economics exam paper

Name: Sherman Yau Heng Fatt OUID: 149579 Location & Group number: KL29 E-mail add: [email protected]

1. How has an open trading system helped Malaysia? How has it hurt Malaysia?

Proponents of an open trading system contend that international trade results in

higher levels of consumption and investment, lower prices of commodities, and a

wide range of products choices for consumers. Under an open trading system,

Malaysia has showed a positive sign of growth in all sectors according to Malaysia

trade 2004. Domestic demand, particularly private consumption, continues sustaining

growth for five consecutive years, while private investment, which began to pick up

last year, has become more entrenched, resulting in a private sector-led growth. The

government has also generated new source of growth, resulting in manufacturing,

which has become more diversified with high-end, value-added and new emerging

industries and products.

However, arguments against this trade system tend to be voiced during period of

excess production capacity and high unemployment. This may led to many

Malaysians fear getting laid off, especially at those firms operating in import-

competing industries. Also, workers face demands of wages concessions from their

employees, which often threaten to export jobs abroad if wages concessions are not

agreed to.

2. What do you think Malaysia’s competitive advantage is? Has it changed? What

was it before? Will it change in the future? What will it be?

Malaysia is an investor-friendly country and has been successful in attracting

investment. Under the Malaysia external trade policy, the government tend to present

a strong and stable government with efficient infrastructure and sound economic

policies. Investors find these even more important than merely having a set of global

rules and regulations on investment. Like other developing countries, Malaysia is

concerned that having global rules on investments will hinder the ability of the

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International Economics ECO 40963

government to screen the type of investments that we want to promote in the country

given scarce resources.

Moreover, Malaysia has adopted long and medium term development plans that call

for the effective use of scarce resources through promoting investments in

appropriate and strategic industries. Multilateral rules could restrict the country's

ability to provide special incentives and privileges to local investors for social and

strategic reasons, as members may not be able to discriminate between local and

foreign investors once they are allowed into the host country. Malaysia attracts

foreign investment, in other words, she has a healthy economy, will tend to have a

net capital inflow and this will be associated with a trade deficit. There is every

reason to see the benefits of such a situation. Both the acquisition of imports and the

foreign investment are good for the country.

3. What is a product largely imported to Malaysia? What happens to Malaysian

terms of trade if demand for this product increases?

Malaysia trade statistics recorded a new high of RM34.66 billion, expanding 9.6%

from RM31.63 billion in May 2004. Import growth was mainly led by increase in

imports of intermediate and capital goods to sustain manufacturing activities to meet

external demand. As we noted, demand and supply condition determine the basis for

trade and the direction of the trade. Demand also helps establish the international

terms of trade, that is, the relative prices at which commodities are exchanged

between nations. If demand for imports of intermediate and capital goods increases,

the price for this particular product will rise; thus it will show a deterioration in a

Malaysia terms of trade that the prices of its exports fall relative to the prices of its

imports over the given time period. This may lead to reduced export sales and less

revenue earned from exports, and we could hardly say that Malaysia welfare has

improved.

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4. What is Malaysia’s industrial policy? What has the government tried to create a

comparative advantage in? Has it worked? Why or why not?

Malaysia industrial policies emphasize specialization and reallocation of existing

resources found domestically. It overlooks the fact that additional resources can be

made available to the trading nation because they can be created or imported.

However, these policies has also suffered from being increasing costs, in which

additional use of limited resources results in rising their units costs as resources

become fully used. Although these policies hold in the short run, empirical evidence

suggests that unit costs may decrease over time – partly because firms learn to be

more efficient and partly because of economies of large-scale production.

5. Which of the arguments for tariffs do you feel are most relevant in today’s

Malaysia? Why?

Malaysia feel that developed nations tend to insist that developing nations open their

markets to industrial products from the developed world, yet refuse to open their

markets to agriculture goods from the developing world. For example, United States

have used aggressive antidumping and countervailing duties to limit access to their

markets. Furthermore, the current concept of free trade supports the free movement

of products and employers, which favors the developed nations, but not the free

movement of employees (i.e., labor), which would favor the people of developing

nations.

6. Does Malaysia’s government provide any subsidies? If so, what kind and are

they effective? If not, should they? Why or why not?

Malaysia’s government grants subsidies to their producers to help improve their

trade position. By providing domestic firms a cost advantage, a subsidy allows them

to market their products at prices lower than warranted by their actual cost or profit

considerations. Governmental subsidies assume a variety of form, including out right

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cash disbursements, tax concessions, insurance arrangements, and loans at below-

market interest rates. Two types of subsidies can be distinguished: a domestic

subsidy, which is sometimes granted to producers of import-competing goods, and

an export subsidy, which goes to producers of goods that are to be sold overseas. In

both cases, the government adds an amount to the price the purchaser pays rather

than subtracting from it. The net price actually received by the producer equals the

price paid by the purchaser plus the subsidy. The subsidized producer is thus able to

supply a greater quantity at each consumer’s price. Moreover, when a subsidy is

given to an industry, it is often in return for accepting government conditions on key

matters such as wage and salary levels.

