International Economics Flashcards
(184 cards)
1
Q
Is there a precise definition of globalisation
A
No, it is used to refer to a variety of ways in which countries are becoming more and more closely integrated, not just in the economic sense, but also culturally and politically.
2
Q
Tell me what is consider one of the best definitions of globalisation in the economics sense
A
The definition is by Peter Jay, who was the BBCs economics correspondent in 1996: ‘the ability to produce any good or service anywhere in the world, using raw materials, components, capital and technology from anywhere, sell the resulting output anywhere and place the profits anywhere.
3
Q
Is globalisation a new phenomenon
A
No because there have been many periods in history when there was considerable integration between countries, for example, during the height of the Roman Empire.
However, the pace of global integration has increased considerably over the last 50 years.
4
Q
How, in the economic sense, is globalisation characterised
A
An Increase in trade as a proportion of world GDP.
Increased movements of financial capital and people between countries.
Increased international specialisation and division of labour. It is increasingly common for parts and components of products to be made in different countries and for assembly to occur in another country.
The growing importance of global or transnational companies (TNCs)
An increase in foreign direct investment (FDI)
5
Q
Define foreign direct investment
A
(FDI) is cross border investment by a business in one economy with the objective of obtaining a lasting interest in an enterprise resident in another economy. It may involve the acquisition by a business in one country of a business in another country.
6
Q
List to me the factors contributing to globalisation
A
A variety of factors have contributed to the increased economic integration of countries:
Fall in transport costs
Decline in cost of communications
Lowering of trade barriers
Collapse of communism and the opening up of China
Transnational (global) companies
Growth in the number and size of trading blocs (regional trade agreements)
7
Q
Tell me how the following factor has contributed to globalisation/increased economic integration of countries: fall in transport costs
A
One of the most significant factors Is the fall in transport costs. In real terms the price of transporting goods has decreased significantly, enabling goods to be imported and exported more cheaply.
8
Q
Tell me how the following factor has contributed to globalisation/increased economic integration of countries: decline in the cost of communications
A
Coupled with a fall in transport costs has been a decline in the cost of communications. In particular, the cost of using the internet has fallen greatly over the last 20 years and its availability has increased.
9
Q
Tell me how the following factor has contributed to globalisation/increased economic integration of countries: the lowering of trade barriers
A
The lowering of trade barriers since the Second World War has been a major factor in the growth of world trade. The world trade organisation (WTO) - formerly the general agreement on tariffs and trade - has been responsible for negotiating reductions in tariffs and other barriers to trade in rounds of talks, the most recent of which is the Doha round.
10
Q
Tell me how the following factor has contributed to globalisation/increased economic integration of countries: the collapse of communism and the opening up of China
A
Both the collapse of communism and the opening up of China to world trade have contributed to globalisation. Countries which were previously not open to FDI became much more integrated into the world trading system.
11
Q
Tell me how the following factor has contributed to globalisation/increased economic integration of countries: transnational companies
A
Transnational (global) companies have taken advantage of the reduction in trade barriers and the development of the internet to organise trade on a global scale.
12
Q
Tell me how the following factor has contributed to globalisation/increased economic integration of countries: growth in the number and size of trading blocs (trade agreements)
A
It has resulted in increased trade between the member countries of these blocs.
13
Q
Tell me about an impact of globalisation on countries to do with the law of comparative advantage
A
Free trade enables the application of the law of comparative advantage, which suggests that, when countries specialise in the goods in which they have a comparative advantage (i.e the goods can be produced at a lower opportunity cost), then world output and living standards will increase. It is evident that the growth of world trade in both goods and services has been associated with increased growth in real GDP.
However, the global financial crisis that became particularly evident in 2008 led to a period of deglobalisation, in which countries adopt protectionist policies in an attempt to protect domestic employment. This leads to a decline in specialisation and trade. More recently, trade has recovered.
14
Q
Tell me an impact of globalisation on countries to do with inequality
A
Globalisation has been associated with increased inequality within developed countries. As much manufacturing has been transferred to developing countries, the demand for unskilled workers has declined in developed countries, resulting in a fall in their wages relative to those of skilled workers.
15
Q
Tell me how globalisation impacts on governments
A
If globalisation results in an increase in economic growth and, therefore, in incomes, then governments should receive extra tax revenues. However, transfer pricing by global companies may result in lower tax revenue from corporation tax.
16
Q
Define transfer pricing
A
When a global company manages its accounting of internal transactions within the company to show the highest profits in the country in which corporation tax is lowest.
17
Q
How can globalisation impact on producers
A
For producers, there are likely to be benefits in terms of lower production costs as a result of offshoring and also economies of scale.
18
Q
How can globalisation impact on consumers
A
For consumers, globalisation may mean a wider choice of goods. Further, prices may be lower, leading to an increase in consumer surplus.
19
Q
How can globalisation impact on workers
A
Globalisation has been criticised on the basis that it has promoted exploitation of workers, including the use of child labour. It is argued that globalisation has driven down wages (especially those of unskilled workers) as a share of GDP. Further, health and safety laws and regulations are usually less demanding in developing countries, which might have detrimental effects on the workforce.
