4.2.6 - The International Economy

Question 1

Define Globalisation

Answer 1

Is the ever increasing integration and interconnectedness between the countries of the world

Question 2

Explain the characteristics of globalisation (6)

Answer 2

Greater trade in goods and services between countries

Higher level of labour migration between countries

Increasing transfers of capital between countries through FDI

Free interchange of technology and intellectual property

More regional specialisation

More globally recognised brands

Question 3

Explain the causes of globalisation (5)

Answer 3

Trade liberalisation - countries, like China, have adopted an open door policy and lowered protectionist barriers

Multinational corporations- MNC’s are able to gain monopoly power and the ability to set prices globally , due to economies of scale and technological knowledge, with countries wanting firms to locate in the country.

Improvements in communication - there has been a increase in the speed and availability of international communication, allowing businesses to offshore production and still maintain control.

Containerisation- the development of container ships has generated increases in efficiency for firms transporting goods globally

Closer political relations - countries have become more accepting to global trade

Question 4

Explain the impact of globalisation on consumers (3) (positive and negative)

Answer 4

Consumer choice - the availability of goods and services has increased due to globalisation

Prices - as production switches from high to low cost locations, firms are able to charge lower prices to consumers

Incomes - globalisation has raised incomes in developing countries. (N) But has led to stagnant incomes in countries where production has been moved away from

Question 5

Explain the impact of globalisation on employees (3) (positive and negative)

Answer 5

Employment- (N) large-scale structural unemployment has occurred in the manufacturing sector of developed countries. (P) has led to increased employment in developing and emerging countries

Migration - (P) globalisation has seen an increased flow of economic migrants in search of a better standard of living, they fill skill gaps and can also create jobs. (N) However it can be said that migration has taken away jobs from people in the host country and lowered wage rates as well as put a strain on education, housing and healthcare

Wages - (N) workers in developing countries have to be willing to match the low wages people in developing countries are willing to work for. (P) has led to increased incomes in developing countries

Question 6

Explain the impact of globalisation on producers (3)

Answer 6

Specialisation - (P) globalisation has led to countries producing what they are best at, increasing dependency on each other. (N) does increase risk when trade links breakdown

Markets- (P) globalisation allows firms to source products from a wide range of countries and increased incomes in developing countries increase the potential number of customers available

Tax avoidance - (P) firms have the ability to transfer price as they operate in several different countries. (N) reduces government tax revenue

Question 7

Explain the impact of globalisation on the environment

Answer 7

(N)Has led to increased prices of raw materials, environmental degradation and over extraction and water and air pollution
(P) MNCs have the ability to minimise environmental problems due to the financial resources and technological knowledge they possess

Question 8

Explain the benefits of MNCs to economies (3)

Answer 8

Will generate employment opportunities

Provide wages to people in developing countries

Government receives tax revenue from profit generated

Question 9

Explain the drawbacks of MNCs to an economy (5)

Answer 9

Will pay extremely low wages to employees

Will bring the workers from developed country for high skilled jobs

Property rights and regulations are less clear, leading to environmental problems

Transfer pricing is common, reducing tax revenue

Employees are often treated in an ethical manner

Question 10

Explain the reasons for international trade (3)

Answer 10

Differences in factor endowments - countries have different factor endowments. Saudi Arabia has large reserves of oil whilst Japan has very little

Product differentiation - many traded goods are similar but not identical with different functions and specifications in different countries

Political reasons - countries sign trade deals with each other which lock their suppliers into doing business

Question 11

Define Absolute Advantage

Give an example using Portugal and England

Answer 11

Exists when a country is able to produce a good more cheaply in absolute terms than another country. A theory by Adam smith

Portugal can produce both Wheat and Wine but is more efficient in the production of wine than England, so has an absolute advantage. England has a absolute advantage over Portugal in the production of wheat, leading to exchanged trade and specialisation

Question 12

Define Comparative Advantage

Give an example using England and Portugal

Answer 12

Exists when a country is able to produce a good at a lower opportunity cost than another country. A theory by Daniel Ricardo

