Trade, Capital Flows and Exchange Rates Flashcards

Flashcards covering trade, capital flows, and exchange rates from an economics lecture.

What are the main topics covered in this lecture on trade?

The reasons for trade, absolute and comparative advantage, critical assumptions, and limits to trade.

What is the basis for gains from trade through specialization?

Countries can benefit if they specialize and produce goods at which they can exploit their skills, resources, and economies of scale.

What defines absolute advantage in trade?

A country's ability to produce a particular good using fewer resources than another country.

What is the definition of terms of trade?

The average price of exports divided by the average price of imports (PX/PM) (base year index of 100).

What are the limits to specialization and trade?

Increasing opportunity costs from increasing specialization, diminishing marginal productivity of factors, and mobility of factors of production.

What are some other reasons for gains from trade beyond comparative advantage?

Decreasing costs, differences in demand, increased competition, trade as an ‘engine of growth,’ knowledge drivers, and non-economic advantages.

What are the arguments for restricting trade?

Infant industry argument, senile industries that have run down, changing comparative advantage, to prevent dumping, to prevent other trade that is going on using unfair practices.

List methods of restricting trade.

Tariffs, quotas, administrative barriers, import licenses, embargoes, subsidies to domestic producers, government procurement processes, and exchange controls.

What are the components of the current account in the balance of payments?

Trade in goods, trade in services, income flows (interest and dividend income, net), and current transfers (or unilateral transfers).

What does the capital account include?

Payments in and out for past investments and forgiveness of debt.

What is included in the financial account?

Investment – direct and portfolio, flows to and from reserves of the central bank.

What is the rate of exchange?

The rate at which one currency trades for another.

What determines a floating exchange rate?

A floating exchange rate is a rate determined by the market forces – supply and demand.

What are the shifts in currency demand and supply?

Differences in interest rates, differences in inflation rates, rise in domestic incomes relative to those abroad, relative investment prospects abroad improve, and speculation.

How can a government reduce short-term exchange rate fluctuations?

Using reserves, borrowing from abroad in FX, and changes in interest rates.

How can governments maintain a fixed rate of exchange over the longer term?

Deflation/reflation actual legal controls on imports or foreign exchange dealing, and supply side policies.

What are the advantages of maintaining a fixed exchange rate?

Certainty helps investment and long-term trade deals, no volatility from speculation, takes away a method for the government to behave irresponsibly.

What are some of the advantages of a floating exchange rate system?

Automatic adjustment to a free floating price equilibrium, no crises as reserves fall, automatic adjustment to external shocks, governments can use its policies (fiscal and monetary) to control the domestic economic variables

What theory implies the nominal exchange rate between two countries will come to rest when the price of a basket of everything, costs the same in both countries when translated at the nominal exchange rate?

Purchasing Power Parity Theory