Theme 4 Content Flashcards

Question

# 4.1 - International economics Disadvantages of globalisation for high income countries

Answer 1

* **Job Displacement**: When companies move operations to low-wage countries, or when competition increases due to the opening of markets, workers in high-income countries may find themselves out of work. * **Income Inequality**: Globalization can exacerbate wage disparities between high-skilled and low-skilled workers. According to the IMF the share of income going to the top 1% of earners in advanced economies has increased by more than 3 percentage points since the 1980s, partly due to globalization. * **Environmental Degradation**: Finally, globalization can have negative environmental impacts in high-income countries. The transportation of goods across long distances, as well as the exploitation of natural resources in developing countries, can contribute to carbon emissions and other forms of pollution.

Answer 2

1. **Economic Dependence**: One disadvantage of globalization is that developing nations can become overly dependent on the export of a few key commodities or industries, leaving them vulnerable to fluctuations in global demand and prices. 1. **Exploitation of Labour**: As multinational corporations seek to lower costs, they may outsource production to countries with lower labour standards, wages, and working conditions. 1. **Environmental Degradation**: As companies seek out the cheapest sources of raw materials and production, they may exploit natural resources and pollute local environments. This threatens the sustainable growth of many poorer countries

Answer 3

1. **Increased access to foreign markets**: Globalization has allowed the UK to expand its markets beyond its national borders. For instance, the value of UK exports increased from £196 billion in 2000 to £613 billion in 2019. 1. **Attraction of foreign investment**: FDI in the UK increased from £62 billion in 2000 to £1,033 billion in 2019, reflecting the country's ability to attract and benefit from international investment. This has an impact on AS and long run aggregate supply. 1. **Improved productivity and innovation**: A Study by the National Bureau of Economic Research found that exposure to international competition has driven innovation in UK firms, leading to increased factor productivity and competitiveness.

Answer 4

1. **Increased foreign investment**: An increase in foreign investment in developing countries, providing a source of capital, technology, and expertise. FDI inflows to Sub-Saharan Africa increased from $10 bn in 2000 to $46 bn in 2020. 1. **Expanded access to global markets**: According to the World Bank, the value of exports of goods and services from Sub-Saharan Africa increased from $79 billion in 2000 to $338 billion in 2019, reflecting the growth in global trade. 1. **Increased access to technology and knowledge**: Access to new technologies and knowledge from around the world can drive economic growth and development. Cell phone penetration in Sub-Saharan Africa increased from 3% in 2000 to 44% in 2020, reflecting the growth in technology adoption in the region.

Answer 5

When one country can produce a good / service at a lower OC cost than another country.

Answer 6

When an economy can produce a greater total of goods for the same quantity of inputs.

Answer 7

This occurs when two countries have absolute advantage in different products. Countries should specialise in their advantage and import the good they don't have advantage in.

Answer 8

When two countries, with absolute advantages in different products trade with each other

Answer 9

Theory of comparative advantage - even if a country has absolute advantage in all goods, trade can still benefit if there is a difference in the OC

Answer 10

As long as a country has a comparative advantage in some resource (as long as it faces a lower opportunity cost than another country for that resource), then it can benefit from trade.

Answer 11

* **Efficiency and Productivity**: Specialization allows countries to focus on producing what they are most efficient at, leading to increased productivity and economic growth. * **Consumer Benefits**: International trade provides consumers with a wider variety of goods and services at competitive prices, improving their standard of living. * **Resource Allocation**: It enables efficient resource allocation as countries can allocate resources to industries where they have a comparative advantage, reducing wastage. * **Economies of Scale**: Specialization often leads to larger production scales, which can result in economies of scale, further reducing production costs. * **International Cooperation**: Trade fosters peaceful international relations and cooperation as countries become interdependent. * Theory of comparative advantage states countries should specialise in goods with the lowest OC - (This will boost economy + lead to greater output globally).

Answer 12

* **Countries could become over-dependent**. (if one export fails, collapse. e.g. Manchester, shipbuilding). Dutch disease. * **High interdependence** - trade prevented e.g. wars = massive problems. * **Job Displacement**: Specialization can lead to job displacement in industries where a country does not have a comparative advantage, causing unemployment and social issues. * **Dependency**: Over-reliance on imports for critical goods can make a country vulnerable to supply disruptions or price fluctuations. * **Income Inequality**: While trade can benefit a nation as a whole, it may exacerbate income inequality if the gains are not equitably distributed. * **Environmental Concerns**: Specialization in resource-intensive industries may lead to environmental degradation if not regulated properly. * **Trade Imbalances**: Persistent trade deficits can lead to indebtedness and economic instability for some countries. * **Loss of Domestic Control**: Relying on imports for essential goods can compromise a nation's control over its own economy and security.

Answer 13

Italy lost comparative advantage for manufacturing, forced to move from a secondary to a tertiary economy.

Answer 14

Efficient use of resources for comparative advantage. Export-led growth. e.g. Singapore and South Korea.

Answer 15

Even though USA has an absolute adv. in both machines + food, OC of the two countries are different. Theory of comparative adv. states countries should specialise where they have the lowest OC. USA - machines, G. - food.

Answer 16

Because they may still be able to produce a good at a lower relative opportunity cost. This means that both countries can focus on what they have a lower opportunity cost in and increase total output.

Answer 17

* **LEDCs may have a comparative advantage in primary products** - Therefore should continue to develop in areas which they are strongest - Argument given by the Bad Samaritans * **Some rich countries have been able to use primary products to develop** - Saudi Arabia and oil. - Primary product revenue should be used to reinvest into manufacturing. * **Forward markets can be used to fix prices in advanced to reduce volatility and risk.** * Not all primary products have a low YED - Diamonds in Botswana. * **Primary products rose steeply in price between 2000-2008 while prices for manufactured goods was falling. They also rose post-pandemic.**

Answer 18

* Ignores transport costs - Might eliminate comparative cost advantage. * Ignores economies of scale. * Assumes there are only two economies producing two goods. * Assumes that traded goods are homogenous. * Assumes perfect factor mobility. * Assumes no trade barriers * Assumes perfect information

Answer 19

* Transport costs are not considered * Strategic industries - risky to be reliant on another country * Not just 2 countries in the world producing goods * Infant industries might be damaged

Answer 20

* Trading Blocs - within blocs members have reduced trade barriers so more trade between them * Exchange rate - changes in exchange rate mean changes in competitiveness of exports and amount of imports, SPICED/WIDEC * Emerging economies - they are major exporters of manufactured goods and services, altering global trade dynamics * Comparative advantage - countries exports g/s that they have comparative advantage in and import those they have a disadvantage in. This drives international trade patterns (TEEC) Also * Tarrif and non tarrif barriers, FDI, changes in competitiveness and inflation rates.

Answer 21

When the patterns of trade are changed, due to blocs. (Reduced benefits from specialisation).

Answer 22

* UK has increasingly hada comparative advantage in services rather than good. -> Usually financial services. * Foreign trade has increased as a proportion of GDP. Exports are now around 30% of national income. * The UK does earn money from North Sea Oil. * EU has become main trading partner since joining the EEC

Answer 23

The rate of exchange of one product for another when two countries trade.

Answer 24

The quantity of exports that need to be sold to buy a given quantity of imports.

Answer 25

Avg export prices index / Avg import prices index x 100. (Remember X over M).

Answer 26

Increasing, increased injections into economy.

Answer 27

Use equation ToT = avg.Xprices/ avg.M prices. If X prices ↑, ToT ↑. If M prices ↓, ToT ↑.

Answer 28

SR - anything that affects price LR - anything that affects productivity

Answer 29

In the LR, the price of primary products declines compared to manufactured products. (Terms of trade for primary products tends to fall in the LR).

Answer 30

Profit margins for chocolate are better than cocoa.

Answer 31

Primary product dependency.

Answer 32

When rapid development of one sector of the economy precipitates a decline in other (non-resources) sectors. (Other industries don't take off, Rostow's model doesn't occur).

Answer 33

* A change in exchange rate. spiced/widec * Inflation * A change in demand for imports and exports * Changing incomes affect pattens of demand. * Changes in productivity * Incomes * PRIMARY PRODUCT DEPEDENCY * Protectionism - tarrifs increase prices so terms of trade worsen

Answer 34

Falling import prices Rising export prices

Answer 35

Inflation - would increase export prices. Tarrifs - would increase import prices. An appreciation in the exchange rate

Answer 36

Higher productivity A weaker exchange rate

Answer 37

1. Would lead to a reduction in import expenditure 1. A rise in export revenue 1. Increase in net trade and an improvement in the balance of payments.

Answer 38

* If imports are price inelastic - consumers are not responsive to the fall in price so spend less on imports * And exports are price inelastic - other countries continue to buy exports despite the increase in price.

Answer 39

* If demand for imports imports are elastic * And demand for exports are price elastic

Answer 40

1. Increase in import expenditure 1. Decrease in export revenue 1. Bad for current account balance

Answer 41

1. Fall in import spending 1. Increased export revenue 1. There is an improvement on the current accounta balance of payments

Answer 42

* Likely will be bad for the current account - commidities are very price inelastic. * This would mean as prices fall, export revenues will also fall * This means a deterioration in trade balances and cut in aggregate demand. * **Evaluation**- Commodities are very volatile. Likely future increase. Longrun/short run. * Or, depends on what is happening with imports.

Answer 43

* For every import, a country has to export more * A decline in terms of trade reduces the ability to import goods. * Less purchasing power means worse standards of living * Can make it harder to pay foreign debt.

Answer 44

1. Might make exports more competitive - better for balance of payments. 1. The impact of a decline in the terms of trade will depend on the elasticity of demand. If demand is elastic, the lower price of exports will cause a bigger % increase in demand. 1. Some LDC’s have seen an improvement in terms of trade because of rising price of commodities and food post-2008. It is not always LDCs who see a decline in the terms of trade. 1. It is important to distinguish between a short-term decline in terms of trade and a long-term decline. A long-term decline is more serious for reflecting a fall in living standards.

Answer 45

A group of countries with trade agreements.

Answer 46

Regional Trading Bloc. Free Trade Area Preferential Trade Area Customs union. Common / single markets. Monetary unions. Economic union.

Answer 47

A group of countries in a geographical region that protect themselves from imports from non-members. (Also reduction / elimination of internal tariffs).

Answer 48

Trans-Pacific Partnership (TPP)

Answer 49

* **Trade creation** - Makes it easier for countries to trade within the bloc and specialise - Exploit comparative advantage. Economies of scale from new markets. Greater competition * **More FDI** - MNCs can invest in the free trade area as they can avoid tariffs and other trade restrictions.

Answer 50

* **Trade diversion** - Trade is diverted away from former partners - when the UK joined the EU it began trading less with the commonwealth. might lead to overall fall in economic output. * **Country might be better off outside** - they can sign lots of bi-lateral agreements * **Might make developing countries worse off** - Do not have enough economies of scale so their infant industries die off. * **Less efficient use of world resources** - Trading blocs distort comparative advantage because they entain the use of trade restrctions - Might be more effective to persue global free trade in the WTO. * Increased negative externalities of production, resource depletion & environmental damage

Answer 51

Reduced tariff barriers on all goods coming from other members. (Members allowed to impose restrictions on those outside the FTA)

Answer 52

Reduced barriers on some goods (Used to protect domestic industries)

Answer 53

The removal of tariff barriers between members and acceptance of common external tariff against non-members. May also have preferential import tariffs rates that apply to trade agreements with the customs union has entered into with other countries or groupings of countries

Answer 54

No barriers to trade between members - freedom of asset / factor mobility. Common external tariffs on imported goods from outside.

Answer 55

Harmonisation of macroeconomic policies e.g. common rules regarding monopoly powers, anti-competitive practices and the removal of custom posts. (Best example is the EU).

Answer 56

1. **No customs posts between countries** - Just as goods and people are free to travel between Manchester and London, they should be as free to travel between London and Milan 2. **Identical product standards** - The existence of individual national safety standards on cars, for instance, is a barrier to trade just as it would be if cars sold in London had to meet different safety regulations as cars in Bristol 3. **Harmonisation of taxes**- If the tax on the same car is £2000 more in the UK than in France, then UK residents will buy their cars in France and drive them over -> distorting pattern of trade 4. **A common currency** - Having to buy foreign currency is a barrier to trade, hence there should be a common currency as there is in the UK

Answer 57

* **Import-tariffs free access to a single market of nearly 500 million people** - Opportunity to exploit economies of scale – leading lower long run unit costs and higher profits * **Easier access to foreign direct investment** - Inward FDI can lift trend rates of economic growth and raise factor productivity * **Access to EU structural funds** - Investment helps improve infrastructure and potential output (long run aggregate supply * **Better access to EU capital markets** - Eu companies can more easily raise extra investment funds from bond and capital markets * **Discipline of intense competition from being inside the EU single market** - Businesses must become more cost efficient + improve their dynamic efficiency to remain competitive

Answer 58

* 'lack of control' over immigration * Fairness/equity of subsidies + grants * Competition -> loss of domestic jobs * Profits/wealth in capital markets

Answer 59

Countries with a single currency and exchange rates monitored by a central bank.

Answer 60

EU - Eurozone. (Results in loss of monetary policy for members).

Answer 61

* **Trade creation** - Specialise, Comparative Advantage. * **Savings on transaction costs** - No need to convert currencies. * **Greater certainty for firms** - Fluctuations are less likely. Increases business confidence. Firms do not have to worry about unfavourable currency fluctuations. For example, after the mini budget the £ fell to almost parity with the dollar. * **Increased economies of scale** - New markets are unlocked, firms can expand and reduce costs. * **Price stability** * **Currency risk** – Euro is more stable than smaller currencies. Reduced currency risk makes is easier for smaller countries to borrow money * **Trade** – Euro enhances the gains from being in the single market – e.g. it encourages more cross border trade in goods and services * **Investment** – Membership of Euro is likely to stimulate inward investment e.g. in industries such as tourism, financial services, car-making * **Competition** – Euro increases price transparency and market competition which then helps consumers to find products at better prices

Answer 62

* **Loss of control over monetary policy** - countries can't use monetary policy in order to adopt to local problems. One sized fits all. * **Loss of exchange rate flexibility** * **Reduced control over fiscal policy** - 3 % limit on budget deficit and 60% limit on national debt or face a fine * **Transition costs** - Adjustment costs when switching currencies * **Makes countries excessively interdependent** - Contagion.

Answer 63

* **Similar trade cycles** - So that interest rates synergise. E.g. interest rate rises to curb inflation in a booming Germany will not help Spain if it is in recession. * **Mobility of factors of production** - Reduces the impact of shocks, as worker can migrate to other countries. * **Mobility of finance** - There should be complete mobility of finance with prices & wages free to adjust based on market conditions. * **Automatic fiscal transfers** - Some form of automatic fiscal transfer is needed for countries that are doing badly. E.g. Greece and Portugal. This will reudce the need of excahnge rate adjustment, which might have ben the prior policy response. * **Similar economic situation** – so interest rate changes have similar effects across the union

Answer 64

To help members use trade to raise living standards and create jobs.

