4.1 a International Economics Cars production Laptops production
Terms of trade (ToT)
Country A 20 50 ToT ca lculates t he amo unt o f im ports
Impacts of globalisation : Country 8 10 20 that a country's exports can buy
Positive Negative
• Increase in consumer choice Increased environmental Country Count ry A has absol ute
Assumptions/limitations of the theory 50 ToT = index pf ~xport pri_ces
Low prices for consumers degradation/ pollution A's PPF advantage in the prod uction
of comparative advantage: Index o f im port prices
Improved living standa rds
Access to chea p fact o r inputs fo r
Increased interdependence ➔
recession in one country spread s
All count ries produce identical goods
Free movement of factor inputs
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...J
o f both goods (i.e. it ca n
produce more o f bot h goods
cheaply using t he sa m e 1Sup;o; ; at ove r ~ e-;a;; 20
y; ar7 ti; - -
businesses quickly I index of import prices has fallen by 5%, while I
Zero transportation costs resources t han country B).
Firms can make higher profits Access t o cheap labour abroa d ➔ l the index of export prices has risen by 9%.
• Ze ro economies of scale I
due to access to a bigger ma rket local unem ployme nt will rise
• Perfect information 1The terms of t rade w ill be: ~ - I
• Encourages specia lisation ➔
~ Country A needs to I ToT = l 09 Xl00=114.7 I
increased efficie ncy Characteristics of glob alisation: Advantages of trade Disadvantages of trade fo rego 2.5 unit s o f I 95 I
Reduction in unemployment Increased t rade 1-- ---'•" n'"'
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io_n _ _ _ laptops t o produce 1 ca r IThis suggest s that the terms of trade have I
Increased revenue from import Increased interdependence Great er choice for • Count ries become inte rdependent 7 (20:50). l improved by 14.7%. _ _ _ _ _ _ _ _
tariffs fo r gove rnm e nts More foreign direct investment consumers Terms of t rade may worsen (i.e. t hey import Cou ntry B needs to give
(FDI) and t ra nsnat ional companies Chea per goods for higher-value goods and export low-value goods)
Impacts of improvement in ToT:
up 2 units of laptops to
Increased globalisation ove r t he (TNCs) consumers Over-reliance on t he production of one good prod uce 1 ca r {10:20). Advantages Disadvantages
last 50 years: Easy access t o factor inputs • Greater efficiency Countries lacking comparative advantage will • Greate r • Loss of international
• Better m eans of communication Firms experience lose out choice for com petitiveness
(e.g. internet) and transport economies of sca le • Unwanted goods can be 'dumped' in poorer Country B has comparative consumers • Leads to a current account
World Trade Organisation (WTO) Wider market ➔ higher countries at very low prices, w hich is bad for advantage in the production o f • Better deficit
- red uction in t rade barriers
G\obalisation local firms ca rs (i.e. it can produce ca rs at a living • As demand for exports
Creation of TNCs lower opportunity cost than standards decreases, unemployment in
co unt ry A). t he export ind ustry increases
Factors that affect ToT:
The World Trade Organisation (WTO) promotes free t rade by fo llowing a policy of I •
/------------,
Tariff increase on the price of 1
Prier> of r,H<; Relative inflation rates
Highe r inflation ➔ exports costly ➔
Domestic dem<1nd Dome,t1c supply
trade liberalisation . It provides a platform for t rade negotiations and settlement imports ➔ lower demand ToT im proves
I
of any trade issues between member co untries. I• Revenue for government (ABCD) Relative productivity rates
• Conflict between WTO and regiona l t rade ag ree m e nts ➔ latter lead to trade I• Domestic consumer surplus Greater productivity ➔ comparative
diversio n, w hich decreases trade elsewhere and undermines compa rative advantage. increased by P1P1DE advan tage ➔ ToT improves
l. Welfare loss (ADE + BCF) I Exchange rate (ER)
Regional trade agreements / moneta ry unions: ------------✓ Higher ER ➔ exports costl y ➔
Advantages Disadvantages World supply ToT im proves
Reasons for restrictions on f ree trade:
No tra nsaction costs • Transition costs, e.g. menu costs 1) Protecting loca l industries:
Infant industries are new ind ustries Divert trade from ---!!ii,,... Trade
Greater price transpa rency
No need to account for ER fluctuations,
• No control over monet ary policy
that need t ime to matu re out
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Q .· Or: Quantity of cars Trade ,;,r old to new partne r;--"'" diversion
w hich hurt countries' competitiveness Sunset industries are firms in decline New unports blocs ~ Create new trade -+- Trade
but t hey may be useful creation
Attract FDI ➔ good for growt h Old imports Factors that influence it:
Count ries need to be self-sufficient in
industries such as defence and energy Comparative advantage : poorer countries
Types of trade blocs: tend t o export low-value goods, e.g. crops
2) Preventing 'dumping' from very cheap Types of trade barriers:
1) Free Trade Area (these can be bilat eral or regional) imports while richer countries tend to export high-
Tariffs - tax on imports
- Free movement of goods and services 3) Protectingjobs value goods, e.g. ca rs
- Each member ca n set their own trade barriers for non-members • Quotas - limit on numbe r o f imports
4) Less dependency No. of emerging economies: these are rich
2) Cust oms union • Subsidies - grants to loca l producers in cheap labour, w hich helps t he export
5) Correct current account deficit
- Membe r countries have a joint trade policy for all non-membe rs Non-tariff ba rriers-e.g. health and safety requirements sector to grow
6) Avoid competition
3) Common market Growth of trading blocs and bilateral trade
7) Retaliation
- Free movement of factor inputs Impacts of trade barriers: agreements : t hese elimin ate t rade barriers
4) M oneta ry Union Advant ages Disadvantages Changes in relative exchange rat es: these
Single currency - as in the Eu rozone determine the ratio of imports to exports
• Revenue for government Less choice for consumers
Conditions necessa ry fo r success incl ude: Restrictions on from tariffs • Higher prices fo r between 2 countries, e.g. pound
► Similar growth patte rns and business cycles of member count ries depreciatio n w ill make UK exports chea per
Local firms make higher
► Similar cultu res to decrease barriers to free movement free trade consumers
abroad
profits • Lower living st andards
► Increase spending in adversely affected (from this move) areas
Local jobs are protected Inequality Pattern of trade
, ✓- '
4.1b International Economics I Significance of trade imbalances:
I• As a negative trade balance increases, it
becomes more and more difficult to finance.
