international economy

Question 1

6 Causes of Globalisation

Answer 1

Improvement in communication

Improvements in transport

Containerisation

Increased free trade

Reduction of trade barriers

Closer political ties between countries

Question 2

Characteristics of Globalisation

Answer 2

Greater trade in goods and services

Higher levels of labour migration

Increasing transfers of capital between countries through FDI and portfolio investment

Increased regional specialisation

Greater use of outsourcing
Part of a firm’s production is performed by another firm

More global brands being developed

Question 3

Consequences of Globalisation for more developed countries

Answer 3

Increasing ability to outsource production to low cost countries

Potential for higher sales and output by targeting products at fast growing economies

Economies of Scale may be exploited by producing on a global scale

Increased competition for firms in developed economies from low cost producers

Ability of firms to recruit on a larger scale, which may push down wages in the local economy

Possible “brain drain” with skilled workers moving overseas

Question 4

Consequences of Globalisation for less developed countries

Answer 4

Increasing dominance by global brands from developed economies
“McDonaldisation”

Issues of treatment of local workforce, Subject to potential exploitation by global corporations

Having to adopt free market macroeconomic policies in order to attract FDI

Having to open up markets to foreign competition
Even if the result is the failure of local businesses

Question 5

Multinational Corporations

Answer 5

MNCs are businesses that operate in at least two countries

Question 6

Benefits of MNCs to Economies:

Answer 6

Employment
MNCs will often generate many new jobs with a boost to GDP (Potential multiplier effect)

Wages
MNCs may have to offer higher wages to attract workers

Tax Revenue
Higher tax revenue for the economies, coming from profits generated, incomes earned

Question 7

Drawbacks of Multinational Corporations

Answer 7

Effect on employment levels may not be as significant. Many MNCs will bring in skilled labour from developed economies. Will only recruit workers for less skilled jobs.

They will pay lowest wage possible. If there is a significant labour surplus, pay will be offered at very low rates.

Environmental concerns
MNCs are able to exploit lack of regulations by depleting natural resources and not producing output on a clean way. Pollution is a negative externality.

Tax Avoidance
Tax revenue may not rise significantly as profits can be transferred around the global business to ensure that taxes are paid only in economies with low rates of tax

Workers may be treated in an unethical manner. Many less developed economies do not provide workers with clear protection. MNCs can exploit this for their advantage

Question 8

Benefits of Foreign Trade

Answer 8

Access to cheaper goods and services

Greater range of goods and services

Ability to lower average costs through specialisation

Question 9

Absolute Advantage

Answer 9

The ability of an economy to produce more of a good or service than a competitor, e.g country a produces more food than b, but b produces more clothes than a.

Both countries should specialise in the industry that they have an absolute advantage in

Specialisation increased world output. So if the countries trade, then each country will be better off

Question 10

Comparative Advantage

Answer 10

The ability of an economy to produce a good or service for a lower opportunity cost than a competitor

When one country may be better at producing both products

Question 11

Assumptions of the model of Comparative Advantage

Answer 11

The amount of factors a country has is fixed and cannot be improved.

Factors of Production are immobile between countries.

There are constant returns to scale. Opportunity cost is constant. If there are economies of scale, it would increase the case for specialisation.

Transports costs are small enough not to cancel out the benefits of specialisation and trade

There are no barriers to trade

Question 12

Assumptions of the model of Comparative Advantage

Answer 12

The amount of factors a country has is fixed and cannot be improved.

Factors of Production are immobile between countries.

There are constant returns to scale. Opportunity cost is constant. If there are economies of scale, it would increase the case for specialisation.

Transports costs are small enough not to cancel out the benefits of specialisation and trade

There are no barriers to trade

Question 13

Changing pattern of UK trade with the rest of the world

Answer 13

The UK is a fairly open economy - foreign trade counts for around 30% of the country’s GDP.

A shift away from trading with Commonwealth countries and towards North America.

The EU now accounting for the majority of both UK imports and exports.

A gradual decline in the export of manufactured goods from the UK.

Growth in services exports.
Especially financial services

Faster growth in imports compared with exports.
Leading to current account deficit

China and India becoming more significant for UK imports

Question 14

Protectionist policies

Answer 14

Protectionism
Implementing policies that will protect an economy through restrictions on imports.

Tariff
A tax on imported goods and services.
These work by increasing the price of imported products relative to domestic output.
Should lead to a contraction of demand and also encourage a switch to domestic substitutes

Quota
A restriction on the number of a particular kind of import into an economy.
An import quota is a non-tariff barrier. Quotas will reduce the quantity of imports and help domestic suppliers as they can sell more and sell at a higher price. However, this leads to higher prices for consumers and could lead to retaliation with other countries placing tariffs.

