IB Economics Section 3: International Economics – Flashcards
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1. lower *costs & prices* 2. greater *choice* 3. different *resources* 4. *economies of scale* (bigger markets = lower costs) 5. more *efficient allocation of resources* 6. *foreign currency* (which can then be used for purchases)
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Why do countries trade?
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When a country is able to produce more of a good than another country given the same resources i.e. they are *more efficient*. No brainer!
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Absolute Advantage
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When a country can produce a good at a *lower opportunity cost* than another country i.e. "we can make radios AND televisions cheaper than you, but £1 invested in making TVs makes more than £1 in radios so we'll make the televisions and you can make the radios"
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Comparative Advantage
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1. Country X 2. Country X has an absolute advantage 3. 1/4 of a car 4. 2 computers 5. Anything less than 4 computers 6. Anything less than 1/2 car 7. Country X should buy 3 computers and sell 1 car.
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1. Which country has comparative advantage? 2. Does that country have absolute advantage? 3. What is the opportunity cost for Country X when it makes 1 computer? 4. What is the opportunity cost for Country Y when it makes 1 car? 5. At what 'price' (expressed in computers) should Country X import cars? 6. At what 'price' (expressed in cars) should Country Y import computers? 7. At what rate should Country X buy computers from Country Y?
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1. No such things as a perfect market > countries don't have perfect knowledge > products are rarely homogenous > likely to be barriers to entry (tariffs) 2. Transport costs 3. Not just two economies but lots of them. Complex!
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Problems with the theory of Comparative Advantage
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No barriers but there will be *transaction costs* (FOREX) and *transportation costs*.
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Even 'Free trade' is rarely free.
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Any action that reduces the competitiveness of imported goods.
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Protectionism
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- tariff - quota - subsidy - administrative barrier - health & safety regulations ("EU requirements") - government procurement policies ("UK suppliers only") - voluntary export restraints
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Types of protectionist measures (8)
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1. employment 2. infant (sunrise) industries 3. risks of over-specialisation (don't want all our eggs in one basket) 4. strategic/defence industries: need a steel industry for ships, planes & bombs. 5. product standards - do we want exploding computer cables from Cairo and hormone treated beef from USA? 6. taxes (on imports) = revenue for the government. 7. balance of payments deficit must be addressed.
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What & why might a country want to protect? (7)
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1. Loss of comparative advantage opportunities 2. Higher prices for consumers. 3. Loss of competitiveness and innovation 4. When Governments get involved they may act politically. 5. Retaliation (trade wars)
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Arguments against protectionism. (5)
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A tariff is a *tax* levied *on imported goods*. The tariff can be an ad valorem tax (percentage based) or a specific rate based on volume, weight etc.
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What is a Tariff?
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A *payment by government* to domestic firms to *encourage production*.
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What is a subsidy
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A *quantitative limit on imports* set by government.
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What is a 'Quota'?
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An *Embargo* - a complete ban. USA would not trade with Cuba (no Havana cigars!) and will not trade with North Korea.
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and the ultimate quota limit is...........?
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Made up of member countries and aims to create a global *free trade* environment by: - eliminating trade barriers (tariffs, quotas) - eliminating subsidies on domestic production (tyres) - eliminating dumping of goods (farm produce e.g. milk) - standards for labour laws (no sweat shops) - protecting intellectual property rights (looky-looky man)
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What is the purpose of the World Trade Organisation?
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The price/rate at which one currency can be exchanged for another.
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What is the exchange rate?
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> Growth: demand for imports weakens currency but low growth is a sign of weakness. > Monetary policy (i.e. interest rates) will impact on outflows/inflows of investments > Fiscal policy: budget surplus will strengthen the currency. > rate of inflation but Purchasing Power Parity suggests this will self-correct.
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What determines the exchange rate? (4)
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A 'free market' exchange rate determined by supply and demand for the currency.
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What is a floating exchange rate?
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> No foreign reserves needed > Less import inflation risk.
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Advantages of Floating Exchange rates?
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Uncertainty
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Disadvantage of Floating Exchange rates?
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*No such thing* really. An exchange rate that links to another currency within a *narrow band*. The central bank *(BofE) manipulates the exchange rate to stay within the band.
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What is a fixed exchange rate?
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1. Use reserves (of gold or other currencies) to buy £s (driving up demand = driving up the exchange rate) 2. Sell reserves of £s to buy other currencies (lowers demand = lower price) 3. Move interest rates (Up attracts foreign money; Down means investors move money out of sterling)
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What levers can the government/central bank pull to move the exchange rate?
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*Certainty* which encourages firms trade encouragement disciplined fiscal/monetary policy, little current account deficits, lack of speculation.
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Advantages of Fixed exchange rates
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Needs large *foreign reserves* May become impossible to support the currency. *The Greek problem*: if another economy is growing quickly (Germany) their currency should be getting stronger and Greek exports should be getting cheaper but the euro rate is fixed so Germany just keeps selling to Greece, Greece keeps buying and the Greek economy keeps getting weaker and the German economy keeps getting stronger until it implodes.
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Disadvantages of Fixed exchange rates The Greece Story.
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No such thing as a totally truly floating exchange rate (just as there's no such thing as a truly perfect market). At some point government will step in to manage (manipulate?) the exchange rate.
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Managed exchange rate
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PRO: *downward pressure on inflation* 'cos imports are cheap. PRO: *UK companies become more efficient* as they must compete against cheap imports CON: *UK business may fail* under the increased competition.
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Pros & Cons of a high exchange rate (strong £)
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PRO: *more demand for UK products* ('cos imported goods are more expensive) PRO: *increased employment* in exporting companies CON: *inflation*. Cost of imports is rising.
