§11 Trade and Integration - Knowledge

Question 1

5 ways of analysing international trade

Answer 1

1. Comparative advantage
2. Exchange Rates
3. BOP
4. Regional integration and trading blocs

Question 2

Sources of comparative advantage

Answer 2

1. Different factor endowments
2. Varying factor intensities of different outputs
3. Heckscher - Ohlin Theory

Question 3

Effects of international trade

Answer 3

1. Increase Global GDP (TPC > PPC)
2. Allows EOS exploitation
3. Increased competition, higher CS.
4. Dynamic efficiencies
5. Factor price equalisation

Question 4

Examples of dynamic efficiencies arising from international trade?

Answer 4

1. Knowledge and technology transfer

2. Licensing

Question 5

Terms of trade concepts

Answer 5

1. Definition … (other deck)
2. Formula… (other deck)
3. Mathematical causes of deterioration, improvement.
   - Good/bad scenarios for each.
4. Prebisch Singer

Question 6

Mathematical causes of deterioration , improvement in TOT

Answer 6

Improvement:
IAXP rises at rate faster than increase of IAMP
Det:
IAMP rises at a faster rate than the IAXP

Question 7

Good/bad scenarios for improvement/deterioration in TOT

Answer 7

TOT Improvements can be bad:
1. Higher domestic costs ....
2. Appreciation of domestic currency
TOT Good:
1. higher global demand ...
-- Follow through with detailed analysis.

Question 8

Reasons for short run volatility in commodity prices

Answer 8

1. PED and PES both

Question 9

Reasons for long run downward trend in primary commodity prices

Answer 9

1. Supply increases a lot
   - Technological progress
2. Demand increases but not by as much
   - Income inelastic demand

Question 10

Problems of comparative advantage in explaining trade patterns

Answer 10

1. Intra regional trade
2. Intra industry trade
   - - Seemingly at odds with Comp . Adv

Question 11

Summarise predictions of CA Theory for international trade patterns

Answer 11

1. Trade most likely where greatest divergence of DOCRs.
2. Inter regional trade
3. Inter industry trade

Question 12

3 reasons why CA may be too simple

Answer 12

1. Transportation costs -> intra regional
2. monopolistic competition among manufacturers –> inter industry
3. Regional trading blocks –> Inter industry and inter regional.

Question 13

3 exchange rate systems

Answer 13

1. Freely floating
2. Fixed
3. Semi-fixed / Semi-floating

Question 14

Reasons for demand and supply of currency

Answer 14

D (UK's X, K inflows) 
S(M from rest of world, K outflows)
1. Trade
2. Short term capital flows (hot money)
3. Long term capital flows (portfolio, direct investment)

Question 15

Advantages of freely floating regime

Answer 15

1. Leaves monetary policy free to inflation target
2. Enhances operation of monetary policy…
3. Mechanism for damping external economic shocks
4. Less speculation, less likely to be under/over valued persistently, convergence to PPP rate.

Question 16

Problems with freely floating regime

Answer 16

1. CB may not inflation target after all….??
2. Depr. not a sustainable way of maintaining competitiveness (factor price imports increase–>higher cost push inflation).
3. Lack of inflation control can produce run on currency
4. Depreciation in ER may not improve CA of BOP: J curve and Marshall Lerner condition.
5. ER instability with very sticky contracts (downward sloping supply even).

Question 17

How can a fixed ER be enforced?

Answer 17

1. CB intervenes in FOREX by (a) trading its reserves (b) changing forex restrictions to influence D+S to change ER to desired value.

Question 18

Advantages of fixed ER systems

Answer 18

1. Reduced ER uncertainty – facilitates more trade + Investment
2. Less OC of hedging on Futures - reduced cost of international trade.
3. Disciplines domestic firms - no change of depreciation improving their competitiveness

Question 19

Problems of fixed ER regime

Answer 19

1. opportunity cost of huge foreign currency reserves
2. Loss of control over domestic monetary policy
3. Speculative attacks - over/under valuation e.g. Black Wednesday ERM
4. International retaliation - e.g. USA and China antidumping and undervalued Yen.

Question 20

Causes of exchange rate flucutations

Answer 20

1. Rates of inflation
2. Interest rates
3. Rates of EG
4. Labour productivity
5. International competitiveness (all determineLR capital flows and demand for imports/exports)
6. Speculation (SR)

Question 21

Consequences of ER fluctuations

Answer 21

1. Balance of payments SR LR MLC J Curve
2. Imported inflation
3. Consumer surplus/producer surplus
4. Profit margins of lower factor import prices
5. Risk and uncertainty – discourages trade?
6. Response: pricing goods for export market / monetary union.

Question 22

Causes of BOP CA deficit (trade deficit)

Answer 22

1. High consumption / national income
2. High investment spending - imports of capital goods from abroad
3. Change in comparative advantage
4. Overvalued ER
5. Structural weakness - low investment, high ULCs/low productivity, poor non price competition.

Question 23

Policies to correct deficit on CA of BOP

Answer 23

1. Where there’s confidence in a country’s external debt usually no need.
2. otherwise Trade deficit becomes unsustainable :
   (a) Expenditure reducing
   (b) Expenditure switching
   (c) Supply side

Question 24

Examples of expenditure switching policies

Answer 24

1. Depreciation in ER
2. Tariffs on imports
3. Subsidising exports.

Question 25

Problems of expenditure switching policies

Answer 25

1. Depends on PED / PES - MLC J curve
2. Higher import prices –> higher inflation?
3. Retaliation / WTO sanctions
4. Loss of consumer surplus and DWL

Question 26

Expenditure reducing - examples

Answer 26

1. Raise T
2. Reduce G
3. Raise Interest rates

Question 27

Problems with Expenditure reducing

Answer 27

Reduce jobs and income – recessionary!!!

Question 28

SSPs - exmaples

Answer 28

• Tackles CAUSE of Trade deficit
• Raising productivity
  Reducing domestic inflation
  Reducing ULCs
  Raising Investment and Productivity