4.1 - International economics

Question 1

Define Globalisation

Answer 1

Globalisation refers to the increased economic integration between countries.

Question 2

What is Foreign direct investment (FDI) ?

Answer 2

Foreign direct investment is where a company establishes operations e.g. a factory, in another country or when it acquires physical assets or a stake in an overseas company.

Question 3

What are capital flows?

Answer 3

Capital flows refer to all the money moving between countries as a consequence of investment flows into and out of counties around the world.

Question 4

What are key characteristics of globalisation?

Answer 4

1- Increased trade as a proportion of GDP

2- Increased foreign direct investment

3- Increased capital flows between countries.

4- Increased movement of people between countries.

Question 5

What are the causes of globalisation?

Answer 5

1- A decrease in transport costs: containerisation resulted in economies of scale and falling long run average costs.

2- Improvement in IT and communication.

3- A reduction in world trade barriers

4- The growth of trading blocs

5- The increased importance of global companies or transactional companies (TNCs): TNCS have undertaken much FDI which involves offshoring.

Question 6

What is offshoring?

Answer 6

Offshoring refers to companies transferring manufacturing to a different country.

Question 7

What are the impacts of globalisation on consumers?

Answer 7

1- Consumers have more choice since there are a wider range of goods available from all around the world.

2- Lower prices: as firms take advantage of comparative advantage and produce in countries with lower costs.

3- Increased living standards

4- Many consumers worry about loss of culture

Question 8

What is the impact of globalisation on workers?

Answer 8

1- Increased employment opportunities.

2- Job losses in the western world in sectors such as manufacturing

3- TNCs might exploit workers in developing countries by paying low wages.

Question 9

What is the impact of globalisation on producers?

Answer 9

1- Firms will be producing on a larger scale so will benefit from economies of scale and higher profits.

2- Firms can benefit from offshoring thus reducing costs. As low skilled labour is much cheaper in developing countries.

3- Local producers who are uncompetitive may be forced out of business.

4- Technology transfer is likely to occur, when TNCs invest in a country they are likely to bring modern technology. This can increase productivity.

Question 10

What is the impact of globalisation on the government?

Answer 10

1- The government may receive increased tax revenue due to the TNCs and the workers they employ

2- Global companies may engage in tax avoidance, thus reducing government income.

Question 11

What is the impact of globalisation on the environment?

Answer 11

1- The increase in world production has led to greater demand for raw materials therefore depleting resources.

2- Increased trade will result in more transport and more pollution.

3- Globalisation means the world can work together to tackle climate change and share ideas and technology.

Question 12

What is the impact of globalisation on inequality?

Answer 12

There is evidence that globalisation has resulted in increased inequality within some countries. One reason for this is that the demand for unskilled labour has decreased in developed countries, so increasing the earning gap between the highest paid and the lowest paid workers. However inequality between countries has fallen over the last 40 years.

Question 13

What is a transnational corporation (TNC)?

Answer 13

Also known as a Multinational Corporation (MNC), is a large business that operates in multiple countries. These companies often have a headquarters in one country but manage production or deliver services in several other foreign countries.

Question 15

Illustrate absolute advantage between country A and B where country A has an advantage in rice, an B has an advantage in cars.

Answer 15

Question 16

When does a country have comparative advantage?

Answer 16

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

Question 17

What did David Ricardo demonstrate?

Answer 17

That trade between two nations can be beneficial to both if each specialises in the production of a good in which it has a comparative advantage. (there must be a difference in the opportunity cost)

Question 18

What are the assumptions for the law of comparative advantage?

Answer 18

1- Constant returns to scale, which would imply that the PPFs are drawn as straight lines.
2- No transport costs
3- No trade barriers
4- Perfect mobility of factors of production between different uses.
5- Externalities are ignored.

Question 19

What are the assumptions for the law of comparative advantage?

Answer 19

1- Constant returns to scale, PPFs are drawn as straight lines
2- No transport costs
3- No trade barriers
4- Externalities are ignored

Question 20

Illustrate comparative advantage

Answer 20

Question 21

Illustrate comparative advantage

Answer 21

Question 22

What are the limitations of the law of comparative advantages?

Answer 22

1- Free trade is not necessarily fair trade.

2- The law of comparative advantage is based on unrealistic assumptions such as constant costs of production, zero transport costs and no barriers to trade.

3- If the opportunity costs were the same, there would be no benefit from specialisation and trade.

Question 23

What are the limitations of the law of comparative advantage?

