IB Economics Section 4: International Economics
Terms in this set (55)
When a country is able to produce more of a good than another country given the same resources i.e. they are more efficient.
When a country can produce a good at a lower opportunity cost than that of another country.
Free trade is trade that contains no intrusion or barrier in the flow of goods and services between countries. The only disadvantage a country may face is transaction costs such as foreign exchange, transportation costs.
Protectionism is any form of action that is taken by a country that reduces the competitiveness of imported goods in favour of domestically produced goods.
A tariff is a tax levied on imported goods. The tariff can be an ad valorem tax (percentage based) or a specific rate based on e.g. volume, weight etc.
A quantative limit on imports set by the importing country. Domestic producers will end up producing more goods because of the higher price resulting from limited imports.
A payment by government to domestic producers to encourage an increase in production.
Voluntary Export Restraints
When a foreign producer limits the amount of a good exported to another country, often as a result of political pressure from the importing country.
Administrative 'red tape' which adds to the overall cost of the imported good such as extensive documentation, testing of the product to ensure it complies with local safety standards.
Health and Safety Standards
Standards that must be complied with to all goods coming into a country. For example, medicines might be required to have FDA approval, child car seats have to pass crash testing.
Standards that must be complied with if the good creates an impact on the environment. E.G. refrigerators must not have CFC's in them, new cars must meet emission standards.
An industry in the domestic market that would have little chance of competing against international firms if they were open to competition.
Records export revenues from goods and services and import payments for goods and services.
Records money inflows and outflows from foreign investment, loans, loan repayments.
A country sells its goods to another country at a price that is below its production cost.
The spread of economic, social and cultural ideas across the world and growing uniformity between different places. It has resulted from the increased integration of economies through trade, investment and capital flow, made possible through improvements in technology.
A large free trade zone or near-free trade zone formed by one or more tax, tariff and trade agreements.
Where there is a common (same) tariff set for member countries receiving goods from non-member countries. Free trade exists between member countries. This solves the problem of re-exporting taking place, as happens in a FTA. HOWEVER, if Monaco prior to the customs union had tariffs of 4% from goods coming from Country Y, a higher tariff (7%) now exists, making imported goods more expensive for consumers in Monaco.
A group of countries imposing few or no duties on trade with one another and a common tariff on trade with other countries.
World Trade Organisation
An organisation made up of member countries which aims to create a global free trade environment. It deals with eliminating trade barriers (tariffs, quotas), ensuring dumping of goods does not take place, reducing/eliminating subsidies on domestic production, focussing on standards for labour laws and ensuring intellectual property issues are dealt with in a fair manner.
Balance of payments
records all inflows and outflows resulting from a country's economic activity in the domestic economy and foreign sectors in a given time period.
Current account deficit
A current account deficit means the capital account will be in surplus.
The exchange rate
The price/rate at which one currency can be exchanged for another.
Fixed exchange rate
An exchange rate that links to another currency within a narrow band or corridor. The central bank buys and sells its own currency on the foreign exchange market and/or changes the domestic interest rate to keep the exchange rate within the corridor.
Floating exchange rate
Where the value of the exchange rate is determined by supply and demand of the currency.
Managed exchange rate
Where the exchange rate can fluctuate within a narrow band in the short run and in the long run it can be re-aligned. It is also called an "Adjustable Peg System".
A fall in the value of one currency against another with a floating exchange rate.
When a managed/pegged currency is realigned to a lower value band.
An increase in the value of one currency against another with a floating exchange rate.
When a managed/pegged currency is realigned to a high value/band.
Occurs when people buy/sell currency to make a profit.
Advantages of Fixed exchange rates
Certainty, trade encouragement, disciplined fiscal/monetary policy, little current account deficits, lack of speculation.
Disadvantages of Fixed exchange rates
Lack of monetary policy freedom, a need for foreign reserves, possibility of increased unemployment, import inflation.
Advantages of Floating Exchange rates
Balance of payments adjustment, no foreign reserves needed, domestic monetary policy freedom, reduced speculation, less import inflation risk.
Disadvantages of Floating Exchange rates
Lack of predictability, lack of monetary/fiscal policy prudence, loss of efficiency.
Advantages of Single Currency/Monetary Integration
Trade creation, greater competition, benefits of scale, lower transaction costs.
Disadvantages of Single Currency/Monetary Integration
Loss of domestic monetary policy, restricted domestic fiscal policy, regional unemployment.
Current account deficit issues
Paid for by borrowing money from overseas or overseas investment, in the long run problems with this are: loan repayment issues, higher interest rates attracting foreign investment, foreign capital leaves. Good issues: greater choice for consumers (due to increased imports).
