Evaluate the possible effects of the introduction of a single currency by a trading bloc (30)

A trading bloc is a group of countries which get together and decide to allow free trade between members of the trading bloc. The European Union is an example of a trading bloc and not every member of the EU ; such as the UK; has decided to take part in the Euro Zone (the single currency for European countries: the Euro).

A single currency would allow for trade creation amongst the countries with this currency. The single currency means that goods can be exchanged between countries in the trading bloc because there are no barriers such as exchange rate barriers. The single currency allows goods to be exchanged quickly because of the similar currency meaning that countries can just buy goods from other countries within the trading bloc without having to exchange the currency in order to purchase the goods. The effects of this leads to an increase in standards of living for the consumers within the trading bloc as they can get the goods easily and cheaply (no exchange rate difference)  so they have a much higher choice of goods.  

Another effect is the possibility of Foreign Direct Investment occurring. FDI is when a firm tries to invest abroad into a foreign market. The single currency could encourage FDI into the trading bloc – bringing with it an inflow of capital into the trading bloc. For example, Japanese car makers could set up in Germany to take advantage of the single currency and trading bloc i.e. sell cars to any country in the EU without protectionist barriers such as Tariffs and there are also no exchange rate barriers. No exchange rate barriers allow consumers from any country in the Euro zone to purchase the Japanese cars easily with the usage of the Euro. Therefore, it will again benefit consumers as they can purchase a range of goods with the Euro, it also benefits the economy as FDI will increase employment and will let the government gain revenue through corporation tax.

Consumers are the main stakeholders who will benefit from the single currency. As mentioned above, consumers can get goods easily within the trading bloc as the single currency allows goods to be exchanged without having to change from one currency to another. Also, producers can get raw materials from within the trading bloc for low prices because the similar currency leads to the raw materials being priced the same regardless of which country the producer is in (as long as it is in the trading bloc). Therefore the low costs of raw materials could have a knock on effect to consumers as they can get goods for a much lower price. Overall, the consumers will highly benefit from the single currency.

Eval. Monetary Policy is the usage of Interest Rates and control of the money supply to try to meet macro economic objectives, mainly to control inflation. The introduction of a single currency to a trading bloc means that Monetary Policy cannot be used to control the economy as interest rates for the single currency are controlled by one back such as the European Central Bank controlling a single interest rate for the Euro. Monetary Policy is vital to make sure an economy is growing and functioning correctly, without a Monetary Policy an economy can suffer drastically – such as Greece who are now in huge debt and face other issues such as high unemployment! Therefore, joining the single currency may not be as ideal as it seems because it gives the government less control and the ECB’s interest rate may not be at a rate for every single country so come countries will benefit while others will not.

Eval. The single currency will only work if all the economies are convergent. That means that they are similar and heading in a similar direction, factors include: inflation, GDP growth rate and unemployment…basically all the macroeconomic objectives. If some countries are not convergent and not following the same pattern as the rest of the countries then they will feel the disadvantages of the single currency in the long run. For example, if Germany is facing a decrease in GDP growth and the ECB decides to put long term high interest rates then the rest of the countries will face a decrease in economic growth which may be good for them if they want to avoid a boom but Germany will just keep having a decrease in Economic growth.

Eval. On the subject of similar interest rates. The countries within the trade bloc need to help each other succeed and they are all dependent on each other’s actions. So, like what is happening in the EU at the moment, if one of the countries has a massive budget deficit and face massive debt then the other countries in the EU need to make sure that they do everything in their power to help that country and make sure the strength of the single currency and trade bloc. Currently, Greece is facing massive debt and may default soon, so the other countries need to spend huge sums of money to keep Greece alive which is a pain for the countries who are bailing them out – such as Germany. In the long term, if one country faces debt then this could accumulate and may even lead to knock on effects where other countries within this single currency face the same problem, in the end all the countries will be affected.

Eval. The single currency will also affect countries outside of the trade bloc. If the single currency is strong then other countries outside the single currency may start to export their goods to the countries within the single currency because a strong currency leads to an increase in demand for imports. This could lead to the countries outside the currency benefiting from the high amount of exports they are exporting to the trade bloc that they could face high employment and increasing economic growth. Therefore, not only will countries within the trade bloc face the effects of a single currency, other countries will also be stakeholders and face the effects of a single currency. 