Wine is relatively cheaper to produce in Portugal than England and vica versa with wheat

Question 13

Explain the theory of comparative advantage

Answer 13

States that countries will find it mutually advantageous to trade if comparative costs of production differ

Question 14

State the assumptions of the theory of comparative advantage model (4)

Answer 14

Factors of production are immobile between countries

There are constant returns to scale

Transport costs are very low

There are no barriers to trade

Question 15

Explain the benefits of trade (4)

Answer 15

Specialisation- comparative advantage shows that world output can be increased if countries specialise in what they are best at producing

Economies of scale - trade allows economies of scale to be maximised and costs reduced

Choice - trade allows consumers the choice of what to buy from around the world, consumer welfare is increased

Innovation - competition due to free trade provides an incentive to innovate . New goods and services are put into the market and new and more efficient processes are created

Question 16

Explain the costs of trade (7)

Answer 16

Over dependence - countries can become over dependent on foreign trade, with smaller countries relying on the exports of one or two commodities

Unemployment- changes in demand have led to structural unemployment

Risk- trade exposes a country to risk, demand or prices for exports could suddenly fall.

Distribution of income - benefits of trade often go to higher income groups, widening income inequality

Environment - environmental degradation and unsustainable development

Loss of sovereignty- when a country signs a international treaty they lose some of their ability to make decisions

Loss of culture - trade brings foreign ideas and products to a country, potentially leading to a loss of traditional culture

Question 17

Explain the changing patterns of UK trade with the rest of the world

Answer 17

The UK is an open economy, where foreign trade counts for 30% of the country’s GDP

There has been a shift away from trading with Commonwealth countries and more towards the EU and North America

The EU now accounts for the majority of UK imports and exports

There has been a gradual decline in the export of manufactured goods from the UK and a increase in the exports of services

There has been a faster growth in imports compared to exports, leading to a trade deficit

Question 18

Define Relative Costs

Answer 18

Are the opportunity costs of producing an extra good in comparison to another country

Question 19

State and explain which country has the comparative advantage when:
England can produce 4 units of Wheat and 8 units of Wine
Portugal can produce 15 units of Wheat and 10 units of Wine

Answer 19

To produce one unit of wine in England they could produce 2 units of wheat. England has the comparative advantage in producing wheat

To produce one unit of wine in Portugal they could only produce 0.66 units of wheat. Portugal has the comparative advantage in producing wine

Question 20

Define Protectionism

Answer 20

Is the use of economic policies deliberately to regulate trade between countries, mainly to reduce imports

Question 21

Define a tariff

Answer 21

Is a tax on imported goods. Done to reduce imports as a higher price is likely to be charged to consumers, reducing demand for imports and raising tax revenue for the government

Question 22

Explain and draw the effect a tariff will have on a domestic market

Answer 22

World suppliers are able to charge a lower price, increasing demand for world goods and decreasing demand and supply of domestic goods.

Tariffs reduce the quantity demanded of a imported good. This increases producer surplus for domestic firms, as they are better able to compete, and decreases consumer surplus, as they are forced to pay higher prices.

There is a welfare loss to society and tax revenue is collected by the government.

Question 23

Define a Quota

Answer 23

Is a physical limit on the quantity of a good imported, in order to increase the market share of domestic businesses. Increases the price of imports and therefore reduces demand.

Question 24

Define Export subsidies

Answer 24

Are given by the government to exporters in order to increase supply and make exports more globally competitive

Question 25

Define Subsidies to reduce imports

Answer 25

Are subsidies given to domestic firms who compete with importers, to allow them to produce at a similar price and be more competitive.

