EEC-11
Book-9
Q: Differentiate between interregional and
international trade. What factors determine gains from international trade? (June, 07) 10
Ans: Inter-regional trade is trade between different regions within
the same country, whereas international trade is between different countries.
The difference between inter-regional trade and international trade, is only
one of degree, not of kind. The fundamental principles in both cases are the
same. International trade, like interregional trade, is the result of division
of labour. In internal or inter-regional trade, people specialised producing
goods in which they have a greater comparative advantage; the same thing
happens in international trade. There are, however, several differences between
domestic trade and foreign trade which necessitate the formulation of a
separate theory of international trade.
The
capital and labour between two countries are not so mobile as between two
different parts of the same country. It is on account of the greater mobility
of labour and capital within the country that there is a tendency for the
equalization of interest and wage rates. Sometimes, the production conditions
differ from country to country. For example, one country can be more advanced
than another country in science and technology. Thus, the production costs will
be lower in the former country. One country can be endowed with greater and
more abundant natural resources than another country. Thus, on account of these
differences, the production costs, of the same commodity can be different in
the two countries. Generally speaking, there are no restrictions on the flow of
trade between two parts of the same country. As against this, there is a
multiplicity of restrictions on trade between two countries. Since a country has
one common currency, there are no difficulties 'in making payments in internal
trade. But there sue different currencies in different countries. As such, a
number of foreign exchange difficulties arise in international trade.
Sometimes, the scarcity of foreign exchange limits the size of Imports from
other Countries.
The extent of gain from trade is
determined by many factors. We can discuss them under the following heads:
Relative Differences in Cost Ratio: The extent of
gain from trade is determined by the relative differences in cost ratios. If a
country has greater differences in cost ratios it will gain more because if the
differences are marginal then gains will also be marginal. Thus, gains are
directly related to productivity and efficiency conditions prevailing in a
country. Higher the productivity and efficiency greater will be the gains from
trade.
Reciprocal Demand: Reciprocal demand
also determines the extent of gain. If, for example, country A demand is more
and country B is not willing to supply at the existing rate, then rate will
change in favour of B. Or, if country A's demand is less and country B is
willing to supply more then the terms of trade will favour country A. The
relative strength and elasticity of demand of both the countries will determine
the gains from trade. In other words, the extent of gain from trade is
determined by reciprocal demand.
Higher
the efficiency in production, greater will be gains. Further, income and nature
of the commodity, which will influence the demand, will influence the gain. As
more than one country is involved in trade, we have to consider the relative
capability and demand of both the countries. Sometimes, size of a country also
influences the gains. It can be said that the gains to a small country will be
relatively larger, because^ a small country faces many obstacles and
limitations in large scale production. In this way size of a country also
influences the gain. On the other hand, in a very small country, availability
of domestic reasons will be limited in size and variety. ,Jhis may have adverse
effects oil efficiency. Therefore, we cannot make any generalization and relate
the gains to the size of an economy.(623 Word) …..Too long
Q: Why do countries trade with each other?
Critically examine the Ricardian theory of comparative
advantage in this regard. (June, 08)
5+15=20
Ans: Countries trade with each other due to the following
reasons
·
No
country can be completely self sufficient, and trade between countries is
therefore essential to ensure a supply of a country’s needs.
·
It
enables the people to enjoy those goods and services which they cannot produce
themselves or which they can produce at a relatively high cost.
·
There
is unequal distribution of productive resources by the nature on the surface of
the earth. Countries differ in respect of climatic conditions, availability of
cultivable land, forests, mines, mineral products, labour, capital technology
and entrepreneurial skills etc. Given their diversities, no country has the
potential to produce all the commodities at the least cost.
·
Just
as there is division of labour in the case of individuals, the countries also
adopt this principle at the international level. Each one of them specializes
in the production of only such commodities, which they can produce at
comparatively lower cost than the others. They export such products toothers
and in return import those products in the production, of which they have
comparative cost disadvantage.
In
recent years, the theory of comparative cost has come in for scathing criticism
at the hands of eminent economists like Bertil Ohlin and Frank Graham. The main
criticisms levelled against the theory are as follows :
(i) Assumption of Labour Costs.
The most fundamental criticism against the theory is that it had its roots in
the labour-cost theory of value. But this is not valid assumption, since beyond
a point the law of increasing or decreasing cost operates. The cost ratios are
bound to change when specialisation between the two countries has gone apace.
(ii) Assumption of Fixed Proportions.
It is assumed that the various factors of production are always combined in the
same fixed proportion. If costs other than the labour costs are admitted into
the analysis of relative values, then they must always constitute a constant
percentage of total costs, otherwise value would be determined by something
other than labour costs. This assumption is totally wrong and unrealistic. In
the real world, there is a wide variation in the proportion in which the
factors of proportion are combined with each other.
(iii) Assumption of Constant Costs.
Another criticism of this theory relates to its assumption of constant costs.
According to the classical economists, the Law of Constant Costs prevails in
every industry so that additional units of the same commodity.can be produced
at a constant labour cost per unit. But this assumption of constant costs is
totally wrong and unrealistic.
(iv) Assumption of Internal Mobility
and External Immobility. Another drawback of the classical theory of
comparative costs is to be found in its basic assumption that, internally,
factors of production are completely mobile, but internationally they are
wholly immobile. The assumption is totally wrong, unrealistic and contrary to
facts. Internally, the factors of production are never perfectly mobile.
Internationally, too, the factors of production are not perfectly immobile as
assumed by the theory.
(v) Absence of Transport Costs.
Still another criticism of the theory relates to its assumption that transport
costs do not exist. This is manifestly a wrong and unrealistic assumption.
There are several branches of production in which transport costs are even
higher than production costs. A particular commodity cannot enter into
international trade unless the difference in production costs between the two
countries is higher than the cost of transporting it from one country to
another. Transport costs are, thus, too important to be ignored.
(vi) Unrealistic Theory. The
theory of comparative cost is unrealistic in the sense that actual production
in a country may not accord with the principle of comparative advantage. In
other words, a country may produce even those goods in which it does not
possess any comparative advantage. In these days of national self-sufficiency, every country
tries as best as it can to be self-sufficient in the production of important
commodities on military and strategic grounds.
(vii) Complete Specialization
Impossible. This theory has been criticized on the ground that complete
division of labour and specialization would not be possible. It may be possible
for a small country to specialize in the production of one commodity or a few
commodities. But it is simply out of question for a big country like, USA,
China or India to specialise. Thus, again the theory though looks plausible, is
not realistic.
Other than the above mentioned
criticism, there are many other criticism of comparative cost theory. (745
Words)
Q: In
what way is domestic trade different from foreign trade? Discuss the comparative costs theory of
trade. (June, 03) 5+15
Ans: There
are certain basic differences between domestic trade and international trade.
The main differences between internal trade and international trade are-
- The capital and labour
between two countries are not so mobile as between two different parts of
the same country. It is on account of the greater mobility of labour and
capital within the country that there is a tendency for the equalization
of interest and wage rates.
- one country can be more
advanced than another country in science and technology. Thus, the
production costs will be lower in the former country.
- One country can be endowed
with greater and more abundant natural resources than another country.
Thus, on account of these differences, the production costs, of the same
commodity can be different in the two countries.
