The global economy

Question 1

Benefits of trade for importers and exporters

Answer 1

Importers could import goods at a lower world price if they can’t produce at such a low price.

Exporters could export goods at a higher world price and gain revenue. Benefit from being able to produce goods at a lower price.

Question 2

Benefits of international trade

Answer 2

G - Greater choice (benefits consumers)
E - economies of scale: int. trade => larger markets => sell more (benefiting producers) => fixed cost spread across more units of ouptut => decreasing average costs (economies of scale)
E - efficiency: international trade => increased competition => firms must increase efficiency to decrease costs of production and compete => lower costs (benefits consumers)
international trade => specialisation of countries in good with lowest opportunity cost to maximise benefits of trade => efficient resource allocation

Question 3

define absolute advantage

Answer 3

produce more efficiently (faster rate and at a higher quality for more profit) than the rest of the world

Question 4

what is theory of comparative advantage

Answer 4

even if country doesn’t have absolute advantage in production, it and other countries can still benefit from trade

Countries should specialise in production of the good with lowest opportunity cost, and this will increase world output (although benefits of trade not necessarily equally shared)

Question 5

Limitations/Assumptions of the theory of comparative advantage

Answer 5

Assumptions:
Full employment of resources in the best way. In reality, not all country’s resources suited for producing only one good. No country can fully specialise producing one good without significant resource waste.

Only produce two goods that are identical to to two goods produced in another country. In reality, not identical and consumers prepared to pay more for quality => harder to determine comparative advantage if the goods are different

Perfect information - all economic actors share same knowledge of all prices and quantities in the market at the same time. In reality, perfect information about the price, costs and productivity of all g/s is almost impossible to obtain.

Question 6

Define tariff

Answer 6

Tax per unit on imported g/s

Question 7

Effects of tariffs on stakeholders (domestic producers, foreign producers, consumers, government, society)

Answer 7

Domestic producers: Benefit form increased revenue and producer surplus

Foreign producers: Lose revenues

Consumers: Lose as they pay higher prices

Government: Beneift from increased tax revenue

Society: Lose

• from welfare loss as consumers pay more and consume less.
• some production shifter from efficient foriegn producers to inefficient domestic producers => resources misallocated => lost efficiency

Question 8

When are tariffs most effective?

Answer 8

tariff is essentially an increase in price, so when demand is elastic

Question 9

What is a quota and why would governments use it?

Answer 9

physical limit on volume of an import.

Slows imports without giving an unfair advantage to the domestic market.

Question 10

Effects of quotas on stakeholders

Answer 10

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Question 11

Define subsidy and reasons for it

Answer 11

Payment per unit of output from the government to a specific industry to help lower production costs and boost production

Question 12

The effects of a subsidy on stakeholders (domestic producers, foreign producers, consumers, government, society)

Answer 12

domestic producers - better off. Increased revenu and producer surplus

foreign producers - worse off, sell less to domestic producers

consumers - no change in consumer surplus

government - worse off as it has to pay the subsidy to the domestic producers. Payment has oportunity cost of taxpayer money.

society - More is produced by relatively inefficient domestic producers so resources are being misallocated, leading to a welfare loss fo society.

Question 13

Types of administrative barriers (another type of trade barrier)

Answer 13

• product standards
• voluntary export restraints (where exporting country voluntarily agrees to reduce export volume)
• ‘Buy National’ policies (encourage consumers to buy goods from domestic producer

Question 14

arguments for trade protection

BRUSHED

Answer 14

B - Balance of payments correction (slow/stop imports to prevent outflow of funds)

R - revenue for government(from tariffs)

U - unfair competition (eg. stolen intelllectual property)

S - sunrise (infant)/sunset industries job protection, protecting sunrise industries also helps less-developed countries to diversify their industrial base (broad prodcution capabilities of a nation in key industries, eg. inputs to produce steel can laso produce bridges and cars)

H - health and safety (regulation is trade protection)

E - environment

D - dumping prevention (firms exporting goods a price below production cost to gain market share in a new makret, a predatory pricing behaviour)

Question 15

Arguments against trade protection

Answer 15

C - Choice for products is limited

R - Retaliation (from trading partners leading to trade war)

R - Resource Misallocation: policies distort prices

E - Effeciency decreased for domestic firms. No incentive to be efficient without threat of foreign competition

E - Export competiveness decreases for downstream industries of the subject of the policy, eg. if tariff on cocoa imports => all chocolate in country more expensive => chocolate exports les competitive

P - Price Increases for domestic consumers

Question 16

Define preferential trade agreements (PTAs)

What stage of economic integration is this?

Answer 16

Preferential trade agreements (PTAs) reduce/remove trade barriers for specific g/s between participating countries

1st stage of economic integration.