7. Concerning intellectual property, what is Malaysia’s policy (official and

unofficial)? What do you actually do (buy pirated music or videos)?

Intellectual property is an invention, idea, product, or process that has been registered

with the government and that awards the inventor (or author) exclusive rights to use

the invention for a given time period. Malaysia governments use several policies to

protect intellectual property such as copyrights are awarded to protect works of

original authorship (for example, music compositions, textbooks); trademark are

awarded to manufacturers and provide exclusive rights to a distinguishing name or

symbol (for example, “Coca-Cola”); patents secure to an inventor to a term, usually

15 years or more, the exclusive right to make, use, or sell the invention. Furthermore,

the government enforcement personnel always carry a raid to certain shopping areas

to strike at pirated goods such as automobile parts, jewelry, sporting goods and

watches, piracy of audio and videotapes, computer software, and printed materials.

To protect and respect the intellectual property, I will surely support the original

version, no matter music or video CD, or computer software and etc. I also do agree

with the government steps in protecting the intellectual property and give my full

cooperation by providing the useful information to the related authorities regarding

the illegal selling of counterfeit products.

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8. Why are less-developed nations concerned with commodity-price stabilization?

Is Malaysia concerned with this? For what materials?

The composition of less developed nations’ exports emphasis on primary products

and these nations concentrated in only one or a few primary products. Thus, a poor

harvest or a decrease in market demand for that product can significantly reduce

export revenues and seriously disrupt domestic income and employment levels. In

addition, export prices and receipts can be very volatile when supply and demand

conditions are price-inelastic. Therefore, it is vital important for them to enact

commodity price stabilization policies to increase their level of income and standard

of living.

Malaysia has also concerns with commodity-price stabilization for its commodity

products such as palm oil and rubber; however, Malaysia has recently generated new

source of growth, resulting in manufacturing, which has become more diversified

with high-end, value-added and new emerging industries and products.

9. Is Malaysia a member of any economic integration agreements (i.e. free trade

areas, customs union, common market, economic union, monetary union)? If so,

how is it working? If not, should it be? What kind and with whom?

Malaysia is a member of the ASEAN Free Trade Area (AFTA). AFTA is a

collective effort by ASEAN member countries to reduce/eliminate tariffs on intra-

ASEAN trade in the goods sector. The target is to achieve tariff between 0-5% in

2003 for the six original member countries, Vietnam by 2006, Lao PDR and

Myanmar by 2008 and Cambodia by 2010, and eliminate quantitative restrictions

and other non-tariff barriers. The reduction/elimination of tariff is undertaken

through the Common Effective Preferential Tariff Scheme.

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The primary objective of AFTA is to enhance ASEAN’s position as a competitive

production base producing for both the regional and global markets. This is to be

achieved through:

Promotion of intra-ASEAN trade and industrial linkages, specialization and

economies of scale; and

Promoting the region as an efficient and competitive production base for

investments.

Malaysian companies will be able to benefit from:

Preferential access into the larger market of ASEAN with a population of 530

million.

A wider base for competitive sourcing of raw materials from countries in the

region.

Opportunity to cooperate and collaborate with ASEAN partners to tap both the

regional and global markets.

10. What are the major industries in Malaysia in which foreigners place direct

investments? What are the major foreign industries in which Malaysian

businesses have chosen to place direct investments?

To aid the economic growth, Malaysia aims to make the region a competitive base to

attract foreign direct investment through the implementation of programs and

activities on investment liberalization, facilitation and promotion. The agreement

covers direct investment related to manufacturing, agriculture, fisheries, forestry and

mining, and services activities related to these sectors. On the other hand, ASEAN as

a group continues to be Malaysia’s largest trading partner. In 2002, total trade with

ASEAN was RM161.8 billion, accounting for 24.6 per cent of Malaysia’s global

trade. For Malaysia, pineapple canning, palm oil industry and refinery, sugar

refinery, sawn timber, veneer and plywood, petroleum refinery, batik, extraction of

timber, fisheries, cement and oleo-chemicals have been those businesses chosen to

place direct investments.

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11. What is meant by the balance of payments? Why does the balance-of-payments

statement “balance”? Is Malaysia’s current account in deficit or in surplus? Is

this a good thing? Why or why not?

