Global Economy & Financial Markets - Year 2 Macroeconomics Flashcards
1
Q
term
A
definition
2
Q
Define globalisation.
A
The ever increasing integration and interconnectedness of global economies into a single international market.
3
Q
What are the main causes of globalisation?
A
- Improvements in transport infrastructure2. Improvements in communication and I.T.3. Trade liberalisation4. International financial markets5. Growth of Transnational Corporations (TNCs)
4
Q
What are the impacts of globalisation on consumers?
A
+Greater choice of goods (luxury foreign goods)+Lower price (comparative advantage, reduced barriers to free trade)-May lead to higher prices as increasing incomes can increase demand for goods-Loss of culture
5
Q
What are the impacts of globalisation on workers?
A
+TNCs create jobs and offer training for workers+Increased demand for high-skilled labour drives wages up-Inequality from poor working conditions and low wages for low-skilled workers-Inwards migration may lower wages (increased labour supply)
6
Q
What are the impacts of globalisation on firms?
A
+Advanced technology brought in by TNCs may spillover into other industries+Risk-bearing economies of scale as they sell in more countries+Able to exploit cheap labour-Firms unable to compete with TNCs will die out
7
Q
What are the impacts of globalisation on the government?
A
+Gain more tax revenue from TNCs paying corporation tax-TNCs have lobbying power over governments which can lead to corruption and bribery-Government may lose out from tax avoidance or evasion
8
Q
What are the impacts of globalisation on the environment?
A
-Increased world production means more raw materials are mined-Therefore more global greenhouse emissions
9
Q
What are the impacts of globalisation on economic growth?
A
+Encourages foreign direct investment (FDI)+Positive multiplier leads to greater final injection+Incentivises domestic firms to improve efficiency which can lead to greater net economic efficiency (LRAS increase)-If consumers import more than firms export, this can cause a trade deficit and counteract the economic growth
10
Q
Define comparative advantage.
A
Where a country can produce a product at a lower opportunity cost than another.
11
Q
Define absolute advantage.
A
Where a country can produce more goods with fewer inputs than other (therefore more efficiently).
12
Q
What does the Law of Comparative Advantage state?
A
To maximise world efficiency in allocating scarce resources, countries should trade with one another and export the goods they have a comparative advantage in, this is mutually beneficial to both parties.
13
Q
What are the limitations to the theory of comparative advantage?
A
It is assumed that:-No transport costs-Costs are constant and there are no economies of scale-Goods are homogenous-Factors of production are perfectly mobile-No tariffs-Perfect information
14
Q
What are the advantages to specialisation and trade?
A
+World output can be increased if countries specialise+Economies of scale, reduces costs and prices+Market competition encourages innovation+Greater choice of goods
15
Q
What are the disadvantages to specialisation and trade?
A
-Over dependence structural unemployment-Negative externalities on environment-Loss of autonomy and sovereignty
16
Q
Define trading bloc.
A
An agreement between two or more countries to encourage free trade by reducing or eliminating protectionist barriers such as tariffs, quotas etc.
17
Q
What is the difference between a bilateral and multilateral trade agreement?
A
A Bilateral trade agreement is between two countries. A Multilateral trade agreement is between more than two countries.
18
Q
What is meant by economic integration?
A
The process by which separate economies become more interconnected through the reduction or elimination of trade barriers.
19
Q
What are the six levels of increasing economic integration?
A
- Preferential Trade Agreement2. Free Trade Area3. Customs Union4. Common Market5. Monetary Union6. Economic Union
20
Q
Advantages of trading blocs.
A
+Can lead to trade creation+Creates jobs if output is increased+Increased competition encourages innovation and efficiency+Larger consumer market leads to economies of scale+Greater choice of goods
21
Q
Disadvantages of trading blocs.
A
-Can lead to trade diversion-Oligopolistic competition as inefficient firms driven out-Retaliation and trade disputes-Reduced national sovereignty
22
Q
Preferential Trading Area (PTA)
A
Tariffs are reduced on selected goods
23
Q
Advantages of Preferential Trading Area (PTA)
A
+Lower prices for consumers+Promotes intra-regional trade+Enhances world efficiency through specialisation
24
Q
Disadvantages of Preferential Trading Area (PTA)
A
-Government spends resources on a unsubstantial trading bloc-Inefficiencies in resource allocation if inefficient producer produces goods
25
Advantages of Free Trade Area (FTA)
+Promotes intra-regional trade+Lower prices for consumers+Enhances world efficiency through specialisation
26
Free Trade Area (FTA)
All tariffs and quotas are removed between member countries, however they are free to impose their own tariffs on countries outside of the bloc.