- Generally speaking, there
are no restrictions on the flow of trade between two parts of the same
country. As against this, there is a multiplicity of restrictions on trade
between two countries.
- Since a country has one
common currency, there are no difficulties in making payments in domestic
trade. But there are different currencies in different countries. As such,
a number of foreign exchange difficulties arise in international trade.
The
theory was first propounded by economist, David Ricardo. According to this
theory, a country tends to specialize in the production of those commodities in
which it possesses a comparative advantage by virtue of its climate, natural
resources, skill of its people and capital equipment. The term comparative
advantage means the special abiliity of the country to provide a particular
commodity or service relatively more cheaply than other commodities or
services. The various assumptions of the theory are- Two countries, two commodities, Only labour
costs and no money cost, No transportation charges, Production to take place
under conditions of constant cost, free trade and perfect compitition in the
production of the goods.
The
movement of trade between the two countries, according to this theory, is
determined by cost differences. We can explain
Ricardo's comparative cost theory by taking an example. we have taken two
countries and two commodities and the amount of labour needed (in hours) to
produce one unit each of X and Y as given below:
|
Country
|
Hours
reqd. for
|
|
|
Commodity
X
|
Commodity
Y
|
|
|
A
|
120
|
100
|
|
B
|
80
|
90
|
From
the above table, it is clear that country A is able to produce 1 unit of X with
120 hours of labour while it can produce 1 unit of Y with 100 hours of labour.
Thus, X is more expensive than Y. One unit of X will cost 120/100 units of Y.
In country B, it takes 80 hours of labour to produce 1 unit of X and 90 hours
of labour to produce 1 units of Y. Notice that country B has absolute advantage
in both lines of production because it takes less labour in B than A to produce
both X and Y. However, within B, Y is more expensive per unit than X. One unit
of X costs 80 90 or 0.89 units of Y
Although country B has absolute advantage in both lines of production,
each country has a comparative advantage in different goods. A has a comparative advantage in producing
that good whose opportunity cost lower
in this country than in the other country. The opportunity cost of 1 unit of X
for Y in country A is 120/100=12/10 while in country B it is 80/90 or 8/9.
Thus, the opportunity cost of X for Y is lower in B than A. On the other hand
the opportunity cost of 1 unit of Y for X in country A is 100/120 = 10/12,
while in country B it is 90/80 or 9/8. So opportunity of Y for X is lower in A
than i B. Thus, B has a comparative advantage in producing X while A has a comparative
advantage in producing Y.
We saw above that in country A, one unit of X traded for
120/100 or 1.2 units Y, while in B, one unit of X traded for 80/90, or 0.89
units of Y. If country A could import one unit of X for less than 1.2 units of
Y, and if country B could import more than 0.89 units of Y for 1 unit of X,
both countries would gain from international trade. Thus, permanent
international trade between the two countries can take place only if there are
comparative differences in production costs between the two countries. (750 Words)
******Internal=Interregional=domestic
Q: Examine the theory of comparative cost
advantage of international trade. (Dec.,07) 20
Ans: In
recent years, the theory of comparative cost has come in for scathing criticism
at the hands of eminent economists like Bertil Ohlin and Frank Graham. The main
criticisms levelled against the theory are as follows :
Assumption of Labour Costs. The most fundamental
criticism against the theory is that it had its roots in the labour-cost theory
of value. The most fundamental criticism against the theory is that it had its
roots in the labour-cost theory of value. But this is not valid assumption,
since beyond a point the law of increasing or decreasing cost operates. The
cost ratios are bound to change when specialisation between the two countries
has gone apace.
Assumption of Fixed Proportions. Based on the
labour cost theory of value, this theory requires the further assumption that
the various factors of production are always combined in the same fixed
proportion. If costs other than the labour costs are admitted into the analysis
of relative values, then they must always constitute a constant percentage of
total costs, otherwise value would be determined by something other than labour
costs. Now this assumption of fixed factoral proportion is totally wrong and
unrealistic. In the real world, there is a wide variation in the proportion in
which the factors of proportion are combined with each other.
Assumption of Constant Costs. Another
criticism of this theory relates to its assumption of constant costs. According
to the classical economists, the Law of Constant Costs prevails in every
industry so that additional units of the same commodity.can be produced at a
constant labour cost per unit. But this assumption of constant costs is totally
wrong and unrealistic.
Assumption of lnternal Mobility and
External Immobility.
Another drawback of the classical theory of comparative costs is to be found in
its basic assumption that, internally, factors of production are completely
mobile, but internationally they are wholly immobile. The assumption is totally
wrong, unrealistic and contrary to facts. Internally, the factors of production
are never perfectly mobile. Internationally, too, the factors of production are
not perfectly immobile as assumed by the theory.
Absence of Transport Costs. Still another
criticism of the theory relates to its assumption that transport costs do not
exist. This is manifestly a wrong and unrealistic assumption. There are several
branches of production in which transport costs are even higher than production
costs. A particular commodity cannot enter into international trade unless the
difference in production costs between the two countries is higher than the
cost of transporting it from one country to another. Transport costs are, thus,
too important to be ignored.
Unrealistic Theory. The theory of
comparative cost is unrealistic in the sense that actual production in a
country may not accord with the principle of comparative advantage. In other
words, a country may produce even those goods in which it does not possess any
comparative advantage. In these days of
national self-sufficiency, every country tries as best as it can to be
self-sufficient in the production of important commodities on military and
strategic grounds.
Complete Specialization Impossible. This theory has
been criticized on the ground that complete division of labour and
specialization would not be possible. For e.g a small size country will possess
limited natural resources, therefore, it could specialize in the production of
one commodity. It would devote all its resources to the production of that
particular commodity. Despite this, its production of commodity would not be
adequate to meet the requirements of both the countries. The large-sized
country, on the contrary, would have to produce both the commodities. In other
words, it would produce even that commodity in the production of which it
possesses no comparative advantage merely because the small-sized country
cannot, in view of its limited resources, produce that commodity in abundance
to meet the full requirements of both the countries.
Clumsiness of the Theory. This theory
has been castigated by Bertil Ohlin as unduly cumbersome and unreal. The major
drawback of this theory is that it does not take into account cost differences
in the two countries in their entirety. The theory leaves out interest on
capital, transportation charges and other items from the production costs. This
is obviously a wrong and unrealistic treatment of the subject. (704 Words)
Q: Explain the
Heckscher-Ohlin theory of international trade. How does it differ from Ricardian comparative-advantage theory? (Dec., 06) 20
Ans: The Heckscher-Ohlin model was produced as
an alternative to the Ricardian model of basic comparative advantage. The
theory argues that the pattern of international trade is determined by differences
in factor endowments. It predicts
that countries will export
those goods that make intensive use of locally
abundant factors and will import goods that make intensive use of factors that
are locally scarce. Core assumptions of the H-O model: (1) Labor and capital
flow freely between sectors (2) The production of shoes is labor intensive and
computers is capital intensive (3) The amount of labor and capital in two
countries differ (difference in endowments) (4) free trade (5) technology is
the same across countries (long-term) (6) Tastes are the same.
