6 International trade and globalisation

Question 1

Specialisation

Answer 1

A process of concentrating on one specific skill or task within the production line.

Question 2

Individual specialisation

Answer 2

We have already mentioned athletes. Other examples include doctors, dentists, lawyers, nurses, teachers, hairdressers, farmers, financial advisors.
By specialising in their chosen profession they can become more efficient in their tasks and improve the quality and quantity of their output.

Question 3

Firm specialisation

Answer 3

Firms can gain a reputation for their highly specialised product.

The French Revolution Bakery in Bucharest, Romania specialises in making a range of delicious éclaire’s (a type of pastry with a creamy filling). They are so well known for their excellent product that the bakery is recommended to tourists by locals as one of the first places to visit.

Question 4

Regional specialisation

Answer 4

Regions can become famous for their specialisation in particular products. For example, Dafen in southern China has become famous as a community of artists who paint original and reproductions of masterpieces. Tourists visit in great numbers to get an excellent copy of the Mona Lisa or a Picasso.

Question 5

Country specialisation

Answer 5

Countries too can specialise in the production of goods and services and then export these to the world.
Some examples of this international specialisation would be as follows:
France – cheese and wine
Ethiopia – coffee
Ghana – cocoa
Thailand – tourism
New Zealand – wine, wool and meat (lamb)
Chile – copper
Denmark – bacon
Brazil – soy

Question 6

International specialisation

Answer 6

International specialisation occurs when countries have an advantage in the quantity or quality of their resources.
If they have a high quantity, they are usually able to export these at competitive prices.
If the quality of their resources are very good, they may be able to export them at higher prices than some of their competitors.
It can also occur when a country is able to produce its goods and services at a lower price than its competitors.
This may be due to lower labour costs in the country.

Question 7

Advantages of specialisation

Answer 7

Increase in investment
Improvements in efficiency
Improvements in productivity
Economies of scale
Increase in innovation

Question 8

Disadvantages of specialisation

Answer 8

Labour turnover
Replacing capital for labour
Overspecialisation
Decrease in choice
Decrease in innovation

Question 9

Advantages of specialisation at the national level

Answer 9

Greater output
Lower per-unit costs and capital investment
Economies of scale

Question 10

Disadvantages of specialisation at the national level

Answer 10

Infant industries
Interdependence
Lack of diversification

Question 11

Globilisation

Answer 11

The integration of markets in the global economy with fewer barriers to trade.

Question 12

The pros of globalisation

Answer 12

Countries can benefit from an inflow of foreign direct investment, by attracting the production plants of multinational corporations. The new investment in the host country by the multinationals will improve technology and labour skills and boost the economy.

Global peace is normally the result when there is globalisation. Countries that trade with each other do not normally go to war with each other.

Technological sharing leads to increased innovations throughout the world.

A more efficient use of resources and new technology leads to productivity gains which leads to global economic growth.

Answer 13

Multinational investment in a host country is very transactional. If there are enough resources and they are cheap then the multinationals will continue to operate in the host country, but once labour costs begin to rise they will look to other lower-cost regions to operate in.

The multinational company’s home country where the production once took place may experience an employment loss. The original manufacturing workers will be displaced, increasing the unemployment rate. Also, the trend of outsourcing employment will produce downward wage pressure.

Multinational companies may bankrupt and drive out local business because these local businesses cannot compete with the multinational’s operating model, which benefits from economies of scale.

Without international standards, multinational companies may produce too much without taking into full account environmental and labour standards.

Question 14

The advantages of multinational corporations

Answer 14

Foreign investment
More efficient use of resources
Lower product prices
Higher profits
Greater consumer choice
Technology transfer
Competition

Question 15

The disadvantages of multinational corporations

Answer 15

Losing investment
Environmental standards
The exploitation of resources
Dislocation of labour resources in the home country

Question 16

Benefits for producers of free trade

Answer 16

Economies of scale
Specialisation
Efficient use of resources
Increased competition

Question 17

Benefits for consumers of free trade

Answer 17

Lower prices
Greater choice

Question 18

Benefits for countries of free trade

Answer 18

Foreign exchange
Tax revenue
Economic growth

Question 19

Methods of protection

Answer 19

Tariffs
Quotas
Subsidies
Embargos
Voluntary export restraints

Question 20

Tarrif

Answer 20

A tax on a foreign good that is bought domestically.