Question 17

Types of preferential trade agreements (PTAs) and what they mean
MBR

Answer 17

Bilateral trade agreement - 2 countries agree to engage in freer trade, meaning countries agree to reduce/remove tariffs for some but not all g/s

Multilateral trade agreement - more than 2 countries form such an agreement. Aim to form stronger relationships/become free trade area

Regional trade agreements (RTAs) - between countries geographically close to each other, eg. EU

Question 18

Define trading bloc, 4 types?

Four Countries Cunningly Mislead

Answer 18

• closer level of economic integration than PTAs

F - Free trade areas: free trade internally (non-common external policy)

C - Customs unions: free trade internally, common external policy

C - Common market: free trade internally, common external policy free movement of factors of production, eg. EU

M - Monetary unions: free trade internally, common external policy, free movement of factors of production, shared currency. eg. Eurozone/European Monetary Union

Question 19

Advantages of trading blocs

Mighty Elephant Buys Peanuts

Answer 19

M - market access increases => economies of scale benefits
E - employment opportunities through labour mobility
B - bargaining power increases in multilateral negotiations
P - political stability and cooperation

Question 20

Disadvantages of trading blocs

So Difficult

Answer 20

S - Sovereignty decreases

D - Difficulty of engaging in multilateral trade negotiations

Question 21

Factors that contribute to globalisation

FEMTO

Answer 21

F - Freer trade and competition

E - Economics on free market dominates and gains respect.

M - Multinational corporations (MNCs)

T - Technological Advancements

O - Organisations, eg. WTO and World Bank

Question 22

Advantages of monetary unions

Peppa Pig Understands Chinese, Really?

Answer 22

P - Price stability
P - Power in global trade increases because economic size increases.
U - Uncertainties reduced: all economic actors have consistent expectation about prices in just one currency.
C- Competitive business environment => economic efficiency + growth
R - Relations between countries improves from regularly negotiating issues

Question 23

disadvantages of monetary unions

Panda Controls Flying Car

Answer 23

P - Political difficulties: disagreements between politically/economically ideologically different countries. Large distance between deicsion-making process of union and ordinary voters in each member so people feel decisions are being made that they didn’t vote for.

C - control over monetary policy decreases

F - Fiscal policy restrictions

C - cost is high initially to change currency. eg. menu costs.

Question 24

Define floating/flexible exchange rate

Answer 24

currency value determined by supply/demand forces on foreign exchange market. Float freely without government interference.

Question 25

Where does demand of currency come from

Answer 25

• Foreigners buying exports.
• Foreign investment. Either long-term investment (aka foreign direct investment) or short-term portfolio investment, aka hot money.
• Foreign tourists
• Speculators in foreign exchange
• The central bank

Question 26

Where does supply of currency come from

Answer 26

• domestic demand for imports
• domestic investors investing internationally
• domestic tourists travelling internationally
• Speculators
• Central banks

Question 27

Define appreciation/depreciation

Answer 27

increase/decrease in the value of a currency in terms of another

Question 28

Factors that affect exchange rates

Answer 28

• Trade (demand for imports/exports)
• Investment (FDI/portfolio)
  Remittances (transfer of money from foreign workers back home)
• Speculation (buying/selling of foreign currency to make profit)
• Relative inflation rates (affects prices of imports/exports)
• Relative interest rates (affects prices of imports/exports)
• Central bank intervention, eg. reserves of foreign currency

Question 29

Consequences of changes in the exchange rate

Answer 29

Inflation rate:
depreciation => increase in cost of prodcution (usually imported) => cost-push inflation.
depreciation => increase in (X-M) => demand-pull inflation

Economic growth:
volatile exchange rates => damages investor and business confidence => less investment => less economic growth
depreciation of net exporter’s currency => economic growth

Unemployment:
appreciation => exports more expensive =>unemployment increase. However could also have
appreciation => cheaper prices for imported raw materials => cheaper costs of production for domestic industries => increased output for those industries => decreased unemployment

Current account balance:
- balance of trade, income balance and currency transfers between country and rest of the world
depreciation of net exporter => balance of trade increases

Living standards:
appreciation for net importer => imports cheaper => cost of living decreases => living standards improve

Question 30

define fixed exchange rate and how it is maintained.

Answer 30

Set exact value of the exchange rate in terms of another currency. Central bank does this by monitoring supply and demand in Forex, intervening by: buying/selling currency reserves + adjusting monetary policy, to maintain the fixed value of the currency.

Question 31

Difference between devaluation/revaluation and appreciation/depreciation

Answer 31

Devaluation/revaluation is in a fixed exchange rate system, when central bank engineers the exchange rate to make the currency stronger/weaker by buying selling currency reserves on forex.

appreciation/depreciation is when demand/supply forces increase/decrease value of currency

Question 32

What is managed float exchange rate system and its goal?

