4.1- International Economics

Question 1

What are the causes of Globalisation?

Answer 1

DEF- Globalisation- the process by which economies have become increasingly integrated and interdependent, increasing level of cross border trade, investment and migration

CAUSES: TGF GT

TRADE LIBERALISATION- barriers to trade such as tariff barriers have decreased as countries have realised the benefits of free trade in promoting growth by exploiting their comparative advantages. Promotes comp – increasing LRAS. Through the work of the WTO who’s main role is to reduce trade barriers between nations. Trade between countries has increased- leading to greater economic integration between countries.

GROWTH OF TRADING BLOCS- this is where trading blocs like the EU and ASEAN have either deepened their integration or have formed promoting more free trade and easier movement of labour between member states. Consequently more trade and labour migration between these members is promoted and FDI is likely to increase leading to the greater integration of these economies

GROWTH OF MULTINATIONAL CORPORATIONS- As technology improves, mobility of capital is easier and access to world markets is easier, MNCs can become very large in terms of production levels and profitability. Consequently to expand further to international markets MNCs will move and operate in various countries leading to the greater interdependence of nations in the form of increased FDI. Supernormal profits. Take advantage OF cheap labour costs. They have used marketing to become global, and by growing, they have been able to take advantage of economies of scale, such as risk-bearing economies of scale. The spread of technological knowledge and economies of scale has resulted in lower costs of production

TECHNOLOGICAL ADVANCEMENTS- occurred in terms of internet improvements, software development and transportation improvements in particular. Thus to trade internationally and operate business = more efficient= quicker- cheaper- opening up markets increasing trade FDI and migration flows

FALL IN TRANSPORT COSTS- occurred due to innovations and greater privatisation of transport. Cheaper and faster= promoting more trade. FDI and migration flows have increased with this improvement in mobility both of labour and capital

Question 2

How has globalisation caused inequality? WITH EVAL

Answer 2

SPECIALISATION AND TRADE- Cheaper to source materials from elsewhere, contraction in domestic supply and a fall in employment and real incomes- structural u/e and a decline in SOL. Wages pressure- inequality. Deindustrialisation – higher rates of long-term u/e social depravation

HIGHER PROFITS FROM MNCS- pay-outs to executives increasing dividends. Because of tax avoidance, tax revenues generate- insufficient to pay for public services, welfare systems. UK 2017 MNC avoid paying £6 billion in tax rev

EVAL:

It increases demand for high skilled workers and lowers the expected earnings of people in relatively low skill and low knowledge occupations.- FDI creates more formal employment and income for people employed in those sectors but perhaps at the expense of similar workers in higher income countries whose skills are no longer in demand

Question 3

What are the PROS of Globalisation?

Answer 3

W EOS GCC

INCREASE IN WORLD EFFICIENCY- with greater free trade and specialisation, resources are allocated where countries have their comparative advantage. Consequently, allocative efficiency is attained and with money to act as a means of exchange, the basic economic problem is solves maximising benefit to both consumers and producers

Large Economeis of Scale- larger international market to access, businesses have the potential to grow much larger and sell to many more consumers around the world. With greater benefit from purchasing and technical economies businesses will lower their average costs of production increasing productive efficiency. Lower costs translate into higher profitability and potentially lower prices for the consumer

Increased competition and lower prices- s- fierce competition, producers do what they can to compete- allocative efficiency and great benefit to the consumer through lower prices, higher quantity, quality, and choice. Businesses may be forced to re-invest and be innovative – best quality of a diversified range

Increased choice for consumers and businesses- businesses can source raw materials from all around the world ,find the cheapest prices. Similarly, consumers can access a greater market to buy their goods and services from. Businesses benefit from lower costs of production- lower prices, greater market share, higher profitability, consumers= welfare, material and non- material living standards can improve markedly

Higher rates of GDP growth- greater market size and specialisation – greater export potential and revenue generated from exports for countries with large comparative advantages- AD and thus economic growth will increase. Unemployment will decrease- firms respond by giving more labour- increasing incomes and living standards, prosperity. Tax revenues hypothecated capital investment, public goods and merit goods, retraining programmes- invest into supply side policies. Absolute poverty= reduced= inc social mobility

Question 4

Wha are the Cons of globalisation?

Answer 4

ISES

GROWING INCOME INEQUALITY- higher growth may not be translated into higher incomes for all. Corrupt governments who don’t redistribute tax revenue effectively, capital intensive sector production or from one dominant sector are all potential causes of this widening gap. Thus key macro objective not met- increasing relative poverty and deteriorating government finances. Developing nations- sig parts of the population may continue to live in absolute poverty holding back economic development

RISE IN STRUCTURAL UNEMPLOYMENT- major industries go into decline- struggle to compete internationally where other countries have the comparative advantage and low cost labour benefit- macroeconomic objective is lost. Occupational immobility of these workers promotes a problem for the gov where re training is necessary. There’s a cost to the gov directly but also indirectly – higher u/e benefits

ENVIRONMENTAL COSTS- with FDI increasing, growth etc, negative externalities increased e.g. very high pollution levels, resource depletion, resource degradation and deforestation. Consequently, wellbeing and quality of life decrease. Not sustainable. UN 200 trillion a year

OVER SPECIALISATION- exploiting comparative advantage, risk of becoming too over reliant on a narrow range of goods and service. If the industry collapses or declines where specialisation has occurred no industry can prosper. In developing nations, dual economy could persist trapping the economy in low levels of development

Question 5

WHAT ARE THE EVALUATION FOR GLOBALISATION?

Answer 5

Is there fully functioning free trade?- Whilst tariff barriers and quotas have been reduced, the greater spread of subsidies and non-tariff barriers, particularly in agriculture, detriment of developing countries. The WTO has been successful in increasing free trade in the manufacturing and service sectors where developed countries are dominant whereas poorer countries, who are still reliant on the primary sector for exports and growth

Efficient and effective environmental policy- prevent the destruction of the environment. Education schemes must be in place for local workers to have human capital to take newly created jobs - working in sectors that are not natural for the local population and do not necessarily match their innate skill set. Those who lose their job due to strong and more efficient competition re-training to become occupationally mobile to transfer into other sectors

Tempting for countries to trap themselves in resource curse- and not develop other sectors of the economy when globalisation = huge revenue generation from the primary sector- dangerous for developing countries who are prone to slumps in primary commodity markets, resource depletion and recessions abroad. Government to encourage diversification - companies or entrepreneurs to enter the manufacturing sector where greater value-added production takes place /incomes are higher, breaking the resource curse that can trap developing countries in poverty cycles and low- level development. Countries that have diversified better income, living standards and sustained growth

The government must also make sure that infrastructure is developed- to allow for the economy to fully benefit from trade. Reducing trade barriers is not enough for the full benefits of trade to be realised if roads, railway lines and ports are not suitable to accommodate the volumes of goods and services that international trade demands.

Question 6

What is the link between globalisation and economic growth?

Answer 6

Globalisation increases investment within countries; the investment of TNCs represents an injection into the economy, larger impact due to the multiplier. It creates an incentive for countries to make supply-side improvements to encourage TNCs to operate in their countries.

TNCs may bring world class management techniques and technology which can have knock on benefits to all industries as these techniques and technologies are available for them too.

Overcoming the drawbacks of globalisation:

Trade will increase output since it allows exploitation of comparative advantage.

However, the power of TNCs can cause political instability as they may support regimes which are unpopular and increase economic diversification and drive innovation undemocratic but that benefit them or could hinder regimes which don’t support them

Comparative cost advantages will change over time and so companies may leave the country when it no longer offers an advantage which will cause structural unemployment and reduce growth.

Question 7

What is absolute advantage?

Answer 7

A country has absolute advantage in the production of a good or service if it can produce it using fewer resources and at a lower cost than another country. Produce a good more cheaply relative to other countries

Question 8

What is comparative advantage?