Question 15

Arguments for Protectionism (5)

Answer 15

Protection of Jobs
Jobs will often be lost to low cost producers overseas

Anti Dumping
Where low cost producers “dump” large quantities of a product onto another country’s market, below cost price. Often leading to the closure of local firms which cannot compete with low-cost producers.

Sunset industries
Industries in long term decliner may benefit from protection so they decline gradually as opposed to suddenly. Minimising demand shocks to the domestic economy.

Strategic Reasons
Some industries are seen as strategically important and should not be allowed to fail. Such as Agriculture.

Infant Industry Argument
Small infant industries cannot benefit from economies of scale right away so need protection from large competitors

Question 16

Degrees of International Economic Integration

Answer 16

Preference Areas
Countries agree to levy reduced tariffs on certain trades.

Free Trade Areas
Member countries abolish tariffs on mutual trade.
Each partner determines its own tariffs on trades with non member countries.

Customs Unions
Trading bloc in which member countries in enjoy internal free trade in goods and possibly services. Free intra union trade but a common external tariff on all members’ trades with non members.

Common Markets
Customs unions with additional provisions to encourage trade and integration through free mobility of factors.

Economic Unions
Further harmonisation in the areas of general, economic, legal and social policies.

Political Unions
Ultimate form of economic integration.
Involve the submersion of separate national institutions.

Question 17

World Trade Organisation

Answer 17

WTO attempts to promote
Trade Liberalisation:
Trade without barriers (or with reductions in trade barriers).
More than 100 countries are members of the WTO

Question 18

Balance of payments

Answer 18

Balance of Payments looks at all the inflows and outflows of money that take place in the UK

Question 19

Sections of the Balance of Payments

Answer 19

Capital Account
Financial Account
Current Account

Question 20

Capital Account

Answer 20

Includes capital transfers.
Purchases and sales of some non-financial assets.

Question 21

The Financial Account

Answer 21

Net Foreign Direct Investment (FDI)
The buying of productive assets located outside the country of ownership. New Business/Buying an existing business.

Net Portfolio Investment
The buying of financial assets located outside outside the country of ownership.
Foreign Investor buying shares in a UK business would appear as an inflow.

Short-term Speculative Capital
Money which can be moved immediately between currencies to maximise its return (hot money).

Question 22

Current Account

Answer 22

Trade in goods
Calculates value of goods exported - value of goods imported.

Trade in services
Calculates the value of services exported - value of services imported.

Primary Income
Flows of income from investments abroad - flows of income from foreign investments in the UK.
Investment income relates to the earnings from assets located outside the UK.
Includes earnings such as dividends and interest earned overseas.
Previously a surplus but now a deficit for the UK

Secondary Income
Transfers of money received in the UK - Transfers of money pad by the UK abroad
Remittances
Foreign Aid
Grants
Gifts

Question 23

Factors determining Exports

Answer 23

Foreign GDP
As foreign GDP rises, spending in those countries rise thus leading to greater demand for UK goods and services.

Productivity
If UK productivity rises relative to foreign productivity, this means UK can produce more output for the same amount of input.
This means UK exports are more competitive and cheaper, so increases demand for Exports.

Inflation
If UK inflations is higher than foreign inflation, prices of UK goods are rising faster than goods produced abroad.
Meaning UK goods become less price competitive thus leading to lower exports.

Question 24

Policies to correct a deficit on the Current account

Answer 24

Expenditure Reducing Policies
Policies that reduce spending in the economy.

Expenditure switching policies
Policies that encourage a switch away from imports and encourage exports.

Question 25

Expenditure Reducing Policies

Answer 25

Higher Taxes
Lower Government spending
Higher Interest Rates

Question 26

Issues with Expenditure Reducing Policies

Answer 26

Deflationary policies reduce the rate of economic growth and this will lead to higher (cyclical) unemployment.

They are not popular with those who vote as they reduce living standards.

Higher interest rates may increase the exchange rate, leading to lower volumes of exports.

Question 27

Expenditure Switching Policies

Answer 27

Protectionist Policies
Trade barriers to restrict the flow of imports into a country leading to consumers switching to domestically produced goods instead.
Quota/Import Tariff/Export Subsidy.

Supply-Side Policies
Improving the supply side of the economy should improve the current account balance through improvements in productivity and keeping inflation low.
Making UK Exports more competitive.

