4.1 International Economics

Question 1

globalisation

Answer 1

• globalisation is the ever increasing integration of the word’s local, regional, and national economies into a single international market

Question 2

characteristics of globalisation

Answer 2

• increase in free trade in goods and services, e.g. China - export-led growth
• free movement of capital between countries
• free movement of labour between countries
• free interchange of technology

Question 3

factors contributing to globalisation

Answer 3

• trade in goods; developing countries have acquired capital and knowledge to manufacture goods, and it’s easier to transfer them due to efficient transport. MNCs move production abroad to countries with cheaper labour which allows developing countries to trade with developed ones
• trade in services; e.g. trade of tourism, call centre services and software production has risen from developing countries to developed countries
• trade liberalisation; growing strength of WTO (advocates free trade) has contributed to the decline in trade barriers
• multinational corporations (MNCs); growth of MNCs (companies who control production in multiple countries) means they take advantage of economies of scale and lower costs of production
• international financial flows; flow of capital and FDI across countries has increased due to the removal of capital controls
• communications and IT; spread of IT has made it easier and cheaper to communicate which increased interconnectedness - better transport links and easier transfer of info
• containerisation; cheaper to ship goods across the world as goods are distributed in standard sized containers so they’re easier to load and cheaper to distribute, thus reducing costs and increases competitiveness

Question 4

impacts of globalisation on individual countries

Answer 4

• trade imbalances between countries, e.g. US runs a large current account deficit with China who runs a large surplus
• income and wealth inequalities within countries if benefits and costs of globalisation aren’t evenly spread
• inequality between countries can rise as some gain more from globalisation than others
• spread of culture across the globe - some argue there’s a loss of cultural diversity and others argue the spread is positive and helps improve quality of life

Question 5

impacts of globalisation on governments

Answer 5

• some govts. may lose their sovereignty due to the rise in international treaties which are hard to resist

Question 6

impacts of globalisation on producers, consumers and workers

Answer 6

• they can earn the benefits of economies of scale and specialisation as firms grow
• firms are more competitive which encourages them to lower AC and become efficient, which makes goods cheaper
• firms can also lower AC by switching production to places with cheaper labour
• globalisation leads to general rise in world GDP which increases consumer living standards and helps lift people out of absolute poverty
• however increased inequality as some gain more than others
• some services may become homogenised, e.g. hotels, or there may be an increased variety of goods and services
• job opportunities for workers across the globe
• structural unemployment if labour shifts abroad
• some workers may be exploited, e.g. in countries with cheaper labour costs

Question 7

impacts of globalisation on the environment

Answer 7

• higher pollution due to increased production and car use
• consumers may show more concern towards the environment as average incomes rise
• higher emissions from transport of goods

Question 8

absolute and comparative advantage

Answer 8

• absolute advantage; when a country can produce goods using fewer FoP than another
• comparative advantage; when a country can produce goods at a lower OC than another

Question 9

assumptions of comparative advantage

Answer 9

• transport costs are 0; doesn’t account for moving products between countries and this is more/less of an issue depending on a nation’s location
• perfect knowledge exists; each country knows what it has a CA in and knows the CA of other countries
• factor substitution is easily achieved; economies can quickly adjust to changing global market conditions by switching from capital to labour and vice versa
• constant costs of production

Question 10

advantages of specialisation and trade in an international context

Answer 10

• greater world output so there’s a gain in economic welfare
• higher quality products as production is focussed on what can be produced the best
• consumers have a greater variety
• lower AC as the market becomes more competitive
• outward shift in PPF curve
• more opportunities for economies of scale

Question 11

disadvantages of specialisation and trade in an international context

Answer 11

• less developed countries may use up their non-renewable resources too quickly so they may run out
• countries may become over-dependent on the export of one commodity so if there’s an issue like poor weather conditions, the economy will suffer
• more structural unemployment as production moves abroad

Question 12

factors influencing the pattern of change between countries

Answer 12

• comparative advantage; recent growth in exports of manufactured goods from developing countries as they have lower labour costs so production shifted here
• impact of emerging economies; e.g. China, India; they’ve obtained a much higher market share of global businesses so other countries are losing out as trading relationships change
• growth of trading blocs and bilateral trading agreements; e.g. WTO; leads to trade creation between members (shifting production from a high cost to low cost country) but diversion from elsewhere (shifting trade from a country with a low OC to a high one)
• changes in relative exchange rates; a rise in ER of a country will decrease its exports and shift trade to another country