20
Q
How can globalisation impact on the environment
A
The external costs associated with increasing globalisation are becoming increasingly apparent, especially in relation to increased trade, air travel and environmental degradation. Global warming associated with various forms of pollution arising from increased trade is one example of external costs arising from increased globalisation.
21
Q
Tell me about producing at an absolute and comparative advantage - the theory of comparative advantage
A
This law states that, even if one country has an absolute advantage in the production of all goods, it can still benefit from specialisation and trade if it specialises in the production of goods in which it has a comparative advantage (I.e if it specialises in the production of those products in which its opportunity cost is lowest). The crucial requirement is that there must be a difference in the opportunity cost of producing the products.
22
Q
Define absolute advantage
A
When a country can produce more of a product than another country.
23
Q
Define comparative advantage
A
When a country can produce a product at a lower opportunity cost than another country, so it has a relative advantage in producing that product.
24
Q
Tell me about the assumptions underlying the theory of comparative advantage
A
No transport costs
No trade barriers
Constant returns to scale, ie. average cost of production is constant.
Perfect mobility of resources between users
Buyers/consumers have perfect knowledge.
25
To determine whether trade will be worthwhile, what must be calculated
The opportunity costs must be calculated.
If a country has a comparative advantage of a good it has a lower opportunity cost.
For trade to be beneficial, the terms of trade must lie between the opportunity cost ratios.
26
How are terms of trade measured
The terms of trade must lie between opportunity cost ratios for trade to be beneficial
The terms of trade are measured as follows:
(Index of export prices/index of import prices) x 100
You should note that, if the opportunity costs were the same, then there would be no benefit from specialisation and trade.
27
Tell me the limitations of the principle of comparative advantage
Transport costs might outweigh the benefits of comparative advantage
Similarly, trade barriers might distort comparative advantage
Increased specialisation and production might result in rising average costs caused by diseconomies of scale.
However, despite these limitations, many economists support the view that free trade brings net benefits to the global economy.
28
Tell me the advantages of specialisation and trade
Efficient resource allocation: specialisation and free trade based on comparative advantage result in an efficient allocation of resources
Higher world output and, therefore, higher living standards.
Lower prices and more choice for consumers
Incentive for domestic producers to become more efficient
Larger markets for firms, enabling them to benefit from economies of scale.
29
Tell me the disadvantages of specialisation and trade
The law of comparative advantage is based on unrealistic assumptions
For developing economies, specialisation in the production of primary products might prevent diversification into more productive manufacturing industries
There is a danger of over dependence on imports, especially those of strategic importance.
A country’s goods and services may be uncompetitive, resulting in a persistent trade deficit.
30
How do you calculate opportunity cost
The amount of the one good not chosen to be produced divided by the quantity of the good being chosen to be produced
31
List to me the factors that influence patterns of trade
Changes in comparative advantage
Emerging economies
Trading blocs and bilateral trading agreements
Changes in relative exchange rates
32
Tell me how the following factor can influence patterns of trade: changes in comparative advantage
Comparative advantage may change as a result of factors such as changes in labour skills and productivity, discovery of new natural resources and the adoption of new technology
33
Tell me how the following factor can influence patterns of trade: emerging economies
The pattern of world trade has also been greatly affected by the growth of emerging economies, for example China, which is now a major manufacturer.
34
Tell me how the following factor can influence patterns of trade: trading blocs and bilateral trading agreements
Since the Second World War there has been a significant growth in the number and size of trading blocs. Given that most of these have free trade between member countries and that customs unions have common external tariffs, trading blocs have had an important influence on the pattern of world trade. Similarly, bilateral trade agreements (agreements between 2 countries) have also affected trade patterns
35
What’s a bilateral trade agreement
Agreements between 2 countries
36
Define trading bloc
A group of countries that trade freely but protect themselves from imports from non-members
37
Tell me how the following factor can influence patterns of trade: changes in relative exchange rates
A long term change in a country’s exchange rate against those of other countries will affect the relative competitiveness of that country’s goods and services and so will influence trading patterns. For example, if country A’s currency depreciates against those of other countries, then its goods and services will become more competitive and so its exports are likely to increase and imports decrease relative to those of other countries.
38
What’s the calculation of the terms of trade
The terms of trade (T/T) are calculated by using the following formula:
T/T = index of export prices/index of import prices x 100
Therefore, the terms of trade is the relationship between the price of exports and the price of imports or the rate at which exports exchange for imports.
39
Define terms of trade
The average price of a country’s exports relative to the average price of its imports.
40
List to me the factors that influence a country’s terms of trade
Relative inflation rates
Changes in raw material prices
Changes in exchange rate
Tariffs
Dependency on primary products
41
Tell me how the following factor influences a country’s terms of trade: relative inflation rates
If the uk inflation rate is higher than that of its trading partners then export prices will be rising relative to import prices, so causing a rise in the UKs terms of trade.
42
Tell me how the following factor influences a country’s terms of trade: changes in raw material prices
For a developed country which imports most of its raw materials, a rise in imported raw material prices would cause a fall in its terms of trade.
43
Tell me how the following factor influences a country’s terms of trade: changes in exchange rates
If a country’s exchange rate increases relative to those of other countries then its export prices would rise and its import prices would fall, so causing its terms of trade to increase.
44
Tell me how the following factor influences a country’s terms of trade: tariffs
If a country imposes a tariff on imported goods then this would cause an increase in import prices and so would result in a fall in the country’s terms of trade.