Current account surplus issues
Good issues - foreign assets, generation of income. Negative issues: domestic consumption/investment issues and tax losses due to less domestic investment.
Ways to fix current account deficit
A combination of increasing export revenue and/or decreasing import spending. This can be done by:
-Devaluing the currency
-Making domestic goods more competitive than imports through the use of subsidies or tariffs
-Reducing demand for imports
-Improving the competitiveness of domestic firms through eg research and development.
Devaluing the Exchange Rate - Managed ER
Devaluing the currency will .... Make the relative price of domestic goods cheaper compared to imported goods - imports become relatively more expensive. Exports become cheaper.
Protectionism - Expenditure Switching Policy
This is where ...The government imposes a policy which diverts domestic spending away from imports to domestically produced goods. This could include trade barriers (tariffs, quotas) or devaluing the currency.
Reduction in Aggregate Demand - Expenditure Reducing Policy
This is where ....The government implements policies which reduce AD which reduces spending on imports. The amount of the fall in import spending will be determined by the MPM (Marginal Propensity to Import). Government policies to reduce AD include a contractionary fiscal policy or tight monetary policy.
Supply Side Policies - Increasing Competitiveness
This is where ......
The competitiveness of the domestically produced goods is increased by reducing labour costs, investing in technology for greater productivity and efficiency. However this would take time to implement and the benefits to occur.
Capital Account Deficit
The country has increased its holdings of capital, property and financial assets OVERSEAS.
Capital Account Surplus
The country has received net inflows of money from overseas that may be used to fund imports, or is for foreign investment domestically.
The balance of payments will not necessarily improve or deteriorate if the exchange rate changes. This depends on the value of exports or imports changing.
Depreciation of the currency
- Marshall-Lerner Condition, balance of payments improve
High elasticity -> PEDx + PEDm > 1
- Elasticity = 1 , unitary elasticity -> PEDx + PEDm = 1
Balance of Payments is unchanged
- Elasticity low (inelastic) -> PEDx + PEDm < 1
Balance of Payments deteriorates
Exports become cheaper immediately but it takes time when exports become cheaper for foreign consumers to buy more and domestic producers to produce more. * Think drugs and medicines: takes time for effects. E.g if oil price increases, takes time for consumers to find domestic substitutes.
Terms of Trade
The ratio of export prices to import prices using a common currency. Price = in dollar terms - not quantity!!
Changes in terms of trade
>Improvements in Terms of Trade: The ratio of export prices to import prices has improved.
Benefits: Ability to consume more imports may improve living standards.
Problems: If exports are elastic, this may deteriorate the current account balance, decrease national income (GDP) and employment.
> Deterioration in Terms of Trade: The ratio of export prices to import prices worsens.
Benefits: If demand for exports and imports are elastic, it may improve the current account balance, GDP employment.
Problems: Higher prices of imports produce consumer choice and possibly debt.
A deterioration of the terms of trade can cause a large impact on developing countries - especially as they rely on a few commodities for export earning, and these goods tend to have a low price elasticity (not luxury but basic type goods). This results in much needed imports such as machinery becoming more expensive, which may hinder any increase in output, higher debt servicing costs more - exports are required to earn foreign currency which is used to repay foreign debt.
Formula for changes in terms of trade
Formula: (Index of Average Export Prices) ÷ (Index of Average Import Prices) x100
Changes in the terms of trade:
> Changes in the short run:
A change in the exchange rate
An increase in demand for exported goods (D increase, price increase) will improve the terms of trade. An increase in supply of exported goods (S increase, price decrease) will decrease the export price index.
Implementing trade barriers, devaluing or revaluing the currency.
Foreign investment can cause the exchange rate to appreciate which will result in lower import prices and higher export prices - improving the terms of trade.
> Changes in the long run:
Supply side policies, which result in LRAS shifting to the right, will decrease domestic prices (inflation) compared to our trading partners.
Gluts (large supply) in the market can depress prices in the long term.
Increased incomes will increase the demand for secondary/tertiary products. This tends to benefit the terms of trade for developed but does not help developing countries.
International commodity agreements may stop prices rising/falling which will limit any changes in the terms of trade.
Effect of Elasticity for Exports and Imports
Primary goods tend to be inelastic in their nature. A change in supply will result in a large change in the price for primary goods. Secondary and tertiary goods tend to be elastic in their nature. A change in supply will result in a small change in the price for secondary/tertiary goods.
Effect of Elasticity on Terms of Trade, Balance of Payments
- If the terms of trade falls (say due to an increase in the number of suppliers around the world), this will result in the price of the good falling.
- Depending on the elasticity of the good, this will result in total revenue received from these goods either increasing or decreasing. This will affect the current account - either improving it or resulting in it worsening.