4.1 International Economics Flashcards
1
Q
What is the definition of globalisation?
A
The integration of local, regional and national economies into a single international market
2
Q
What are the four characteristics of globalisation?
A
- Free trade of goods and services
- Free movement of labour
- Free movement of capital (finance)
- Exchange of technology and intellectual property
3
Q
What is free trade of goods and services?
A
- Firms have markets in different places and source their factors of production from other countries.
- Supply chains are globalised.
- Consumers can buy products from a range of other countries.
4
Q
What is free movement of labour?
A
Workers are able to seek jobs anywhere they wish, and firms can access labour from any country
5
Q
What is the danger of free movement of labour?
A
Firms can relocate in order to exploit low cost labour
6
Q
What is free movement of capital?
A
- This is investment across international borders - foreign direct investment
- Capital can be owned by foreign firms, and domestic firms can own capital abroad.
- Profits can be repatriated.
7
Q
What is the exchange of technology and IP?
A
Firms can buy and sell technology across borders and firms are able to protect IP abroad
8
Q
What are the five factors contributing to globalisation?
A
- Improvements in transport infrastructure (containerisation) and communications technology
- Trade liberalisation (WTO)
- Increasing number of global companies
- End of the cold war - collapse of communism and opening up of China
- Development and deregulation of international financial markets
- Growth in the number and size of trading blocs
9
Q
What is trade liberalisation?
A
Widespread removal of protectionist barriers and tariffs.
10
Q
What is the impact of globalisation on consumers? Three positives + EVAL.
A
- Increased consumer choice
- BUT goods are now homogenised, e.g hotels or fashion
- Prices are lower due to specialisation and comparative advantage
- BUT average world incomes rising means prices may rise
- Overall income rise, e.g in China
- BUT stagnant incomes below average (e.g in USA) due to structural unemployment
11
Q
What is the impact of globalisation on workers? Three points + EVAL
A
-
Structural unemployment due to loss of domestic industry
- Only speeding up rate of change not creating it
- Increased migration and better standards of living
- Migrants take blame for taking jobs or lowering wage rate due to increased competition, or strained education and housing
-
Wages have decreased for low skilled workers in developed nations (compete w/ developing nations
- Low skilled workers in developing nations are doing better
12
Q
What is the impact of globalisation on firms? Two points + EVAL
A
- Firms are increasingly dependent on foreign suppliers and markets, easily disrupted supply chains (Covid, Brexit)
- Reduce risks as firms can source products from a wider variety of countries
- Wider supplier network can lower costs of production
- Chains easily disrupted
13
Q
What is the impact of globalisation on governments? One points + EVAL
A
Increase in economic growth should result in an increase in profits for firms and incomes for consumers, which should hence increase tax revenues for governements
BUT, transfer pricing may occur - this is where a global company manages its accounting of company transations to show the highest profits in countries where corporation tax is lowest - meaning they are tax avoiding and tax revenues may decrease.
14
Q
What is the impact of globalisation on countries as a whole? Three point + 2 x EVAL
A
- Increase in real GDP due to comparative advantage and increased production
- Deglobalisation to protect domestic employment has lead to protectionism that has decreased trade
- Increased inequality in developed economies as labour is transfered away
- Decreased inequality in deveoloping economies benefitting from new jobs
- Harms natural resources and the environment from travel e.g. airplanes
15
Q
What is absolute advantage?
A
This is when a country is able to produce (when all resources are devoted) more of one good than another country.
16
Q
What is comparative advantage?
A
The ability of one country to produce a good with a lower opportunity cost than another country, meaning it has a relative advantage in producing that good
17
Q
What are the 5 assumptions underlying the theory of comparative advantage?
A
- No transport costs
- No trade barriers
- Constant returns to scale - i.e. average cost of production is constant
- Perfect mobility of resources between different uses
- Buyers/consumers have perfect knowledge
18
Q
Why is comparative advantage a justification for international trade?
A
- Both countries can specialise into producing the good they have the lower opportunity cost in, and then free trade enables both countries to consume outside of their PPF.
- This is because they are both producing the most they can, and then can trade between each other.
19
Q
What are 3 limitations of the principle of comparative advantage?
