BEC-International &a remaining economic concepts Flashcards
International Economics Defined
Study of economic activity that occurs across national boundaries.
Absolute advantage Defined
Ability of a county, business or individual to produce a good or provide a service more efficiently than another entity.
*more efficiently = with fewer “input” resources
Comparative advantage Defined
Ability of one country, business or individual to produce a good or provide a service with lower opportunity cost than another entity.
*derive from differences in availability of resources and technology among entities.
To maximize output (considering comparative advantage)
Entities should specialize in the goods or services they provide at the least opportunity cost.
Entities should trade with other entities for goods and services for which they do not have a comparative advantage.
Principle of Comparative Advantage
The total output of two or more entities will be greatest when each produces the goods or services for which it has the lowest opportunity cost and they engage in trade with each other.
Porter’s Four Attributes of National Advantage
- Factor Endowment (advantages in factors of production–land, labor, infrastructure, etc.)
- Demand Conditions (nature of domestic demand for a good or service)
- Relating and supporting industries (extent to which supplier and related industries are internationally competitive)
- Firm strategy, structure and rivalry (hot entities are created, organized, managed and how they compete)
Porter’s Four Outcomes that given national advantage
- availability of resources and skills
- Information used to determine which opportunities to peruse with resources and skills
- Goals of individuals within entities
- Pressures on entities to innovate and invest.
Socio-Political Issues
Central Claim: International economic activity causes or exacerbates domestic social and economic problems. Ex: increased domestic unemployment
Responses to socio-political issues
- Import quotas = restrict the quantity of goods that can be imported – INAPPROPRIATE
- Import tariffs = taxes on imported goods that increases cost in domestic market – INAPPROPRIATE
- Training/Retraining
- Research and Development Support
- Improved Infrastructure
Currency Exchange Rate
Price of one unit of a country’s currency expressed in units of another country’s currency.
Lower the domestic currency is relative to a foreign currency the better
Balance of Trade
Difference between money value of imports and exports
Exports > Imports = trade surplus
Exports < Imports = trade deficit
Element of a country’s balance of payments accounting with other countries
Balance of Payments
Summary accounting of US base transactions with all other countries during a period of time
Balance of payment accounts: (3)
- Current account
- Capital account
- Financial account
Current Account Defined
Net dollar value for a period of:
•amounts earned from export of goods and services
•amounts spent on import of goods and services
•net factor flow (income) from foreign investments-dividends & interest
•net factor flow from foreign aid and grants
Sum of all = NET BALANCE
Capital Account Defined
Net dollar value for period of:
•Inflows from investments and loans by foreign entities
•Outflows from investments and loans by US entities made abroad
*Reflects net change in foreign ownership of US assets and US ownership of foreign assets
If foreign investment in US > US Investment abroad = surplus for period
Financial Account Defined
Net dollar amount of:
•US owned assets located abroad
•Foreign owned assets in the US
*shows accumulated amount of investments:
•both government and private
•monetary (gold, securities, etc.) and non-monetary (P,P&E)
Surplus = sum of earnings and inflows sum of spending and outflows
Deficit = sum of spending and outflows exceeds sum of earnings and inflows
Deficit Balance of Payments
Import balance of payments = Imports and foreign investment by US entities > exports and investment by foreign entities in U
Causes greater demand for foreign currency than dollars.
Direct exchange rate Defined
Domestic price of one unit of a foreign currency
1 Euro = $1.10
“D”irect = “D”omestic price
Indirect exchange rate Defined
Foreign price of one unit of a domestic currency
$1.00 = .909 Euro ($1.00/$1.10)
2 major ways exchange rates are determined:
- Free-floating currency – exchange rate is determined by market forces of supply and demand for a currency. (Ex: currency is treated like a commodity) * most industrialized nations have this form
- Pegged or Movable currency – exchange rate is fixed by the government, with frequent revisions.
Currency Supply is determined by
A country’s central bank
Ex: the Federal Reserve Bank for the US determines currency supply through monetary policy.
Currency Appreciation Defined
The vale of a currency increases (becomes stronger) relative to another currency
•it takes less domestic currency to buy foreign currency or goods sold in that currency.
Currency Depreciation Defined
The value of a currency decreases (becomes weaker) relative to another currency.
•it takes more domestic currency to buy foreign currency or goods sold in that currency.