Each region specializes in the
production of those commodities for which it was best suited in terms or
natural resources and factor equipment. It then exchanges these commodities for
other goods for which other regions were better suited. Bertil Ohlin, thus,
points out that variations in productive factors is a cause of interregional
trade and specialization. The variations in productive factors or,
factor-endowments cause differences in prices in different countries and the
price-differences are the cause of international trade. In the words of
Ellsworth, "The immediate cause of interregional trade in goods is to be
found in price-differences. In other words, interregional (or, international)
trade is a price phenomenon."
Now question is- Under what
circumstances do relative commodity prices differ in different countries?
Differences in relative commodity prices depend upon the demand for and the
supply of a commodity in the two regions. The demand for a commodity depends
upon consumers' wants, and consumers' income. The supply of a commodity depends
upon supply of productive factors, and technical conditions of production.
According to Ohlin, the technical conditions of production are virtually the
same everywhere; hence this factor can be safely kept out of the discussion.
Consequently, differences in relative commodity prices depend upon the two
conditions, namely, consumers' wants, and consumers' income, the demand and the
supply of the productive factors. Bertil Ohlin's main conclusion can, thus, be
summarized as follows:
(i) The immediate cause of interregional or
international trade is the differences in relative commodity prices in the two
geographical regions or countries.
(ii) Differences in the relative
commodity prices are due to the relative scarcities of productive factors in
the two regions or countries. In the words of Ohlin, "International trade,
thus, implies an exchange of abundant factors for the scantily
supplied factors." Ellsworth has summed up Ohlin's theory thus :
"Regional differences in factor-equipment occupy the fundamental position
in the explanation of interregional specialization and trade. Given such
differences, factor-prices will vary from region to region which, in turn,
means that commodity prices will differ."
Ohlin's theory departs from the classical (Comparative Cost
Theory) in the following respects:
(i) It seeks to explain the phenomenon of international trade in
terms of general theory of value rather than the Labour theory of value.
(ii) Unlike the classical theory, Ohlin's theory asserts that
there is no need for a separate theory of international trade.
(iii) Ohlin's theory is a type of location theory and stresses the
space element. It is simply the multiple market theory of pricing. Hence it is
more realistic than the highly abstract classical theory of comparative costs,
(iv) Since Ohlin's theory takes two or more factors of production
into account, factor supplies become crucial determinant of comparative
advantage. In the classical theory, only one factor-labour is considered, hence
factor supply aspect is rendered irrelevant.
Thus Ohlin's theory integrates factor markets into international
trade theory.
(v) The classical theory
seeks to establish the welfare propositions of the international trade theory.
On the other hand, Ohlin's theory represents a contribution to positive
economics. It attempts a scientific explanation of the structure of
international trade.
(vi) The classical theory laid emphasis on the quality of a single
factor labour. On the other hand, in Ohlin's theory it is the quantity of all
factors and not their quality in different regions which account for the
emergence of international trade.
(vii) In the classical theory, comparative advantage arises from
superior skills or techniques. But this superiority may vanish when others have
learnt the technique. Hence, international trade will come to an end. But
Ohlin's theory asserts that international trade will always continue, because
international trade arises from differences in relative commodity costs which are
due to relative differences in factor prices and relative differences in factor
requirements.
(viii) The classical theory does not explain why there are
differences in comparative costs, but Ohlin's factor-proportions analysis is
able to do so.
Thus, Ohlin's theory represents a real departure from the
classical doctrine and is a great improvement thereon. (787 Words)
********Heckscher-Ohlin
theory of international trade is also know as Modern theory of international trade and Richardian Theory of
Comparative Cost is also known as Classical theory of international trade
Q: What do you
mean by balance of payments? What are the components of a balance-of- payments account? (Dec., 06) (Dec., 01) 10
Ans: The balance of
payments of a country is an annual record of its monetary transactions with
other countries of the world. It is an important index which reflects the true
economic position of . country, whether the country is a creditor or a debtor
country. There are various types of monetary transactions taking place amongst
the countries of the world. Broadly speaking, we can classify them under three
heads : (i) The exports and imports of a country give rise to monetary
transactions with other countries. The exports give rise to receipts from
foreign countries while imports result in payments which are to be made to
foreign countries for imported goods, (ii) The international lending and
borrowing also give rise to monetary transactions amongst the countries of the
world, (iii) The servicing of foreign debts and their final repayments also
result in international payments and receipts. Thus, the balance of payments
is an annual record of the international receipts and payments of a country.
The
BOP is divided into two main categories: the current account
and the capital account Within these categories are sub-divisions, each of
which accounts for a different type of international monetary transaction.
The Current Account: The current
account is used to mark the inflow and outflow of goods and services into a
country. Earnings on investments, both public and private, are also put into
the current account. Within the current account are credits and debits on the
trade of merchandise, which includes goods such as raw materials and
manufactured goods. Services refer to receipts from tourism, transportation,
engineering, business service fees etc. When combined, goods and services
together make up a country's balance of trade (BOT). Receipts from
income-generating assets such as stocks are also recorded in the current
account. The last component of the current account is unilateral transfers like
grants, remittances and other transfers.
The Capital Account: The capital account is where all
international capital transfers are recorded. It includes both long term and
short term borrowing and lending, repayment of capital, sale and purchase of
securities and other assets to and from foriegners- indiviadual and
governments. International monetary flows related to investment in business,
real estate, bonds and stocks are also documented. Also included are
government-owned assets such as foreign reserves, gold, held with the IMF,
private assets held abroad, and direct foreign investment. Assets owned by
foreigners, private and official, are also recorded in the financial account. (405
Words)
Q: Distinguish
between free trade and protection. Also discuss their relative merits and demerits. (Dec.,
99) 20
Ans: Free
Trade refers to that state in which there is unrestricted exchange of goods
and services amongst the various countries of the world. It is a type of trade policy
that allows traders to act and transact without interference from government.
Thus, the policy permits trading partners mutual gains from trade, with goods
and services produced according to the theory of comparative advantage, while Protection
refers to that policy of the government under which a number of restrictions
are imposed on import trade with a view to giving protection to home
industries. This policy is closely aligned with anti-globalization, and contrasts with free trade,
where government barriers to trade are kept to a minimum.
Both Free trade and Protection have relative merits
and demerits-
(i)
Harmful to Economically
Underdeveloped Countries. Due to free trade the
underdeveloped and weak industries of backward countries cannot face the
unequal competition of well-established industries in the developed countries.
Poorer countries have argued that they needed to protect “infant industries” so
they can get them off the ground in the first place.
(ii)
Basic Industries and
employment: The basic industries are need for the speedy economic
development of a country, because without these industries, the economic growth
of a country cannot be automatic and self-sustained. The new industries come
into existence as a result of the policy of protection and the people get
increasing opportunities of employment within the country.The basic industries
and volume of employment in a country can be increased by following the policy
of protection. Free trade will stagnet the growth of new industries and hence
employment.
(iii)
Improvement in Balance of
Trade. The policy of protection is sometimes supported on
the ground that it leads to a perceptible improvement in the balance of trade
of a country. If the imports are cut down through the imposition of high import
duties, there shall be improvement in the balance of trade of the country.
(iv)
Home Market: When the government cuts down its imports by following the policy of
protection this encourages the sale of home-made goods within the country.
Consequently, the volume of employment increases within the country. With
increased employment, the demand for home-made goods increases still further, resulting
in a further development of the home market.