A
- Transport costs might outweigh the benefits of trade
- Trade barriers may distort the advantage
- Increased production may result in rising average costs caused by diseconomies of scale
20
Q
What are the overall benefits of international trade and specialisation? [5]
A
- Increased scope for specialisation and therefore increased global production/consumption and higher living standards
- More growth means more firms can access economies of scale
- Increased competition - encourages the freeing up of resources (creative destruction)
- Sharing of technology and resources for firms
- Lower prices for consumers through imports
21
Q
What is the overall effect of trade on the global allocation of resources?
A
A more efficient global allocation of resources.
22
Q
Give and explain the six costs/risks of international trade.
A
- Overdependence/overspecialisation, e.g. export-led growth AD
- Structural unemployment - lack of demand for uncompetitive goods/exported labour
- Inequality - trade may only benefit the wealthy/developed countries
- Depletion of natural resources
- Loss of sovereignty e.g. the EU
- Loss of culture by trading goods
23
Q
Explain the four factors influencing the pattern of trade between countries
A
- Changes in comparative advantage
- Emerging and developing economies
- The size and number of trading blocs
- Changes in relative exchange rates
24
Q
What is the terms of trade?
A
The average price of a country’s exports relative to the average price of its imports
25
What is the formula for the terms of trade?
index of export prices
\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ x 100
index of import prices
26
What does an 'improvement' in the T/T mean and what is it caused by?
The **value** of the T/T **increases**, this can be caused by:
* **High relative domestic inflation** - export prices are rising relative to import prices
* A change in the **price of raw materials** - depending on whether the country net imports or exports raw materials, a decrease in the price of these would either lower their export prices or import prices
* An **appreciation in the exchange rate** would increase export prices and decrease import prices
* **Removal of protectionist barriers** - if tarrifs are loosened, this would decrease import prices
27
What is a '**deterioration**' in the T/T and what is it caused by?
The **value** of the T/T **decreases**, this can be caused by:
* **Low relative domestic inflation** - export prices are falling relative to import prices
* A change in the **price of raw materials** - depending on whether the country net imports or exports raw materials, an increase in the price of these would increase their export prices or import prices
* A **depreciation in the exchange rate** would decrease export prices and increase import prices
* **Imposition of protectionist barriers** - if tarrifs are introduced, this would increase import prices
28
Is a **deterioration** in the T/T bad for the trade balance?
**YES:**
**If it is caused by a fall in global demand, the value of exports are decreasing and the trade balance is worsening**
_NO:_
_If it caused by an improvement in competitiveness and demand for exports is elastic, then the quantity sold increases by more than the price falls so the value of exports is increasing_
29
Is a **deterioration** in the T/T bad for the domestic economy?
**YES:**
**If it is caused by a fall in global demand, there will be less exports sold and so less employment in the export industry = less growth**
_NO:_
_If it is caused by a fall in export prices due to an increase in competitiveness and if demand for exports is elastic, then the value of exports increases and there is MORE demand in export industries = more growth_
_If it caused by an increase in import prices, then imported goods and costs of production increase (cost-push inflationary pressure) and so producers and consumers switch to domestic goods = more employment and growth_
30
What are the four types of trading blocs?
1. **Free trade areas** - trade barriers removed between certain countries (NAFTA/USMCA)
2. **Custom unions** - no trade barriers between countries, plus a **common external tariff** on goods imported from outside the bloc (e.g. the EU)
3. **Common market** - a custom union with the added dimension of **free movement** of labour and capital (e.g. the East African Common Market)
4. **Monetary unions** - custom unions that have adopted a **common currency** (e.g. the Eurozone)
31
What is the problem with free trade areas with **no common external tarrif?**
**Trade deflection** - the member with the lowest tariff imports the good, and then it is re-exported in the free trade area with no tarrifs
This means that the countries in the FTA with the highest tariff cannot enforce them, unless they impose 're-export tariffs'
32
What is the greatest cost of entering a trading bloc? (diagram)
**Trade diversion**
* Before entering the trading bloc, country A applies the same tarrif on importing the good from both country B and C
* Country C has cheaper prices, so A imports all the good from there
* Once A enters a block with B, the good is now cheaper from B, meaning the UK imports all the good from there even though they are not the cheapest producer
* This **undermines the principle of comparative advantage**
33
What is the greatest benefit of entering a trading bloc?