Answer 8

occurs when a country can produce a good or service at a lower opportunity cost than another country. This means they have to give up producing less of another good than another country, using the same resources.

A country can change over time e.g. due to greater research and development and innovation in newer and more sophisticated techniques providing a country with lower cost advantages.

Can gain a comparative advantage due to either greater quantities of factors of production or better quality factors of production e.g. greater abundance of natural resources, labour, machinery.

Country with higher skilled labour force- comparative advantage in manufactured goods. Country with a natural resource endowment and good climate- adv. in primary commodity extraction.

Question 9

What is the evaluation for comparative advantage?

Answer 9

Comparative advantage theory assumes perfect info for both producers and consumers- If consumers however lack information of where the cheapest goods are being produced, they may buy from an inefficient producer allowing these businesses to survive and be profitable.

TRANSPORT COSTS ARE ASSUMED TO BE 0- which clearly does hold in the real world. Large transport costs may erode a country’s comparative advantage and make it cheaper to import goods from a less efficient producer located closer.

Countries without the comparative advantage may be highly non price competitive. This is because these countries might have focused more on service quality, branding, advertising, product longevity. Realising that consumers do not only consume based on price but non price factors, less efficient producers can still be profitable without the comparative advantage.

High inflation rates over time can erode the price competitiveness of goods and services produced in countries with a comparative advantage. If this persists in the long run, the comparative advantage might be lost.

Question 10

What are the advantages of specialisation and trade?

Answer 10

Comparative advantage shows how world output can be increased if countries specialise in what they are best at producing, this will increase global economic growth.

Trading and specialising allows countries to benefit from economies of scale , which reduces costs and therefore decrease prices globally.

Different countries have different factors of production and so trade allows countries to make use of factors of production, or the things produced by these factors, which they otherwise may have been unable to.

Trade enables consumers to have greater choice about the types of goods they buy, and so there is greater consumer welfare.

Trade also means there is greater competition, which provides an incentive to innovate. This creates new goods and services and new production methods, increasing consumer welfare and lowering costs respectively.

Countries which isolate themselves for political reasons, like North Korea, have found that their economies tend to stagnate.

Question 11

What are the disadvantages of specialisation and trade?

Answer 11

However, trade can lead to over-dependence, where some countries become dependent on particular exports whilst others become dependent on particular imports. This can cause problems if there are large price falls in the exports of if imports are cut for political reasons= economy can collapse

It can cause structural unemployment, as jobs are lost to foreign firms who are more efficient and competitive. The less mobile the workforce, the higher the chance that changes in demand due to trade will reduce output and employment over long periods of time- problem in the UK as some areas such as Manchester suffer from unemployment as their traditional industries declined, for example ship-building.

The environment will suffer due to the problems of transport as well as the increased demand for resources e.g. deforestation.

Countries may suffer from a loss of sovereignty due to signing international treaties and joining trading blocs, for example in the EU.

They may see a loss of culture as trade brings foreign ideas and products to the country.

Question 12

What are the factors influencing patterns of trade?

Answer 12

Patterns of trade can change significantly over time e.g. up to the 1980s the UK traded predominantly with Commonwealth Countries. In 2020, 46% of trade was with EU countries & 26% was with the USA

Comparative advantage: Countries will trade where there is a comparative advantage to trading. A change in the comparative advantage- affect the trade pattern. There has been a recent growth in the exports of manufactured goods from developing countries to developed countries. Their share of world trade has risen and the volume of manufactured goods that they export has increased. However, since China’s population is now ageing, their wage competitiveness has fallen- due to the rise of the middle class in China, demand higher wages and consume more.

Emerging economies: Countries grow at different rates and when they grow, they are likely to need to import more goods and services than before as well as exporting more to pay for this. Emerging economies shift the trade pattern by taking up a larger proportion of a country’s imports and exports than they had previously. The collapse of communism has meant that more countries, especially developing countries, are participating in world trade.

Trading blocs and bilateral trading agreements: These increase the level of trade between certain countries and so influence the pattern of trade because trade increases between these countries and decreases between others. Joining the EU meant that the UK traded a lot more with European countries than previously, and less with countries outside the EU.

Relative exchange rates: The exchange rate affects the relative prices of goods between countries. A change in price will affect the pattern of trade. It can be argued that the UK’s trade deficit with Europe is due to the strength of the pound. China have kept their currency weak in order to increase their trade surplus by making exports more competitive.

Question 13

What is terms of trade and how is it calculated?

Answer 13

Terms of trade- an index that shows the value of a country’s average export prices relative to their average import prices. It’s an indicator of the level of imports a given basket of exports can buy calculated using this equation:

Terms of trade= index of average export prices/ index of average import prices *100

The terms of trade can worsen if export prices fall or if import prices rise; the terms of trade can also improve if export prices rise or if import prices fall

Movement in the terms of trades is said to be favourable if the terms of trade increase as the country can buy more imports with the same level of exports.

Question 14

What are the factors influencing a country’s terms of trade?

Answer 14

An improvement in the terms of trade will be caused by a rise in export prices or a fall in import prices. A deterioration will be caused by a fall in export prices or a rise in import prices.

In the short run, exchange rates, inflation and changes in demand/supply of imports or exports affect the terms of trade since these affect the relative prices of imports and exports.

In the long run, an improvement in productivity compared to a country’s main trading partners will decrease the terms of trade since export prices will fall relative to import prices. This can be caused by new technology, more efficient labour etc.

Another long run factor is changing incomes. This affects the pattern of demand for goods and services. For example, a rise in world income causes a rise in demand for tourism and so a country with a strong tourist industry, such as Spain, may see a rise in prices in that industry and hence an increase in their terms of trade. The PrebischSinger hypothesis suggests the long run price of primary goods declines in proportion to manufactured goods, which means those dependent on primary exports will see a fall in their terms of trade.

In general, anything which affects the price of a country’s imports or exports will affect its terms of trade

Question 15

What are the reasons for a deterioration in the terms of trade?

Answer 15

A weak exchange rate- this could be because of the currency is increasing as the nation is purchasing more imports. Consequently, the price of imports increases whilst the price of exports decreases worsening the terms of trade- more exports need to be sold to purchase the same level of imports.

An improvement in international competitiveness- could be because of a fall inflation, rise in productivity, tech. export prices will fall relative to import prices, worsening terms of trade Lower demand for a nation’s exports- could be because of falling incomes abroad as economies of major trading partners in recession- export prices will fall relative to import prices worsening the terms of trade

If world incomes are rising but a country is specialising in the production and export of primary commodities whilst importing capital or manufactured goods. Demand for primary commodities is income inelastic whilst demand for manufactured goods is income elastic. Consequently, world incomes would rise, demand and thus prices for manu goods will rise faster than demand and prices for primary commodities worsening the terms of trade for such a country; prebisch- singer hypothesis

Question 16

What are the reasons for an improvement in terms of trade?

Answer 16

A strong exchange rate

A worsening in international competitiveness

Higher demand for a nations export- could be because of rising incomes abroad as economies of major trading partners boom. Export prices will rise relative improving terms of trade

Question 17

What are the impacts of improvement/ deterioration in terms of trade ?

Answer 17

If PED of exports and imports is inelastic, a favourable movement in terms of trade would improve the CA on the balance of payments whilst if it is elastic, a favourable movement would worsen the CA.

An improvement in the terms of trade - fall in GDP and a rise in U/E, if it is caused by a rise in export prices, exports will fall and if it is caused by a fall in import prices, imports will rise- A reduction in production within the country = fall in jobs and output. However, a long-term decline in the terms of trade suggests a long-term decline in SOL as less imports can be bought.

Cause of the change. If an improvement has occurred due to increased demand for exports, then this will be beneficial for the country. If a deterioration is caused by an improvement in international competitiveness, this will also be beneficial. For an improvement to be beneficial, export revenues must increase.

