Unit 4: The Global Economy

Free trade

is the absence of government intervention of any kind in international trade, so that trade takes place without any restrictions (barriers) between individuals, firms or governments of different countries.

Tariffs

also known as custom duties are taxes on imported goods.

Before the tariff: Domestic production =

Pw x Qs

Before the tariff: Domestic consumption =

Pw x Qd

Before the tariff: Foreign production =

(Qd - Qs) x Pw

After the tariff: Domestic production =

Pw + tariff x Qs1

After the tariff: Domestic consumption =

Pw + tariff x Qd1

After the tariff: Foreign production =

(Qd1 - Qs1) x Pw

After the tariff: Government revenue =

(Qd1 - Qs1) x tarif

Import quota

a legal limit to the quantity of a good that can be imported in a particular time period.

Quota revenue =

(Qd1 - Qs1) x (Pq - Pw)

Production subsidies

payments per unit of output granted by the government to domestic firms that compete with imports.

after subisidy: Government expenditure =

(Psub - pw) x Qs1

Export subsidies

a per-unit amount paid by the government to producers to increase exports.

after export subsidy : Government expenditure =

(Qs1 - Qd1) x Per-unit sub

Administrative barriers

are administrative obstacles that importers must overcome to get their goods into a country

Infant industry

allows domestic producers to gain efficiencies in production to be able to compete with more efficient firms abroad.

National security

industries like airlines, minerals, and chemical production can be seen as essential for national security and therefore worth protecting.

Health and safety

countries may be concerned that imported goods don’t meet their standards.

Diversification

protection can help the economically least developed countries protect domestic industries that can help diversify the economy away from the primary sector.

Anti-dumping

dumping is the act of selling a good below its production cost. Dumping is illegal according to international agreements but is extremely difficult to prove and therefore used as an excuse to impose trade protections.

Unfair competition forms

○ Dumping

○ Production/export subsidies

○ Administrative barriers

○ Undervalued currencies

○ Violation of international property right

Economic integration

economic cooperation between countries and coordination of their economic policies and economic links between them.

Preferential trade agreement (PTA)

an agreement between two or more countries to lower trade barriers on particular goods in trade with each other.

Bilateral trade agreement

an agreement between two countries.

Multilateral trade agreement

an agreement between many countries.

Regional trade agreement

an agreement between countries in a specific geographical location.

Trading bloc

a group of countries that have agreed to reduce tariffs or other barriers to trade with the purpose of having free or freer trade and cooperation between them.

Free trade area (FTA)

a group of countries that agree to gradually eliminate trade barriers between themselves. This is the most common type of integration.

Customs unions

have all of the characteristics of FTAs with the addition of a common trade policy with all non-member countries. Individual countries cannot make their own trade agreements with non-member countries.

Common market

has all of the characteristics of a FTA and customs union with the addition of removing all trade barriers between them and eliminating barriers on movement of any factors of production.

Monetary union

involves the characteristics of a common market with the addition of a common currency and common central bank.

World Trade Organization (WTO)

an organization that aims to liberalize trade across the world.

Foreign exchange

refers to foreign national currencies.

Exchange rate

the value of one country’s currency in terms of another.

Appreciation

is the increase in the value of one currency in terms of another in a free floating exchange rate system.

Depreciation

a fall in the value of a currency in terms of another in a free floating exchange rate system.

Causes of changes in ER - demand

Exports and factors affecting exports:

● Foreign demand for exports of goods.

● Foreign demand for exports of services.

● Rate of relative inflation to other countries.

● Relative growth rates.

Investment and factors affecting investment:

● Inward FDI (foreign direct investment) and portfolio investment (financial investments).

● Relative interest rates.

Other factors:

● Inward inflow of remittances.

● Speculation that the currency will appreciate.

● Central bank intervention to buy more of the currency (not part of free floating).

Causes of changes in ER - supply

Imports and factors affecting imports:

● Domestic demand for imports of goods.

● Domestic demand for imports of services.

● Rate of relative inflation to other countries.

● Relative growth rates.

Investment and factors affecting investment:

● Outward FDI and portfolio investment.

● Relative interest rates.

Other factors affecting currency supply:

● Outward flow of remittances.

● Speculation that the currency will depreciate.

● Central bank intervention to sell more of the currency (not free floating).

If you were given information that 1€ is equal to $1.16 USD you could use this data to calculate how much $1 is in terms of euros.

1 dollar = 1/1.16 euro = 0.86206897 euro - which rounds to $1 = 0.86€

f you owned a ski shop in Austria but imported your skis from the US for $1,200 a pair and you ordered 50 pairs how much would the skis cost in euros if we used the exchange rate from above?

$1,200 x 50 = $60,000 - then to find the price in euro you multiply $60,000 by 0.86€ = 51,600€

Revaluation

the increase in value of one currency in terms of another in a fixed or managed exchange rate system.

Devaluation

the decrease in value of one currency in terms of another in a fixed or managed exchange rate system.

Overvalued currency

a currency that has a value that is too high relative to its free market value

Undervalued currency

a currency that has a value that is too low relative to its free market value.

Fixed exchange rate system

exchange rates are fixed by the central bank of each country at a particular level (or narrow range), and are not permitted to change freely in response to changes in supply or demand.

Managed exchange rate (managed float)

when an exchange is allowed to float within certain upper and lower limits.

Pegged exchange rate

when an exchange rate is allowed to float within a certain range of the dollar or euro.

Balance of payments

a record (usually a year) of all transactions between a country’s residents and all other countries

Credits

all payments received from other countries.

Debits

all payments paid to other countries.

Income

the inflow of all rents, interest, and profits from abroad.

Current transfers

the inflow of transfers such as gifts, remittances (money sent home to relatives), foreign aid, and pensions.

Foreign direct investment (FDI)

when MNCs invest into the productive capacity of domestic firms.

Portfolio investment

buying of financial investments like stocks and bonds.

Reserve assets

the central bank buying and selling currency. If they buy their own currency it will count as a credit if they add more reserve currencies it counts as a debit.

Official borrowing

money borrowed counts as a credit while money loaned counts as a debit.

BoP =

Current Account + Capital Account + Financial Account = 0

current account

tracks the difference between a country's total exports and total imports (including goods, services, and transfers)

trade deficit

Imports exceed exports

(Net Exports is negative)

Trade Surplus

Exports exceed Imports

(Net Exports is positive)

financial capital account

tracks the ownership of assets held by foreigners and ownership of foreign assets

Positive Net Capital OUTFLOW

a country invests outside more than other countries invest inside it (Net Capital INFLOW is negative)

Net Capital OUTFLOW is negative

a country has a current account deficit, they will have a capital account surplus