**Trade creation**
* Before entering the trading bloc, country A places tarrifs on imports coming from a country within the block
* After entering the bloc, it removes all tarrifs
* This means that there is increased specialisation and trade, at lower prices
34
Overall, how do trading blocs compare to global trading policies?
They are the **second best solution**, compared to overall free trade:
* Global free trade **\>** trading blocs **\>** widespread protectionism **\>** autarky
* This is because they **distort global trade patterns** compared to total free trade, but in the short term they increase trade
* But in the long run, it is more difficult to achieve free trade and there are therefore **dynamic benefits that are prevented**
This means it **depends on the size and depth** of integration in the bloc, and how the countries were trading before they joined the bloc
35
What are the benefits of joining a monetary union? [5]
1. It promotes **trade and investment**
* eliminates echange rate uncertainty as there is no need to convert currency to trade and exporters have a greater degree of knowledge in expected demand
* eliminates transaction costs
2. It promotes higher level of inward **foreign direct investment**
* reward for investment will be in the same currency, so there is greater certainty
3. Greater **price transparency**
* consumers can compare prices more easily reduces information failure and increase competition
36
What is the benefit of joining a monetary union for countries with weaker/ less well-managed economies?
For countries with weaker economies, a single currency promotes **low inflation** and enables governments to borrow at **lower interest rates**. This is because:
* Countries **can't use monetary policy** to devalue their debt, so inflation stays low
* There is a **lower risk of lending** to weaker economies as they can't devalue their debt, meaning interest rates are lower
* A more **credible** central bank from a strong monetary union means that inflation is more likely to be met as inflation is a **'self-fufilling prophecy'**
37
What are the costs of joining a monetary union for all countries? [3]
1. It severly **limits** the range of **demand-side stimulus** for individual countries
* a single currency means the loss of independent monetary policy, meaning individual nations cannot adjust QE/IR
* the use of a single monetary policy affects all countries differently
* fiscal policy **may** also be constrained by rules for fiscal discipline (e.g. debt cannot exceeed 60% of GDP in eurozone, defecit cannot exceed 3% of GDP - although not enforced)
2. A country **cannot devalue** their currency in a debt crisis
3. The **loss of exchange rates** as a mechanism for macroeconomic adjustment
* floating exchange rates can help automatically correct a trade defecit
* if a member country has a **trade deficit** with another member country, it no longer has its own national currency that adjusts
38
What is the cost of joining a monetary union for countries with stronger economies?
Weaker countries in the monetary union **may expect fiscal transfers and support flows** from stronger countries, as the weaker economies are constrained in their ability to use other methods to suppoer their economies
e.g. Greece and Germany, when Greece was facing a debt crisis it had to rely on Germany to lend it money to survive
39
What determines if a monetary union will be successful?
If it is an **_optimal currency area_**:
1. **Are the economies similar?**
* countries with similair economies and industrial structures reduce the likelihood of aysmmetric and aysnchronous shocks
2. **Is there an effective system of fiscal transfer?**
* there has to be political willingness and union identity for money to be transfered in case of a shock
3. **Is there free movement of labour?**
* high rates of unemployment in one country can be mitigated by workers moving to elsewhere in the union, reducing need for transfers
40
What are the functions of the World Trade Organisation (WTO)?
Promoting **free trade** and competiton:
* forum for negotions
* administering trade agreements
* monitoring national trade policies
* handling/settiling **disputes**
* promoting economic development and reform
41
What were two successes of the Uruguay Round of negotiations?
1. Established **WTO**
2. Average tariff cut of **38%**
42
Why did the Doha Round fail?
* Developing countries had benefited less in the Uruguay Round, so expected compensation from this one - developed ones expected a clean slate
* Developing countries negotiated as a bloc and argued against intellectual property protection, to the dismay of developed ones
43
Why might there be a conflict between trading blocs and the WTO?
The WTO is a staunch supporter of free trade, and whilst they would appreciate trade creation, significant **trade** **diversion** would not please them.