45
Tell me how the following factor influences a country’s terms of trade: dependency on primary products
If a country is dependent on primary products then according to the Prebisch-Singer hypothesis it may find that its terms of trade decrease over time.
46
How can changes in a country’s terms of trade affect living standards
An upward movement in the terms of trade is usually referred to as an ‘improvement’ because it implies that the country has to export less to buy a given quantity of imports. This implies a higher standard of living for the citizens of that country. In contrast, a fall in the terms of trade is referred to as a ‘deterioration’ because it implies that more must be exported to gain a given quantity of imports, which, in turn, implies a fall in living standards.
47
How can changes in a country’s terms of trade affect the balance of payments on current account
An upward movement in a country’s terms of trade would decrease the competitiveness of its goods and services because its export prices would be rising relative to its import prices. Consequently, the country’s balance of payments on the current account is likely to deteriorate. In turn, this could cause a depreciation in its exchange rate.
48
How can changes in a country’s terms of trade affect the rate of inflation
A fall in a country’s terms of trade may be associated with a higher rate of inflation if the fall was caused by an increase in the price of imported raw materials.
49
How can changes in a country’s terms of trade affect developing countries
Resource-rich developing countries sometimes suffer from what is called the ‘resource curse’. This arises because ownership of minerals and fuels causes an appreciation in the exchange rates of the currencies of these countries and, in turn, an increase in the terms of trade. This results in a loss of competitiveness of their manufactured goods and services, leading to slower economic growth than might otherwise have been the case.
50
What are regional trade blocs
Intergovernmental associations that manage and promote trade activities for specific regions of the world. Trading blocs may take several forms:
Free trade areas
Customs unions
Common markets
Monetary unions
51
What are the forms trading blocs can take
Free trade areas
Customs unions
Common markets
Monetary unions
52
What’s a free trade area
Trade barriers are removed between member countries, but individual members can still impose tariffs and quotas on countries outside the area. An example is the North Atlantic free trade area (NAFTA)
53
What are customs unions
The characteristics of custom unions include free trade between member states and a common external tariff on goods imported from outside the bloc. Examples include the European Union (EU) and the customs union of Russia, Belarus and Kazakhstan (formed in 2010)
54
What are common markets
These are customs unions but with the added dimension that it is not only goods and services that can be moved freely within the area (between member states), but also factors of production (especially labour). Examples include Mercosur and the East African common market.
55
What are monetary unions
These are customs unions that adopt a common currency. The eurozone area of the EU is an example of such a union.
56
List the costs of regional trade agreements
Trade diversion
Distortion of comparative advantage
Loss of independent monetary policy
57
Tell me how trade diversion is a cost of regional trade agreements
Trade may be diverted away from low cost producers outside the bloc to high cost producers within the bloc because of the existence of tariffs on goods from outside the bloc.
58
Tell me how the distortion of comparative advantage is a cost of regional trade agreements
The existence of trade restrictions on goods from countries outside the agreement will distort comparative advantage and lead to a less efficient allocation of resources, lowering global economic growth.
59
Tell me how the loss of independent monetary policy is a cost of regional trade agreements
This would be relevant to countries in monetary unions which would be unable to control their own interest rates and exchange rates.
60
Tell me the benefits of regional trade agreements
Trade creation. The removal of trade barriers between member countries of the bloc will result in increased specialisation and trade between them
Increase in FDI. Global companies may wish to invest inside a trading bloc to avoid trade restrictions
61
Tell me the further benefits that monetary unions might enjoy
Elimination of transaction costs. In other words, there would be no costs involved in changing currencies when goods are imported or exported.
Price transparency. A single currency means that consumers have the ability to compare prices more easily across national borders.
Elimination of currency fluctuations between member countries. This eliminates uncertainty and might help to attract FDI
62
What are the two key functions of the WTO
To promote free trade among the 188 member countries through so called ‘rounds of talks’
To settle trade disputes between members
63
What are the possible conflicts between regional trade agreements and the WTO
The existence of trading blocs has two significant consequences:
Trade creation
Trade diversion
While trade creation is a goal of the WTO, the trade diversion which results from regional trade agreements is clearly not
Nevertheless, it may be argued that the growth in both the number and size of regional trade agreements has contributed to the WTO goal of promoting free trade.
64
List me the reasons for restrictions on free trade (protectionism)
To protect infant industries
To protect geriatric industries
To ensure employment protection
To prevent dumping
To correct a balance of payments deficit on current account
To restrict imports from countries whose health and safety regulations and environmental regulations are less stringent
For strategic reasons
To raise tax revenue
In retaliation
65
What does the term protectionism refer to
Measures designed to limit free trade.
66
Tell me about the reason to restrict free trade: to protect infant industries
This argument might be particularly relevant to developing countries that are in the process of industrialisation. Without protection, infant industries might be unable to compete because they have yet to establish themselves and are too small to benefit from economies of scale.
67
Tell me about the reason to restrict free trade: to protect geriatric industries
These are industries that might demand protection so that they have time to restructure and rationalise production, which would enable them to become competitive once again. Typically, these occur in developed economies that are losing their comparative advantage.