Answer 65

Tries to negotiate trade agreements and resolve trade problems. (By reducing protectionism + ↑ integration).

Answer 66

* Allows rich countries to exploit developing countries, paying low wages and making them work in conditions that would be completely unacceptable in the developed world - Glencore in Zambia, DRC * Is causing environmental disaster as rich countries plunder the poor countries * Destroys native cultures and replaces it with an American way of life. * Forces poor countries to lower their barriers to trade whilst rich countries keep theirs * Gives ownership of the rules of the world trading system to a few rich countries and their multinational companies

Answer 67

* If the WTO cannot produce multilateral agreements between all member countries then countries will resort to signing ever more regional trade agreements (RTAs) * RTAs do not produce anywhere near the economic gains that could be achieved by a world trade agreement * Still arguably better than nothing so long as trade creation > trade diversion

Answer 68

* **Conductor** – come up with a set of rules that apply to international trade. They also bring countries together at conferences & encourages them to reduce or eliminate protectionist trade barriers between themselves e.g. The Doha Round conferences * **Tribunal role** – Settling disputes between members, countries are encouraged to work it out between themselves but sometimes they don't. Member countries can file a complaint if they believe a trading partner has violated a trade agreement. The WTO will then run a hearing & make a judgement * **Monitor roles** – The WTO reviews the trade policies of its members to make sure that WTO rules are being applied fairly and consistently * **Training role** - The WTO provides training to government official in (mostly) developing countries, to help them engage in trade with other WTO members.

Answer 69

Taxes placed on imports.

Answer 70

X and Y represent net welfare loss. Yellow box represents govt. rev.

Answer 71

Welfare loss is greater with quotas, as there is no tax revenue generated by the govt

Answer 72

Qs of domestic producers increases from Q1 to Q4. Qs of world producers decreases from Q2 to Q3.

Answer 73

Increases prices, due to reduced world supply. Reduces QoL for consumers. However, govt. revenue from tax may improve QoL in LR (hypothecated). Other eval: Infant industry argument: domestic producers increase producer surplus + increased market share increased job protection in domestic economy.

Answer 74

Triangles X and Y = net welfare loss. (Net welfare loss as areas of X and Y larger than revenue). Reduction in CS larger than increase in PS.

Answer 75

Potential distortion of comparative adv. - as this theory assumes no tariffs. Tariff alters the cost advantage that countries may have built up through specialisation. (Another downside is retaliation - need a para to memorise for this one).

Answer 76

When importing country represents a very small proportion of the total demand for the good. ∴ Any protectionist diagram can be evaluated by elasticity of world supply i.e the optimal tariff argument.

Answer 77

A country with a large proportion of global trade experiences a smaller price increase when tariffs are imposed. Reducing the MSC all while govt. benefits from tax rev.

Answer 78

The country with a large proportion of global demand reduces global price (as they import less). The usual price increase of a tariff is offset by this fall in global prices.

Answer 79

* Not much increase in domestic price (as share of global demand is sufficiently large for protectionist country). * Tax revenue for govt. equal to the value previously earned by foreign producers (before the fall in world prices).

Answer 80

Horizontal, perfectly elastic.

Answer 81

Optimal tariff theory: Tariff can actually increase a countries welfare, if the area of tax revenue is larger than the loss in consumer surplus. (Condition is country must represent large proportion of global demand).

Answer 82

Size of tariff x no. of imports.

Answer 83

Retaliation. (Countries will retaliate with tariffs that cause domestic country to overcome their portion of DWL).

Answer 84

An additional tariff, above normal import tariffs.

Answer 85

A 'tit for tat' trade war.

Answer 86

However, there is net welfare loss overall, represented by blue boxes.

Answer 87

* **Infant industries** - To protect new firms that would be unlikely to succeed at start-up due to the level of global competition. Once established support is removed * **Sunset industries** - At the end of the life cycle, these firms are on their way out & the government chooses to support them to help limit the economic damage that would occur if they closed abruptly * **Strategic industries** - Industries such as energy, defense & agriculture are essential to self-sufficiency & security. Being reliant on other countries for these creates vulnerabilities for a nation * **Dumping** - Dumping is anti-competitive & can harm a country's industries. Excess output is sold in another country below costs (illegal) or below normal prices in the home market * **Employment** - helps fix structural unemployment and offshoring * **Current Account deficit** - When imports > exports the amount of money leaving the country to support foreign firms is greater than that entering to support domestic firms. Protectionism aims to correct this imbalance * **Raise tax revenues to lower budget deficit** - Important for countries that are developing as they have a limited domestic tax base

Answer 88

Outward shift in domestic supply to Q3. Higher prices due to relative shortage.

Answer 89

They create a relative shortage, total output falls:

Answer 90

* Before the tariff domestic producers produced output equal to Q1 & their revenue was equal to Pw x Q1 * After the tariff was imposed domestic producers produced Q3 & their revenue was equal to Pw X Q3 * Domestic producer surplus has increased by area 2 * Over-reliance on protectionist policies can lead to ineffieinces

Answer 91

* Before the tariff domestic consumers consumed Q2 products at a price of Pw * After the tariff domestic consumers consumed fewer products (Q4) at a higher price of Pw+tariff * Domestic consumer surplus has decreased by areas 1, 2, 3 & 4 * Domestic industries become more competitive and so may get better products

Answer 92

* After the tariff is imposed the government receives tax revenue equal to ((Pw+tariff) - Pw) x (Q4-Q3) - area 3 * Protectionist policies may strain diplomatic relations and lead to retaliation by trading partners.

Answer 93

* The standards of living for consumers worsen as the value of their income is eroded as they are paying higher prices * Domestic firms who benefit from increased production may increase employees' wages -------> This would increase the standard of living for employees

Answer 94

* Workers in industries that have been experiencing structural unemployment due to foreign competition will feel that the tariff results in them being treated more fairly * Protectionism can exacerbate income inequality if it benefits specific industries or groups while imposing costs on others. * It may also affect global income distribution by limiting opportunities for developing countries to export.

Answer 95

* **Absolute quota** – A simple physical limit either a volume or a value * **Tariff rate quota** – These allow a certain number of imports to gain a discount on the usual tariff rate * **Voluntary export restraints (VER)** – This is when a government limits the amount of exports from one country to another for a particular type of good.

Answer 96

* Quotas tend to cause a bigger fall in economic welfare because the government don’t gain any tax revenue, that you get with tariffs. * Quotas allow the country to be certain on the number of imports coming in. Tariffs is more unknown because it depends on the elasticity of demand and how consumers and suppliers react to the tariff. Tariffs depend on the market * Quotas may be harder to enforce if it is difficult to count the amount of the good coming into the country. * Quotas could be more unfair. Some export firms may do well if they get the quota allowance, but others may lose out. It becomes a political issue on how to distribute the quotas. Firms may also dislike the uncertainty of not knowing how many quotes to gain. Could be more corruption with quotas, so puts politicians are put under pressure.

Answer 97

Payments to domestic producers which lower their costs.

Answer 98

* Decreases costs of production * Increases output * Increases international competitiveness * Higher revenues will lift profits and possible lead to higher share price. More output could lead to economies of scale Evaluation: Risk of dependency, removes the incentive to be more competitive by innovation, increasing efficiency and productivity

Answer 99

The subsidy may not be large enough to change the world price. So won't affect them But could lower the overall price Eval Facing higher taxes if the subsidy is expensive

Answer 100

Can be an effective non-tariff barrier to reduce the volume of imports by encouraging domestic production Eval: Doesn't generate tax revenue. More spending can increase budget deficit. Opportunity cost

Answer 101

* Risk of Retaliation and a possible trade war * Market Distortions * Higher prices for consumers * Regressive effect on income inequality * Incentives to by-pass controls in shadow markets * Higher costs for exporters

Answer 102

* Increases their output * Raises the selling price * Increases their revenue

Answer 103

* Decreases their output * Compared to a tariff, those firms who manage to export in the quota receive a higher price for their sales

Answer 104

Results in higher prices & less choice

Answer 105

* They do not receive any tariff revenue (as there is no tariff) * They may receive higher tax revenue at the end of the financial year when domestic firms pay their corporation tax. * More employment so more taxes that way and also achieve some objective of low unemployment

Answer 106

Reduces for consumers as higher prices erode the purchasing power of their income

Answer 107

Improves for domestic firms but worsens for foreign firms

Answer 108

Makes it harder for them to compete with domestic firms

Answer 109

Improves for consumers as they benefit from lower prices - their income goes further

Answer 110

Domestic firms can compete more equally

Answer 111

* Limits foreign competition * Protects levels of outputs * May increase selling price & revenue

Answer 112

* Acts as a disincentive to sell into foreign markets * Costs of meeting the non-tariff barriers may significantly reduce profit margins

Answer 113

May reduce choice/variety in a market

Answer 114

* They may lose some credibility with the WTO * Enforcing the non-tariff barriers may be difficult or expensive

Answer 115

* Less choice & higher prices erode standards of living * Product labelling information may improve decision making & quality of life

Answer 116

May help improve equality e.g. environmental standards help create equal production inputs which results in equality in the costs of production

Answer 117

The sum total of a country’s income and expenditure on foreign trade together with all its international capital movements It’s split into two sections….. Current account Capital & financial account Always = 0

Answer 118

* (Balance of) trade in goods * (Balance of) trade in services * (Net) income flows from abroad * (Net international) transfer payments.

Answer 119

How much is spent on imports vs the total value of exports

Answer 120

X = Positive M = Negative

Answer 121

1. Current account 1. Financial account 1. Capital account 1. Balancing items

Answer 122

Ensures BoP is always 0. S for currency = D for currency. (E.g. CA deficit can be compensated for by FA surplus).

Answer 123

Rate of consumer spending on imports AKA Marginal propensity to import. (↑M ↓BoP). International competitiveness. Structure of the economy. (De-industrialisation can harm export sector; e.g. Italy). Exchange rate. (Can influence export value).

Answer 124

* **Relatively low productivity** * **Relatively high value of a countrys currency** * **Relatively high rate of inflation** * **Rapid economic growth resulting in increased imports** * **Non-price factors such as poor quality and design** * Poor Price * Recession * Volatile global prices * Government policy

Answer 125

1. Low productivity raises costs 1. Exporting firms with low productivity may find themselves at a price and cost disadvantage in overseas markets which will decrease competitiveness and the level of exports 1. With higher domestic prices, consumers may also buy abroad thus increasing the imports 1. Falling exports and rising imports creates a deficit

Answer 126

1. Currency appreciation makes a country's exports more expensive relative to other nations 1. Foreign buyers look for substitute products which are priced lower 1. Exports fall and the balance on the current account worsens 1. Similarly, currency appreciation makes imports cheaper 1. Domestic consumers may switch demand to foreign goods and as imports rise, the balance on the current account worsens

Answer 127

1. A relatively high rate of inflation makes a country's exports more expensive than other nations 1. Foreign buyers look for substitute products which are priced lower 1. Exports fall and the balance on the current account worsens 1. Similarly, high inflation may mean that goods/services are cheaper in other countries 1. Domestic consumers may switch demand to foreign goods and as imports rise, the balance on the current account worsens

Answer 128

1. Rapid economic growth raises household income 1. Households respond by purchasing goods/services with a high-income elasticity of demand (income elastic) 1. Many of these goods are imported and as imports rise, the balance on the current account worsens

Answer 129

1. When a country develops a reputation for poor quality and design, its exports fall as foreign buyers look for better substitutes elsewhere 1. Domestic buyers who are able to shop abroad also choose to buy better quality products elsewhere and the level of imports rise 1. A fall in exports and a rise in imports worsens the balance on the current account

Answer 130

* Signals a long term loss of competitiveness * May mean higher unemployement * Withdrawl from circular flow, drag on aggregate demand * May create imported inflation * Leads to a falling exchange rate - higher import costs. * Fall in GDP * Withdrawl from circular flow

Answer 131

* Depends on the size of the deficit and how long it persists * Might be cyclical * Depends on what the imports are - capital goods and investment will improve future growth prospects. * Depends on if the exchange rate is fixed or floating, In a floating system, the balance of payments deficit should be self correcting * Might be financed by a surplus on the financial account

Answer 132

* Competitive economy - High productivity, investment, training, quality * Low inflation * Low exchange rate * Vast natural resource - Kuwait, UAE * Trade cycle * Government policies - competitive supply side policies * Surplus of savings over investment

Answer 133

* **Retaliation** - Countries with large deficits might retaliate by putting up barriers to trade to reduce imports - American withdrawl from NAFTA * Resources are focused on producing to meet export demand rather than export demand, so lower consumer living standards * **Rise in the exchange rate** - makes exports more uncompetitive in the long run. * **Inflation** - high demand for exports could create inflation.

Answer 134

* **Do nothing** and leave it to market foces in Forex market to self-correct deficit * **Use expenditure switching policies** - change relative prices of exports and imports * **Use expenditure reducing policies** - lower real incomes and AD - cutting demand for improts but causes unemployment * **Use supply-side policies**

Answer 135

* This is because it has to pay for everything it consumes and funds in some way - to fund a current account deficit, a country must be selling assets to foreign investors. * It is debatable whether this is sutainable in the long run since, if people invest in a country, at some point they will require a return on their investment, and this will cause a deficit on the financial account

Answer 136

1. **Depreciation of the exchange rate** - Reduces relative price of exportds & make imports more expensiive - BUT risk of cost push inflation - which erodes competitive boost + fall in incomes 2. **Import tariffs** - Increases the price of imports & makes domestic output more price competitive - BUT risk of retaliation from other countries if import tariffs are used as BoP policy 3. **Low rate of inlfation (perhaps deflation)** - Keeps general price level under control and makes exports more competitive - BUT risks from deflation as a way of achieviing intenal develuation - including lower investment

Answer 137

1. **Increase in income taxes** - Reduces real disposable incomes causing falling demand for imports - BUT cut in living standards and risk of damage to work incentives in labour markets 2. **Cuts in real levels of government spending** - Lower aggreagate demand, firms may look to export their spare capacity - BUT damage to short term economic growth, risks that austerity hits investment

Answer 138

Means finaince from abroad (in form of loans or foreign direct investment) is required in order to fund continued imports * This may mean that a country is gradually selling its assets * Owing money to a foreign entity creates vulnerabilites * 2008 GFC - Greece owend creditors significant sums and was required to pay these back making numerous problems their economy. Creditors insisting on being paid back quickly * Run up large external debts and then relying on foreign capital * May switch towards protectionist policies * Can lead to fall in relative living standards if economoc growth slows down

Answer 139

Focus of allocation of resources is on meeting foreign demand as opposed to meeting domestic demand * This can limit availabilty of goods/services in the local economy which can possibly decrease the standard of living for some households * It can also create instabiloty in the forex maket if there is a floating exchange rate * Saving more than they spedn * May adopt a policy of delibrately under-valuing the currency * May be under-consuming (affecting living conditions)

Answer 140

major issue with trade imbalances is that it strengthens those who want to move away from free trade. Large trade imbalances leading to rise of de-globalisation – creating trade tensions --> tariff and non-tariff barriers

Answer 141

A net improvement in trade will only occur if (PED X + PED M) is more than 1. (Good evaluation to the J-Curve).

