IB Economics International Economics
Terms in this set (47)
Define international trade.
Exchange of goods and services between countries.
Identify and explain the gains from trade.
Lower prices, Greater choice, differences in resources, economies of scale (size of market increases so does demand), Increase competition, more efficient allocation of resources, source of foreign exchange.
Define and give examples of specialization and the division of labour.
When firms are large, individuals may specialize in specific, narrower tasks such as accounting manager or market manager, and they should become more knowledgeable and so more efficient. Larger production units will also lead to greater scope for division of labour where a production process is broken down into a number of simple and basic tasks.
Describe the objectives and functions of the World Trade Organization.
WTO is an international organization that sets the rules for global trading and resolves disputes between its member countries. WTO aims to increase international trade by lowering trade barriers and providing a forum for negotiation. GATT dealt mainly with reduction of tariffs, but later negotiations include other areas such as dumping legislation and non-tariff issues.
Define free trade.
Between countries where there are no barriers to trade put in place by governments or international organizations.
Arguments for protectionism.
Protecting domestic employment, Protecting economy from low-cost labour, protecting infant (sunrise) industries, to avoid the risk of over-specialization, strategic reasons, to prevent dumping, to protect production standards, raise government revenue, correct a balance of payments deficit, protection national security.
Arguments against protectionism.
Protectionism may rise prices to consumers an producers of imports that they buy, lead to less choice, competition diminish making firms more inefficient, distorts comparative advantage leading to inefficient use of world resources, may hinder economic growth, potential for corruption.
Explain and illustrate free trade.
Types of protectionism.
TARIFFS: (tax that is charged on imported goods), shifts the supply curve upwards by the amount of the tax, causes domestic producers to increase their production.
SUBSIDIES: (amount of money paid by the government to a firm, per unit of output, making them more competitive) shift the domestic supply curve downwards by the amount of subsidy.
QUOTAS: (physical limit on the numbers or value of goods by governments that can be imported into a country) shifts the domestic supply to the right.
Describe administrative barriers that may be used as a means of protection.
Rules and procedures in connection with the transaction put in place. In a number of areas, special international ground rules have been agreed, which limit the ways in which countries can regulate trade.
Define exchange rates.
Value of one currency expressed in terms of another currency.
Describe a Fixed exchange rate.
Value of currency is fixed, or pegged to the value of another currency, to the average value of a selection of currencies or to the value of some other commodity such as gold. Usually carried out by government or central bank. SEE NOTES FOR DIAGRAM
Distinguish between devaluation and a revaluation of a currency.
Revaluation: If the value of the currency in a fixed exchange rate regime is raised
Devaluation: If the value of the currency in a fixed exchange rate regime is lowered.
Describe a Floating exchange rate.
Value of a currency is allowed to be determined solely by the demand for, and of, the currency on the foreign exchange market. There is no government intervention to influence the value of the currency. SEE NOTES FOR DIAGRAM
Distinguish between depreciation and appreciation of a currency.
Appreciation: Currency in a floating exchange rate regime rises
Depreciation: value falls
Describe factors leading to changes in demand for, and supply of, a currency.
•Increase in demand for goods and services (inflation rates being lower than other countries inflation rates making goods and services relatively less expensive, increase in income of overseas countries, change in tastes)
•Investment prospects improve
•Interest rates increase making more attractive to save there than other places
•Speculators in other countries think value of currency will rise.
•Country increases their demand for international goods and services thus exchanging more of their currency (caused by inflation rates being higher than international rates, increase in countries incomes, change in your countries tastes)
•International investment prospects improve
•International interest rates increase making more attractive to save there
SEE NOTES FOR DIAGRAMS
Describe Management exchange rate.
No currency in the world allowed to be completely freely floating. When currency subject to extreme fluctuations and the government, or central bank, will fell that they must intervene in order to stabilize the exchange rate. Common systems are setting upper and lower exchange rate value and then allow currency to float freely so long as it does not move out of that band.
