International Economic Issues

Question 1

Terms of Trade

Answer 1

A measure of a country’s export prices relative to its import prices

Question 2

Absolute Advantage

Answer 2

-> Ability to produce more of a product than another country, with the same amount of resources

Question 2

Comparative Advantage

Answer 2

> Ability to produce a product at a lower opportunity cost than another country (in comparison)

Question 2

Protectionism

Answer 2

Definition -> Action designed to reduce international trade
Main Reason -> Countries fear that without trade barriers, domestic industries may not be able to compete with foreign imports

Question 3

Free Trade Benefits

Answer 3

1)Lower Overall Price
2)Greater Choice of Goods for Consumers
3)Firms benefit from Economies of Scale
4)Increased Exports
5)Specialisation -> Countries gain an increase in economic welfare

Question 3

Causes of Changes in Terms of Trade

Answer 3

)Globalisation -> Expansion of world trade in goods & services + capital flow, leading to international interdependence
2)Economic Development -> Increased demand for raw materials may push up prices, improving the terms of trade of primarily exporting countries (eg. Canada or South Africa)
3)Price Elasticity of Demand -> If Inelasticity of Exports is greater than Imports’ -> Terms of trade will improve, since export prices can be increased further than import prices
4)Economic Development -> Import Demand Increases -> Terms of trade worsen; Supply of Import Substitutes Increases -> Terms of trade improve; More Goods for Exports -> Terms of trade improve
5)Exchange Rate -> Depreciation or Devaluation -> Terms of trade worsen; export prices have fallen, import prices have risen (relative to the domestic currency)
6)Protectionist Measures -> Eg. Tariffs -> When these measures are taken, import prices are likely to fall, overall improvement in the terms of trade
7)Population Growth -> More Goods are Demanded -> Therefore import demand rises, overall worsening in the terms of trade
8)Competition -> Monopoly in a Good’s Production -> It can raise the good’s national price, overall improvement in the terms of trade

Question 4

Impact of Changes in Terms of Trade

Answer 4

1)Trade Balance -> If Terms of Trade Improve, but both PEDs are Elastic -> Overall worsening of trade balance + possible unemployment, since total export income falls and total import spending rises** \n **If Terms of Trade Improve, but both PEDs are Inelastic -> Overall improvement of trade balance, since total export income rises and total import spending falls
2)Developing Countries -> Usually Dependent on Raw Material Exports ->Fall in their export prices significantly deteriorate their terms of trade; ** \n Standard of Living Falls -> Earn less from same volume of exports, cannot afford to import as much \n Important Note -> The opposite holds true; improvement in terms of trade is likely to improve its standards of living
3)Price Competitiveness -> If Terms of Trade Improve -> Export prices increase more than import prices; fall in competitiveness and export demand; damages the BOP \n Export PED -> Determines how much export demand falls \n **If Terms of Trade Worsen -> Rise in competitiveness and export demand; benefits the BOP

Question 5

Limitations of Absolute Advantage

Answer 5

1. Too Simple: It only considers labor as a factor of production, ignoring other important factors like capital and technology.
2. No Change Over Time: It doesn’t consider that technology or skills can improve over time, which can change which country has an advantage.
3. Ignores Trade Costs: It assumes there are no transportation costs or trade barriers like tariffs, which is not realistic.
4. No Exchange Rates: It doesn’t consider how currency exchange rates affect trade.
5. Full Employment: It assumes everyone is always employed, ignoring unemployment issues.

Question 6

Limitations of Comparative Advantage

Answer 6

1. Simple Assumptions: It assumes production costs stay the same, ignoring that they can change with more production.
2. No Change Over Time: Like absolute advantage, it doesn’t consider changes over time in technology or production techniques.
3. Fixed Resources: It assumes resources (like labor and capital) don’t move between countries but can move freely within a country.
4. No Environmental Costs: It doesn’t consider environmental impacts of increased production and trade.
5. Income Inequality: It can lead to situations where trade benefits the overall economy but makes income distribution more unequal.
6. Perfect Markets: It assumes markets are perfectly competitive, ignoring monopolies or other market controls.
7. Cultural and Social Factors: It doesn’t take into account cultural or political factors that affect trade.
8. Government Role: It ignores the role of government policies in supporting or protecting certain industries

Question 7

1) Tariff

Answer 7

• Definition -> Tax/Duty on a particular product as it is being imported
• Either Specific or Ad Valorem
• Purpose -> Shift good’s supply curve to the left
• Main Outcome -> Import’s Competitiveness falls, Price rises, Quantity Demanded Falls
• Extent of Fall in Qd -> Depends on the Import’s PED
• Domestic Industry -> Sees its competitiveness increased, hence its own production sales rise
• Main Drawback -> Consumer welfare is reduced, Market distortion, production inefficiency, retaliation, regressive
• BUT the elasticity o f Sd and Dd matters