The balance of payments is the government's attempt to measure all international

trade activity. The major accounts in the balance of payments are exports, imports,

capital inflows, and capital outflows. Exports and imports are goods and services

sold to and purchased from foreign interests, respectively. In addition to exports and

imports, much of the trade in the world involves situations where no assets leave or

enter a country. These exchanges are called capital flows. Capital inflows occur

when foreign interests acquire assets in this country. Examples include the purchase

of stocks, bonds, real estate, and businesses. Conversely, capital outflows occur

when domestic interests acquire assets in another country. When the dollar value of a

country's imports exceeds the dollar value of its exports, the country has a trade

deficit. If the country is exporting more than it imports, it has a trade surplus. A trade

deficit implies that due to the trade of goods and services, more currency is flowing

out of the country than into the country. This net currency outflow is generally

associated with a net capital inflow. Similarly, a trade surplus is associated with a net

capital outflow.

From Malaysia external trade report, a trade surplus of RM 5.09 billion was recorded

in June 2004. This was the eightieth consecutive month of trade surplus since

November 1997. Trade figures for June show that Malaysia's total trade had grown

significantly by 29.2% to RM 74.41 billion compared with RM 57.57 billion the

previous year. From a quarterly perspective, total trade for the second quarter of

2004 was 10.8% higher than that of the first quarter of 2004 and trade in June was

6.1% higher than that in May. Thus, this would either benefit exporting industries or

it would benefit the domestic competitors of foreign imports

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12. Why are exchange rate quotations stated in different financial centers

consistent with one another? Is it better to have a strong or weak/dollar (and

Ringgit)? Why?

The Wall Street Journal’s foreign-exchange quotations include those of the New

York foreign-exchange market and the International Market located in Chicago. Both

spot quotations and forward quotations are provided. The exchange rate is the price

of one unit of foreign currency in terms of the domestic currency. A dollar

depreciation is an increase in the number of dollars required to buy a unit of foreign

exchange.

In the foreign-exchange market, currencies are traded around the clock and

throughout the world. Most foreign exchange trading is in the inter-bank market.

Banks typically engage in three types of foreign-exchange transaction: spot, forward,

and swap. The equilibrium rate of exchange in a free market is determined by the

intersection of the supply and demand schedules of foreign exchange. These

schedules are derived from the credit and debit items in a nation’s balance of

payments. Also, exchange arbitrage permits the rates of exchange in different parts

of the world to be kept the same. This is achieved by selling a currency when its

price is high, and purchasing when the price is low. Thus, exchange rate quotations

stated in different financial centers consistent with one another.

In my opinion, it is better to have a dollar (and ringgit) stabilized, and the foreign

trader and investor are advised to deal in the forward market for protection from

possible exchange rate fluctuation to ensure the steadily economic growth of the

world.

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13. Explain how the following factors affect the Dollar’s (and Ringgit’s) exchange

rates:

a) a rise in the US price level compared to foreign prices

b) tariffs and quotas placed in US imports

c) increased demand for Us exports

d) rising productivity in the US relative to other countries

e) rising deal interest rates overseas relative to US rate

f) an increase in US money growth

g) an increase in US money demand

Like other prices, the exchange rate in a free market is determined by both supply and

demand conditions. A nation’s demand for foreign exchange is derived from, or

corresponds to, the debit items on its balance of payments. The supply of foreign

exchange refers to the amount of foreign exchange that will be offered to the market

at various exchange rates, all other factors held constant. As long as monetary

authorities do not attempt to stabilize exchange rates or moderate their movements,

the equilibrium exchange rate is determined by the market forces of supply and

demand.

A rise in the US price level compared to foreign prices will depreciate the effect

on the Dollar’s exchange value

tariffs and quotas placed in US imports will appreciate the effect on the Dollar’s

exchange value

increased demand for Us exports will appreciate the effect on the Dollar’s

exchange value

rising productivity in the US relative to other countries will appreciate the effect

on the Dollar’s exchange value

rising deal interest rates overseas relative to US rate will appreciate the effect on

the Dollar’s exchange value

an increase in US money growth will appreciate the effect on the Dollar’s

exchange value

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an increase in US money demand will depreciate the effect on the Dollar’s

exchange value.

14. How can adjustments in Malaysian domestic interest rates help promote

payments balance?

Malaysian domestic interest rates aim to restore equilibrium in the balance of

payment. For example, assume that Malaysia enjoying a surplus, and Singapore,

facing a deficit. The inflow of gold from the deficit to the surplus nations

automatically results in an increase in Malaysia’s money supply and a decline in the

money supply of Singapore. Given a constant demand for money, the increase in

Malaysia’s money supply would lower domestic interest rates. At the same time,

Singapore’s gold outflow and declining money supply would bid up interest rates. In

response to falling domestic interest rates and rising foreign interest rates, the

investors of Malaysia would find it attractive to send additional investment funds

abroad. Conversely, Singapore investors would not only be discouraged from

sending money overseas, but might find it beneficial to liquidate foreign investment

holdings and put the funds into domestic assets.

