International Econs Flashcards
What is the theory of comparative advantage?
The theory of CA states that if 2 countries have differing CA in the production of 2 goods, each country should specialize in their area of CA (where the country has the ability to produce that good at a lower opportunity cost). Trade based on mutually agreeable terms of trade will allow both countries to consume outside their original possibility production curve and enjoy higher living standards.
List the assumptions underlying the Theory of CA
Other than simplifying assumptions such as the existence of 2 countries producing 2 goods each, the theory also assumes:
i. the absence of transport costs,
ii. no barriers to trade,
iii. perfect factor mobility within countries (resulting in constant opportunity costs of production), and
iv. imperfect factor mobility across countries
What should students observe when presenting numbers under the Theory of CA explanation (this applies to both table / PPC representations)?
Depict one country having absolute advantage (AA) in the production of both goods. This makes the case for free trade more compelling, since we are able to explain why even a resource-rich giant like China is willing to trade with a smaller country like Vietnam. Furthermore, it avoids sending the signal that the basis of trade is due to differences in AA.
What is the 70/30 rule in this topic?
When explaining the basis of trade, 70% of the answer should be dedicated to explaining the Theory of CA, while 30% pertains to explaining other reasons for trade. The latter includes:
- greater variety; access to cheaper imports
- economies of scale from large-scale production
- competition from imports spurs efficiency among domestic producers
- (X-M) as an engine of growth
What is protectionism?
It is the practice of erecting barriers e.g. import tariffs to inhibit free trade, usually to protect domestic interests.
What is an infant industry?
It is an industry with potential comparative advantage in the production of a good, but is too underdeveloped to realise its potential. Exposure to foreign competition (e.g. firms with larger economies of scale) may prematurely crush the industry
What is dumping?
It is the act of selling goods at a cheaper price in foreign markets, sometimes below cost in order to chase out foreign producers and to establish market leadership
How can we describe a country’s pattern of trade?
By looking at its volume, composition and direction of trade between a country and other trading partners
What is trade creation and trade diversion?
Trade creation is the increase in trade among member countries of a trade agreement due to the removal of trade barriers. Trade diversion occurs when trade is diverted from a more efficient producer to a less efficient one due to the formation of a FTA or regional trade agreement.
What is globalization?
It is greater integration of national economies, leading to increased flow of (i) goods and services, (ii) capital and (iii) labour across national boundaries.
What are the factors that affect a country’s currency?
a) The demand for the country’s currency. The demand for a country’s currency is derived from foreigners’ demand for its goods and services and financial assets.
b) The supply of the country’s currency. The supply of a country’s currency is derived from residents’ demand for foreign goods and services and financial assets.
Break down the factors that affect the demand for a country’s currency
a) The demand for the country’s exports, which is affected by the price-competitiveness of the country’s exports, the income levels of trading partners, and the quality-competitiveness of the country’s exports
b) The demand for investments into the country, which consists of short-term investments (hot money) and long-term investments. Hot money flows are affected by changes in interest rates and expected changes in exchange rates. Long-term investments are affected by the level of corporate taxes in the country and investor confidence. Lower exchange rates also make it cheaper to set up physical assets (e.g. factory) within the country, although future earnings will be worth less in domestic currency.
Break down the factors that affect the supply of a country’s currency
a) The country’s demand for imports, which is affected by the price-competitiveness of imports, the income levels of the country’s citizens and the quality-competitiveness of imports.
b) The level of the country’s outward investments, which consists of short-term investments (hot money) and long-term investments. Hot money flows are affected by changes in interest rates and expected changes in exchange rates. Long-term investments are affected by the level of corporate taxes and investor confidence. Lower exchange rates also make it cheaper to set up physical assets (e.g. factory) within the country, although future earnings will be worth less in domestic currency.
What does the internal value of a currency refer to?
Internal value refers to the purchasing power of a currency (which shares an inverse relationship with inflation)
What does the external value of a currency refer to?
It refers to the country’s exchange rate.