BEC International Economics Flashcards
Reasons an entity would engage in international activity?
- Develop new markets, increase exports (market diversification)
- Obtain commodities not available domestically (resource acquisition)
- Obtain goods at a lower cost than available domestically (reduced production costs)
Absolute advantage
Entity can produce particular good/service more efficiently than another entity.
Comparative advantage
Exists when one entity has ability to produce good/service at lower opportunity cost. Entities should specialize in goods they produce at least opportunity cost.
Principle of comparative advantage
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.
Porter’s 4 factors that lead to competitive advantage
- Availability of resources/skills
- Information to know what to pursue
- Goals of individuals within the firm
- Pressure on firms to innovate and invest
What represents a reduction in the balance of payment accounts for the US? (deficit)
Import of assets from foreign countries, investments made abroad by US entities
What represents an increase in the balance of payment account? (surplus)
Exports and investments made in the US by foreign entities.
Exchange rate
Price of one unit of country’s currency expressed in units of another. Lower the cost of foreign currency=cheaper foreign goods (imports) while exports would be more expensive for foreign nation
Dumping
Sale of a product in a foreign market at a lower price than is charged in the domestic market. Combatted with quotas/tariffs on dumping product.
What is effect when foreign competitor’s currency becomes weaker compared to US dollar?
Foreign company will have advantage in US market because the dollar will buy more of the foreign competitor’s goods.
Exchange rates are determined by:
Supply and demand in exchange market (ex. if you go to Europe and buy euros, will increase demand and dollar cost of euros)
Call option
Option to buy something at set rate in set amount of time.
Put option
Option to sell something at set rate in set amount of time.
Direct exchange rate
Domestic price of one unit of FC (1 euro-$1.10)
Indirect exchange rate
Foreign price of one domestic unit of currency ($1.00=.909 euro), calculated as 1.1/1
Exchange rate determination:
- Political and economic environment (more stable=more desirable currency)
- Relative interest rates- higher interest rates spur more investment and value of that currency will increase
- Relative inflation- lower inflation=more purchasing power which increases value of that currency
- Public debt level- higher public debt, likely higher inflation, deters foreign investment, weaker currency
- Current account balance- deficit lowers the exchange rate (weakening)
Management of currency exchange rates:
- To increase value of dollar, buy dollars using FC= less supply of dollars or increase interest rate to increase demand for US currency
- To decrease value of dollar, sell dollars using FC=more supply or decrease interest rates.
When currency appreciates (gets stronger)
- Foreign goods are cheaper
- Domestic producers maintain lower prices, encourages efficiency, downward pressure on inflation
- Domestic producers have trouble competing and domestic and foreign markets
When currency depreciates (gets weaker) aka there is a decline in the exchange rate
- Domestic goods become cheaper, increases export demand
- Increasing demand decreases unemployment
- Imported good are more expensive, increases cost of imported inputs (increases costs)
Transaction risk
Possible unfavorable impact of changes in currency exchange rates on transactions denominated in foreign currency. Gains/losses recognized in period of change in exchange rate.
Translation risk
Possible unfavorable impact of changes in currency exchange rates on financial statements of an entity when those statements are converted.
Economic risk
Possible unfavorable impact of changes in currency exchange rates on firm’s future international earning power.
Matching
Incurring equal amounts of receivables and payable in foreign currency, thus offsetting losses/gains
Transfer pricing
Determination of the amounts at which transactions between affiliated entities will be recorded. Price charged by selling division to buying division. Want to maximize tax savings when transactions occur over national borders.
Goal congruence
Department managers make decisions consistent with the goals and objectives of org as a whole.
Goal incongruence
Exists when actions encouraged by reward structure of a department conflict with goals of other departments or the organization as a whole.
Suboptimization
When managers act in own best interest, organization as a whole will suffer leading to this.
Transfer pricing options:
- Negotiated prices
- Variable cost-pricing - based on standard costs
- Full-cost (absorption) pricing- fixed costs allocated to product by selling division become variable costs for purchasing division
- Cost-plus pricing- same as full cost except cost added is set amount, not % of fixed costs
- Dual Pricing- selling division records sale at market value and buying division records at standard variable costs
Foreign direct investment (FDI)
Involves investment in non-monetary assets (property, plant, equipment) in foreign location. Would NOT include investment in foreign bonds.
Globalization
Movement toward more integrated and interdependent world economy with mobility of goods, services, labor, technology and capital throughout the world.
The World Bank
One of two global financial institutions with objective of promoting econ development, lending to developing countries for infrastructure.