1. A fall in the terms of trade caused by a fall in export prices for a country dependent on primary commodities could reduce AD in the economy- demand for primary commodities is price inelastic - prices fall so do revenue generated from their export for developing countries= economic growth will fall in developing countries reducing incomes and SOL via a fall in gdp
2. A fall in the terms of trade could significantly worsen the government budget position. As export prices fall and demand is inelastic, revenues decrease, reducing tax revenue collected from corp tax, income tax and VAT. Consequently, gov will have less revenue to spend on education, healthcare, infrastructure- for the long run performance
3. A developing nation likely to experience higher levels of indebtedness. If export prices fall so do revenue- harder to service existing debt.

Question 18

Is a terms of trade improvement good for an economy? WITH EVAL

Answer 18

DEPENDS…

If due to higher export demand- Higher export demand, improving the terms of trade via higher export prices, beneficial, export revenues increases improving CA position and thus increasing AD

THE price elasticity of demand for exports . Price inelastic demand, export price increases, demand for exports decrease but proportionately less than price increase. Export rev increase increasing CA position and boosting AD. However growing force of globalisation means in reality there are many substitutes available for an importing country. Demand for a country’s exports will be more elastic over time worsening CA position and AD

Question 19

What are the factors contributing to globalisation ?

Answer 19

In 2000 the value of global trade was approximately $6.45 trillion. By 2020 this figure was at $19 trillion

FACTORS:

The improved ability for firms to easily connect and to promote themselves internationally as a result of the internet & improvements to communications technology e.g Skype, WhatsApp, WeChat etc

The Increased effectiveness of the World Trade Organisation (WTO) in negotiating new trade agreements & in helping countries to open up to free trade (trade liberalisation), thus increasing international specialisation & the volume of trad

Question 20

What is a regional trading bloc?

Answer 20

A regional trading bloc is a group of countries within a geographical region that protect themselves from imports from non-members.

§ They sign an agreement to reduce or eliminate tariffs, quotas and other protectionist barriers among themselves. Examples include NAFTA (North America), the EU, ASEAN (Asia) and MERCOSUR (South America).

§ Most regional trade agreements take the form of bilateral agreements, between one single country and another single country. Some agreements are multilateral or plurilateral agreements, between at least three countries

Preferential trading areas ( PTA)-

Question 21

What are the different trading blocs?

Answer 21

Preferential trading areas (PTA): These are where tariff and other trade barriers are reduced on some but not all goods trade between member countries.

§ Free trade areas (FTA): These occur when two or more countries in a region agree to reduce or eliminate trade barriers on all goods coming from other members. Each member is able to impose its own tariffs and quotas on goods it imports from outside the trading bloc.

§ Customs unions: A customs union involves the removal of tariff barriers between members and the acceptance of a common external tariff against non-members. This means that members may negotiate as a single bloc with third parties such as other trading blocs or countries.

§ Common market: This establishes free trade in goods and services, a common external tariff and allows free movement of capital and labour across borders. When the EU was established, it was a Common Market. EU citizens can work in any country in the EU.

MONETARY UNIONS-§ This is sometimes called a currency union. Members of a monetary union share the same currency, same central bank, same monetary policy. This is more economically integrated than a customs union and free trade area. The Eurozone is an example of this.

A common central monetary policy is established when a monetary union is formed. The single European currency, the Euro, was implemented in 1999 to form the Eurozone.

§ Monetary unions use the same interest rate. The Euro, for example, floats against the US Dollar and the Pound Sterling. An economic union is the final step of economic integration. There will be a common market with coordination of social, fiscal and monetary policy.

Pros of this:

Non fluctuating exchange rate
Lower costs from currency conversion
Increased business confidence
Currency more stable against speculation
Prices between countries easier to compare

Cons of this:

Loss of monetary policy autonomy, countries have different economic circumstances so monetary policy won’t benefit everyone. Uk prior to 2008 crash was booming but interest rates were kept very low

No potential for countries to alter their exchange rates
Cost of currency conversion very high
Lack of a fiscal union - countries can be reckless with fiscal policy which can destablise entire union (Greece, Portugal had to adopt strict austerity measures due to overspending)

Question 22

What are the advantages and disadvantages of a trading bloc?

Answer 22

Encourages specialisation (resources are allocated where countries have a comparative advantage + economies of scale (productive efficiency, lower average costs- profitability

§ Greater competition domestically-removal of barriers- encouraging innovation , lower prices-=productive and allocative efficiency- increase in world efficiency

§ Firms may be able to grow much larger by creating a larger customer market- may be difficult given different customer markets in different countries. Economies of scale will be increased

§ Firms inside the bloc are protected from cheaper imports from outside, for example those in the EU are protected from Chinese imports.

§ Greater choice for consumers- welfare increase

§ Creates employment opportunities, if leads to an increase in output

DISADVANTAGES:

Inefficient producers within the bloc are protected from efficient producers outside the bloc= trade diversion consumers lose out e.g. zombie firms

§ Less national sovereignty. Loss of resources, most successful countries will attract capital and labour. Regional ineq

§ Reduction in competition as inefficient firms are driven out of the business – monopoly power. market –oligopolistic

§ Retaliation as the creation of one regional trading bloc - lead to creation of others = can lead to trade disputes.

§ Countries are no longer able to benefit from trade with countries in other blocs- blocs likely to distort world trade

One dynamic loss may be the loss of resources, most successful countries attract capital and labour (since both are free in a common market)= heightens regional inequalities as the richest countries experience faster rates of growth. Firms may set up factories etc. in the poorer countries, as labour is cheaper, and therefore helps them to grow but also mean they lose the most skilled labourers to more successful countries

§ Creating and maintain trading blocs can distract governments from the gains of signing full free trade agreements. Bilateral trade agreements can bring very little gain to the two countries making the agreement but can take up significant government resources.

§ They distribute the gains from trade unequally, developed countries often gaining most and developing countries being impacted little.

§ May be weak if they cover a very limited range of goods.

§ Trading blocs can be seen as ‘second best’ solutions in a world with protectionism. Economic efficiency would be
maximised if there were no barriers to trade.

Question 23

What is trade creation and trade diversion? What is the trading bloc more likely to lead to?

Answer 23

Trade creation-when trade is created by the joining of a customs union. Consumption shifts from a high cost domestic producer to a low cost partner producer

Trade diversion- consumption shifts from a lower cost producer outside the trading bloc to a higher cost producer within e.g. New Zealand butter vs European butter

§ A trading bloc is more likely to lead to trade diversion than trade creation when it has a very high external tariff as this will push countries to buy from within the bloc or if there is a relatively small cost difference between goods purchased within and outside the block. The higher the tariffs imposed by a country before joining the market, the more likely it is that trade creation rather than diversion will take place.

§ If joining a FTA leads to more trade creation than diversion, it is welfare improving. If it leads to more diversion than creation, the FTA is reducing welfare.

Question 24

What is the role of the WTO?

Answer 24

The World Trade Organisation was set up in 1995 to replace the GATT, which had aimed to reduce protectionism. It has two main aims: to bring about trade liberalisation and to ensure countries act according to the trade agreements they have signed.

§ Set and enforce rules on int. trade
§ Resolve trade disputes/ tribunals
§ Provides a form for negotiating trade liberalisation
§ Monitor further trade liberalisation
§ Increase transparency of the decision making process
§ Help developing countries fully benefit from global trade

One problem is that for any agreement to take place, all countries must agree to it and so any country is able to veto an agreement. This veto may also be politically motivated, for example retaliation against the US for something unrelated

Question 25

What are the possible conflicts within the WTO?

Answer 25

Regional trade agreements contradict WTO’s principles as a common external tariff on trade outside the trading bloc introduces protectionism. Customs unions and FTA can be seen as violating the WTO’s principle since not all trading partners are treated equally.

