4.1 A global perspective pt2

Question 1

Why is infant industries a reason to place protectionist measures

Answer 1

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
* Allows domestic firms to grow
* To develop E.O.S - gives them leverage to compete with big, international cooperations around the world.

Question 2

Definition: sale of a G/S below its CoP

Why is ‘dumping’ a reason to place protectionist measures

Answer 2

Example: excess subsidies on given G/S will lead to excess supply so firms may sell them below CoP to other countries
* Countries where these products are being sold to will suffer
* Domestic industry cannot compete

Question 3

Why is domestic unemployment a reason to place protectionist measures

Answer 3

When firms outsource production or cetrain industries experiencing structural unemployment, govt will step in to protect jobs.

Question 4

Why is ‘unfair’ low cost labour abroad a reason to place protectionist measures

Answer 4

Many countries offer cheap labour & low-cost production due to poor environmental regulations. Protectionism can help apply pressure to bring about change in these countries

Question 5

Why is to improve the C.A. deficit a reason to place protectionist measures

Answer 5

When M>X
Amount of £ leaving to country to support foreign firms are greater than £ entering to support domestic firms

Question 6

Define tariff

Answer 6

A tariff is a tax on imported goods/services (customs duty)

Question 7

Using the trade tariff diagram, how does the supply curve represent marginal CoP

Answer 7

Every extra unit being produced from Q1 to Q3 is being produced at an extra cost when domestic suppliers are producing it than if world suppliers were producing it.
This means resources are being provided to inefficient prodcers when it should’ve gone to world suppliers.

Question 8

Analyse the trade tariff diagram

Answer 8

• Q1-Q2 represents excess demand
• W.S + tariff ↑ P from Pw to Pw + tariff
• Domestic D contracted ↓ Q2 to Q4
• Domestic S ↑ Q1 to Q3
• Quantity of M ↓ Q1Q2 to Q3Q4
• Govt revenue ↑ (tariff revenue generated for govt to collect)
• D.W.L of C.S and world effiency
• P.S ↑ and C.S. ↓

Question 9

Definition: physical limit on imports

Effect of import quota’s

Answer 9

• This limit is usually set below the free market level of imports
• As cheaper imports are limited, a quota raises the market price
• As cheaper imports are limited a quota may create shortages
• Some domestic firms benefit as they are able to supply more due to the lower level of imports
• This may increase the level of employment for domestic firms

Question 10

Effect of subsidies given to producers/ suppliers

Answer 10

• A subsidy lowers the cost of production for domestic firms
• They can increase output & lower prices
• With lower prices their goods/services are more competitive internationally
• The level of exports increases
• The increased output may result in increased domestic employment

Question 11

Impact of protectionism

Answer 11

• Higher prices for consumers, especially on G/S that can’t be produced domestically, e.g. bananas in the UK, increasing inflation globally
• Higher prices for consumers due to domestic firms facing less competition from abroad
• Less choice for consumers as imports become too expensive
• Fewer firms may decide to export due to increased cost/bureaucracy to abide by, reducing
  global competition and therefore lower global GDP, higher global inflation
• Reduction in comparative advantage globally leading to less productivity
• Increase in cost of raw materials for firms –> difficult for firms to remain price competitive in global market - sales volume fall, firms may layoff workers, fall in profits, hard to finance investment = fall in investment of innovation –> dynamic inefficiency
• Some X- orientated firms rely on M (vertical specialisation)

Question 12

Reasons countries protect themselves, as a chain

Answer 12

To give domestic firms a chance against MNCs and the comparative advantage of foreign trade rivals, especially for young domestic industries who haven’t reached their minimum efficient scale and older domestic industries. Protectionism also protects domestic employment, income and GDP through export led growth against leakages in their current account , and thus protecting domestic living standards. Countries may also try to protect themselves against unfair dumping of cheap products onto world markets, domestic firms can’t compete against. Also, some forms of protectionism allow the government to earn tax revenue to use in their domestic economies, and lastly, domestic governments may want to restrict the import of goods which may be demerit goods or create market failure. Ha Joon Chan advocates protectionism to allow developing economies to grow.