Question 26

Define Administrative Barriers

Answer 26

Involves strategies to reduce imports or encourage exports. This can involve product standards, which requires importers to adapt their product to meet standards. This increases costs for importers, leading to higher prices and reduced demand

Question 27

Define Exchange Rate manipulation

Answer 27

Involves a government lowering their exchange rate in order to make exports cheaper and imports more expensive

Question 28

Explain the Protection of Jobs as a argument for protectionist policies

Answer 28

Globalisation often leads to jobs being lost to lower cost producers overseas. Prevents structural unemployment in the country

Question 29

Explain the protection of infant industries as a argument for protectionist policies

Answer 29

Involves protecting small, newly established businesses which do not benefit from economies of scale the same way large overseas producers can . They are protected until a time they have grown and can compete.

Question 30

Explain the prevention of dumping as a argument for protectionist policies

Answer 30

Done to prevent dumping, where a low cost overseas producer dumps large quantities of a product onto another countries market below market price.
Leads to the closure of domestic firms who cannot compete.

Question 31

Explain the protection of sunset industries as a argument for protectionist policies

Answer 31

Involves protecting industries who are in long-term decline to allow them to decline naturally rather than in a sudden manner, minimising demand shocks to the domestic economy

Question 32

Explain Strategic reasons as a argument for protectionist policies

Answer 32

A government may want to keep an industry running as it is seen as strategically important and one that should not be allowed to fail, agriculture

Question 33

Define Trade Diversion

Answer 33

Refers to the decrease in economic welfare from joining a free trade area

Question 34

Explain a trade diversion graph where:

The UK is currently importing without a tariff from Japan, at a cheaper price than Germanu. When it joins the EU a tariff is put on Japanese imports

Answer 34

The UK has no tariffs on any global imports.

The UK imports from Japan due to it being the cheapest importer

When the UK joins the EU trade union they adhere to the tariffs set by the EU.

This leads to tariffs causing a rise in the price of Japanese imports

The UK then imports from Germany as they are the cheapest importer

This reduces consumer surplus, as they have to pay a higher price from Germany than they were from Japan. Producer surplus increases as domestic producers can supply at a more similar price to German imports

There is economic welfare lost in society

Question 35

Define Trade Creation

Answer 35

Refers to the increase in economic welfare from joining a free trade area

Question 36

Explain a trade creation graph where:

The UK previously imported from the EU with a tariff charged. The UK the joins the EU

Answer 36

The UK import from the EU whilst charging tariffs.

There is a lack of consumer surplus and higher producer surplus

When the UK joins the EU they no longer charge tariffs.

There is a increase in consumer surplus, as they pay lower prices, an decreased consumer surplus, as they find it harder to compete with EU imports.

There is a net welfare gain to society as the price of imports decrease.

Tax revenue is lost from the UK government as there is no longer tariffs charged for EU imports.

Question 37

Define the Balance of payments

Answer 37

Is a record of a country’s transactions with the rest of the world, it shows the receipts from trade and consists of the current and financial account.

Question 38

Define the Current account

What does it consist of (4) (surplus or deficit)

Answer 38

Is a record of all payments for trade in goods and services plus income flow.

Balance of trade in goods - deficit
Balance of trade in services - surplus
Net primary income (interest,profit,dividends and remittances) - deficit
Net secondary income (military and overseas aid) - deficit

Question 39

Define the Capital and Financial account

What does it consist of (3) (surplus)

Answer 39

Includes transactions that results in a change of ownership of financial assets and liabilities.

Net balance of foreign direct investment
Net balance of portfolio investment flows (inflows and outflows of debt and equity, bonds)
Balance of banking flows (hot money in and out of the banking system)

Question 40

Explain how the balance of payments always balances using the UK as an example

Answer 40

A deficit on the current account represents imports being greater than exports.

This means higher levels of domestic demand and high consumption.

If consumption is high it means savings are low

Savings are used as a source for banks to lend money and purchase bonds and shares, this reduces the amount of money available for UK firms, governments and individuals

The UK government, firms and banks turn to overseas governments, banks and firms for investment.

This results in a inflow of money into the capital and financial account, resulting in a surplus and therefore a balance of payments.