(v)
Proper Utilization of the
Factors of Production. Under free trade every country specializes in the
production of those commodities in which it enjoys the maximum advantage. Since
production is based on the principle of comparative costs, the country is able
to utilize its productive resources in a proper manner under a policy of free
trade.
(vi)
Benefits to the Consumers. The indigenous industrialists have to compete with the foreign
industrialists under the policy of free trade. Hence, they try to sell their
products at cheap prices by cutting down their production costs. Moreover the
policy of protection often feeds those industries which are not efficient or
economical for the country. Such industries automatically come to end or
improve their standards in course of time. Also, the home industries have to
face the competition of foreign industries, they cannot set up monopolistic
combines to maximize their profits.
(vii)
Reduction in Foreign Trade. When a country reduces its imports through a policy of protection,
its exports also decline because the Other countries retaliate by imposing
import duties on its exports. Thus, the policy of protection often results in a
serious decline in foreign trade,
(viii)
Proper Utilization of
Natural Resources: There is always wasteful utilization of a country's
natural resources under the policy of free trade. The reason is that when a
country acquires specialization in the production of a particular commodity,
then this results in a speedy exhaustion of material resources in the country.
But there is no such fear under a policy of protection.
There are many more pros and cons of
free trade and protection policy which are addressed time to time but from the above
discussion, it appears that the advantages of the policy of protection are
several times its disadvantages. In fact this is the reason why almost all
countries of the world including the developed countries have abandoned the
policy of free trade today in favour of the policy of protection. (702
Words)
Q: Explain the difference between Balance
of trade and Balance of payments. How does balance
of payments always balance? (June, 01) 10
Ans: The balance of payments of a country is an
annual record of its monetary transactions with other countries of the world.
It is an important index which reflects the true economic position of country,
whether the country is a creditor or a debtor country. There are various types
of monetary transactions taking place amongst the countries of the world. On
the other hand, the balance of trade of a country shows its trade transactions
with the rest of the world during the course of a year. It indicates the relationship
between the value of exports and the value of imports of the country in
question. But the balance of trade takes into account only visible exports
and imports. The visible exports and imports are those which are
actually recorded at the ports. If the money value of exports is greater than
the money value of imports, then the balance of trade is said to be favourable
to the country. If imports are more than exports then, the balance of trade
is said to be unfavourable for the country.
But it is not only the visible imports and exports which
give rise to international payments and receipts. There can be several other
items known as invisible items which can give rise to international
receipts and payments such as the services rendered by shipping, insurance and
banking companies, debt repayments and payments of interest, expenditure by
tourists, payments of dividends on capital invested by foreigners, etc. So, to
know the real international monetary position of a country, it shall be more
appropriate to refer to the balance of payments of the country concerned. The
balance of payments is a wider and a more comprehensive concept than the
balance of trade. In addition to the values of visible exports and imports, the
balance of payments also includes various types of invisible imports and
exports or non-commodity items which give rise to international receipts and
payments.
The balance of payments on current account is said to be
balance when the total of the credit items is exactly equal to the total of the
debit items. However, as mentioned above, this rarely happens. Hence there is
either a deficit or a surplus in the current accounts of balance of payment.
This deficit or surplus is met by transfers in the capital account. In other
words, the balance of payment is made to balance through the capital account.
This deficit can be covered by- drawing upon the country’s foreign exchange
reserve, by borrrowing from abroad and by exporting gold. Now the IMF grants
temporary accomodation to bridge the gap. (433 Words)
Q: Explain the concept of (a) terms of
trade, (b) offer curve, and (c) reciprocal demand. Explain with the help of a diagram. (June, 99) 20
Ans: The terms of trade measures the rate
of exchange of one good or service for another when two countries trade with
each other. There are several measures of terms of trade, each
representing a different concept The important measures among them are: (i) Net
barter terms of trade; (ii) Gross baiter terms of trade; and (iii) Income terms
of trade. The following are the main factors on which
the terms of trade of a country may depend:
(i) Elasticity of demand and supply; (ii) Availability of substitutes;
(iii) Size of demand; (iv) Rate of Exchange; (v) Production pattern of a
country. We calculate the terms of trade as an index number using the
following formula:
ToT = 100 x Average export price
index / Average import price index
If export
prices are rising faster than import prices, the terms of trade index will
rise. This means that fewer exports have to be given up in exchange for a given
volume of imports. If import prices rise faster than export prices,
the terms of trade have deteriorated. A greater volume of exports has to be
sold to finance a given amount of imported goods and services. The terms of trade fluctuate in line with
changes in export and import prices. Clearly the exchange rate and the rate of
inflation can both influence the direction of any change in the terms of trade.
Offer curve: In
international trade, an offer curve shows the quantity of one type of
product that an agent will export ("offer") for each quantity of
another type of product that it imports. The offer curve is simply another
useful way to describe an individual's demand behavior. We can also use the
offer curve to describe the market's demand behavior, by summing up the
behavior of individuals. While the offer curve can be constructed when there
are more than two goods, it is most useful in the two-good case. The offer
curve was first derived by English economists Edgeworth
and Marshall.
The
Offer Curve is derived from the country's PPF. We describe a Country
named K which enjoys both goods Y and X. It is slightly
better at producing good X, but wants to consume both goods. It wants to
consume at point C or higher (above the PPF). Country K starts in Autarky
at point C. At point C, country K can produce (and consume) 3 Y
for 5 X. As trade begins with another country, and country K begins to specialize in producing good X.
When it produces at point B, it can trade with the other country and
consume at point S. We now look at our Offer curve and draw a ray at the level 5 Y for 7 X. When full specialization
occurs, K then produces at point A, trades and then consumes at point T.
The price has reduced to 1 Y for 1 X, and the economy is now at equilibrium
Reciprocal
demand: The
concept that, in international trade, it is not just supply and demand that
interact, but demand and demand. That is, a trading equilibrium is a reciprocal
equilibrium in which one country's demand for another country's products (and
willingness to pay for them with its own) matches with the other country's
demands for the products of the first. Normally when we think of trade in
general, we think about the ideas of supply and demand and how they relate to
each other. When it comes to international trade, the notion of
"reciprocial demand" makes us think about how demand and demand
relate to each other as well. Basically the concept of reciprocal demand is
about how there is a trading equilibrium when Country X's demand for Country
Y's products is linked up with Country Y's demand for Country X's products. For
example, consider a situation (totally oversimplified, but it might help) where
Country X produced oranges but no apples. Maybe Country X would like to produce
apples, but for whatever reason (climate, lack of infrastructure, or other
barriers to entry) they can't. Country Y produces apples, but not oranges, and
doesn't produce oranges for the similar reasons why Country X doesn't produce
apples. The people in both countries want both kinds of fruit, hence the idea
of "reciprocal demand," which just means that there is demand for
what the first country produces in the second country, and there is demand for
what the second country produces in the first. The two countries can engage in
trade that satisfies the demand in each nation for the other's product. (758
Words)
****Diagrams not
available for Terms of Trade and Reciprocal Demand
Q: Discuss in brief the conditions under
which market fails. (June, 08) 12
Ans: Market failure is
said to be exists when the production or use of goods and services by the
market is not efficient. That is, there exists another outcome where all
involved can be made better off. Market failures can be viewed as scenarios
where individuals' pursuit of pure self-interest leads to results that are not
efficient - that can be improved upon from the societal point-of-view. According to mainstream economic analysis, a
market failure (relative to Pareto efficiency) can occur for three main
reasons.