27
Disadvantages of Free Trade Area (FTA)
-Government spends resources on a unsubstantial trading bloc-Can cause current account deficit
28
Advantages of Customs Union (CU)
+Promotes intra-regional trade+Stimulates competition and innovation+Enhances economic efficiency through specialisation
29
Customs Union (CU)
Free trade between members, and a Common External Tariff is placed on non-member nations.
30
Disadvantages of Customs Union (CU)
-Trade diversion-Retaliation and trade disputes from non-members
31
Common Market (CM)
Free movement of factors of production between members.
32
Advantages of Common Market (CM)
+Increased geographical mobility so workers are able to relocate+Transfer of skills, knowledge and technology
33
Disadvantages of Common Market (CM)
-Brain Drain-Unequal distribution of benefits
34
Monetary Union
Countries share the same central bank, monetary policy and currency.
35
What are the features of the Eurozone?
1. Share a common currency: Euro2. CPI Inflation target is 2%3. Euro floats as a currency against the USD and GBP4. Member nations must not run large budget deficits (>3% of GDP)
36
Advantages of Monetary Union for Eurozone countries.
+Increases business confidence (non-fluctuating exchange rate and stable currency allows them to predict future investment plans)+Eliminates the cost of currency conversion+Protects currency against speculation and eliminates asymmetric information - prices easy to compare
37
Disadvantages of Monetary Union for Eurozone countries.
-Cost of changing currency is high (notes in circulation, menu, admin, removing old notes etc.)-Loss of Monetary Policy autonomy-Countries are unable to alter their exchange rates to change C.A balance-Increased interdependence between nations
38
What are the conditions required for the success of a Monetary Union (Optimal currency zone)?
1. Free movement of capital and labour2. Automatic fiscal stabilisers in place3. Share the same business cycle
39
What is the Convergence Criteria to join the Eurozone?
1. Inflation rate can't be more than 1.5% higher than the union's 3 best performing members2. Long-term interest rates can't be higher than 2% above the union's 3 best performing members3. Should not be in excessive fiscal debt4. Must have a stable currency against the Euro
40
Economic Union (full economic integration)
Fully integrated economies, complete coordination of fiscal, monetary and social policies.
41
When does trade creation occur?
When low cost, efficient producers with comparative advantage within a trading bloc replace high cost domestic producers.
42
How would you represent trade creation on a diagram?
Shows the removal of a tariff from a foreign producer following the creation of a trading bloc where the perfectly elastic supply curve moves down, showing an increase in output from a more efficient producer. Government revenue is lost, previously lost world efficiency and consumer surplus are gained.
43
When does trade diversion occur?
When high cost, inefficient producers within a trading bloc replace more efficient foreign producers with comparative advantage following the imposition of a Common External Tariff.
44
How would you represent trade diversion on a diagram?
Shows the perfectly elastic supply curve of the producer with comparative advantage shifting upwards above the trading bloc after a common external tariff is imposed. Lost world efficiency, lost bloc efficiency, lost consumer surplus.
45
What are the terms of trade?
The quantity of exports that need to be sold in order to purchase a given level of imports.
46
How is the terms of trade index calculated?
[Average export price index / Average import price index] *100
47
What factors can change the terms of trade?
SR: Exchange rates, inflation rates, supply and demand of exports and importsLR: Changes in incomes, Long run productivity
48
How does a change in terms of trade affect the domestic economy?
1. Improvement in terms of trade lead to a fall in (X-M) which can cause a fall in GDP and rise in unemployment2. If PED of X and M is inelastic, improving TOT = improving CA3. If PED of X and M is elastic, improving TOT = worsening CA4. If export demand has caused improvement TOT then this is beneficial5. Important to consider export revenues
49
What is the association between the price elasticity of demand for exports and imports and the terms of trade?
If exports are price elastic, a rise in export prices leads to an increase in terms of trade but worsen current accountIf exports are price inelastic, a rise in export prices leads to an increase in terms of trade and current account.If imports are price elastic, a rise in import prices leads to a decrease in terms of trade but improve current accountIf imports are price inelastic, a rise in import prices leads to a decrease in terms of trade and current account.
50
State the Prebisch-Singer hypothesis.
There will be a long run decline in the terms of trade for countries that depend on natural resource exports.This is because it is hypothesised that import prices will rise faster than export prices as countries export commodities with an inelastic YED, but import manufactured goods with an elastic YED.
51
What is the objective of the World Trade Organisation (WTO)?
1. Establish trade liberalisation and encourage free trade2. Make sure countries act according to trade agreements3. They hold 'rounds' where representatives gather
52
Criticisms of the World Trade Organisation (WTO)
-All countries must agree for an agreement to take place-Veto may be politically motivated (eg. retaliation)
53
Define trade liberalisation.
