Edexcel Economics 4.1

Globalisation

The process by which economies and cultures have been drawn deeper together and have become more inter-connected through global networks of trade, capital flows and the rapid spread of technology.

Factors contributing to globalisation (4)

1. Containerisation - The real prices and costs of ocean and air shipping have come down due to the widespread use of standardised containers and reaping of economies of scale in freight industries.

2. Technological advances - Cuts the cost of transmitting and communicating information.

3. Less protectionism - less tariffs allowing more trade flows.

4. Some countries have cut corporate taxes to attract inflows of foreign direct investment.

Transnational corporations (TNCs)

Companies that operate in at least two countries, with a headquarters in one country but with business operations usually in a number of others. They manufacture in countries with relatively lower unit labour costs to increase profits and returns for shareholders.

Advantages of globalisation (4)

1. Globalisation encourages both producers and consumers to have benefits from the deeper division of labour and use economies of scale.

2. More competitive markets through trade incentivises businesses to seek cost-reducing innovations.

3. Trade can help drive faster economic growth which leads to higher income per head.

4. Freer movement of labour between countries can help relieve labour shortages.

Drawbacks from globalisation (5)

1. Rising inequality, the gains from globalisation will be uneven.

2. Threats to global commons such as damage to ecosystems and water scarcity.

3. External shocks in one region can rapidly spread to other as the world is more inter-connected.

4. Trade imbalances lead to protectionist tensions and wider use of tariffs and quotas.

5. May be structural unemployment as manufacturing is outsourced to other countries.

External shocks

Events that come from outside a domestic economic system.

Negative external shocks create instability and can lead to periods of weaker economic growth. E.g. extreme weather events, Covid-19.

Absolute advantage

When a country can supply a product using fewer resources than another nation.If a country using the same factors can produce more of a product then it has absolute advantage.

Comparative advantage

Countries can benefit from trade by specialising in goods or services they can produce at a lower opportunity cost compared to others, even if they do not have an absolute advantage in producing any good.

Gains from trade (4)

1. Deeper specialisation and benefits from economies of scale

2. Increased market competition and product quality for consumers

3. Reduced prices for sonumsers from market contestability

4. Trade can lead to a better use of scarce resources

Allocative efficiency

Competition from lower-cost import sources drives market prices down closer to marginal cost and then reduces the level of supernormal profits.

Productive efficiency

Specialising and selling in larger markets encourages increasing returns to scale.

Dynamic efficiency

Economies open to trade may see more innovative businesses which invest more in research and development and also in the human capital of their workforce to help raise labour productivity

X-inefficiency

Intense competition in markets provides a disciple on businesses to keep their unit costs under control to remain price competitive and profitable.

Risks of specialisation and trade (2)

1. Volatile global prices affecting profits for producers and tax revenue for the government.

2. Rising structural unemployment as the pattern of demand changes

Pattern of trade

How a country's imports and exports are distributed across different goods, services, and trading partners.

Terms of trade (ToT)

Measures the relative prices of a country’s exports compared to the prices of imported goods and services.

Terms of Trade (ToT) index = (price index for exports) / (price index for imports) x 100

Factors influencing terms of trade

1. Global prices for raw materials and components

2. The exchange rate

3. Tariffs and other trade barriers such as quotas

4. Domestic and global inflation rates

Free trade area (FTA)

Where there are no import tariffs or quotas on products from one country entering another.

Bilateral trading agreement

The exchange of goods and services between two economies.There will be reduced or no import tariffs, quotas, export restraints and other trade barriers.

Customs union

Abolish tariffs and quotas between member nations to encourage free movement of goods and services. Adopt a common external tariff on imports from non-member countries.

Common markets

A deeper integration between participating countries countries by including free movement of labour across borders.

Monetary union

A form of integration past a single market, there is a single currency between members.