68
Tell me about the reason to restrict free trade: to ensure employment protection
Cheap imports might threaten jobs in the domestic economy and workers might demand that the government takes action to limit imports.
69
Tell me about the reason to restrict free trade: to prevent dumping
‘Dumping’ refers to goods being exported to another country at below the average cost of production. It is a form of predatory pricing and, if it can be proved, is illegal under the WTO rules. This is one of the few arguments in favour of protectionism that can be justified in terms of economic theory because it unfairly distorts comparative advantage.
70
Define predatory pricing
A deliberate strategy by a firm aimed at driving competitors out of the market by setting its prices below average variable costs.
71
Tell me about the reason to restrict free trade: to correct a BoP deficit on current account
Restrictions on imports might help to reduce the imbalance between the value of imports and the value of exports. However, under a system of floating exchange rates, it is possible that this correction will happen automatically.
72
Tell me about the reason to restrict free trade: to restrict imports from countries whose health and safety regulations and environmental regulations are less stringent
Some argue that developing countries might have an unfair competitive advantage because production is not subject to the same laws and regulations that apply to developed countries, so enabling them to produce at a lower cost.
73
Tell me about the reason to restrict free trade: for strategic reasons
A country might introduce protectionist policies on goods of strategic importance in time of war so that it is not dependant on imports. Food, defence equipment and energy are items frequently used as examples of such goods.
74
Tell me about the reason to restrict free trade: to raise tax revenue
Tariffs might be an important source of tax revenue for developing countries
75
Tell me about the reason to restrict free trade: in retaliation
Barriers to trade might be imposed by a country because another country has restricted the import of its goods.
76
List the most common ways to prevent free trade
The most common are tariffs, quotas, subsidies to domestic producers and non tariff barriers.
In countries where the exchange rate is not freely floating, the authorities might also hold down the value of the currency artificially to give their goods a competitive advantage.
77
What are tariffs
These are sometimes referred to as custom duties: they are simply taxes on imported goods.
78
What does a tariff look like on a diagram
There is demand and domestic supply forming usual cross.
Then horizontal line under equilibrium of world supply, and slightly above (but still below domestic equilibrium) is world supply + tariff as another horizontal line. This causes a reduction in consumer surplus, increase in producer surplus, fall in imports, increased tax revenue
Pls check out diagram on page 16
79
Tell me about quotas
Import quotas place a physical restriction on the amount of goods that can be imported. They have similar effects to those of tariffs, in that the price of imported goods will rise and domestic producers should gain more business. However, unlike tariffs, the government does not receive any revenue.
80
Tell me about subsidies to domestic producers
Protectionist measure
Grants given to domestic producers by the government artificially lower their production costs, so enabling their goods to be more competitive. Subsidies therefore act as a barrier to trade
81
Tell me about non tariff barriers
These take a variety of forms, including labelling, health and safety regulations, environmental standards and documentation in country of origin. In effect, such regulations increase the costs of foreign producers and so act as a barrier to trade.
82
Tell me the impact of protectionist policies on consumers
Higher prices and less choice
83
Tell me the impact of protectionist policies on producers
Less incentive for domestic producers to become more efficient
84
Tell me the impact of protectionist policies on governments
A government would receive tax revenue from tariffs but subsidies to domestic producers would incur a cost on tax payers. Once such barriers are introduced, it might prove to be difficult to remove them because of the adverse effect on domestic producers.
85
Tell me the impact of protectionist policies on living standards
Protectionism results in a less efficient resource allocation because trade barriers distort comparative advantage and reduce specialisation, which will result in lower world output and, therefore, lower living standards.
86
Tell me the impact of protectionist policies on equality
Trade barriers imposed by developed countries on goods from developing economies could increase inequality between these two sets of countries.
87
What is the balance of payments
The balance of payments is a record of fall financial transactions between one country and other countries. When there is an inflow of foreign currency into the uk, this is recorded as a positive item, whereas when there is an outflow of foreign currency, this is recorded as a negative item.
The main components of the balance of payments are the current account and capital and financial account (formerly called the capital account)
88
What is the current account composed of
The trade balance
The income balance (now renamed primary income)
Current transfers (now renamed secondary income)
89
Tell me about the trade balance as a component of the current account
This is the value of goods and services exported minus the value of goods and services imported. The trade balance may be separated into the trade in goods balance and the trade in services balance.
90
Tell me about the income balance (now renamed primary income) as a component of the current account
This is income flows into the country from non residents minus income flows out of the country from residents to non residents. Income refers to compensation to employees and investment income, for example.
91
Tell me about current transfers (now renamed secondary income) as a component of the current account
This relates to items such as food aid and the UKs contributions to the EUs common agricultural policy (CAP)
92
Tell me about the capital and financial account
Formerly called the capital account.
This comprises transactions associated with changes of ownership of the UKs foreign financial assets and liabilities. A key factor influencing the financial account is foreign direct investment (FDI). Also included are portfolio investment in shares and bonds, changes in foreign exchange reserves and the short term capital flows, often referred to as ‘hot money’ flows, associated with speculation.