Question 21

Quota

Answer 21

A trade protection limiting the physical quantity of a foreign product allowed into a country.

Question 22

Subsidy

Answer 22

A per-unit amount of money given by governments to firms to reduce their cost of production and increase the supply of goods and services.

Question 23

Embargo

Answer 23

A complete prohibition on trade with a country or a specific product.

Question 24

Voluntary export restraints

Answer 24

One government persuades another government to pressure its exports into limiting supplies into markets

Question 25

Trade protectionism

Answer 25

When government policies are used to protect domestic industries from international trade.

Question 26

Reasons for protection

Answer 26

Protecting infant industries
Supporting declining industries
Supporting strategic industries

Question 27

Consequences of protectionism

Answer 27

Due to trade protectionism, consumers will face higher prices and less consumer satisfaction. Also, the market will be underproducing the amount the consumer most desires.

When the government is supporting infant and declining industries, it forgoes supporting others. In other words, there is a high opportunity cost to protect an industry.
This may actually promote inefficiencies, because resources are moved to the inefficient industry and away from the ones your country has a competitive advantage in.
This could potentially mean that infant industries may never grow up and declining industries will always need assistance.

Question 28

Trade war

Answer 28

A trade protection contest between two countries.
A trade war ultimately means higher import costs as manufacturers and producers must pay more for production tools, commodities and intermediate goods from foreign markets.

Question 29

Foreign exchange rate

Answer 29

The value of one currency in terms of another, which is determined by the foreign exchange rate market.

Question 30

Floating exchange rate system

Answer 30

A system where exchange rates are set by the market forces of demand and supply.

Question 31

Fixed exchange rate system

Answer 31

A system where the exchange rate remains fixed relative to other currencies.

Question 32

Equilibrium exchange rate

Answer 32

The rate where quantity demanded and quantity supplied is equal for one currency relative to another.

Question 33

Determination of exchange rates

Answer 33

The exchange rate at any given point in time is determined by the world market of buyers and sellers.
The market for foreign currencies is equal to those consumers, firms and governments willing and able to buy foreign currency and all those willing and able to supply foreign currency.

Question 34

Fluctuation of currency

Answer 34

The exchange rate at any given point in time is determined by the world market of buyers and sellers. The market for foreign currencies is equal to those consumers, firms and governments willing and able to buy foreign currency and all those willing and able to supply foreign currency.

Question 35

Appreciation

Answer 35

The value of a currency rising relative to another, which occurs from increased demand or decreased supply of the currency.

Appreciation enables the currency to purchase more of competing currencies. It also makes the currency more expensive for foreigners to purchase.

Question 36

Depreciation

Answer 36

The value of a currency lowers relative to another, which occurs from decreased demand or increased supply of the currency

Depreciation enables foreigners to purchase more of the country’s goods and services.
It also increases the cost to buy other currencies, and thus increases the cost of imports.

Consumer imports would decline, business costs of production would rise, and import merchants would suffer higher costs.
In contrast, exporters would benefit from increased sales and profits.

Question 37

Determinants of exchange rate demand and supply

Answer 37

Income
Tastes
Speculation

Question 38

Speculation

Answer 38

Trading high-risk financial assets with the hopes of earning high returns.

Question 39

Causes of foreign exchange rate fluctuations

Answer 39

Income
Speculation
Tastes
Interest rates
Inflation
Multinational corporations

Question 40

Effects on imports when appreciation happens

Answer 40

Consumers would have more disposable income and savings. Imports would become cheaper and would thus increase, as it would be more affordable for consumers to purchase foreign consumer goods like cell phones and cars. Because goods have become cheaper to buy, consumers can spend less on them and thus increase their savings.

Businesses would find that their costs of production fall, as imported factors of production (such as raw materials and labour) become cheaper. For example, since Tanzania imports most of its energy factors of production, the cost of these inputs would fall. The lower factors of production would lead to more profits, which would lead to greater future capital expenditures.