Consequences of Currency Appreciation
- Foreign goods become cheaper for domestic buyers
- Encourages increased domestic efficiencies-in order to compete
- Puts downward pressure on domestic inflation-by keeping prices low
- Makes it difficult for domestic producers to compete in domestic and foreign market
Consequences of Currency Depreciation
- Domestic goods become cheaper relative to foreign goods, which increases exports
- Increased exports increases domestic employment
- Imported goods become more expensive
- Drives up cost of foreign inputs-raw materials, components, etc., as well as consumer goods.
Freely fluctuating exchange rates
Automatically correct a lack of equilibrium in the balance of payments.
Spot Exchange Rate Defined
The exchange rate between currencies for immediate delivery (exchange); the rate “on the spot”.
Forward Exchange Rate Defined
The exchange rate between currencies existing at the present for future delivery (exchange).
Exchange Rate Discount or Premium Defined
The difference at a point in time between the spot Exchange Rate and the forward exchange rate for two currencies.
Transaction Risk Defined
The possible unfavorable impact of changes in currency exchange rates on transactions that are denominated in a foreign currency.
“Denominated” Defined
The transaction is carried out in a foreign currency, not the dollar.
3 ways for a firm to mitigate transaction risk
- MATCHING - incur equal payables and receivables in the same currency for offsetting effects; a loss on one would be offset by a gain on the other.
- LEADING/LAGGING PAYMENTS and COLLECTIONS - paying obligations or collecting receivables earlier or later than otherwise to avoid exchange rate changes.
- HEDGING - using offsetting or contra transactions so that a loss on one would be offset by a gain on the other.
Hedging Defined
A risk management strategy that involves using offsetting or contra transactions so that a loss on one would be offset by a gain on the other.
Foreign Currency Hedging Defined
The hedge of exposure to changes n the dollar value of assets, liabilities or planned transactions to be settled (denominated) in a foreign currency.
Translation Risk Defined
The possible unfavorable impact of changes in currency exchange rates on financial statements of foreign operation that are converted from a foreign currency to the domestic currency.
*when a Domestic entity had a foreign sub that prepares FS in a foreign currency.
Economic Risk Defined
The possibility that changes in exchange rates will alter value of FUTURE revenues and costs
2 ways a firm can mitigate economic risk
- Distribute productive assets in different countries with different currencies
- Shift sources of revenues and expenses to different locations with different currencies.
Foreign currency hedging is accomplished primarily through _____ ______
Forward contracts.
Foreign currency forward exchange contract Defined
A contract to buy or sell a specified amount of a foreign currency at a specified date at a specified rate
*exchange contracts are legal obligations to buy or sell
A foreign currency option contract Defined
A contract that gives the right (option) to buy or sell a specified amount of a foreign currency for a specified time at a specified rate.
*exercise of the contract is at the discretion of the option holder (the buyer)
A put is an option that….
Gives its owner the right to sell a specific security at fixed conditions of price and time.
Transfer pricing Defined
Amount at which goods and services are transferred between affiliated entities.
IRS Code for transfer pricing:
Requires income allocation based on unctions performed and risks assumed by each party.
In practice, transfer pricing may be based on:
- cost to the selling unit - either variable or full cost
- market price - the price of such goods or services in the market, if available
- negotiated price - between buying and selling units
Globalization Defined
The movement toward a more integrated and interdependent world economy.
Purpose of the World Bank
To promote general economic development
Purpose of the International Monetary Fund (IMF)
To maintain order in the international monetary system by providing funds to economies in financial crisis including currency crisis, banking crisis and financial debt crisis.
Foreign direct investment occurs when a domestic entity invests in…
Foreign production facilities. (Non monetary - PPandE)
Globalization of Trade Defined
The exchange of goods and services between and among countries
“Take aways” from globalization of trade
- International Trade had drown dramatically over recent years
- U.S. Trade also has grown dramatically over recent years, especially since the 1990s
- U.S. is worlds largest import country
- china has experienced the greatest export growth and is now the worlds largest export country.
Globalization of Production Defined
Sourcing or producing goods and services from around the world.
Outsourcing Defined
Acquiring goods or services from a separate of external provider under contractual terms
Outsourcing Risks:
Quality - goods or services do not meet buyers standards
Security - provider misappropriated intellectual property, trade processes, data, etc.
Export/Import - home country or source country restricts the transfer of goods.
Currency Exchange - cost of goods and services in domestic currency increases.