The removal of protectionist policies with the aim of encouraging free trade between countries.
54
Arguments for free trade.
+More effcient allocation of resources through comparative advantage and specialisation gains (potential for trade creation)+Encourages competition between producers+Leads to greater innovation and dynamic/static efficiencies+Global market for producers and greater choice for consumers+Job creation in exporting industries+Political peace and stability
55
Advantages of trade liberalisation.
+Deadweight gain of world efficiency+Improved market competition incentivises business efficiency, productivity and research/development+Firms have access to global market which can lead to economies of scale+Consumers have greater choice of goods
56
Disadvantages of trade liberalisation.
-Government loses tax revenue-Overspecialisation can be risky-Structural unemployment if demand shifts from domestic suppliers to imports-Domestic firms unable to compete-Income inequality
57
Define protectionism.
The use of economic policies to regulate free trade between countries with the aim of reducing imports
58
What are the reasons for protectionism?
1. Protect domestic employment2. Infant industry argument3. Protect from dumping (market flooding from surpluses)4. Protects against unfair competition5. Mitigates the risk of over specialisation in one industry
59
What are the main forms of protectionism?
1. Tariff: A tax imposed on imports2. Quota: A restriction on quantity of imports3. Subsidy: Aims to boost domestic production4. Embargo: A complete ban on imports5. Regulations: Quality and legal reasons some goods can't be sold in the country
60
How would you draw a diagram to show the imposition of a tariff on a country?
Foreign country is assumed to have comparative advantage, so the perfectly elastic supply curve lies below the equilibrium point of the domestic market. Imposing a tariff shifts their supply curve up, leading to reduced imports, increased domestic production, DWL of world efficiency, gain of government revenue and DWL of decreased consumer surplus
61
How would you draw a diagram to show the imposition of a subsidy as a means of protectionism?
Imposing a subsidy on domestic production shifts their supply curve outwards to Sd + Sd+subsidy. Price in the market is unchanged (although, there is an effective change in price for producers) - there is no change in domestic demand, so no DWL of consumer surplus. There is a DWL of efficiency as inefficient domestic producers begin to supply more and government expenditure is e + f + g.
62
How would you draw a diagram to show the imposition of a quota on a country?
Imports reduced from Q1Q2 to new Q1Q3. Domestic supply shifted outwards parallel to original supply curve, and increases from Q1 to Q1 + Q3Q4. Domestic demand constracts from Q2 to Q4. Excess demand (Q3Q2) is satisfied by an increase in price from P1 to P1+quota. There is a DWL of efficiency and consumer surplus, as a more inefficient domestic producer is supplying more goods (Q2Q4).
63
Define exchange rate.
The purchasing power of a currency in terms of what it can buy of another. The bilateral exchange rate is simply the value of one currency in terms of another.
64
What is Purchasing Power Parity (PPP)?
Purchasing power parity uses a basket of goods and services and measures the price of specific goods in different countries. It is also used to compare the absolute purchasing power of the countries' currencies.
65
What is a spot exchange rate?
The spot exchange rate is the rate of a foreign-exchange contract for immediate delivery. Spot rates are the price that a buyer will pay for a foreign currency.
66
What is a forward exchange rate?
The forward exchange rate is what a foreign currency is agreed to be worth at some time in the future. A company can enter into a forward contract on exchange rates to help hedge against exchange rate fluctuations.
67
What is a floating exchange rate?
An exchange rate system where the value of the currency is determined purely by the forces of supply and demand. Most systems are floating.
68
What is a fixed exchange rate?
An exchange rate system where the government sets their currency against another and that exchange rate does not fluctuate.
69
What increases the demand for a currency?
1. Increase in relative interest rates (hot money inflows)2. Speculators anticipate appreciation of currency3. Increase in Foreign Direct Investment (FDI)4. Rise in foreign incomes5. Increase in international competitiveness (e.g. reduced relative inflation, lower unit labour costs etc.) --> Firms move in
70
What increases the supply for a currency?
1. Decrease in relative interest rates (hot money outflows)2. Speculators anticipate depreciation of currency3. Rise in domestic incomes4. Decrease in international competitiveness (e.g. high relative inflation, high unit labour costs etc.) --> Firms move away
71
What are the advantages of an appreciation of a currency?
+Cheaper to import which can boost living standards+Can tackle demand-pull inflation+Increased competition --> Efficiency gains domestically
72
What are the disadvantages of an appreciation of a currency?