Examine the factors which might explain the depreciation of sterling against the euro. (20 Marks)

The value of the pound fell from £1 = €1.47 in May 2007 to £1 = €1.18 in November 2008. Examine the factors which might explain this depreciation of sterling against the euro. (20 Marks)

A depreciation of the Pound is when the value of the Pound becomes weaker relative to other currencies around the world. In the example provided, one pound could buy 1.47 Euros in May 2007 however by November 2008 the Pound had depreciated and could only buy 1.18 Euros. There are a variety of factors which could lead to a depreciation of the Pound against the Euro.

Interest rate in Monetary Policy affects the value of the Pound and in the past 2 years the UK has set low interest rates. This is because of the recession and therefore, they wanted to try and boost economic growth. Low interest rates led to a depreciation in the Pound in the following ways. Firstly, fewer Pounds were demanded by foreign investors because they didn’t want to put their money in UK banks as they would get less money if they saved their money in the UK banks with low interest rates. So as Demand decreased, the value of the Pound decreased as well (DIAGRAM SHOWING A SHIFT TO THE LEFT IN DEMAND). Also, Supply for the Pound would increase as people who saved their money in UK banks would take their money out and place it in other banks with higher interest rates. Therefore as supply of the Pound increased the value of the Pound depreciated (SUPPLY SHIFTING TO THE RIGHT IN DIAGRAM).

A trade deficit is when a country’s imports have a higher value than a country’s exports. The UK has a massive trade deficit and this affects the value of the Pound. Imports depreciate the Pound because as domestic UK consumers buy goods from abroad they need to convert their British Pounds for the other currency for example Euros if they are buying Beer from Germany. Therefore, the supply of the Pound will increase as they are exchanging their Pounds for Euros and hence, the value of the Pound will depreciate as Supply of the Pound increases. Exports tend to appreciate the value of the pound because when foreign consumers buy domestic UK goods they must exchange their currency to Pounds to purchase the UK goods. For example, Germans buying British Pharmaceuticals from the UK must exchange their Euros to Pounds and as the demand for Pounds increases the value will increase. However, in a trade deficit the overall effect is a depreciation of the Pound as the value of imports is larger than the value of exports so the depreciation effect is larger than the appreciation effect.

Another factor which could lead to a depreciation of the Pound is speculation. Speculation in the currency market is the buying and selling of a currency based on future prices. During November 2008, global recession had just started. The UK was massively affected by this global economic meltdown and its currency was also affected as a result. Because the UK was regarded as an unstable economy many investors decided not to invest within the UK and speculators also decided to sell the British Pound and buy other more stable currencies. Because of the fall in the demand for the Pound AND the increase in the supply of the Pound within the market, the value of the Pound fell massively and lead to a depreciation of the Pound.  

Eval. The UK can use interest rates (Monetary Policy) to control their economy as they have control of the Bank of England. All the other countries in the Euro Zone cannot use interest rates to control their economies. Anyway, the UK has had low interest rates over the last 2 years and still saw an appreciation in the value of their currency and therefore there must be other more significant factors which are affecting the value of the Pound. Due to this I believe that interest rates may not be a significant factor affecting the value of the Pound plus it could take time before effects are actually seen!

Eval. In my opinion, the UK trade deficit is a major factor which led to the depreciation in the value of the Pound. The UK faces a large deficit in the trade of goods which offsets the surplus in investment income and trade in services. Therefore, I believe this huge trade deficit must be the major factor affecting the value of the Pound… especially because the UK consumers have a high marginal propensity to import. Marginal Propensity to import is when incomes increase and how much of this increased income is used to buy imports. The UK has a high Marginal propensity to import and therefore I believe that the trade deficit is one of the most significant factors which depreciated the Pound.