Legal - possible violation of a country’s laws.
Foreign Direct Investments Defined
Establishing owned or controlled facilities in a foreign location to produce goods or services.
Market Risk Defined
The risk that the value of an asset will decline as a result of a decline in general economic conditions.
Capital Markets Defined
Bring together providers of capital (investors) and users of capital (borrowers).
Limitations of Domestic Capital Markets
- Limited by size and wealth of domestic residents
- Limited supply of domestic capital increases cost
- providers are limited to domestic investment opportunities
The Global Capital Market
Interconnected set of financial institutions and national markets that permit the trading of securities and other financial assets between and among investors and borrowers world-wide.
Eurodollar market (Euromarket)
Provides short and intermediate-term loans world-wide denominated in U.S. dollar
*held outside of U.S.
International Bond Market (Eurobonds)
Long-term loans outside borrower’s home country
Offered in most major currencies
Avoids most government regulation
Foreign Licensing
Granting a foreign entity the right to use an asset
*Royalties are received
Foreign Franchising
Special form of licensing in which the franchiser typically mandates strict operating procedures.
Foreign Joint Venture
An entity established in a foreign location and jointly owned by two or more otherwise unrelated entities.
*one owner typically is in the foreign location.
Foreign Subsidiary
Entity acquires or establish a foreign subsidiary - a controlled, but legally separate entity.
Another term for establishing a new foreign subsidiary
“Greenfield Venture”
Strategic Planning Defined
Sequence of interrelated procedures for determining an entity’s long-term goals and objectives and identifying the best approaches for achieving those goals and objectives.
General Steps in the Strategic Planning Process:
- Establish mission, values and goals
- Assess the environment
- Establish objectives
- Formulate strategies
- Implement strategies
- Evaluate and control Activities
Mission Statement Defined
Provides expression of the purpose and range of entity activities
Values Defined
Establish the underlying beliefs that govern operations and how relationships with other parties are conducted
Goals Defined
General purposes toward which entity endeavors are directed
•typically mid-to-long-term in outlook
•may encompass multiple objectives
Establish Objectives
State the desired measurable results to be achieved, typically including measures related to:
•profitability, growth, market share and innovation.
3 generic strategies (from Michael Porter)
- Cost Leadership
- Differentiation
- Focus
What framework is used for gushing the attractiveness of the competitive environment of an industry?
Michael Porters “Five Forces”
Used to determine the nature, operating attractiveness, and probable long-run profitability of a competitive industry.
PEST Analysis = A macro-assessment of:
Political
Economic
Social
Technological elements of an environment
PEST is particularly important when…
Considering to establish a new (foreign) operation
Industry defined
Group of entities that produce goods or provide services which are close substitutes and which compete for the same customers.
5 factors in Porters “Five Forces”
- Threat of new entrants into the market
- Threat of substitute goods or services
- Bargaining power of buyers
- Bargaining power of suppliers
- Intensity of rivalry
What components of SWOT pertain to the internal environment
Strengths and Weaknesses
What components of SWOT pertain to the external environment
Opportunities and Threats
Basic Strategy Purpose
Leverage strengths to achieve objectives and goals.
Specific Strategy = unique to entity.
Porters 3 Generic Strategies
- Cost leadership
- Differentiation
- Focus - cost leadership or differentiation applied to narrow market
Cost leadership strategy
Become low cost provider in an industry.
•sell goods or services at average market price and earn profits higher than competitors.
OR
•sell goods or services below average market price and gain market share.
•seek to minimize costs, invest significantly in production and distribution assets, and have high levels of expertise in production design, manufacturing and distribution
Differentiation Strategy
Developed product or service that offers quality or uniqueness valued by customers.
•Value added by quality or uniqueness permits a premium price that more than covers extra cost of goods or services.
- will have highly skilled and creative product or service development personnel
- have leading edge research capabilities
- have strong and dedicated marketing and sales personnel
- have reputation for innovation, quality and service
Focus Strategy
Achieve either cost leadership or differentiation within a narrow segment of industry (“Niche” market)
- have outstanding market research and understanding of target group
- have ability to trailer strengths in product or service development to target group
- have a high degree of customer satisfaction and loyalty
Alternative Resources-Based Model
- alternative strategic planning model
- assesses resources and capabilities of an entity
- bases strategy on collection of resources and capabilities to take advantage of opportunities in market
