1. Define and Discuss a Tariff and Describe its Economic Effects
A tariff is a tax that a government imposes on goods and services that are imported. It is one of the most effective tools used to shape a trade policy, due to it enables to control trade. It is done through increasing the cost of imports, both goods and services, in a way that is costly to the consumer. It is a way of cushioning domestic producers against their foreign counterparts. Based on the propensity to purchase cheap foreign imports by consumers, the inexistence of tariffs makes the latter better off and domestic producers worse off. However, when tariffs are imposed, the situation is vice versa (Mankiw & Taylor, 2006, p.188). On the flipside, tariffs can decrease the efficiency of domestic industries and stimulate trade wars, since countries, which export, may be compelled to counter by imposing taxes on imports.
2. Define and Discuss Net Exports and Net Capital Outflow
Net exports can be defined as the total value of countrys exports minus the total value of its imports (Mankiw & Taylor, 2006, p. 144). They have a very important variable when it comes to calculating countrys GDP and aggregate demand. If exports exceed imports, the economy observes a trade surplus. On the contrary, it has a trade deficit, if the former exceed the latter. Net exports are closely interconnected with exchange rates. They fall due to the appreciation of the latter, and a rise in imports leads to a decrease in exports. On the other side, net exports rise because of the depreciation of exchange rates. As a result, imports decrease, while exports increase. Similar to exchange rates, tariffs, trade barriers and a countrys economic condition also have an impact on net exports.
Net capital outflow (occasionally referred to as foreign investment) denotes a variation existing between the consumption of foreign assets by the countrys population and the foreign consumption of domestic assets. Analyzing from the foreign capital investment perspective, there are foreign direct investments and foreign portfolio investments. The former take place when a national firm ventures into a new market in another country, while in the latter case, a countrys company buys a foreign stock. Net capital outflow is calculated by subtracting the latter from the former (Nicholas, 1998, p. 676). It can be positive or negative. A positive net capital outflow is the one when the national consumption of foreign assets exceeds foreigners consumption of domestic assets. A negative net capital outflow is the one when the situation is vice versa. A positive net capital outflow takes capital out of the country concerned, while a negative one leads to an inflow of capital into the national economy.
3. Describe Supply and Demand in the Market for Loanable Funds and the Market for Foreign-Currency Exchange. Discuss how These Markets are Linked
Supply and demand are tools used to know the forces behind the two markets of an open economy. They are the market for loanable funds and for foreign-currency exchange. In the former, the sum of what people wish to save must balance the desired quantities of national and net foreign investments. National savings supply loanable funds, while domestic and net foreign investments result into the demand for such funds. However, the real interest rate determines the supply of and demand for loanable funds (Mankiw, 2011, p. 660). If it is increased, people get a Pavlovian response to save, rising the amount of loanable funds available. In order to stabilize the supply and demand of the latter, the interest rates should be adjusted. A stabilized interest rate results into people saving precisely the wanted amounts of both net foreign investments and domestic investments.
In the foreign-currency exchange market, other nations currencies are traded against U.S. dollars. Here, through adjusting, the real exchange rate determines the price significant in balancing the foreign currency in terms of demand and supply. Dollar demand for buying net exports must be equal to dollar supply necessary for exchanging foreign currency for assets overseas at a real exchange rate. The link between the two markets is that the prices of both must adjust concurrently to stabilize the supply and demand. In the process, net foreign investments, net exports, national savings, and domestic investments are determined.
4. Explain why the Long-Run Aggregate-Demand Curve is Downward Slopping
A long-run aggregate-demand curve slopes downwards, because nominal wages can be negotiated again in the long run. Aggregate price is adjusted to a change in nominal wages. The level, by which it increases, determines the costs of production; if both of these changes are equal in terms of levels, they render formerly lucrative output, just like the one prior to the price increase, and formerly profitless output. It implies that aggregate output is constant, as long as nominal wages are pliable; thus, there is no alteration of output production either after the rise or fall of the level of aggregate price.
5. List and Discuss the Three Theories for why the Short-Run Aggregate-Supply Curve is Upward
The three theories include the sticky-wage, the sticky-price, and the misperception theory (Mankiw, 2011 p. 736). The first one proposes that the upward curve of the short-run aggregate-supply is a result of nominal wages that sluggishly adjust to changing economic situations. That sluggishness results from long-lasting workers-firms contracts, which tend to fix nominal wages. In addition, slow but gradual adjustments may attribute to this from the social perspective in relation to what constitutes fairness. Slow adjusting wages decrease the profit of employment and output, making companies decrease the supply of their goods and services.
The sticky-price theory proposes that an upward-sloping supply curve is a result of the propensity of the slowness of particular goods and services in adjusting. It may be attributed to long-lasting workers-firms contracts that fix nominal wages. It is worthwhile noting that different prices adjust differently, and in that sense, an abrupt price decrease may make some companies be left with prices exceeding expectations and lessen their production of goods and services.
The misperception theory proposes that the upward sloping may be a result of general price adjustments, which may contribute to brief misperceptions of suppliers of what is going on in the market. Due to these misleads, suppliers have Pavlovian responses of adjusting their prices.
Bonus Question: List and Discuss Five Arguments Often Given to Support Trade Restrictions and how Economics Respond to the Arguments
There are several arguments that are often given to support trade restrictions: protecting jobs, national security, protecting young industries, avoiding competition, and responding to trade restrictions by foreign partners. The proponents of protecting jobs claim that when a particular item is traded for free with other countries, its price falls, then the quantity of it is reduced in the country involved. It subsequently causes a reduction of employment in the sector. The second argument is national security. Its followers claim that free trade on some items may be aimed to make weapons. For instance, free trade on steel may be claimed to be for manufacturing guns and tanks. The third argument is shielding young industries. The proponents of this argument claim that trade restrictions are vital in assisting new and up-and-coming industries in making a start. Later on, those industries will be better placed to fight it out with their seasoned foreign companies. The forth argument is nipping unfair competition in the bud. Its proponents claim that the idea of free trade will only be appealing, if the rules are uniform in all countries and that subjecting companies to various laws and regulations in the expectation of contending against them in the international market is unfair. The last argument is a Pavlovian response to trade restrictions imposed by foreign countries. A lot of policymakers opine that trade restrictions act as a good bargaining chip during negotiations with their trading affiliates (Mankiw, 2011, p. 189). They cite that trade restrictions act as effective tools of eliminating the ones already imposed by foreign governments.