Answer 23

1- Free trade is not necessarily fair trade (the rich countries might exert their monopsony power to force producers in developing countries to accept very low prices)

2- The law of comparative advantage is based on unrealistic assumptions such as constant costs of production, zero transport costs and no barriers to trade.

3- If the opportunity costs were the same there would be no benefit from specialisation and trade.

Question 24

What are the advantages of specialisation and trade?

Answer 24

1- Higher living standards and increased employment would result from an increase in world output.

2- There are lower prices and therefore higher consumer surplus and increased choice.

3- There is a transfer of management expertise and technology.

4- There are economies of scale.

5- There is a reduction in the power of monopolies.

Question 25

What are the advantages of specialisation and trade?

Answer 25

1- Higher living standards and increased employment due to increased world output. 2- Lower prices mean higher consumer surplus and increased choice. 3- There are economies of scale 4- Increased competition means there is a reduction in the power of monopolies 5- There is a transfer of management expertise and technology.

Question 26

What are the disadvantages of specialisation and trade?

Answer 26

1- There is a deficit on the trade in goods and services balance if a countries goods and services are uncompetitive. 2- There is a danger of dumping

Question 27

What are the disadvantages of specialisation and trade?

Answer 27

1- There is a deficit on the trade in goods and services balance if a country's goods and services are uncompetitive 2- There is a danger of dumping: when a product is sold in a foreign country for less than the cost of making the product. Countries with surpluses of goods might dump then on other countries which could back local producers go bankrupt. 3- There may be increased unemployment 4- TNCs may become global monopolies and exploit consumers. 5-There could be unbalanced development. Only the industries where the country has the comparative advantage will be developed, leading to a sectorial imbalance.

Question 28

What are the further possible disadvantages developing countries may face due to free trade?

Answer 28

1- Infant industries may be unable to compete and go out of business 2- Monopsony power of firms in developed economies might force producers in developing economies to accept low prices for their products. 3- Declining terms of trade occur for countries dependant on primary products

Question 29

What is free trade?

Answer 29

Free trade is when international trade is left to its natural course without tariffs, quotas, or other restrictions. It does not restrict imports or exports.

Question 30

What does a declining terms of trade mean?

Answer 30

Declining terms of trade means that a country gets less value for its exports relative to the cost of its imports. The country must export more to buy the same amount of imports.

Question 31

What is meant by the term "patterns of trade" ?

Answer 31

The trends and changes in what, how much, and with whom countries trade over time.

Question 32

What are the key factors influencing patterns of trade between countries?

Answer 32

1- Changes in comparative advantage. 2- The growth in exports of manufactured goods, especially from low wage countries to developed economies. 3- The growth of global supply chains 4- The increased importance of emerging economies as trading partners. 5- The growth of trading blocs and bilateral trading agreements 6- Changes in relative exchange rates.

Question 33

What does the terms of trade measure?

Answer 33

The price of a country's exports relative to the price of its imports.

Question 34

What is the formula to calculate a countries Terms of trade?

Answer 34

Question 35

What factors influence a country's terms of trade?

Answer 35

1- The country's rate of inflation 2- The country's productivity relative to that of other countries 3- Tariffs 4- The country's exchange rate

Question 36

What does an increase in a Terms of trade actually mean?

Answer 36

The price of a country’s exports has risen relative to the price of its imports.

Question 37

What is the effect of an increase in a country's terms of trade?

Answer 37

1- Higher living standards: the country can import more for a given quantity of exports. 2- A deterioration in the current account of the balance of payments

Question 38

What is a Trading bloc?

Answer 38

A trading bloc is a group of countries that agree to reduce or eliminate trade barriers between themselves.

Question 39

What are some examples of trade blocs?

Answer 39

1- European union 2- USMCA 3- ASEAN

Question 40

What are the types of trading blocs (4) ?

Answer 40

1- Free Trade areas: trade barriers are removed between member countries but each member can impose trade restrictions on non members. 2- Customs unions: there is free trade between member countries combined with a common external tariff on goods from countries outside the customs union. 3- Common Markets: these have the same characteristics as customs unions but include the free movement of factors of production between member countries. 4- Monetary unions: these are customs that adopt a common currency. For example the eurozone.

Question 41

What is trade diversion?

Answer 41

Trade diversion occurs when trade is diverted from a more efficient exporter towards a less efficient producer.

Question 42

What are the costs of trade agreements /trading blocs? including costs associated with monetary unions.

