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Revised Technical Test Answers Set 1.docx

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Pat Lemieux

Technical Test Answers Set #1 1. Describe and compare the “comparative” vs. “competitive” advantages concepts. What is the relevancy of these concepts to international trade and globalization based on the articles and textbooks reviewed in BU481 and BU491. Comparative advantage - The law of comparative advantage refers to the ability of a party (an individual, a firm, or a country) to produce a particular good or service at a lower opportunity cost than another party. It is the ability to produce a product with the highest relative efficiency given all the other products that could be produced. - Comparative advantage explains how trade can create value for both parties even when one can produce all goods with fewer resources than the other. The net benefits of such an outcome are called gains from trade. - Country 1 is more efficient than country 2 at producing both products, however there are still gains for each country through trade. - Country 1 produces the product that they are the most efficient at producing and country 2 produces what is left over. - It is important for managers to understand what factors contribute to the comparative advantage of both countries Competitive advantage - Competitive advantage is defined as the strategic advantage one business entity has over its rival entities within its competitive industry. Achieving Competitive Advantage strengthens and positions a business better within the business environment. - Once a firm has achieved a competitive advantage based on cost or product differentiation (through branding, R&D, design or service), it may be able to use its current competitive position to erect barriers to entry for other, later entrants. - To achieve scale and scope economies through standardization or reap absolute economies through specialization - Once a firm has achieved a competitive advantage based on cost or product differentiation it may be able to use its position to erect barriers to entry for later entrants Comparison: In business clusters (like Silicon Valley), there is both comparative and competitive advantages that benefit all companies. Companies are competing against each other to retain clients, but are also helping each other by forming partnerships. Relevancy - Need to create value for buyer and seller for trade to happen and create benefits for the long term - Improve quality of life for citizens of countries who trade - Reduce national debt 2. Define and describe the “comparative advantage” concept including an example. Please describe two fundamental assumptions supporting this concept. Please define and describe two relevant implications of this concept to international trade and globalization based on the articles reviewed in BU491. Comparative advantage refers to the ability of a person or a country to produce a particular good or service at a lower marginal and opportunity cost. Countries make better use of their resources and are more efficient when they focus on producing goods/services for which their opportunity cost is lowest. Two fundamental assumptions supporting this concept: i) Labour is the only input in the production process ii) Only two countries engaged in the trade of only two goods/services Relevant implications on international trade and globalization i) In analyzing the effects of trade on an industry, the important factor is the comparison of the two efficiency ratios among trading partners and how they change over time. Producers in some countries may find ways to increase their efficiencies to the point where they gain a comparative advantage in different products. ii) The most important point of this concept is that even if one country is more efficient in both products/services, there are still gains to be made through trading between countries. Example: Using machinery, a worker in one country can produce both shoes and shirts at 6 per hour, and a worker in a country with less machinery can produce either 2 shoes or 4 shirts in an hour, each country can gain from trade because their internal trade-offs between shoes and shirts are different. The less-efficient country has a comparative advantage in shirts, so it finds it more efficient to produce shirts and trade them to the more-efficient country for shoes. 3. Define and describe the “absolute advantage” concept including an example. Please describe two fundamental assumptions supporting this concept. Please define and describe two relevant implications of this concept to international trade and globalization based on the articles reviewed in BU491. Absolute advantage refers to the ability of a party (an individual, or firm, or country) to produce more of a good or service than competitors, using the same amount of resources. Each country will specialize in the good/service for which they have an absolute advantage when they are open for trade. Two fundamental assumptions supporting this concept: i) Labour is the only input in the production process ii) Only two countries engaged in the trade of only two goods/services Relevant implications on international trade and globalization i) Both more product X and more product Y are produced and consumed and as a result both countries are better off ii) The gains from trade may not be shared equally. In general, the smaller the country and the greater its absolute advantage in one product relative to the absolute advantage of the other country, the greater its share of the gains. Example: Party A can produce 5 widgets per hour with 3 employees. Party B can produce 10 widgets per hour with 3 employees. Assuming that the employees of both parties are paid equally, Party B has an absolute advantage over Party A in producing widgets per hour. This is because Party B can produce twice as many widgets as Party A can with the same number of employees. 4. Please identify and describe two benefits and one drawback for counties that open their borders to international trade. Your answers should be grounded on principles covered in class. Please define and describe one potential option available to countries / firms on how best to address or mitigate these drawbacks. Benefits of opening borders for international trade: i) The rise in the international trade is essential for the growth of globalization. The restrictions to international trade would limit countries to the services and goods produced domestically, and they would lose out on the valuable revenue from trading globally. As deduced from the theory of comparative advantage, all countries involved in international stand to make gains. i) Trade brings about an equalization of the returns to factors of production; thus, trade tends to equalize capital costs and wage rates among countries over time. A major drawback of opening borders for international trade is the potential for firms to take advantage of the cheap labour and weaker policies of other countries. Firms begin to more freely outsource or move operations to foreign companies and as a result the local economy begins to suffer. We discussed this issue in class in regards to the Scott’s Miracle case. Outsourcing to China would be cheaper for the company, but people in their current plant would be have to be fired and all future jobs would be in China. 