Eval. I also believe that speculation has a major impact on the value of the pound especially during the critical time of a recession. Most people were scared about their money so they wouldn’t spend their money on investing in things such as the Pound as they are scared about how strong the UK economy was at the time. People would also be naturally scared of their money at this credit crunch time so they would just save their money rather than spend it. Thus, I believe speculation and the recession was a major factor affecting the value of the pound. However, if people decided to save their money in UK banks during this recession time then demand for the Pound would increase and actually the value could appreciate!

To conclude, it is not one factor that affects the value of the pound… it is the interlocking combination of factors and how they affect each other which leads to an overall effect on the value of the Pound. In this case, the Pound depreciated. 

Unit 4 : Protectionism 30 Marks

Evaluate the significance for the UK balance of payments on current account of increased use of protectionist policies (30)

The Current Account is an account which measures the level of imports and exports within the UK and lets the government know whether they are in Surplus        (Imports< Exports) or Deficit (Exports< Imports). The main factors on the Current Account are (in decreasing order): Trade of goods, Trade of services, Investment Income and Balance Transfers. Currently, the UK faces a huge balance of trade deficit.

Protectionism is where the UK will try to reduce the amount of imports entering the country for various reasons. Hence, reducing the huge trade deficit they are already facing and also to protect employment and domestic industries.

The first form of protectionism is tariffs. These are taxes places on imports entering the UK. If tariffs are successful they will reduce the number of Imports because they increase the price of goods entering the country and this will tend to discourage consumers from buying the goods because of the inflated prices. DIAGRAM OF TARIFFS INCLUDED HERE. As you can see from the diagram, the tariffs will reduce the quantity of imports and will reduce consumer surplus as price increases and less people are prepared to charge high prices for the good. The reduction of imports will improve the UK balance of payments on the current account and reduce the huge trade deficit.

The second form of protectionism is Quotas. Quotas work by completely restricting the amount of goods entering a country to a certain level for example the UK may only allow 100,000 Cars from America enter the economy per year, no more than that is allowed. Unlike tariffs, Quotas do not let the government gain any additional revenue as the goods are not being taxed, they are merely being restricted from entering the country. INCLUDE DIAGRAM HERE. The diagram above shows how the quota level which is perfectly inelastic completely restricts the quantity of goods entering the country thus increasing price and also reducing consumer surplus. This form of protectionism again reduces imports as less foreign goods enter the country and this reduces the UK’s trade deficit.

Other forms of protectionism are non-tariff barriers. The first one is red-tape and administration costs. These are when a country makes it difficult for goods to enter the country such as health and safety checks and a lot of paper work which will waste a lot of time. These are very difficult to prove and countries will do it to reduce the amount of imports entering the country. The UK would definitely do it because they are facing a huge trade deficit and will try any method to stop imports from entering the country.

Another form of protectionism tends to be controversial - embargos. An Embargo is where a country completely bans the importing of a certain product. For example, due to poor political relationships, America decided to place an embargo on all goods from Cuba. If the UK placed an embargo on goods for certain products, this form of protectionism completely stops the importing of certain products so reduces the number of imports entering a country leading to a reduction in the trade deficit to the UK.

Eval. Tariffs do not place a stop to importing of products, it merely reduces the price of the good and so should deter the number of imports entering the UK. Therefore, the effectiveness of tariffs depends on the elasticity of the product being taxed. For example, oil is a highly inelastic product as nearly everyone in the UK relies on oil for heating, electricity, manufacturing and of course transportation. Therefore, a tariff placed on oil may not be effective in reducing the quantity of imports and hence may not lead to a reduction in the trade deficit faced by the UK.

Eval. Quotas I believe, are very effective at reducing the trade deficit faced by the UK. Unlike tariffs, they will definitely lead to a reduction in imports because it places a limit to the number of imports and hence I believe is one of the most effective ways of reducing the quantity of imports. Quotas have high significance in trying to reduce imports but they do have their disadvantages: they may lead to retaliation by other countries. Other countries may in fact, place Quotas on UK exports entering their countries and thus the UK’s exports may reduce as a result. The overall effect, may not lead to a reduction in the trade. Thus, their aim of reducing their trade deficit by using Quotas may back fire and therefore is government failure.