Advantages from single currency (3)

1. Reduced currency risk so it is easier to borrow money.

2. Membership of single currency will have inward investment from tourism.

3. A shared currency eliminates the conversion price when trading.

Risks from having a single currency

1. A country’s central bank loses the freedom to set monetary policy interest rates to meet macroeconomic objectives.

2. You can’t choose to have a managed depreciation to help improve competitiveness overseas.

3. There are lots of adjustment costs when switching currencies especially for retailers.

Main reasons for protectionism

1. Infant industry argument - protecting emerging economies until they have achieved economies of scale.

2. Sunset industry argument - Use tariffs to slow the decline of old sectors and limit structural unemployment.

3. Raise tax revenue from tariffs.

4. Preserve jobs in key industries

5. Can be retaliatory to another country’s policies.

Import dumping

Selling goods abroad below the cost of production or below the domestic selling price. It is allowed unless it harms domestic industries in the importing country.

Import quota

A physical limit on the quantity of a good that can imported into a country.

Import tariff

A tax on imports that may be ad valorem or a specific tax.

Impact of a quota on different stakeholders

Domestic producers - benefit from the cap on imports by increasing the market price and making it more profitable to be in the market.

Consumers - They are likely to face a higher price in the market because of the limited on imports products, less competition may also decrease quality.

The government - Improved external balance from the reduction in imports and an expansion of GDP from increased domestic production.

Domestic subsidy

Any form of government financial help to domestic businesses. They help firms to lower their costs and become more competitive.

Current account (3)

1. Net balance of goods and services

2. Net primary income (interest, profits, dividends)

3. Net secondary income (overseas and military aid and remittances

Capital account (3)

1. Sale/transfer of patents, copyrights, franchises, leases and other transferable contracts

2. Debt forgiveness/cancellation

3. Capital transfers of ownership of fixed assets.

Financial account

1. Net balance of foreign direct investment flows

2. Net balance of portfolio investment flows

3. Balance of banking flows (hot money)

4. Changes to the value of reserves of gold and foreign currency

Foreign direct investment (FDI)

Investment from one country to another that involves establishing operations or acquiring tangible assets, including stakes in other businesses.

Portfolio investment flows

This is when people/businesses from one country buy shares or other securities such as bonds in other nations.

Key causes of a current account deficit

• Poor price and non-price competitiveness

• Strong exchange rate affecting demand for exports and imports

• Recession in one or more major

• Volatile global prices

• Strong domestic growth

Expenditure switching policy

Policies that are designed to change the relative price of imports and exports.

Expenditure switching policy examples (3)

• Devaluation of the exchange rate - reduces relative price of exports and makes imports more expensive.

• Import tariffs - increases the price of imports and makes domestic output more price competitive.

• Low rate of inflation - Keeps price level under control and makes exports more competitive.

Expenditure reducing policies

Policies that are designed to lower real incomes and AD and thereby cut demand for imports.

Expenditure reducing policy examples (3)

• Increase in income taxes - Reduces real disposable incomes, causing falling demand for imports

• Cuts in real government spending - lowers aggregate demand, firms may look to export their spare capacity.

• Low rate of inflation - Keeps general price level under control and makes exports more competitive.

Exchange rate

The rate at which one country’s currency can be exchanged for other currencies in the foreign exchange market.

Exchange rate systems (3)

• Free floating currency - Where the external value of a currency depends fully on market forces of supply and demand.

• Managed floating currency - When the central bank may intervene in the foreign exchange markets to affect the value of a currency to meet macroeconomic objectives.

• Fixed exchange rate system - A monetary regime where a country’s government or central bank ties the official value of its domestic currency to another currency or a basket of goods.

Unit labour costs

Labour costs per unit of output.

Unit labour costs = total labour costs / total output

Benefits of international competitiveness (4)

• Improved living standards

• Stronger trade performance from an increase in export sales

• Employment creation

• Higher government tax revenue

Problems of international competitiveness (4)

• Trade surpluses might invite a protectionist response

• Growing income inequality

• Might cause an exchange rate depreciation

• Possible risks of demand pull inflation