Answer 142

Short term negative effect (of devaluation as demand inelastic). Long term positive effect (of devaluation as demand becomes more price elastic). REGARDING THE CURRENT ACCOUNT.

Answer 143

* In the short-term, a fall in the price of exports will only cause a smaller percentage rise in quantity demanded. * A rise in the price imports will cause a smaller percentage fall in demand for imports. Therefore, the value of imports actually rises (we spend more on imports) * Therefore, if demand is inelastic, following a depreciation, we actually get a worsening of the current account account

Answer 144

In the long-term, demand for exports and imports will tend to become more price elastic. (more sensitive to price) * Therefore, a fall in the price of exports will cause a bigger percentage rise in quantity demand. (And therefore we get a bigger rise in the value of exports) When demand is elastic, the value of exports rises – and we get an improvement in the current account position. * Also, if demand for imports is price elastic, then there will be a bigger percentage fall in demand for imports. In this case, the total spending on imports starts to fall.

Answer 145

* In the short-term, firms and consumers may have contracts to keep buying the good. * It takes time to find alternatives. * The higher price of imports will be an incentive for domestic firms to increase production, but this takes time * Elasticity and time

Answer 146

* The current account will depend on consumer spending and the rate of economic growth. * It also depends on consumer spending in foreign countries (hence demand for exports) * It depends on Inflation (e.g. depreciation can cause imported inflation which reduces the competitiveness of exports) * Firms may engage in insurance policies to hedge against exchange rate movements.

Answer 147

1. Depreciation due to current account deficit 2. WIDEC 3. Imports should ↓, Exports should ↑ 4. So C.A deficit should imprive 5. BUTTT 6. Elastics of D+S, contracts have been signed so 7. Short term, imports might not reduce, exports might not imprive 8. So CA deficit gets worse before it gets better

Answer 148

This is a weighted index of sterling's value against a basket of currencies where the weights are based on the importance/share of trade between the UK and each country

Answer 149

* External value is set by market forces * No intervention by central bank * No target for the exchange rate

Answer 150

* **Trade/current account balances** – strong trade and CA surplus see currencies appreciate as money flows into circular flow by exports and inflows of investment * **Foreign direct investment** – more FDI means increase in currency demand and so rising exchange rate * **Portfolio investment** – strong inflows of investment into equities and bonds from overseas sees currency appreciation * **Interest rate differentials** – hot money

Answer 151

1. Rise in policy interest rates by central bank 2. Currency more attractive for investors 3. Attracts inflows of short term hot money 4. Causes outwarad shift in currency demand 5. Currency appreaciates in value in floating system

Answer 152

1. Recession in a trading partner 2. Causes a fall in export sales 3. Worsening of trade balance 4. Inward shift of currency demand 5. Currency will depreacite

Answer 153

Decrease in investment from overseas will mean a decrease in demand for pounds and a depreciation of currency

Answer 154

Combination of fixed & floating mechanism. Central bank determines prefered currency value and thn lets the currency flucturate within a certain range of the preferred value. If it goes outisde the range then the cenral bank will intervene

Answer 155

* **Chanes in monetary policy interest rates** * Changes in interst rates - lower interst will depreciate the exchange rate * Causes movments of "hot money" in and out of country * **Quantitative easing** * Increas liquiduty in banking system, causes an outflow of money leading to depreaciation of ER * **Direct buying/selling in the currency market (intervention)** * **Taxation of overseas currency deposits and capital controls** * Taxation of foreign deposits in banks cuts profts from hot money inflows * Gov could introdeuce control of the free flow of capital in and out of a country

Answer 156

1. In a managed floating currrency system, one way that a central bank can influecne the external value is by changing interest rates 2. For example, if they want to achieve a depreciation, they might opt to lower their main monetary policy interest rate 3. A fall in interest rates reduces the returns on overseas money held in a country's banking system. The real reutnr may become negative 4. As a result, lower interest rates might cause an outflow of short-term "hot money" from commercial banks to other countries 5. This will cause an outward shift of the supply curve for the currency as investors look for currencies with higher expected returns 6. In this way, assuming other central banks have kept their rates constant, a fall in interest rates might lead to a depreciation

Answer 157

When a country deliberatelt intervenes to drive down the value of the currency to provide a competitive lift to aggregate demand, output and jobs in their export industries. Countries with persitent trade deficits and rising unemployments this could be an attractive option

Answer 158

* Can be seen as a form of trade protection so inveites retaliatory action * Goes against princples of trade based on comparitive advantage * Cutting the exchange rate makes it harder for other countries to export, negativelt affecting their growth rate which in turn can damage the volume of trade that takes place between nations

Answer 159

The central bank negotiates with the IMF to fix (peg) their currency to another one Could be party so - 1 Brunei dollar = 1 Singapore dollar Often not party so - 7.75 Hong kong dollars = 1 US$

Answer 160

* A revaluation occurs if the Central Bank decides to change the peg and increase the strength of its currency * A devaluation occurs if the Central Bank decides to change the peg and decrease the strength of its currency

Answer 161

1. A depreciation is a fall in the external value of a currency inside a floating exchange rate system 2. Consider for example a deprecation of the UK £ agaisnt the Euro. The £ might fall from Euro 1.50 to Euro 1.20, a drop of 20% 3. As a result exporters can reduce the foreign price of goods and services sold overseas 4. This makes UK exports relatively cheaper in overseas markets. Relative export prices fall leading to improved competitveness 5. In addition, the UK price of imported products will increase £1 buys fewer euros. For example, imported cars will be more expensive 6. A rise in import prices will make domestic producers in the UK appear relatively more competitive purely in cost and price terms

Answer 162

* Depreciation of the £ causes exports to be cheaper for foreigners to buy & imports to the UK are more expensive * The extent to which this improves the current account balance depends on the Marshall-Lerner condition * This follows the revenue rule which states that in order to increase revenue, firms should lower prices for products that are price elastic in demand * If the combined elasticity of exports/imports is less than 1 (inelastic), a depreciation (fall in price) will actually worsen the current account balance * It is also important to recognize that there is a time lag between the depreciation of the £ and any subsequent improvement in the current account balance * This is explained by the J-Curve effect * It takes time for firms & consumers to respond to changes in price * Once it becomes evident that price changes will last for a longer period of time, firms & consumers switch * E.g. a firm in the USA has been importing electric scooters from the UK. If the Euro depreciates, the price of scooters in France becomes relatively cheaper. In the short-term, the USA firm will not switch immediately to purchasing scooters from France as the exchange rate may soon bounce back. They also have a good relationship with their UK suppliers. In the long term they are likely to switch

Answer 163

* Net exports are a component of aggregate demand (AD) * A depreciation that results in an increase in net exports will lead to economic growth

Answer 164

* Cost push inflation is likely to occur as the price of imported raw materials increases with currency depreciation * Net exports are a component of aggregate demand (AD) * A depreciation that results in an increase in net exports will lead to an increase in aggregate demand * This may lead to an increase in demand pull inflation * Could be a stimulus to GDP growth * An appreciation of the currency will have the opposite effect

Answer 165

* If depreciation leads to an increase in exports, unemployment is likely to fall as more workers are required to produce the additional products demanded * An appreciation of the currency will have the opposite effect so decrease in exports, unemployment rises as less is produced

Answer 166

* The impact of a depreciation on living standards can be muted * As imports are more expensive, households face higher prices & less choice, which detracts from living standards * Rising exports can decrease unemployment & increase wages/income which means an improved standard of living for some households * The impact of an appreciation on living standards will be the opposite

Answer 167

* Depreciation of a currency makes it cheaper for foreign firms to invest in the country and can increase the FDI * The money they have available to invest is worth more when the currency has depreciated * An appreciation has the opposite effect

Answer 168

* When consumers from your country want to buy products form another, they will first have to sell your country's currency in exchange for the other country's currency before they can buy the product * This means dmenad for the other country increases, and that the supply of your currency increases

Answer 169

* FDI refers to international firms investing abroad, usually into factories to decrease costs of production * Inward FDI means a firm invests into your economy (money goes in). More demadn for domestic currency * Outward FDI means a domestic firm invests in another ecnomy (money goes out). More supply of domestic currency

Answer 170

* Some people/firms/governments may purchase financial investments from abroad. This includes stocks, options and bonds * Inward investment means someone from abroad wants to purchase investments in your country (money goes in). More demand for domestic currency * Outward investment means someone from your country wants to purchase investments abroad (money goes out). More supply of domestic currency

Answer 171

* Remittances refers to money sent from people working abroad sending their money back to their home country * More demand for the home currency, while more supply of the original currency

Answer 172

* Speculation here refers the purchasing of a currency in hope that its value will increase * More demand for investment currency, while more supply of the original currency

Answer 173

* High inflation rates will make the country's exports less competitve, which will reduce exports, which in turn reduces the demand for the country's currency * Additionally, if inflation is hurting a currency, investors may sell this currency in exchange for a more stable one * More demand for stable currency, while more supply of the inflationary currency

Answer 174

* High economic growth -> inflation -> central banks increases interest rates -> investors see high returns on bank depoists -> more money is put into local banks * High economic growth -> more confidence in the economy -> more investment from other countrys * More demand for high growth economy's currency, while more supply of the original currency. Here, we assume the economic growth would increase the inflation rate A counter point * High economic growth -> more net imports from other countries as demand outweights supply * More demand for other foreign currencies, while more supply of the high growth economy's currency

Answer 175

1. Time lags 2. Size of change 3. Is change permanent 4. Coefficients of PED for exports and imports (marshall-lerner condition) 5. Size of any second round multiperler and accelerator effects 6. The type of economy (differnet for developing and develped countries) 7. Degree of openness of the economy to international trade (measured by value of trade as a % of GDP)

Answer 176

* Reduces the need for a central bank to hold large amounts of currency reserves * Freedom to set monetary policy interest rates to meet domestic objectives * May help to prevent imported inflation * Insulation for an economy aftern an external shock especially for export-dependent countries * Partial automatic correction for a current account/trade deficit * Less risk of a currency becoming significantly over/undervalued

Answer 177

* No guarantee that floating exchange rate will be stable * Volatility in a floating currency might be detrimental to attracting inward investment * A lower (more competitive) exchange rate does not necessarily correct a persistent current account deficit - consider the J curve theory and the importance of non-price competitiveness

Answer 178

* Certainty of currency value gives confidence of inward investment from overseas businesses * reduced need to engage in and costs of "currency hedging" for businesses such as airlines * Currency stability helps to control inflation - i.e. it is a discipline on businesses to keep labour costs low * A stable currency can lead to lower borrowing costs (i.e lower yields on government bonds) * Imposes responsibility on government macro poliices e.g. to keep inflation under control * Less speculation in the curency market if the fixed exchange rate is regarded by traders as credible

Answer 179

* Reduced freedom to use interest rates for other macro objectives such as stimulating GDP growth * Many developing countries do not have sufficiently large foreign currency reserves to be able to maintain a fixed exchange rate over some time * Difficult for countries to use a competitive devaluation of their fixed exchange rate - creates political tensions and possible retaliation * Devaluation of a fixed exchange rate can lead to a surge in cost-push inflation - this is damaging to competitiveness and has regressive impacts on poor families

Answer 180

* Fixed rates may be optimal for developing countries wanting to control inflation * Export-dependent economies may favour a managed floating rate e.g. to offset fluctuating world prices * Not every country has the scale of foreign currency reserves needed to influence the price of a currency * The choice of currency regime is hugely important for developing and emerging countries. Some have opted to join a monetary union e.g. the 19 members of the Euro Zone

Answer 181

* The competitiveness of a country's exports abroad and its ability to compete with imports at home * Depends on price and non price factors such as quality, reliability and brand name

Answer 182

* Product quality * Innovation * Reliability * Performance * Marketing * Brand loyalty * After sale services * Branding

Answer 183

1. Environmental taxes - costs for carbon emissions 2. Employment protection laws and health & safety regulations 3. Statuatory requirements - pensions 4. Employment taxes - employers national insurance - increased in 2024 autumn budget

Answer 184

The main measures are * Relative unit labour costs * Relative export prices * Quality ## Footnote Others * Productivity * Unit costs * Levels of investment * R&D expenditure * Training and education

Answer 185

Total labour costs/ouput Determined by 1. Average wages/salaries 2. Labour productivity

Answer 186

* A country's exchange rate appreciates * Wages costs rises relatively faster than other nations * Labour productivity growth is relatively slower

Answer 187

* Monetary policy interventions aimed at a currency depreciation e.g. a managed floating exchange rate * Wage controls e.g. wage/pay freezes for people working in the public (state) sector * Supply-side measures designed to raise labor productivity/efficiency across many industries

Answer 188

The price of the UK's exports compared to the exports of the UK's main trading partners. (High relative export prices is bad for competitiveness).

Answer 189

* An appreciation of the currency - export price rise in overseas markets * A period of high relative inflation * Export businesses experience higher costs e.g. higher minimum wages - prices rise to protect profits so inflation * When exports are hit by import tariffs

Answer 190

* FoP. * Exchange rates. * Economic stability. * Domestic demand. * Domestic competition. * Openness to trade. * Productivity. * Regulation. * Inflation / Investment. * Finance (access to). * Taxation.

Answer 191

* Competitive exchange rate – maybe moving to a managed floating currency * Competitive tax environment – attract inward investment and encourage new business to set up * Investment in human capital – improves quality of the workforce – more funding for higher education * Increase r&d – drive faster pace of innovation – r&d tax credits * Stronger market competition to raise factor productivity and lower relative export prices * Stable macroeconomic environment – low inflation and steady economic growth --> business confidence and investment * Investment in critical infrastructure – better road, air and rail links, improved darts, faster broadband

Answer 192

* Subsides – lower cost of research e.g. pharmaceuticals * Tax incentives – can encourage different aspects * Lower employment taxes – stimulate skilled migration from overseas * Lower capital gains taxes – encourage small businesses to set up * Special economic zones – attract research-intensive businesses

Answer 193

* Macro competitiveness has important micro foundations – businesses drives it, gov is there to regulate a little * Competitive markets and innovative business * Skills, aptitudes, and attitudes within a diverse workforce * Competitive advantage comes from having * Globally scaled businesses close to or at technological frontier * Culture of innovative businesses start-ups * A financial system that can support it all * Reliance on currency depreciation/devaluation and wage cost is not a sustainable competitiveness strategy * The most competitive countries tend to have the highest minimum wages * There is a continuous global battle for the most talented, highly skilled workers * "races to the bottom" e.g. in tax rates and wages have a limited impact in the long run

Answer 194

**A strategy to boost price competitiveness by reducing wage costs and raising productivity without currency devaluation. Achieved via fiscal austerity (tax hikes, spending cuts) and/or higher real interest rates, causing deflationary pressure**. Common in fixed-exchange-rate countries (e.g., Ecuador, Eurozone members like Greece) and **requires years of low relative inflation/deflation**. Examples: Latvia, Greece, Ecuador post-financial crises.

