macro- international economies 4.1 Flashcards
(19 cards)
globalisation
globalisation - process in which national economies have become increasingly integrated and interdependent
factors contributing to globalisation:
- trade liberalisation - decreased trade barriers and increased free trade (show fall in tariff diagram - more free trade - exports increase - AD increases…)
- trading blocs - a group of countries that join together and agree to increase trade between themselves (produce good they have comparative advantage in - can benefit from economies of scale and lower costs - lower prices - exports increase - AD increases…)
- increased specialisation - produce good they have comparative advantage in…)
- growth of TNCs - cheaper for TNCs to operate in developing countries as labour costs are cheaper - creation of jobs in developing countries - standards of living increase - as more people work, inequality falls - move closer to the line of PE// human capital can also be boosted due to TNCs due to transfer of knowledge - quality of labour increases - LRAS increases
cons of globalisation:
- over-dependence - some countries become dependent on particular exports for growth
- structural unemployment - specialisation means that workers have narrow skill set - if industry goes into decline then they will find it difficult to transition to other sectors
- changing tastes/fashion - countries that specialise in specific products may struggle if demand declines - unemployment
- environmental costs - increased trade - increased CO2
- increasing world incomes lead to increasing demand for goods and services - increase in price - worsening inequalities
specialisation and trade
- comparative advantage - a country should specialise in producing goods and services it can produce at the lowest opportunity cost
- absolute advantage - when a country can produce a good using fewer FOP than another country
diagram - comparative and absolute advantage:
- 3x3 table
- country A and country B on left hand side
- good A and good B on top
diagram - comparative and absolute advantage:
- x axis and y axis - 2 goods
- draw 2 lines - PPF
- the line which produces more of both goods - absolute advantage
- country with shallower PPF - comparative advantage for x axis, other country will have comparative advantage for y axis
assumptions of comparative advantage:
- no transport costs - if transport costs are high, a country might lose its comparative advantage because the final cost of the product might exceed the cost of producing it domestically
- homogenous goods - model assumes that goods produced in different countries are perfect substitutes
- rates of inflation ignored - a country might have the comparative advantage in producing a good but this doesn’t include inflation
- no import controls - if import controls exist then a country may not import goods from the place with the lowest opportunity cost
advantages of specialisation and trade:
- specialising allows countries to benefit from economies of scale - lower COP - boost international competitiveness - exports increase - AD increases - labour is a derived demand - employment increases - increased disposable income - more spending - positive multipler effect - AD increases - growth and development and mutually reinforcing - living standards increase and inequality falls
disadvantages of specialisation and trade:
- over-dependence - some countries become dependent on particular exports for growth
- structural unemployment - specialisation means that workers have narrow skill set - if industry goes into decline then they will find it difficult to transition to other sectors
- changing tastes/fashion - countries that specialise in specific products may struggle if demand declines - unemployment
- environmental costs - increased trade - increased CO2
TOT
- TOT - the quantity level of exports that need to be sold in order to purchase a given level of imports
- TOT = index price of export/index price of imports x 100
example:
- base year = 100
- year 1 TOT = 100
- year 2 TOT = 102
- improvement in TOT (TOT figure increased) - the price of the basket of exports can buy more imports than it could’ve done before
- deterioration of TOT (TOT figure decreased) - the price of basket of exports can buy less imports than it could’ve done before
when does TOT improve:
- export prices increase
- import prices decrease
- both
what causes changes in the TOT - SR:
- relative inflation rates - inflation increases - price of exports increases - improvement in the TOT BUT reduces the competitiveness of exports// also depends on elasticity
- exchange rate - SPICED/WPIDEC - affects the price of imports/exports - affects TOT
what causes changes in the TOT - LR:
- increase in productivity - COP decreases - feeds through into lower export prices - leads to deterioration of TOT BUT competitiveness of nations exports increases