First, an agent
in a market can gain market power, allowing them to block other mutually
beneficial gains from trade from occurring. This can lead to inefficiency due
to imperfect competition, which can take many different forms, such as
monopolies, monopsonies, cartels, or monopolistic competition, if the agent
does not implement perfect price discrimination. In a monopoly the market
equilibrium will no longer be Pareto optimal. The monopoly will use its market
power to restrict output below the quantity at which the MSB is equal to the
MSC of the last unit produced, so as to keep prices and profits high.
Second, the
actions of an agent can have externalities, which are natural to the methods of
production, or other conditions important to the market. For example, when a firm is producing steel
it absorbs labor, capital and other inputs, it must pay for these in the
appropriate markets, and these costs will be reflected in the market price for
steel. If the firm also pollutes the
atmosphere when it makes steel, however, and if it is not forced to pay for the
use of this resource, then this cost will be borne not by the firm but by
society. Hence, the market price for steel will fail to incorporate the full
opportunity cost to society of producing. In this case, the market equilibrium
in the steel industry will not be optimal. More steel will be
produced than would occur were the firm to have to pay for all of Its costs of
Abduction. Consequently, the MSC of the last unit produced will exceed its MSB.
Finally, some
markets can fail due to the nature of certain goods, or the nature of their
exchange. For instance, goods can display the attributes of public goods or
common-pool resources, while markets may have significant transaction costs,
agency problems, or informational asymmetry. In general, all of these
situations can produce inefficiency, and a resulting market failure. (408
Words)
Balance
of Trade and Balance of Payments (Dec., 99) 5
The
balance of payments of a country is an annual record of its monetary
transactions with other countries of the world. It is an important index which
reflects the true economic position of country, whether the country is a
creditor or a debtor country. There are various types of monetary transactions
taking place amongst the countries of the world. On the other hand, the balance
of trade of a country shows its trade transactions with the rest of the world
during the course of a year. It indicates the relationship between the value
of exports and the value of imports of the country in question. But the balance
of trade takes into account only visible exports and imports. The visible
exports and imports are those which are actually recorded at the ports.
Balance of Payment also reflects invisible items which can give rise to
international receipts and payments such as shipping, insurance and banking
companies, expenditure by tourists, etc. The balance of payments is a wider and
a more comprehensive concept than the balance of trade. (176 Words)
Balance of
payments, for any
country, always balances (Dec., 00) 5
The
balance of payments on current account is said to be balance when the total of
the credit items is exactly equal to the total of the debit items. However, as
mentioned above, this rarely happens. Hence there is either a deficit or a
surplus in the current accounts of balance of payment. This deficit or surplus
is met by transfers in the capital account. In other words, the balance of
payment is made to balance through the capital account. This deficit can be
covered by- drawing upon the country’s foreign exchange reserve, by borrrowing
from abroad and by exporting gold. Now the IMF grants temporary accomodation to
bridge the gap.(111 Words)
Balance of
Payments (Dec., 02), (June, 02) 5
The
balance of payments of a country is an annual record of its monetary
transactions with other countries of the world. It is an important index which
reflects the true economic position of . country, whether the country is a
creditor or a debtor country. There are various types of monetary transactions
taking place amongst the countries of the world. Broadly speaking, we can
classify them under three heads : (i) The exports and imports of a country give
rise to monetary transactions with other countries. The exports give rise to
receipts from foreign countries while imports result in payments which are to
be made to foreign countries for imported goods, (ii) The international
lending and borrowing also give rise to monetary transactions amongst the
countries of the world, (iii) The servicing of foreign debts and their final
repayments also result in international payments and receipts. Thus, the
balance of payments is an annual record of the international receipts and
payments of a country. The
BOP is divided into two main categories: the current account
and the capital account Within these categories are sub-divisions, each of
which accounts for a different type of international monetary transaction. (196 Words)
Terms
of Trade (Dec., 02)- 2 (Dec.,07)- 3
The terms of
trade measures the rate of exchange of one good or service for another when
two countries trade with each other. There are several measures of terms
of trade, viz. Net barter terms of trade; Gross baiter terms of trade; and
Income terms of trade. The following are the main
factors on which the terms of trade of a country may depend: (i) Elasticity of demand and supply; (ii)
Availability of substitutes; (iii) Size of demand; (iv) Rate of Exchange; (v)
Production pattern of a country. We calculate the terms of trade as an
index number using the following formula:
ToT = 100 x Average export price
index / Average import price index. (115 Words)
Free Trade
verses Protection (June,
00) 5
Or
Free
trade vs. Restricted trade (Dec., 02) 5
Free trade is a type of trade policy
that allows traders to act and transact without interference from government.
Thus, the policy permits trading partners mutual gains from trade with goods and
services produced according to the theory of comparative advantage.Under a free trade
policy, prices are a reflection of true supply and
demand, and are the sole determinant of resource allocation. Free trade differs from
other forms of trade policy where the allocation of goods and services amongst
trading countries are determined by artificial prices that do not reflect the
true nature of supply and demand. On the other hand Protection in
economics is the economic policy of restraining trade between
states, through methods such as tariffs on imported goods, restrictive quotas,
and a variety of other restrictive government regulations designed to
discourage imports, and prevent foreign take-over of local markets and
companies. This policy is closely aligned with anti-globalization, and contrasts with free trade,
where government barriers to trade are kept to a minimum. In other words it
refers to policies or doctrines which "protect" businesses and
workers within a country by restricting or regulating trade with foreign
nations. (191 Words)
*****Protection=
Restricted Trade
Offer curve (June, 06), (June, 03) 2
In international
trade, an offer curve shows the quantity of one type of product that an
agent will export ("offer") for each quantity of another type of
product that it imports. The offer curve is simply another useful way to
describe an individual's demand behavior. We can also use the offer curve to
describe the market's demand behavior, by summing up the behavior of
individuals. While the offer curve can be constructed when there are more than
two goods, it is most useful in the two-good case. (87
Words)
Assumptions of
Ricardo's comparative cost theory of trade (Dec.,
03) 5
According to
Ricardo's comparative cost theory of trade theory, a country tends to
specialize in the production of those commodities in which it possesses a
comparative advantage by virtue of its climate, natural resources, skill of its
people and capital equipment. The term comparative advantage means the special
abiliity of the country to provide a particular commodity or service relatively
more cheaply than other commodities or services. The various
assumptions of the theory are as follows: Production costs means only
labour costs to be expressed terms of so many units of labour. All labour was
assumed to be homogeneous.Production was assumed to take place under conditions
of constant cost. The factors of production were perfectly mobile within the
country, but totally immobile between countries. It is assumed that there are
no transportation charges and that there are no restrictions on the movement of
international trade from one country to ariother. Only two countries and two
commodities are to be considered at a time. (163 Words)
Heckscher-Ohlin theory of international trade (June, 03) 5
The
Heckscher-Ohlin model was produced as an alternative to the Ricardian model of
basic comparative advantage. The theory argues that the pattern of
international trade is determined by differences in factor endowments. It predicts
that countries will export
those goods that make intensive use of locally
abundant factors and will import goods that make intensive use of factors that
are locally scarce. Core assumptions of the H-O model: (1) Labor and capital
flow freely between sectors (2) The production of shoes is labor intensive and
computers is capital intensive (3) The amount of labor and capital in two
countries differ (difference in endowments) (4) free trade (5) technology is
the same across countries (long-term) (6) Tastes are the same. Main conclusion
of Modern theory of international trade can, be
summarized as- (i) The immediate cause
of interregional or international trade is the differences in relative
commodity prices in the two geographical regions or countries. (ii) Differences
in the relative commodity prices are due to the relative scarcities of
productive factors in the two regions or countries. (176
Words)
Public Debt (June,
02) 2
Public debt
represents State borrowings from the public. It has been classified under two
heads—internal debt and external debt. Internal debt is contracted by the
government from the citizens of the country. On the contrary, external debt is
taken by the government from foreign individuals, institutions and governments. (49
Words)
Foreign Trade
Multiplier (Dec.,
00) 2
Foreign
trade multiplier is the extension of Keynesian multiplier theory to the open
economy where there are flows of goods and capital between a country and
others. In the open economy foreign trade, imports and exports of an economy
are also to be taken into account as these have multiplier effect on changes in
the national income of a country. (60
Words)
Externalities (June,
06),(Dec., 99), (June, 99)2 (June,
08) 3
Measures
of Budget (Dec., 06) 5
Deficit
Quantity (Dec., 06) 5
Characteristics
of public good (Dec.,
03) 5
A public goods is defined as a goods that one person's consumption
of the goods does not reduce the amount available to others. The same benefits
are available to all and without mutual interference. Such good can be provided
by both Public and Private sectors. For e.g. public good provided by Government
is national defence and public good provided by private sector is television or
radio signal. Public goods are characterised by two factors non-rivals and
exclusion. Non rival concept of Public goods is something where good provided
is available to each person in the community. For example, a television signal
that is available to one person can be made available to all persons in the
area within the range of the signal. One viewer's use of the television signal
does not reduce its quality or the amount for others. Exclusion principle applies
when the good is provided to all community i.e it is non rival but its
consumption is made available on paying the price; who does not pay, is
excluded. For e.g Cable connection is available to all person in the community.
