4.1 - International economics

Question 1

Define globalisation

Answer 1

The increased integration and inter-dependence between countries economically, socially and culturally.

Question 2

Define foreign direct investment (FDI)

Answer 2

When a private sector company in one country establishes operations or acquires physical assets or stakes in another country.

Question 3

Define offshoring

Answer 3

When companies transfer manufacturing to a different country, where production costs are lower, in order to raise their profits.

Question 4

Define transfer pricing

Answer 4

A form of tax avoidance, where firms manipulate the price of their goods & services so that profit is increased in areas of low tax.

Question 5

Define absolute advantage

Answer 5

When a country can produce a good more than another country with the same amount of resources (quantity of inputs per unit of time).

Question 6

Define comparative advantage

Answer 6

When a country can produce a good with a lower opportunity cost than that of another country.

Question 7

Define trans/multinational corporations (TNCs & MNCs)

Answer 7

A company that is involved with the international production of goods or services, foreign investments, or income and asset management in more than one country.

Question 8

Define terms of trade

Answer 8

Measures the price of a country’s exports relative to the price of its imports.

avg. export price index/avg. import price index x 100

Question 9

Define trading blocs

Answer 9

A group of countries that agree to reduce or eliminate trade barriers between them.

Question 10

Define trade diversion

Answer 10

Occurs when trade is diverted from a more efficient exporter towards a less efficient producer (low cost producer outside bloc to higher cost producer inside bloc).

Question 11

Define trade creation

Answer 11

The removal of trade barriers between countries resulting in increased trade between them (high cost to a lower cost producer).

Question 12

State the theory of comparative advantage

Answer 12

Countries will find specialisation mutually advantageous if the opportunity costs of production are different.

Question 13

Define dumping

Question 14

Define quotas

Question 15

Define protectionism

Question 16

Define capital account

Question 17

Define global trade imbalances

Question 18

Define the Marshall-Lerner condition

Question 19

Define international competitiveness

Question 20

Define unit labour costs

Question 21

State the J-curve effect

Question 22

Define a currency-war

Question 23

Define sectoral imbalance

Answer 23

Refers to an imbalance in the 3 main sectors of the economy - primary, secondary and tertiary.

Question 24

Define exchange rate

Answer 24

The value of one currency in relation to other countries.

Question 25

State the three exchange rate systems

Answer 25

Floating, fixed and managed.

Question 26

Explain the floating system

Answer 26

The exchange rate is determined by market forces.

For the currency on the forex market:
- If there’s excess DEMAND, then prices rise so the currency is worth more. This is an APRECIATION.

• If there’s excess SUPPLY, then prices fall so the currency is worth less. This is a DEPRECIATION.

Question 27

Explain the fixed system

Answer 27

A country’s currency is fixed against that of other countries.

• A REVALUATION occurs if the Central Bank decides to change the peg (fixation) 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.

Question 28

Explain the managed system

Answer 28

When the exchange rate is neither entirely fixed or floating. The central bank determines the preferred currency value, in which it’s then free to FLUCTUATE within a certain range.

If it goes ABOVE:
- Central Bank sells its own currency in forex markets to increase its supply. This DECREASES the value of the currency.

If it goes below:
- Central Bank buys its own currency in forex market (using foreign reserves) to increase its demand. This INCREASES the value of the currency.

Question 29

State the factors influencing the floating exchange rate

Answer 29

• Relative inflation rates
• Relative interest rates
• Current account balance
• Foreign direct investment
• Speculation

Question 30

Explain relative interest rates as a factor influencing the floating exchange rate

Answer 30

They influence the flow of ‘hot-money’ between countries.

If interests rates are INCREASED:
- The demand for £’s by foreign investors increases (exports increase) & the £ APPRECIATES.

If interests rates are DECREASED:
- The supply of £’s increases as investors sell their £’s in favour of other currencies (imports increase) & the £ DEPRECIATES.

Question 31

Explain relative inflation rates as a factor influencing the floating exchange rate

Answer 31

As UK’s inflation rises relative to other countries , it’s exports become more expensive, so there is less demand for UK products by foreigners, which means there’s less demand for the £. So value of the £ DEPRECIATES.

Question 32

Explain the current account as a factor influencing the floating exchange rate

Answer 32

UK exports have to be paid for in £’s and imports have to be paid for in the local currency which requires £’s to be supplied to the forex market.

• INCREASING trade surplus will lead to an APRPECIATION of the £.
• INCREASING trade deficit will lead to a DEPRECIATION of the £.

Question 32

Define international competitiveness

Answer 32

Refers to how well a country’s product competes in international markets. The lower the level of international competitiveness, the more likely that the country will face a current account deficit.

Question 33

State the 2 ways of measuring international competitiveness

Answer 33

Relative unit labour costs
Relative export prices

Question 34

Explain relative unit labour costs as a way of measuring international competitiveness

Answer 34

The total wages in an economy / output
- This provides a number that indicates the labour costs for each unit of output produced.
- If the relative unit labour costs of a country is lower than that of another country, then it’s more competitive in the international market.

Question 35

Explain relative export prices as a way of measuring international competitiveness

Answer 35

Monitoring export prices provides an insight into whether they are rising or falling over time.

If a country’s export prices are falling relative to other countries, than they are more competitive in the international market.

Question 36

State the factors affecting international competitiveness

Answer 36

• Unit labour costs
• Rate of inflation
• Regulations
• Wages & non wage costs
• Real exchange rates

Question 37

Explain real exchange rates as a factor affecting international competitiveness

Answer 37

• This is the nominal exchange rate adjusted for inflation levels between countries.

Calculated as: nominal exchange rate - domestic price level / foreign price level

• A rise in the exchange rate of the pound will cause exports to become more expensive and thus make UK goods less competitive as their price decreases.