Devaluation
A sudden fall and significant fall in the value of the exchange rate.
A devaluation of the currency means that each unit of currency can buy less foreign currency than before the devaluation.
Exports appear cheaper to foreign consumers meaning that exports will rise.
Imports will be more expensive as the lower exchange rate means more currency is needed to buy the same amount of foreign currency…
Leading to less imports.

Question 28

Issues with Expenditure Switching Policies

Answer 28

Devaluing a currency may improve the current account balance but it depends on the elasticity of demand for both exports and imports.
Protectionist policies may lead to countries retaliating with similar tariffs on UK exports which means fewer UK exports sold.

Question 29

Marshall - Lerner Condition

Answer 29

The requirement that devaluation will improve the current account balance only if the total of the price elasticities for imports and exports is greater than 1.

Question 30

J Curve

Answer 30

The observation that after a devaluation the current account worsens initially before improving.

Demand usually becomes more price elastic over time as more substitutes are found.

For foreign consumers, export prices fall but this does not immediately lead to significantly higher exports. This increase in exports will occur only once demand becomes more elastic - over time.

Imports become more expensive after the devaluation, but the demand for these will not fall much in the short term as demand is initially price inelastic.

Therefore, value of imports will rise initially and fall only once consumers switch away from the now more expensive imports (Demand becomes more elastic).

Current account balance may worsen in the short term but improve in the longer term

Question 31

Exchange Rate

Answer 31

The price of one currency expressed in terms of another currency.

Exchange rates are determined by the forces of supply and demand

Question 32

Determinants of Exchange Rate Movement

Answer 32

Interest Rate Movements

Foreign Trade

Relative Inflation

Foreign Direct Investment

Expectations

Question 33

Determinants of exchange of rate movement:

Interest Rate Movements

Answer 33

If UK interest rates rise relative to those of other economies, there will be an inflow of short term “hot money” into the UK to take advantage of higher interest rates.

This means increased demand for the pound.

Higher interest rates leads to a rise in exchange rates.

Lower interest rates leads to a fall in exchange rates.

Question 34

Determinants of exchange of rate movement:

Foreign Trade

Answer 34

Increase demand for imports would mean an outflow of pounds in order to buy the foreign currency needed to purchase the imports.

This increases the supply of pounds.

Fall in exports leads to a fall in exchange rates.

Rise in exports leads to a rise in exchange rates.

Question 35

Determinants of exchange of rate movement:

Relative Inflation

Answer 35

If UK inflation is higher than the economies of trading partners, exports become less price competitive.

This reduces demand for exports and will lead to a lower exchange rate; Normally a reduced demand for pound

Question 36

Determinants of exchange of rate movement:

Foreign Direct Investment

Answer 36

Increasing FDI to the UK will increase the demand for the currency
Leading to a rise in the exchange rate

Question 37

Determinants of exchange of rate movement:

Expectations

Answer 37

Exchange rates are often determined by expectations of event occurring rather than the actual event itself

Example: After an interest rate rise, the exchange rate does not also rise because the interest rate rise is anticipated beforehand

Question 38

Floating Exchange Rates

Answer 38

Where the government makes no attempt to influence the value of the currency.

Question 39

Advantages of Floating Exchange Rates

Answer 39

Monetary Sovereignty
Interest rates are set on the needs of the UK economy alone rather than having to stabilise the exchange rate

Automatic Adjustment to Current Account balance
A large deficit on the current account would see an outflow of pounds, which should lead to the exchange rate falling.
Thus automatically leading to restoring export competitiveness.

There is no need for the government to hold extensive stocks of foreign currencies.

Question 40

Disadvantages of Floating Exchange Rates

Answer 40

Uncertainty for businesses
Not knowing the value of the currency makes it harder for businesses to plan ahead for leaky prices, profit margins and possible sales volume.

Overvalued/Undervalued currency
The exchange rate may remain high or low due to speculators deciding to either buy or sell the currency.
Overvalued currency makes it difficult for those wanting to export.
Undervalued currency would generate cost push inflation.

Question 41

Fixed Exchange Rates

Answer 41

Where the government intervenes in the foreign exchange market to stabilise a currency’s value against one or more currencies.

Question 42

Methods of Intervention for Fixed Exchange Rates

Answer 42

Monetary Policy
Changes in interest rate deliberately enacted to alter the demand for currency.

Open Market Operations
Buying and selling of foreign currency to influence the demand and supply of the currency.

Capital Controls
Restrictions on the quantity of currency that can leave or enter an economy.

Question 43

Advantages of fixed exchange rates

Answer 43

Easier trading for businesses
Making it likely there will be expansion of trade between those with fixed rates against another as there is less risk of fluctuations.