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Pros & Cons of low exchange rate (weak £)
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The difference between what we export and what we import.
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BALANCE OF PAYMENTS
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Records *export revenues* from goods and services and *deducts import payments* for goods and services. Buying and selling 'stuff'.
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What is the current account?
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*Inflows and outflows from foreign investment, loans, interest on loans, property*. Investments don't get used up - have an indefinite life.
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What is the capital account?
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More investment into the UK than invested abroad. Inflow of foreign currency can be used to fund imports.
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What is a Capital Account Surplus?
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A country has increased its holdings of capital, property and financial assets OVERSEAS.
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Capital Account Deficit?
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*The spread of economic*, social and cultural *ideas across the world and growing uniformity* between different places. It has resulted from the increased integration of economies through trade, investment and capital flow, *made possible through improvements in technology*.
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What is Globalisation?
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A large *free trade zone* formed by one or more *tax, tariff and trade agreements*.
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Trading bloc?
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*Free trade zone* between member countries. AND a *common (same) tariff set for goods from non-member countries*. > May cause shift of production to low cost countries e.g. 'nearshoring' in Romania, Hungary & Poland.
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Customs union?
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*Customs union* AND *common policies on product regulations* e.g. European Directives on health & safety.
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Common market?
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A *common market* AND a *single currency* and a central bank.
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Monetary Union?
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> lower transaction costs (no need to convert currencies) > certainty: can predict the cost of resources > more efficient allocation of resources (bigger market)
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List 4 advantages of a Monetary Union.
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> a single monetary policy (interest rate) *cannot fit the different needs of different economies*. > *asymmetric shock*: affects different countries differently e.g. illegal immigration is a bigger issue in France than in other EU countries (immigrants gather around Calais).
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List 2 disadvantages of Monetary Union
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The *ratio of export prices to import prices* using a common currency. *A measure of buying power*: shows how much we can spend on imports for every £ of exports.
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Terms of Trade?
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(Index of Average Export Prices) ÷ (Index of Average Import Prices) x 100
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Terms of Trade formula?
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Good News: Ability to consume more imports may *improve living standards*. Bad News: If exports are elastic, this may *deteriorate the current account balance*, decrease national income (GDP) and employment.
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Improvement in Terms of Trade: Good News & Bad News
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Good News: If demand for exports and imports are elastic, it may *improve the current account* balance, GDP employment. Bad News: Higher prices of imports produce consumer choice and possibly debt.
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Deterioration in Terms of Trade: Good News & Bad News
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> *LEDCs rely on a few commodities* (coffee, tea) for export earnings; tend to have *inelastic supply curve*. Fall in demand has big impact on price. > LEDCs *cannot easily or quickly switch 'production'*. Takes years for a tea plant to mature - no alternative products available. > *imports* are manufactured 'secondary' goods (e.g. machinery) with *high demand elasticity* (as world demand increases prices rise more). > the *gap widens*.
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Terms of Trade: Specific problems for developing countries
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> Oil exporting countries have been earning supernormal profits and have *accumulated wealth*. > When world demand falls they restricted the quantity even further thus *keeping the price high*. > They *stockpile the oil* produced until demand returns. > They *can do this because a) oil can be stored and b) they are rich* enough to 'ride it out'.
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Why do countries that depend totally on oil not have the same problem with Terms of Trade?
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1. A change in the *exchange rate* 2. An increase in *demand for exported goods* (D increase, price increase) will improve the terms of trade. An increase in supply of exported goods (S increase, price decrease) will decrease the export price index. 3. Implementing *trade barriers*, devaluing or revaluing the currency. 4. *Foreign investment* can cause the exchange rate to appreciate which will result in lower import prices and higher export prices - improving the terms of trade.
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Short run changes in the terms of trade
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1. *Supply side policies*, which result in LRAS shifting to the right, will *decrease domestic prices* (inflation) compared to our trading partners. 2. *Gluts* (large supply) in the market can depress prices in the long term. 3. *Increased incomes* will increase the demand for secondary/tertiary products. This tends to benefit the terms of trade for developed but does not help developing countries. 4. *International commodity agreements* may stop prices rising/falling which will limit any changes in the terms of trade.
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Long run changes in the terms of trade
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A fall in the value of one currency against another with a floating exchange rate.
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Depreciation
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When a managed/pegged currency is realigned to a lower value band.
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Devaluation
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Occurs when people buy/sell currency to make a profit.
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Speculation
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Government increases competitiveness of UK firms: by reducing labour costs (subsidies), investing in technology and infrastructure (spending/grants). > takes time.
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Supply Side Policies - Increasing Competitiveness
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If exchange rate falls, the balance of payments will only improve if elasticity is greater than 1 (i.e. if Quantity demanded increases).
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Marshall-Lerner Condition
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- Marshall-Lerner Condition, balance of payments improve High elasticity -> PEDx + PEDm > 1 - Elasticity = 1 , unitary elasticity -> PEDx + PEDm = 1 Balance of Payments is unchanged - Elasticity low (inelastic) -> PEDx + PEDm < 1 Balance of Payments deteriorates
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Depreciation of the currency
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> It takes time. Things continue to get worse before they get better. e.g. exchange rate falls so exports become cheaper ? foreign consumers begin to switch to UK for supplies.
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J-curve
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- If the terms of trade falls (say due to an increase in the number of suppliers around the world), this will result in the price of the good falling. - Depending on the elasticity of the good, this will result in total revenue received from these goods either increasing or decreasing. This will affect the current account - either improving it or resulting in it worsening.
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Effect of Elasticity on Terms of Trade, Balance of Payments