TOT evaluation:
- depends on the PED of exports and imports
- international competitiveness
trading blocs and WTO
- trading bloc - a group of countries that join together and agree to increase trade between themselves
- regional trade agreement - free trade between member countries within a particular region e.g. SAFFA
different types of trade blocs:
- free trade area (FTA) - free trade between member countries but free to trade however they want with non member countries
- customs union - free trade between member countries while maintaining common external tariffs on imports from non member countries
- common market - free trade between member countries while maintaining common external tariffs on imports from non member countries // also allow free movement of labour and capital among member countries
- monetary union - countries within bloc decide to adopt the same currency, same central bank and same monetary policy e.g. euro zone
conditions needed for a successful monetary union:
- the trade cycles of member countries should be similar
movement of labour:
- labour should be able to move freely without any major barriers e.g. language - the main languages of the eurozone are english, french and german
costs and benefits of trading blocs:
- countries can exploit their comparative advantage - specialise where they have an advantage - costs fall - lower prices - export demand increases - AD increases…
- trading bloc - fall in tariff diagram - fall in price - increase in consumption from __ - consumer surplus increases - lower prices mean those on lower income households can access the good - less inequality
- trade creation - when a trade agreement shifts production from a high cost non member country to a low cost member country
costs:
- over-dependence - some countries become dependent on particular exports for growth
- structural unemployment - specialisation means that workers have narrow skill set - if industry goes into decline then they will find it difficult to transition to other sectors
- changing tastes/fashion - countries that specialise in specific products may struggle if demand declines - unemployment
- environmental costs - increased trade - increased CO2
- trade diversion - when a trade agreement shifts production from a low cost non member country to a high cost member country
- WTO - international organisation that regulates world trade
functions/roles of WTO:
- resolve trade disputes
- promote free trade
- if agreements have been signed, WTO ensure that trade is happening as it has been agreed
conflicts between the WTO and regional trade agreements:
- trade blocs can be unfair to non-members - tariffs are removed for members but stay for non-members, which can harm those outside the bloc
- trade blocs break WTO’s equal treatment rule - WTO says all countries should be treated the same, but blocs give special deals to members
advantages of monetary union:
- non-fluctuating exchange rate (the exchange rate is likely to be more stable than other individual countries) - it is likely to be more of a reliable country to invest in/trade with - increased investment and trade
- reduced costs from currency conversion - more likely for consumers to spend as 0 money is being converted
disadvantages of monetary union:
- loss of monetary policy autonomy - if one country’s economic stance is completely different to another country, the policies set by the sole monetary policy authority could be problematic for that country
- country’s cannot artificially change their exchange rate e.g. if a country has falling exports, it may want to depreciate its currency to improve competitiveness - this is not possible in a monetary union
pattern of trade
factors influencing the pattern of trade:
- comparative advantage - a change in comparative advantage will affect the pattern of trade
- emerging economies - as they growth, demand for imports will increase - affect pattern of trade
- trading blocs and bilateral trading agreements - increases trade between certain countries and decreases trade between others - affect pattern of trade
- relative exchange rates - ER affect the prices of goods - affect whether consumers will buy goods - affect pattern of trade
reasons for protectionism
- protectionism - any barrier that restricts free trade taking place
reasons for protectionism:
- infant industry argument - BUT protecting these industries can also lead to inefficiency - shielded from competition - less incentive to be efficient
- protect against ‘dumping’ - sale of a good below its cost of production - harms domestic producers as they can’t compete with prices below costs//BUT dumping is hard to prove - if u protect thinking that dumping is taking place then there could be strict retaliations against you
- protect domestic employment
