Global Economics Flashcards

Benefits of International Trade

• Lower prices and greater choice for consumers.
• Ability of producers to benefit from Economies of Scale.
• Ability of producers to acquire needed resources.
• More efficient allocation of resources.
• Increased competition.
• Source of foreign exchange.
• Increased interdependence and reduced chance of hostilities among trading partners.
• Exports can lead to economic growth.

Absolute and Comparative Advantage

• Absolute advantage: A country can produce more of a good or service with the same amount of resources, resulting in a lower unit cost of production.
• Comparative advantage: A country can produce a good or service at a lower relative opportunity cost than other countries.

Sources of Comparative Advantage

1. Differences in factor endowments
   • Access to good farmland
   • Suitable climate for agriculture
   • Beautiful scenery for tourism
   • Supply of mineral/oil deposits
   • Plentiful supply of cheap, unskilled labor
   • Access to forestry or fishing
2. Level of technology available

Globalisation

• How has globalisation transformed the way goods and services are produced and traded across borders?
• What is the role of FOREX in globalisation?
• In what ways does globalisation facilitate the spread of ideas, cultures, and values?
• What role does technology play in promoting globalisation?

Debate: Is Globalisation Always Beneficial?

• Consider people, planet, profit.

Protectionism

• Methods of protectionism
• Reasons for and consequences of protectionism

Free Trade

• Under free trade, citizens can import goods/services at a price of $P_w$, lower than the domestic price $P$.
• Domestic output is at $Q<em>1$, and imports are $Q</em>2 - Q<em>1$ at the price of $P</em>w$.
• Governments implement protectionist policies to reduce imports.

International Specialisation and Free Trade

• Offer numerous benefits regarding optimal allocation of resources on a world scale.
• Most countries do not pursue perfectly free trade due to associated consequences and engage in some form of restricted trade.

Methods of Protectionism

1. Tariffs
2. Subsidies to domestic producers
3. Quotas
4. Trade embargoes
5. Rules and regulations
6. Nationalistic Campaigns

Tariffs (Customs Duties)

• Definition: A tax imposed on imported goods/services.
• Tariffs work best when demand for the import is price elastic (domestic substitutes exist).
• Tariffs provide tax revenue for the government.

Tariffs Impact on Price and Quantity

• Tariffs raise the price of imported goods/services from $P<em>1$ to $P</em>2$, shifting the world supply curve upwards from $S<em>w$ to $S</em>w + \text{Tariff}$.
• Domestic suppliers are willing to supply more at $Q_4$.
• As prices increase to $P<em>2$, consumers decrease demand to $Q</em>3$.
• Imports decrease from $Q<em>1Q</em>2$ to $Q<em>4Q</em>3$.

Impact of Tariffs

• More goods are produced by less efficient domestic firms, increasing their revenue.
• This creates more employment in these industries but could negatively impact jobs in downstream industries due to increased costs of production.
• Less of the good will be supplied by foreign firms.
• The government collects import tax revenue.
• Domestic consumers pay higher prices and have less choice.

Domestic Subsidies

• Definition: A grant/payment by the government to a domestic firm per unit of output.
• Lowers costs of production for domestic producers, making them more price competitive relative to foreign firms, shifting the domestic supply curve down/right, allowing firms to increase supply.

Impact of Domestic Subsidies on Output

• Before the subsidy, domestic output was at $Q<em>1$ and imports were $Q</em>1Q<em>2$ at the price of $P</em>w$.
• As the subsidy lowers costs of production, domestic firms increase supply from $S<em>d$ to $S</em>{ds}$ and now supply $Q_3$ amount of goods.
• This means imports decrease to $Q<em>3Q</em>2$.
• Price does not change for consumers, so demand remains at $Q_2$.

Impact of Domestic Subsidies

• More of the good will be produced by less efficient domestic firms (0$Q<em>1$ to 0$Q</em>3$), and their revenues increase from area 0$P<em>wXQ</em>1$ to 0$P<em>w + \text{sub}WQ</em>3$.
• Less of the good will be supplied by foreign firms ($Q<em>1Q</em>2$ to $Q<em>3Q</em>2$) & revenue decreases from $Q<em>1XYQ</em>2$ to $Q<em>3ZYQ</em>2$.
• There will be an opportunity cost for the government; tax revenues used to pay for the subsidy are no longer available to support other government programs. Spending is area $P<em>wZWP</em>w + \text{sub}$
• There will be more jobs available domestically.

Quotas

• Definition: A physical limit imposed on the quantity of a good that can be imported into a country.
• Before the quota, $Q<em>2$ amounts of goods are produced domestically, and $Q</em>2Q_1$ amounts of goods are imported.
• When the government places a quota, they limit the number of imports to $Q<em>2Q</em>3$.

