REVIEW OF THE SUBJECT INTERNATIONAL ECONOMICS 1. General information - Time: 90 minutes - Materials are not allowed to be used during the exam - The exam includes 25 multiple choice questions (5/10 points) and 03 short essays (5/10 points) 2. Review the contents 2.1. MCQs Part 1: International Trade - Introduction: o Definition of international trade, autarky/closed economy - o Trade openness ratio o Gravity model International trade theories: o Mercantilism o Absolute advantage theory o Comparative advantage theory: comparative advantage, opportunity cost, PPF, range of price, the pattern of trade, benefits from trade o Factor endowments and the H-O model: factor abundance, factor intensity, PPF, the pattern of trade, benefits from trade - Tariff: Types, objectives, effects, ERP - an effective rate of protection (2 inputs), - Non-tariff barriers: Quota, Export subsidies, Dumping (predatory vs. persistent dumping). Part 2: International resource movement and multinational corporations - International Investment: Definition and types of international investment; Concepts, motivations, and benefits of FPI and FDI; horizontal vs. vertical FDI; Figures illustrate capital movement from one nation to another nation. - MNCs: definition, motivations, impacts on the host country and home country - International labor movement: Figures illustrate labor movement from one nation to another nation, brain drain. Part 3: International Finance - BOP: definition, structure, accounting principles, surplus, deficit - Foreign exchange market and foreign exchange rates o Foreign exchange market: definition, characteristics, functions, actors o Foreign exchange rate: definition, classification (cross exchange rate), determinants, exchange rate equilibrium, depreciation, appreciation, devaluation, revaluation. - o Hedging in the forward market International monetary system: Exchange rate regime, e.g., fixed, freely floating exchange rate regime, etc. 2.2. Essays Part 1: 1 question (2 points) - Ricardo highlighted that nations with low productivity and absolute disadvantages in all goods can still gain from trade. Does this imply that we need not worry about countries with lower labor productivity than the global average? Provide a brief explanation supported by examples. Comparative Advantage, Not Absolute: Focus is on relative efficiency. A country might be less productive in everything compared to another, but it can still have a comparative advantage in a specific good if it's less inefficient in producing that good relative to others. Example: Imagine Country A takes 2 hours to make a shirt and 1 hour to make a bushel of wheat, while Country B takes 3 hours for a shirt and 2 hours for wheat. Though Country B is absolutely slower, Country A has a comparative advantage in wheat (less time difference compared to shirts) and B in shirts. Trade allows them to specialize and benefit. - If a tariff and a quota result in the same volume of imports, they will exert identical influences on prices and welfare. Do you concur with this statement? Provide a concise explanation. No, I don't concur. While a tariff and a quota might restrict imports to the same level, they will likely have different effects on prices and welfare. Here's why: Tariff: A tax on imports, raising the price consumers pay. This extra money goes to the government as revenue. Quota: A physical limit on the amount that can be imported. The price increase depends on how much demand surpasses the limited supply. - David Ricardo's theory of comparative advantage suggests that trade won't happen if a country is less efficient in producing all goods. Do you support this statement? Offer a brief explanation and support your response with numerical examples. No, I don't support this statement. David Ricardo's theory of comparative advantage actually suggests the opposite - that trade can still be beneficial even if one country is less efficient in producing all goods compared to another country. Ricardo's theory argues that countries should specialize in producing goods where they have a comparative advantage, i.e., where they can produce at a lower opportunity cost compared to other goods. Even if one country is less efficient in producing all goods, there may still be differences in the opportunity costs of producing those goods. Trade allows countries to specialize in the production of goods where they have a comparative advantage and then trade for other goods, resulting in mutual gains. Let's illustrate this with a simple numerical example: Consider two countries, A and B, and two goods, Apples and Bananas. Country A can produce either 10 Apples or 20 Bananas in a day. Country B can produce either 15 Apples or 30 Bananas in a day. Here are the opportunity costs for each country: For Country A: The opportunity cost of producing one Apple is 2 Bananas (20 Bananas / 10 Apples). The opportunity cost of producing one Banana is 0.5 Apples (10 Apples / 20 Bananas). For Country B: The opportunity cost of producing one