- to raise government revenue (e.g. tariff - tax on imports) - can be used to fund important things e.g. merit and public goods
- to improve a current account deficit - restrict spending on imports and increase expenditure on domestically produced goods//BUT expect retaliation
tariffs
- tariffs - taxes placed on imported goods
tariff diagram:
- supply curve: shifts upwards from Sw to Sw+tariff (horizontal)
- price: price increases from Pw to Pw+tariff
- domestic supply: extension in supply from Q1 to Q3 - this is because domestic firms face less foreign competition as a result of the tariff and therefore are more willing to supply
- domestic demand: contraction in demand from Q2 to Q4 - due to the law of demand
- excess demand decreases (difference between Q3 and Q4) - because domestic supply has increased and domestic demand has decreased
- tariff revenue: vertical distance between SW and Sw+tariff x difference between Q3 and Q4
- DWL of CS (triangle right of tariff revenue)
- DWL of world efficiency (triangle left of tariff revenue) - domestic suppliers are producing extra units bcos they are less efficient at producing it// also due to fall in efficiency and innovation due to a fall in competition as a result of the tariff
- CS: decreases - creates DWL CS
- PS: increases
evaluation of tariff:
- regressive - disproportionately affects lower income households more than higher income households
- depends on the size of tariff
- elasticity - when demand is inelastic, consumers are not very responsive to price changes - even if the price of the imported good rises, consumers will still purchase the good - this is because the good is a necessity, or there are no close substitutes available etc
- production inefficiencies - deadweight welfare loss of world efficiency (left triangle) - domestic suppliers are producing extra units but they are less efficient at producing it than world suppliers
- retaliation - expect retaliation from the nation you’ve imposed the tariff on and expect it to be much stronger
quota
- import quota - limit on imports
quota diagram:
- diagram shows that Q2 is the quota - beyond Q2 cannot be imported
- fall in imports - from Q1Q2 to Q1Q3
- thus allows domestic firms to increase both supply and price - they face less foreign competition
- due to the rise in price, quantity demanded falls __
- quota leads to higher prices for consumers - fall in CS - creates DWL of CS
- due to a fall in foreign competition - domestic firms become less innovative and efficient - DWL of world efficiency
evaluation of quota:
- depends on the size of quota
- elasticity - when demand is inelastic, consumers are not very responsive to price changes - even if the price of the imported good rises, consumers will still purchase the good - this is because the good is a necessity, or there are no close substitutes available etc
- production inefficiencies - deadweight welfare loss of world efficiency (left triangle) - domestic suppliers are producing extra units but they are less efficient at producing it than world suppliers
- retaliation - expect retaliation from the nation you’ve imposed the quota on and expect it to be much stronger
trade subsidy and non tariff barriers
- trade subsidy - subsidy given to domestic suppliers in order to reduce COP - pass that lower cost onto consumers via lower prices - more internationally competitive - exports increase
subsidy diagram:
- when a subsidy is implemented it reduces COP for firms - as a result, domestic supply increases from Q1 to Q3
- this leads to a fall in imports from Q1Q2 to Q3Q2
evaluation of subsidies:
- depends on the size of subsidy
- retaliation - expect retaliation from the other nations and expect it to be much stronger
- government cost - vertical distance between the 2 supply curves x Q3
non tariff barriers:
- product standards - imposing standards on imported goods - deters imports e.g. canada specified that all jam imported into canada needed to be in a certain size of jar
- embargo - total ban on imported goods
balance of payments
- balance of payments - a record of a country’s transactions with the rest of the world
- it’s called the BoP as the current account should balance with the capital/financial account e.g. if the current account balance is positive, then the capital/financial account balance is negative (and vice versa)
components of the balance of payments:
- current account
- capital account - includes transactions in fixed assets
- financial account - includes transactions in financial assets
current account split into 4 parts:
- trade in goods
- trade in services
- income - income entering and leaving the country
- transfers - e.g. government paying aid to other countries
- visible exports/imports - goods
- invisible exports/imports - services
current account:
- current account surplus - exports are greater than imports