§ However, they can complement the trading system and the WTO strives to ensure non-members can trade freely and easily with members of a trade bloc.

§ Some might argue the WTO is too powerful or that it ignores the developing countries, as developed countries do not trade freely with developing countries.

§ The protectionist approach of the USA and China currently provides a threat to the WTO system.

Question 26

What are the arugments for UK membership of the EU? ( Arugments for staying within EU)

Answer 26

The UK benefits from increased trade - tariffs within the EU do not exist allowing trade creation to occur- comparative advantages. Trade creation stimulates an increase in trade leads - efficient allocation of resources. Allows net exports to grow accessing a market – no costs, AD increases stimulating short-term growth and reducing U/E

Evaluation: heavily dependent upon UK negotiation post Brexit. If the UK GOV - continue to negotiate free trade or strong trading relationship with the EU theoretically UK goods can still be highly demanded within the EU and the UK negotiating trade deals with non-member countries can more than recoup any remaining lost export revenue.

The EU’s large market size, makes the UK a great economy for foreign businesses to invest- a flexible, educated and skilled labour market, relative low corporation taxes, the ease of accessing finance and strong infrastructure. Foreign businesses see the UK as the gateway to Europe- big export potential to other EU countries. Leaving the EU is likely to result in outward FDI, lower economic growth and employment as a result.

§ Evaluation: UK currently relies on investors abroad buying up UK debt to finance its CA deficit, in this way running a financial account surplus. Large FDI inflows also help in this regard. Brexit puts financing the CA deficit under huge pressure= investor panic, a currency crisis
and full economic crisis for the UK.

Brexit has triggered a large drop in the value of the pound by around 10%. Exports cheaper= export revenues increase. Britain is a net importer, weak exchange rate is bad = imports dearer when bought in foreign currency - firms import raw materials for their production, costs of production rise =cost push inflation, reducing economic growth =stagflation

§ Evaluation Long term. If a weaker pound incentivises more business to focus on export opportunities, the UK over time may develop more of a manufacturing base using the weak pound as their competitive advantage allowing for improvements in the CA position and more balanced growth.

The loss of immigration could hurt the UK economy. EU migrants entering the UK fill jobs that would otherwise go vacant - the productive potential of the UK economy could decrease with lower rates of economic growth over time. Such immigrants pay also significant tax revenues to the UK government allowing spending on education, healthcare, infrastructure and welfare to take place. If they are told to leave the UK or simply if immigration is reduced, taxes may rise to compensate for the lower tax take.

§ Evaluation: Immigrants put pressure on key public services - EU immigrants eligible for many of the same rights as UK citizens such as free access to the NHS, Therefore, the government spending side to uncontrolled EU immigration may outweigh the tax revenue paid them, not deteriorating public finances

Question 27

What are the arugments for UK to leave the EU ( arguments for brexit)

Answer 27

UK businesses will receive a large benefit being outside the EU, UK - free from burdensome regulations that increase costs of production and make it harder to produce and trade- previously trade diversion. Such regulations include product standards, employment regulation’s, environmental regulations =there will be more ‘free’ trade outside the EU with greater jobs being created, higher economic growth= higher incomes in the UK.

Evaluation: Certain EU laws are beneficial for workers & consumers. Losing these may be against interests of stakeholders. HOWEVER UK gov will replace these regulations. Such sovereignty could outweigh loss of EU regulation

UK sovereignty will be restored- freely set its own laws, control its own borders and not have to pay EU membership fees. UK citizens will be free to vote for the laws and policies they want their own elected governments to enact and with membership fees not being paid to the EU, hypothecated on key UK public services like schooling, healthcare and infrastructure= reduction in inequality, U/E- improve infrastructure

Evaluation: The exact membership fee figure is not exactly known .Those in favour of continued UK membership of the EU argue that this is very small price to pay for the large benefits of being part of the EU (trade, attracting FDI, job creation, economic growth). Simply put, the benefits outweigh the membership costs.

Being outside the EU allows the UK to negotiate its own free trade deals with countries outside the EU who have previously suffered from trade diversion like Thailand- could cause a misallocation of resources, meaning UK can now
trade freely with countries outside the EU potentially gaining more rev from this trade than is being lost. EU not as important to the UK as it once was; 90% of global growth to be outside EU by 2050- diversify into green tech

Evaluation: trade deals take a long time to negotiate- mean time UK follows WTO rules- tariffs/other forms of protectionism apply= could reduce export rev for the UK in the S/T - uncertainty over l/t relations affecting domestic jobs businesses that are reliant upon trade

Question 28

What is the currency case for membership of the Euro: Advantages of monetary union?

Answer 28

Exchange rates are not expected to fluctuate dramatically. Trade and investment increase, as there is reduced uncertainty. Businesses trying to plan for the future - easier to make accurate predictions about costs and revenues. The level of risk and returns on investment easier to assess, increasing investment.

§ High business confidence is extremely beneficial for countries in the Eurozone as international competitiveness will increase with better planning tools for investment. Exporters and importers have greater confidence in the long-term value of the E/R- this certainty increases the volume of trade. foreign firms attracted by stable E/R, acting as an incentive to invest abroad (FDI) with more certainty= actual and potential growth for the economy

§ Falling transaction costs = fewer barriers to trade, increase competition, reduce prices. Eliminating exchange-rate uncertainty will spur still more trade; it may also lower interest rates, therefore making it cheaper to borrow to finance new investment. In the European case, the benefits may be greater still because when each country had its own currency, speculative pressures heightened the risk of costly exchange-rate movement

§ Both consumers and firms- make significant savings in the cost of transaction, development of larger markets for goods and services as a result of not having to convert currencies. Being part of a larger single market with the same currency= facilitate more trade, domestic investment and foreign investment cost savings =substantial. Consumers in Eurozone countries, living standards = increase- travel without the cost of converting currencies, import without currency conversion cost

A common currency, which has great credibility with it being used to in a larger currency zone, should be more stable against speculation than individual, independent currencies. This once more facilitates trade, domestic investment and foreign direct investment.

§
A common currency makes price more obvious to compare between countries where prices equalise across borders. This is because being part of a greater market all with the same currency will force intense competition as companies cannot price discriminate. Consequently, consumers will benefit from lower prices, higher consumer surplus and a greater choice. Great price transparency

Question 29

What is the case against membership of the euro? Disadvantages of monetary union?

Answer 29

§ The loss of monetary policy autonomy (ability for individual countries to set I/R). More exposure to vulnerable shocks, macroeconomic stability is lost. Less ability for export led growth. Countries in deep recession or inflation, if the centralised interest rate in the Eurozone differs from what is needed nationally, problems worse.

§ The lack of fiscal union allowing some countries to act irresponsibly with fiscal policy causing instability within the union. Individual countries enact fiscal policy often without regard - Maastricht criteria once they are members of the Euro area. The consequence of one country’s irresponsibility could create widespread panic and speculation over the safety of the currency leading to currency and area collapse.

§ One size fits all- it doesn’t. countries need different policies to manage their economies
Greece – internal devaluation of their economy- attempts to improve competitiveness through lower wage costs and
prices. Wages haven’t fallen much because of sheltered oligopolistic and high VAT
The cost of currency conversion is high, taking old currency out printing new currency, rewriting price lists, converting databases= time consuming £££. This activity carries a large OC, this money could be used more productively elsewhere- boost productivity of those that work in export sector/tax allowances =promote investment in export sector. Firms may also use these S/T costs to raise prices- currency conversion could be inflationary

Question 30

What are the reasons for restrictions on free trade?

Answer 30

Infant industry argument: An infant industry - just being established -need to build reputation/ customer base - cover a lot of sunk costs, meaning AC will be higher. Industry - unable to compete in international market and so gov protects until - able to compete on an equal level. ineffective as firms grow inefficient -gov - poor record of ‘picking winners.