Question 41

Effects on exports when appreciation happens

Answer 41

Consumers are hurt because they will have to pay more for the same goods, and some may not be able to afford the items at all. Others will substitute to a cheaper and invariably a lower quality good.

Businesses will suffer as well because they will not sell as many goods. Reduced sales hurts profits, employment and future growth.

Question 42

Inelastic products: appreciation

Answer 42

Import
The cost of the imported products will fall, which is a benefit to retailers, but the quantity consumed would not change.
If the retailer passes along the price reduction then the consumer will benefit.

Export
The price of the exported medicine will rise. Revenue also rises because consumption will not fall due to the inelastic nature of the product.

Question 43

Inelastic products: depreciation

Answer 43

Imports
The price of the imported products rises due to the weaker currency.
This increases total revenue due to the higher price.

Exports
The price of the exported products falls due to the weaker currency.
The lower price does not impact the quantity sold, so total revenue falls because the price effect is greater than the quantity effect.

Question 44

Elastic products: appreciation

Answer 44

Imports
Consumers and retailers will benefit because the cost of imported products will fall due to the stronger currency.
Sales and profits will rise because the quantity effect is greater than the price effect.

Exports
The cost to purchase exported products will increase, which will reduce the quantity sold, lowering sales and profits.

Question 45

Elastic products: depreciation

Answer 45

Imports
Consumers and retailers are hurt because the cost of imported products rises due to the weaker currency. Sales and profits will fall.

Exports
The cost to purchase exported products will decrease, which will increase the quantity sold, increasing sales and profits.

Question 46

Advantages of fixed exchange rates

Answer 46

Export-driven economies benefit from fixed exchange rates.
The greater current demand for goods results in instant sales and potentially higher profits, but on the other hand, the currency will appreciate, making the goods more expensive in the future.

In contrast, when using a fixed exchange rate system, the negative secondary effect of an appreciating currency never occurs because the government defends the fixed rate.
Businesses appreciate the consistency of price and will reward the country with future sales.

Question 47

Disadvantages of fixed exchange rates
Appreciating currency

Answer 47

When the currency is appreciating and a fixed exchange rate system is used, the government needs to maintain the fixed exchange rate by selling more of its currency on the foreign exchange markets and buying up the currency of the country it faces a current account surplus with.
The central bank could also lower the interest rate, which would lead to capital outflow and depreciate the currency.
The unintended consequences of these currency interventions could cause inflationary pressures.

Question 48

Disadvantages of fixed exchange rates
depreciating

Answer 48

When the currency is depreciating in a fixed exchange rate system, the government needs to maintain the fixed exchange rate by buying its own currency in the foreign exchange markets with its supply of gold or major foreign reserve currencies like the USD.
This will prop up the currency, but the reduced gold and foreign reserves will leave it at risk of greater future volatility and therefore at risk of a financial crisis.
The central banks could also raise the interest rate, which would lead to capital inflows and thus enable the peg to be maintained.
The unintended consequence of this could be a slowdown of investment spending due to higher business costs due to the higher interest cost.

Question 49

Advantages of floating exchange rates

Answer 49

Advantages of floating exchange rates
A floating exchange rate system, through the self-regulating actions of demand and supply, can help to correct a merchandise trade deficit and also stabilise the exchange rate.

Question 50

Disadvantages of floating exchange rates

Answer 50

When an export-driven economy’s exchange rate starts appreciating due to a floating exchange rate system, product prices for exports rise.

This lowers net exports, increasing the unemployment rate and reducing GDP.

Export economies benefit when their trading partners know the prices of their products will not change from month to month.

Question 51

Balance of payments

Answer 51

A record of all money flowing into and out of a country from trade during a specific period of time.

Question 52

Debit

Answer 52

An outflow of money from an import.

Question 53

Credit

Answer 53

An inflow of money from an export.

Question 54

Current account

Answer 54

Section of the balance of payments that includes trade, services, income and unilateral transfers.

Question 55

Balance of trade in goods

Answer 55

Among the four different subdivisions in the current account, the balance of trade in goods is the most discussed by media, citizens and politicians.
This subdivision is also called the visible balance. When a country imports goods, money leaves the country and is recorded as a debit on the current account.
When a country exports goods, money enters the country and this is recorded as a credit on the current account.