Quotas Continued

• Due to a limit on imports, there is excess demand or a shortage of goods in the market of $Q<em>3Q</em>1$ at the price of $P_1$.
• This results in upward pressure on the price from $P<em>1$ to $P</em>2$. As prices rise, quantity demanded decreases to $Q_4$.
• As prices rise, it is more profitable for domestic firms to produce, so they now also produce $Q<em>3Q</em>4$ amount of goods.
• No more goods can be imported due to the quota.
• Domestic producers now supply 0$Q<em>2 + Q</em>3Q<em>4$ amount of goods, and imports are $Q</em>2Q_3$.

Impact of Quotas

• Domestic consumers pay a higher price for the good and have less choice.
• More of the good is produced by domestic firms, allowing these firms to make higher revenues.
• Foreign producers can export less of their good into the country.

Trade Embargoes

• A trade embargo is an extreme form of quota.
• It enforces a legal ban on trade in a particular product from a given country.
• Often imposed as some form of political punishment (e.g., the US embargo on goods/services from Cuba).

Rules and Regulations

• Excessive regulations increase 'red tape' (bureaucracy), making it more time-consuming, challenging, and costly to import goods.
• This disincentivizes foreign firms from exporting their goods into that country, serving as a form of protectionism.

Nationalistic Campaigns

• Government-sponsored campaigns designed to encourage people to buy domestically produced goods rather than foreign substitutes.
• These can work in the short run but can be costly to maintain.

Arguments in Favour of Protectionism

1. Protecting domestic employment.
2. Protecting infant (sunrise) industries.
3. Protecting declining (sunset) industries.
4. Correcting a balance of payments deficit.
5. Protecting strategic industries (like agriculture or weapons production).
6. Protecting industries from unfair foreign competition (dumping).
7. Ensuring that goods entering the country meet health and safety standards.
8. Raising revenues for a government through the use of tariffs.

Arguments Against Protectionism

1. World output and standards of living can decline.
2. Global resources will not be put to best use without specialisation.
3. Domestic firms may become inefficient.
4. Firms cannot fully exploit economies of scale.
5. Trade barriers increase the cost of trading.
6. Other countries may retaliate.
7. Consumers have a smaller range of goods to choose from.

Economic Integration

• Definition: Trading blocs are agreements between countries intended to free up trade.
• This can encourage trade among member countries, but they can also collectively use protectionist policies against external countries.

Stages of Economic Integration

1. Preferential trade area
2. Free trade area
3. Customs union
4. Common markets
5. Economic & monetary union
6. Complete economic integration

Preferential Trade Area

• An agreement between two or more countries to lower trade barriers (not fully eliminate) between each other on particular goods/services.
• Allows members easier access to markets of other members for selected products or materials.
• Agreements can be Bilateral, Multilateral, or Regional.

Free Trade Area

• An FTA is an agreement between countries to slowly eliminate trade barriers and ultimately trade freely among themselves.
• They can still pursue their own trade policies towards other non-member countries.

Customs Unions

• Countries eliminate trade barriers and trade freely between members.
• Member countries adopt common policies towards all non-member countries.
• All member countries act as a group in trade negotiations and agreements with non-members.

Common Markets

• Member countries trade freely, have common policies towards non-members, and eliminate all restrictions on the movement of factors of production.
• Factors of production (labor and capital) can cross borders freely.

Economic & Monetary Union

• Member countries of a common market adopt a common currency and central bank responsible for monetary policy.
• They still have control over their fiscal policy.

Complete Economic Integration

• Member countries have no control of economic policy.
• Decisions on monetary and fiscal policies are fully integrated.

Benefits of Economic Integration (Trade Creation)

• When a country joins the EU, trade barriers are removed.
• The price of imports decreases from $P<em>2$ to $P</em>1$, so consumers pay a lower price and demand more at $Q_4$.
• Imports increase from $Q<em>2Q</em>3$ to $Q<em>1Q</em>4$.
• Domestic output decreases from $Q<em>2$ to $Q</em>1$.
• $Q<em>1Q</em>2$ amount of goods is now produced by more efficient foreign producers, improving world efficiency.

WTO (World Trade Organization)

• The only global international organization dealing with the rules of trade between nations.
• Goal is to help producers of goods and services, exporters, and importers conduct their business.

History of the WTO

• Born out of negotiations in 1948.
• Current work comes from the 1986–94 Uruguay Round and earlier negotiations under the General Agreement on Tariffs and Trade (GATT).
• Currently hosting new negotiations under the ‘Doha Development Agenda’ launched in 2001.

WTO Membership

• There are currently 21 observer nations and 164 member nations of the World Trade Organisation.
• 95% of countries in the world are either member nations or observers.
• There are 650 paid employees of the WTO.

Functions of the WTO

• Administering WTO trade agreements
• Forum for trade negotiations
• Handling trade disputes
• Monitoring national trade policies
• Technical assistance and training for developing countries
• Cooperation with other international organizations

Objectives of the WTO

1. Enhancing the standard of living and income, promoting full employment, expanding production, trade, and optimum utilization of world’s resources.
2. Introducing sustainable development.
3. Ensuring that developing countries secure a better share in world trade.