Protection from unfair competition: Across the world, different rules apply - producers in different countries can produce at different prices. Domestic producers - unable to compete with firm that very low labour costs or very low health and safety costs due to regulation or with a firm that is heavily subsidised by the government. Some will argue the government should intervene to protect domestic producers from this

Question 31

Infant industry arugments, dumping, protect against unemployment? Discuss these as reasons for restrictions on free trade?

Answer 31

INFANT INDUSTRY ARGUMENT:

Small firms do not have EOS to compete with companies in large industries in developed countries-particularly strong for developing countries looking to diversify into manufacturing and overcome the risk of primary commodity over specialisation/resource curse. Protectionism allows -small industries time to grow, get bigger ,benefit from EOs- reduce costs of production and compete with more established industries abroad

Evaluation:
§ Imposing protectionism - fail in medium to L/T- complacency and protectionist dependency preventing costs of production decreasing enough to become competitive. X-inefficiency

§ Do developing countries have the international power to enact imposing P on developed countries without risking retaliatory protectionism = big assumption.

PROTECT AGAINST DUMPING

§ Dumping is where you export a good lower than the costs of production in the exported country too - due to heavy subsidies or minimum price schemes generating an excess supply. Protectionism is likely to be imposed- dumped products will be artificially more competitive than home products - industry decline, structural u/e, anger against political establishment if no action is taken against the countries

Evaluation:
§ Dumping is extremely difficult to prove- information regarding costs of production/ proving that products have purposefully sold below cost - real challenge for the WTO. If protectionist measures are imposed by a country due to perceived dumping, accused country may feel wrongly targeted, retaliate in return leading to tit for tat protectionism. Trade talks WTO - better option- resolve disputes diplomatically rather than trade war - harms international relations in l/t

Protect against UNEMPLOYMENT

§ For countries that lose their comparative advantage, de-industrialisation = end result leading to structural U/E for workers. This imposes a large cost - GOV lose a key macroeconomic objective, popularity, financially costly job - re- train these workers - occupationally mobile. Protectionism can prevent this happening, maintaining incomes/ SOL

Evaluation:
§ If the industry is already in decline protectionism - delaying the inevitable. Despite the social costs of u/e, cost to the gov of increases in u/e - better to allow these workers to become more occupationally mobile - transfer into other sectors whether their u/e is more secure. Significant negative externalities/ individual costs of U/E - enough to persuade the GOV - intervention is necessary- particularly if loss of competitiveness is dumping from abroad.

TO ELIMINATE A CURRENT ACCOUNT DEFICIT AND PROMOTE ECONOMIC GROWTH?

§ Protectionist policies - increase price of imported goods or simply block imports from entering the country= reducing expenditure on imports, which ceteris paribus = improve the trade balance of the C.A thus rectifying a C.A deficit. As net exports increase with improvements in the C.A position, (X – M) will increase -boosting actual growth.

Evaluation:
§ Retaliation of trading partners. Countries will frown upon the fact that their economy and exporters suffer due to a trade deficit in a different country – not react kindly to any protection imposed. Retaliation takes place where protectionism is enacted back on the initial country’s imports but much strongly reducing that country’s revenue more so than the import expenditure they’ve saved = in the long term worsening trade deficit. Protectionism = argued to culminate in tit for tat, punitive retaliation that is a zero-sum game for all involved.

Question 32

What is a tariff? WITH DIAGRAM ANALYSIS

Answer 32

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

Domestic producers/retailers have to pay the tariff when the good/service crosses the border into the country

This raises the cost of production for domestic firms

Firms often pass on the increased costs to consumers in the form of higher prices
These higher prices allow some domestic firms to increase their output (law of supply)

More inefficient domestic firms are now producing at the expense of more efficient firms
globally who reduce their output due to the tariff

With increased domestic output, employment may increase

DIAGRAM ANALYSIS:

A tariff raises the price of the world supply from Pw to Pw + tariff. This reduces the quantity of imports from Q1Q2 to Q3Q4

World supply (Ws) is considered to be infinite & this supply curve is added to the domestic demand (DD) & supply (SD) curves

The pre-tariff market equilibrium is seen at PwQ2

Domestic firms supply up to Q1 at a price of Pw
Foreign firms supply the difference equal to Q1Q2 at a price of Pw (imports)
After the tariff is imposed, the world price increases from Pw to Pw+ tariff

The new market equilibrium is seen at Pw+tariffQ4

Following the law of demand, the quantity demanded contracts from Q2 to Q4
Following the law of supply, the quantity supplied by domestic firms extends from Q1 to Q3
The level of imports is reduced from Q1Q2 to Q3Q4

Question 33

What is a quota?

Answer 33

A quota is a physical limit on imports e.g. in June 2022 the UK extended their quota on steel imports for a further two years in order to protect employment in the domestic steel industry

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 34

What are subsides to domestic producers?

Answer 34

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 35

What are non-tariff barriers?

Answer 35

There are many strategies that can be used to create barriers to trade using less obvious methods than tariffs, quotas & subsidies

Health & safety regulations e.g. in 2017 the EU put a new health regulation in place regarding the permitted level of aflotoxins in nuts. Aflotoxin levels are naturally higher in southern hemisphere countries & it effectively blocked the import of southern hemisphere nuts

Product specifications e.g. Canada specified that all jam imported into Canada needed to be in a certain size of jar. Many countries do not usually manufacture jars in the required size

Environmental regulations e.g. in November 2021 new regulations were put in place in the EU & the USA to limit the amount of imports of ‘dirty steel’ - predominantly this is steel produced using coal fired power stations which are prevalent in China

Product labelling can be expensive for firms to apply & may limit their desire to sell into certain markets

Question 36

What is the impact of protectionist policies? TARIFF

Answer 36

Tariff- using the diagram.

Domestic producers- Before the tariff domestic producers produced output equal to 0Q1 & their revenue was equal to Pw X Q1

After the tariff was imposed domestic producers produced 0Q3 & their revenue was equal to Pw X Q3

Domestic producer surplus has increased by area 2

Domestic consumers-

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

GOV:

After the tariff is imposed the government receives tax revenue equal to ((Pw+tariff) - Pw) x (Q4-Q3) - area 3

STANDARDS OF LIVING:

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

EQUALITY:

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

Question 37

What is the impact of protectionist policies? QUOTAS?

Answer 37

Domestic producers-
Increases their output
Raises the selling price
Increases their revenue

Foreign producers-

Decreases their output

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

Consumers- results in higher prices and less choice

Government- 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

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

Equality- Improves for domestic firms but worsens for foreign firms

Question 38

What is the impact of protectionist policies? SUBSIDIES?

Answer 38

Domestic producers-

Decreases costs of production
Increases output
Increases international competitiveness

Foreign producers- Makes it harder for them to compete with domestic firms

Consumers- Lowers prices

Gov- This costs the government the amount of the subsidy
There is an opportunity cost associated with every subsidy provided

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

Equality- Domestic firms can compete more equally

Question 39

What is the impact of protectionist policies? NON TARIFF ?

Answer 39

Domestic producers-

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

Foreign producers-

Acts as a disincentive to sell into foreign markets

Costs of meeting the non-tariff barriers may significantly reduce profit margins

Consumers- May reduce choice/variety in a market

Gov:

They may lose some credibility with the WTO

Enforcing the non-tariff barriers may be difficult or expensive

Standard of living:

Less choice & higher prices erode standards of living

Product labelling information may improve decision making & quality of life

Equality:

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

Question 40

What is the balance of payments and what are the components?

Answer 40

A country who participates in foreign trade will be sending and receiving money from other countries and they keep track of these transactions in a balance sheet, called the balance of payments: 2 SECTIONS

The current account:

Trade in goods, trade in services and income and current transfers.