-Increased imports, reduced exports --> C.A deficit-Reduced economic growth-Higher structural unemployment rates in exporting industries
73
What are the advantages of a depreciation of a currency?
+Reduced imports, greater exports --> C.A surplus+Higher economic growth+Lower rates of unemployment
74
What are the disadvantages of a depreciation of a currency?
-Higher inflation-Will only lead to a C.A surplus if Marshall-Lerner condition is met
75
State the Marshall-Lerner condition.
A devaluation of a currency will only lead to a rise in the trade balance if the combined elasticities of demand for exports and imports is greater than one.
76
What are financial markets?
Financial markets are where buyers and sellers can buy and trade a range of monetary or financial services and assets.
77
What are the functions of financial markets?
1. Facilitate savings2. Lend to businesses and individuals3. Facilitate exchange of goods through a payment system4. Provide a forward market5. Provide an equity market
78
Explain how financial markets facilitate savings.
Transfer spending power from the present into the future by storing money in a savings account or holding shares in the stock market.
79
Explain how financial markets facilitate lending to businesses, individuals and governments.
Act as a financial intermediary as the step between taking the money from one person to another, since money from savings is used for investment. Lending allows and encourage consumption, investment and government spending.
80
Explain how financial markets facilitate the exchange of goods and services.
Create a payment system, central banks print notes, institutions process digital transations, companies offer offer credit card services, banks buy and sell foreign currencies.
81
What is a forward market?
When parties agree to buy or sell an asset at a future date for a price determined in the present.
82
What is a futures market?
When a price is agreed for a transaction that will be carried out at some future date - involves high levels of market speculation.
83
Explain how financial markets provide a forward market.
The forward market exists for commodity markets and in foreign exchange, and helps to protect against speculation by providing stability.
84
What is an equity market?
Where stocks and shares of companies are bought and sold.
85
Explain how financial markets provide a market for equities.
Stock markets provide a way for owners to create liquidity in the market which allows for firms to finance expansion, however people would be unlikely to buy shares if they were unable to sell them later.
86
What is a money market?
Financial market in which borrowing is facilitated for a short-term, typically under one year.
87
What is a capital market?
Financial market in which longer-term (> 1 year) financing is traded - includes Government bonds, shares.
88
What is a spot market?
A financial market in which a transaction is made immediately at the prevailing price.
89
What is a foreign-exchange market?
A market where different currencies are traded, they can be spot markets, contract for the present, or forward markets where contracts are made for some time in the future. Highly speculative market are financial institutions aim to make a short-term profit from a volatile market.
90
What is a commodity market?
Where raw goods like gold, oil, and agricultural products are bought and sold.
91
What are derivatives in finance?
Derivatives in finance are financial contracts whose value is derived from the performance of an underlying asset, index, or rate.
92
What is a derivatives market?
Where people buy and sell financial assets that are based on the value of other financial assets, eg. CDOs values were based on the performance of U.S. mortgages.
93
What is an insurance market?
Where individuals, firms and governments can buy insurance. Involves risk assessment and mitigation so no insurance company carries too much risk in case of a disaster.
94
What is a collateralised debt obligation (CDO)?
A collateralised debt obligation is a financial derivative from the mortgage market.
95
How did investment bankers expect to make money through the purchase of collateralised debt obligations?
Investment bankers invested heavily in CDO's due to their ever-increasing values in the housing market caused by vast speculation and false credit ratings creating a market bubble as a result.
96
Why did CDO's fall in value rapidly?
Subprime mortgages were sold without proper documentation or proof of income, which led to defaults by ineligible homeowners, causing a surge in home supply, a drop in home values, and consequetly reduced demand due to a negative wealth effect. This, coupled with increased mortgage defaults, contributed to the bursting of the CDO bubble.
97
What is a credit default swap?
A financial contract agreement acting like insurance that the seller will compensate the buyer in the event of a debt default.
98
What is a credit crunch?
A sudden reduction in the general availability of loans or credit in financial markets.
99
What can trigger a credit crunch?
1. When lenders have limited funds available to lend2. Lenders are unwilling to lend additional funds3. Lenders have increased the cost of borrowing to a rate unaffordable for most borrowers
100
What are subprime mortgages?
Mortgage loans that are granted to borrowers who do not qualify for conventional mortgage, they do not ask for proof of income or any documentation.
101
What did the UK Monetary Policy do in response to the 2008 Global Financial Crisis?
UK MPC implemented signifcant expansionary measures by lowering interest rates to 0.5% in 2009 and a new system called Quantitative Easing, by increasing the money supply to reduce long-term bond interest rates to stimulate the economy.
102
Explain how market bubbles may arise in financial markets, providing an example.