International Monetary Fund (IMF)
One of two global financial institutions with objective of maintaining order in international monetary system by providing funds for those in currency, banking or financial debt crisis.
General Agreement on Tariffs and Trade (GATT)
Established in 1947 and replaced by WTO in 1995, goal of liberalizing trade, harmonizing intellectual property laws and decreasing transportation and other costs.
Challenges to globalization:
- Political system-democratic or totalitarian, stability
- Economic system- free-market to command (gov), effects inflation, currency exchange rates and restrictions on transfer of profits out of the country
- Legal system- property rights, contract law, intellectual property, product safety and liability laws
Which good does the US export more than import?
Capital goods and agricultural goods
Largest import and export nations?
US (importer) and China (exporter)
Do both imports and exports enter into determination of GDP for a country?
YES
Market risk
Risk that the value of an asset will decline as a result of a decline in general economic conditions.
Reasons for outsourcing?
Cost savings, improved quality, reduced time to delivery, focus on core business, scalability, access to knowledge and talent.
Risks of outsourcing:
- Quality risks
- Security risk
- Export/import risk- restrictions
- Currency exchange risk
- Legal risk
Globalization of production
Sourcing of goods/services from around the world to take advantage of differences in cost and qualify of the factors of production and gain competitive advantage.
Capital markets
Markets in which securities are traded and include stock, bond and money markets
Global Capital Markets
- Euromarket- US dollar deposits are made outside US
2. Eurobonds- international bond market
The entity borrowing in a foreign currency would be exposed to currency exchange risk.
True, the entity the borrows in its home currency is NOT subject to currency exchange risk
Which three countries are largest export countries?
US, China, Germany
What is the US share of worldwide exports?
10%
Goods with low value to weight ratio are less likely to be suitable for importing.
True because they are low value for their weight and more weight to transport=more costs
Methods of cross-border activity:
- Importing/exporting
- Foreign licensing
- Foreign franchising
- Forming a foreign joint venture
- Creating or acquiring a foreign subsidiary
Government expropriation
Taking assets from company for public use or benefit, can mitigate risk by borrowing funds from foreign bank to pay for assets and then default on loan when expropriation occurs.
Repatriation restrictions
Movement of funds from a foreign country to a home country. Would be a cash flow consideration in international business along with exchange rate risk.
What is macro-environmental analysis?
Analysis of a country or region, the PEST tool can be used in this analysis. Looks at external environment, the WHERE a company should be located.
What does PEST stand for?
PEST EL?
Politcal (tax, trade, labor laws), Economic (interest, inflation), Social (age, education), Technological (R&D, state of automation)
Environmental and Legal
Five forces model identifies factors in industry for long-term competition and long-run profitability
- Treat of entry into market by new competition
- Threat of substitute good or service
- Bargaining power of buyers
- Bargaining power of suppliers of inputs
- Intensity of rivalry
Bargaining power of buyers is greatest when:
- Products are standardized
- Large # of suppliers
- Few dominant buyers that account for large part of sales
- Information is widely available
- Cost of switching providers is low
Bargaining power of suppliers of inputs greatest when:
- There are few substitute inputs
- Many users and few suppliers
- EEs are unionized
- Suppliers can move downstream in distribution channel
Intensity of rivalry affects operating factors and pricing strategy and affected by:
- Structure of competition (size)- many small entities have greater competition than with market leader
- Differentiation- greater differentiation= less rivalry
- Industry price structure- high fixed costs= more competitive because have to be efficient
- Strategic objectives- degree of growth
- Customer switching costs- less rivalry with higher costs
- Exit barriers- higher exit barriers= more rivalry
What analysis is concerned with relationship between entity and its environment?
SWOT (SO focus on entity, WT focus on environment), the HOW a company should operate
Two basic strategies for competitive advantage (Porter):
- Cost leadership
- Differentiation
Focus is the 3rd strategy based on competitive scope and applies to the niche market where differentiation or cost leadership can also be focus.
Cost leadership strategy elements
Creating a efficient operations, exclusive access to inputs, outsourcing, vertical integration…entities have significant capital invested, high levels of manufacturing expertise, efficient distribution
Differentiation strategy
Highly creative development people, reputation for innovation, strong marketing and sales…can do this with market research new product development, continuous improvement and customer-oriented services.
Type of exchange that derives from changes in currency exchange rates that alter the value of future transactions?
Economic exchange risk- future transactions and earning power
Globalization permits a lower cost of capital.
True
Region with greatest decline in overall output in the last 40 years.
Europe