Answer 195

A deliberate reduction in a country's currency value (under a fixed/semi-fixed exchange rate) to boost export competitiveness and raise import costs. Goals include shrinking trade deficits and lowering the real value of sovereign debt. Faster than internal devaluation. Examples: Egypt (16% devaluation in 2016) and Ghana (17% in 2019).

Answer 196

1. Severe loss of output and rising unemployment 2. Fall in nominal wages reduces living standards 3. Risks from sustained price deflation 4. Real value of debt increases 5. Danger of a country suffering a permant loss of output (known as "hystersis")

Answer 197

1. Increase in cost-push inflation from higher import prices 2. Reduces real income because of a rise in inflation 3. No guarantee that the trade deficit will improve (refer to the J-curve concept) 4. Foreign creditors will demand higher interest rates on new issues of government and corporate debt 5. Currency uncertainty makes country less attractive to inward FDI

Answer 198

* Improved living standards e.g. measured by real GNI per capita (PPP) * Stronger trade performance from an increase in export sales * Virtuous circle of economic growth * Employment creation * Higher government tax revenues as incomes and profits increase

Answer 199

* Trade surpluses might invite a **protectionist response** * Possible risks of **demand-pull inflation** * Competitiveness might be achieved at the expense of **growing inequality of income and wealth** * Higher productivity might be achived at expense of a **worsening work-life balance** and increased incidence of mental health problems * Increased competitiveness might cause a country's **exchange rate to appreciate**

Answer 200

The 'loss' in potential human development because of poverty.

Answer 201

When a household does not have sufficient income to sustain even a basic acceptable standard of living to meet peoples basic needs Is a multi-dimensional about more than very low income per capita World bank - less than $2.15 a day

Answer 202

* Income compared to other people - those living below a certain threshold income. * In the UK and the EU, a household is in relative poverty if they are living in a household with income below 60% of median household income. * Poverty line for a single working age adult is £141 a week. * Around 1/5 of people in the UK live in relative poverty.

Answer 203

1. Population growing faster than GDP in low income countries leading to lower per capita incomes 1. A severe household savings gap – many families unable to save and living on less than $1.90 per day – poverty trap 1. Absence of basic government/public services such as education and universal care, welfare system 1. Effects of endemic corruption in government and business 1. High levels of debt and having to pay high interest rates on loan 1. Damaging effects of civil war and natural disasters both lead to huge displacements of population 1. Low rate of formal employment - people in insecure jobs with poverty wages 1. Absence of basic property rights, lack of which may constrain ability to own land | The causes are often complex and multi-causal

Answer 204

1. Cuts in top rate income taxes, the wealthy get wealthier 1. Surging executive pay and high rewards for skilled workers compared to other employees 1. Regressive effects of higher food and energy prices on poorer households 1. Deep market failures in access and affordability of good quality education, health & basic housing 1. Declining strength of trade unions in many countries and the rising monopsony power of some big employers

Answer 205

The Multi-Dimensional Poverty Index (MPI) measures poverty beyond income by assessing deprivations across 10 indicators in health (child mortality), education (years of schooling), and standard of living (Access to drinking water). Key findings (2019): * 23% of people (1.3 billion) in 101 countries lived in multidimensional poverty. * Two-thirds of these individuals reside in middle-income countries. * Over half are under 18, highlighting youth vulnerability. The MPI evaluates progress against sustainable development goals to reduce severe deprivation in emerging and developing nations.

Answer 206

Due to the higher rate of return on capital. (Rich get richer e.g. can mortgage more houses to rent out).

Answer 207

A visual indicator of inequality in an economy.

Answer 208

Gini Coefficient = Area of A / Area of A + Area of B.

Answer 209

0 1 or 100

Answer 210

Income inequality Wealth inequality

Answer 211

% of income = y % of population = x

Answer 212

A numerical indicator of wealth and income distribution and inequality.

Answer 213

* Education, training and skills * Trade unions * Benefit system * Pension payments * Wage rates * Employment Legislation * Tax Structure * Asset Ownership

Answer 214

* The higher the skill level the higher the level of income. * A country with a poor education system will see greater inequality than one with a good education system * Education being a barrier to entry to a job

Answer 215

* Countries with strong trade union membership tend to have higher levels of income. * With low trade union membership, the exploitation of workers through low wages is easier

Answer 216

Countries that provide a range of benefits (such as unemployment, disability, child support, housing support etc) raise the income of the lowest 20% of the population resulting in more equal distribution

Answer 217

* State pension payments ensure a minimum standard of living for retirees resulting in a more equal distribution of income. * Countries without it have a much higher percentage of pensioners living in poverty

Answer 218

* The purpose of a national minimum wage is to improve the equity in the distribution of income. * Without it, more households would be earning less and inequality would increase

Answer 219

Generally, the more workers are protected by law, the better the income distribution in an economy e.g. maternity benefits ensure that new mothers have a higher level of income during the first months of leave after a birth

Answer 220

* Progressive tax systems allow all income earners to contribute to public revenue according to their ability. * Decreasing taxes on the lower end and increasing it on the upper end would mean that the system is more progressive and there would be a more equal distribution of income

Answer 221

* Assets generate income. * The more equal the asset ownership in an economy the less the inequality in income distribution. * This was one reason why the UK government changed the law in 1980 allowing council house tenants the right to buy their property at a discounted rate. * It is also a reason for the current shared ownership scheme

Answer 222

1. Low life expectancy and fewer years of healthy life expectancy 1. Low school enrollment rates – families can't afford it – widens gender opportunity gap 1. Low access to basic health care and poor nutrition - impairs brain development among young people 1. Vulnerability to loan sharks/access to credit 1. Limited access to affordable technology – digital divide – been decreasing, more smartphone use 1. Much lower productivity which then leads to lower wages 1. Low real spending power limits the size of domestic markets for goods and services 1. Low prices for primary commodities – small farmers have little to no bargaining power

Answer 223

Inequality increases as an economy develops and moves from agriculture to industry. Then it improves through rebalancing (by the govt.). + inequality falls.

Answer 224

Inequality against economic growth

Answer 225

Piketty theory

Answer 226

* **Low savings ratio** – this affects firms ability to invest and expand. * **Balance of payments problems** – those people on high incomes in the cities may spend it on large volumes of imports because they have a Westernised life style. This in turn can lead to a balance of payments deficit. * **Lack of entrepreneurship** – the poor will have no capital to start their own business and better themselves because their incomes are not high enough to save. * **Absolute poverty could remain high** – because of a lack of spending power in the economy and the lack of job creation. Also tax revenues are low, so there is no money to provide merit goods like education and health or develop infrastructure. * **Capital flight** – in developing countries the very wealthy may transfer their assets to ‘safe havens’ (see section 14.5) * **Social problems** – crime, political instability.

Answer 227

* Capitalism creates inequality because it requires incentives for it to work - e.g. entrepreneur = profit; workers = wages * Entrepreneur & workers rewarded according to risk, productivity and ability - But capitalism not just about creating inequality… * Wealth, tax revenue and jobs it creates has lifted living standards for all and millions out of poverty - Relative poverty still a problem in developed countries

Answer 228

1. The profit motive - Businesses are assumed to be driven by the profit motive when making investment, output and employment decisions. Inequality can widen through flow of dividends to shareholders. * However, even in capitalist system people are motivated to run their businesses as a social enterprise – profits reinvested for social/environmental purposes * The government can tax high profits and incomes through a progressive tax system so that the final distribution is less unequal than original income * The government can tax high profits and incomes through a progressive tax system, to help improve final distribution of income * Competition policy and intervention by industry regulators can help control monopoly profits and keep real prices down for consumers 1. A capitalist labour market: In competitive labour markets, wages and earnings are influenced by the forces of labour demand and labour supply. In theory there are few limits to pay that can be achieved by the top earners including those with scarce skills that the market values and executives who have the power to set their own wages, bonuses, share options. At the lower end, the majority of people earning low wages are not represented by a trade union and have little bargaining power * However – there are many possible interventions in labour markets that can alter the final distribution of income and help control inequality * Minimum wage legislation * Legal caps on executive pay * Legal protection for employees such as in flexible jobs associated with the gig economy * Government investment in human capital promoting skills and employability of vulnerable groups of society can increase earnings potential

Answer 229

Thomas Piketty’s core argument is that **capitalism naturally leads to rising wealth inequality over time**. He uses historical data to show that when the return on capital (profit from wealth, e.g., rent, dividends, or investments, abbreviated as r) is higher than the economic growth rate (growth of incomes/output, abbreviated as g), wealth concentrates in the hands of those who already own assets.

Answer 230

Critics of his say that capital has helped to make the world to make the world more equal. Point of the impact of globalisation driving by increasing specialisation, trade and the diffusion of new technologies as helping to reduce extreme poverty and reduce the gap in per capita incomes between countries. World is now more equal than it was in 1950, around the same levl as 1850

Answer 231

An increase in living standards in a country

Answer 232

* **Economic growth** - an increase in the total value of goods and services produced in an economy in a year * **Economic development** - an improvement in living standards and economic welfare over time. Most common measure being HDI

Answer 233

The 'loss' in potential human development because of poverty.

Answer 234

* **Health** as measured by life expectancy at birth. * **Education** as measured by the expected years of schooling. * **Income** as measured by real GNI per capita at purchasing power parity. Each of these three indicators are given equal weighting and a mean is taken to give a figure between 0 and 1. The higher the number, the greater the development.

Answer 235

* It is a **composite indicator** which provides a more useful comparison metric than single indicators do * It incorporates **three of the most important metrics for households** i.e. health, education and income * It is **widely used** all over the world which provides an opportunity for **meaningful comparisons** * It provides a **goal for governments to use when developing their policies** e.g. it may help identify that the education levels are holding back improvements to the HDI and government policy can target that * It provides citizens with an understanding of how their quality of life compares to other countries * ** Comparisons over time can be made**

Answer 236

* It does not measure the inequality that exists as it uses the mean GNI/capita - doesn't show Income inequality * It does not measure or compare the levels of absolute and relative poverty that exist * For many countries it does not provide useful short-term information as gathering the data required for the calculation is difficult. This means the data often lags reality by several years * PPP values change quickly and so the numbers can become inaccurate * Doesn’t show political freedoms – gender opportunities and human rights * Equal weighting of indicators may not show the countries priorities

Answer 237

IHDI - inequality adjusted HDI * Will be equal to HDI when there is no inequality, but falls as inequality rises. Never greater than HDI * Provides greater insight into differences in human development that exist in a country as oposed to average human development MPI - Multi-dimensional Poverty Index (MPI) * It measures the complexities of poor people’s lives, * Tracks deprivatiion across 3 dimensions - Health (child mortality), education (years of schooling) and living standards (access to clean water). Has 10 indictors within these dimensions * Household is poor if they have 1/3 or more of the wieghted indicators

Answer 238

* Primary product dependency * Volatility of commodity prices * The savings gap: Harrod-Domar model * Foreign Currency Gap * Capital Flight * Demographic factors * Access to credit and banking * Infrastructure * Debt * Education and skills * Absence of property rights

Answer 239

* In 2022 copper exports from Zambia accounted for 70% of their total exports and primary products in excess of 90%. They are suffering from over-specialisation * **Primary products tend to have a very low-income elasticity of demand (YED)**. As world income rises, there is a less than proportional increase in demand * This means that there is **limited scope to continue increasing demand** * Primary products have very little added value * Exporting manufactured products raises the added value, incomes and profits * **Natural disasters** – can wipe out production of the primary product * Often non-renewable. So country suffers when they run out of the product. **Natural resources – limited supply** * **Prebisch-Singer Hypothesis** - more on other flashcard * **Dutch disease** - more on other flashcard

Answer 240

* **The Prebisch Singer Hypothesis suggests the long run price of primary goods declines in proportion to manufactured goods. ** * Manufactured goods are more YED ELASTIC * which means those dependent on primary exports will see a fall in their terms of trade. * This leads to a fall in purchasing, might lead to balance of payments problems and fall in living standards in the future. * However, in recent years, there has been a rise in the prices of some key commodities, such as food, cocoa and oil and a fall in prices of some manufactured goods due to the expansion to places like China.

Answer 241

**Dutch disease** refers to the negative economic impact that can occur when a **country experiences a resource boom** (such as discovering large oil reserves). This boom can **lead to a stronger currency and higher wages**, which in turn **makes the country's other exports less competitive** on the global market. As a result, **other sectors, like manufacturing, may decline.**

Answer 242

* LEDCs may have a comparative advantage in primary products * Therefore should continue to develop in areas which they are strongest. * Argument given by the Bad Samaritans * Some rich countries have been able to use primary products to develop * Saudi Arabia and oil. - Primary product revenue should be used to reinvest into manufacturing. * Forward markets can be used to fix prices in advanced to reduce volatility and risk. * Not all primary products have a low YED - Diamonds in Botswana. * Primary products rose steeply in price between 2000-2008 while prices for manufactured goods was falling. They also rose post-pandemic.

Answer 243

* Due to the inelastic nature of both the demand and supply of commodities, small changes in demand or supply can lead to large changes in price * In 2020, 25% of Bolivia's GDP was generated by exports. Commodities accounted for 60% of its exports * When commodity prices rise, GDP rises - and vice versa * **A more diversified range of exports prevents this** * Volatility of prices mean that producers income and countries earning are rapidly fluctuating. Making it difficult to plan and carry out long term investment. Rapid falls in producers incomes causes poverty. Investment down and so is confidence so decrease in real GDP * When prices of commodities rise for a number of years – causes over investment in the production of the commodity causes long term risk when the price eventually falls

Answer 244

Developing countries have lower incomes and thus they save less. So therefore there is less money for banks to lend, reducing borrowing and thus reducing investment/consumption. A savings gaps is the difference between the actual savings and the level of savings needed to achieve a higher growth rate * In the 1950's two economists identified the savings gap as a major constraint on growth * The Harrod-Domar model identified the following benefits of increased savings * Increased savings → increased investment → higher capital stock → higher economic growth → increased savings * Based on this, any intervention (foreign or governmental) to increase the capital stock in an economy will lead to growth

Answer 245

* It does not account for many other factors such as labour productivity, corruption, technological innovation * It was created based on data from wealthier industrialising nations as opposed to very poor undeveloped countries * It focused only on physical investment and ignored other types such as investment in human capital (labour)

Answer 246

Emphasis on the importance of savings in the economy.

Answer 247

A foreign currency gap happens when currency outflows persistently exceeds currency inflows. If exports are low in either quantity or value, there will not be enough foreign currency to buy the necessary imports

Answer 248

1. When a counry runs a persistent current account deficit 1. When there is an outflow of capital from investors - capital flight 1. There is a fall in the value of inflows of remittances

Answer 249

1. Country does not have enough foreign currency to pay for essential imports such as medicines, food 1. And other raw materials and replacement component parts for basic machinery. 1. The country might not be able to pay off debts and might have to default/seek loan from IMF - bad for credit rating and makes it difficult to seek loans in the future

Answer 250

* Can be solved by FDI * Or foreign aid to increase the amount of foreign currency in the economy

Answer 251

* Occurs when money or assets rapidly leave a country * This may happen due to political upheaval, economic sanctions, war, or changes to government policy (e.g. interest rates). Or lack of confidence in country's stability, hide it from the government or for profit repatiration * From Feb 2022 to June 2023 Russia had a net capital outflow of $253 billion due to invasion of Ukraine

Answer 252

* It creates a savings/foreign currency gap, which reduces Investment and the ability to fund imports. * Might make it impossible to pay off debts. Will have to seek an IMF bailout * Reduces any tax inccomes for the government from the withdraw of savings/financial investments.