44
Why would a country restrict trade? State 4 reasons. [9 total]
1. Protect infant/sunset/geriatric **industries** (e.g. energy)
2. Protect **employment**
3. Promote **self-sufficiency**
4. **Correct** **imbalances** on current account
5. **Retaliation** to other countries/anti-dumping
6. Reduce **competition** from countries with poor regulatory standards/cheap labour
7. Strategy in times of war
8. Prevent **dumping**, illegal under WTO
9. To raise **tax**
45
What are the four methods of protectionism? Give an example of each.
1. **Tariffs** - Trump v China
2. **Quotas** - Bush and EU textiles
3. **Subsidies** - CAP
4. **Administrative Barriers** - EU/US cattle with growth hormones
46
What is a tariff? Describe/draw the tariff diagram.
A tax on imports.
47
How does a tariff work? [3]
1. The tariff **raises prices** above the global one
2. This means that more **domestic** producers are able to **compete** with foreign ones
3. The extension in domestic supply and contraction in domestic demand (caused by the higher price) means **imports** and quantity consumed **decreases**.
48
What is the impact of a tariff on consumers?
Welfare **loss**.
49
What is the impact of a tariff on domestic producers?
Welfare **gain**.
50
What is the impact of a tariff on total welfare?
Net **loss** - including subtracted tax revenue for government.
51
What are the positive impacts of a tariff? [2]
1. Reduced imports and increased production mean an **increase in AD**, living standards and employment.
2. Improved **current account balance**
52
What is a quota? Describe the diagram.
A **legal limit** on the quantity that can be imported in a given year (either volume or value)
53
What are the possible negative impacts of a tariff? [2]
1. Domestic firms become **inefficient** as there is no incentive to reduce costs - "**X-inefficiency**"
2. **Inflationary**: **demand-pull** as demand for domestic goods and services increase, **cost-push** as costs of production increase.
54
How does a quota work? [2]
1. By limiting the amount of imports, there is **excess demand at the global price**
2. This means that **prices are pushed up** until imports are exactly equal to the quota, allowing more **domestic producers** to **compete**
55
What is a quota rent?
**The extra money** gained by foreign producers by selling their goods at the higher quota price compared to the lower global price
56
What is a subsidy? (in the context of protectionism).
Describe the diagram
Payments by the government to firms for each unit of output, with **the goal of reducing imports or raising exports.**
57
What are the benefits of a quota? [2]
1. **Quota rents** better for foreign producers, less controversial
2. Quotas can be used to protect producers from sudden price fluctuations and **stabilise market**.
58
What are the negatives of a quota? [2]
1. Quota rent for foreign producers **could be tax revenue** for government if they imposed a tariff
2. Allocation of quota licences prone to **corruption** by foreign government
59
What is the advantage of a subsidy?
It **doesn't raise prices** or decrease consumer welfare
60
What are the disadvantages of a subsidy? [2]
1. Considerable, **expensive** government spending
2. Encourages possible **dumping** practices (e.g. chinese steel)
61
What is an administrative barrier?
The use of a rule, regulation or other requirements to **make it more difficult for foreign producers to export** to a certain country
62
Give three examples of administrative barriers [9 total]
1. Paperwork
2. Packaging requirements
3. Bureaucratic/custom delays
4. Animal welfare, hygiene and production standards
5. Ingredient standards
6. IP
7. Banned substances
8. Environmental standards
9. Regulations on weights/sizes
63
Give three justifications for protectionism.
1. **Anti-dumping** tariffs (supported by WTO)
2. Sunset and infant **industries**, where policies are time-limited and gradually removed
3. Short term tariffs can **boost economy** and **jobs**
64
What is the balance of payments?
A record of all financial transactions flowing into and out of the country
* Inflows of foreign currency are _credit_/_positive_ items
* Outflows of foreign currency are _debit_/_negative_ items
65
What are the three components of the balance of payments? What is the main one?
1. **The current account**
2. The financial account
3. The capital account
66
What is the current account composed of?
* The trade balance
* The primary income (income) balance
* The secondary income (current transfers) balance
67
What is the trade balance?
Component of the current account, it is the value of **goods and services** _exported_ **minus** the value of **goods and services** _imported_
* It may be seperated into the trade in goods balance (**visible** balance) and the trade in services balance (**invisible** balance)
68
What is income/primary income?
A component of the current acount, this is when income flows into/out of the country as a **factor** **of** **production**
e.g. sending wages home, holiday home rents, repatriation of profits
69
What is secondary income/current transfers?