The balance on this account should exactly offset the current account balance (although, in practice, there is a significant component comprising errors and omissions)
93
List to me causes of current account deficits
These include:
Relatively low productivity, meaning that the country’s good and services are not competitive internationally
Relatively high inflation
Overvalued exchange rate
Dependence on highly priced imported raw materials
Relocation of manufacturing industries to low wage countries
Protectionism by other countries
94
List to me causes of current account surpluses
These include:
Relatively high productivity, meaning that the country’s goods and services are more internationally competitive
Relatively low inflation rate
Undervalued exchange rate
Abundance of minerals, fuels and agricultural produce which is in high demand by other countries
Relocation of manufacturing industries from high wage countries
Protectionist policies designed to reduce imports
95
What are the main reasons for the UKs current account deficit
The high value of sterling 1996-2008
Continuous economic growth 1992-2008 - the uk has a high marginal propensity to import and so rising real incomes have led to a significant increase in imports
Relatively low productivity of the UKs workers, resulting in higher average costs
The relocation of manufacturing to countries with lower labour costs (eg China and Eastern European countries)
The euro zone crisis since 2009, which has meant slow growth and weak demand for the UKs exports.
The deterioration in ‘net income balance’, I.e net income from interest, profits and dividends
The ‘Chindia effect’ - the industrialisation of China and India has led to a flood of cheap imports into the UK
96
List the possible measures to reduce a current account deficit
Supply side policies designed to increase productivity and competition
Expenditure reducing policies
Expenditure switching policies (eg protectionist policies and depreciation/devaluation of the country’s currency.
97
To reduce a country’s imbalance on the current account, tell me how supply side policies designed to increase productivity and competition would work
These would help to improve the competitiveness of the country’s goods and services and so lead to an increase in exports and a decrease in imports. Examples of supply side policies include:
Education and training aimed at increasing the productivity of the workforce
Tax breaks and investment allowances to stimulate purchase of capital equipment
Measures to promote small- and medium-sizes businesses to promote competition
Privatisation, deregulation and contracting out of public services
98
To reduce a country’s imbalance on the current account, tell me how expenditure reducing policies could work
These could include deflationary fiscal policy, I.e measures to reduce aggregate demand by raising taxes and/or decreasing government expenditure. If direct taxes were raised then disposable income would fall, causing a fall in consumption and, consequently, a fall in imports, so resulting in an improvement in the balance of trade.
NB (note well) many countries have independent central banks so it is not within their power to raise interest rates as a means of reducing a current account deficit.
99
To reduce a country’s imbalance on the current account, tell me how the expenditure switching policy: protectionist policies would work
Protectionist policies such as tariffs, quotas and subsidies to domestic producers. However, it should be noted that WTO rules and membership of trading blocs might make it impossible/illegal to employ these measures.
100
To reduce a country’s imbalance on the current account, tell me how the expenditure switching policy: devaluation/depreciation of the country’s currency may work
A country with a fixed exchange rate could devalue its currency. However, under a system of floating exchange rates, a depreciation of the exchange rate of the country’s currency could only be engineered by reducing interest rates or through quantitative easing, but these monetary tools would not be available to a government if the central bank were independent.
101
Tell me about the significance of global trade imbalances
Like the UK, the USA has experienced large current account deficits, while, in contrast, China has experienced huge current account surpluses. Whether such global imbalances can be sustained in the long run is a major question.
On the one hand, if the deficits are easily financed by inflows on the financial account, there may be no cause for concern. Further, under a system of floating exchange rates, over time, there should be an automatic adjustment (ie a deficit would cause the exchange rate to fall). On the other hand, continuous deficits by the USA have, in effect, been financed by the Chinese, which may not be a sustainable option in the long run.
102
What’s the nominal exchange rate
The number of units of the domestic currency that can purchase a unit of a given foreign currency
103
What is the real exchange rate
The real exchange rate is calculated to measure the movements of the competitiveness of the country’s currency vis-à-vis another country’s currency on the basis of the inflation differential between the countries. In other words, the real exchange rate is the nominal exchange rate adjusted to reflect the different inflation rates in the countries of the two currencies concerned
104
What are effective exchange rates
They are estimated to measure the movements of a country’s currency value or average exchange rate in a basket of currencies of trading partner countries.
105
What’s a country’s trade-weighted exchange rate
It’s a common form of the effective exchange rate. It is the average exchange rate of a basket of currencies, weighted by the amount of trade with each country.
106
What is the exchange rate
The rate at which one currency exchanges for another. In other words, it is the price of one currency in terms of another eg £1 = $1.50.
There are three main exchange rate systems: floating, fixed and managed
107
What are the three main exchange rate systems
Floating, fixed and managed
108
What are floating exchange rates
Under a system of floating exchange rates, market forces (supply of, and demand for, the currency in the foreign exchange market) determine the value at which one currency exchanges for another.
109
What are fixed exchange rates
Under a system of fixed exchange rates, the value at which one currency exchanges for another is fixed by the central bank or the government against another currency or a basket of currencies or gold.
110
What are managed exchange rates
Under a system of managed exchange rates, market forces determine the value at which one currency exchanges for another but intervention by the central bank influences the exchange rate of the currency.
111
When does a revaluation of a currency occur
A revaluation of a currency only occurs under a system of fixed exchange rates when the government decides to increase the value of its currency against other currencies or gold.
112
When does an appreciation of a currency occur
Under a system of floating exchange rates when the value of a currency increases against another currency as a result of the operation of market forces.