Its quality or amount also doesnot diminishes, i.e it is non-rival ; but who
donot pay for it are devoid of it or rather excluded. (209 Words)
***Club Goods: Incudes
Non-rival and Non Exclusion : Also known as Pure Public Goods, eg.
Television signal
Non-rival and Exclusion :
e.g. Cable TV Connection or elctricity by Govt.
Impure Public Goods includes
Rival and Non Exclusion :
e.g Using of Beach. No body can be excluded for using beach
as it is a public place but if it is already filled or congested
it is difficult to use.
Rival and Exclusion :
This is provided by private sector. E.g. any personal product like
TV or Refrigirator
(Go through Book9 Unit 21
Page 29 and 30) Important
Merit Goods
In all the types of goods— private goods, impure
public goods and pure public goods it is the consumer who decides whether they
want to consume the good or not. However, there are few exceptions. For e.g. a
rider of motorised two-wheeler vehicles must wear helmets, for their own good
and safety. Helmets would be private goods, but since it is an external agency,
the government which decided that people have to wear helmets, helmets become a
merit good as well. Thus, there are goods which seem worthy of consumption and
it is decided by an external agency, frequently the government. This type of
goods is called merit goods. Merit goods are goods, which are consumed on the
social interest or in other words, goods for which it is thought that
consumption should be encouraged are called merit goods.(139 Words)
Comparative
Cost Theory for 5 marks
The
theory was first propounded by economist, David Ricardo. It was further
developed and refined by J. S. Mill, Cairnes and Bastable. According to this
theory, a country tends to specialize in the production of those commodities in
which it possesses a comparative advantage by virtue of its climate, natural
resources, skill of its people and capital equipment. The term comparative
advantage means the special abiliity of the country to provide a particular
commodity or service relatively more cheaply than other commodities or
services. According to the theory a country will concentrate on the production
of those goods and services in which it has cost advantages and exchange them
for goods and services produced by other countries for the production of which
it was either less suited or had positive cost disadvantages. The concept of
comparative advantage also explains why a country capable of producing a wide
variety of goods and services at a lower cost than any other country should
concentrate on producing that good or Service for which its cost advantage is
the greatest and leave the production of other goods in which it has a positive
but less cost advantage, to other countries. (196
Words)
Q: Discuss the theory of comparative cost
advantage of international trade. (Dec.,07) 20
Ans: The
theory was first propounded by economist, David Ricardo. It was further
developed and refined by J. S. Mill, Cairnes and Bastable. According to this
theory, a country tends to specialize in the production of those commodities in
which it possesses a comparative advantage by virtue of its climate, natural
resources, skill of its people and capital equipment. The term comparative
advantage means the special abiliity of the country to provide a particular
commodity or service relatively more cheaply than other commodities or
services. According to the theory a country will concentrate on the production
of those goods and services in which it has cost advantages and exchange them
for goods and services produced by other countries for the production of which it
was either less suited or had positive cost disadvantages. The various
assumptions of the theory are as follows :
(i)
Production costs means only labour costs to be expressed in terms of so
many units of labour.
(ii)
All labour was assumed to be homogeneous.
(iii)
Production was assumed to take place under conditions of constant cost.
(iv) The factors of production were
perfectly mobile within the country, but totally immobile between countries.
(v) It is assumed that there are no
transportation charges and that there are no restrictions on the movement of
international trade from one country to another.
(vi) Only two countries and two
commodities are to bo considered at a time.
The movement of trade between the two countries,
according to this theory, is determined by cost differences. We can explain Ricardo's comparative cost theory by taking
an example. we have taken two countries and two commodities and the amount of
labour needed (in hours) to produce one unit each of X and Y as given below:
|
Country
|
Hours reqd. for
|
|
|
Commodity X
|
Commodity Y
|
|
|
A
|
120
|
100
|
|
B
|
80
|
90
|
From the table, it is clear
that country A is able to produce 1 unit of X with 120 hours of labour while it
can produce 1 unit of Y with 100 hours of labour. Thus, X is more expensive
than Y. One unit of X will cost 120/100 units of Y. In country B, it takes 80
hours of labour to produce 1 unit of X and 90 hours of labour to produce 1
units of Y. Notice that country B has absolute advantage in both lines of
production because it takes less labour in B than A to produce both X and Y.
However, within B, Y is more expensive per unit than X. One unit of X costs 80/
90 or 0.89 units of Y Although country
B has absolute advantage in both lines of production, each country has a
comparative advantage in different goods.
A has a comparative advantage in producing that good whose opportunity cost lower in this country than
in the other country. The opportunity cost of 1 unit of X for Y in country A is
120/100 g 12/10 while in country B it is 80/90 or 8/9. Thus, the opportunity
cost of X for Y is lower in B than A. On the other hand the opportunity cost of
1 unit of Y for X in country A is 100/120 = 10/12, while in country B it is
90/80 or 9/8. So opportunity of Y for X is lower in A than B. Thus, B has a
comparative advantage in producing X while A has a comparative advantage in
producing Y.