Market bubbles in financial markets arise when asset prices significantly exceed their intrinsic values due to speculative buying, leading to a sudden and unsustainable increase in demand.In 2008, CDOs led to excessive speculation and the belief that they will ever-increase because they were caused by prime mortgages led to a crash as they were in fact subprime mortgages.
103
Explain how asymmetric information may arise in financial markets, providing an example.
Asymmetric information in financial markets occurs when one party has more perfect information than the other. During the 2008 Recession, the real rating of mortgages was unknown by investment banks as credit rating agencies rated subprime mortgages as prime with AAA ratings.
104
Explain how externalities may arise in financial markets, providing an example.
Externalities in financial markets arise when the actions of one party affect others without corresponding compensation or recognition.In 2008, the burst of the CDO market bubble led to not only investors being harmed, but the cost of bailing out the banks was to the taxpayer, alongside there being significant job losses.
105
Explain how moral hazards may arise in financial markets, providing an example.
Moral hazards arise in financial markets when individuals or institutions take risks, knowing that they won't bear the full consequences of their actions.Financial institutions were accused of pursuing short-term profit by taking excessive risk because they would be bailed out by the governments again.
106
Explain how market rigging may arise in financial markets, providing an example.
Market rigging in financial markets occurs when participants manipulate market conditions or prices to gain an unfair advantage.
107
Explain how regulatory capture may arise in financial markets.
When regulatory agencies, instead of serving the public interest, become influenced or controlled by the industries they are meant to regulate.
108
Summarise the South Sea Bubble.
Investors were lured into buying shares of the South Sea Company, expecting huge profits from overseas trade. However, the company's actual operations were limited, and the bubble burst, causing a financial crisis and substantial losses for investors in 1720.
109
Summarise the Payment Protection Insurance (PPI) scandal.
Involved the widespread mis-selling of insurance to customers in the UK alongside loans and credit cards. Financial institutions misled consumers, and when the scandal surfaced, these institutions faced large compensation claims for the mis-sold policies, leading to financial and reputational consequences.
110
Summarise the Libor scandal.
Involved the manipulation of the London Interbank Offered Rate (Libor), a key interest rate. Banks were found to have submitted false rates to benefit their own trading positions. The scandal led to fines for major financial institutions.
111
Explain the saying 'run on the banks'?
Where a large number of depositors rush to withdraw their money from a bank due to concerns about the bank's solvency or financial stability. This can lead to a crisis for the bank if it faces liquidity issues and struggles to meet the sudden demand for withdrawals.
112
Explain the saying 'Hedge your bets'.
To reduce the risk of a negative outcome by making additional investments or taking precautions.
113
What are the primary roles of central banks?
1. Control monetary policy through interest rates and the money supply to keep inflation low and stable2. Act as a bank to the government3. Act as a bank to other banks4. Regulate the overall financial market
114
How is the financial market regulated to prevent large-scale crashes?
Regulation includes preventing market rigging, banning unsuitable product sales, capping interest rates to avoid consumer exploitation, ensuring deposit insurance for stability, and enforcing liquidity ratios for prudent banking.
115
What is meant by prudential regulation?
Rules and standards imposed by financial regulatory authorities to ensure the stability and soundness of financial institutions, protecting the interests of depositors, investors, and the overall financial system
116
What is the role of the FPC - Financial Policy Committee?
It identifies and monitors risks that threaten the resilience of the UK financial system as a whole. It also has power to take action to counter those risks. An example of such a risk is unsustainable levels of debt and credit growth.
117
What is the role of the PRA - Prudential Regulation Authority?
Responsible for the prudential regulation and supervision of around 1,500 banks, building societies, credit unions, insurers and major investment firms.
118
What is the role of the FCA - Financial Conduct Authority?
Responsible for the regulation the conduct of nearly 45,000 businesses in the UK to ensure that financial markets work well and fairly.
119
What is the role of the FSCS - Financial Services Compensation Scheme?
Protects consumers when financial institutions fail. If a bank collapses, consumers and businesses are eligible for a claim of up to £85,000.
120
What is stress testing, and what is its purpose?
Regulatory authorities present hypothetical economic 'What If?' scenarios to commercial banks such as high inflation and unemployment based on the UK's economic cycle. It also ensures these banks hold a minimum reserve of liquid capital to absorb losses in case of a crisis.
121
What is systematic risk?
The risk that is inherent to the entire market which cannot be eliminated through diversification and is associated with economic downturns, changes in interest rates and geopolitical events.
122
What is ring fencing?
UK banks are required by UK law to separate core retail banking services from their investment and international banking activities to prevent risky decisions made by commerical banks affecting consumers.
