International

Question 1

Benefits of International trade

Answer 1

1. Lower Prices for consumers (differneces in quality of labour force, more access to raw materials among other factors may lead to foreign countries being able to produce cheaper goods)
2. Greater domestic choice
3. Difference in resources
4. Economies of scale (bigger market [because of international trade] allows firms ito increase thgeir size which can lead to economies of scale)
5. Increased competition
6. More efficient allocation of resources
7. Sources of foreign exchange. ( wich has the benefit of allowing countries to buy imports and use foriegn exchange reserves to offset a disequilibriumn on the balance of payments)

Question 2

Benefits of Specialisation and Exchange

Answer 2

Allows countries to consume combinations of goods and services that lie beyond its own PPC. This is based on the theory of reciprocal absolute advantage.

Question 3

Causes of comaparative advantage

Answer 3

Hecksher-Ohlin theory of interantional trade states that a country in which labour is relatively abundant will specialise in producing goods or services whose production is labour intensive. (same applies for countries in which capital is relativley abundant)
More generally, based on their factor endowment.

Question 4

Limitations to theory of comparative advantage

Answer 4

1. Assumed that consumers have perfect knowledge, which in reality is not the case
2. assumed there are no transport costs
3. Basic theories/models assume two economies producing two goods
4. It is usually assumed that costs do not change and that there are constant returns to scale
5. Assumes homogenous products
6. assumes free trade
7. Assumes factors of production stay in one country when in fact labour and capital are free to move

Question 5

Objectives and functions of WTO

Answer 5

(World trade Organisation)
Regulator and of World trading, setting rules of trading and solving disputes between member countries.
All member countries grant most favoured nations status to another member nation which grant trade concessions to one another.
Aims:
-administer trade agreements
-be a forum for trade negotiation
-handle trade disputes between member countries
-monitor national trade policies
-provide technical assistance and training for developing countries
-cooperate with other int organisations.

Question 6

Forms of protectionism

Answer 6

1. Tariffs
2. Quotas
3. Embargos
4. Others e.g. product standards, red tape

Question 7

Arguments for protectionism

Answer 7

1. Protecting domestic employment (structural unemployment created in sunset industries is prevented)
2. Protecting economies from cost of labour abroad
3. Protecting sunrise/infant industries
4. Risk of over-specialisation (over dependency on export markets of one or two two products)
5. strategic reasons (e.g. during war)
6. Prevent dumping by developed countries
7. Protect product standards (and so protecting health, safety and environment) (e.g. EU ban of US GH meat)
8. Raise government revenue (15% of total revenue for developing countries IMF estimate)
9. Correct balance of payment deficit

Question 8

Arguments against protectionism

Answer 8

1. Misallocation of world’s resources (distortion of comparative advantage).
2. Danger of retaliation/trade wars.
3. Potential for corruption.
4. Increased cots of production because of lack of competition.
5. Reduced export competitiveness.
   - Because of all reasons above may hinder economic growth.

Question 9

In the case of fixed exchange rates when the value of the currency (or commodity) is fixed to rises, the government maintain their fixed exchange rates by…

Answer 9

…. increasing demand for the currency by buying back the excess supply using foreign currency reserves.

Question 10

How does demand for a currency rise in a floating exchange rate system?

Answer 10

• if there is an increase in the demand for US goods and Services (inflation lower than foreign countries, increase in foreign income, change in foreign taste)
• US investment prospects improve
• US interest rates increase (making it more attractive to save their)
• Speculation of future rise in currency in question

Question 11

When does supply for a currency rise in a floating exchange rate system?

Answer 11

• domestic consumers increase demand for foreign goods increases (because of increase in domestic inflation, increase in domestic income, change of taste for foreign goods)
• Investment prospects abroad improve
• Foreign interest rates increase making it more attractive to sae abroad
• speculation domestically think value of domestic currency will fall

Question 12

High exchange rate advantages

Answer 12

1. Downwards pressure on inflation
2. More imports can be bought
3. Forces domestic producers to improve their efficiency to improve their international competitiveness.

