries with strict pollution controls may find consumers import the goods from other countries where legislation is lax and pollution allowed. However supporters of free trade would argue that it is up to individual countries to create environmental legislation

Q 1(a) Definition of 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 contrasts with free trade, where government barriers to trade and movement of capital are kept to a minimum. In recent years, it has become closely aligned with anti-globalization. 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.

Q1 (a) Forms of protectionism

TARIFFS: These are taxes imposed on goods (and sometimes also services) entering a Country from abroad and are the most common form of protection to domestic producers (as they result in higher prices of the imported good). Tariffs also generate significant Revenues for the government. QUOTAS: These typically specify the maximum quantity of a product that can be imported from a particular country over a specific period. The most famous example of a quota system is the multi-fibre agreement (MFA) under which the EC (prior to 1993 each country in Europe had a separate MFA system) allots to each of the major textile producers (India, China, Malaysia, Korea etc.)A specific limit for each textile product. Thus for knitwear say, EC may specify that it will import not more than Q1 from China, Q2 from India etc. Note that with a quota, prices

in the home market are higher than they otherwise would be so that the effect is similar to a tariff but less transparent and does not generate any revenue for the home government. SUBSIDIES: An alternative form of protection is to subsidise domestic producers.2 types of subsidies may be distinguished (I) those which focus upon the industry in general (e.g. cheap credit, tax incentives and direct subsidies as in the US shipbuilding industry, Korean automobiles, IT industry in India) (ii) those which focus upon the export activity of the industry (export credit, shipment credit, loan guarantees etc.) Unlike tariffs which generate revenues for the government, subsidies involve expenditure for the Exchequer. Regulatory Barriers: In recent years several new forms of protectionism have emerged. These can generally take 3 forms (I) specifying standards for certain products, so that the products do not harm the health of domestic consumers. Standard examples pertain to leather products and pharmaceuticals. (ii) Specifying standards for certain products, so that the domestic environment is not damaged (e.g. pollution standards for imported cars) (iii) Specifying conditions under which certain products are produced (child labour in the carpets and clothing industry)

Q1 (b) Reasons for protectionism

(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 labours & 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 (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. Lets 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. Lets not forget that there are many industries that are steel related. So bankruptcy of mills have negative spill over onto others (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. From the diagram below, revenue from tariff is given by the area of KLMN

(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 (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 (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 (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 (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 them. In short, to filter the cultural imperialism

Q2 (a) Meaning of money and its attributes

What is money? Money is any good that is widely used and accepted in transactions involving the transfer of goods and services from one person to another. Economists differentiate among three different types of money: commodity money, fiat money, and bank money. Commodity money is a good whose value serves as the value of money. Gold coins are an example of commodity money. In most countries, commodity money has been replaced with fiat money. Fiat money is a good, the value of which is less than the value it represents as money. Dollar bills are an example of fiat money because their value as slips of printed paper is less than their value as money. Bank money consists of the book credit that banks extend to their depositors. Transactions made using checks drawn on deposits held at banks involve the use of bank money.

Q2 (b) Functions of money

Money is often defined in terms of the three functions or services that it provides. Money serves as a medium of exchange, as a store of value, and as a unit of account.

Medium of exchange. Money's most important function is as a medium of exchange to facilitate transactions. Without money, all transactions would have to be conducted by barter, which involves direct exchange of one good or service for another. The difficulty with a barter system is that in order to obtain a particular good or service from a supplier, one has to possess a good or service of equal value, which the supplier also desires. In other words, in a barter system, exchange can take place only if there is a double coincidence of wants between two transacting parties. The likelihood of a double coincidence of wants, however, is small and makes the exchange of goods and services rather difficult. Money effectively eliminates the double coincidence of wants problem by serving as a medium of exchange that is accepted in all transactions, by all parties, regardless of whether they desire each others' goods and services. Store of value. In order to be a medium of exchange, money must hold its value over time; that is, it must be a store of value. If money could not be stored for some period of time and still remain valuable in exchange, it would not solve the double coincidence of wants problem and therefore would not be adopted as a medium of exchange. As a store of value, money is not unique; many other stores of value exist, such as land, works of art, and even baseball cards and stamps. Money may not even be the best store of value because it depreciates with inflation. However, money is more liquid than most other stores of value because as a medium of exchange, it is readily accepted everywhere. Furthermore, money is an easily transported store of value that is available in a number of convenient denominations. Unit of account. Money also functions as a unit of account, providing a common measure of the value of goods and services being exchanged. Knowing the value or price of a good, in terms of money, enables both the supplier and the purchaser of the good to make decisions about how much of the good to supply and how much of the good to purchase.

REFERENCES Markusen, J.R., Melvin, J.R., Kaempfer, W.H. and Maskus, K.E. (1995). International Trade: Theory and evidence. Boston: McGraw-Hill. Bhagwati, J.N. (1988). Protectionism. Cambridge: MIT Press. Choi, K. and Harrigan, J. (Eds.) (2002). Handbook of International Economics. Oxford: Basil Blackwell www.cliffsnotes.com/study_guide/Definition-ofMoney.topicArticleId-9789,articleId-9744.html

JOMO KENYATTA UNIVERSITY OF AGRICULTURE AND TECHNOLOGY. HBC 2125 INTRODUCTION TO MACROECONOMICS ASSIGNMENT 1

BACHELOR OF BUSINESS INFORMATION TECHNOLOGY YR1 SEM 2 NAME: HUSSEIN.M.A.KHAMIS REG NO: HD232-C0005-0315/2010