Question 41

State the factors causing a current account deficit (6)

Answer 41

Overvalued exchange rate 
Economic growth
Decline in competitiveness 
Higher inflation 
Recession in other countries 
Financial flows

Question 42

Explain how a overvalued exchange rate causes a current account deficit

Answer 42

If the currency is overvalued it will make imports cheaper, therefore raising demand, and exports uncompetitive

Question 43

Explain how economic growth is a factor causing a current account deficit

Answer 43

An increase in national income means people tend to have more disposable income to consume, leading to increased imports as domestic producers are often unable to meet demand

Question 44

Explain how a decline in competitiveness is a factor causing a current account deficit

Answer 44

A decline in the export manufacturing sector has reduced exports as they are not competitive

Question 45

Explain how Higher inflation is a factor which causes a current account deficit

Answer 45

If inflation rises faster than other countries it will make UK exports less competitive and imports more competitive. However inflation may lead to a depreciation in the value of the currency, making imports more expensive and exports more competitive.

Question 46

Explain how a Recession in other countries is a factor causing a current account deficit

Answer 46

If the UK’s trading partners experience a recession it will reduce demand for UK exports

Question 47

Explain how Financial flows are a factor causing a increase in the current account deficit

Answer 47

If a country can attract financial flows (FDI and Short term portfolio investment) it enables them to run a current account deficit as they have a financial account surplus

Question 48

Is a current account deficit bad

Answer 48

If a country has a current account deficit it usually has a financial account surplus

Whether a current account deficit is bad or not depends on what a country does with the surplus in the financial account.

If a country uses the inflows of overseas investment to increase the productive potential of the economy, RGDP will grow in proportion with debt. This reduces the debt from running a current account deficit.

If a country does not use the inflows effectively, the proportion of debt will continue to grow, leading to increased debt repayments for a country

Question 49

Explain why a current account deficit can be harmful (3)

Answer 49

If the deficit is financed through borrowing it is unsustainable, as most countries will be burdened with high interest debt, reducing ability for capital spending.

Running a deficit on the current account therefore means a surplus on the financial account and therefore a significant amount of foreign ownership, reducing long term income and increased withdrawals from the economy

May eventually cause a loss of confidence by foreign investors, if they remove their investment it will lead to withdrawals from the economy and therefore a fall in the value of the currency, reduced consumption and investment and a recession.

Question 50

Explain Protectionism policies as a policy to address a current account deficit

Why is it not a good method

Should the UK use this method

Answer 50

Involves tariffs, quotas and other protectionist barriers to reduce imports and therefore the current account position.

However is not favoured by economists. The country will become less globally competitive as domestic producers have no incentive to improve efficiency. Also other countries will retaliate by introducing their own protectionist policies, reducing exports.

Now more realistic as the UK is not part of the EU, but it is still a part of the WTO so is more difficult to implement.

Question 51

Explain Devaluation of the currency as a policy to address a current account deficit

Why is it not a good method (J curve, Marshall lender condition)

Should the UK use this method

Answer 51

Involves the government buying foreign currency, in order to deliberately increase the supply of GBP and lead to a significant fall in the value of the exchange rate. Leads to exports becoming more competitive and imports more expensive, improving the current account position.

Can lead to increased AD, as X is greater than M, leading to demand pull inflation. Furthermore the J curve effect will see a further current account deficit before improvements. This is due to the Marshall Lerner effect where the devaluation of the currency does not improve the current account position in the short run. This is because there is a time lag and contracts still in place, leading to reduced exports. In the long run, when suppliers come out of their contracts and consumers become more aware of domestic substitutes it leads to the current account deficit being reduced.

In the UK currency devaluation is not realistic, due to the operation of a free floating exchange rate system, where the government cannot manipulate exchange rates as market forces determine the rate.

Question 52

Explain Supply side policies as a policy to address a current account deficit

Why is it not a good method

Answer 52

Involves government spending to improve the supply side of the economy, making exports more competitive and improving the current account position.

However requires government spending and a likely fiscal deficit