113
When does a devaluation of a currency occur
Only occurs under a system of fixed exchange rates when the government decides to decrease the value of its currency against other currencies or gold.
114
When does the depreciation of a currency occur
Occurs under a system of floating exchange rates when the value of a currency decreases against another currency as a result of the operation of market forces.
115
Tell me the factors influencing the value of a currency
Relative inflation rates
Relative interest rates
The state of the economy
The balance of payments on current account
Political factors
Speculation
116
Tell me how the following factor influences the value of a country’s currency against other currencies: relative inflation rates
If the country’s inflation rate is higher than that of its major competitors then, according to purchasing power parties (PPP) analysis, it would be expected that the value of the currency would fall. The PPP rate is the rate at which a particular product would be sold at the same price in the uk and abroad when expressed as a common currency.
117
Tell me how the following factor influences the value of a country’s currency against other currencies: relative interest rates
If the uk has higher interest rates than those of other countries, then foreigners with surplus balances are likely to place them in UK banks, so increasing the demand for sterling and causing the value of the pound to increase.
118
Tell me how the following factor influences the value of a country’s currency against other currencies: the state of the economy
If, for example, the uk economy is performing well, this will increase the confidence of speculators and foreign investors, who will buy sterling, so causing its value to rise.
119
Tell me how the following factor influences the value of a country’s currency against other currencies: the balance of payments on current account
If there is a persistent deficit on the current account, then the supply of the currency would be high relative to demand for it and the value of the current would be expected to fall. In practice, this factor is not significant because the flows of money associated with trade are small compared with ‘hot money’ flows and other transactions recorded in the financial account.
120
Tell me how the following factor influences the value of a country’s currency against other currencies: political stability
In developing countries, instability may cause a loss of confidence in the country’s currency.
121
Tell me how the following factor influences the value of a country’s currency against other currencies: speculation
The exchange rate might be affected by speculation concerning a range of possible events, including factors such as the future state of the economy, a change in government or impending strikes. For example, if it is expected that the economy will recover from a recession much more quickly than originally thought, then speculators may buy sterling, so pushing up its value.
122
What are the two main ways by which the exchange rate of a currency against other currencies may be influenced
Foreign currency transactions
Interest rates
These are methods of government intervention in currency markets
123
Tell me about foreign currency transactions to influence the exchange rate of a currency against other currencies
The central bank can intervene in the foreign exchange market in attempts to influence the exchange rates of its currency against other currencies.
To bring about an appreciation in the exchange rate of the currency against other currencies, the central bank would buy its currency on the foreign exchange market in exchange for foreign currency. The increase in demand for domestic currency would cause an increase in its value against foreign currencies.
In contrast, to engineer a depreciation of the exchange rate of its currency, the central bank would sell its own currency on the foreign exchange market in exchange for foreign currency. This increase in supply would cause a fall in the value of the current against foreign currencies.
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Tell me about the use of interest rates to influence the exchange rate
To bring about an appreciation of the currency against other currencies, the central bank would raise interest rates. For example, in December 2014, the central bank of Russia raised interest rates to 17% with the aim of making it more attractive for foreign citizens to place money in Russia’s banks, so increasing demand for roubles on the foreign exchange market.
A reduction in interest rates would have the opposite effect, making it less attractive for citizens and foreign nationals to hold money in that country’s banks. This would cause an increase in supply of the currency on the foreign exchange market and so reduce its value against other currencies.
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What’s the meaning of competitive devaluations/depreciations
Competitive devaluations or depreciations are sometimes referred to as currency wars because a devaluation/depreciation by one country results in other countries taking measures to devalue their currencies.
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Define currency war
When a country deliberately reduces the value of its currency in order to gain a competitive advantage and this results in other countries taking similar action.
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Tell me the effects of a competitive devaluation/depreciation
These could cause:
An increase in the rate of inflation because imports would become more expensive
A decline in world trade because of the uncertainties associated with fluctuating exchange rates
Further, countries could retaliate by imposing protectionist measures, eg. Tariffs, as happened in the 1930.
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Tell me how a change in the exchange rate of a currency would effect the current account on the bop
A depreciation/devaluation makes a country’s goods and services more competitive and so should lead to an improvement in its current account.
It will make the price of goods exported from domestic country decrease and make the price of goods imported to domestic country decrease.
The consequence of this is that demand for exports is likely to rise while demand for imports is likely to fall. This is likely to cause a reduction in the size of the deficit on the current account of the balance of payments. However, this is dependant on the marshal Lerner condition being met and look at the J curve effect.
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What is the Marshall-Lerner condition
For there to be an improvement in the current account, the Marshall Lerner condition must be fulfilled - i.e the sum of the price elasticities of demand (PEDs) for imports and exports must be greater than 1.
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Tell me about the J-curve effect
It is possible that there could be a time lag before the full effects of the depreciation of the currency work through the economy, such that the sum of the price elasticities of demand would be less than 1 in the short run but greater than 1 in the long run. This gives the J curve effect.
The diagram has y axis = balance of payments on current account, x axis starts on middle of y axis. The curve itself is like a tick ✔️ shape and starts under the x axis and then goes above the x axis. The x axis is time.