Question 13

terms of trade

Answer 13

• the ratio of a country’s average price of exports to their average price of imports
• index price of exports / index price of imports x100
• ToT above 100 are improving, but below 100 are worsening

Question 14

factors influencing a country’s terms of trade

Answer 14

• anything affecting the price of a country’s imports or exports will affect its ToT
• ToT improves if export prices rise or import prices fall
• ToT deteriorates if export prices fall or import prices rise
• higher inflation / ER - rise in prices so more expensive to the world - ToT worsens
• improved productivity - lower costs so lower prices - ToT improves if exports are inelastic

Question 15

impact of changes in a country’s terms of trade

Answer 15

• improvement in ToT - less exports needed to buy imports - standard of living improves
• if products are elastic, they’re less internationally competitive, so an improvement in ToT will worsen the current account on the BoP, causing a lower output gap and higher unemployment

Question 16

types of trading blocs

Answer 16

• trading bloc; a group of countries who come together and agree to reduce / eliminate any barriers to entry that exist between them
• free trade area; no trade barriers between them but maintain their own restrictions with other countries, e.g. CUSMA
• customs union; no trade barriers between them, but a common external barrier, e.g. EU
• common market; no trade barriers between them, a common external barrier, and free movement of labour and capital between them, e.g. EU
• monetary union; no trade barriers between them, a common external barrier, free movement of labour and capital, and a common currency and central bank, e.g. Eurozone

Question 17

conditions needed for a successful monetary union

Answer 17

• e.g the Eurozone
• free movement of labour without any major barriers
• similar trade cycles to avoid tensions with the union
• mobility of finance
• automatic fiscal transfers to countries which are performing poorly

Question 18

costs of regional trade agreements

Answer 18

• trade diversion occurs as countries reallocate trade to partners in their agreement, which may worsen global efficiency
• structural unemployment as production shifts
• increased negative externalities of production, resource depletion and environmental damage
• transitioning to a monetary union can be expensive and firms may find it hard to adjust their menu prices
• members lose ability to set IR and control supply of money
• loss of sovereignty (authority of the state)

Question 19

benefits of regional trade agreements

Answer 19

• trade creation improves efficiency and generates higher incomes
• tariffs between member countries are eliminated
• common tariffs to third party countries simplify trading conditions
• monetary union simplifies trading costs and provides pricing transparency
• some members gain from improved monetary policy conditions, e.g. lower IR rates than the individual country’s would’ve been
• less uncertainty surrounding ER

Question 20

role of the WTO in trade liberalisation

Answer 20

• World Trade Organisation (WTO) was established in 1995 to promote free trade, as they believe it’s the best way to raise living standards and create jobs
• WTO promotes world trade by reducing / eliminating protectionist trade barriers
• it also settles trade disputes by acting as the judge and organising trade negotiations

Question 21

conflicts between regional trade agreements and the WTO

Answer 21

• regional agreements often shift trade from a non-member with a comparative advantage to a member without one
• they often institute common trade barriers on non-members which is the opposite of trade-liberalisation
• can be beneficial for member countries but may result in global inefficiency
• WTO advocates for free trade between all member countries

Question 22

reasons for restrictions on free trade (protectionism)

Answer 22

• infant industries may need protecting from the level of global competition
• sunset (declining) industries may need help to limit the economic damage that would occur if they closed abruptly
• strategic industries are essential to self-sufficiency and security, so these can’t be global, e.g. defence
• to correct a current account deficit
• tackle structural unemployment and industry declines
• preventing dumping (selling products at unfairly low prices in foreign markets)
• to prevent overspecialisation and allow for diversification
• to protect countries with cheap labour and low-cost production, e.g. through labour / environmental regulations

Question 23

types of protectionsim

Answer 23

• tariffs
• quotas
• subsidies to domestic producers
• non-tariff barriers

Question 24

tariffs

Answer 24

• diagram 1
• a tax on imports, aimed to restrict them

Question 25

quotas

Answer 25

• a physical limit on quantity of imports
• set below free market level of imports
• as cheaper imports are limited, a quota can raise prices and cause shortages
• may lead to retaliation with other countries placing tariffs on our imports

Question 26

subsidies to domestic producers

Answer 26

• this will lower costs of production for domestic firms
• they can increase output and lower prices, so their goods are more internationally competitive
• exports increase which may increase domestic employment