Eval. I believe red tape and administration work are not very significant ways of trying to reduce imports. Although, time consuming, imports may not be reduced if the goods being imported are highly important for example a firm in the UK may need a highly specialised piece of machinery to enhance efficiency and thus will go through the time consuming work just to help them in the long run. Thus I believe red tape is not an effective form of reducing imports and also it may again lead to retaliation although it is of course hard to prove.

Eval. Embargos will definitely lead to a reduction in the UK’s balance of trade deficit however, embargos are not placed on goods to help improve the UK’s balance of trade deficit. They are placed on goods to try and improve consumer welfare by reducing the imports of de-merit goods and goods which will lead to negative externalities such as Cuban cigars. So, embargos I believe, will not be used by the UK as an effective way of reducing the quantity of imports entering and will be used for other reasons. Hence, in my opinion, it is not an effective way of improving the UK’s balance of trade deficit.

Overall, I believe that tariffs and quotas are the only significant ways of reducing the UK’s balance of trade deficit and in my opinion the UK should start thinking about increasing its exports rather than reducing their imports if they want to remain competitive and improve their massive trade deficit.

Unit 4: Protectionism 20 Marks

Assess the main economic determinants of a country's demand for imports (20)

An import is a good or service which enters a country resulting in money leaving the economy. Although goods/services are entering the country, the result is a withdrawal of the circular flow of income as money leaves the economy. 

One reason a country would want to import is the fact that they would like to remain competitive in foreign markets, thus leading to an increase in the imports for new machinery. For example, the UK want to stay competitive in the agriculture industry so they import the newest, most efficient farming machinery to allow them to be more specialised in the industry compared to competition from foreign countries. So trying to improve the dynamic, allocative and productive efficiency of an industry is a determinant which would affect the demand for a country’s imports.

The income of the people within a country affects a country’s demand for imports. Usually, people with higher incomes tend to demand imports because imports tend to be better quality and they are more expensive than domestic goods. The imported goods are better quality because the goods are made in countries which are speicalised in making that specific good so will make it at a high quality and efficiently for example Japanese cars. The goods tend to be more expensive when you import them because you must pay the import tax (tariffs) which tend to increase the price of the good, so a Japanese car would be cheaper if bought in Japan compared to when it is bought abroad i.e. Egypt. Therefore the average level of income for people within an economy will affect a country’s demand for imports.

Another factor which affects a country’s demand for imports is whether a good is available within the country or not. For example, the UK does not have a large supply of sand and will therefore tend to import the sand from places such as the UAE. Therefore, the supply of a good within a country will affect the demand for imports. This is especially the case when it comes to goods which are vital to a country, for example, oil and energy will be needed in manufacturing and building houses so the UK will demand oil from abroad leading to a rise in the UK’s imports.

Eval. I believe the significance of importing technology to help maintain competitiveness in foreign markets is a major determinant of a country’s imports. The UK especially must stay competitive in order to be able to compete with emerging markets such as China. Therefore, this pressure of trying to stay competitive, efficient and productive is one of the main factors which affect a country’s demand for imports.

Eval. In my opinion, the UK’s main imports arise from foreign firms setting up within the UK and sending their profits back to their domestic country – Japanese car makers set up within the UK and send profits back to Japan (this is an import). Therefore, incomes of people within some countries may not be a major determinant affecting the demand for imports. Also, some goods that are imported are actually the same price as domestic goods because the country is within a trading bloc and there may not be any tariffs. Therefore some goods/services may not be more imported when they are imported so people’s incomes may not be a main determinant in affecting the demand for imports. However, income could become a main determinant because developing countries may have a population earning a low wage so the local people may prefer to live off of local products rather than spend more money for imports. I believe, imports is a peculiar factor and may be a country’s main determinant however it depends on the country you are dealing with!

