International Trade And Foreign Exchange Market Flashcards
Give a description of the classical theory of international trade
The major theories of international trade consist of mercantilism, absolute advantage and comparative advantage
How would the modern theory compare to the classical theory?
The classical theory tries to demonstrate the gains from international tradewhile the; modern theory concentrates on the basis of trade. The classical theory does not provide the cause of differences in comparative advantage. The modern theory explains the differences in comparative advantage in terms of differences in factor endowments. The classical economists explained the phenomenon of international trade in terms of the old, discredited labour theory of value. The modern theory explained international trade in terms of the general equilibrium theory of value.
Compare absolute advantage to comparative advantage. What differences exist?
Both terms deal with production, goods and services. Absolute and comparative advantage are two important concepts in international trade that largely influence how and why nations devote limited resources to the production of particular goods. Absolute advantage is a condition in which a country can produce particular goods at a lower cost in comparison to another country. On the other hand, comparative advantage is a condition in which a country produces particular goods at a lower opportunity cost in comparison to other countries. While absolute advantage is a condition where the trade is not mutually beneficial, comparative advantage is a condition in which the trade is mutually beneficial. Absolute and comparative advantage are two important concepts in international trade that largely influence how and why nations devote limited resources to the production of particular goods. .Absolute advantage refers to the superior production capabilities of one nation versus another, comparative advantage is based on the concept of opportunity cost.
What is mercantilism and why is this an important term?
Belief in the benefits of profitable trading; commercialism. A theory that suggests that the wealth of the world is fixed and that a nation that exports more and imports less will be richer. Example: The idea of mercantilism helped drive laws in the colonies that would establish England as their only trading partner, to allow England to sell the goods and stabilize their economy. Historical Significance: Mercantilist thought and laws made the colonies believe they needed independence from England to properly trade and prosper. General Significance: Mercantilism allows countries to improve their economic standing by exporting more goods than they import, enabling them to gain more money in relation to other countries.
What are the critical features of the product life cycle?
Product has three life cycle stages: new, maturing, and standardized. First stage, production of a new product (such as a TV) that commands a price premium will concentrate in the United States, which exports to other developed nations. In the second, maturing stage, demand and ability to produce grow in other developed nations (such as Australia and Italy), so it is now worthwhile to produce there. In the third stage, the previously new product is standardized (or commoditized). economic theory that accounts for changes in the patterns of trade over time.
How would you describe strategic trade?
Strategic trade theory Strategic intervention by governments in certain industries can enhance their odds for international success First-mover advantage Advantages that first entrants enjoy and do not share with late entrants.
How are supply and demand related to the exchange rate of a country?
when demand is high, prices rise and the currency appreciates in value. In contrast, if a country imports more than it exports, there is relatively less demand for its currency, so prices should decline. In the case of currency, it depreciates or loses value.
Which theory came first, mercantilism or modern-day protectionism?
Mercantilism
If a company seeks to limit foreign exchange rate exposure in the forward direction, what is the most effective way to do this?
Forward transactions, an act know as currency hedging
What is transaction risk?
The exchange rate risk associated with the time delay between entering into a contract and settling it.
Explain the concept of “hedging” as it relates to reducing various types of risk.
A transaction, such as forward transactions, that protects traders and investors from exposure to the fluctuations of the spot rate.
What is the difference between currency hedging and strategic hedging?
Currency Hedging is a way to protect traders and investors from being exposed to the fluctuations of the spot rate. Strategic hedging is a means of spreading out activities in different currency zones in order to offset the currency losses in certain regions through gains in other regions (currency diversification)
What advantages exist with first mover?
Proprietary, technological leadership, pre-emption of scarce resources, establishment of entry barriers to late entrants, avoidance of clash with dominant firms at home, relationships with key stakeholders, (such as governments.)
What advantages exist with late mover?
Opportunity to free ride on first-mover investments, Resolution of technological and market uncertainty, First mover’s difficulty to adapt to market changes.)
Consider the model of foreign market entries. How is scale-of-entry related/relevant?