Question 8

2)Import Quota

Answer 8

• Definition -> Legal limit on the quantity of the good that can be imported to a country
• Eg. USA -> Quota on sugar imports
• Licenses -> Are given to firms allowing them to import up to a set limit
• Consumer Welfare Loss -> Greater loss than tariffs, since no tax revenue is generated

Question 9

1. Infant Industry

Answer 9

For Protectionism:
Definition: Industry expected to have a comparative advantage but is currently small and unable to compete with established foreign industries.
Protectionism: Helps the industry establish its comparative advantage and compete independently.
Short Run: Leads to higher prices.
Long Run: Expected to result in lower prices.
Issues: Difficult to accurately identify and decide when protection is no longer needed.
Diversification: Helps reduce dependence on a single product, especially in developing countries.

Question 9

Excessive Administrative Burdens // Red Tape

Answer 9

Definition -> Excessive “red tape” imposed on importers, in order to make importing more difficult
Purpose -> Limit the quantity of imports of particular products into a country
Types of Red Tape -> Establishing Health/Production Standards, Detailed Documentation, Scarce Set Entry Points, Multiple Procedures and Tedious Documentation Processes
Main Outcome -> Benefits domestic producers but consumer welfare is reduced (due to sharper scarcity of imported available options)
Arguments

Question 10

3)Export Subsidy

Answer 10

Definition -> Money given to an exporter, so that the price of a good can be reduced, thus more competitive internationally
Increases Sales -> Output and Employment Increase
Drawback -> May increase inefficient allocation of resources
Government -> Could have used the money to focus on goods with potential comparative advantage
Main Effect -> Long-term economic growth may be reduced

Question 10

4)Embargoes

Answer 10

Definition -> Complete ban on products from a particular country
Political Reasons -> Embargoes are usually the result of disputes between nations or during times of war
Placed on Dangerous/Harmful Products -> Eg. Drugs
Longest Standing Embargo -> USA on foreign trade with Cuba

Question 11

2. Unfair Competition

Answer 11

For Protectionism:
Low-Cost Labor: Countries with vast supplies of low-cost labor (e.g., China, India) can sell at prices with which industrial countries cannot compete.
Exploitation: Protectionism is compelling if labor exploitation is proven.
Against Protectionism:
Comparative Advantage: Countries benefit when opportunity costs differ, suggesting industrial nations should specialize in products where they have a comparative advantage.
Retaliation: Leads to significant falls in world trade and global welfare

Question 12

3. Unemployment

Answer 12

For Protectionism:
Home Industries: Protecting home industries increases competitiveness and preserves employment.
Argument: Often used alongside infant/sunrise industry arguments.
Against Protectionism:
Flaw: Protectionism doesn’t address why home industries couldn’t compete initially.
Comparative Advantage: Nations should compete in markets where they have a comparative advantage.
Alternative Solutions: Other methods (monetary, fiscal, supply-side policies) are better for solving unemployment.

Question 13

5. Dumping

Answer 13

For Protectionism:
Predatory Dumping: Justified if the intention is to destroy foreign competition, leading to long-term negative effects on the importing country.
Against Protectionism:
Persistent Dumping: Difficult to justify as the exporting country has a comparative advantage, leading to lower prices and welfare gains for the importing country.

Question 14

Current Account

Answer 14

Definition -> Record of transactions in terms of trade in goods, services and primary & secondary income
Trade in Goods -> Export and import of goods

Question 15

Secondary VS Primary Income

Answer 15

Primary Income -> Income from interest, profits, dividends from foreign investment + payments from people living overseas
Secondary Income -> Transfer of money that is not an investment, without receiving anything in return, Eg. Donations, overseas aid, military grants, etc.

Question 16

Surplus VS Deficiency

Answer 16

Surplus -> Payments received greater than payments made by the country
Deficit -> Payments received smaller than payments made by country

Question 17

Financial Account

Answer 17

Definition -> Record of the movement of money in the form of investments by residents of a country and inward flow of investment
Net Portfolio Investment -> Shares/stocks, Government/Corporate bonds and derivatives
Net Foreign Investment -> E.g. Huawei opens research facility in the UK
Reserve Assets -> Holdings of foreign currencies

Question 17

Calculating the Balance of the Current Account

Answer 17

Balance of the CA -> Difference between money flowing in and money flowing out
Components -> Trade in goods & services and 1ry and 2ry income
Imbalance in the CA -> Either a deficit (negative figure) or a surplus (positive figure)
Example -> Trade in Goods = 373,149 credits + 504,029 debits = -130,880 deficit imbalance of trade in goods
Balance of Trade in Goods & Services -> Trade in Goods Balance + Trade in Services balance

Question 18

Causes of Imbalances in the Current Account (Deficit)