Eval. As we develop we take for granted that we can get all sorts of products all year round without having to worry about harvests and various other factors. I believe, the main determinant affecting the demand for imports is whether the good or service is available within the country or not. Nowadays, products can be transported from one continent to another in only a matter of days. Therefore, it is relatively easily to import products which are not available within a country and the government will choose to do this because they want their citizens to have as much choice as possible. Also, nowadays, people cannot live without electricity or petrol to power their cars. So for countries without inelastic goods such as oil, the main determinant which affects the level of imports is the supply of these inelastic goods within the country. Again, it depends on which country you are talking about because some countries will have all the essentials it needs and will not import goods and some countries are very socialist and will not import goods even if they are lacking this good within the economy.

For all the factors above, the country we are talking about will determine which factor is the main determinant of a country’s imports.

Examine the significance of the factors which have contributed to increased globalisation in recent years

Globalisation is the international integration of markets around the world for goods, labour and capital.

Trading blocs are groups of countries that have agreements in place to engage in free trade – there are no barriers to trade and no protectionism. Over recent years there has been a massive increase in the number of trading blocs such as the European Union which contains 28 European countries with the ability to freely trade goods, services, labour and capital. Trading blocs lead to an increase in globalisation because it encourages firms to set up businesses within the trading blocs as they can sell their goods or services without any barriers. Therefore, more foreign firms will start to invest and move abroad to be part of the trading blocs. As firms are moving around the world to gain trade advantages, globalisation is increased and consumers will benefit as they will have more choice for goods and services.

Transportation cost is the cost of transferring goods around the world. As we have developed, it has become cheaper to travel by plane, boat and rail. This is because our technology has developed we have been able to make planes for relatively low prices and relatively quickly. The increase in supply of the vehicles and the availability of transport options means that firms can transport their goods for very low prices. This increases globalisation because firms will be willing to produce their goods abroad for cheap costs and then transport the finished product to many markets around the world. For example, Marks and Spencer could set up in China, produce clothes for cheap costs and then transport the finished clothes to retailers all over the world. The low transport costs will encourage firms to set up in other countries and the cost of transport will not matter to them as it is relatively cheap. Also, as transportation becomes more efficient, goods cam be transported very quickly and the products can be in stores practically every day of the year!

Communication is vital to the running of a business, without good communication messages and important decisions cannot be passed on from managers and directors down to the employees and labour work force. In the modern world, it is very easy and cheap to communicate with people from overseas. As these communication networks improve, firms will find it cheap and easy to set up abroad yet keep their communication networks strong. Globalisation can also increase, because it is easier for people (labour) to move to other countries and find jobs as they have the internet with all the information they need – housing and job vacancies. The internet has also made it possible for most good to be sold online and available to be sent all over the world. Therefore, this encourages firms to set up abroad in countries where production costs are low and then the goods can be sold domestically or sold to consumers via the internet.

Eval. I believe trade blocs had a significant impact on increasing globalisation. Before trade blocs, firms would not have any incentive to invest in foreign countries because of tariffs (taxation on imports). Now that trade blocs are found in many places around the world, firms have a massive incentive to set up (Foreign Direct Investment) within these trade blocs because they can freely move resources between countries in that bloc without having to pay any tariffs. They can easily move capital and labour to any of the countries in that bloc without facing taxation. This has lead to many firms setting up within these trade blocs so globalisation increases as the main incentive for any firm is increased profits and being able to set up in a trade bloc where labour can be brought in from any country in the bloc will reduce the firms costs and increase its profit.

Eval. Currently, with low transportation costs globalisation will increase. I believe that in the long run when raw materials run out, the cost of transporting goods around the world will increase dramatically because the supply of fossil fuels decreases leading to an increase in the price of oil and petrol. Therefore, in the long run, the reduction in the supply of fossil fuels may lead to a decrease in globalisation as firms will find it extremely costly to transport their goods from country to country in planes that use up a lot of fuel. However, in contrast, I believe that transportation costs may not increase dramatically because of the emergence of other sources of energy such as renewable solar power and bio fuels.

Eval. The increase in globalisation will have negative effects in the long run to many stakeholders. Firstly, the environment will become deteriorated as the increased transportation will pollute the earth and increase the effect on global warming. Also, labour in the countries encouraging FDI may become exploited and earn wages below the minimum wage. The labour will work just to earn this wage as they find it hard to find a job and will therefore continue to work for such a low wage. The firm may be a victim of this approach because if the media find out and spread the word then the firm may suffer from negative publicity and consumers will avoid buying their products. Negative publicity is extremely significant and has devastating effects on the firm because a reduction in demand may eventually lead to a loss being made and the firm shutting down.  