THE CAPITAL ACCOUNT AND FINANCIAL ACCOUNT

The capital account is relatively unimportant as it mainly records transfers of immigrants and emigrants taking money
abroad or bringing to the UK, or government transfers such as debt forgiveness to Third World countries. The financial account is more important and is split into three main parts:

§ Foreign direct investment (FDI)
§ Portfolio investment
§ Other investments.
FDI - flow of money to purchase part of a foreign firm (10% of more of the ordinary shares) e.g. BT buying a 15% share in a telecommunications company in Brazil. Portfolio investments are the same

Question 41

What are the causes of deficits and surpluses?a

Answer 41

If there is a current account deficit: must be a surplus in capital and financial account

If there is a current account surplus: there must be a deficit in the capital and financial account

CAUSES OF CURRENT ACCOUNT DEFICIT:

Relatively low productivity-
Low productivity raises costs

Exporting firms with low productivity may find themselves at a price & cost disadvantage in overseas markets which will decrease competitiveness & the level of exports

With higher domestic prices, consumers may also buy abroad thus increasing the imports

Falling exports & rising imports creates a deficit

RELATIVELY HIGH VALUE OF THE COUNTRYS CURRENCY:

Currency appreciation makes a country’s exports more expensive relative to other nations

Foreign buyers look for substitute products which are priced lower

Exports fall & the balance on the current account worsens

Similarly, currency appreciation makes imports cheaper

Domestic consumers may switch demand to foreign goods & as imports rise, the balance on the current account worsens

RELATIVELY HIGH RATE OF INFLATION:

A relatively high rate of inflation makes a country’s exports more expensive than other nations

Foreign buyers look for substitute products which are priced lower

Exports fall & the balance on the current account worsens

Similarly, high inflation may mean that goods/services are cheaper in other countries

Domestic consumers may switch demand to foreign goods & as imports rise, the balance on the current account worsens

RAPID ECON GROWTH RESULTING IN INCREASED IMPORTS:

Rapid economic growth raises household income

Households respond by purchasing goods/services with a high-income elasticity of demand (income elastic)

Many of these goods are imported & as imports rise, the balance on the current account worsens

Question 42

What are the ways to reduce a current account deficit?

Answer 42

Expenditure reducing policies-

Contractionary fiscal policy-increase in income tax, increase in corporation tax and cut in GOV spending and contractionary monetary policy
such as increases Interest rates or a decrease in the money supply- reduce the level of AD in the economy and thus reduce incomes throughout the economy, which will reduce the marginal propensity to import; less ‘sucking in’ of imports. This reduces the demand for imports and thus the expenditure on them which will, ceteris paribus, improve the trade balance in the C.A thus rectifying a C.A deficit.

Evaluation:
Expenditure reducing policies conflict greatly with other macroeconomic objectives. In this case the trade balance improves but as a side effect, there is a fall in economic growth and a rise in U/E. These side effects are often much worse than the benefits of an improved trade position and hence are rarely used to reduce C.A deficits

Expenditure switching policies-

Protectionism- imposing or increasing tariffs, quotas, embargoes, domestic subsidies or non-tariff barriers. These policies will either increase the price of imported goods or simply block imports from entering the country thus reducing the expenditure on imports which will, ceteris paribus, thus rectify a C.A deficit.

Evaluation
§ Retaliation of trading partners. Countries will frown upon the fact that their economy and exporters suffer due to a trade deficit in a different country. Retaliation takes place - protectionism is enacted back on the initial country’s imports butt much strongly reducing that country’s revenue more so than the import expenditure they’ve saved = in the l/t worsening trade deficit. Protectionism = argued to culminate in tit for tat, punitive retaliation that is a zero-sum game for all involved.

§ Protectionism goes against the aims and principles of the WTO. One core rule of the WTO is for member countries to only impose protectionist measures approved by the WTO that are fair and consistent. Breaking such rules using tariffs to reduce C.A deficits will lead to a heavy fine being imposed or the WTO allowing trading partners to impose stricter, legal retaliation back.

§ Protectionist measures such as Tariffs can be inflationary leading to a conflict of GOV objectives- tariffs increase price of imported goods = increase the costs of production for businesses - reliant on such imports. These costs - passed onto the consumer via higher prices = cost push inflation. Even finished goods that are imported into a country - higher price increasing inflation throughout the economy.

§ Protectionism worsens the allocation of resources- promotes more domestic production when produces don’t necessarily have the comparative advantage- more resources go to less efficient domestic producers instead of more efficient foreign producers= CA distorted - resources misallocated = allocative inefficiency.

Exchange rate could be weakened:

By reducing I/R (increasing hot money flows), increasing the money supply or selling domestic currency reserves. A weak exchange rate = exports cheaper and imports dearer. Demand for imports and therefore expenditure on imports will decrease whereas the demand for exports and therefore revenue generated by exports will increase= improvement in the trade balance of the C.A and reduce a C.A deficit or move it to surplus.

Evaluation:

Depends on whether the Marshall-Lerner condition is satisfied. The sum of elasticities for net exports in the UK is - 0.78 - demand for exports is inelastic, as the price of exports decrease, demand will increase -therefore decreasing export revenue. UK the Marshall-Lerner condition is not satisfied, there will be a net increase in import expenditure relative to export revenue, worsening the trade balance, worsening a C.A deficit contrary to what theory suggests. This may therefore not increase AD where growth will not increase, U/E may not decrease and demand-pull inflation may not increase.

§ Marshall lerner condition will not be satisfied in the s/t due to very price inelastic demand for M AND X. contractual agreements make it difficult to switch, business take a while to adjust to E/R, J curve effect- where the CA position for a country more likely to move from initial deficit to worse deficit, noticeable time lag when contracts end and economic agents adjust to a permanently lower E/R. satisfy condition

§ Inflation. DPI - increases = conflict of macroeconomic objectives, AD increases in the economy, pressure is put on existing FOP increasing the price of them. Also, firms must now pay for imported raw materials, more expensive- pass on these extra costs via higher price= cost push inflation. Worse is for a nation that depends heavily on imported commodities and raw materials, could significantly dampen economic growth - leading to recession alongside higher than target inflation- stagflation. Pound fell 10%- inflation increased. Imported inflation

§ Purposeful E/R weakening could lead to retaliation and currency wars- seen to be acting in a protectionist way – outrage in trading partners- fall in export rev and economic growth.

§ Depends on severity of the trade restrictions applied by foreign gov. fall in E/R insignificant impact if gov has strict controls on exports

§ Depends upon income/ demand overseas. Demand overseas is weak - recession in major trading economies, demand for exports =low despite a fall in export prices via a weak E/R. Export revenues may not increase- C.A deficit unaffected or even worsening it.

§ Depends upon the income and demand at home. If demand at home is strong- boom - demand for imports will be high ‘sucking in’ imports despite a rise in import prices via a weak E/R. Import expenditure – may not decrease - C.A deficit unaffected or even worsening it.fex

Question 43

What are the evaluation points to rectify a current account deficit?

Answer 43

The cause of the current account deficit. GOV needs to know root cause and target policies - directly overcome the underlying problem. Expenditure reducing policies will only be useful if there is excessive import expenditure due to high incomes. Structural issues- supply side policies= long-term solution. Consequence of using wrong policies, macroeconomic objectives conflicts, burdens on future tax payers or worsened international relations.

Is the current account deficit really a problem?

§ A small deficit is unlikely to be difficult to finance especially if GDP growth rates are increasing faster than the current deficit- implies that a country can afford its borrowing to finance the C.A deficit without risk of panic fuelled currency crisis in the long term. GOVs looking to use expenditure reducing policies - worsen growth and U/E unnecessarily.

§ However, if the deficit balloons and grows at a faster rate than increases in real GDP, = unsustainable and indicative of debt dependency = negative consequences of running a C.A deficit more significant.