Answer 32

in between the floating/fixed systems. Currency can fluctuate from forces of supply and demand, but confined within a set range.

Goal is to avoid significant fluctuations in a short period.

Question 33

Advantages of fixed over floating exchange rates.

Answer 33

• Economic stability
• Flexibility for policy makers: can focus on economic problems other than the exchange rate because they know it’s constant.

Question 34

Advantages of floating over fixed exchange rates.

Answer 34

• ease of adjustment: excess imports/exports automatically adjusted from automatic appreciation/depreciation
• no need for foreign currency reserves since no need to intervene in the market

Question 35

What is balance of payments and its equation

Answer 35

all monetary inflows and outflows of a country

BoP = Current account + Capital account + Financial account = 0

Question 36

What is current account and its equation

Answer 36

inflows/outflows from imports/exports
Also includes income flows + transfers, eg. foreign aid.

Current account = – (Capital account + Financial account)

Question 37

What is capital account and financial account

Answer 37

a record of transactions in income-producing assets, eg. Direct Investment (FDI) and Portfolio Investment (Bonds, Savings, Equity)

Question 38

four components of the current account:

Answer 38

• Balance of trade in g/s: Exports-imports
• Income: payments for the factors of production
• Current transfers: payment between governments not in exchange for g/s, eg. foreign aid.

Question 39

two components of the capital account:

Answer 39

• Capital transfers: transactions involving transfers of ownership of fixed assets, funds linked to the buying/selling of fixed assets, or debt forgiveness
• Transaction in non-produced, non-financial assets: eg. transfer of ownership of lease between landlord and tenant

Question 40

four components of the financial account:

PORF

Answer 40

P - Portfolio investment: buying/selling financial capital (shares, bonds, commodities, currencies)
O - Official borrowing: gov borrowing/lending from IMF, World Bank, or foreign gov
R - Reserve assets: foreign currency reserves held by central bands
F - Foreign direct investment (FDI): purchase of a part of a whole domestic firm, by a foreign fir

Question 41

How does current account surplus/ deficit affect exchange rate?

Answer 41

A current account surplus occurs when revenue arising from the sale of exports, inflowing income and transfers is greater than funds flowing overseas to pay for imports, outgoing income and transfers.

Increased demand for exports => increased demand for domestic currency => demand shifts rightwards =>currency appreciates

Question 42

How does financial account affect the exchange rate?

Answer 42

influx of foreign money in domestic banks => increase in demand for domestic currency => demand curve shifts rightwards => appreciation

appreciation => increased export price and decreased import prices => decreased (X-M) => current account deficit

Question 43

implications of a persistent current account deficit

Answer 43

• exchange rates: since current account deficit involves less exports => foreigners buying less domestic currency => depreciation => price of exports fall => exports increase again => closes the current account deficit
• interest rates increase: deficit means imports>exports. Extra money may come from borrowing. Increased debt with less revenue decreased credit rating => investors think it is a risky investment => increased int/r
• (foreign) ownership of domestic assets: current account deficit => depreciation (see above) => decrease price (in foreign currency) of domestic assets => increased foreign ownership
• economic growth: deficit (imports>exports) => domestic firms decrease output => AD shifts leftwards => GDP decreases => recession and an increase in unemployment

Question 44

solutions for current account deficit

SEE

Answer 44

S - Supply-side policies: Focus on increasing the productive capacity and productivity of the economy (shifting LRAS outwards). eg. reducing business regulations, trade union power, and minimum wages. But developing countries should make it easier to start new businesses, improving access to credit and decreasing corruption. Must balance reduction in regulatory constraints with maintaining appropriate protection for workers/environment. Improving access to eduation, healthcare and infrastructure also improves productivity
E - Expenditure-switching policies: protectionist policies to switch consumption from imports to domestic goods, eg. tariffs, quotas, subsidies)
E - Expenditure-reducing policies: slow down domestic spending through contractionary demand-side policies (monetary/fiscal) which reduces income. Imports are a function of income, so income decreases => imports decrease => current account deficit decreases. But sacrificing the economy (GDP) for the sake of the current account.

Question 45

Effectiveness of solutions for current account deficit

EES

Answer 45

Expenditure-switching policies: if goods are inelastic, tariffs will not be effective => will not solve current account deficit
Expenditure-reducing policies: if AD is on elastic portion of Keynesian AS curve, too much contractionary demand-side policies will lead to recession
Supply-side policies: both expenditure-switching and expenditure-reducing policies do little to solve the underlying inefficiences. Only way to improve a current account deficit in the long run is to increase the competitiveness of exports and domestic goods through supply-side policies.