Unit 3: January 2010 Question 12 - US Motor Vehicle Market

a)    Market Share is the percentage of total sales in the market that a company has. The market share of Japanese car manufacturers is set to increase in the long run because “the ten most popular fuel-efficient vehicles sold in the US are all made by Japanese and German car manufacturers”. Because of “rising petrol prices”, consumers of cars want to purchase cars that are more efficient and do not require as much petrol demand as the “petrol guzzlers” such as GM’s Hummer. Therefore, consumers will demand more efficient Japanese cars and because of increasing demand the market share of Japanese car manufacturers will increase.

b)    REFER TO DIAGRAM:

Variable costs are costs which change when output changes. Petrol prices are increasing so it costs more to produce car parts such as tires. Costs are also increasing as “employee costs have increased at a faster rate than inflation”. Falling demand is caused due to the fact that there are new entrants into the market such as Japanese and Chinese manufacturers. Consumers are demanding more Japanese cars as they are becoming increasingly fuel efficient and so demand for US motor vehicles is decreasing. The diagram below illustrates how the AC cure and MC curves have shifted upwards as variable costs are increasing. The diagram also shows how AR and MR have decreased and shifted left due to the decrease in demand for US motor vehicles such as Ford. Therefore because the AC curve is higher than the AR curve a loss is made and is shaded in the diagram – this leads to a decrease in Quantity from Q to Q1.

c)    Dynamic efficiency – is the difference between actual efficiency and potential efficiency. The fact that US car manufacturers are supplying cars at a loss illustrates how the US car manufacturers will indefinitely suffer from dynamic inefficiency. The firm will not be able to reinvest because they are not making a profit and so therefore will not be able to increase research and development into features such as a more fuel efficient engine or new features in the car such as a TV screen. Demand for cars is elastic because there are many choices from many international car manufacturers so as reinvestment is limited the car will not have a quality as high as the quality of other cars such as the fuel efficient Japanese cars. Hence, demand will fall even more and because of the loss, dynamic inefficiency will be present in the US car manufacturer.

Eval. The government could subsidize any of the big firms as they want to keep their local cars competitive against the foreign cars. If the government does give subsidies to the firms then the cars manufacturers will be able to reinvest the money and increase the efficiency of car production such as building a factory in every single state to reduce transport costs. However in this current climate this is unlikely as governments have limited capital and will use it to reinvest in major industries such as improving education.

d)    A Loss is where revenue is lower than costs. Therefore in order for a US car manufacturer such as GM to reduce it’s loss it has to either increase it’s revenue or decrease it’s costs.

To increase revenue, I believe GM needs to diversify and produce cars to incorporate the different market segments which demand cars. For example, they should continue producing “petrol guzzling” Hummers but try to accommodate a car for a market such as a small car for couples or single people, or an SUV for families. Diversifying products means that they can expand into different markets and so have a higher chance to gain more revenue.

Another way revenue can increase is if the “‘big three’ car manufacturers” collude together. Collusion is when firms work together to reduce competition and gain benefits such as higher profits. Collusion can occur in this industry because there are a few large firms so trust can occur between them. Also, there is brand loyalty in the car market so this means there are high barriers to entry because it will be hard for new entrants to enter the market and steal market share from the big firms. Finally the US car manufacturers seem to produce quite similar cars meaning that collusion and working together can occur.

Eval. Cross subsidizing can only occur when one product is making a profit because then this profit can be used in research and development to produce and innovate new cars such as an SUV to accommodate the family yet it has the engine of a race car. Just being able to develop new cars for different markets will also take a large amount of investment into advertising the cars in motor vehicle magazines and TV. All of the 3 major firms are making losses and therefore I believe none of them will want to spend any money into developing a car because if the product fails and doesn’t sell as much as predicted then even more money is wasted in the research and development of this failed product.