We saw above that in country A, one unit of X traded for
120/100 or 1.2 units Y, while in B, one unit of X traded for 80/90, or 0.89
units of Y. If country A could import one unit of X for less than 1.2
units of Y, and if country B could import more than 0.89 units of Y for 1 unit
of X, both countries would gain from international trade. Thus,
permanent international trade between the two countries can take place only if
there are comparative differences in production costs between the two
countries. This is known as the Theory of Comparative Costs. (682 Words)
Net Barter Terms of Trade
It is obtained by dividing the index of export prices by the index
of import prices bom indices expressed in percentages and the quotient thus
obtained also expressed in percentage. In symbols it is PX / PM
X 100, where PX stands for the index number of export prices
and PM stands for the index number of import prices.
Let us take an example. If the index number of export prices of
country A is 200 and index number of import prices is 100, then the net barter
terms of trade will be equal to 200/100 x 100=200. This means that the
Net barter terms of trade of a country A have shown an increase of 100 per cent
over the base period. If the value of the Net barter terms of trade comes to
lower than 100, that means that the terms of trade have fallen to that extent.
From the point of view of a country, a rise in the net barter terms of trade is
favourable because as a result of the rise, the country has now to pay a
smaller quantum of exports in return for the same volume of imports or
alternatively the same volume of exports for a larger quantum of imports. (208
Words)
Gross Barter Terms of Trade
It is obtained by dividing the index of the physical quantity of
exports by the index of the hysical quantity
of imports, all expressed
in terms of percentages.
In symbols, QX/ QM X100 where QX stands for the index number of
quantity of exports, and QM stands for the index number of quantity
of imports. If QX =100 and QM
=80 then the gross
barter terms of trade will be equal to 100/80 x 100= 125 which
means that the gross barter terms of trade have shown an improvement of 25 per
cent. (93 Words)
Income Terms of Trade
This is obtained by dividing the value of exports (Value
index=Quantity index X Price index), divided
by the index of import prices. In symbols, QX X PX/
PM X 100. A rise
in this index means that a country can obtain a larger volume of imports from
its sale of exports in a given year relative to the base year. (60 Words)
Q.
Distinguish between Private and Public Debt.
Ans: Following are the main differences between
private debt and public debt :
(i) The government can force the people
to lend to it, but no private individual can compel another individual to give
loans to him.
(ii) The government can repudiate loans
taken from the public whereas the private individual can, under no
circumstances, refuse repayment of loans to another private individual. The
government can effect unilateral reduction in the rate of interest on public
loans. But a private individual is not in a position to do so.
(iii) The government can contract loans
from the public for a very long time. A private individual, on the contrary,
can secure loans, at best, for a short period only.
(iv) The government can borrow both from
internal as well as from external sources. In other words, it not only borrows
from others, it can borrow from itself. When the government covers the deficit
through printing paper notes, that amounts to taking loans from itself. But a
private individual can borrow from external sources only.
(v) The loans taken by
the government are generally spent to promote the welfare of the people,
including the creditors. For example, when the government spends the loan-money
on developmental projects, it benefits almost all sections of the community
including the creditors. On the contrary, private loans are not spent in the interests
of the creditors.
(vi) Under public debt, the creditor can
realize his capital by selling the government securities in the market. But
this is not possible in the case of private debt.
(vii) Public debt produces a deep impact
on production of wealth in the country. As against this, private debt produces
no such impact.
(viii) Since government's credit is high,
it is able to secure loans at Cheaper interest rates than the private
borrowers.
(ix)
The government repays the public debt by taxing the people. The
creditors also make their contribution in this task. As against this, the
burden of private debt is never born by the creditors.
(x) Public debt is always spent for
productive purposes, whereas private debt may be spent both for productive as
well as unproductive purposes. (358
Words)
Internal
Debt and External Debt
Public
debt represents State borrowings from the public. It has been classified under
two heads—internal debt and external debt. Internal debt is contracted by the
government from the citizens of the country. On the contrary, external debt is
taken by the government from foreign individuals, institutions and governments. The internal debt is better than
the external debt. Firstly, when loans are taken from the foreigners,
the country has to pay a heavy sum of money by way of interest. This results in
the remittance of huge funds to foreign countries. Secondly, external
debt can also pose a danger to the economic and political independence of the
country. An internal debt does not increase the total availability of resources
within the country. It simply involves transfer of resources from the
bond-holders to the government. An external debt, on the contrary leads to an
increase in the total availability of resources for the debtor-countries,
because it represents a transfer of wealth from the creditor-nation to the
debtor-nation. (166 Words)
Q. 1. Account for the large increase in the public
debt of modern governments.
Ans: The size of public debt has increased
tremendously in modern times: There is hardly any government today which has
not contracted loans from its people. Following are the main causes of the
extraordinary increase in public debt in modern times :
(i) Developmental
Planning. Modern governments have abandoned the policy of laissez-faire.
They now actively intervene in economic affairs according to the
requirements of the economy. For example, modern governments resort to planning
with a view to accelerating the rate of economic growth. For this purpose, the
government has to borrow funds on a large scale from the public.
(ii) Unpopularity
of Taxation. Taxation, whether old or new, is always unpopular with the
public which generally opposes the imposition of new taxes. To get over this
opposition, the government adopts the easy path of public borrowing.
(iii) Facing
Natural Calamities, The government sometimes borrows money from the public
to cope with natural calamities, such as, fainines, floods, earthquakes, etc.
though the size of such loans is not
substantial.
substantial.
(iv) Waging
Wars. During the wars, the governments have to borrow heavily from the
public. In fact, this has turned out to be the most important reason for the
phenomenal increase in public debt.
(v) Covering
Temporary Deficit in the Budget. Sometimes, the government does not think
it appropriate to meet the deficit in the budgef by resorting to additional
taxation. In such a situation, the government may resort to borrowings from
the public.
(vi) Dealing
with Depression. Public borrowing is also looked upon as an effective
measure to deal with depression and unemployment in the economy. The reason is
that if the government resorts to additional taxation at such a time, it is
bound to have an adverse effect on the capacity to work and to invest, of the
people.
(vii) Controlling
Inflation. Through public borrowings on a large scale, the government can
neutralize the excessive purchasing power in the hands of the public. This will
have the effect of reducing inflationary pressures in the economy. Public
borrowing has become quite popular with the governments both in the developing
as well as the developed countries in view of its importance as an
anti-inflationary measure. (363 Words)
Q: How will you justify the increase in public
expenditure ? What causes are responsible for the recent increase in public
expenditure ?
Ans: The
modern governments not only perform such primary functions as the civil
administration as well as the defence of the country, but also take
considerable interest in promoting the economic development of their respective
countries. The public expenditure has increased in recent years due mostly to
the developmental activities of the government. Hence, the increase in
expenditure is quite justifiable.
The
main reasons for the increase in public
expenditure are as follows :
(i) Developmental Work. Modern governments
have also taken up developmental work in addition to their primary functions of
administration and defence. For example, the Central and the State Governments
in India perform a large variety of developmental functions. In fact, sustained
efforts are being made to bring about the all-round development of the economy
under the Five Year Plans.
(ii) Increase of Population. As a result,
the governments have to incur greater expenditure to meet the requirements of
their increasing population. In fact, the public expenditure increases in the same
propor tion in which the population increases.
(iii) Rise in the Price-level. As a result
of the rise in the price-level, the public expenditure has gone up everywhere.
The reason is that like the private individuals, the government has also to buy
goods and serv ices from the market at higher prices.