§ Once more if the deficit is caused by structural problems, it would be long term and persistent.

Question 44

What are the significance of global trade imbalances?

Answer 44

Current account imbalance is not much of a problem as long as the capital and financial account is in surplus.- financial crisis of 2008 dramatically reduced the amount of capital flowing around the global economy and showed how quickly the position of the capital account can change. Pound fell 10% In Brexit. 25% in GFC

§ Exposed to macroeconomic shocks

§ Since the late 1990s, concerns about global imbalances which can be measured in two ways: imbalances on the C.A and imbalances in assets owned abroad or borrowing owned abroad. The two linked since if a country has a constant surplus, then it will tend to build up a stock of assets abroad whilst if they have a constant deficit, they will owe more and more to foreign creditors. This may become an issue if imbalances are large.

§ Problems arise if foreign investors refuse to lend to a ‘country’- but it is an individual or institution which takes the loan and not the country. If they refuse to lend to a bank or the GOV, this will have much larger impacts than if they refuse to lend to a firm or individual.

§ Today, deficits are less of a concern to countries: the US and UK have no problem financing their deficits and borrowing has not built-up unsustainable debts.

§ C.A imbalances become a problem when GOVs can’t repay their foreign currency debts.

§ Countries with large deficits are seen as having a problem, whilst those with large surpluses are seen as being successful but in reality, those with surplus cause just as much instability as those with deficits.

§ C.A surpluses cause losses for citizens in a country who don’t see the high living standards which they could
enjoy from consuming more.

Question 45

What are the different exchange rates?

Answer 45

Exchange rate- the purchasing power of a currency in terms of what it can buy of other currencies.

§ Floating exchange rate- price of one currency in terms of another is determined by the forces of demand and supply. Appreciation, depreciation

§ Fixed exchange rate- price of one currency in terms of another is set/ maintained by central authorities. Revaluation- devaluation

§ Managed floating exchange rate- value of the currency is determined by demand and supply but Central Bank will try to prevent large changes in the e/r by buying and selling currency and I/R

Question 46

What is the difference between reevaluation and appreciation?

Answer 46

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

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

Question 47

What is the difference between devaluation and depreciation

Answer 47

A devaluation occurs if the Central Bank decides to change the peg and decrease the strength of its currenc

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 48

What are the factors affecting a floating exchange rate?

Answer 48

What factors cause an appreciation- factors that shift demand for the pound to the right

1. Increases in income abroad. As incomes abroad increase, MP of foreigners to buy UK G&S increases. This increases demand for UK exports and thus demand for the pound from D1 to D2- APPRECIATE from P1 to P2
2. Relative rise in UK I/R- as UK rates increase and are relatively higher than the rest of the world, investors will put their money in UK banks. ‘hot money inflows= increase demand for the pound shifting the demand curve = appreciation
3. An increase in FDI in Britain. Higher demand for the pound as capital needs to be brought by foreign businesses in pounds to operate in the UK. Staff need to be paid in pounds forcing an exchange of foreign currency into pound INCREASING DEMAND for pound forcing an exchange of currency into points. APPRECIATION
4. Imports- supply side. INCREASES
5. Speculators anticipating a rise in the pound- look to make a speculative gain. Speculators anticipate a rise in pound,buymorepound,increasingdemand-sellitwhenitincreases=gain.Shiftsdemandright-APPREC. a
6. Improvement in international competitiveness - better labour prod, investment/ low inflation rate. UK exports more price comp/ non-price comp demand for exports increase. UK goods bought in £ demand increases= apprec
7. High investor confidence into the economy- high confidence in l/t state with little economic volatility, investors move their money into UK banks for a good rate of return. Increase demand for pound= appreciate

FACTORS CAUSING A DEPRECIATION

UK Businesses investing abroad- selling the pound , shift supply curve right= depreciation. Outflows of FDI

Speculators anticipating a fall in pound-sell pounds, increasing supply= depreciation from P1 to P2

Increase in income domestically - MPI, consumers ‘sucking in’ imports, investors sell pound, supply curve to the right, depreciation

A fall in relative interest rates- investors move their money to foreign countries, better return. Hot money outflow shifting supply right, depreciation

Low investor confidence in the economy- sell the pound to get a more stable, reliable rate – sell ££- depreciate

Question 49

What is intervention in the markets using interest rates and forex transactions?

Answer 49

Changing interest rates: if the Central Bank wants to appreciate the country’s currency, it would raise interest rates thereby making it more attractive for foreigners to move money into the country’s banks (hot money). Decreasing interest rates has the opposite effect & causes a depreciation

Buying & selling currency in the forex market: The Central Bank can change the demand or supply for their currency using their reserves. If they want to appreciate the currency then they buy it on the forex market using foreign currencies e.g. to bolster the value of the £, the Central Bank could take US$’s from their reserves & buy £’s. If they want to depreciate the currency then they sell their own currency & buy foreign currencies

Question 50

What are the advantages and disadvantages of depreciation/devaluation? WITH EVAL

Answer 50

Improved trade balance-exports cheap, imports dear. Theory suggests that demand for imports and thus expenditure on imports will decrease, demand for exports and revenue generated will increase= imp in trade balance of C.A – move to surplus or reduce def. esp true if country suffers larger trade in goods than services

Increased growth and reduced unemployment- exports cheap, imports dear. (X-M) component of AD, AD will rise increasing economic growth. Labour is a derived demand, more employment is needed to produce extra goods and services demanded reducing u/e in the economy

FDI: A fall in the currency may increase FDI because it becomes cheaper to invest. However, if the currency is continuing to fall then this is an indication that an economy has serious economic difficulties which will discourage investment

DISADVANTAGES:

.INFLATION- Demand pull inflation- AD increases putting pressure on existing factors of production, increasing prices of them. , firms may more for imported raw materials. Costs of production increases SRAS to the left and firms pass on extra costs via higher prices. Worse for a nation heavily dependent on imported commodities, significantly dampen economic growth; even leading to a recession alongside higher thn target inflation- stagflation

Evaluation (opposite for appreciation):

§ Depends on whether the Marshall-Lerner condition is satisfied. sum of elasticities for net exports in the UK is - 0.78 - demand for exports is inelastic, as the price of exports decrease, demand will increase -therefore decreasing export revenue. UK the Marshall-Lerner condition is not satisfied, there will be a net increase in import expenditure relative to export revenue, worsening the trade balance, worsening C.A deficit contrary to what theory suggests. This may therefore not increase AD where growth will not increase, U/E may not decrease and demand-pull inflation may not increase.

§ Marshall learner condition will not be satisfied in the s/t due to very price inelastic demand for M AND X. contractual agreements make it difficult to switch, business take a while to adjust to E/R, J curve effect- where the CA position for a country more likely to move from initial deficit to worse deficit, noticeable time lag when contracts end and economic agents adjust to a permanently lower E/R. satisfy condition

§ Depends on severity of the trade restrictions applied by foreign gov. fall in E/R insignificant impact if gov has strict controls on exports

§ Depends upon size of depreciation. Large depreciation- increase demand for exp sig, large drop in price of expo sway foreign firms and consumers to purchase exp that have dropped by a greater margin. Could lead to inflation AD increases further - economy reaches FE - pressureut on excess resources increasing demand pull inflationary pressure. Large depreciation greatly increase import prices thus increase firms COP- CPInflation

§ Whether a weak exchange rate will rectify a C.A deficit depends upon income and demand overseas. demand overseas is weak - recession in economies of major trading- demand for exports will be low despite fall in export prices via weak e/r . Export revenues = not increase leaving the c.a def unaffected/ even worsening it.

§ Incomes and thus demand at home. If demand at home is strong due to a boom demand for imports -high ‘sucking in’ imports despite rise in import prices via weak e/r. Import expenditure may therefore not decrease leaving the C.A deficit unaffected/ even worsening it.

