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Flashcards in International Deck (42)
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Benefits of International trade

1. Lower Prices for consumers (differneces in quality of labour force, more access to raw materials among other factors may lead to foreign countries being able to produce cheaper goods)
2. Greater domestic choice
3. Difference in resources
4. Economies of scale (bigger market [because of international trade] allows firms ito increase thgeir size which can lead to economies of scale)
5. Increased competition
6. More efficient allocation of resources
7. Sources of foreign exchange. ( wich has the benefit of allowing countries to buy imports and use foriegn exchange reserves to offset a disequilibriumn on the balance of payments)


Benefits of Specialisation and Exchange

Allows countries to consume combinations of goods and services that lie beyond its own PPC. This is based on the theory of reciprocal absolute advantage.


Causes of comaparative advantage

Hecksher-Ohlin theory of interantional trade states that a country in which labour is relatively abundant will specialise in producing goods or services whose production is labour intensive. (same applies for countries in which capital is relativley abundant)
More generally, based on their factor endowment.


Limitations to theory of comparative advantage

1. Assumed that consumers have perfect knowledge, which in reality is not the case
2. assumed there are no transport costs
3. Basic theories/models assume two economies producing two goods
4. It is usually assumed that costs do not change and that there are constant returns to scale
5. Assumes homogenous products
6. assumes free trade
7. Assumes factors of production stay in one country when in fact labour and capital are free to move


Objectives and functions of WTO

(World trade Organisation)
Regulator and of World trading, setting rules of trading and solving disputes between member countries.
All member countries grant most favoured nations status to another member nation which grant trade concessions to one another.
-administer trade agreements
-be a forum for trade negotiation
-handle trade disputes between member countries
-monitor national trade policies
-provide technical assistance and training for developing countries
-cooperate with other int organisations.


Forms of protectionism

1. Tariffs
2. Quotas
3. Embargos
4. Others e.g. product standards, red tape


Arguments for protectionism

1. Protecting domestic employment (structural unemployment created in sunset industries is prevented)
2. Protecting economies from cost of labour abroad
3. Protecting sunrise/infant industries
4. Risk of over-specialisation (over dependency on export markets of one or two two products)
5. strategic reasons (e.g. during war)
6. Prevent dumping by developed countries
7. Protect product standards (and so protecting health, safety and environment) (e.g. EU ban of US GH meat)
8. Raise government revenue (15% of total revenue for developing countries IMF estimate)
9. Correct balance of payment deficit


Arguments against protectionism

1. Misallocation of world's resources (distortion of comparative advantage).
2. Danger of retaliation/trade wars.
3. Potential for corruption.
4. Increased cots of production because of lack of competition.
5. Reduced export competitiveness.
-Because of all reasons above may hinder economic growth.


In the case of fixed exchange rates when the value of the currency (or commodity) is fixed to rises, the government maintain their fixed exchange rates by...

.... increasing demand for the currency by buying back the excess supply using foreign currency reserves.


How does demand for a currency rise in a floating exchange rate system?

-if there is an increase in the demand for US goods and Services (inflation lower than foreign countries, increase in foreign income, change in foreign taste)
-US investment prospects improve
-US interest rates increase (making it more attractive to save their)
-Speculation of future rise in currency in question


When does supply for a currency rise in a floating exchange rate system?

-domestic consumers increase demand for foreign goods increases (because of increase in domestic inflation, increase in domestic income, change of taste for foreign goods)
-Investment prospects abroad improve
-Foreign interest rates increase making it more attractive to sae abroad
-speculation domestically think value of domestic currency will fall


High exchange rate advantages

1. Downwards pressure on inflation
2. More imports can be bought
3. Forces domestic producers to improve their efficiency to improve their international competitiveness.


High exchange rate disadvantages

1. damage to export industries (possibly leading to unemployment)
2. damage to domestic industries (as imports have become relatively less expensive)


Advantages of low exchange rates

1. Increase in employment in export industries
2. Greater employment in domestic industries


Disadvantages of low exchange rates

Inflation because imports are more expensive.