Answer 253

* If the dependency ratio is high it means there is less money available for savings and investment * Many developing countries have high dependency ratios * Developing countries have higher population growth, which limits development. IF population grows by 5%, the economy needs to grow by 5% to keep living standards the same

Answer 254

* No way to gain loans for spending, or investment * People cannot save money * Poor families have to resort to loan sharks with punitive interest rates, leaving them in debt. Cements people in poverty. However, * Technology might allow people to gain access to financial systems via mobile phone instead of physical branch. * Microfinance encourages people to take out loans for investment.

Answer 255

* Difficult to move raw materials, labour - high costs, not profitable. * Lack of water and energy makes it impossible to run factories. * Lack of communications technology means buyres and sellers cannot communicate. * Therefore deters foreign investment. * Expensive to improve and also conflicts with environmental goals * Makes service and production less reliable if the roads are bad for example

Answer 256

* Foreign aid/loans can be used to improve infrastructure - Belt and Road Initiative and World Bank Loans. * Foreign investors will improve infrastructure where there are valuable raw materials. * Chinese belt and road. - Building a new high speed rail from Nairobi to Mombasa

Answer 257

* High levels of borrowing crowds out the market. * Raises interest rates or creates competition for resources. * Firms want to borrow to expand but crowded out * Opportunity cost - paying off loans means that less can be spent on education and infrastructure. * Higher taxes needed to pay off government debt - reduces business confidence and restrains growth. * May create a debt cycle for developing countries - interest is so high that the country can never repay - e.g. Ferdinand Marcos. Creates intergenerational inequality

Answer 258

* Human capital (Gary Becker) * Adequate human capital ensures the economy can be productive and produce goods and services of a high quality. It helps generate employment and raise standards of living. * Countries like China and South Korea invested heavily in their human capital when they were developing, and this has benefitted them in the long term. Ethiopia suffers from high illiteracy rates at around only 49%. (Unesco) * Investing in this supply-side policy increases the potential output of the country (shifts the production possibility frontier outwards) * Higher education/skill levels → higher human capital → increased productivity → higher output → higher income

Answer 259

* Education and skills can be improved - Oportunidades programme in Mexico and Bolsa Familia in Brazil * Foreign aid can also be used

Answer 260

* Savings gap can be filled by FDI, aid or debt cancellation, e.g. FDI flows to Africa in 2014 were about $60bn. * Microfinance

Answer 261

* In many countries, property is the main household asset which can be used to secure loans or generate income * A lack of property rights in some developing countries prevents this from happening * Loss of property rights in Zimbabwe led to economic collapse

Answer 262

* Corruption * Poor Governance * Wars * Political instability * Geography * Disease

Answer 263

This is a major problem in many countries. Often money intended for investment is siphoned off by corrupt politicians resulting in a lower level of investment. Corruption also diverts funds to certain groups who have bribed or lobbied officials (e.g. multinational firms) resulting in projects that deliver a low level of growth and development

Answer 264

Leads to inefficient use of resources and poor decision-making. It may also result in laws/regulation which directly inhibit growth and development

Answer 265

Conflict destroys infrastructure, disrupts supply chains and often reduces the post war supply of labour. Conflict shifts the production possibility curve inwards

Answer 266

If governments keep changing, it results in constantly changing policies and priorities. It also reduces confidence in the economy and international investors are slower to invest as they are fearful of losing their investment

Answer 267

It is harder for landlocked countries to generate economic growth. Often transportation and administration costs are higher than those with access to ports, which increases the costs of production and decreases international competitiveness. Natural terrain can also be a limiting factor e.g the arid, mountainous terrain of Pakistan

Answer 268

HIV/AIDS and malaria have a negative impact on economic growth

Answer 269

Factors limiting development include microeconomic ones like inelastic demand and supply for commodities, and macroeconomic ones such as high debt levels. These factors limit growth and development overall. Development improves conditions for individuals through higher incomes and for firms through increased sales.

Answer 270

* Fiscal discipline - greater control on government spending, defcitis and debt * Reallocating state spending away from subsides - to health care, education, infrastructure * Tax reforms * Liveralising market interest rates * Floating rather than fixed exchange rate * Trade liberalisation * Privitisation * Foreign direct investment * Subsidiy removal * Microfinance

Answer 271

Involves a country lowering import tariffs and relaxing import quotas and other forms of protectionism. One key aim is to make an economy more open to trade and investment so that it can engage more directly in regional and global economy.

Answer 272

Removing a tariff (ceteris paribus) leads to: * A fall in market prices from P1 to P2 * An expansion of market demand from Q2 to Q4 * A rise in the volume of imported cars (no longer subject to a tariff) to a new level of Q1-Q3 * A contraction of domestic production as demand shifts to relatively cheaper imported products * A gain in overall economic welfare including a rise in consumer surplus * There is a fall in the producer surplus going to domestic manufacturers of these cars

Answer 273

* Lower prices for consumers/households which then increases their real incomes * Increased competition/lower barriers to entry attracts new firms * Improved efficiency - both allocative & productive * Might affect the real wages of workers in affected industries

Answer 274

* Multiplier effects from higher export sales * Lower inflation from cheaper imports - causing an outward shift of short run aggregate supply * Risk of some structural unemployment/occupational immobility * May lead to initially to an increase in the size of a nation's trade deficit

Answer 275

* Lower prices * Economies of scale * Increased market competition * Improved allocative efficiency

Answer 276

* Lost tariff revenues * Financing costs for necessary infrastructure * Regulatory refroms for common product standards * Local businesses may suffer loss of profit/jobs when facing stronger competition

Answer 277

Investment by one private sector company in one country into another private sector company in another country.

Answer 278

* Technology transfer- Firms bring technologically advanced capital from a more developed country - reduces primary dependances * Current account balance improves - As more is exported * Increased (I) AD - Growth and tax revenues. * Fill a foreign currency gap * Improved infrastructure - MNCs will want road/rail to transport any goods that they produce - also in power sector * Higher capital intensity/capital deepening I.e. more capital per worker leads to higher productivity * Better training for local workers leading to improved human capital and less risk of structural unemployment * Investment grows a country's export capacity * More competition in markets which then lowers prices for consumers and increases their real incomes * Creates new jobs leading to higher per capital incomes and increased household savings * FDI can promote a shift to higher productivity jobs and high value-added industries

Answer 279

* Multinationals wield power within host countries, and they gain favourable laws & regulations * Foreign multinationals take advantage of weak laws on environmental protection * Multinationals have been criticised for poor working conditions in foreign factories * Profits made in an LEDC are often repatriated to the host country * Imports of components/capital goods initially have a negative effect on a country's trade balance * Multinationals may only employ local labour in lower skilled jobs * Inequality – profits from FDI flow disproportionately to powerful elites * Many global corporations use tax avoidance techniques to increase their profits * Ethical standards form TNC's may be poor – especially in mining, farming and textiles

Answer 280

* Attractive rates of corporation tax * Soft loans and tax relief/subsidies * Trade and investment agreements * Flexible labour force + skilled workers * Creation of Special Economic Zones * High quality critical infrastructure * Open capital markets for remitted profits * Attraction of relativaly low unit labour costs

Answer 281

1. **Market Efficiency** * Restores market efficiency by aligning prices with true supply and demand. * Prevents overproduction, promoting long-term market stability. 1. **Encourages Innovation and Efficiency:** * Encourages innovation and cost-effective practices, enhancing long-term competitiveness. * Eliminates reliance on guaranteed income, reducing complacency among businesses.. 1. **Reduces Fiscal Burden and Corruption**: * Reduces subsidy dependency, allowing government funds to be redirected to critical sectors like education and healthcare. * Minimizes corruption risks by curbing misallocation of financial support. 1. **Environmental Benefits**: * Mitigates environmental harm by reducing intensive farming practices, preserving soil, forests, and biodiversity. * Aligns energy prices with environmental costs, encouraging cleaner energy alternatives. 1. **Accurate Pricing and Behavioral Incentives**: * Aligns energy prices with environmental costs, promoting sustainable consumption. * Improves food choices by reducing the unintended shift toward less nutritious options. 1. **Improved Producer Resilience**: * Farmers can enhance efficiency and access markets by diversifying income, adopting technology, or forming cooperatives.

Answer 282

1. **Economic Hardship for Producers** * Leads to a sharp decline in farm incomes, limiting investment in innovation and sustainability. * Increases risks of business closures, unemployment, and rural poverty, particularly for small-scale farmers. 1. **Food Security Risks** * Reduced agricultural output may worsen malnutrition and food shortages for low-income groups. * Decline in export surpluses could negatively impact trade balances and foreign exchange earnings. 1. **Higher Consumer Prices** * Rising food and energy costs disproportionately affect poor households, worsening inequality. * Consumer surplus declines as prices rise, leading to welfare losses. 1. **Short-Term Instability** * Sudden subsidy removal may cause supply shocks, price volatility, and social unrest (e.g., protests over fuel or bread prices). 1. **Potential Environmental Trade-Offs** * Desperate producers might resort to unsustainable practices (e.g., illegal logging) to offset lost income, worsening environmental damage. 1. **Transition Challenges** * Lack of alternative safety nets (e.g., unemployment benefits) in developing economies could deepen poverty during the adjustment period

Answer 283

* Floating exchange rates help countries absorb external shocks by adjusting currency values, boosting export competitiveness during crises. * They reduce the need for central bank interventions and large foreign reserves, easing monetary policy management. * Floating systems attract foreign investment by eliminating the need for capital controls on currency flows. * Market-determined exchange rates are not inherently volatile and prevent unsustainable defense of fixed rates.

Answer 284

* A floating currency suits countries with a low trade-to-GDP ratio, as exchange rate fluctuations have a smaller impact on trade balance and inflation. * Smaller nations or those with limited reserves may prefer a shared currency, like the euro, for stability. * Economies with a dominant trade partner might favor a pegged currency to maintain trade advantages.

Answer 285

* Micro-credit - small scale loans * Micro-savings - savings clubs provided by charoities * Micro-insurance - safety net to prrevent people from falling back into extreme poverty * Remittance management

Answer 286

* Helps overcome the savings gap which limits entrepreneurship * High rates of repayment because the system is built on social capital/trust * Provides loans to people that would otherwise be able to recieve them - e.g. women. * Provides money for investment and entreprueneurial activity * Helps the poor to increase their incomes so reduces poverty and increases standards of living, e.g. means poor families can afford school fees. * Should increase growth and reduce unemployment.

Answer 287

* Low success rate for new small businesses * Alleged forcible collection of debt in many villages – this is hard to monitor * Perhaps relatively ineffective compared to the impact of migrant remittances & foreign direct investment * May be difficult to get off the ground because locals don't want to take a risk and get into debt. * Lack of education may mean locals don't understand what micro-finance loans are and what the terms are. * Micro-creditors may take advantage of debtors and charge extortionate rates of interest - India's SKS charges between 23-35%. * Not actually used for investment - instead used to pay for weddings, school fees. * Mental health issues. * Reduction in other forms of aid

Answer 288

* Private companies have a profit incentive to cut costs and be more productively efficient - no more corruption * Government gains revenue from the sale of assets and no longer has to support a loss-making industry * If a state monopoly is replaced by a number or firms this extra contestability in an industry will lead to lower prices which helps to increase the real incomes of poorer households * The competitiveness of the macro economy may improve especially if privatisation leads to increased investment and benefits from economies of scale. Improved competitiveness will then drive higher exports and long run GDP growth

Answer 289

* Social objectives are given less importance because privately-owned firms are driven by the profit motive * Some activities are best run by the state operating in the public interest because they are strategic parts of the economy e.g. water supply, steel and railways and have the characteristics of a natural monopoly * Government loses out on dividends from any future profits * Public sector assets are **often sold cheaply**, and the privatisation may suffer from **corruption** * Privatisation leads to **job losses as firms increase their efficiency** – this increases the risk of poverty for those affected especially if they are structurally unemployed * Unless privatised corporations are **regulated effectively**, there is a risk of creative private monopolies who use their market power to increase prices and profits, this can have a regressive effect on the distribution of income.

Answer 290

* **Protecting domestic industries** . This can help to ensure that domestic industries are able to grow and develop, and that they are not undercut by cheaper imports. (Import substitution / infant industry argument) * **Generates tax revenues for the Brazilian government**. revenue can fund investment in infrastructure, provision of public & merit goods * **Import tariffs can support domestic jobs and investment** and thereby promote growth & development by lifting per capita incomes

Answer 291

* **Higher prices**: Tariffs can lead to higher prices for consumers which reduces real incomes and can worsen relative poverty. * **Productive inefficiency**: Protectionism can lead to emergence of X-inefficiencies and reduced innovation / dynamic efficiency * **Risk of tit-for-tat trade wars**: Where countries impose tariffs on each other's goods with escalating measures. (Game theory)

Answer 292

* **Enhanced Productivity**: Human capital development, particularly in education and skills training, increases the productivity of the labour force. * **Poverty Reduction**: By improving the skills and employability of the population, human capital development enables individuals to secure higher wages. * **Innovation and Technological Advancement**: A well-educated and skilled workforce is more likely to engage in research, development, and innovation. * **Foreign Direct Investment (FDI)**: Companies are more likely to invest in countries with a well-educated and skilled workforce, as it reduces their training costs and improves the overall business environment. * **Economic Diversification**: A skilled labour force can reduce a country's reliance on a single industry or sector, making its economy more resilient.

Answer 293

* **Financial Barriers**: Many families in low-income countries struggle to afford school fees, uniforms, books, and transportation. This can lead to children dropping out of school to contribute to household income. * **Lack of Access to Schools**: In rural and remote areas, schools may be inaccessible or too far from students' homes. * **Quality of Education**: Inadequate resources, poorly trained teachers, and overcrowded classrooms can result in a low-quality education. * **Gender Disparities**: Gender bias often prevents girls from attending school, particularly in societies where traditional roles and early marriage are common. * **Cultural and Social Norms**: Some cultural norms and practices may prioritize child labor or discourage education, particularly for girls or marginalized groups.