Question 13

High exchange rate disadvantages

Answer 13

1. damage to export industries (possibly leading to unemployment)
2. damage to domestic industries (as imports have become relatively less expensive)

Question 14

Advantages of low exchange rates

Answer 14

1. Increase in employment in export industries

2. Greater employment in domestic industries

Question 15

Disadvantages of low exchange rates

Answer 15

Inflation because imports are more expensive.

Question 16

Why government would want to intervene in exchange market?

Answer 16

• Lower the exchange rate in order to increase employment
• Raise exchange rate to fight inflation
• Avoid large fluctuation in float in exchange rate and thus improve business confidence
• Improve a current account deficit

Question 17

Advantages of fixed exchange rate

Answer 17

1. Reduce uncertainty for all economic agents in the country
2. Government makes extra effort to ensure low inflation to ensure international competitiveness
3. (in theory) Reduce speculation in foreign exchange markets.

Question 18

Disadvantages of fixed exchange rates

Answer 18

1. Often goal of low unemployment in an economy will be sacrificed as the tools implemented to maintain the fixed rates e.g. increase interest rates may have a deflationary effect on economy. (restriction in freedom for policy makers)
2. Government needs to maintain the high level of foreign reserves to make clear ability to defend currency by buying and selling of foreign currencies
3. Variables have to be taken into account when setting the exchange rate at the wrong level can lead to a decrease in international competitiveness.
4. Undervaluing currency may lead to international disagreement as this will make their products more internationally competitive.

Question 19

Advantage of floating exchange rate

Answer 19

1. Interest rates are free to be employed as domestic monetary tools
2. The exchange rate should adjust itself to fix a current account imbalance
3. Not necessary to keep high level of foreign reserves and gold

Question 20

Disadvantage of floating exchange rate

Answer 20

1. create uncertainty on international markets
2. Influenced more by more factors than demand & supply
3. Could worsen already high inflation (cost push inflation caused by exchange rate dropping to much to fix inflation)

Question 21

Relationship between three accounts in the balance of payments

Answer 21

Current account balance= capital account balance + financial account balance (+net errors and emissions)

Question 22

Implications/consequences of persistent current account deficit

Answer 22

1. Foreign ownership of domestic assets (threat to economic sovereignty)
2. Country may be heavily indebted (short term drain on current account and will increase deficit in long term and the danger that a government lending money could withdraw it at any time) (an inability to pay debts would lead to reduction in credit rating meaning harder to borrow in future)

Question 23

Methods to deal with persistent current account deficit

Answer 23

1. Expenditure switching policies
2. Expenditure reducing policies
3. Supply side splices to increase competitiveness of domestic producers

Question 24

Expenditure switching policies to improve current account

Answer 24

Switch expenditure away from imports and towards domestically produced products
eg:
-gvt policies to depreciate/devalue currency
(Effectiveness of this depends upon the price elasticity of demand for imports and exports)
-protectionist measures (restrict imports)
WTO prevents many of these techniques and gets rarely want to sacrifice competition for this

Question 25

Expenditure reducing policies

Answer 25

Reduce AD in an attempt to reduce expenditure on imports.
eg
-Deflationary fiscal policies (increase indirect tax/reduce gvt expenditure)
-deflationary monetary policies (increasing interest/ restricting money supply)
But, conflict of internal and external interests in economy.

Question 26

If there is a surplus in the three accounts the exchange rate……

Answer 26

…… appreciates

Question 27

If there is a deficit across the three account the exchange rate will…

Answer 27

depreciate

Question 28

Current account deficit deficit/ Capital account surplus indicates:

Answer 28

That the total spending by domestic households, government and firms is greater than the gross national disposable income
Or that the level of investment in a country exceeds the level of gross national saving.

Question 29

Significance of current account imbalance

Answer 29

the significance of an imbalance depends not upon the magnitude of the imbalance but instead upon its size RELATIVE TO GDP.

