International Trade and Capital Flows

Question 1

Gross domestic product vs. Gross National Product

Answer 1

GDP: goods and services within the borders of a country.
GNP: good and services by the citizens of a country.

Question 2

What is an absolute advantage?

Answer 2

If one country can produce a good at a lower cost in terms of resources compared to another.

Question 3

What is an comparative advantage?

Answer 3

A country has a comparative advantage in the production of a good if its opportunity cost in terms of other good that could be produced instead is lower than that of another country.

Opportunity cost of Wine = Cost Wine/Cost of Cloth
Opp. cost of A= Cost A/Cost B

As long as opportunity costs differ, there are benefits from trade.

Question 4

What is the Ricardian model of trade?

Answer 4

Over has one factor - labor. The source of differences in production is caused by different levels of technology.

Question 5

What is the Heckscher and Ohlin model of trade?

Answer 5

Two factors of trade - capital and labor. The source of advantage is the relative amounts of factor factor the countries possess. There is a redistribution of wealth within each country between labor and the owners of capital.

Question 6

What are the arguments for government trade restrictions?

Answer 6

Infant industry - protection from foreign competition is given to new industries to grow to an internationally competitive scale.
National Security - may produce domestic to ensure availability during conflict.

Other but not well supported: protect domestic jobs, protect domestic industries, response to foreign restrictions.

Question 7

What are the main types of trade restrictions?

Answer 7

Tariffs: taxes on imported goods.
Quotas: Limits on amount of imports.
Export Subsidies: payments to firms that export.
Minimum Domestic : some percentage of product comes from local sources.
Voluntary restraint: limits how much is exported to avoid tariffs and quotas.

Question 8

What does a tariff do?

Answer 8

Increases domestic price, decreases import. Domestic producers gain, foreign exporters lose, and domestic gov gets revenues.

Question 9

What does a quota do?

Answer 9

Restricts quantity imported, raises prices, revenue from licenses.

Question 10

What is the overall effect of trade restrictions?

Answer 10

Reduces Imports
Increase Prices
Decrease consumer surplus
Increase domestic supply
Increase producer surplus

Question 11

What is the overall effect of trade restrictions?

Answer 11

Reduces Imports
Increase Prices
Decrease consumer surplus
Increase domestic supply
Increase producer surplus

Question 12

What are types of capital restriction and its effects?

Answer 12

Prevent flow of capital across borders. Outright denial of investment, prohibition of certain investments. Decreases economic welfare. In short term can protect developing countries from severe capital influx and flight during expansionary and contractionary times.

Question 13

What are the types of trading blocs in increasing integration?

Answer 13

Free Market - No restrictions.
Customs Union - No barriers amongst members, common resctrictions against non members.
Common Market - Free flow of labor
Economic Union - common institutions and economic policy.
Monetary Union - same currency

Question 14

What is the balance of payments (BOP)?

Answer 14

Current account + capital account + financial account

Question 15

What is included in the current account?

Answer 15

Merchandise and Services: all raw materials, and manufactured goods that are bought sold or given away.
Income Receipts: Include foreign income from dividends on stock holdings and interest of debt securities.
Unilateral transfers: one way trasnfers of assets such as money received from those working abroad. Aid - debited from giving country.

Question 16

What is in the capital account?

Answer 16

Capital transfers: assets brought or taken with when someone leaves.
Sales and purchases of non-financial assets.

Question 17

What is in the financial account?

Answer 17

Gov owned assets abroad - include gold, currency, securities, reserve position in the IMF, credits, assets, DFI, claims against foreign banks.
Foriegn owned assets in the country.

Question 18

How do decisions made by consumers, firms and gov effect the BOP?

Answer 18

Foreign borrowing results in a capital account surplus which means there is a trade deficit.

Equality: X - M = private savings + gov savings - investment

Question 19

How do decisions made by consumers, firms and gov effect the BOP?

Answer 19

Foreign borrowing results in a capital account surplus which means there is a trade deficit.

Equality: X - M = private savings + gov savings - investment

Question 20

What is the purpose of the IMF, World Bank and World trade org?

Answer 20

IMF: monetary cooperation, expansion and growth of trade, exchange stability, establish system of payments, making resources to member available

World Bank, Technical assistance to developing countries. Two parts - IBRD and IDA IBRD - aims to reduce poverty, IDA helps poorest countries.

WTO: deals with the global rules of trade between nations - interpreting agreements and commitments. Guarentees trade rights.

Question 21

What is the purpose of the IMF, World Bank and World trade org?

Answer 21

IMF: monetary cooperation, expansion and growth of trade, exchange stability, establish system of payments, making resources to member available

World Bank, Technical assistance to developing countries. Two parts - IBRD and IDA IBRD - aims to reduce poverty, IDA helps poorest countries.

WTO: deals with the global rules of trade between nations - interpreting agreements and commitments. Guarentees trade rights.

Question 22

How can we take advantage of an arbitrage opportunity with currency?

Answer 22

1. Borrow Domestic to buy foreign
2. Invest foreign at higher interest rate.
3. Buy forward contract and exchange at forward date
4. Pay back interest on borrowing

Forward rates prevent arbitrage.

Question 23

What are the options for countries without their own currency?

Answer 23

Formal Dollerization - just use someone elses currency.

Join Monetary union.

Question 24

What are the options for exchange regimes for countries that have their own currency?

Answer 24

Currency board - a commitment to exchange a domestic currency for a foreign currency at a set rate.
Conventional fixed peg - pegs its currency against another within a margin. Changes rates by purchasing or selling foreign currency.
Crawling peg - XR is periodically adjusted.
Managed floating exchange rates - influence XR in response to specific indicators such as BOP, inflation, or employment.
Independent floating - free market XR and foreign XR intervention is the only way to change it.

Question 25

What are the two approaches for interpreting exchange rate effects on trade and capital flows?

Answer 25

Elasticities approach - focuses on the impact of exchange rate changes of total value of imports and exports. When currency value drop, it will improve trade balance to a greater degree if goods are elastic. Subject to the Marshall-lerner condition = WxEx + WmEm > 1

Question 26

What are the two approaches for interpreting exchange rate effects on trade and capital flows?

Answer 26

Elasticities approach - focuses on the impact of exchange rate changes of total value of imports and exports. When currency value drop, it will improve trade balance to a greater degree if goods are elastic. Subject to the Marshall-lerner condition = WxEx + WmEm > 1

Absorption Approach: Focuses on capital account

BT = Y - E BT = Balance of trade, Y=domestic production of goods and services or national income. E = domestic absorption of goods and services which is total expenditure.

Question 27

What is the J-curve effect?

Answer 27

Because delivery of goods usually has payment in the future, trade balance in the short run is insensitive to changes. May initially make trade deficit worse.