This process facilitates the automatic restoration of payments equilibrium in

Malaysia and Singapore. Because of the induced changes in interest rates, stabilizing

capital movements automatically flow from the surplus to the deficit nation, thereby

reducing the payment imbalances of both nations.

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15. Suppose ABC Inc. a US auto manufacturer building cars in Mexico sales,

obtains all of its auto components from the US and these costs are denominated

in dollars. Assume the dollar’s exchange rate appreciates against the Mexican

Peso. What happens to ABC’s costs and to the price of their cars in Mexico?

Changes in relative costs because of exchange–rate fluctuation also influence relative

prices and the volume of goods traded among nations. By increasing relative U.S.

production costs, a dollar appreciation tends to raise U.S. export prices in foreign-

currency terms, which induces a decrease in the quantity of U.S. goods sold abroad;

similarly, the dollar appreciation leads to an increase in U.S. imports. By decreasing

relative U.S. production costs, dollar depreciation tends to lower U.S. export prices

in foreign-currency terms, which induces an increase in the quantity of U.S. goods

sold abroad; similarly, the dollar depreciation leads to a decrease in U.S. imports.

Thus, ABC’s costs and the price of their cars in Mexico will increase and the cost

will surely be transferred and spread to the consumers.

16. What factors underlie a nation’s decision to adopt floating or fixed exchange

rates? Why is the Ringgit pegged to the US dollar? Should Malaysia’s currency

be allowed to float?

In choosing an exchange-rate system, a nation must decide whether to allow its

currency to be determined by free-market forces (floating rate) or to be fixed

(pegged) against some standard of value. If a nation adopts floating rates, it must

decide whether to float independently, to float in unison with a group of other

currencies, or to crawl according to a predetermined formula such as relative

inflation rates. The decision to peg a currency includes the options of pegging to a

single currency, to a basket of currencies, or to gold.

Instead of utilizing fixed exchange rates, some nations allow their currencies float in

the foreign-exchange market. By floating (or flexible) exchange rates, means

currency prices that are established daily in the foreign-exchange market, without

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restrictions imposed by government policy on the extent to which the prices can

move. With floating rates, there is an equilibrium exchange rate that equates the

demand for and supply of the home currency. Changes in the exchange rate will

ideally correct a payments imbalance by bringing about shifts in imports and exports

of goods, services, and short-term capital movements.

Malaysia’s currency should float as it provides several benefits. First, the prices of

the traded products of many developing nations are determined primarily in the

markets of industrialized nations such as the United States; by pegging, say, to the

dollar, Malaysia can stabilize the domestic-currency prices of their imports and

exports. Second, many nations with high inflation have pegged to the dollar (the

United States has relatively low inflation) in order to exert restraint on domestic

policies and reduce inflation. Pegging the exchange rate may thus lessen inflationary

expectations, leading to lower interest rates, a lessening of the loss of output due to

disinflation, and a moderation of price pressures.

17. Distinguish among external balance, internal balance, and overall balance.

Which does Malaysia’s government strive for? Give some examples?

When a nation experience inflation with unemployment, achieving overall balance

involves three separate targets: BOP equilibrium, full employment, and price

stability. Three policy instruments may be needed to achieve these targets.

Expenditure-switching policies can help a nation attain overall balance. Although

these measures are designed primarily to influence the nation’s external sector, they

have secondary impacts on its internal sector.

Given a fixed exchange-rate system, for monetary policy the disequilibrium zones of

employment-with-BOP-surplus and inflation-with-BOP-deficit are zones of policy

agreement. The disequilibrium zones of employment-with-BOP-deficit and inflation-

with-BOP-surplus are zones of policy conflict; a dilemma exists for monetary

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authorities concerning which objective to pursue. A combination of policies may be

needed to resolve these economic problems.

Additional export sales provide an injection of spending into the economy, which

encourages additional production and thus reduces the level of unemployment. In

terms of the figure, the currency depreciation induces movement in a northeasterly

direction, promoting both internal balance and external balance.

18. A nation’s need for international reserves is similar to your personal desire to

hold a cash balance. Explain.

Just as an individual desires to hold cash balances, national governments have a need

for international reserves. The chief purpose of international reserves is to enable

nation to finance disequilibrium in their balance-of-payments positions. When a

nation finds its monetary receipts falling short of its monetary payments, the deficit

is settled with international reserves. Eventually, the deficit must be eliminated,

because central banks end to have limited stocks of reserves.

From a policy perspective, the advantage of international reserves is that they enable

nations to sustain temporary balance-of-payments deficits until acceptable

adjustment measures can operate to correct the disequilibrium. Holdings of

international reserves facilitate effective policy formation because corrective

adjustment measures need not be implemented prematurely. Should a deficit nation

posses abundant stocks of reserves balances, however, it may be able to resist

unpopular adjustment measures, making eventual adjustments even more

troublesome.

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economics exam paper

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