Exchange Rates

• An exchange rate is the value, or price of one nation’s currency expressed in terms of another currency.

Reserve Currency

• A reserve currency is a foreign currency that is held in significant quantities by central banks as part of their foreign exchange reserves.

Exchange Rate System

• Establishes the way in which the exchange rate is determined.
• Crucial policy decision with significant impacts on the flexibility of the exchange rate.

Floating Exchange Rates

• The rate of exchange is determined by supply and demand on the foreign exchange market (FOREX).
• The government does not intervene to influence the value of a currency.
• If there is an increase in demand or decrease in supply of a currency, it will appreciate, and vice versa, it will depreciate.

Appreciation / Depreciation

• If one currency loses value relative to another (its exchange rate decreases), the currency has depreciated.
• If one currency gains value relative to another (its exchange rate increases), the currency has appreciated.

Reasons for EU citizens demanding the US$

• An increase in US interest rates.
• An increase in demand for US exports.
• Investment opportunities in the US improve.
• Speculation whether the US$ will appreciate in the future.

Reasons for the US supplying the US$

• Interest rates are higher in the EU than US.
• An increase in demand for EU exports.
• Investment opportunities in the EU improve.
• Speculation whether the Euro will appreciate in the future.

Fixed Exchange Rate

• The value of the currency is fixed or pegged to the value of another currency, or to the average value of a group of currencies.
• The government must intervene to maintain the value at the pegged rate.

Maintaining a Fixed ER

• The central bank uses exchange rate policy (buying/selling of currencies that it keeps as reserves) to maintain the currency value at the pegged rate.

Revaluation / Devaluation

• Devaluation: the pegged rate is reduced.
• Revaluation: the government adjusts the pegged rate so that the currency is revalued upward.

Managed Exchange Rate

• Exchange rates are allowed to float to their market levels over long periods of time.
• Central banks intervene to stabilise them over the short term.

Advantages of a High ER

• Production materials & costs of final imported goods will be lower.
• Each unit of domestic currency can buy more foreign currency so more imported G/S can be bought.
• International comp will force domestic producers to be more efficient.

Disadvantages of a High ER

• Unemployment may rise in the export industry due to higher prices on the world market.
  • There will be a fall in demand for domestic G/S as imports could be cheaper.

Advantages of a Low ER

• Employment will be created in the export industries due to increase in international competitiveness.
  Expensive imports encourage the consumption of domestic G/S. Domestic firms thrive.

Disadvantages of a Low ER

• Imported raw materials and components will be more expensive creating cost-push inflation.

Economic Development and Inequality

• Economic Development: A broad measure of economic well-being that takes into account factors beyond monetary income.
• Economic Inequality: Is the unequal distribution of income and opportunity between different groups in society.

International Barriers to Economic Development

1. Geographical Barriers
2. Protectionism by developed countries
3. Over-specialization
4. Technical Barriers (regulations & standards)

Policies to Promote International Trade to Improve Economic Development & Reduce Inequalities

1. Economic Diversification
2. Foreign Direct Investment (FDI)
3. Import Substitution
4. Export Promotion
5. Trade Liberalisation
6. Economic Integration

Economic Diversification

When achieved, economies are not simply reliant on the production and sale of one type of good. Instead their risks are spreaded producing a variety of goods, ideally in different sectors

• Advantages: can reduce vulnerability and spread risk. Can reduce the impact of random shocks and changes in demand or supply.
• Disadvantages: Less specialisation, which results in reduced efficiency. Higher costs of production due to moving away from comparative advantage, and less effective use of limited resources

Foreign Direct Investment (FDI)

• FDI is long-term investment by private multinational corporations (MNCs) in countries overseas.

Advantages of FDI

1. Provide a flow of capital into a developing country.
2. This capital investment helps to increase productive capacity in the economy.
3. MNC’s provide employment.
4. MNC’s may help improve infrastructure in the economy (i.e. roads, ports).
5. Training provided may MNC’s may improve the skills of the workforce.
6. MNC’s can help diversify the economy away from relying on primary products and agricultural products which are often subject to volatile prices and supply shocks.

Disadvantages of FDI

1. Wage rates offered may be very low.
2. LDC’s may have fewer rules about pollution or human rights. These loose rules might also lead to exploitation.
3. LDC’s may operate unsustainably and deplete natural resources or create negative externalities.

Import Substitution Industrialisation (ISI)

• This is an inward-oriented strategy with a focus on producing goods domestically rather than importing them.

Export Promotion (Export-led Growth)

• This is an outward-oriented growth strategy focused on increasing exports and export revenue.
• The country concentrates on producing and exporting products for which it has a comparative advantage.

Trade Liberalisation

• This involves the removal, or at least reduction, of trade barriers that block the free trade of goods and services.
• The belief is that this policy will increase world trade and enable developing countries to concentrate on the production of goods for which they have a comparative advantage.

Trade Agreements

• In the absence of progress with multilateral trade agreements or at the WTO level, nations may choose to start locally with regional trade agreements.