Initially, the current account deteriorates, since demand for imports is price inelastic because of contracts or stocks of goods. Also, demand for exports may be inelastic because it takes time for consumers to adjust to the price changes. In the longer term, demand for both imports and exports may become more elastic and, if the Marshall Lerner condition is fulfilled, the current account will improve.
131
How will a change in the exchange rate of a currency effect economic growth and employment
If there is an increase in net exports following a depreciation in the value of a country’s currency against other currencies, then aggregate demand (AD) will increase, causing an increase in real output. In turn this should result in an increase in employment and a decrease in unemployment.
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How will a change in the exchange rate of a currency effect the rate of inflation
Following a depreciation, inflationary pressures could arise from two sources:
The increase in AD, described above, resulting from a rise in net exports.
Imported inflation, the rise in import prices, especially of raw materials and commodities, is likely to increase costs of production, causing a leftward shift in the aggregate supply curve and therefore an increase in the rate of inflation.
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How will a change in the exchange rate of a currency effect foreign direct investment (FDI) flows
A depreciation in the exchange rate of country A’s currency against others would potentially make it more attractive for foreign companies to invest in that country because a unit of a foreign currency would buy more units of country A’s currency.
However, if the depreciation is indicative of a lack of confidence in the country’s economy, then FDI inflows may not increase.
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What does a country’s international competitiveness refer to
A country’s ability to sell its goods and services in domestic and international markets at a price and quality that is attractive in those markets. Competitiveness may be measured in terms of price or non price factors. The non price factors include quality, design, reliability and availability
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Tell me measures of international competitiveness
Relative labour costs
Relative export prices
The global competitiveness index
^ these are price factors
Non price factors: quality, design, reliability and availability
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Tell me about relative unit labour costs as a measure of international competitiveness
This refers to the measurement of labour costs in one country relative to those in another country. To make international comparisons, the figures are converted into a single currency and expressed as an index number.
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Tell me about relative export prices as a measure of international competitiveness
These might be affected by factors such as productivity (relative to other countries). This may be measured in terms of labour productivity, which is output per worker per hour worked.
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Tell me about the global competitiveness index as a measure of international competitiveness
This is a composite devised by the world economic forum and is based on factors such as infrastructure, macroeconomic stability, health and education, degree of efficiency in the labour and goods markets, technological readiness and innovation.
Top rankings in 2014-15 were Switzerland, Singapore and the USA
The uk was 9th
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List me factors influencing international competitiveness
Real exchange rate
Wage costs and non wage costs
Other factors
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Tell me how the real exchange rate influences international competitiveness
Competitiveness is determined by a variety of factors but one of the most important is a country’s real exchange rate, which is the nominal exchange rate adjusted for changes in price levels between countries.
Real exchange rate = (nominal exchange rate x domestic price level)/ foreign price level
There will be a depreciation in the real exchange rate if the nominal exchange rate falls or if the prices of goods abroad rise relative to prices in the home country. Therefore, a fall in the real exchange rate will cause an increase in the competitiveness of a country’s goods.
In contrast, the real exchange rate will increase if the nominal exchange rate rises or if the uk price level rises relative to the foreign price level. Consequently, an appreciation of the real exchange rate is associated with a fall in the country’s competitiveness.
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Tell me the formula for calculating the real exchange rate
Real exchange rate = (nominal exchange rate x domestic price level)/foreign price level
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Define real exchange rate
The nominal exchange rate adjusted to reflect the different inflation rates (and therefore, purchasing power) of the currencies concerned.
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Tell me how wage costs influences international competitiveness
Wage costs are the most important cost of production for many industries. Consequently, if wages are higher in the uk than in China, it is likely that the prices of goods in the uk will be higher than those of China. However, the relationship between labour productivity and wages is crucial in influencing unit labour costs.
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Tell me how non-wage costs influences international competitiveness
These costs include:
National insurance contributions paid by employers (taxes on employment)
Health and safety regulations
Environmental regulations
Employment protection and anti-discrimination laws
Contributions into company pensions scheme
These non wage costs are frequently much higher in developed countries than in developing countries and so have the effect of reducing the international competitiveness of goods and services from developed countries.
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List to me the other factors that might influence international competitiveness
supply side policies:
Education and training schemes
Public sector reforms
Infrastructure spending
Privatisation and deregulation
Investment incentives
Increase labour market flexibility
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How could education and training schemes influence international competitiveness
Governments can try to improve international competitiveness through a variety of supply side policies.
Education and training schemes may increase the occupational mobility of labour. Education and training influence the level of human capital, which is defined as the knowledge and skills of the workforce.
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Tell me how public sector reform influences international competitiveness
Aimed at reducing red tape and regulations
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Tell me how spending on infrastructure influences international competitiveness
Government expenditure to improve infrastructure (eg roads, railways, telecommunications, power generating stations and water supply)
Government may also do privatisation and deregulation
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Tell me now incentives for investment influences international competitiveness
Incentives for investment such as tax breaks if companies use profits for investment or for research and redevelopment
150
Tell me how measures to increase labour market flexibility influences international competitiveness
Such as making it easier to hire and fire workers, reducing the strength of trade unions and allowing the use of flexible hour contracts.
151
How may international agreements prevent individual countries from increasing their competitiveness by raising tariffs
For example, the uk cannot simply introduce tariffs on goods from other EU countries because of its legal obligations as a member of the EU. Similarly, most countries are members of the WTO, whose rules prevent a country unilaterally imposing protectionist measures unless there is justifiable case.