A component of the current acount, this is when money is sent/recieved from abroad with **no return expected**
e.g. donations, gifts, aid, EU and government transfers across borders
70
What are the three components of the financial account?
1. Foreign direct investment (**FDI**)
2. Foreign portfolio investment (**FPI**)
3. 'other investments' - including the buying and selling of reserve assets
71
What is foreign portfolio investment?
Money that flows across borders in order to purchase **foreign financial assets**: stocks, shares, bonds, securities etc
If foreign FPI is **inwards**, it is an **inflow**
72
What is foreign direct investment?
Money that flows across borders due to investment in foreign firms/productive activities: either
* 'controlling interest' of a firm (more than **10%** of it)
* _or_ physical **capital**
**Inwards** FDI is an **inflow**
73
What must the balance of payments (i.e. financial account and capital account + current account) add up to?
**Zero** - they must **balance** each other out
74
What are three countries with a persistent CA surplus?
1. China
2. Germany
3. Saudi Arabia
75
What are three countries with a current account deficit?
1. USA
2. UK
3. India
76
What is an example of a country with a CA and FA that are broadly in balance?
Belgium
77
What is the implication of a current account deficit and what could this be caused by?
An **excess of imports over exports**, meaning outflows are greater than inflows. It could be caused by:
1. Low exports - **lack of competitiveness**, inflation?
2. High imports and low savings - **overspending** of credit/borrowing by consumers and governments which is unsustainable
3. **Rapid economic growth** - lots on inwards FDI can create a financial acount surplus and so a CA deficit, especially if they are importing capital equipment from abroad to increase LRAS
4. An **overvalued** exchange rate
78
What is the implication of a current account surplus and what could this be caused by?
Indicates an **excess** **of exports**, meaning outflows are smaller than inflows. This could be caused by:
1. High **competitiveness** - low wages, productivity, low inflation etc.
2. High **savings** rate - uncertainty, cultural
3. Undervalued exchange rate - **competitive devaluation**
79
Is a current account deficit necessarily a problem? [4]
**No** - it depends on:
1. What it was caused by - overspending is bad but rapid growth is not
2. If it can be financed - are there sufficient FA inflows?
3. What is being imported - do the imports generate future returns i.e. capital goods in developing economies
4. The exchange rate system - it may self-correct in a floating exchange rate system
* Imports \> exports, the currency depreciates, this dampens imports and boost exports
80
Is a current account surplus always a good thing?
Generally **not problematic**, but it suggests that there are **poor living standards** caused by **low** **consumption**
It also means that other countries have **deficits**, which may increase **protectionism** and caused global **hostility**
81
What are the three types of policies to correct a current account deficit?
1. **Supply-side** policies - either free-market or interventionist
2. **Expenditure**-***reducing*** policies - deflationary demand-side policies
3. **Expenditure**-***switching*** policies - aiming to reduce imports and buy domestically
82
How would supply side policies reduce a current account deficit? Also give two evalutions.
These would improve the **competiveness** **of** **exports** (price, quality) of exports e.g. education and infrastructure
EVAL:
1. Very _expensive_
2. Must be _targeted_ correctly, could go wrong
83
How would expenditure reducing policies reduce a current account deficit? Also give two evalutions.
Contractionary fiscal policy - this would **reduce AD**, which would reduce incomes and therefore the marginal propsensity to import, hence reducing overall imports
Contractionary monetary policy - raising interest rates to **reduce the monetary supply and AD**
EVAL:
1. **Conflict** **of macroeconomic** **objectives**, e.g. employment, growth
2. MPM may be low already
84
How would expenditure switching policies reduce a current account deficit? Also give two evalutions.
1. **Protectionism** e.g. tariffs would directly reduce imports, and subsidies can help exports
2. **Devalue** the exchange rate (fixed) or cause a **depreciation** (floating) by lowering interest rates/selling domestic currency reserves - making imports more expensive
EVAL:
1. **WTO** may restrict protectionism, retaliation may dampen your exports
2. **Marshall-Lerner** condition must be met
85
Define an exchange rate.
The **price** of one currency in terms of **another**
86
What is a floating exchange rate?
An exchange rate where the government **does not intervene** in the foreign exchange market.