Question 27

non-tariff barriers

Answer 27

• health and safety regulations, e.g. EU in 2017 for level of aflotoxins in nuts
• product specifications, e.g. Canada jar sizes
• environmental regulations; e.g. EU and USA limiting ‘dirty steel’
• product labelling; can be expensive for firms and limit their desire to sell into certain markets
• embargoes; ban on trade with a country - usually politically motivated

Question 28

impact of tariffs on stakeholders

Answer 28

domestic producers; increase in revenue
foreign producers; decrease in revenue
- consumers; rise in prices
- government; high tax revenue
- standards of living; lower standard of living as consumer income is eroded with higher prices, but domestic firms may increase wages with higher profits
- equality; industries experiencing structural unemployment due to foreign competition will be treated more fairly

Question 29

impact of quotas on stakeholders

Answer 29

• domestic producers; increase in revenue
• foreign producers; higher revenue for ones who make sales but low sales for firms that don’t
• consumers; higher prices and less choice
• government; no tariff revenue but may recieve higher corporation tax revenue
• standards of living; lowers for consumers as purchasing power is eroded through high prices
• equality; improves for domestic firms but worsens for foreign firms

Question 30

impact of subsidies on stakeholders

Answer 30

• domestic producers; increases international competitiveness
• foreign producers; harder for them to compete with domestic firms
• consumers; lowers prices
• government; costs them the amount of the subsidy and there’s an OC for every subsidy provided
• standards of living; improves for consumers as their income goes further when prices are lower
• equality; domestic firms can compete more equally

Question 31

impact of non-tariff barriers on stakeholders

Answer 31

• domestic producers; limits foreign competition
• foreign producers; acts as a disincentive to sell into foreign markets
• consumers; reduced choice
• government; enforcing barriers may be expensive
• standards of living; reduced due to less choice and higher prices
• equality; may improve, e.g. environmental standards help equality in costs of production

Question 32

balance of payments

Answer 32

• the record of all financial transactions between a country and the rest of the world
• 2 main components;
• current account; all day-to-day transactions related to goods/services / transfer of income
• financial & capital account; all transactions related to savings, investment and currency stabilisation
• current account should balance with the capital and financial account (but in reality it never balances perfectly)

Question 33

current account components

Answer 33

• trade in goods balance
• trade in services balance
• investment income
• current transfers

Question 34

causes of deficits and surpluses on the current account

Answer 34

• surplus; net inflow of money into circular flow of income
• UK has a surplus with services but a deficit with goods and a net deficit
• causes of a deficit;
• appreciation of the currency; stronger currency means cheaper imports
• economic growth; higher demand can increase demand for imports
• less competitive; if other countries become less internationally competitive, exports should fall
• deindustrialisation; e.g. declining manufacturing sector in the UK means more goods have to be imported
• membership of trade union; e.g. fees are paid for membership of the EU

Question 35

measures to reduce a country’s imbalance on the current account

Answer 35

• rise in income tax - reduces disposable income - reduces demand for imports - however it can also reduce domestic demand
• reduced govt. spending - reduce AD and fall in imports
• but as the fiscal policy measures end, households will revert back, so it’s only effective in the short-run
• supply-side policies to increase productivity and make the country more internationally competitive which will increase exports
• make domestic economy more competitive through privatisation and deregulation which will lower their AC
• bank may lower IR to cause depreciation and reduce the deficit - but it may be inflationary for the domestic economy

Question 36

significance of global trade imbalances

Answer 36

• if one country runs a current account surplus, another is running a deficit
• persistent deficits are problematic as finance from abroad is required to fund continued imports
• persistent surpluses are an issue as it means the focus of allocation of a nation’s resources is on meeting foreign demand as opposed to meeting domestic demand, which can limit availability in the local economy

Question 37

exchange rate systems

Answer 37

• ER; the price of one currency in terms of another
• floating ERS; forces of supply and demand determine the rate, e.g. Australia
• fixed ERS; country’s central bank intervenes to fix the ER in relation to another currency, e.g. UAE
• managed ERS; free market determines the value of a currency but the central bank will intervene at times to keep it within a desired range, e.g. China

Question 38

difference between revaluation and appreciation of a currency

Answer 38

• revaluation; when the currency’s value is officially increased in a fixed ERS
• appreciation; when the value of a currency increases under a floating ERS