Answer 42

1- Trade diversion: Trade may be diverted away from low-cost producers outside the bloc to high cost producers within the bloc 2- Distortion of comparative advantage: trade barriers against non members are likely to cause a decrease in specialisation and a fall in world output Costs associated with monetary unions: 1- Transition costs: one off costs associated with changing menus, price lists when a currency is introduced. 2- Loss of independent monetary policy: countries no longer have control of their own interest rates. 3- Loss of exchange rate flexibility.

Question 43

What are the benefits of trade agreements/ trade blocs? Including benefits associated with monetary unions

Answer 43

1- Trade creation: the removal of trade barriers between member countries results in increased trade between them. 2- Increase in Foreign direct investment (FDI): TNCS gain unrestricted access in selling goods to consumers in the bloc. 3- Increase in economic power: A large trading bloc might be in a better position to negotiate trade agreements with other countries and trading blocs. Benefits associated with monetary unions: 1- Elimination of transaction costs: these are the costs involved in changing currencies when goods are imported or exported. 2- Price transparency: consumers have the ability to compare prices more easily across national borders. 3- Elimination of currency fluctuations between member countries: this could encourage increased investment by businesses

Question 44

What are the key roles of the World Trade Organisation?

Answer 44

1- To promote free trade- this is achieved through various rounds of talks. 2- To settle trade disputes between member countries.

Question 45

What are the possible conflicts between regional trade agreements and the WTO?

Answer 45

Regional trade agreements restrict trade with non member countries, which conflicts the aims of the WTO. However the number and size of the regional trade agreements have been increasing which plays a role in promoting free trade.

Question 46

What are the reasons for restrictions on free trade?

Answer 46

1- To correct a deficit in the trade in goods and services balance. 2- To prevent dumping 3- To reduce unemployment 4- To reduce the risk of disruption resulting from problems in the global economy. 5- To prevent sectorial imbalance 6- To limit the monopoly power of global companies. Developing countries may have particular reasons for restricting trade: 1- To protect infant industries 2- To limit monopsony power of firms in developed economies.

Question 47

What are the types of restrictions on free trade?

Answer 47

1- Tariffs: These are taxes on imported goods. 2- Quotas: These are limits on the quantity of a product imported. 3- Subsidies to domestic producers: subsidies are government grants to a firm which reduces the costs of production 4- Non tariff barriers: These include, health and safety regulations, environmental regulations, labelling of products and bureaucracy.

Question 48

Illustrate the effects of a tariff.

Answer 48

Question 49

From the graph of tariffs, label the price paid by consumers, domestic output, imports, tax revenue and net welfare loss before and after the tariff

Answer 49

Question 50

When drawing supply and demand graphs for the effects of restrictions on world trade, why is world supply horizontal (perfectly elastic)

Answer 50

It is because the domestic country is small relative the world market. It cannot influence the world price with its own supply and demand. The world market has many producers so the price remains the same regardless of the quantity bought in one country.

Question 51

Illustrate the effect of a subsidy. And explain the effects.

Answer 51

Before subsidy: price paid by consumers is P1, Domestic output is OX, imports are XZ. After subsidy: price paid by consumers is p1, domestic output is OY and imports is YZ.

Question 52

What is the impact of protectionist policies on consumers?

Answer 52

Tariffs and quotas result in higher prices and a reduction in both consumer surplus and consumer choice.

Question 53

What is the impact of protectionist policies on producers?

Answer 53

Domestic firms face less competition and have less incentive to produce at lowest average cost. Foreign producers will loose out.

Question 54

What is the impact of protectionist policies on the government?

Answer 54

If tariffs are imposed, a government would receive tax revenue. This might help reduce a fiscal deficit or increase a fiscal surplus.

Question 55

What is the impact of protectionist policies on living standards?

Answer 55

Protectionism distorts comparative advantage. This means that specialisation is reduced, resulting in lower output

Question 56

What is the impact of protectionist policies on equality?

Answer 56

Tariffs are a regressive tax meaning they don't take into account a persons income and thus may increase income inequality.

Question 57

What is the balance of payments?.

Answer 57

The balance of payments is a record of all financial transactions between one country and those in the rest of the world.

Question 58

What are the two main components of the balance of payments?

Answer 58

1- Current account 2- Capital and financial account.

Question 59

What are the four components of the balance of payments?

Answer 59

1- Trade in goods balance: value of goods exported - value of goods imported 2- Trade in services balance: value of services exported - value of services imported. 3- Primary balance (investment income): income earned from assets overseas - income paid to foreigners for assets owned in the UK. 4- The secondary balance (current transfers): payments received from foreign institutions and citizens minus payments paid abroad.