\
1
E§ii:Hy\M®l·····~ -
i:MU Hence, loans have to be taken out. This is
because a negative current account implies a
positive capital account.
Forces of demand and
supply determine the value
Jt!"'
Floating
Managed
I
Fixed
~ The value of
currency is
Current account IC/A) Capita l accou nt I
I• Government spending may fall significantly of the currency + manually pegged
~ ~----'-.;.,. to repay those loans.
Also, if exports outstrip imports, domestic Indirect
against another
currency (o r gold)
Capital Financial Speculative consumers may be faced with limited choice. government
Factors influencing the ER:
investment investment capital flow s Trade imbalances also lead to massive interventio n, e.g.
Relative interest rate
\ currency fluctuations ➔ affects global trade. buying/selling
If relative interest rate is higher ➔ people
'---------------✓ encouraged to save money in UK banks to
currency,
determines the
Reducing current account imbalances: get a higher return on their savings ➔
Loans/grants va lue of currency
received and/or
1. Expenditure-reducing policies dema nd for£ increases ➔ £ appreciates.
given out by Policies that reduce AD, e.g. increasing income t ax ➔ Relative inflation rate
reduces disposable income ➔ demand for imports If relative inflation hig h e r ➔ exports
income governments
decreases. appear more expensive ➔ demand for UK
E,cpenditure-switching policies exports fa ll ➔ £ depreciates. Foreign currency transactions
Policies that affect demand for imports, i.e . trade • Speculation To increase the cu rrency value, central bank
Causes of C/A deftc1t Causes of C/A surplus barriers, e.g. imposing tariff ➔ imports become If people speculate that the value of£ w il l will buy domestic cu rrency. This reduces
High inflation rate ➔ cheap Protectionist measures expe nsive ➔ demand for imports falls. fall, they w ill se ll their £s for another su pply of£ and increases its demand . Thus,
imports decrease imports 3. Supply-side policies currency with a higher value. As demand £ appreciates.
Relatively low labour Low inflation ➔ cheap exports Policies that affect demand for exports, e.g. for£ decreases, it depreciates ➔ se lf- Interest rates
productivity ➔ increased lower exchange rate ➔ cheap increasing spendi ng on educat ion ➔ improves labour fulfill ing prophecy. To increase the cu rrency value, central bank
average cost ➔ cheap imports exports productiv i ty ➔ improves quality/quantity of exports State of the economy will raise the interest rate. This increases
Higher exchange rate ➔ cheap Low domestic growth ➔ ➔ demand for exports rises. Economy improving ➔ investors feel demand of£, as saving in UK banks reaps
imports increased demand for exports 4. Doing nothing confident ➔ demand for£ rises ➔ higher rewa rds. Thus,£ appreciates.
High domestic growth ➔ Relatively high labour Some of the policies described above have downsides, £ appreciates.
increased demand for imports productivity ➔ low average e.g. raising taxes will also affect domestic demand and
Effects of devaluation/depreciation:
Growth in large eco nomies ➔ cos t ➔ cheap exports imposing trade barriers is often met with retaliation.
increased dema nd fo r imports Thus, some countries may opt to do nothing. Makes exports more co mpetitive ➔ cu rrent ·acco unt surpl us
However, if all cou ntries devalue their currencies, the n nobody gai ns from it
Internat iona l competitiveness:
Creates jobs in the ex port industry Current account (C/A}
Export-led growth 1. The Marshall-Lerner condition posits that depreciation only leads to a
Improves trade deficit C/A improvement if (PEDHporu + PED1mporu > 1).
2. The J-curve suggests changes in the ER have t ime lags. Initially C/A
deteriorates because in the short-run exports and imports have inelastic
Over-reliance on exports can become a problem if the world demands. Later, as dema nds become more elastic, we see an
economy experiences recession ➔ massive job losses improvement.
Relative unit labour costs
If labour in cou ntry A is more
productive or gets lowe r Inflation
Factors affecting international co m•p•••••itiv e ne s•s•: •• •• • •••• ••••• •••• •• wages than co untry B, then Growth and unemployment ER depreciates ➔ imports appea r
1. Relative unit labour costs 0
0 0 0 0 0 the former is said to be more ER depreciates ➔ demand for exports rises ➔ more expensive, and if co untry is
2. Relative level of regulation
internatio nally competitive job creation ➔ more consumer spending ➔ relia nt o n imports ➔ infl ation
If firms in a country face less regulation, then they are more compet itive more growth
(i.e. it can export more)
3. Relative Inflation
• Relative export prices
Exports from a country with lower inflation compared to others appea r chea per
If country A's export prices
4. Relative non-wage costs Foreign direct investment (FOi} flows
are lower than country B's,
If other factor inputs In a country are cheaper compa red t o another country, it ER depreciates ➔ domestic goods
then the former can export
w ill be able to pro duce goods cheaply ➔ more exports appea r c he ape r ➔ more FOi flows
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