87
What is a fixed exchange rate?
Where governments **actively intervene** in the foreign exchange rate to maintain a fixed exchange rate with another currency.
88
What is pegging?
Fixing one exchange rate to another.
89
What is a managed exchange rate? Give and explain three examples.
A **hybrid** of fixed and floating exchange rates.
1. **Adjustable** peg - short term pegging, peg can change in the long term
2. **Crawling** peg - form of AP, pegged between bands that rise and fall over time
3. **Managed**/dirty float - exchange rate freely flows with some intervention to reduce volatility
90
What is an appreciation of the currency?
When the currency is **worth more** in terms of another - i.e. it strengthens
91
What is a depreciation of the currency?
When the currency is **worth less** in terms of another - i.e. it weakens
92
What is a revaluation of the currency?
When a currency's peg is **increased**
93
What is a devaluation of the currency?
When a currency's peg is **decreased**
94
What factors influence floating exchange rates? [5]
1. Demand for **exports**
2. Demand for **imports**
3. **Interest** rates
4. Foreign **investment**
5. Expectations about the exchange rate - **speculation**
95
How does demand for exports and imports affect the floating exchange rate?
Demand for exports affects the demand for the currency.
⬆X=⬆D(£) = ⬆ER
Demand for imports affects the supply of the currency.
⬆M = ⬆S(£) = ⬇ER
96
How do interest rates affect the floating exchange rate?
* If interest rates are **competitive**, savers may convert to the currency to receive higher reward for saving.
* ⬆IR = ⬆ER
97
How does foreign investment affect the floating exchange rate?
* Increased investment from abroad means more home currency is bought.
* ⬆D(£) = ⬆ER
* Increased investment from home to abroad means more home currency is sold.
* ⬆S(£) = ⬇ER
98
How do expectations affect the floating exchange rate? Give one example.
* If speculators believe the value of the currency is going to fall, they will stop buying it and sell off what they own
* ⬇D(£) + ⬆S(£) = ⬇ER
This is a **self-fufilling prophecy** - e.g. following Brexit vote, pound fell by 20%
99
How can governments manipulate a fixed exchange rate? [3]
1. Buying and selling of **reserve assets**
2. Adjusting **interest rates**
3. Import and exchange **controls**
100
How does buying and selling foreign currency reserves work?
The central bank can buy or sell large amounts of **FOREIGN** currencies to influence their own exchange rate.
* **_Either_**: they sell their foreign currency reserves and buy their own currency, meaning ⬆D(£) = ⬆ER
* **_Or_**: they use newly printed money to buy foreign currency and sell their own currency, meaning ⬆S(£) = ⬇ER
101
What is the impact of a currency devaluation/depreciation on imports?
More home currency is needed to buy a foreign good, so imports are more expensive. Therefore, the **value of imports fall**.
102
What is the impact of a currency devaluation/depreciation on exports?
Less foreign currency is needed to buy a domestic good, so exports are more competitive. Therefore, the **value of exports increases** (no change in price received by domestic firms).
103
What are four possible impacts of a devaluation/depreciation of a currency?
1. Economic **growth**
2. **Inflation**
3. Improved current account **balance**
4. Increased **FDI**
104
How would a devaluation/depreciation of a currency affect economic growth?
* Imports are a **negative component** of AD, whereas exports are **positive**.
* Therefore, if the value of imports falls and the value of exports rises, **net exports rise** and hence **so does AD**.
* This means the country will be producing more and **closer to YFE**, and so there is economic **growth**, as well as better living standards and higher employment.
105
What does the impact of a devaluation/depreciation on economic growth depend on? [2]
1. The **importance** **of exports** to the economy (e.g. Germany-47% vs India-18%)
2. The **cause** of the change in exchange rates (e.g. Brexit)
106
How would a devaluation/depreciation of a currency affect inflation?
* AD increasing means there is **demand-pull** inflation, as output moves onto the inelastic part of the LRAS where there is **less spare capacity**, increasing prices.
* Imported **factors of production increase in cost**, increasing the cost of production. This shifts the SRAS inwards and prices up, and so there is **cost-push** inflation.
107
What does the impact of a devaluation/depreciation on inflation depend on? [2]
* The **response of the Central Bank** - can raise IR to keep inflation itself. Hence there is inflationary pressure, but not inflation.