Question 60

What are the elements of the capital and financial account?

Answer 60

1- Foreign direct investment: investment by foreign companies into the UK - investment by UK companies abroad. 2- Portfolio investment in shares and bonds: purchase of UK shares and bonds by foreigners minus purchase of foreign shares and bonds by UK citizens. 3- Short term capital flows. 4- Changes in foreign currency reserves.

Question 61

What are the causes of deficits on the current account.

Answer 61

1- Relative low productivity 2- Increase in a country's exchange rate against that of other countries. 3- Continuous economic growth, resulting in an increase in imports. 4- The reallocation of many manufacturing industries from developed countries to countries where labour costs are lower.

Question 62

What are the causes of surpluses on the current account?

Answer 62

1- Relatively high productivity 2- A decrease in a country's exchange rate against that of other country's. 3- A decrease in economic growth resulting in a decrease in imports.

Question 63

What are the measures to reduce a country's deficit on the current account?

Answer 63

1- Expenditure reducing policies: deflationary fiscal and monetary policy. This reduces AD and leads to a reduction in imports. 2- Expenditure switching policies: these include tariffs, quotas and export subsidies. 3- Devaluation/depreciation of a country's currency. 4- Supply-side policies.

Question 64

What are measure to reduce a current account surplus?

Answer 64

Policies to decrease exports and increase imports. Increasing domestic demand due to tariffs.

Question 65

What are expenditure reducing policies?

Answer 65

They are policies designed to reduce aggregate.

Question 66

What are expenditure switching policies

Answer 66

They are policies designed to alter the pattern of a country's expenditure between domestic and imported goods.

Question 67

When do global trade imbalances occur?

Answer 67

When some countries have large current account deficits while other countries have large current account surpluses.

Question 68

What are 2 examples of countries that run current account deficits?

Answer 68

USA and UK

Question 69

What are 2 examples of countries that run current account surpluses?

Answer 69

China and Germany

Question 70

What are the reasons why a persistent current account deficit may be undesirable?

Answer 70

1- It could indicate that the country's goods and services are uncompetitive. 2- It may result in an increasing rate of unemployment 3- The country may be forced to borrow foreign currency from other countries or from the international monetary fund (IMF) 4- Under a system of floating exchange rates, it could result in a depreciation of the exchange rate

Question 71

When might a current account deficit not be regarded as a major problem?

Answer 71

1- If it is caused by imports of capital goods 2- If it is only a short run problem 3- If it can be financed easily by inflows into the financial account.

Question 72

What are the reasons why a persistent current account surplus may be undesirable?

Answer 72

1- It could result in inflation since AD is increasing. 2- It may imply that living standards are falling since there are less goods and services available for domestic consumption. 3- It could cause an appreciation in the value of the county's currency, making the country's goods and services less competitive. 4- It might cause other countries to impose restrictions on imports.

Question 73

What is an exchange rate in economics?

Answer 73

It is the rate at which one currency exchanges for another, or the value of one currency in relation to other currencies,

Question 74

What are the 3 exchange rate systems and explain each.

Answer 74

1- Floating exchange rate: under this system the exchange rate is determined by market forces (supply and demand) 2- Fixed: In this case the country's currency is fixed against other currencies. 3- Managed: this is essentially a floating exchange rate but one which is subject to intervention by the central bank in the foreign exchange market in order to influence the exchange rate of the country's currency.

Question 75

What is a revaluation?

Answer 75

It is when a country decides to increase the exchange rate of its currency under a system of fixed exchange rates.

Question 76

What is an appreciation?

Answer 76

An appreciation refers to an increase in the exchange rate of a country's currency under a system of floating exchange rates.

Question 77

What is a devaluation?

Answer 77

A devaluation is when a country decides to decrease the exchange rate of its currency under a system of fixed exchange rates

Question 78

What is a depreciation?

Answer 78

A depreciation refers to a decrease in the exchange rate of a country's currency under a system of floating exchange rates.

Question 79

What are the factors influencing floating exchange rates?

Answer 79

1- Relative inflation rates: if a country has a higher inflation rate than its competitors, its purchasing power will fall relative to its competitors and in the long term it is likely its value will fall. 2- Relative interest rates: if a country has much higher interest rates than others, this may attract money into its banks from abroad, causing increase demand for the currency and causing its value to rise. 3- Current account balance: if a country experiences an increase in its current account deficit, the supply of the currency its increasing relative to the demand for it. This would result in a depreciation in its currency. 4- Foreign direct investment: a country which is a net recipient of FDI will experience an increased demand for its currency, so causing its value to depreciate. 5- Speculation

Question 80

What are the methods of government intervention in currency markets?