Apple is 2 Bananas (30 Bananas / 15 Apples). The opportunity cost of producing one Banana is 0.67 Apples (15 Apples / 30 Bananas). In this scenario, Country A has a comparative advantage in producing Bananas because it has a lower opportunity cost (0.5 Apples) compared to Country B's opportunity cost (0.67 Apples). Conversely, Country B has a comparative advantage in producing Apples. Even though Country B is more efficient in producing both goods, according to Ricardo's theory, it's still beneficial for both countries to specialize and trade based on their comparative advantages. This trade will result in both countries obtaining more of both goods than if they were to produce in isolation. - Consider the following hypothetical data on labor requirements in A and B to produce two goods C and D: A B Labor needed to make one C 3 hours 4 hours Labor needed to make one D 9 hours 20 hours a. What is the opportunity cost of D in each country? A's opportunity cost of D: For every 1 D produced, A gives up 9/3 = 3 Cs. B's opportunity cost of D: For every 1 D produced, B gives up 20/4 = 5 Cs. b. Identify the comparative advantage of each nation and the pattern of trade. A can produce 1 D while giving up only 3 Cs, while B needs to give up 5 Cs Therefore, A has a comparative advantage in D due to its lower opportunity cost. c. A will likely export D and import C from B. What is the international exchange rate (D per C) possible with free trade? We know A has a comparative advantage in D, so they will be willing to trade D for a price greater than their opportunity cost (3 Cs). Conversely, B has a comparative disadvantage in D, so they will be willing to trade for a price lower than their opportunity cost (5 Cs). Therefore, the possible exchange rate with free trade will be between 3 Cs and 5 Cs per D. d. If two countries agree to trade at a price of one D for four Cs, which country will get the higher benefit? A's benefit: a. By producing 1 D and exporting it for 4 Cs, A gains 4 Cs and only gives up 3 Cs in production. b. This results in a net gain of 1 C. B's benefit: c. By importing 1 D for 4 Cs, B avoids the opportunity cost of 5 Cs for producing the D themselves. d. This results in a net gain of 1 C. Both countries gain equally from trade at this specific exchange rate (1 D for 4 Cs). They both benefit by 1 C compared to their pre-trade situation. Part 2: 1 question (1 point) - A French investor acquires a hundred shares in an American corporation, constituting a minor ownership stake. The investor is entitled to receive dividends, participate in shareholder decisions, and trade the stock for potential profit or loss. The primary concern lies in the short-term value of the stock rather than the company's longterm profitability. If the share price experiences significant fluctuations, the investor may opt to swiftly sell the share. Define whether the French investor's investment is categorized as FDI or FPI and provide the rationale. The French investor's investment is classified as FPI (Foreign Portfolio Investment) rather than FDI (Foreign Direct Investment). Here's the rationale: FDI Characteristics (Not Present): Control: FDI aims to gain control or significant influence over a foreign company, typically involving a large investment and potentially a seat on the board. This is not the case here, as the investor holds a minor stake. Long-term involvement: FDI generally involves a long-term commitment to the company's development and growth. Here, the focus is on short-term stock price fluctuations. Active participation: FDI often involves active participation in the management or operations of the company. This investor doesn't exhibit any such involvement. FPI Characteristics (Present): Passive investment: FPI involves passive investments in financial assets like stocks, bonds, or mutual funds. This aligns with the French investor's situation, as they hold a passive stake in the American corporation. Short-term focus: FPI typically concentrates on short-term returns through capital appreciation (stock price increase) or dividend income. This aligns with the investor's focus on short-term price fluctuations and potential profit/loss. Limited influence: FPI investors generally have limited influence on the company's operations. This aligns with the French investor's minor ownership stake. - Examine the reasons why labor migration can yield both positive and negative consequences for unskilled immigrants. Positive Consequences: Improved Earnings: Unskilled immigrants can escape poverty and send remittances back home, significantly improving their families' standard of living. Skill Development: Through work experience and potentially training programs, unskilled immigrants can develop new skills, increasing their future earning potential. Cultural Exchange: Immigration brings diverse cultures together, fostering understanding and enriching the receiving society. Negative Consequences: Lower Wages: An influx of unskilled labor can drive down wages for both