Chapter 13

Question 1

Advantages of International Trade

Answer 1

1. Specialisation and exploiting CA
2. Exploit economies of scale
3. Export goods excess goods when supply is greater than demand
4. Trade drives growth when exports have high income elasticity of demand
5. Political, social, cultural advantages
6. Increased competition increases domestic productivity
7. Increased competition reduces domestic price
8. Increased competition increases product variety and choice

Question 2

Elasticity and trade gain

Answer 2

• domestic demand and supply less elastic on readable goods

- more elastic on overseas demand and supply

Question 3

Limits to trade

Answer 3

1. Government restrictions
2. Transport costs outweighing CA
3. Factors of production may move between countries not the product

Question 4

Why does specialising increase opportunity costs in the long run

Answer 4

Using resources that are less and less suited to the good and sacrificing other goods at an increasing amount

Question 5

Comparative advantage

Answer 5

Having a lower opportunity cost of producing the good

Question 6

Absolute advantage

Answer 6

Producing one unit of good using fewer scarce resources than another country

Question 7

Law of comparative advantage

Answer 7

When the opportunity cost of producing two different goods is different each country can gain from trade if it produces and exports those goods for which it has a lower opportunity cost and importing the rest

Question 8

How does abundant resources affect CA

Answer 8

Increased CA if producing products that use that resource

Question 9

4 reasons countries have advantages in some products and not others

Answer 9

1. Availability and quality of resources
2. Demand in the home market
3. Competition between firms
4. Existence of related and supporting industries (efficient value chain)

Question 10

Competitive advantage of nations

Answer 10

Ability of countries to compete in market for exports and with potential importers. Depends on government policy and the factors that indicate comparative advantage

Question 11

8 methods of restricting trade

Answer 11

1. Customs/tariffs on imports
2. Quotas on import volumes
3. Exchange controls (limits on how much foreign exchange is available to importers
4. Import licensing (requiring importers to have licenses)
5. Embargoes (bans)
6. Admin regulations
7. Procurement policies (favouring domestic suppliers for government purchases)
8. Dumping (exports sold at prices below MC - as a result of government subsidies)

Question 12

Strategic trade theory

Answer 12

Protecting certain industries to enable them to compete more effectively with monopolistic rivals abroad
(Increase long-run competition and to exploit CA that they couldn’t have before)

Question 13

Infant industry

Answer 13

New industry with potential CA but is not developed enough to realise the potential

Question 14

Optimum tariff

Answer 14

Tariff that reduced imports to where MSC=MSB

Question 15

4 strategic trade arguments for restricting trade

Answer 15

1. Protect infant industries
2. Reduce reliance on goods with little dynamic potential
3. To prevent dumping and other unfair trade practices
4. Prevent the establishment of a foreign-based monopoly

Question 16

Economic arguments in favour of restricting trade

Answer 16

1. Spread risks of exposure to fluctuating markets
2. Reduce influence of trade on consumer tastes
3. Prevent the importation of harmful goods
4. Take account externalities
5. Take advantage of market power in world trade
6. Protect declining industries
7. Improve balance of payments

Question 17

4 non-economic arguments in favour of restricting trade

Answer 17

1. Maintain self-sufficiency in case trade is denied in the future
2. Impose trade sanctions on countries with which the country disagrees politically
3. Maintain tradition ways of life
4. Maintain a diverse society based on a range of industries rather than one based too narrowly on certain industries

Question 18

8 problems with protection

Answer 18

1. Increases price of goods
2. Imposing a tariff leading to welfare loss
3. Restraining might be a better solution for declining industries
4. May lead to world multiplier effects due to reduced exports worldwide
5. May lead to retaliation from other countries (reducing trade, higher costs, less choice)
6. Protecting them could lead to them remaining inefficient
7. Large costs in administering the policies
8. Could lead to corruption

Question 19

5 rules that WTO members have to follow

Answer 19

1. Non-discrimination
2. Reciprocity (if a nation benefits from a tariff reduction it should reduce its own tariffs)
3. Prohibition of quotas
4. Fair competition (countries can ask permission to retaliate against any trade barriers erected against it)
5. Binding tariffs (a country cannot raise existing tariffs without negotiation with their trading partners)

Question 20

Balance of payments account

Answer 20

Record of all economic transactions between the residents of a country and the rest of the world for a specific time period.

Question 21

3 constituent accounts of balance of payments (and a 4th item to ensure account balances)

Answer 21

1. Current account
2. Capital account
3. Financial account
4. Net errors and omissions item

Question 22

Current account of the balance of payments

Answer 22

records a country’s imports and exports of goods and services, plus incomes and transfers of money to and from abroad

Question 23

Four component parts of the current account

Answer 23

1. Trade in goods account - exports(+), imports(-) of physical goods.
2. Trade in services account - records income from(+), expenditure on(-) services
3. Net income flows - rent/dividends/wages earned abroad by a country’s residents(+) and earned in the country by foreign residents(-)
4. Net current transfers of money - international transfers of money by individuals and firms, and government contributions to(+) and receipts(-) from international organisations

Question 24

What is recorded in the capital account of the balance of payments

Answer 24

1. Capital transfers (e.g. transfer of ownership of long-term assets, money brought in by migrants, official debt forgiveness by goverments)
2. Acquisition or disposal of non-produced, non-financial assets such as patents, copyrights, trademarks and franchises

Question 25

Financial account of the balance of payments

Answer 25

flows of money into (+) or out of (-) the country for investment or as bank deposits or other financial institutions

Question 26

4 component parts of the financial account

Answer 26

1. Direct investment - in physical assets
2. Portfolio investment - in financial securities
3. Other financial flows - loans/short-term bank deposits
4. Flows to and from the country’s reserves - of gold and other foreign currency

Question 27

Exchange rate

Answer 27

Rate at which one country trades with another on the foreign exchange market.

Question 28

Exchange rate index

Answer 28

Weighted average of the exchange rate of a country against all other currencies expressed as an index (weights are based on the proportion of transactions.)

Question 29

Arbitrage

Answer 29

Buying an asset in a market with a low price and selling in a market where it has a higher price to make a profit

Question 30

Floating exchange rate

Answer 30

Occurs when exchange rate is determined purely by supply and demand, with no government or bank interventions

Question 31

Currency depreciation vs appreciation

Answer 31

Depr: Fall in free market domestic currency exchange rate
Appr: Rise in free market domestic currency exchange rate

Question 32

6 possible causes of depreciation in currency

Answer 32

1. Fall in domestic interest rates (relative to abroad)
2. Higher inflation in the domestic currency
3. Rise in domestic incomes
4. Investment opportunities improving abroad
5. Speculation that exchange rate will fall
6. Long-term changes in international trading patterns