- current account deficit - imports are greater than exports
financial account:
- portfolio investment - buying and selling of financial assets e.g. bonds and shares etc
- FDI
capital account (relatively unimportant):
- debt forgiveness
- capital transfers by migrants
causes and consequences of a current account deficit
causes and consequences of CA deficit:
demand side causes:
- strong domestic growth - incomes increase - imports increase
- recession overseas - incomes abroad decrease - demand for exports decrease
- strong exchange rate - imports are cheaper and exports are more expensive - demand for exports decrease//demand for imports increase
supply side causes:
- low investment e.g. outdated technology - COP increases - exports are less competitive - demand for exports decrease
- low productivity - COP increases - exports are less competitive - demand for exports decrease
- high relative inflation - COP increases - exports are less competitive - demand for exports decrease
policies to reduce CA deficit
expenditure reducing policies:
- expenditure reducing policies - reduce AD - incomes decrease - demand for imports decrease
- contractionary monetary policy
- contractionary fiscal policy (reduce government spending, increase taxation)
(both shift AD left - reduce incomes - reduce demand for imports)
evaluation:
- conflict of objectives - by reducing AD, CA deficit may close BUT growth may decrease and unemployment may increase
- evaluation of monetary and fiscal policy
expenditure switching policies:
- expenditure switching policy - switch spending away from imports to domestic goods - protectionism e.g. tariffs, quotas, domestic subsidies, non tariff barriers
evaluation (protectionism):
- evaluation of protectionist policies
- expenditure switching policy - switch spending away from imports to domestic goods - weaken exchange rate (imports expensive, exports cheaper)
weaken exchange rates:
- decrease interest rates - hot money outflow - investors chase the best interest rate - supply of currency increases - depreciation of currency - weak exchange rate
- sell currency and buy foreign currency reserves - supply of currency increases - depreciation of currency - weak exchange rate
evaluation (exchange rates):
- depends on J curve effect and marshal lerner condition// marshall-lerner condition - if the PED of exports + the PED of imports does not sum to greater to 1 then a weak exchange rate will not improve current account deficit - will actually make it worse// J curve effect - in the SR, a weak exchange rate will worsen the CA deficit before it improves (WPIDEC - imports expensive - importers may still have existing contracts// exports - takes time for people to respond to lower prices) - x axis: time, y axis: current account
- retaliation and currency wars - other countries may react by reducing their exchange rate
- supply side policies to boost international competitiveness - boost countries exports
evaluation:
- time - LR policy
- cost - large opportunity cost
- no guarantee of success
causes and consequences of a current account surplus
demand side:
- high incomes abroad - increased demand for exports
- low incomes at home - reduce demand for imports - reduce expenditure on imports
- weak exchange rate (imports expensive, exports cheap)
supply side:
- low relative inflation - exports are price competitive - increase demand for exports
- high productivity - COP decreases - exports are price competitive - increase demand for exports
- strong investment e.g. up to date technology - lower COP - exports are price competitive - increase demand for exports
consequences:
- increased economic growth - unemployment will decrease BUT demand pull inflation may be triggered - phillips curve
- risky if a country is too reliant on exports for growth
international competitiveness
- international competitiveness - the ability of a nation to compete successfully overseas
3 factors that make a country competitive:
1. price competitiveness
2. non price competitiveness
3. ability to attract FOP/FDI e.g. skilled labour from abroad, capital from abroad, attracting businesses from abroad etc
measures of competitiveness:
- ULC (unit labour cost) - total labour cost/output// productivity increases - lower ULC - improve price competitiveness// high minimum wages - increase ULC - less price competitive
- TOT - the quantity level of exports that need to be sold in order to purchase a given level of imports - TOT improves - less price competitive// TOT worsens - more price competitive
policies to improve international competitiveness:
supply side policies:
- tax incentives - lower corporation tax - increased retained profit - increased investment - increased efficiency - lower COP - more price competitive
- government spending on education - e.g. improving skills through training/apprenticeships - human capital increases - productivity increases - lower unit labour costs