Why government would want to intervene in exchange market?

-Lower the exchange rate in order to increase employment
-Raise exchange rate to fight inflation
-Avoid large fluctuation in float in exchange rate and thus improve business confidence
-Improve a current account deficit


Advantages of fixed exchange rate

1. Reduce uncertainty for all economic agents in the country
2. Government makes extra effort to ensure low inflation to ensure international competitiveness
3. (in theory) Reduce speculation in foreign exchange markets.


Disadvantages of fixed exchange rates

1. Often goal of low unemployment in an economy will be sacrificed as the tools implemented to maintain the fixed rates e.g. increase interest rates may have a deflationary effect on economy. (restriction in freedom for policy makers)
2. Government needs to maintain the high level of foreign reserves to make clear ability to defend currency by buying and selling of foreign currencies
3. Variables have to be taken into account when setting the exchange rate at the wrong level can lead to a decrease in international competitiveness.
4. Undervaluing currency may lead to international disagreement as this will make their products more internationally competitive.


Advantage of floating exchange rate

1. Interest rates are free to be employed as domestic monetary tools
2. The exchange rate should adjust itself to fix a current account imbalance
3. Not necessary to keep high level of foreign reserves and gold


Disadvantage of floating exchange rate

1. create uncertainty on international markets
2. Influenced more by more factors than demand & supply
3. Could worsen already high inflation (cost push inflation caused by exchange rate dropping to much to fix inflation)


Relationship between three accounts in the balance of payments

Current account balance= capital account balance + financial account balance (+net errors and emissions)


Implications/consequences of persistent current account deficit

1. Foreign ownership of domestic assets (threat to economic sovereignty)
2. Country may be heavily indebted (short term drain on current account and will increase deficit in long term and the danger that a government lending money could withdraw it at any time) (an inability to pay debts would lead to reduction in credit rating meaning harder to borrow in future)


Methods to deal with persistent current account deficit

1. Expenditure switching policies
2. Expenditure reducing policies
3. Supply side splices to increase competitiveness of domestic producers


Expenditure switching policies to improve current account

Switch expenditure away from imports and towards domestically produced products
-gvt policies to depreciate/devalue currency
(Effectiveness of this depends upon the price elasticity of demand for imports and exports)
-protectionist measures (restrict imports)
WTO prevents many of these techniques and gets rarely want to sacrifice competition for this


Expenditure reducing policies

Reduce AD in an attempt to reduce expenditure on imports.
-Deflationary fiscal policies (increase indirect tax/reduce gvt expenditure)
-deflationary monetary policies (increasing interest/ restricting money supply)
But, conflict of internal and external interests in economy.


If there is a surplus in the three accounts the exchange rate......

...... appreciates


If there is a deficit across the three account the exchange rate will...



Current account deficit deficit/ Capital account surplus indicates:

That the total spending by domestic households, government and firms is greater than the gross national disposable income
Or that the level of investment in a country exceeds the level of gross national saving.


Significance of current account imbalance

the significance of an imbalance depends not upon the magnitude of the imbalance but instead upon its size RELATIVE TO GDP.

(because current account deficit indicates spending beyond current income meaning sone spending is funded by previously saved income or out of future income and so the smaller the deficit as a share of GDP the smaller the burden)


Explain the process shown in a J-curve

Lower exchange rates from point they were previously at, but because communication is not perfect = will take time for other countries to realise prices in this country have fallen.
In addition, they may be tied into contracts which cannot be broken in the short term meaning they cannot change suppliers immediately.
This means PEDexports will be inelastic and export revenue will fall as a consequence of the reduced prices (which fell more quickly than demand will rise).
The same applies for imports.
Overall, this will worsen the deficit (point Y on diagram).
By the time a current account deficit reaches point Y he PEDimports and PED exports has risen to the point where there sum is greater than 1.
This means the Marshall-Lerner condition is satisfied and the current account balance will improve (point Z).