Answer 294

1. Strategies to improve nutrition and reduce the extent of stunted growth among young people 2. Other health interventions can increase school attendance - a famous study in Kenya by Esther Duflo found that deworming in childhood reduced school absences while raising wages in adulthood by as much as 20% 3. Increased investment in primary and secondary schooling 4. Incentives to attract an inflow of skilled migrant workers and curb 'brain drains' of highly qualified people 5. Investment in training to re-skill people at risk of structural unemployment from the fast-changing pattern of employment including robotics and AI 6. Cash transfer interventions can increase demand for education, especially among the poorest families who must make hugely difficult decisions about how to spend a meagre budget

Answer 295

**Above equilibrium price** * Reduce import costs and input prices (increased competitiveness) * A more stable currency - encouarges investment as firms know in advante their export revenues and imported input costs * Make debt easier to repay. **Below equilibrium price** * Keep goods cheap to make exports more internationally competitive. * Encourage FDI * Prevents primary product exports from appreciating exchange rates - Dutch disease (If set below equilibrium) **General** * **Price Stability**: If a currency is depreciating, it can lead to higher inflation due to increased import prices. Central banks can use interventions to moderate these fluctuations and maintain price stability. * **External shocks mitigation**: A managed floating exchange rate helps developing and emerging market countries withstand external shocks. These include changes in global commodity prices or economic crises in major trading partners, by allowing the currency to adjust to shifting external conditions.

Answer 296

* Not all countries have central banks with sufficient reserves of gold and foreign currency to make intervention in a currency market effective. * There can be political pressure on central banks to intervene in the foreign exchange market for short-term political gains, which may not be in the long term economic interest of the country. * Other countries might regard managed floating as a form of trade protectionism which in turn might lead to the risk of retaliatory action * Maintaining a managed exchange rate may reduce the incentive for a country to implement necessary economic reforms. Governments may rely on the exchange rate as a temporary fix rather than addressing structural issues.

Answer 297

* Navigate around exploitation by TNCs. * The government can insist that any investment that takes place has to be in joint venture with a local company. shared ownership * Profits always stay in the country and the circular flow, knowledge and infrastructure is retained. * **Access to better technology and expertise:** Can help developing countries to improve labour productivity and competitiveness. This will lift per capita incomes. (Improved human capital / knowhow) * **Job creation**: Joint ventures can create jobs. This helps to reduce unemployment, creates positive multiplier effects, raises factor incomes and can generate extra tax revenues for the government. * **Savings Gap and Export Potential:** Investment linked to joint ventures helps to overcome a domestic savings gap. And can promote an increase in productive capacity and capabilities.

Answer 298

* One way to reduce MNCs exploiting developing countries is by making foreign firms establishes joint ventures with local firms - shared ownership * This obliges the MNCs to share profits with a local firm * As a result, not all of the profits are sent back to a foreign country * Also results in a transfer of knowledge from the MNC to the firm in the developing countries

Answer 299

* **Dominant partners**: Potential ceding of control to multinational organisations who might take a majority stake in the joint venture. * Joint ventures might lead to **exploitation of workers and the environment** in low-income nations. Much depends on the quality of government & extent of corruption

Answer 300

* Schemes run by the government, a group of countries or a group of producers to stabilise the price of a product. * E.g. International Cocoa Organisation (ICCO), International tin council (ITC) * They buy and sell on the open market to maintain minimum and maximum prices of the product. * Buffer stock schemes operate in commodity markets where prices are volatile.

Answer 301

* **Cobweb theorum** - This year's output is based on last year's prices. * Producers assume that high prices will persist - they all invest and increase their output. Leads to a fall in prices. * Produces assume that low prices persist - they will decrease their output, increasing the price. * **Inelastic demand and inelastic supply** * Price changes are more than proportionate.

Answer 302

* There is a price ceiling and a price floor * If the price goes above the price ceiling (P2), buffer stock scheme sells x-y of stock to bring down price below the price ceiling. * If price goes below price floor (P1), buffer stock scheme buys a-b of stock to maintain price above price price floor.

Answer 303

* Under this system, the scheme tries to maintain the price at a target price Pt. * If supply > S1 the scheme buys up A-B to maintain the price target. * If supply < S1, the scheme sells back E-F to the market to maintain the price target.

Answer 304

* Stabilises income of producers * Protects jobs * Stabilises prices for consumers - some commodities are necessities - e.g. wheat, rice. * Improves the balance of payments - importnant for countries that are primary product dependent. * Reduces monopsony power of buyers, e.g. MNCs and coffee. * Firms can force prices up * **Investment**: When prices are stable, producers are better able to plan and invest, in new capital which can lead to increased yields and improved quality. This, in turn, can lead to higher per capita incomes and a reduction in extreme poverty. * **Food security**: In low-income countries, buffer stock schemes can help ensure food security by maintaining adequate supplies of key commodities. This can help prevent food shortages and price spikes for example after an external shock.

Answer 305

* Costs - admin & storage costs are high. * Could encourage over production * Prevents exit of inefficient producers * Large scale producers may benefit more than the small scale producers it's supposed to protect - they have EOS. * Fee to join the scheme * **Management**: Governments may struggle to effectively manage a scheme in poorer rural areas with limited storage infrastructure and technical expertise. Inadequate storage facilities can lead to falling quality of stocks which command lower prices * **Inefficiency**: Prices might be set too high – favouring producers – which in the long run leads to over-production, surpluses mounting and risks causing environmental damage. These externalities might be seen as a form of government failure.

Answer 306

1. **Subsidies**: Governments can provide subsidies to farmers, either in the form of direct payments or through subsidies for inputs such as fertilizers and seeds. This can help reduce the cost of production and increase the competitiveness of farmers. 1. **Agricultural insurance**: Governments can offer insurance programs that provide protection against crop losses due to weather events or other factors. 1. **Rural infrastructure**: Governments can invest in infrastructure such as roads, water supply, and electricity, which can improve productivity/competitiveness of farmers. 1. **Market information systems**: Governments can invest in market information systems that provide farmers with real-time information on prices, supply and demand 1. **Farmer cooperatives**: Governments can support the development of farmer cooperatives, which can help farmers increase their relatively bargaining power against monopsonistic buyers. This can help farmers negotiate better prices for their products.

Answer 307

A developing economy split into two sectors: 1. Traditional rural/agricultural sector (low productivity, surplus labor). 1. Modern urban/industrial sector (high productivity, capital-intensive).

Answer 308

Surplus rural laborers can move to the urban sector without reducing agricultural output due to underemployment in subsistence farming.

Answer 309

Excess labor supply keeps wages low; only rise after the Lewis Turning Point (surplus labor exhausted).

Answer 310

Profits from industry are reinvested to expand production, creating jobs and absorbing rural migrants

Answer 311

1. Initial phase: Labor shifts from rural to urban sectors. 1. Growth phase: Urban sector expands via reinvestment; rural sector shrinks. 1. Turning point: Rural surplus labor dries up, wages rise.

Answer 312

When surplus rural labor is exhausted, causing rural wages to rise and signaling transition to a mature industrial economy.

Answer 313

* Oversimplifies rural productivity (ignores potential agricultural innovation). * Assumes rigid wages and unlimited labor (not always realistic). * Neglects urban unemployment or informal sector challenge * Forced industrialisation has tended to lead to a waste of scarce resources because the industries have failed. Government failure * Encouraging rural depopulation will simply lead to urban poverty, not increased affluence.

Answer 314

Focus on **industrialization** and **labor reallocation** to modern sectors for structural economic transformation.

Answer 315

* Industrialisation: the Lewis model * Development of tourism * Development of primary industries * Fairtrade schemes * Aid * Debt relief

Answer 316

* Employment creation, tourism tends to be a labour-intensive industry * Tourism typically employs a higher percentage of women and younger people starting out in the labour market * Export earnings – it generates important foreign exchange (US$s) * Important source of diversification for many smaller countries – helps them move away from primary product dependency * Gives a boost to AD - creating local and regional income-multiplier effects * Accelerator effects from capital investment such as in airlines, roads and telecoms – leads to an increase in long run aggregate supply (LRAS)

Answer 317

* Exploitation of local labour by overseas transnational tourist businesses (monopsony) * M/any workers in tourism are migrants suffering from poor employment conditions * Outflow of profits from foreign-owned resorts. * All-inclusive deals often ignore the local economy – reduces the multiplier effect * Negative externalities – for example from construction, congestion and increased waste as tourist resorts expand * Rising property prices can make housing less affordable for local people. Wider risk of increasing inflation if tourism causes a domestic economic boom. * Deepening pressures on local cultures + concerns with security and public health

Answer 318

Initiatives ensuring fair payment for producers in developing countries, promoting sustainable farming, and improving working conditions by setting minimum prices and offering community development premiums.

Answer 319

* **Income Generation:** Ensures that producers receive a minimum price. Helps stabilize income and provide a safety net against global price volatility. Counter balance to monopsony power * **Market Access:** Fairtrade certifications allow small scale producers with access to consumers in higher-income global markets that they might not have been able to reach without the certification. Leads to increased sales, higher revenues and profits could fund capital reinvestment * **Community development**: Fairtrade initiatives sometimes include funds for community development profits e.g. schools, healthcare facilities * **Environmental Sustainability:** Fairtrade includes environmental standards and promotes sustainable agricultural practices

Answer 320

* **Limited sales**: Often criticized for its limited reach. Not all producers reach the certification requirements and many small-scale farmers remain excluded * **Certification Costs**: Obtaining and maintaining Fairtrade certification can be costly. These costs might be prohibitive for some smaller producers and co-operatives * **Market Dynamics:** Impact can be limited in markets where it constitutes a small fraction of total sales. In some sectors Fairtrade producers may struggle to compete with non-certified products in terms of price * **Complexity and Bureaucracy:** It can be complex and bureaucratic, particular for small producers who may lack the resources to navigate it effectively.

Answer 321

* Calculated to cover the cost of sustainable production and provide a reasonable livelihood for the farmers and workers * Acts as a safety net for producers. Typically set at 15% above the commercial price * Protects small scale farmers from market fluctuations

Answer 322

* **Debt Forgiveness** – The complete cancellation of a country's debt by its creditors. Typically, only granted after a natural disaster of if a country has taken significant steps to implement economic reforms * **Debt Restructuring** - Involves the renegotiation of a country's debt terms with its creditors. May involve extending the maturity of the debt, lowering the interest rate, reducing the principal amount owed * **Debt Rescheduling**: Involves changing the schedule of the debt payments so that a country can meet its debt obligations without defaulting * **Debt Equity Swaps** - Involve exchanging a country's debt for equity in local companies or infrastructure projects. Can help to reduce a country's debt burden and promote economic growth

Answer 323

* Debt relief can help **alleviate extreme poverty** in low-income countries by freeing up funds for a government that can be used for healthcare, sanitation, education and other key social services * Debt relief might **stimulate growth** by enabling countries to invest in capital without being burdened by debt interest repayments. * Debt relief can provide **humanitarian relief** to countries that have experienced natural disasters or civil conflicts, which can further exacerbate their already fragile economic situations.

Answer 324

* Debt relief may create a **moral hazard** by encouraging countries to accumulate debt with the expectation that it will eventually be forgiven. This might encourage **fiscal irresponsibility** in the future. * Debt relief may also have a **negative impact on a country's credit rating**, making it more difficult for them to secure loans in the future. * Debt relief may be seen as **unfair or inequitable** to developing countries that have responsibly managed their government finances and do not receive similar relief. * Debt relief eased pressure on weak governments to be efficient and adopt good econoimc policies

Answer 325

Is money or technical assistance given by one country to another to promote economic and social development

Answer 326

* **Project Aid**: Financing projects for a doner such as irrigation systems, hospitals * **Technical assistance**: Funding of expertise such as engineers, medics * **Humanitarian aid**: Emergency disaster relief, food aid, refugee relief and disaster preparedness * **Soft loans**: A loan made on a concessionary basis such as China – Africa * **Tied aid**: Projects tied to suppliers in the donor country * **Debt relief**

Answer 327

* Overseas aid can play a role in stabilizing post-conflict environments and in disaster recovery * Long-term aid for health and education projects - builds human capital and stronger social institutions. * Targeted aid that lifts trend growth rate of poorest countries benefits donor countries as external trade grows * Fill the savings gap * Consumers in developing countries have low incomes and therefore save very little. Savings are lower than the level required to generate high economic growth (according to the Harrod Dommar model). Inflows of foreign capital, supplied by foreign aid would help fill the savings gap. * Provides funds for infrastructure and development, HUMAN CAPITAL– therefore creates jobs, a multiplier effect and growth. Help a country MOVE AWAY FROM PPP * Cover the FOREIGN CURRENCY GAP * Export revenues are likely scarce. Foreign aid would provide foreign currency to import machinery, capital equipment and essential raw materials. OR basic essentials like food to reduce abolsute poverty * Reduce absolute poverty

Answer 328

* Poor governance - aid might leave the recipient country. It can finance corruption by ruling political elites and reinforce their power * Lack of transparency – hundreds of $m is spent each year on aid consultants and high-income country non-governmental organisations * Dependency culture – heavy reliance on overseas aid might harm an entrepreneurial culture. Most aid is “tied” to the donor country in some shape or form * Aid may lead to a distortion of market forces and a loss of economic efficiency and might also cause higher rates of inflation * WHITE ELEPHANT PROJECTS - Much aid has been wasted on prestige projects E.g. Lotus Tower in Sri Lanka. Rather than schools. * Loans have to be repaid with interest. Current interest on world bank loans are 2.5% (Feb 2023)

Answer 329

* **Skcepticism of Centralized Planning**: Easterly is critical of large, top-down development programmes and centralized planning. He argues that such approaches often lack the flexibility and local knowledge required to address the diverse and complex needs of poor communities. * **Local Solutions**: Easterly advocates for more attention to local, context-specific solutions. He believes that local knowledge and bottom-up approaches are more likely to lead to successful development outcomes. * **The Role of Markets**: Easterly is supportive of market-based approaches and the importance of entrepreneurship in driving economic growth and development. He sees the private sector as a critical player in poverty reduction.

Answer 330

1. **Reducing poverty and inequality**: Direct cash transfers provide **a direct and effective way of reducing poverty and inequality** by giving money to people who need it the most. This improves living standards of low-income households and might reduce the Gini coefficient. It might also **reduce the scale of labour migration / possible brain drains**. 1. **Empowerment**: Direct cash transfers empower individuals by giving them the freedom to spend the money as they see fit. By providing a reliable and predictable source of income, cash transfers help households to plan and make investment in their own human capital. It can keep kids in school for longer. It can **improve mental health outcomes**. 1. **Stimulating local economies**: Direct cash transfers can stimulate local economies by **increasing demand**. This can lead to increased economic activity and formal job creation, especially in areas where there is **high unemployment and under-employment** 1. **Cost-effectiveness**: Cash transfers may be less expensive to administer than **in-kind transfers** (such as food or clothing), which can be more difficult to distribute and monitor.

Answer 331

1. **Sustainability**: Critics argue that direct cash transfers may not be sustainable in the long run, as they do not address the root causes of poverty and inequality, such as lack of access to education, health care, and employment opportunities. 1. **Dependency**: Some argue that direct cash transfers may create a culture of dependency among recipients, perhaps discouraging them from seeking employment. This might perpetuate the cycle of absolute poverty. 1. **Inflation**: Direct cash transfers may contribute to inflation by increasing demand for goods and services such as food. If prices rise, the real purchasing power of transfers may be eroded, reducing impact on poverty reduction 1. **Corruption**: There are concerns that direct cash transfers may be subject to corruption, with government officials or others embezzling funds or diverting them to politically connected individuals or groups.