Further, it is not possible for the UK government to devalue its currency because the pound is a floating currency. Also, since the Bank of England is independent, the government cannot directly engineer a depreciation in the exchange rate of the pound through a reduction in interest rates because control of interest rates is no longer in its hands.
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What are the benefits of being internationally competitive
A surplus on its current account of the balance of payments
Export led growth
Low levels of unemployment
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Tell me about the problems of being internationally uncompetitive
A fall in international competitiveness is likely to be reflected in a deterioration in the trade in goods balance of the balance of payments. In turn, this could result in an increase in unemployment, especially in industries in which exports are significant. A fall in exports could have a negative multiplier effect on GDP, so causing a reduction in economic growth.
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What does globalisation refer to
The increased economic integration between countries through, for example, increased trade.
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What factors have contributed to increased globalisation
The lowering of trade barriers
Lower communication and transport costs
The opening up of China
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How can the benefits of globalisation be analysed
Using the law of comparative advantage and costs, using concepts such as external costs and increased inequality
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What does the law of comparative advantage state
That trade between two nations can be beneficial to both if each specialises in the production of a good with lower opportunity cost
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What are the main roles of the WTO
Promote free trade
Settle trade disputes
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What are trading blocs
Groups of countries that trade freely among themselves but set trade barriers against non members
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What are the arguments for protectionism
Employment protection, prevention of dumping, protection of infant industries, retaliation
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What forms may protectionism take
Tariffs, quotas, subsidies to domestic producers, non tariff barriers
162
What is the current account of the BOP mainly concerned with
The trade in goods and services between countries
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When is the financial account important
When considering FDI and ‘hot money’ flows between countries
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Why may current account deficits be caused
Caused by factors including:
A lack of competitiveness, an overvalued exchange rate, relatively low productivity, and non price factors such as poor quality and design
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When do global imbalances arise
When some countries have persistent current account deficits while others have persistent current account surpluses.
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In a free market, exchange rates are determined by...
The supply of and demand for currencies on the foreign exchange market.
However, exchange rates may be fixed in relation to another currency or managed by the central bank through intervention in the foreign exchange market.
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What may a floating exchange rate be affected by
Factors such as confidence, relative interest rates, relative inflation rates, expectations about the future state of the economy.
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Revaluation or appreciation of a currency implies what
That it’s exchange rate has increased against other currencies
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Devaluation or depreciation of a currency implies that
It’s exchange rate has decreased against other currencies.
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A change in the exchange rate of a country’s currency will affect s countries...
Current account of the balance of payments, economic growth, unemployment, rate of inflation and FDI
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What does international competitiveness show
The ability of a country to sell its goods and services in world markets
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The key factors influencing competitiveness are
Relative unit labour costs, relative productivity rates, education and training, capital per worker, infrastructure, non wage factors including national insurance contributions, and regulations eg relating to the environment and to health and safety.
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How could international competitiveness be increased
Supply side policies or by a depreciation of the country’s currency.
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How might a significant increase in transport costs affect globalisation?
It could limit globalisation if higher transport costs make it less likely for firms to relocate production or service activities abroad
175
What is the link between savings ratios and global imbalances
Those countries with very low savings ratios are more likely to have current account deficits on the BOP because a low savings ratio implies a high propensity to consume, with an associated high level of imports.
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What are the main benefits of free trade
Free trade enables countries to specialise according to the law of comparative advantage, which will lead to increased output and, therefore, to higher living standards. For consumers, there should be more choice and lower prices, and firms should benefit from larger markets and economies of scale.
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What factors could cause an increase in a country’s terms of trade
An increase in export prices; a decrease in import prices; an appreciation in the exchange rate of a country’s currency
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What is the key feature of any regional trade agreement (trading bloc)
Free trade between member countries
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What determines the impact of a tariff on imports
The size of the tariff, as well as the price elasticity of demand and the domestic price elasticity of supply. If demand and supply are both price elastic, the tariff will be more effective in reducing imports.
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What factors might cause a balance of trade surplus
Various factors could be responsible, including: relatively low unit labour costs; relatively high productivity; a relatively low inflation rate; undervaluation of the currency; non price competitive advantages such as design, quality and reliability of the product.
181
What’s the distinction between expenditure-switching and expenditure-reducing policies
Expenditure switching policies relate to policies designed to change the composition of expenditure between domestic and foreign goods, eg tariffs, whereas expenditure reducing policies are designed to reduce aggregate demand, eg contractionary fiscal policy.
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What is likely to happen to the value of the euro if members of the eurozone default on their debts
This could result in a loss of confidence in the currency, so causing its value to fall. However, if defaulting countries left the eurozone, leaving just the strong members, then the euro would probably rise in value.
183
What would be the effect on the current account of the BOP following a depreciation in the value of the currency if the sum of the PEDs for exports and imports were between 0 and -1
The current account would deteriorate, ie the deficit would get large, since the Marshall Lerner condition has not been fulfilled.
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What would happen to international competitiveness if a country’s productivity increased at a slower rate than that of its major competitors
That country’s international competitiveness would decline, since a relatively lower productivity rate implies that its unit costs of production would rise relative to its competitors.