Non-equity and equity. Non-equity Reflects relatively smaller commitments to overseas markets. Determines firms MNE status. Equity indicative of relatively larger, harder-to-reverse commitments. Determines firms MNE status.
Theory of mercantilism
The wealth of the world is fixed. A nation that exports more than imports captures a net inflow of “wealth” and thus becomes richer.
According to this theory, international trade is viewed as a zero-sum game
Winners and losers
Absolute advantage
To be more efficient at the production of a good/ service than others
A nation benefits by specializing in economic activities in which they possess an absolute advantage
Comparative advantage
Gains from trade arise from differences in factor endowments or technological process
An agent has comparative advantage over another in producing something when they can produce a good at a lower relative opportunity cost
Product life cycle
The first dynamic theory to account for changes in the patterns of trade over time.
Strategic trade
Strategic intervention by governments in certain industries can enhance their odds for international success.
National competitive advantages of industries
Certain industries within a nation are competitive internationally
Can help countries connect research to industry outcomes
What determines foreign exchange rates
Relative price differences and purchasing power parity
Interest rates and money supply
Productivity and balance of payments
Exchange rate policies
Balance of payments
A country’s international transaction statement, which includes merchandise trade, service trade, and capital movement
Current account balance
Current account = balance of trade + net factor income from abroad + net unilateral transfers from abroad
Floating (or flexible) exchange rate policy
Willingness of a government to let demand and supply conditions determine exchange rates
Clean (or free) float
Pure market solution to determine exchange rates
Dirty (or managed) float
Using selective government intervention to determine exchange rates
Target exchange rates (crawling bands)
Specified upper or lower bounds within which an exchange rate is allowed to fluctuate
Fixed rate policy
Setting the exchange rate of a currency relative to other currencies
Peg
Stabilizing policy of linking a developing country’s currency to a key currency
Bandwagon effect
Effect of investors moving in the same direction at the same time
Capital flight
Phenomenon in which a large number of individuals and companies exchange domestic currencies for a foreign country
Foreign exchange market
Market where individuals, firms, governments and banks buy and sell currencies of other countries
Spot transaction
Classic single shot exchange of one currency for another
Forward transaction
Foreign exchange transaction in which participants buy and sell currencies now for future delivery
Currency hedging
Transaction that protects traders and investors from exposure to the fluctuations of the spot rate
Forward discount
Condition under which the forward rate of one currency relative to another currency is higher than the spot rate
Forward premium
Condition under which the forward rate of one currency relative to another currency is lower than the spot rate
Currency swap
Foreign exchange transaction between two firms in which one currency is converted into another at Time 1, with an agreement to revert it back to the original currency at a specified time 2 in the future
Offer rate
Price at which a bank is willing to sell a cutrency
Bid rate
Price at which a bank is willing to buy a currency
Spread
Difference between the offer price and the bid price
Currency risk
Potential for loss associated with fluctuations in the foreign exchange market
Strategic hedging
Spreading out activities in a number of countries in different currency
IMF International monetary fund
An international organization established to promote international monetary cooperation, and change stability and orderly exchange arrangements
Liability if foreignness
Inherent disadvantage foreign firms experience in host countries because of their nonnative status
What is the resource based view of liability if foreigness
Firms need to deploy overwhelming resources and capabilities to offset the liability of foreigness
Location specific advantages
Benefits a form reaps from the features specific to a place
Agglomeration
Location specific advantages that arise from the clustering of economic activities in certain locations
First mover advantages
Benefits that accrue to firms that enter the market first and that later entrants do not enjoy
Late mover advantages
Benefits that accrue to firms that enter the market later and that early entrants do not enjoy
Scale of entry
Amount of resources committed to entering a foreign market
Modes of entry
Method used to enter a foreign market
Nonequity mode
Mode of entering foreign markets through exports and contractual agreements that tends to reflect relatively smaller commitments to overseas markets
Equity mode
Mode of entering foreign markets through JVs and wholly owned subsidiaries that indicate a relatively larger, harder-to-reverse commitment