Advantages of high exchange rates.
Downward pressure on inflation (if value of exchange rate is high, then price of finished imported goods will be relatively low. The price of imports will reduce the costs of production for firms leading to lower prices for consumers), more imports bought, high value of currency forces domestic producers to improve efficiency to stay competitive.
Disadvantages of high exchange rates.
Damage export industries (uncompetitive), damage domestic industries(imports cheaper).
Advantages of low exchange rates.
Greater employment in export industries, greater employment in domestic industries.
Disadvantages of low exchange rates.
Inflation (low value of currency will make imports more expensive, costs of production will rise possibly leading to higher prices).
Government measures to intervene in the foreign exchange market.
•Lower exchange rate to increase employment
•Raise exchange rate to fight inflation
•Maintain fixed exchange rate to avoid large fluctuations in a floating exchange rate
•Achieve relative exchange rate stability to improve business confidence
•Improve a current account deficit, (spending on imports is greater than the revenue from exports)
Main methods: using their reserves to buy, or sell, foreign currencies, by charging interest rates
Advantages and disadvantages of a fixed exchange rate.
ADVANTAGES: reduce uncertainty, ensure sensible government policies on inflation (as inflation will have harmful effects), reduce speculation in the foreign exchange markets
DISADVANTAGES: government compelled to keep the exchange rate fixed, country needs to maintain high levels of foreign reserves in order to defend its currency, not simple, if at artificially low level may create international disagreement.
Advantages and disadvantages of a floating exchange rate.
ADVANTAGES: interest rates are free to be employed as domestic monetary tools, adjusts itself in order to keep the current account balanced, it is not necessary to keep high level of reserves of foreign currencies and gold.
DISADVANTAGES: create uncertainty on international markets, affected by more factors than simply demand and supply such as government intervention, world events and speculation, may worsen existing levels of inflation.
Role of balance of payments account.
•An accounting record of all monetary transactions between a country and the rest of the world over a given period of time (usually over one year).
•All trades conducted by both the private and public sectors are accounted for in the BOP
Distinguish between debit items and credit items in the balance of payments.
•paid or given money
Components of balance of payments account.
Define current account.
Measure of the flow of funds from trade in goods and services plus other income flows.
Explain the four components of current account.
1. BALANCE TRADE OF GOODS: (visible trade balance, the merchandise account balance).
•Measure of revenue from export of tangible (physical) goods minus the expenditure on the imports of tangible goods over a given period of time.
2. BALANCE TRADE OF SERVICES: (invisible balance, the services balance, or net services).
•Measure of revenue from exports of services minus expenditure on imports of services over given period of time, includes all import and export of all services such as banking, insurance and tourism.
3. NET INCOME FLOWS: (net investment incomes).
•Measure of the net monetary movement of profit, interest, and dividends moving into and out of country over given period of time as result of financial investment abroad.
4. CURRENT TRANSFERS: (net unilateral transfers from abroad).
•Measurement of net transfers of money. Payments made between countries when no goods or services change hands. At government level these payments include foreign aid and grants.
Current account balance=Balance of trade in goods+Balance of trade in services+Net income flows+net transfers
Explain the two components of capital account.
•flow of funds, into the country (credits) and out of the country (debits), associated with the acquisition or disposal of fixed assets
•measure of net monetary movements gained or lost through actions e.g. transfer of goods and financial assets by migrants entering or leaving the country, debt forgiveness, transfers relating to sale of fixed assets (tangible assets that firms own and use in production that have a useful life of at least one year), gift taxes, inheritance taxes, and death duties.
TRANSACTIONS IN NO PRODUCED, NON FINANCIAL ASSETS:
consisting of net international sales and purchases of non produced assists e.g. land or rights to natural resources, and net international sales and purchases of intangible assets such as patents, copyrights, brand names or franchises.
Define Financial account.
Measures the net change in foreign ownership of domestic financial assets.
Elements of financial account.