Question 13

Reasons against protectionism

Answer 13

• Many forms of protectionism, such as tariffs, are regressive affecting income inequality, causing consumers to pay more for something they used to pay less for.
• Prevents economies from fully utilizing their factor abundance and comparative advantage, and thus causing a loss of world efficiency and deadweight loss, distorting the price mechanism
• Can cause retaliation, like the US-China trade war from 2016
• No guarantee the tax revenue gained will be used to benefit the economy, due to corruption

Question 14

Components of BoP

Answer 14

• Financial account
• Capital account
• Current account
• Net errors and omissions

Question 15

What is the capital account

Answer 15

Recaords small capital flows between countries and is relatively inconsequential
E.g. Debt forgiveness, inheritance taxes, death duties, transfers of financial assets by migrants

Question 16

What is money flowing in and out the financial account referred to

Answer 16

Money flowing in is recorded as credit (+)
Monet flowing out is recorded as debit (-)

Question 17

What could a country do if theyre in a current account deficit ot surplus to balance the CA

Answer 17

Current account deficit= run financial account surpluses
Current account surplus= run financial account deficits

e.g. China is in a CA surplus, so they have lots of reserves (excess cash: selling more to the world than buying from world)- so they will invest in countries with a CA deficit like USA, investmemt must be safe and secure, have a good rate of return. This leads to a FA deficit

Question 18

4 marks

Explain the likely effect of a fall in the inflation rate, on the balance of trade.

Answer 18

1. Balance of trade is the difference in value between imports into a country and exports from the country
2. A fall in the inflation rate would mean that goods and services produced would appear relatively less expensive on the world market. Similarly, goods and services imported into the country would appear relatively more expensive
3. The demand for exports that are normal goods would increase
4. The balance of trade would improve

Question 19

What is expenditure reducing policy

Answer 19

• Aim to reduce spending on M in economy to decrease AD so people have low incomes= low MPM
  E.g. Contractionaly monetary policy, Increase I.R, decrease M.S
  Contractionary fiscal policy, decrease govt spending, increase taxation

Question 20

Evaluate expenditure reducing policy

Answer 20

• Conflict of objectives- low growth, unemployment, recession
• Consumer and business confidence- if its high, AD may not fall
• Ouput gap- if eocnomy is at Fe and AD falls, Y may not
• MPM

Question 21

Why is expenditure switching policy used to correct a CA deficit

Answer 21

To target certain M and reduce import expenditure
-Switch spending on M towards domestic G/S instead

Question 22

Demand side causes of CA surplus

Answer 22

• High Y abroad
• Low Y at home (domestic)- reduce D for M
• Weak E.R. (WIDEC)- More D for X so increased revenues , less expenditure for M

Question 23

Supply side causes of CA surplus

Answer 23

• Low relative inflation- X more competitive
• Low unit labour cots- high productivity, weak trade unions, low min wages
• Strong investment (capital, technology)
• Gains in CA
• New resources discoveries

Question 24

Consequences for CA surplus

Answer 24

• ↑(X-M), ↑AD, ↓ U, ↑ demand pull inflation
• Appreciation the E.R.- more D for currency then supply of it- upward pressure on E.R.
• Financial account deficit- buy too much debt from countries in CA deficit, whcih could be worthless assets= financial difficulty
• Can harm international relations- could be using excessive protectionism= retaliation, trade wars
• Sign of unbalanced economy: Too reliant on X (sales overseas)
  So not enough consumer spending, not enough production for domestic conumers e.g. China

Question 25

Define Exchange rates

Answer 25

The price of one currency in another currency

Question 26

Explain the floating exchange rate system

Answer 26

• As with any market, if there is excess demand for the currency on the forex market, then prices rise (the currency is worth more)
  In a floating exchange rate system this is called an appreciation
• If there is an excess supply of the currency on the forex market, then prices fall (the currency is worth less)
  In a floating exchange rate system this is called a depreciation

Question 27

Stronger£ (£ can buy more of another currency)

What can cause an appreciation in the £

Foreigners are demanding the pound so demand shifts right

Answer 27

• Increase in relative I.R.- greater rate of return
• Speculators anticipate increase in £
• Increase in FDI - foreign firms move to UK and pay more on capital, workers wages using £
• Increase in Y abroad- foreigners demand more X
• Increase in competitivness (higher unit labour costs, increase inflation, increase investment) - Higher D for X, more X sold. Increase in X earnings

Question 28

Weaker £ (£ is exchanged for another currency)

What can cause a depreciation in the £

Supply shifts right

Answer 28

• Decrease in relative I.R.- lower rate of return
• Speculators anticipate decrease in £
• Firms moving away from Britain
• Increase in Y domestically- demand more M, UK buy in other currency

Question 29

How to support a fixed E.R.

Answer 29

To support a fixed E.R, the govt or central bank is required to hold large amount of currency reserves

Question 30

How would an increase in I.R. manipulate E.R.