Question 56

Balance of trade in services

Answer 56

Services are intangible, value-generating benefits that are the result of human skills, such as banking, education, tourism, consultancy and more.
As a nation becomes more developed, the services balance grows in size.

When you pay for your hotel room in a foreign country, this activity is debited in the ‘services’ section of the balance of payments.

On the other hand, when a foreigner is staying in a hotel in your country, this amount would be credited to the services balance.

These are sometimes refered to as invisible balances as they refer to non tangibles (cannot be physically held).

Question 57

Primary income transfers

Answer 57

Income includes the resources payments from land, labour, capital and enterprise.

For example, for land, let us imagine a foreign investor bought an apartment complex in your country.

The rental income would be an outflow and debit account for your country’s balance of payments.

On the other hand, let us imagine you owned an apartment complex in a foreign country.

Then that rental income would be an inflow of money and a credit item on the balance of payments.

Question 58

Secondary income transfers

Answer 58

The final subdivision in the current account is secondary income.

Secondary income is a one-way flow of money or goods and services.

Examples are donations for foreign aid or sending money to a relatives overseas (these are called remittances).

During the Covid-19 pandemic, many nations made donations to hard-hit areas, and this charity is an example of secondary income.

Question 59

Calculating the current account balance

Answer 59

current account = balance of trade of goods + balance of trade of services + primary income + secondary income

Question 60

Trade deficit

Answer 60

This occurs when imports of goods and services are greater than the exports of a nation’s goods and services.

Question 61

Trade surplus

Answer 61

This occurs when exports of a nation’s goods and services are greater than its imports.

Question 62

Causes of current account deficits

Answer 62

Imports are too high. This could be due to the following reasons.

When wages are high and economic growth is strong, then a country’s consumers have more purchasing power to buy imported products.

A country’s currency may be strong relative to the currencies of foreign countries. The stronger currency leads to greater purchasing power for imports.

A country’s inflation may be higher than in foreign countries, making foreign goods cheaper. This will increase imports.

Exports are too low . This could be due to the following reasons.

A country’s currency could be high in value relative to the currencies of foreign countries. This would increase the price of the country’s exports.

Inflation in a country also increases the price of its exports. Higher prices lead to fewer exports.

Foreigners’ incomes become weaker due to recession in their countries.

Question 63

Causes of current account surpluses

Answer 63

Exports are too high. This could be due to the following reasons.

A country’s currency is weaker relative to the currencies of foreign countries. The weaker currency reduces the price of exporting goods and services.

A country’s inflation is lower than in foreign countries, which lowers the price of exported products.

A country’s income is lower relative to the income of foreign countries.

Government subsidies for export industries can reduce their costs, lowering the prices of exports relative to foreign producers.

Imports are too low. This could be due to the following reasons.

A country’s currency is weaker relative to the currencies of other countries. This increases the price of foreign goods and decreases the demand for imported goods.

Inflation is higher in foreign countries, making foreign goods more expensive. This lowers the demand for imported goods.

A country’s income is lower relative to other countries, and as a result its consumers cannot afford to buy as many imports.

Trade protectionism such as import tariffs increase the cost of imports and thus reduce the demand of imported goods.

Question 64

Consequences of a current account deficit.

Answer 64

Increased borrowing
Lower standards of living
Depreciating exchange rate
Increasing unemployment
Falling total demand

Question 65

Consequences of a current account surplus.

Answer 65

Increased investment abroad
Higher standards of living
Appreciating exchange rate
Decreasing unemployment
Rising total demand

Question 66

Policies to achieve balance of payments stability

Answer 66

Demand-side policies:
Contractionary fiscal policy
Contractionary monetary policy
Currency devaluation
Household savings incentive policy
Trade barriers

Supply-side policies:
Currency devaluation
Trade policy

Question 67

Primary income transfers

Answer 67

Income includes the resources payments from land, labour, capital and enterprise.

Question 68

Secondary income transfers

Answer 68

The final subdivision in the current account is secondary income. Secondary income is a one-way flow of money or goods and services.