Monetary discipline
Keeping interest rates in line with that of the economy the currency is being fixed against gives monetary policy added credibility.
This means there are less likely to be cuts in interest rates which might be inflationary purely to boost a government’s popularity

Question 44

Disadvantages of fixed exchange rates

Answer 44

Loss of monetary sovereignty
Interest rates cannot be used for domestic purposes and have to be kept at the same level as those in the economy the exchange rate is fixed against.

Large reserves of foreign currency may be needed for government intervention.

No adjustment to current account imbalances.

Question 45

Currency Union

Answer 45

A group of countries which share a common currency.

Question 46

Arguments in favour of joining a currency union

Answer 46

Greater certainty for businesses that trade with members of the currency union.

No costs involved in converting currencies.

No worries about the exchange rate being overvalued or undervalued against other members.

Greater price transparency for consumers.

Question 47

Arguments against joining a currency union

Answer 47

Monetary policy has to be conducted for the currency union as a whole: Individual countries cannot set their own monetary policy.

Businesses may be unable to compete with lower cost producers that are members of the union.

Fiscal policy needs to be used more widely to correct for imbalances across the currency union area.

Countries may have to “bail out” other members that run into problems financing their government debt - Greece.

Question 48

Economic Growth

Answer 48

The increase in the level of national income over time.

Question 49

Economic Development

Answer 49

The growth in a number of criteria being achieved such as Income, freedom and availability of goods.

Question 50

Characteristics of less developed economies

Answer 50

Low level of real GDP per capita.
Dependence on primary products for export revenue.
Fast population growth and a low median age for the population.
A high proportion of the population based in rural areas and likely to be employed in agriculture.
Higher than average size for the informal economy.
Poor levels of infrastructure.
Poorly developed financial markets.

Question 51

HDI (Human Development Index)

Answer 51

Issued by the UN each year and assigns each country a development score.

Limitation is it does not include other characteristics of development such as the level of freedom

Based on:

Real national income per capita: Based on PPP exchange rates.

Health of the Population: Based on life expectancy at birth.

Education of the population: Based on mean years of schooling and expected years of schooling.

Question 52

Other measures

Answer 52

Human Poverty Index
Measure which looks at a range of indicators including life expectancy, poverty rates and literacy rates.

Social Indicators
Individual statistics which look at levels of social development:
Education levels
Access to health and education
Literacy rates

Question 53

Factors affecting growth in development

Answer 53

Investment adds to both short run and long run growth within an economy.
Investment in infrastructure - transport links, public services - would be more useful for development than military investment.

Education and Training will add to short run growth and should also move the economy closer to development.
Education adds to the economies intellectual capacity.
Training increases workers’ employability, either boosting productivity or increasing the range of jobs they can perform

Question 54

Barriers to economic growth and development

Answer 54

Poor Infrastructure
Corruption
Lack of Property rights
Volatile earnings from commodities
Undeveloped financial system
Institutional factors

Question 55

Policies to promote economic growth and development

Answer 55

Market based strategies.
Trade liberalisation: Removal or decreasing trade barriers
Policies to attract inward investment: Such as removing legal barriers to foreign ownership
Allowing the price mechanism to work more freely: Cancelling minimum and maximum prices in individual markets.

Interventionist strategies.
* Infrastructure investment
* Education and training investment
* Investment in tourism and other services
* Overseas aid
* Debt cancellation
* State investment in the welfare system

Question 56

Role of Trade in promoting growth and development

Answer 56

Trade:
Allowing free trade helps development as countries benefit from specialisation in industries where they have a comparative advantage; As long as trade takes place between other countries with minimal barriers, the gains from specialisation can be shared between all.

Some economists have argued that in reality governments of developed economies will protect their own industries from low cost competition and less developed economies by claiming that these countries have an ‘unfair’ advantage in terms of low cost

Question 57

Role of Aid in promoting growth and development, as well as disadvantages

Answer 57

International aid can take many forms:

Money
* Either unconditional transfers or…
* Ones that are tied under some set of condition (must be spent on certain products).
* In the form of a soft loan (loans to less developed countries at a less than market interest rate).
* Goods and Services
Often for a particular cause (sometimes labelled “disaster relief”) such as food in times of famine or clothing when there is a natural disaster.

Disadvantages of aid
* Money may get channelled into benefitting a small group of people (depending on corruption).
* Conditional aid may largely benefit the developed economy granting the aid.
* The systems for redistributing aid may not be present (goods and services does not get given to those who need it).
* Goods and services may not be suitable for the needs of the population.
* Those receiving the money may not have the expertise to spend it wisely, which can lead to expenditure on inappropriate programmes.