•measure of purchase of long term assets
•purchaser aims to gain lasting interest in a company in another economy.
•Includes buying property, outright purchasing of a business or purchasing stocks or shares in a business.
•measure of stock and bond purchases, which are not directly investment as do not lead to lasting interest in a company.
•Consist of buying and selling of treasury bills and government bonds. •Also includes savings account deposits in this category, although in many countries that comes under the heading of "other investment"
•reserves of gold and foreign currencies which all countries hold which are itemized in official reserve account.
•Movements into and out of this account that insure balance of payments is always zero.
Relationship between accounts.
Current account=Capital account+Financial account+Net errors and omission
(Current account and financial account are interdependent)
Relationship between a deficit in the current account, and the exchange rate.
•downward pressure on the exchange rate of the currency.
•In fixed exchange rate system, exchange rate could have been set too high in the short run can be covered by increases in the capital and financial accounts or by the government using reserve assets to balance the accounts yet will run out ands so the exchange rate will need to be depreciated.
Relationship between a surplus in the current account, and the exchange rate.
Result in upward pressure on the exchange rate of the currency.
Define bilateral trade agreements.
Agreement relating to trade between two countries.
Define multilateral trade agreements.
Agreement relating to trade between multiple countries.
Describe trading blocs.
Group of countries that join together in some form of agreement in order to increase trade between themselves or to gain economic benefits from cooperation on some level.
DIFFERENT TYPES: Preferential trading areas, free trade areas, custom unions, common markets, economic and monetary union.
Describe preferential trading areas.
Gives preferential access to certain products from certain countries, done by reducing but not eliminating tariffs. (e.g. between EU and African Caribbean and Pacific Group of States, enables EU to guarantee regular supplies of raw materials and the ACP to gain tariff preferences and access to special funds).
Describe free trading areas.
Agreement made between countries where countries agree to trade freely among themselves but are able to trade with countries outside of the free trade area in whatever way they wish.
Describe custom unions.
Agreement made between countries where the countries agree to trade freely among themselves and they also agree to adopt common external barriers against any country attempting to import into the customs union. E.g. EU.
Describe common markets.
Customs union with common policies on product regulation, and free movement of goods and services, capital and labour.
Describe economic and monetary unions.
Common market with a common currency and a common central bank. Best example is the Eurozone.
Advantages of a monetary union for its members.
•Exchange rate fluctuations will disappear, eliminating exchange rate uncertainty, increase cross border investment and trade
•Enhance credibility, more stable against speculation
•Business confidence member countries improves as less of perched risk involved in trading among the countries
•Transaction costs are eliminated within the monetary union
•Makes price differences more obvious between countries and should over time lead to pries equalizing across borders
Disadvantages of a monetary union for its members.
•Interest rates decided by central bank, individual countries no longer free to set their own interest rates and so the tool of monetary policy is no longer option. Damaging if one country is experiencing an economic situation that is not being experienced by others
•Without fiscal integration, in the form of a common treasury, harmonized tax rates and a common budget, monetary union will be weak and vulnerable, threatening unions stability
•Individual countries not able to alter their own exchange rates in order to affect the international competitiveness of their exports or the costs of their imports
•Initial costs of converting the individual currencies into one currency are very large. Costs include such things as taking old currencies off the market, printing and distributing the new currency, converting database and software, rewriting all price list and invoice system, re pricing all goods and services.
Advantages of trading blocks.
•Greater size of market with the potential for larger export markets
•Increase competition leading to greater efficiency, more choice, and lower prices for consumers
•Further stimulus for investment due to larger market size and foreign investment might be attracted form outside bloc as a way of getting foot in the door of larger market
•Foster greater political stability and cooperation
•Trade negotiations may be easier in world made up of a number of large trading blocs
Disadvantages of trading blocks.
•Enact discriminatory policies against non-members, damaging to achievements of the multilateral trading negotiations of the WTO
•Small or poor economies will have little bargaining power