(iv) Rise of Democracy. The public
expenditure in various coun tries has gone up recently on account of the
establishment of democratic governments in several countries. To achieve the
goodwill of the public, the ruling party offers a large variety of services and
facilities to the public. As a result of this, public expenditure in these
countries has gone up.
(v) Expenditure on War. The world has
witnessed two World Wars during the first eight decades of the present century.
The governments of various countries had to spend astronomical amounts on the
prosecution of war. The public expenditure has naturally gone up as a
consequence of these wars.
(vi) Greater Expenditure on Internal and
External Security. Every government has to spend today more on the
maintenance of internal and external security. The world today is divided into
two. hostile military camps. Each camp is spending increasing amounts to add to
its military strength.
(vii) Welfare State. The State is no longer
the old law and order State. The modern State is a welfare State. It has to
spend increasing amounts on such items as social insurance, unemployment
relief, free medical aid, free education, etc. to improve the economic and
social welfare of the country. (419 Words)
Q: Explain the theories about the Rise in Public
Expenditure
Ans: There
are two broad theories about public expenditure. The first is by the German
economist Adolph Wagner (1875-1917). He did a study of historical facts about
the German economy and propounded what is called, The Law of Increasing
State Activities. He suggested that activities of various levels of
government have an inherent tendency to increase over time. The government
sector in the economy rises faster than the economy as a whole. There is
consequently a rise in government expenditure. Now, this rise in government
expenditure can be expressed in many ways: (a) a rise in absolute levels of
government expenditure, (b) a rise in the ratio of government expenditure to
GNP, (c) a rise in the proportion of the public sector in the economy. Even in
the case of (a), the absolute rise may be in nominal or real terms. One should
also adjust for a secular increase in population and see the rise in per capita
terms. It is not clear in which of the above senses Wagner was talking about
the rise in government expenditure, though Musgrave suggests that the correct
measure should be (c). Also, for (b) above one should as well look at the GNP elasticity
of government expenditure.
Wagner's
law is mainly applicable to modern progressive governments. According to
Wagner, it is applicable mainly in the initial stages of modern government
activities. He felt that as modern industrial society develops, there would be
increasing pressure for social progress and there would be attempts to make
business and industry more socially conscious. The public sector and government
activities would therefore rise.
The
second main theory about rise in government expenditure is by Jack Wiseman and
Alan Peacock and is called the Wiseman-Peacock hypothesis. They studied public
expenditure in Britain for the period 1890-1955 and on this basis suggested
that public expenditure does not increase in a smooth and continuous manner but
in discrete jumps or in a step like manner. This is mainly because unexpected
social disturbances and events take place and government expenditure has to
rise to meet the requirements. Of course, they suggested that the existing
revenue is in most cases not adequate to meet the expenditure requirements, and
revenues, particularly taxes, rise to a new level. This hypothesis is about
occurrence of unusual and abnormal events, but it is largely true that
government expenditures rise over time in almost all modern societies. Buchanan
and Tullock based on U.S. experience, have argued that there is an increasing
discrepancy between government expenditure and government output, with the
former tending to run ahead of the latter. They give two reasons for this.
First, unlike the private sector, the expenditure on government officials
increases faster than the corresponding rise in their output. Secondly, with
the growth of welfare activities and social security, the proportion of people
receiving transfer payments from the government increases. (476 Words)
Q. 1.
Discuss the various sources of public revenue.
Ans: Following
are the main sources of public revenue available to modern governments :
(i)Taxation. It constitutes the most
important source of revenue v the modern governments. A tax possesses essential
characteristics : (a) It is a compulsory payment and every citizen is
legally bound to pay the tax imposed upon him. (b) The tax is paid by
the taxpayer to enable the government to incur certain expenses in the common
interest of society, (c) The payment of a tax by a person does not entitle tern
to receive any direct benefits from the government in return for the tax. (d)
There is no relationship between the tax paid by the person and the benefits
that he may receive as a result of government expenditure.
(ii) Fee.
The term ‘fee' refers to that compulsory payment which is made by those
citizens who receive special benefit from the services rendered by the
government. For example, the licence fee is charged
from those citizens who are given licences by the
government. Generally leaking, the fee is charged according to the magnitude of
the benefits received by the citizens.
(iii) Price. The price is a payment made by the citizens to the vernment
for the goods and services sold to them. For example, the government provides
transport services to the citizens and in exchange targes fares and freights
from them. There is a definite relationship between the price paid and the
benefit received by the citizen. As a matter of fact, the fee and the price are
both paid in exchange for services rendered by the government. But the fee is
the payment made for non-economic services, while price is the payment
made by the citizens exchange for non-economic services, while price is
the payment made by the citizens in exchange for economic services rendered
by the government.
(iv) Special Assessment. The payment made
by the citizens of a particular locality in exchange for certain special
facilities given to them by the authorities is known as special assessment. For
example, if a municipal corporation in a city builds roads in a particular
locality or makes arrangement for the supply of electricity and water, the
value of property in that locality will inevitably go up. To that extent, the
residents will be directly benefited. In such a
case, the municipal corporation can levy a special tax on the residents,
because the value of the property has gone up on account of services rendered
by it. Such a tax is known as 'special
assessment’.
(v) Fines
The government also imposes fines from time to time on those persons
who violate the laws of the country. Of course, the income from this source is
exceedingly small.
(vi) Gifts and Grants. Sometimes, the
government may also earn some income in the form of gifts offered to it by the
citizens. But the amount of this income is limited. Further, the government of
a country may receive grants from foreign governments for general or specific
purposes.
(vii) Duties. The excise duties are
generally levied on those commodities, the consumption of which does harm to
the health and well-being of the citizens. For example, the duties levied on
wine, opium and other intoxicants belong to this category. The object is not to
earn income but to discourage the consumption of harmful commodities by the
citizens.
(viii) Government Properties. Modern
governments also earn some income from properties owned by them. For example,
the royalty from mines and oil-fields, the revenue from forests and the income
from landed property can be included in this category. (593 Words)
Incidence of tax:
Incidence of a tax refers to the money burden of a
tax on the person who ultimately bears it. In other words, when the money
burden of a tax finally settles or comes to rest on the ultimate tax-payer, is
called the incidence of a tax. The incidence of tax remains upon that person
who cannot shift its burden to any other person, i.e, who ultimately bears it
Thus, there are three distinct conceptions- the impact, the shifting and the
incidence of a tax, which correspond respectively to the imposition, the
transfer, and the settling or coming to rest of the tax. The impact is the
initial phenomena, the shifting is the intermediate process, the incidence is
the result.
Impact of tax:
The impact of a tax is on the person who pays the
money in the first instance. In other words, the man who pays the tax to the
government in first instance bears its impact The impact of a tax is,
therefore, the immediate result of the imposition of a tax on the person who
pays in the first instance. It corresponds to what is often but erroneously
called the 'original incidence’ or the 'primary incidence’ of a tax. The impact
of tax as such, denotes the act of impinging. Impact of a tax, therefore refers
to the immediate burden of the tax and not to the ultimate burden of the tax.
Shifting of Tax
Shifting of a tax refers to the process by which
the money burden of a tax transferred from one person to another. Whenever
there is shifting of taxation the tax may be shifted forward or backward.
No comments:
Post a Comment