Chapter 2 World Trade and International Monetary System

Question 1

Integrated Markets

Answer 1

Market in which equivalent assets have the same price everywhere— Characterized by:

1. Low or No transaction Cost
2. Low or No Institutional interference
3. Little or No Informational barriers
4. High Factor Mobility (Labor and Capital)

Question 2

Segmented Markets

Answer 2

Market in which equivalent assets prices vary depending on the location

Characterized by:

1. High transaction Cost
2. Frequent Institutional interference
3. High Informational barriers
4. Low Factor Mobility (Labor and Capital)

Question 3

Factors Contributing to market segmentation

Answer 3

1. Transaction Costs
2. Informational Barriers
3. Regulatory and institutional interference
4. Factor (Labor, Capital) Immobility

Question 4

How to integrate world markets?

Answer 4

Eliminate Trade Barriers

Question 5

Various Trade Blocs

Answer 5

Custom Unions, Common Market, Economic Union, Monetary Union

Question 6

Custom Union

Answer 6

Two or more countries form a Free Trade Area in which trade barriers between the countries are abolished and member countries maintain a common tariff against non-member countries.

Question 7

Common Market

Answer 7

A Common Market is like a customs union but there is free flow of factors of productions between the countries. Ex: No permits are required to work in another member country

Question 8

Economic Union

Answer 8

A Economic Union has the same benefits as a common market but there is a common tax system

Question 9

Monetary Union

Answer 9

A Economic Union has the same benefits as a common market but there is a common tax system with a common currency

Question 10

Floating Exchange rate System

Answer 10

1. Currency values are allowed to change based on market demand and supply without direct interference from government authorities.
2. The value of a currency may appreciate or depreciate relative to others.

Question 11

Protectionism pros and cons

Answer 11

Pros

1. Prevent Dumping
2. Protect Infant industries
3. Revive declining industries
4. Reduce Balance of Trade Deficit

Cons

1. Reduced International Trade
2. Inevitable Retaliation
3. Slows Economic Growth
4. Political Consequences—elections, allies etc.

Question 12

Protectionist measures

Answer 12

Direct Measures

1. Tariffs or customs duties
2. Import quotas, including embargo

Indirect Measures

3. Hidden export subsidies
4. Devaluation of local currency

Question 13

Optimal Tariff argument

Answer 13

Restrict imports up to the point where the benefit from the last import equals the cost to society as a whole

Question 14

Domestic firms’ competitiveness enhancing measures

Answer 14

1. Export Subsidies
2. Grants to Domestic Producers
3. Waiver of Customs Duties on Inputs
4. Funding for industrial Research
5. Funding for Industrial Training

Question 15

Fixed Exchange rate System

Answer 15

1. Governments try to dictate the value of currencies.
   a. Hard Pegs
   b. Soft Pegs
2. The government may devalue or revalue its currency relative to others.
   a. Floating Arrangements
   b. Residual

Question 16

Balance of Payment and its main accounts

Answer 16

The record of all economic transactions between the residents of the country and the rest of the world in a particular period of time.

The BoP’s main accounts are: Current Account, Capital Account and Financial Account

Question 17

Organization that compile BoP statistics

Answer 17

The IMF (International Monetary Fund)

Question 18

Current Account

Answer 18

The account records all international economic transactions with income or payment flows occurring within the year and shows whether the country is a net exporter (Current Account Surplus) or a net importer (Current Account Deficit) of goods and services.

The account has 4 subcategories:

a. Goods trade
b. Services trade
c. Factor income payments
d. Transfer payments

Question 19

Capital Account

Answer 19

Account records net changes in ownership of national assets

Capital Account= FDI+ Portfolio Investment + Other Investment+ Reserve Account

Question 20

Financial Account

Answer 20

Part of the Capital account that records cross-border transactions associated with changes in ownership of long term financial assets and liabilities.

Question 21

Trade Account

Answer 21

The account records all cross-border transactions of goods. The term commonly used to refer to the account is Trade Balance

Question 22

Trade Balance

Answer 22

The value that characterizes the Trade Account. It informs on the country’s status as a net exporter or importer of goods.

Question 23

Official Reserve Assets (ORA)

Answer 23

The ORA account is the account that records the foreign currency and securities held by the central bank of a country used to balance the payments from year-to-year.
The reserves increase in case of a trade surplus and decrease when there is a trade deficit

These assets are:

(i) gold,
(ii) foreign exchanges,
(iii) special drawing rights (SDRs), and
(iv) reserve positions with the IMF

Question 24

Error and Omission of BoP

Answer 24

Measurement errors can occur when attempting to measure the value of funds transferred into or out of a country and are offset with Official Reserve Assets.

Question 25

Sub-Accounts of BoP

Answer 25

Direct Investment Account
Portfolio Investment Account
Other Investment Account

Question 26

World Trade Organization (WTO)

Answer 26

The organization that regulates trade between nations enforcing the GATT (General Agreement on Tariffs and Trade). Its primary goal is to open trade for all.

Question 27

Most Favoured Nation Principle

Answer 27

WTO clause that prevents any nation entering a trade agreement with a WTO member country to favor that country alone but gives the rights of that trade agreement to all WTO member countries.

Question 28

International Monetary Fund (IMF)

Answer 28

The IMF is an international organization that was formed in 1944.

The organization is made up of 189 countries

Its primary mission is to ensure the stability of the international monetary system—the system of exchange rates and international payments that enables states and their citizens to transact with each other.

Question 29

IMF v IBRD Functions

Answer 29

IMF: Provide short term loans to governments with BoP deficiencies

IBRD: International Bank of Reconstruction and Development– Provides loans to middle-income developing countries

Question 30

Bid rate v Ask rate v Mid rate

Answer 30

Bid rate: price at which the dealer is willing to buy the asset

Ask rate: price at which the dealer is willing to sell the currency

Mid rate

Question 31

Bid-ask spread

Answer 31

Ask minus bid (Ask-Bid)