Answer 80

1- Interest rates: to reduce the exchange rate of the country's currency, the central bank would reduce the base interest rate. This would make it less attractive for foreigners with cash balances to leave them in that country, so causing an increase in supply of the currency on the foreign exchange market and so causing a reduction in its value 2- Foreign currency transactions: if the aim is to reduce the exchange rate of the country's currency then the central bank would sell its currency on the foreign exchange market. This increase in supply of the domestic currency would cause a fall in its value. 3- Quantitative easing: there is evidence that QE has had an indirect effect of causing a depreciation of the exchange rate.

Question 81

What is a currency war?

Answer 81

A currency war occurs when nations seek to deliberately depreciate the value of their domestic currencies in order to stimulate their economies.

Question 82

What is the impact of a devaluation/depreciation of the exchange rate on the current account of the balance of payments in the long run?

Answer 82

A devaluation/depreciation would cause: - a decrease in the foreign currency price of a country's exports. - An increase in the domestic price of its imports these two factors would cause an increase in the competitiveness of the country's goods and services, and an improvement on the current account. This will only happen if the Marshall-Lerner condition holds.

Question 83

What does the Marshall-Lerner condition state?

Answer 83

The Marshall-Lerner condition states that a depreciation or devaluation of the currency will only lead to an improvement in the trade balance if the sum of the price elasticities of the demand for imports and exports is less than -1.

Question 84

What is the J curve effect?

Answer 84

The J curve effect is when a county's trade balance initially worsens following a devaluation or depression of its currency and only improves in the long run.

Question 85

What is the effect of a devaluation/depreciation in the current account of the balance of payments, in the short run?

Answer 85

It might cause a deterioration in the current account because: 1- the demand for imports might be inelastic if firms have stocks or if they are tied into contracts 2- the demand for exports might be price inelastic because consumers take time to adjust to the new lower prices.

Question 86

What is the impact of a devaluation/depreciation of the exchange rate on economic growth

Answer 86

In terms of Ad and AS analysis, a devaluation/depreciation should lead to an increase in AD because net exports should rise, causing an increase in real output and a decrease in unemployment.

Question 87

What is the impact of a devaluation/depreciation of the exchange rate on the rate of inflation?

Answer 87

The increased price of imported commodities and raw materials would cause an increase in costs of production, so leading to cost push inflation. Further the increase in AD can result in inflation.

Question 88

What is the impact of a devaluation/depreciation of the exchange rate on foreign direct investment flows?

Answer 88

A depreciation in the value of the Japanese yen would make it cheaper for a US company to invest in Japan because a dollar would be worth more in yen than before the depreciation

Question 89

What is international competitiveness?

Answer 89

International competitiveness measures the cost of a county's goods and services exports relative to those of other countries.

Question 90

What are the two types of competitiveness?

Answer 90

1- Price competitiveness 2- Non-price competitiveness

Question 91

How is international competitiveness measured?

Answer 91

1- Relative unit labour costs: unit labour costs measure the average cost of labour per unit of output. 2- Relative export prices: a country's export prices relative to those of its major competitors are significant for competitiveness. 3- The global competitive index (GCI)

Question 92

What are the factors influencing international competitiveness?

Answer 92

1- Unit labour costs: An increase in unit labour costs higher than the rise in labour productivity may cause a decrease in the economy's cost competitiveness. 2- Productivity: Output per unit of labour. 3- The real exchange rate: exchange rate adjusted for inflation. 4- Labour taxes or subsidies: employers national insurance contributions are regarded as a tax on jobs and so could reduce the competitiveness of a country's goods and services. 5- Government laws and regulations: these include environmental and health and safety regulations, employment protection and a national minimum wage. 6- Research and development (R&D): this might result in technological advancement and increased productivity.

Question 93

What are the benefits of being internationally competitive?

Answer 93

1- An improvement in the current account of the balance of payments. 2- A reduction in unemployment 3- An increase in economic growth because an increase in net exports will cause an increase in AD and have a multiplier effect on national income

Question 94

What are the problems of being internationally uncompetitive?

Answer 94

1- A deficit on the current account of the balance of payments 2- An increase in unemployment 3- A depreciation in the country's exchange rate.