5. Please define and describe “Subsidies”. Please describe the strategic objective of a government in providing subsidies? What is the benefit to a firm receiving subsidies? Why is a subsidy considered a “Tariff Barrier”?. Please provide a related example discussed in class or covered in the article. Subsidies Financial contributions provided directly or indirectly by a government, which confer a benefit, include grants, preferential tax treatment, and government assumption of normal business expenses Most subsidies are made by the government to producers or distributed as subventions in an industry to prevent the decline of that industry (e.g., as a result of continuous unprofitable operations) or an increase in the prices of its products or simply to encourage it to hire more labour (as in the case of a wage subsidy). Subsidies are considered a tariff barrier because they protect industries and smaller firms from foreign firms which operate at lower costs. They can make domestic goods/services artificially competitive against imports. Example Although they lack comparative advantage in sugar production, the US, Japan and EU have maintained strong protection for their domestic sugar industries. Protectionism by developed countries harms foreign sugar producers, many of which are poor farmers in developing countries, by reducing demand a prices for their products. 6. According to the exchange rate article, the author identifies multiple types of exchange rates. Please define and describe three of them. Please describe in details one (1) possible business implications that should be considered by a firm engaged in International strategy formulation related to entering countries with your described exchange rate system? (One implication for each of the three exchange rate systems) i) Fixed exchange rates – A country’s government decides the worth of its currency in terms of either a fixed weight of gold, a fixed amount of another currency or a basket of other currencies. The central bank of a country remains committed at all times to buy and sell its currency at a fixed price and the central bank provides foreign currency needed to finance payments imbalances. Implication: Creates certainty. Fixed rates provide greater certainty for exporters as the trend of demand for their goods will be more apparent. This will help them to plan production systematically. Also there will be greater incentive to invest by buying capital goods, expand operation etc. ii) Pegged exchange rates – A country locks, or "pegs," its currency's exchange rate to another currency or basket of currencies. It is common for a country with a pegged exchange rate to allow its currency to vary within specified limits or bands (often set at ±1% of the target rate) before the country intervenes to force the currency back within the limits. -When a government lowers the target fixed exchange rate, this is called devaluation, and when it increases the rate it is called revaluation. Due to the expense of maintaining an artificially high exchange rate and the pain of large devaluations, many countries that once had pegged exchange rates now allow their currencies to float. Implication: Convertibility of currency – some countries set their exchange rate but have no convertible currency which means that any profits or transactions completed in that foreign country need to be in their specific currency and cannot be exchanged for the company’s domestic currency upon completion of the transactions iii) Floating exchange rates – Currency prices are allowed to seek their own levels, with only modest central bank intervention to smooth out extreme exchange rate fluctuations. Under a managed floating exchange rate system, there is significant government intervention to manage the exchange rate by manipulating the currency's supply and demand. -Currency appreciation and depreciation will affect how expensive imports are, which will consequently affect the demand for the imports and foreign currency until the exchange rates reach equilibrium. Implication: Exchange rate risk - The inherent volatility of exchange rates under a floating system increases the uncertainty of the cash flows for a multinational corporation. Because its cash flows are generated in many parts of the world, they are denominated in many different currencies. When exchange rates change, the dollar-equivalent value of the company's consolidated cash flows also fluctuates. 7. Please describe and contrast the following: Free Trade, Common Market and Economic Union. Please provide a related example discussed in class or covered in the article. Types of Economic Integration 1. Free Trade Area – country combination where the member nations remove all trade impediments among themselves but retain their freedom concerning their policy making regarding non-member countries 2. Common Market – a particular customs union that allows not only free trade of products and services, but also free mobility of production factors (capital, labour, technology) across national member borders 3. Economic Union – a particular common market that involves unification of monetary and fiscal policies; participants introduce a central authority to exercise control over these matters so that member nations virtually become an enlarged single “country” in an economic sense The degree of economic integration increases from 1 to 3. An example of a free trade area is NAFTA, the North American Free Trade Agreement. NAFTA is an agreement signed by the government of Canada, Mexico and the US which opened the door for open trade, ending tariffs on various goods/services such as eggs, corn, meats etc. This allowed corporations to trade freely and import/export various goods on a North American scale. 8. Please describe the following three institutions. WTO, IMF and World Bank. For each one please state two major objectives. Please provide two benefits that these institutions bring to the business world in the context of international business and trade. WTO – World Trade IMF – The international World Bank Organization Monetary Fund Description - a multilateral trade - an international - an international financial organization aimed at organization whereby institution that provides international trade countries contribute money loans to developing liberalization to a pool through a quota countries for capital system from which countries programs with payment imbalances can borrow funds Objectives - main objective is the - promote international - goal is to help raise establishment of trade economic cooperation and standards of living and policy rules that help expansion of international reduce poverty in international trade trade developing countries by expand and raise living - seeks to promote channeling financial standards; the WTO exchange rate stability resources to them from administers trade developed countries agreement, settles trade disputes, reviews national trade policies, and assists developing countries on trade policy issues Benefits - settles trade disputes - member countries of the - assists developing - reviews national trade IMF have access to countries in stimulating policies information on the economic foreign trade and their - administers trade policies of all member participation in the agreements countries multilateral trading system - cooperates with other - increased opportunities for international trade/investment organizations 9. One stated reason for a country to impose tariffs/barriers on products / se
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