Assignment 2: International economics part 2
Question 1: Analyze and describe the impact of the different forms of regional trading arrangements on international trade.
Regional trading arrangements are agreements between two or more countries within a given region on terms of trade between and among them with the main aim of liberalizing trade as well as coordinating other trade related activities. There are four main forms of regional trading arrangements: free trade area, customs union, common market and the economic union. Each of these forms has specific features which promote trade among the countries involved. In a free trade area, member countries abolish tariffs and other trade barriers within them but do not have any common trade policy towards non-members, for example the European Free Trade Association (EFTA). Such an arrangement promotes trade among member countries thus stimulating international trade.
The customs onion is a free trade area that has gone further to establish common trade policies concerning non-members like a common tariff among others. This regional trading arrangement not only promotes trade among the member countries but also with non-members because the latter can then predict with certainty the costs incurred in trading with any member of such a trading arrangement. A common market is a customs union that allows the free movement of factors of production like labor and capital from one country to another within the regional trading bloc. This further promotes trade because people can easily engage in trading activities irrespective of the country in which they choose to operate from. The economic union on the other hand is the customs union that has common economic policies as well as common financial institutions like the central banks, a common currency among others. This trading arrangement plays a very important role in promoting trade among the member countries because of the harmonization of the economic policies which create an enabling environment for growth of trading activities.
Question 2: Analyze and describe the role of the major international trade and financial institutions in fostering trade.
The major international trade financial institutions that play a very crucial role in fostering trade include the International Monetary Fund (IMF), the World Bank Group (WBG) and the World Trade Organization (WTO). Each of these institutions plays its distinct role in promoting trade among many countries around the globe. The role of the International Monetary Fund is to collect economic and social data from member countries with the main aim of monitoring trade and economic progress in these countries. Chief among the objectives of this monitoring function is to enable members increase trade with one another. Therefore, encouraging member countries to reduce tariffs has been one of the roles of this international financial institution as this would increase trade among the countries. The World Bank Group is composed of a number of financial institutions which include the International Bank for Reconstruction and Development and International Finance Corporation among others (Ahearn, 2011). The role of this group of financial institutions is to offer loans to member countries in order to promote their economic development; offer technical support in the countries’ development among other financial services all of which are aimed at promoting economic development of these countries. This assistance from the World Bank group ensures that the country in question is in a better position to trade with other countries all over the world. The world trade organization on the other hand has played the role of liberalizing trade among countries all over the world as well as arbitrating international trading disputes. Liberalizing of trade is achieved through encouraging member countries to reduce or completely abolish the trade tariffs among other trade restrictions. This reduces the cost of importing as well as exporting goods from one country to another thus promoting trade among them. Arbitration of international trade disputes also plays a crucial role in promoting trade because many people would fearlessly engage in trading activities knowing clearly that any potential disputes would be dealt with accordingly.
Question 3: Identify and describe the major economic issues affecting the strategic management of multinational firms
A multinational firm can be defined as any company with assets and employees in more than one country. Such firms engage in production of goods and provision of services to its clients spread all over the world. In order to reduce the cost of production and marketing of the company’s commodities; its management opts to set base in a foreign country especially if the country has a large market for its products. This decision is however accompanied with a number of economic challenges which significantly affect the company’s strategic management. One of these challenges is the cost of production. Sometimes a multinational firm may decide to operate in a country with a high cost of labor among other factors of production like capital. This may occur when the company is eyeing a large market in the country and therefore in spite of the high cost of production; the company’s management would still choose to operate from this particular country.
Another economic challenge that may affect the strategic management of a multinational firm is the existence of cycles in the economic performance of various countries. In such countries, there are cycles of economic boom and economic downturns which keep recurring each year such that the effective demand for goods and services cannot be predicted by the company’s marketing team. This makes it quite challenging to plan for the company’s future since no one can easily state with certainty the expected revenues from the goods being produced. As a result of this, the management of multinational firms; especially those operating in such countries do encounter great challenges in formulating goals and strategies for the future operations of the company. This would not be the case had there been consistency in the country’s economic performance from one period to another.
Question 4: Outline how exchange rates are determined, the types of exchange rate mechanisms, and the role of foreign exchange markets
An exchange rate shows how much one unit of a currency can be exchanged for another currency. Exchange rates are determined by the forces of demand and supply. If for in stance the demand for the US Dollar in the European Union increases in relation to its supply; the value of this currency will increase relative to the Euro. This would therefore create a new foreign exchange rate. Therefore the demand for the currency plays a very crucial role in determining the foreign exchange rates between any two currencies. There are two types of exchange rate systems; the floating exchange rate system and the pegged or fixed exchange rate system. In the floating exchange rate system foreign exchange rates are determined purely by the demand and supply of the currency in question relative to another. If the demand for the US Dollars by Europeans falls, the value of this currency relative to the Euro would therefore fall. In the floating exchange rate system; foreign exchange rates fluctuate freely with no imposed limits. In the pegged exchange rate system on the other hand, the exchange rate is set and maintained artificial by the government of the country in question. This is done especially in the countries with emerging markets in order to protect the economies against economic fluctuations. To effectively achieve this objective the government sets aside large reserves of the currency which would then be used to create and maintain the stability of the country’s currency. Foreign exchange markets play a very important role in enabling people from different countries to trade with one another. This is because it enables one to acquire foreign currency with which to buy goods and services from another country. These markets also enable people to accurately ascertain the value of their investments in foreign countries and hence make appropriate strategic investment decisions (Sarno and Taylor, 2002).
Sarno, L & Taylor, M.P., (2002) The Economics of Exchange Rates
Retrieved from: http://books.google.co.ke/books?id=NDcsBZKmBWQC&pg=PA159&dq=how+exchange+rates+are+set&hl=en&sa=X&ei=-TAwUcKsAoaQ4gTk64CQBQ&ved=0CEgQ6AEwAw#v=onepage&q=how%20exchange%20rates%20are%20set&f=false
Ahearn, R.J., (2011) International Trade and Finance: Key Policy Issues for the 112th Congress
Retrieved from: http://books.google.co.ke/books?id=vIHUG6V4K2MC&printsec=frontcover&dq=international+financial+institution+and+promotion+of+trade&hl=en&sa=X&ei=zDEwUdmzIs3Z4QSO-YDwBw&ved=0CCwQ6AEwAA