* The **degree of importance of imported factors** of production and from where - UK would see more pressure from a GBP/EUR depreciation vs a GBP/USD depreciation as we import lots of FoP from EU.
108
How would a devaluation/depreciation of a currency affect the current account balance?
The CA balance includes the balance of exports - imports. Therefore, dampened imports and boosted exports improves the CA balance.
109
What does the impact of a devaluation/depreciation on the current account balance depend on?
The **Marshall-Lerner condition**.
110
What is the Marshall-Lerner condition?
**PEDx + PEDm \> 1**
111
How do elasticities affect whether a depreciation will improve the current account? Evaluate elastic and inelastic.
* If demand for imports and exports is elastic, there will definitely be a positive effect on the current account.
* If demand is inelastic for both, then X still increases, but the value of M increases too.
* **Marshall-Lerner condition must be met for CA to improve.**
112
How does the time frame affect the Marshall-Lerner condition? What diagram represents this?
* In the short run, PEDx+m is more likely to be **inelastic**, as consumers change habits and firms are held up by contracts.
* In the long run, this doesn't apply, so PEDx+m are **elastic**, meaning the devaluation improves the current account balance
* This can be shown on a 'J' curve, with CA and Time on the axises.
113
How would a devaluation/depreciation of a currency affect foreign direct investment?
It makes inwards investment **cheaper**, as foreign currency buys more of domestic currency
114
What is international competitiveness?
The relative **appeal** of one nation's **exports** compared to another
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What does the impact of a devaluation/depreciation on foreign direct investment depend on? [2]
* Is the country **welcoming** of FDI? e.g. China is not open to foreign investors
* Is the depreciation caused by a lack of **confidence**? This may not invite investment e.g. Brexit
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What is a **currency war**?
When one country deliberately reduces the value of its currency in order to gain a competitive advantage, and this results in other countries taking similair action. Also known as **competitive devaluation**
e.g. in the 1930s after the Great Depression
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What is the impact of a currency war?
* an increase in **inflation** as imports become more expensive
* a decline in world trade because of **uncertainties** of fluctuating ERs
* an increase in **protectionism**
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What are three measures of international competiveness?
1. **Relative unit labour costs** - measured in index number form (wages/output), an increase indicates that labour costs are rising faster than in other countries and means the UK is less internationally competitive.
2. **Relative export prices** - export prices of UK goods compared to main trading partners, expressed as an index. A rise in relative prices means that UK export prices have risen more than countries, indicating a fall in international competitiveness.
3. Global competitiveness index - composite measure derived by World Economic Forum, based on infrastructure, innovation, education etc
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What are the three main factors determining internatial competitiveness?
1. Exchange rates
2. Wage and non-wage costs
3. Productivity
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What is the **real exchange rate** and how does it affect international competitiveness?
The nominal exchange rate adjusted to reflect different inflation rates and purchasing power parities
It is calculated as:
domestic price level
nominal exchange rate x \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
foreign price level
A fall in the real exchange rate increase competitiveness, as export prices fall.
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What are the benefits of being internationally competitive?
1. **Employment** and economic **growth** - higher demand for exports = higher derived demand for labour, boosting AD and letting investment boost AS
2. **Wage** growth - higher demand for workers
3. Higher domestic **purchasing** **power** - boosted incomes and cheaper goods increase purchasing power
4. Current account **surpluses**
5. Higher foreign **investment** - investors want to sell to a powerful domestic market, and exploit the competitiveness of domestic firms.
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What is the problem with being internationally uncompetitive?
* If exports are uncompetitive, there is likely to be a **deterioration** in the balance of trade
* This could increase **unemployment**, espeically in export-based industries
* A fall in exports could have a **negative multiplier effect** on GDP, causing further reductions in growth
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Why is it hard to maintain international competitiveness?
1. **Costs**
* Low wage costs and prices of land and materials will be eroded as the country becomes more developed and wages rise
2. **Exchange Rate** **Impact**
* A CA surplus could lead to a rise in the exchange rate, meaning exports are more expensive and imports are cheaper, reducing competitive advantage.
3. **Retaliatory Trade Barriers**
* Less competitive foreign countries may impose trade barriers to protect their industries