§ Depends upon initial level of economic activity- initially operating large levels spare capacity- increase AD lead- larger increase output, decrease in u/e= easy for firms to expand production using up excess labour and capital- lack of pressure limits rise in inflation potentially no DPI= not making exports less competitive and worsening C.A position

Question 51

What are the impacts of the changes to exchange rates to an economy?

Answer 51

The current account-

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 recognise 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

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

INFLATION-
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
An appreciation of the currency will have the opposite effect

UNEMPLYOMENT- 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

LIVING STANDARDS-
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

FDI- 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

Question 52

What is the case for floating exchange rate with EVAL?

Answer 52

Reduced need for currency reserves- no e/r target – little need CB hold large scale reserves of foreign currency. Holding them is ££- carries large OC-allow for > expenditure- productive areas in economy, sustained, sustainable growth over l/t

Freedom (autonomy) for domestic monetary policy. Allows I/R to be set to meet domestic macroeconomic obj such as stabilising growth or inflation. Cannot happen under fixed E/R – any changes to I/R – fixed rate not being maintained

Useful instrument of macroeconomic adjustment- depreciation= boost to net export demand, stimulate growth. Countries inside eurozone might be hoping for more competitive, weaker euro as a means of creating an injection of demand into slow growing economies. Appreciation useful in keeping inflation under control and towards target

Partial automatic correction for trade imbalances. Floating e/r offers degree of adjustment when BOP is in fundamental disequilibrium- i.e. large trade deficit downward pressure on e/r. should boost export rev and reduce demand for imp and expenditure- rectified c.a deficit. Large trade surplus upward pressure on e/r, reduce exp rev and increase imp exp reducing surplus back to balance

Reduced risk of currency speculation. Explicit e/r target reduced risk of spec. currency market speculator target fixed e/r, believe to be over or undervalue, under floating e/r – risk is minimal as theory PPP is reflected in e/r. consequence of less likelihood of speculative arrack, e/r is unlikely to collapse and trigger econ crisis.

Evaluation against floating e/r:
Floating exchange rates can create uncertainty if volatile- businesses planning future- difficult for predictions about costs, risk and investment harder to assess- levels of investment decline. Once exporters/importers find more difficult to interpret short VS l/t changes in the e/r = uncertainty reduces volume of trade. Foreign firms wary of volatile e/r acts as deterrent to invest abroad (less FDI)= reduced actual and potential growth for economy

Floating exchange rates do not necessarily self-adjust to eliminate trade imbalances nor do they always reflect PPP
often more dominating factors than trade that affect movements in the E/R that can stop PPP being reflective and downward pressure on E/R due to trade deficit. consequently, benefits if do exist will be minimal

Floating exchange rate may worsen inflation. Country high relative inflation - exports less competitive and imports less expensive – E/R fall, more supply of currency than demand however could increase DPI as (X-M) increases also increasing import prices; cost push inflation fuelling overall inflation rate above target

Question 53

What is the case for fixed exchange rates? WITH EVAL

Answer 53

Trade and investment increase, reduced e/r uncertainty. Businesses forecast costs easier, risk and ROI easier to predict, increase FDI. Increase actual, potential growth

Some flexibility permitted- If economic case becomes unstoppable and e/r are set damagingly high/ low; occasional devaluation or revaluation of currency can take place if agreement can be reached with other countries. Countries with fixed e/r reluctant to make parity adjustments

Reductions in the costs of trade (currency hedging)- impossible to predict what will happen to market value of currency, businesses hedge against this volatility by buying currency they need in the forward currency markets, more risky and could be more ££ in SPOT markets. With fixed e/r, businesses spend less on currency hedging if they know currency will hold value in FOREX markets, enabling money to be used more productively to invest

Disciplines on domestic producers- exporters forced to improve competitiveness of goods and services to maintain strong export sales and rev- they know they’ll receive no benefit from weaker e/r. implementing training programmes, exploit E.O.S, negotiating better deals with raw materials. S/T and L/T growth can be promoted, increases in AD, LRAS as result of persistent net export increases and competitiveness improvements

EVAL:

Countries must ensure they have a large level of foreign exchange reseves to maintain a fixed exchange rate- to intervene in FOREX, requires huge reserves. Highly expensive to maintain, OC huge-huge

Interest rate changes to maintain a fixed exchange rate may have detrimental side effects on the rest of the economy- Fixed e/r- danger of falling, I/R rise to maintain value- deflationary impact – lowering AD, reducing. Growth and increasing u/e. no freedom to cut i/r given the lower pressure it’s put on the fixed rate forcing policy

Question 54

What are the measures of internatioal competitiveness?

Answer 54

§ The lower level of international competitiveness, more likely that the country will face a C.A deficit. For goods to be competitive internationally= cheap, have good quality, design or after-sales and good marketing.

MEASURES:

Relative unit labour costs: = total wages divided by real output: the cost of employing workers for each unit of good. A rise in relative unit labour costs in the UK shows that labour cost per unit is rising faster in the UK compared to other countries - UK is becoming less competitive.

§ Relative export prices: This is the price of UK exports compared to the exports of the UK’s main trading partners.

Question 55

What are the factors influencing international competitiveness?

Answer 55

Exchange rates: rise in pound - cause exports to become more expensive, UK goods less competitive as their price changes. However, this depends on the elasticity the good and the reaction of the firms as explained in. China e/r policy- artificially low- export led growth

Productivity: rise = rise in the UK’s competitiveness- costs are lower = prices fall. UK-20% BELOW G7 AVG

Regulation-less adaptable to changes in global market- increases cost of production- reduces competitiveness because of higher costs and slow decision making.

Investment: Investment in infrastructure improves productivity and ensures firms can deliver and produce their product reliably, cheaply and efficiently. Allows firms to develop new products, increases competitiveness

Taxation: High levels of taxation reduce investment and so cause a reduction in international competitiveness in the long term.

Inflation- Low levels of inflation increase competitiveness - UK goods become more competitive over time.

Economic stablity- If the country is not seen as stable, then there will be little long-term investment and so this will reduce competitiveness overtime.

Flexibility: If the labour market is flexible, this will improve competitiveness as businesses will be able to move labour in response to changes in demand prevent unnecessary wage rises- costs and prices low. Flexible and efficient managers manage change within the company adapt production when demand for products changes.

Competition and demand at home: A good level of domestic demand - firms in the country will have economies of scale, and so have low AC curves. Similarly, high levels of competition will mean firms will have to have good quality or cheap products to survive. compete internationally.

Factors of production: good quality FOP - produce more and better-quality goods Openness to trade:

§ Country will experience C.A surpluses- opportunity to invest overseas/ build up a surplus of assets ove

Question 56

What are the benefits and problems of competitiveness?

Answer 56

BENEFITS:

Country will experience C.A surpluses- opportunity to invest overseas/ build up a surplus of assets overseas, on which interest, profit and dividends can be earned.

§ A competitive economy is likely to attract inflows of foreign investment, whether this be by establishing new companies (creating jobs) or buying domestic firms. This will lead to a transfer of knowledge, skills and technology to firms. L/R GROWTH

§ Employment is likely to increase because more goods are being produced, since more goods are exported and less are imported, so more are sold internationally and domestically. A rise in demand for labour will lead to a rise in wages.

§ There will be economic growth, both by supply side improvements due to efficiency and investment and by demand side improvements relating to X-M.

Problems of competitiveness:

§ Competitiveness can be easily lost. Developing countries who’ve benefits - low costs of labour/ costs of materials - could see this eroded - experience export led growth due to comp. C.A surplus - rise in e/r reduce competitivene

§ Less competitive countries may implement trade barriers to protect themselves.

§ Countries who are competitive may become more dependent on overseas countries - suffer from larger issues if global recession