immigrants and native low-skilled workers. Exploitation: Unskilled immigrants might be more vulnerable to exploitation due to language barriers, limited knowledge of labor laws, and desperation for work. Social Strain: A rapid influx of immigrants can strain social services and create competition for resources, leading to tensions with the native population. - Assess the positive and negative impacts on both emigration and immigration countries stemming from the migration of skilled labor. Emigration Country (Sending Country) Impacts: Positive: Reduced Unemployment: Emigration can help reduce unemployment in the sending country, especially if there's a surplus of skilled labor in certain sectors. Increased Remittances: Skilled migrants often earn higher wages abroad, sending remittances back home that boost the economy and improve the standard of living for families. Brain Gain (Indirect): In some cases, emigration can encourage the sending country to invest more in education and training, leading to a long-term improvement in its skilled workforce. Negative: Brain Drain: Loss of skilled workers can deprive the emigration country of essential talent and expertise, hindering innovation and economic growth. Reduced Tax Revenue: Skilled migrants contribute less tax revenue to the sending country, potentially impacting public services and infrastructure development. Knowledge Gap: Emigration can create a knowledge gap in certain sectors, especially if there's limited investment in training new talent. Immigration Country (Receiving Country) Impacts: Positive: Increased Labor Supply: Immigration fills labor shortages in skilled professions, boosting economic growth and competitiveness. Knowledge Transfer: Skilled migrants bring new knowledge, ideas, and innovations that can benefit the receiving country's industries. Cultural Diversity: Immigration fosters a more diverse and vibrant society, potentially leading to new ideas and a wider talent pool. Negative: Wage Depression: An influx of skilled workers can depress wages for similar positions held by native workers. Social Tensions: Rapid immigration can lead to social tensions if there's competition for jobs, housing, and other resources. Integration Challenges: Skilled migrants might face challenges integrating into the new society due to language barriers and cultural differences. - Elaborate on the methods through which Multinational Corporations (MNCs) can implement transfer pricing. Transaction-Based Methods: Comparable Uncontrolled Price (CUP): This method compares the price of a good or service transferred between related parties to the price of an identical transaction between unrelated parties. It's considered the most reliable method but finding truly comparable transactions can be challenging. Resale Price Method (RPM): This method starts with the resale price of a good sold by the receiving affiliate and subtracts a markup reflecting the profit margin earned by that affiliate. This method is useful when the receiving affiliate resells the good without significant transformation. Cost Plus Method: This method adds a markup to the cost of producing the good or service to determine the transfer price. The markup should reflect the arm's length profit margin a company would earn in an unrelated transaction. Profit-Based Methods: Transactional Net Margin Method (TNMM): This method compares the net profit margin of the controlled entity selling the good or service to the net profit margin of comparable unrelated companies in the same industry. It's useful when there are no directly comparable transactions but requires good industry data. Profit Split Method: This method allocates the total profit from a multinational project among all participating affiliates based on their contribution (e.g., assets, risks, marketing efforts). Part 3: 1 question (2 points) - A speculator anticipated a decline in the euro's exchange rate and bought a put option to sell one million euros with an exercise rate of 1.3 dollars per euro. The option premium was 1% of the contract value. On the expiration date, the spot rate for the euro was 1.28 dollars. Calculate his gain or loss. - An exporter purchases a put option to sell ‚ Euro 100,000 in three months, with the exercise rate set at $1 = Euro 1 and a premium of 1% of the contract value. After three months, the spot rate is $0.98 = Euro 1. Will the exporter exercise the option on the due date? - Suppose a speculator expected a decrease in the euro's exchange rate and acquired a put option to sell one million euros at the exercise rate of 1.3 dollars per euro. The option premium was 1% of the contract value. On the expiration date, the spot rate for the euro reached 1.31 dollars. Calculate his gain or loss. - An exporter buys a put option to sell Euro 100,000 in three months, with the exercise rate set at $1 = Euro 1 and a premium of 1% of the contract value. After three months, the spot rate is $1.02 = Euro 1. Will the exporter exercise the option on the due date?