Answer 18

• Limited Domestic Production -> Country relies on imports
• Higher Standards of Living -> Demand for a broader range of goods, imports rise
• Unfavourable Terms of Trade -> Country believes they must export more and more to maintain export revenue, developing countries particularly
• Lack of Competitiveness -> Overvalued currency and/or greater rate of inflation, exports fall, imports rise
• Economic Growth -> Requires import of capital goods = persistent deficit, consumers become better off, thus why they demand more imports
• Inflation Faster than Competitors -> Exports become less competitive than imports, results in trade deficit; may lead to a depreciation to offset this
• Lack of Confidence in an Economy -> Due to factors such as persistent deficits or large rises in Government deficit, investors may fear political change or lack of a stable Government
• Trading Partners with Negative Economic Growth -> Buy less of its exports; the opposite happens when there is rapid growth

Question 19

Exchange Rates

Answer 19

Definition: Price of one currency expressed in terms of another currency or against a basket of other currencies
3 Types of Exchange Rate Systems: Floating, Fixed, and Managed-Float

Question 20

Capital Account

Answer 20

Definition -> Capital transfers, including transfer of ownership of fixed assets or non-financial assets
Examples -> Cash grants, patents, copyrights

Question 21

Causes of Imbalances in the Current Account (Surplus)

Answer 21

Excellent Reputation in Production -> Export demand increases

Question 22

Consequences of Imbalances in the Current Account

Answer 22

Effects on Domestic Economy
- Need to Tighten Fiscal & Monetary Policies → Reduce domestic demand + introduce supply-side policies, improve productive capability.
- Less Access to Imported Goods → As protectionist policies are imposed
- Fall in Foreign Investment → Sine confidence declines, less economic growth + higher unemployment

Effects on External Economy
- Governments Under Pressure → To introduce/increase protectionist measures
- Devaluation of the Exchange Rate → Higher import prices and lower export prices; Important Note → Effectiveness depends on Marshall-Lerner and J-Curve, may lead to further loss of confidence

Question 23

Appreciation vs Depreciation

Answer 23

Appreciation: When a floating exchange rate increases in value compared to another currency
Depreciation: When a floating exchange rate decreases in value compared to another currency

Question 24

Floating Exchange Rate

Answer 24

• A country’s currency’s value is determined solely by supply and demand market forces.

Question 25

Causes of Changes in a Floating Exchange Rate

Answer 25

• Balance of Payments Disequilibrium -> Countries with Deficit ->End up supplying more of their currency, leads to depreciation; ** \n **Eventually -> Foreign money will start to leave to offset its loss in value, again increasing the supply of currency
• High Inflation - > Country with Rate Higher than Others ->Loss in confidence of its currency; ** \n **People Sell the Currency -> Its supply increases on the market, leading to depreciation
• Interest Rates -> International Money ->Seeks the highest return;** \n If Country Raises its Interest Rate ->Attracts inflows of money from foreign investors; \n **Appreciation -> Since foreign investors will need to buy the currency to deposit in domestic institutions
• Speculation -> When one or more people gamble on a currency rising (by buying) or falling (by selling), a floating exchange rate increases in value Aim to Make a Profit: By buying it back at a lower price or selling it at a higher price

Question 26

Trade Weighted Exchange Rate

Answer 26

Definition -> Weighted average of exchange rates of the domestic currency against foreign currency
Weight for Each Country -> Set by its proportion in trade with the domestic country

Question 26

Impact of Changes in a Floating Exchange Rate
(Price Elasticity of Demand for Exports & Imports: Determine the impact of exchange rates and Marshall Lerner’s condition)

Answer 26

Appreciation Fall
Imports rise since cheaper, Exports fall since more expensive Falls, since Net Exports decrease, PL falls, GDP falls, & unemployment rises

Depreciation Rise
Imports fall since more expensive, Exports rise since cheaper Rises, since Net Exports increase, PL increase, GDP increase, & unemployment decrease

Question 27

Fixed Exchange Rates

Answer 27

Definition -> Government fixes the value of its currency to another currency, a basket of currencies, or a commodity, e.g. Gold.

Question 28

Revaluation VS Devaluation

Answer 28

Revaluation -> Government intervenes to increase the value of its currency
Devaluation -> Government intervenes to decrease the value of its currency

Question 28

Ideal Situation

Answer 28

CA in Equilibrium -> Inflows of Money = Outflows of Money
In Reality -> Governments attempt to keep a steady level of imbalance

Question 29

Persistent Deficit

Answer 29

Main Issue -> Country could face severe economic problems
Exchange Rate -> Depreciates with time, purchasing power of domestic currency worsens abroad
Inability to Pay International Debts -> May lead to extreme bankruptcy in some circumstances

Question 30

Persistent Surplus

Answer 30

Main Issue -> Produces difficulties for trading partners
Especially if it’s a Member of Monetary Union -> They are unable to depreciate their exchange rate to offset the trade surplus
Eg. Eurozone -> Faced this issue with Germany being in surplus, while Greece was in debt (both at the same period of time)