Answer 30

1. Increase I.R.
2. Incentivises foreign investors to hold their money in domestic banks
3. Hot money flow inwards
4. Increase in value of E.R.
5. Demand for currency increase

Question 31

How can floating E.R. correct a CA deficit in UK

Answer 31

• M>X - more S of of £ than demand for £
• Leads to depreciation in £ (downward pressure on E.R.)
• Leads to WIDEC
• Weak £, Imports Dear, Exports Cheap
• D for X increase
• Revenue generated from X will increase
• Expenditure for M fall, leakages fall

Question 32

What is speculation

Answer 32

Speculation: the vast majority of currency trades are speculative. Speculation occurs when traders buy a currency in the expectation that it will be worth more in the short to medium term, at which point they will sell it to realise a profit

Question 33

Advantages of floating exchange rates

Answer 33

1. Less need for currency reserves- domestic and foreign may not be viable and is costly
2. Useful instrument for macroeconomic adjustment
3. Partial automatic correction for a trade deficit
4. Reduced risk of currency speculation- E.R. should reach an equilibrium which reflects PPP
5. Freedom for domestic monetary policy- Use domestic monetary policy to deal with domestic issues in economy e.g. inflation

Question 34

Disadvantages of floating exchange rates

Answer 34

• Volatility- if E.R. keeps fluctuating, this decreases incentives for foreign investors to invest in domestic currency
• Self correction of trade deficits unlikely- other factors like speculative flows

Question 35

Advantages of fixed exchange rates

Answer 35

1. Decrease E.R. uncertainity- stable, promotes foreign investment, trade= EASIER
2. Some flexibility is permitted- got can devalue of revalue currency
3. Decreases cost of trade - reduced hedging (buy now to avoid again future E.R. rates increasing)
4. Discipline on domestic producers- cant rely on E.R. falling in value, to maintain competitivness, increase efficiency, invest in R&D + innovation

Question 36

Disadvantages of fixed exchange rates

Answer 36

1. I.R. effects- I.R. used to maintain a fixed E.R. which may lead to low growth, high unemployment
2. Large level of foreign currency reserves needed- expensive and not viable
3. Speculative attacks if E.R. set too low or too high- no guarantee that E.R. decided will correct PPP value- may be over/devalued

Question 37

Define beggar-thy-neighbour’ economic activity

Answer 37

The protection of the domestic economy by reducing imports and increasing exports.
It amounts to one economy manipulating its currency in an attempt to gain an economic advantage without consideration for the ill-effects it may have in other countries, or for some businesses domestically, who rely on imported resources or components.

Question 38

Define competitive devaluation

Answer 38

A competitive devaluation of an exchange rate occurs when one country deliberately acts to lower, that is depreciate, the external value of its currency, in order to secure a competitive price advantage.

Question 39

Consequences of competitive devaluation

Answer 39

• Lowering the relative price of the country’s X’s and subsequently increasing their volume –> provide an advantage for domestic economy
• This is because it will require less of the importing country’s currency to purchase the exported G/S
• Makes competitive M’s more expensive
• Competitive devaluation considered to produce ‘beggar-thy-neighbour’ effect
• M P’s of essential raw materials anf consumer goods rises in the economy that has devalued and domestic output and employment fall in importing economies.

Question 40

Evaluate the consequences of competitive devaluation

Answer 40

• Depends on exports PED- The more price elastic, then the country is likely to experience higher export volumes and higher export revenues
• The impact of the competitive devaluation on the wider macroeconomic variables of inflation, output and employment will depend on the openness of the economies involved. Those with greater reliance on imported rather than domestically produced goods will suffer the greatest negative consequence from this beggar-thy-neighbour economic activity. Higher import prices will contribute to higher inflation, which alone may reduce any significant export price advantages which might otherwise be expected

Question 41

Define international competitivness

Answer 41

The ability of a nation to compete successfully overseas to sustain improvements in living standards and output

Question 42

Factors determining international competitivness

Answer 42

1. ULC’s e.g. NMW, skills, productivity
2. Labour flexibility
3. Labour skills
4. Tax regimes- lower Y tax- attract workers from abroad, low CT= new capital, technology= improves efficiency
5. Innovation
6. Infrastructure
7. Regulation- enforces costs, elongates process of business
8. Economic stability

Question 43

Factors Influencing International Competitiveness

Answer 43

• Labor Costs: Lower labor costs can improve competitiveness.
• Production Efficiency: Efficient production processes reduce costs.
• Exchange Rates: Favorable exchange rates can make exports more competitive.
• High product quality and continuous innovation can enhance competitiveness.
• Investing in research and development (R&D) can lead to competitive advantages.
• Infrastructure and Logistics: Efficient transportation, communication, and infrastructure support competitiveness.
  Shortened supply chains can reduce costs and improve delivery times.
• Government Policies: Favorable trade policies, tax incentives, and regulations can boost competitiveness.
  Stable political environments and legal systems are crucial.