Eval. Collusion is illegal – The competition commission has the right to fine firms up to 10 % of their revenue if they are found to be taking part in collusive practices. In this current climate and due to the fact that all of them are making massive losses, I believe that the major US car manufacturers do not want to risk getting fined, losing even more revenue and ending up with an even bigger loss. Also, I believe that there is still the possibility for new entrants into the car market. Because of increasing petrol prices there is an incentive for car manufacturers to produce sustainable and ‘green’ cars which will be ideal in the future. Therefore, if a manufacturer produces a car which is powered by the light and is extremely convenient then there is a possibility that they can grab a percentage of the market share and thus reduce the power of the major firms in the collusive agreement.

e)    Chinese firms may find it difficult to sell their cars in the US vehicle market for many reasons.

Firstly, the US government may subsidize US car manufacturers and help them get rid of their excessive losses. This assistance may occur because cars are considered important goods for the economy as transportation is vital to the running of many industries such as Post mail. The subsidization of the US car manufacturers means that they can reduce their costs of production (and supply the cars at a lower price) or even reinvest and improve their current car range e.g. reinvest into developing a GPS system for all the cars. This means that Chinese firms may face barriers because their costs of production may be higher than the US firms so they must supply cars at a higher price to cover costs. This will lead to less demand for their cars because the American consumers can just buy the cheaper option – the US cars.

Also, I believe there is brand loyalty towards the automobile industry. Consumers tend to buy the same car from the same manufacturer if they are happy with the car and its efficiency. Therefore it may be difficult for Chinese firms to enter the market and persuade consumers to switch – there is a slight level of inertia because usually when people feel comfortable with their car model they tend to stay with that same car and just buy the newer version of the same car type every few years instead of switching. This is illustrated as GM has 27.2% of the market which legally makes it a monopoly (as it has greater than 25% market share), this is shown in Figure 1.  Hence, Chinese firms need to have a unique selling point or something innovative and new to encourage consumers to try out the Chinese cars. For example, a car that can last 20 days without needing to be refueled with gas is one unique selling point which no other firms have. This is a difficulty and a barrier to Chinese firms because they need to spend large amounts of capital to research, develop and promote these new innovative cars. These high sunk costs (costs which can’t be retrieved when leaving the market) will discourage Chinese firms from selling cars in the US vehicles industry and act as a barrier to entry.

Tariffs are also another reason why Chinese firms would find it hard to sell their cars in the US industry. Tariffs are taxes placed on the importing of products into the US. Importing cars into the US will lead to heavy taxation and therefore the Chinese cars will be sold at a higher price compared to the US cars. A higher price could lead to a fall in demand for Chinese cars and so act as a barrier to entry because Chinese firms will find it hard to compete against cars which are selling for a lower price. This is because cars are elastic as there are many firms supplying cars and so a high price for Chinese cars means that demand and revenue will fall so Americans will opt for their American cars which are sold for a cheaper price as they are not taxed.

Eval. Subsidizing is unlikely in this current economic climate as the government is in massive debt. The government is highly unlikely to grant money to the struggling US car manufacturers and will instead use any money available on infrastructure and paying off its debt. Also if subsidizing does actually occur, the significance of it depends on how much the government actually grants the US firms because the firms are making losses of around 1 Billion Dollars! So the grants given to them may not be significant enough to affect their business model or production methods.

Eval. A higher price on Chinese vehicles does not necessarily mean that it is a disadvantage. A higher price on elastic goods is a sign of high quality and so this may act in the advantage of Chinese firms because consumers who want to buy a luxury vehicle will choose an expensive car as they believe it will have the high quality they demand.

Eval. The tariffs may not be significant because the tax could be a very small portion of the price of the car and may not increase its price to an extent which is significant to the Chinese firms. Also, tariffs may not even be put in place by the US government because it can lead to two main problems. Firstly, the American consumers will have less choice when it comes to purchasing cars and secondly, it may lead to political retaliation from the Chinese government i.e. they may stop US firms from selling their cars in China. So basically, if tariffs do actually occur they many not even be very significant and also they may not be put up in the first place as it may lead to disadvantages to the consumer as well as the government.