Answer 332

Established in 1945 to promote international monetary cooperation Functions * Surveillance – Monitoring the global economy and providing policy advice * Financial assistance – lending to member countries facing balance of payments problems * Technical assistance and training to member countries

Answer 333

* **Austerity Measures and Social Impact** - IMF programmes often improve austerity measures – reducing spending and subsides, which can lead to negative social impacts such as increased poverty and inequalities * **Debt Sustainability** – Loans can contribute to a country's debt burden if not managed effectively. Critics say that the institution should do more to ensure that borrowing countries maintain sustainable levels of government debt * **Financial Sector Deregulation** - Promoting financial sector deregulation, which some say has contributed to financial crisis in the past * **Lack of Accountability** - Some say that the IMF is not sufficiently accountable for its policy recommendations and their consequences, making it challenging to hold the institution responsible for any negative outcomes

Answer 334

Established in 1944, is a group of 5 institutions Main objectives include 1. Providing financial and technical assistance to developing countries 1. Reducing poverty and fostering sustainable economic development 1. Supporting infrastructure projects and social programmes Financial assistance comes in forms of loans, grants and policy advice

Answer 335

* Critics of the World Bank argue that the **institution is risk averse, hugely over-staffed and overly sensitive to criticisms of their flagship projects** and with multi-million-dollar expense accounts in stark contrast to their original mission * The institution has been criticized for being **influenced by more powerful member countries,** potentially leading to decisions that favour those countries' interests over those of smaller or poorer nations * **Infrastructure-Centric Approach**: Some contend that the World Bank's emphasis on infrastructure projects may **neglect crucial areas such as education, healthcare and social services** * Climate change: Critics claim the World Bank has failed to adequately address the scale of the global climate crisis, alongside its traditional mission of alleviating poverty

Answer 336

Not for profit groups – focus on environmental improvements, community developmental and human rights E,g, 1. Oxfam 1. WWF (world wildlife foundation)

Answer 337

Any place or system that provides buyers and sellers the means to exchange goods/services and trade financial instruments * These include bonds, equities, international currencies, and derivatives

Answer 338

* Facilitate savings. * Lend to businesses and individuals. * Facilitate payment systems. * Provide forward markets. * Provide a market for shares (equities).

Answer 339

* Banning market rigging - jail sentences * Liquidity ratios, * Preventing the sale of unsuitable products * Maximum interest rates to prevent consumer exploitation and prevent excessively risky lending * Deposit insurance to protect consumer reposits. * Cap on bonuses

Answer 340

* **Bond Market** – 2021 estimated that global corporate bond market worth $10 trillion * **Stock Market** – Overseas firms can list on the UK stock market * **Currency Market** – Trade in currency markets traded $6.6 trillion per day in 2021 * **Mortgage Market** - there are 11 million outstanding mortgages in the UK as of May 2021

Answer 341

* **To finance a business start-up** – hundreds of thousands per year, over a thousand per day on average * **Finance a merger or a takeover** – value of M&A in 2019 amounted to $3.7 trillion * **Finance Capital investment** – in 2019 business investment grew by 1.8%

Answer 342

* The money market is a financial market for short-term, highly liquid debt securities. * It includes instruments like Treasury bills, commercial paper, and certificates of deposit. * Participants include banks, financial institutions, and corporations seeking short-term financing or investments.

Answer 343

* The capital market deals with long-term debt and equity securities. * It encompasses the primary market (where new securities are issued – for example when a business floats on one or more stock markets) and the secondary market (where existing securities such as bonds and shares are traded). * Securities in the capital market include stocks, bonds, and real estate investments.

Answer 344

* The foreign exchange market is where currencies are bought and sold. * It facilitates international trade and investment by enabling the exchange of one currency for another. * The forex market operates 24/5 and is decentralized. * The most heavily traded currency is the US dollar ($)

Answer 345

Money supply measures total available money, categorized by liquidity: * M1 (Narrow): Physical currency + checking deposits (liquid, daily transactions). * M2/M3 (Broad): Savings/time deposits, near-money (less liquid) Total = M1 + Broad aggregates (M2, M3, etc.).

Answer 346

* Digital money, also known as electronic money or digital currency, refers to a form of currency that exists solely in electronic or digital form. * It does not have a physical counterpart like paper money or coins. * Digital money is used for various types of transactions, including online purchases, electronic fund transfers, digital payments, and peer-to-peer transfers. * It has become increasingly prevalent with the growth of e-commerce, digital banking, and the development of new financial technologies.

Answer 347

* **Convenience**: Digital money provides unparalleled convenience for conducting transactions. Eliminating the need for physical cash or in-person visits to banks. Mobile money technologies have accelerated. * **Globalization**: Digital money facilitates rapid cross-border payments. * **Security**: Many digital money systems incorporate robust security measures, including encryption and authentication, to protect users' financial information. These security features reduce the risk of fraud, theft, and counterfeiting. * **COVID-19 Pandemic:** The pandemic prompted more people to embrace contactless payment methods to reduce the risk of virus transmission.

Answer 348

Finance from shareholders the issue of new shares/stocks which carry voting rights

Answer 349

Borrowing money – requires paying interest (on loans) and may also need security

Answer 350

**Debt**: Debt represents borrowing by individuals or organizations. * It involves periodic interest payments and repayment of the principal amount at maturity. * Bondholders are creditors with a claim on the issuer's assets but no ownership stake. **Equity**: Equity represents ownership in a business or an asset. * Equity holders are shareholders or owners who have a residual claim on the assets and earnings of a company. * Equity securities include common stock and preferred stock.

Answer 351

Corporate Bonds – From a company (lending money to a firm) Government Bonds – From a government (lending money to government) 1. Bond is a loan 1. Repaid when the bond matures 1. Also pays annual interest 1. Market trades the bond after issue

Answer 352

Bond prices and market interest rates are inversely related. When market interest rates rise above a bond's coupon rate, the bond's fixed payments become less attractive than those of newer issues, causing its price to fall. Conversely, when interest rates decline, the fixed payments become more appealing, and the bond's price rises.

Answer 353

A bond yield is the bond's coupon expressed as a percentage of its current market price. For example, if a bond pays a coupon of £1,000 and its current market price is £20,000, the yield is £1,000/£20,000 x 100 = 5% .

Answer 354

New bonds offer higher coupons, making existing bonds with lower fixed payments less desirable, reducing their market price.

Answer 355

* **Inflation risk**: Countries with higher actual and expected inflation will have higher bond yields to compensate investors for the expected loss of real purchasing power. * **Default risk**: Countries with higher national debt or and/or persistently large fiscal deficits will usually have higher bond yields as investors demand compensation for the increased risk of default.

Answer 356

* **Debt service costs**: The government will have to pay more in interest payments on its outstanding debt. This might reduce the financial resources available for spending on education, NHS and other priority areas. * **Currency appreciation**: High bond yields might attract inflows of financial capital (hot money) from overseas which could then cause a currency appreciation. This will help control imported inflation but might worsen the price competitiveness of export sectors

Answer 357

* **Role** – Investment banks specialize in activities related to capital markets, such as underwriting securities, facilitating mergers and acquisitions, and providing services to corporations * **Customer Focus** – Investment banks primarily serve corporations, institutional investors, and high-net-worth individuals * **Regulation** - They are subject to different regulations than commercial banks, often with a focus on securities and financial market operations

Answer 358

* **Underwriting** – assist in raising capital by underwriting securities offering (such as IPO). Buy securities from issue at discount price and sell to public at higher price, profiting from price difference * **Mergers and Acquisitions (M&A) Advisory** – Provide advisory services. Earn fees as a percentage of the transaction value. * **Trading and sales** – Engaged in trading activities in various financial markets, including stocks, bonds, currencies, commodities and derivatives * **Asset Management** – Manage investment portfolios for clients. Charge management frees as a percentage of the assets under management. Also performance fees based on investment returns.

Answer 359

Pooling money from a group of investors and use investment strategies to generate returns. Aim to generate returns that are not correlated to overall market and often considered to be high risk, high reward investment option Key characteristics * **Limited number of investors** - Typically have a limited number of investors, often have high minimum investment amount * **Diversified investment strategies** - Wide range of strategies including long and short position, derivate contracts and leverage. * **Use of leverage** – Use leverage to increase potential returns, but this can also increase the risk. * **High fees** - Charge high fees, typically a percentage of assets under management plus a performance fee based on returns

Answer 360

* Banks are licensed deposit-takers providing a range of savings accounts * They are licensed to lend money and thereby create money via new bank loans, overdrafts and mortgages * A commercial bank's business model relies on charging a higher interest rate on loans (or other assets) than the rate it pays out on deposits (or other liabilities) * This spread on assets and liabilities pays the operating expenses of a bank and helps them to make a profit

Answer 361

Leveraged loans are loans provided to companies with a high level of debt compared to their equity. These loans are typically used by companies with lower credit ratings and are issued by private equity firms or hedge funds rather than traditional banks. The key characteristics of leveraged loans are: 1. High debt-to-equity ratio: The company borrowing the loan has a high amount of debt compared to its equity, making it riskier for lenders. 1. Floating interest rates: The interest rates on leveraged loans are often variable, which means they can change over time. 1. Higher risk: Leveraged loans carry a higher risk of default, which is why they often have higher interest rates and fees than traditional loans.

Answer 362

* **Accepting Deposits**: Commercial banks offer safe and easily accessible deposit accounts, including savings accounts, checking accounts, and fixed deposits. * **Providing Loans**: They extend credit to individuals and businesses for various purposes, such as mortgages, business loans, and personal loans. * **Payment Services**: Commercial banks facilitate payment and fund transfer services through checks, electronic funds transfers, and online banking. * **Safekeeping of Valuables**: Some commercial banks offer safe deposit boxes for customers to store valuable items securely. * **Currency Exchange**: They provide foreign exchange services to facilitate international trade and travel.

Answer 363

* **Cash and Reserves** - Funds held in the central bank or as cash on hand * **Loans and Advances** - The money lent out to borrowers * **Investments** - Securities held by the bank, such as government bonds or corporate bonds

Answer 364

* **Deposits** - Funds held in customer accounts * **Borrowings** - Funds borrowed from other financial institutions * **Capital** - The bank's equity, including share and retained earnings

Answer 365

* **Fractional Reserve System**: Banks create credit by using the fractional reserve system, where they are required to hold only a fraction of their deposits as cash / liquid reserves and can lend out the rest. * **Money Multiplier Effect**: When banks lend out a portion of the funds deposited with them, these funds are deposited in other banks, creating a chain reaction of lending and increasing the money supply. * **Credit Creation Process**: As banks make loans, they effectively create new money in the form of additional deposits. This process multiplies the initial deposit and contributes to economic activity measured by GDP

Answer 366

* **Market forces** – the profitable lending opportunities to businesses and households can often fluctuate for example at different stages of the cycle * The **risks** of lending including default risk from the borrower * **Regulatory policies** such as minimum capital reserve requirements as part of regular bank stress tests * **Monetary policy** - level of policy interest rates set by the Bank of England influences total demand for loans

Answer 367

* **Interest-rate spreads** - Charging a higher interest rate on loans than the rate paid to savers * **Service Fees** – Fees charged when arranging business & personal loans * **Brokerage percentage**s – Many banks provide currency and share-dealing services and charge a brokerage fee for doing so

Answer 368

A non-performing loan (NPL) is a loan where the borrower has stopped making payments and is in default. The loan is considered non-performing when it is more than 90 days overdue. NPLs are a major concern for commercial banks because they represent a loss of revenue and can also have negative effects on the bank's capital and liquidity.

Answer 369

* **Economic downturns**: During economic downturns, businesses and individuals may struggle to repay their loans, leading to an increase in NPLs. * **Industry-specific issues**: Certain industries, such as construction may be more prone to NPLs due to the cyclical nature of their business. * **Credit standards**: When commercial banks loosen their credit standards, they may lend to riskier borrowers, leading to a higher probability of defaults. * **Fraud**: Some borrowers may intentionally default on their loans through fraudulent behaviour, such as falsifying financial information to obtain loans they can't repay. This is a type of financial market failure.

Answer 370

Banks must balance holding liquid assets to meet deposit withdrawals and fund operations with investing in higher-yield, often less liquid assets for profit. Higher liquidity ensures safety and quick access to funds but typically offers lower returns, while investing in less liquid assets can boost earnings yet increases risk. This trade-off is further managed by regulations, such as minimum liquidity requirements imposed by central banks, to safeguard customer deposits and maintain overall financial stability.

Answer 371

* **Poor management**: This can include taking on too much risk, making bad loans * **Lack of diversification** in the bank’s loan portfolio - for example, excessive lending to the volatile property market. * **Insufficient reserves to cover bad loans**: Banks must set aside a certain amount of money to cover the possibility of loan defaults * **Run on the bank**: A bank can fail if too many depositors withdraw their money at the same time, this is called a run on the bank. * **Economic downturns**: Recessions can lead to an increase in loan defaults and a decrease in the value of the bank's assets * **Regulatory failure**: Inadequate regulatory oversight can lead to risky practices, fraud and corruption, and ultimately bank failure.

Answer 372

* **Northern Rock**: This bank failed in 2007. The government had to step in and nationalize the bank in 2008. It was eventually sold to other investors including Virgin Money. * **RBS (Royal Bank of Scotland)**: RBS required a government bailout in 2008 due to its exposure to bad loans and toxic assets. The government took a majority stake in the bank, and it eventually returned to private ownership.

Answer 373

1. A credit crunch, also known as a **credit squeeze**, is a period when the availability of credit from banks decreases, making it harder for individuals and businesses to borrow money. 1. During a credit crunch, lending institutions may become more **risk-averse** and increase their lending standards, making it more difficult for borrowers such as households and businesses to qualify for new loans or to extend their existing debts. 1. Banks may also **call back loans** or reduce credit lines for existing borrowers. This can lead to a decrease in consumer spending and capital investment, which can slow down AD and perhaps cause a recession.

Answer 374

The crisis was triggered by the collapse of the **subprime mortgage market** in the United States, which led to a decline in the value of mortgage-backed securities held by banks and other financial institutions around the world. This caused a **decrease in the availability of credit** and shortly after, an economic recession. Commercial banks became more **risk-averse** and tightened their lending standards, making it harder for individuals and businesses to borrow money. **Credit supply contracted**

Answer 375

1. **Encourages Market Discipline**: Creates an incentive for financial institutions to adopt sound lending models and **avoid high leverage** 1. **Promotes Competition**: Challenger banks can step in whereas bail outs make financial markets less contestable – which is bad for customers in long run 1. **Avoids Moral Hazard**: Government bailouts create a **moral hazard** by providing a **safety net** for banks, which may encourage them to take on excessive risk, knowing that they will be rescued in the event of failure. 1. **Protects Taxpayers**: Bailing out failing banks can be costly to taxpayers. Allowing banks to fail means that losses are absorbed by shareholders and creditors of the bank, not taxpayers.