Question 39

difference between devaluation and depreciation of a currency

Answer 39

• devaluation; when the currency value is officially lowered in a fixed ERS
• depreciation; when the value of a currency falls relative to another currency in a floating ERS

Question 40

factors influencing floating exchange rates

Answer 40

• relative interest rates; high IR increases demand by foreign investors and £ appreciates (hot money flows in)
• relative inflation rates; high inflation means exports are more expensive so there’s less demand and the £ depreciates
• net investment; FDI into the UK increases demand for £ which results in an appreciation
• the current account; increasing trade surplus will result in an appreciation
• speculation; if speculators think a currency will appreciate in the future, demand will increase in the present as they try to make a profit, which leads to an appreciation
• quantitative easing; increase in money supply depreciates the currency

Question 41

govt. intervention in currency markets through foreign currency transactions and the use of interest rates

Answer 41

• buying and selling currency in the foreign exchange market; the CB can change demand / supply for their currency by using their reserves, e.g. if they want to depreciate the value, they’ll sell their own currency and buy foreign currencies
• changing interest rates; CB will raise interest rates to appreciate a country’s currency, as it causes hot money flows in as it’s more attractive for foreigners to move money and save it in the country’s banks

Question 42

competitive devaluation / depreciation and its consequences

Answer 42

• devalued currency makes exports cheaper and imports more expensive, so it may increase EG
• however inflation is also likely to rise due to the higher costs of imports and demand pull inflation from the rise in AD
• current account is likely to improve as there’s less imports and more exports
• costly and hard for govt. to hold large reserves of foreign currencies to maintain a devalued one
• inelastic exports won’t increase significantly if price falls
• if main trading partners have negative economic growth, then demand for exports wont rise much so it’s ineffective
• raises cost of imports used in production which can reduce profits if exports don’t rise as much

Question 43

impact of changes in the exchange rate

Answer 43

• current account; depreciation of £ makes exports cheaper, imports dearer and improves the current account balance
• the extent to which this improves depends on the Marshall-Lerner condition; a devaluation will only improve the balance if the combined elasticity of exports / imports is >1 (elastic)
• there is also a time lag between depreciation and any improvement in the balance as explained by the J-Curve effect (diagram 2); value of imports rises first due to a time lag of a fall in imports
• economic growth; depreciation that increases net exports will increase EG
• inflation; cost-push inflation will occur when imported raw materials are more expensive due to currency depreciation, and demand-pull inflation occurs when a depreciation increases AD for exports
• unemployment; falls if a depreciation increases exports as more required to meet this demand
• living standards; more expensive imports mean less choice and higher prices so SoL reduces, but cheaper and rising exports means an increase in employment and wages which can improve SoL for some
• FDI; depreciation makes it cheaper to invest which will increase FDI

Question 44

international competitiveness

Answer 44

• the ability of a nation to compete successfully overseas and sustain improvements in real output and living standards

Question 45

measures of international competitiveness

Answer 45

• relative unit labour costs; total wages in an economy / output - the cheaper they are, the more competitive the country in the international market
• relative export prices; ratio of one country’s export prices relative to another, expressed in an index - the lower this is, the more competitive the country

Question 46

factors influencing international competitiveness

Answer 46

• labour costs; a rise in this will make exports more expensive as costs of production rise
• productivity; a rise in this will lower unit labour costs
• inflation; high rate means higher prices for exports which worsens competitiveness
• govt. regulation; higher level raises costs of production which makes exports more expensive
• exchange rate; depreciation makes exports cheaper so increases competitiveness
• tax policies; lower tax rate incentivises workers to earn more as they’ll keep more of their income
• interest rates; when these are lower, it encourages spending and investment which increases growth which may cause demand-pull inflation and reduce competitiveness

Question 47

benefits of international competitiveness

Answer 47

• allows countries to export more goods, which increases AD and brings about a current account surplus
• if a country becomes more competitive, they can gain a reputation for their exports which may make them more price inelastic, so they can demand higher prices for their products
• firms can reach out to more consumers, thus gaining more revenue and making a larger profit - this helps them gain economies of scale which helps lower it’s AC of production

Question 48

problems of international competitiveness

Answer 48

• opportunity costs created for govt. spending / govt. policies
• lower tax rates means lower tax revenue for the govt. which can limit public spending
• hard for infant industries to compete so they’re forced out of the market
• supernormal profits of large firms may be eroded away which limits their investment
• being innovative isn’t always successful so may lead to funds being wasted