evaluation:
- costly - opportunity cost
- no guarantee of success - e.g. even tho there’s lower corporation tax, they can choose not to invest
- time lag
- relative concept - if another country uses the same policies more aggressively e.g. lower corporation tax or more spending on infrastructure then our country won’t gain
floating exchange rates
- exchange rate - the price of one currency in another currency e.g. £1 = $1.60
- floating exchange rates - determined by forces of demand and supply (no government intervention)
diagram:
- y axis: P £ in $
- x axis: quantity of £
exchange rate - demand shifts - appreciation:
- increase in relative interest rates - ROR on savings is higher - foreigners will demand the £
- speculators anticipate a rise in the £ - they will move their money to £ - demand for £ increases
- increase in FDI - foreign firms set up in uk e.g. have to pay factory in £ and workers in £ etc - demand for £ increases
- rise in incomes abroad - demand for exports increases - they have to buy in £ - demand for £ increases
exchange rate - supply shifts - depreciation:
- decrease in interest rates - ROR decreases - investors will move money away from the UK - supply of the £ increases
- speculators anticipate a decrease in £
- firms moving away from britain - all £ will be swapped for another currency - supply of £ increase
- increase in incomes domestically - demand for imports increases - have to buy in another currency - supply of £ increases
fixed exchange rate
- fixed exchange rates - a country’s currency value is pegged to another currency - intervention is necessary to keep exchange rates at a fixed value
- to support a fixed exchange rate, the government or central bank require to hold large amounts of currency reserves
- revaluing - government increases the currency’s value by increasing demand
- devaluing - government lowers the currency’s value by increasing supply
if the pound is too strong:
- government sells pounds and buys foreign currency
- increases the supply of the pound
- value of pound falls from __
if the pound is too weak:
- government buys pounds using foreign currency reserves
- increases demand for the pound
- value of pound increases from __
exchange rate changes impacts
appreciation:
- SPICED - imports cheater exports expensive - net exports will decrease - AD falls (diagram)
- firms that import raw materials to produce goods will benefit from cheater imports - COP decreases - shift SRAS to the right
benefits:
- lower inflation - lower demand pull and cost push inflation
- cheaper imports - living standards increase
cons:
- lower economic growth
- higher unemployment
- worsen CA deficit
depreciation:
- WPIDEC - imports expensive exports cheaper - net exports will increase - AD increases (diagram)
- firms that need to import raw materials to produce goods will see an increase in costs - COP increases - SRAS shifts left
benefits:
- higher economic growth
- lower unemployment
- improve CA deficit
cons:
- higher inflation - higher cost push and demand pull inflation
- expensive imports - living standards fall
evaluation:
- depends on how much the exchange rate has risen or fallen
- depends on whether there are restrictions on trade
- depends on J curve effect and marshal lerner condition// marshall-lerner condition - if the PED of exports + the PED of imports does not sum to greater to 1 then a weak exchange rate will not improve current account deficit - will actually make it worse// J curve effect - in the SR, a weak exchange rate will worsen the CA deficit before it improves (WPIDEC - imports expensive - importers may still have existing contracts// exports - takes time for people to respond to lower prices) - x axis: time, y axis: current account
managed exchange rate
managed exchange rate - this is a combination of the fixed + floating mechanism
- exchange rate determined by the forces of supply and demand
- but if the rate is too high or too low, the central bank may step in
currency reserves:
if the currency is too strong:
- government sells currency and buys foreign currency
- increases the supply of the currency
- value of currency falls from __
if the currency is too weak:
- government buys currency using foreign currency reserves
- increases demand for the currency
- value of currency increases from __
- raising or lowering IR
advantages and disadvantages of fixed/floating ER
floating:
advantages:
- decreased need for currency reserves - reduces opportunity cost
disadvantages:
- volatility - floating ER fluctuate a lot - creates uncertainty - reduce investment and trade
fixed:
advantages:
- ER stability - investment and trade increases
disadvantages:
- large levels of currency reserves needed - large opportunity cost in holding large levels of currency reserves