(because current account deficit indicates spending beyond current income meaning sone spending is funded by previously saved income or out of future income and so the smaller the deficit as a share of GDP the smaller the burden)

Question 30

Explain the process shown in a J-curve

Answer 30

Lower exchange rates from point they were previously at, but because communication is not perfect = will take time for other countries to realise prices in this country have fallen.
In addition, they may be tied into contracts which cannot be broken in the short term meaning they cannot change suppliers immediately.
This means PEDexports will be inelastic and export revenue will fall as a consequence of the reduced prices (which fell more quickly than demand will rise).
The same applies for imports.
Overall, this will worsen the deficit (point Y on diagram).
By the time a current account deficit reaches point Y he PEDimports and PED exports has risen to the point where there sum is greater than 1.
This means the Marshall-Lerner condition is satisfied and the current account balance will improve (point Z).

Question 31

Advantages of economic and monetary union

Answer 31

• Elimination of exchange rate fluctuation leading to less uncertainty about export/import/asset prices and hence greater cross border investment and trade.
• Elimination of transaction costs (from exchange rates)
• A currency used in a large area has more credibility and therefore should be more stable
• Improvement in business confidence in member countries as there is less perceived risk involved in trading among the member countries.
• Makes price differences between countries more obvious leading to fewer opportunities for price discrimination between countries by price-making MNCs (therefore over time prices should equalise)

Question 32

Disadvantages of Economic and monetary union

Answer 32

• Loss of monetary policy sovereignty (single interest rate set for all member countries which may help some countries but hinder others made worse if no economic convergence exists)
• Can’t rely on evaluation/depreciation in currency to increase international competitiveness meaning more reliance on Internal devolution, wage restraint and productivity improvement to maintain competitiveness.
• No central fiscal authority meaning without fiscal co-ordination the currency will be unstable/ weak
• menu costs when currency changed.

Question 33

Equation for terms of trade

Answer 33

= (weighted index of average export PRICES) ÷ (weighted index of average import PRICES)
multiplied by 100.

Question 34

An improvement in the TOT

Answer 34

is when there is an increase in export prices and a decrease or no change in import prices.
It is measured by an increase int he TOT value

Question 35

Changes in the TOT in short-run may be result of:

Answer 35

1. changes in conditions of demand and supply for exports and imports
2. changes in relative inflation rates
3. changes in exchange rates

Question 36

Changes in the TOT in long-run may be result of:

Answer 36

1. Changes in income over time
2. Improvements in productivity
3. Technological developments

Question 37

Relationship between the TOT and the current account balance

Answer 37

An improvement in the TOT can lead to an improvement or deterioration in the current account balance. The effect that it has on the current account balance depends on the reason for the TOT improvement.

Question 38

An increase in demand for a country’s exports will…..

TOT and current account balance

Answer 38

cause an increase in the average export price and thus an improvement in the TOT. It walls causes an increase in export revenue meaning an improvement in the current account balance

Question 39

An improvement in the productivity or technology of a country will…..
(TOT and current account balance)

Answer 39

Reduce the cost of production leading to an increase in AS leading to a fall in the domestic price level and therefore a deterioration in the TOT. A country’s products will be more internationally price competitive leading to higher export revenue and an improvement in the current account balance.

Question 40

An increase in inflation in a country will…..

TOT and current account balance

Answer 40

Depend upon whether PED for exports is elastic or inelastic.
If PED is inelastic then as the price of exports rises demand falls less than proportionally, export revenue rises and the current account position improves.
If PED is elastic then as the price of exports rises demand falls more than proportionally export revenue falls and the current account balance deteriorates.

Question 41

Factors leading to decline in commodity prices that took place up to 2001

Answer 41

• Improvement in technology lead to a decrease in the cost of supply (increase in crop yield and thus an increase in the supply of commodities
• Discoveries of new synthetic replacements for natural commodities
• Dumping from developed countries.
• Miniaturisation of goods which has lead to less packaging and therefore decrease in demand for goods previously used to manufacture packages.

Question 42

Harmful effects of decrease in TOT for developing countries

Answer 42

• in order to maintain consumption of imported goods, developing countries have to export an increasing amount of exported goods, driving down the price of these goods meaning more exported goods need to be produced
• high levels of debt and falling export prices leads to a further increase in an economy’s debt creating a viscous circle
• over use of resources to increase export revenue has lead to the creation of negative externalities of production in some developing countries (e.g. heavy use of agrochemical on cotton in Benin).