Answer 376

1. **Preventing Systemic Risk**: A bailout of a failing bank can prevent a bank run, which can trigger a domino effect leading to the failure of other banks in the financial system, creating a systemic risk 1. **Protecting Depositors**: Bailing out a bank can protect depositors' savings and reduce the risk of them losing their money. Deposits in UK banks are insured up to a certain amount. 1. **Externalities from financial market failure**: There are negative externalities from allowing a systemic banking failure – justifies intervention and regulatory reforms

Answer 377

Market failure happens when the price mechanism fails to allocate scarce resources efficiently or when the operation of market forces lead to a net social welfare loss.

Answer 378

1. Externalities from financial instability 1. Monopoly power in financial markets 1. Market rigging 1. Speculative bubbles/irrational behaviour 1. Moral hazard and attitudes to risk 1. Asymmetric information and complexity

Answer 379

A bubble exists when the market price of a financial asset is driven above what it should be such as a speculative boom in housing, crypto, NFTs, commodities or share prices. Speculation can be amplified by herd behaviour where many people take the same decision.

Answer 380

* Gold rushes in the late 19th century * Real estate bubbles * Dot com boom from 1997-2000 * Crypto-currencies

Answer 381

1. **Displacement stage** - excitement grows about a new product/emerging technology 1. **Prices boom** as demand surges + limited (inelastic) supply causing market prices to spike higher 1. **Euphoria** as more investors look to take advantage (Robert Shiller calls this "irrational exuberance") 1. **Profit taking stage** – some investors sell as they realise prices are out of line with fundamentals 1. **Panic** - the herd mentality switches to desperate selling and prices fall fast inflicting big losses

Answer 382

Herd behaviour is where individuals act in a certain way because they believe that others are acting in the same way, even if it may not be the most rational decision. * **Fear of missing out (FOMO)** - investors may feel a sense of urgency to participate in the rally, even if it is not based on sound analysis. * **Availability bias** - investors may place too much emphasis on recent information and ignore longer-term trends. * **Overconfidence** - investors may overestimate their ability to predict the market and make riskier investments. * **Social influence** - investors may be influenced by the actions of others in their social network or by media coverage

Answer 383

* The hot-hand fallacy is a cognitive bias that leads investors to believe that a series of successful investments is indicative of future success, even if it may be due to luck or randomness. * During a financial bubble, investors may become overconfident and continue to make investments based on the assumption that their previous success will continue. This can lead to over-investment in a particular asset, creating a bubble that is not sustainable in the long run. * The hot-hand fallacy can lead to irrational decision-making, as investors fail to recognize that their previous successes may not be predictive of future outcomes. This can result in significant losses when the bubble eventually bursts and the underlying asset's value plummets.

Answer 384

* In his book "Irrational Exuberance," Robert Shiller coined the term to describe the tendency of investors to become overly optimistic during economic booms, leading to a financial bubble. * Shiller argues that this exuberance can cause investors to ignore risks and make irrational investment decisions, leading to a bubble that eventually bursts, causing significant losses. * The concept of irrational exuberance is particularly relevant during periods of rapid economic growth, where investors can become overly confident and lose their ability to accurately assess the risks involved in investments.

Answer 385

**Prospect Theory** (Kahneman & Tversky) argues investors make irrational choices during financial bubbles by: * **Framing decisions around gains vs. losses:** They overvalue potential profits (e.g., "This stock could double!") and downplay risks (overweighting gains). * **Loss aversion**: Fear of losses outweighs desire for gains, leading to: * *Risk-taking*: Chasing high returns (e.g., buying overvalued assets). * *Holding too long*: Refusing to sell declining assets to avoid "locking in" losses. * **Result**: Overconfidence and herd behavior inflate bubbles. When the bubble bursts, loss-averse investors panic, deepening crashes (e.g., 2008 housing crisis). **Key insight**: Emotions distort rational risk assessment, fueling instability.

Answer 386

* Manipulating the market to make a gain at the expense of others. * Eg. Insider trading - using confidential information to buy or sell shares to your advantage. Causes misallocation of resources * For example if high profits of a firm are about to be announced, those with inside information can buy the shares first before the information is public * Banks can also collude to fix interest rates. (RBS and Barclays)

Answer 387

Occurs when there is imbalance in information between agents. For example, financial markets often use complex information – a borrower (such as a small business) has better information on whether they can afford to repay a loan than the lender.

Answer 388

Insider information is confidential, non-public data (e.g., mergers, earnings) that unfairly benefits traders. Using it (insider trading) is illegal, as it distorts market fairness, leading to fines, jail, or reputational harm. Laws prohibit exploiting undisclosed info to protect equal investor access. Key: Unethical advantage → legal penalties.

Answer 389

* **Credit risk**: Banks may have incomplete information about the creditworthiness of borrowers, which can lead to risky lending decisions. This can result in loan defaults and financial losses for the bank. * **Rating agencies**: Banks rely on rating agencies to assess the creditworthiness of borrowers and investments, but these agencies may not always have complete or accurate information. This can lead to inaccurate ratings and further misinformation in the market.

Answer 390

* **Adverse selection**: Insurers may not have complete information about the riskiness of policyholders, which can lead to higher premiums or lower coverage. Policyholders may also have an incentive to conceal information about their risk level, leading to more adverse selection. * **Moral hazard**: Insurance may lead to increased risk-taking by policyholders, since they are shielded from the full costs of their actions. For example, a driver with collision insurance may drive more recklessly than one without insurance.

Answer 391

Moral hazard exists in a market where an individual or organisation takes greater risks than they should do because they know that they are either covered by insurance, or that a government will protect them from any damage incurred as a result of those risks. For example, creditors might be insured from risk by prospects of a government (state) bail-out. Bail-outs may encourage risker behaviour

Answer 392

A financial crisis is a major disturbance / shock to financial markets, associated typically with falling asset prices and insolvency amongst debtors and intermediaries, which ramifies throughout the financial system, disrupting the market’s capacity to allocate financial capital.

Answer 393

* **Currency crisis** when a fixed exchange rate regime collapses, or a currency goes into a free-fall (depreciating rapidly) * **External debt crisis** – when a country cannot attract the capital needed to finance a current account deficit * **Sovereign debt crisis** – when a government cannot afford to pay the interest on their existing debts * **Banking crisis** – when stability of banking system is low leading to a sharp rise in savings deposits and possible run-on banks * **Broad financial crisi**s – which combines elements of all the above

Answer 394

* **The Venezuelan crisis (ongoing)** - an economic collapse characterized by hyperinflation, food and medicine shortages, and political instability. * **The Turkish currency crisis (2018)** - a sharp decline in the value of the Turkish lira, caused by economic mismanagement and political tensions with the United States.

Answer 395

* **USA financial crisis (2007-2008)** - known as the "global financial crisis," was caused by a collapse in the housing market and a wave of mortgage defaults. * **Greek banking crisis (2012-2015)** - caused by the country's debt crisis and the imposition of strict austerity measures, leading to a run on the banks and a loss of confidence in the Greek banking system.

Answer 396

* Financial market failures / behavioural finance * “Irrational exuberance” among investors – see the work of Robert Shiller * Increased complexity arising from financial innovation – such as mortgage bonds * The Minsky Hypothesis – where “financial stability breeds instability” * Macroeconomic and financial policy failures * Unintended consequences of financial deregulation as a supply-side policy * Banks too big to fail? Ever-riskier behaviour due to moral hazard * Failures of credit ratings agencies in pricing risk accurately * Structural changes in the global economy including economic imbalances including global savings glut and extended period of low /negative real interest rates

Answer 397

Many US banks began offering mortgages to subprime borrowers by relaxing lending standards. This led to a rapid rise in housing prices followed by mass defaults as the market collapsed.

Answer 398

The increased issuance of subprime mortgages drove housing prices up rapidly; however, when the market reversed, the high prices and defaults contributed to a major financial collapse.

Answer 399

The crisis was fueled by: * Relaxed lending standards and packaging risky mortgages into securities. * Speculation in the housing market, leading to overvaluation of properties. * The use of complex financial instruments paired with a lack of transparency in financial markets.

Answer 400

The repeal of the Glass-Steagall Act, which allowed banks to engage in riskier behaviors by mixing commercial and investment banking, was a significant factor.

Answer 401

Low interest rates and loose lending standards created an environment rich in easy credit, which led to a flood of subprime mortgages and toxic loans, ultimately fueling a housing bubble.

Answer 402

Credit rating agencies, such as Moody's and S&P, gave high ratings to junk securities—often backed by subprime mortgages—misleading investors about their safety.

Answer 403

They assess the creditworthiness of companies, governments, and other entities by assigning ratings (from AAA to D) that indicate the likelihood of debt repayment, which investors use to gauge risk.

Answer 404

They were criticized for: * Overrating subprime mortgage-backed securities, which later were downgraded. * Conflicts of interest due to payment by the banks issuing the securities. * A slow reaction in downgrading risky securities as the housing market deteriorated.

Answer 405

Because the agencies are paid by the entities they rate, this can create a conflict of interest and may incentivize inflated ratings to preserve business relationships.

Answer 406

* **Losses**: If people default on loans, a bank will suffer losses that erodes capital reserves and reduces its ability to lend. Investors may be unwilling to cover losses. * **Liquidity**: If a bank sees a sudden loss of confidence from depositors and investors, they may struggle to obtain fresh funding in the interbank market and face liquidity problems. This can cause a run on the bank.

Answer 407

Systemic risk is when the **failure of a single financial institution** leads to a **contagion effect** that spreads throughout the financial system and beyond, affecting the stability of the system perhaps **creating a wider crisis**.

Answer 408

* **Credit crunch** - where businesses and households find it difficult to obtain loans, which can in turn lead to a decline in capital investment by businesses and consumption causing weaker real economic growth. * **Fiscal effects** - Rising national debt if commercial banks are wholly or partially bailed-out by the government. This can lead to higher interest rates on bonds & more expensive mortgages and a medium-term rise in taxes

Answer 409

**For** * A bail-out can limit wider systemic risks and mitigate the negative consequences for the real economy. It can prevent negative externalities. **Against** * Letting banks fail can promote market discipline and prevent moral hazard. It encourages creative destruction as new banks and banking models replace failed institutions.

Answer 410

* **Credit risk** is the risk that a borrower will fail to repay their debt (bad debts) * **Liquidity risk** is when a bank does not have enough cash or liquid assets to repay depositors and other creditors if they want their money back.

Answer 411

A central bank is the monetary authority and major regulatory bank in a country. A central bank is responsible for monetary policy and maintaining financial stability. Examples of central banks * Bank of England (UK) * European Central Bank (ECB) for all member nations of the Euro Area * United States Federal Reserve (The Fed) * Bank of Japan (BOJ)

Answer 412

* **Setting interest rates**: Central banks adjust interest rates to control inflation and promote economic growth. * **Regulating banks**: They regulate banks to ensure they are financially sound and to protect depositors. * **Maintaining financial stability**: They act as a lender of last resort, providing liquidity to financial institutions in times of crisis. * **Issuing currency**: They are responsible for issuing and managing the country's currency. This might involve operating with a managed floating exchange rate. * **Conducting research**: They conduct research and provide advice to policymakers

Answer 413

The main interest rate set by a nation’s central bank. This is the rate of interest charged to commercial banks if they must borrow from the central bank when short of liquidity. Market interest rates often take their cue from changes in the Base Interest Rate.

Answer 414

* Rate of growth of real GDP and the estimated size of the output gap * Forecasts for price inflation * Rate of growth of wages and other business costs * Movements in a country’s exchange rate * Rate of growth of asset prices such as house prices * Movements in consumer and business confidence * External factors such as global energy prices and inflation in other countries * Financial market conditions including the rate of growth of credit / money

Answer 415

Lender of last resort is a role central banks play in times of financial distress. When other financial institutions are unable to provide loans, the central bank steps in to lend money to banks and other financial institutions. This prevents liquidity crises and helps to maintain financial stability. * **Emergency lending**: Central banks provide emergency loans to financial institutions in times of crisis to prevent their collapse and limit systemic risk. * **Discount window**: They also provide short-term loans to banks at a slightly higher interest rate than the market rate. This is known as the discount window. * **Collateral requirements**: Central banks require collateral from financial institutions as a condition for lending. This helps to mitigate the risk of default. * **Reputation**: Central banks are known as the lender of last resort due to their ability to provide loans in times of crisis, which can help to prevent financial panics.

Answer 416

* In 2012, the European Central Bank (ECB) provided emergency loans to banks in the eurozone to help stabilize the region's financial system. * In 2020, during the COVID-19 pandemic, central banks around the world acted as lenders of last resort to support their economies. For example, the Bank of England provided emergency loans to UK businesses and the Reserve Bank of India provided liquidity to Indian banks.

Answer 417

* **Issuing government bonds**: Central banks can issue and sell government bonds on behalf of the government to finance its budget and borrow money. * **Managing government debt**: Central banks can help governments manage their debt by buying and selling government bonds in the market, helping to stabilize prices and maintain liquidity. * **Providing advice**: Central banks often provide economic and financial advice to governments, helping them to make informed decisions about fiscal policy and other issues.

Answer 418

* **Operation of monetary policy** – setting base interest rates to meet the inflation target (2%). No direct intervention in the exchange rate – the UK operates a free-floating currency * **Lender of last resort** to the financial system during a liquidity crisis / credit crunch.

Answer 419

* **Lower interest rates**: By purchasing large amounts of government bonds, the central bank increases demand for these assets, which pushes up their prices and reduces their yields. This can lead to a fall in mortgage interest rates and corporate bond interest rates * **Currency depreciation**: Another effect of a large increase in QE by the UK central bank might be a depreciation of the currency. QE increases the money supply and some of this extra liquidity will leave the UK economy – sterling is sold – causing the pound to fall

Answer 420

* **Regulation and Supervision**: The FCA is responsible for regulating commercial banks, investment firms, insurance companies, asset managers, and consumer credit providers. It sets regulatory rules and standards for these firms, conducts prudential supervision, and ensures that they comply with applicable regulations. * **Consumer Protection**: The FCA focuses on protecting consumers by ensuring that financial products and services are fair, transparent, and not misleading. It enforces rules on consumer protection, including those related to the sale of financial products, conduct of business, and treating customers fairly. * **Market Supervision**: The FCA actively monitors financial markets to identify risks and emerging issues

Answer 421

* **Prudential Supervision**: The PRA is responsible for prudential supervision of banks, building societies, credit unions, insurers, and designated investment firms. Prudential supervision involves assessing and ensuring the financial soundness of these institutions to prevent financial instability. * **Setting and Enforcing Prudential Standards**: The PRA establishes prudential standards and requirements that financial institutions must adhere to. These standards encompass capital adequacy, liquidity, risk management, governance, and other aspects of an institution's financial stability. The PRA enforces these standards to ensure that financial firms maintain appropriate levels of financial resources to withstand economic and financial shocks.

Answer 422

* **Prudential regulation**: Require banks to maintain adequate capital to absorb potential losses and withstand adverse economic conditions. Use of stress tests. * **Direct interventions**: Setting maximum loan to valuation ratios in the mortgage market. Increasing the cash-to-deposits ratio for a commercial bank.

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