Question 44

Why would govt spending on infrastructure improve international competitivness

Answer 44

• Transportation e.g. new roads, bridges, airports, railways
• Improve efficiency- easier to move G/S around country and internationally
• Quicker and cheaper= lowers costs
• Productive efficiency
• Translates to lowers P’s
• Improves price competitivness

Question 45

Lower coorporation/ income tax & tax allowances on investment

Why would tax incentives improve international competitivness

Answer 45

• Lower coorporation- increased retained profits of business= investment on technology, capital, software, R&D, innovation- Lower CoP - Lower P’s
• Tax allowances on investment (up to a given threshold, if a firm ringfences profit, they wont be taxed)
• Gives an incentive for businesses to put more moeny aside to use to invest

Question 46

Why would deregulation improve international competitvness

Answer 46

e.g. stringent hiring and firing laws, environmental laws, health and safety standards
* Lowers CoP
* Improve productive effieciency
* Lowers P’s

Question 47

Benefits of Being Internationally Competitive

Answer 47

• Increased Exports: Competitive countries can sell more goods and services abroad, boosting economic growth.
• Job Creation: Export-oriented industries often create jobs, reducing unemployment.
• Higher Standards of Living: International competitiveness can lead to higher incomes and improved living standards for citizens.
• Foreign Direct Investment (FDI): Competitive environments attract foreign investment, leading to economic development.

Question 48

How does international competitivness lead to economies of scale

Answer 48

The benefits of higher levels of output can also arise through economies of scale. These are enjoyed by competitive firms who operate in multiple overseas markets, as well as all firms who compete successfully against imports in domestic markets. The increase in their scale of operation means that they are able to enjoy the benefits of falling average costs of production, including low prices, and higher profits.

If this competitiveness is due, in part, to external economies of scale (derived, for example, from investment in modern infrastructure) then firms generally may also be able to enjoy falling average costs and increase their competitiveness. The result will be an increase in productive efficiency that has an impact on the wider economy.

Question 49

A benefit of a high degree of international competitiveness is the control of domestic inflation.
Why is that?

Answer 49

A benefit of a high degree of international competitiveness is the control of domestic inflation. This is a result of efficiency gains associated with large scale production. The lower average cost of production will also impact on the domestic economy, where the increasingly efficient larger firms are able to pass on their cost savings in the form of lower domestic prices. This will help the economy to move towards allocative efficiency, because the prices charged are likely to more closely reflect the marginal cost of production.

Question 50

Problems of Being Internationally Competitive

Answer 50

• Trade Deficits: Uncompetitive countries may import more than they export, leading to trade imbalances.
• Economic Decline: A lack of competitiveness can result in declining industries and economic stagnation.
• Unemployment: Uncompetitive industries may shed jobs, leading to high unemployment rates.
• Income Inequality: A lack of competitiveness can exacerbate income inequality as some industries decline while others thrive.

Question 51

Asses the possible effects of the fall in the external value of the rupee on the Indian economy

Answer 51

• Improvement in CA of BoP –> X P’s fall= ↑ in volume of X sold and X revenues = ↑ competitivness
• M P’s ↑–> less competitive
• Increase in net exports (X-M) = ↑ AD = ↑in real GDP/ economic growth+ unemployment as firms hire more workers to increase output of X, fall in negative output gap
• Imported inflation: higher cost of imported raw materials and finished goods (magnitude depends on the extent to which these higher costs are passed onto consumers in the form of higher P’s)
• ↑ in debt burden for govt and for banks with external debts (but inflation would erode the real value of debt)

Question 52

Disadvantage of trade surplus

Answer 52

Domestic resources might be too focused on producing goods and services to meet the demand from export markets, rather than demand in the domestic market. Therefore, consumer sovereignty, choice, and the resulting domestic standard of living could be lower than it would otherwise have been without the trade imbalance
Can lead to an appreciation of their currency, as foreigners are demanding their currency, thereby reducing their export price competitiveness, and making increased import penetration possible.

Question 53

Evaluation

What might a trade deficit might not be significant

Answer 53

• Size of the imbalance: A small imbalance will have far less of a negative impact than a larger imbalance.
• Longevity of the imbalance is a key factor in determining the impact. A transient imbalance may be prompted by an ‘asymmetric shock, which will have far less of a negative impact than a long-term persistent imbalance.
• A deficit imbalance is not always a financial burden. The deficit could be financed without the need to borrow if the country has sufficient reserves. This would negate the impact of the pressures of significant loan repayments.
• The extent of the negative impact on domestic resources of a trade imbalance will be determined by the starting point of the economy. If there is already a significant negative output gap, then a deficit trade imbalance will have a greater adverse effect than if the economy is starting from a point of near capacity, or even a positive output gap.