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International economic issues - Coggle Diagram
International economic issues
The reasons for international trade
Advantage
Absolute
One country can produce more of a particular product than another country for a given set of resources
Indonesia - Rice
Comparative
A country can produce a product at a lower opportunity cost than another country
Countries may purchase goods from another country which they could produce at a lower cost, as this enables them to concentrate on producing the products where they are even better at.
Limitations
Transport costs may offset comparative advantage
Exchange rate may not lie between the opportunity cost ratios
Governments want to avoid over specialisation
Other governments may impose trade restrictions
Assumptions
There are constant returns
Resources are mobile
Difference in factor endowments
Quality
Quantity
Types of products produced by a country
Cost of production
Benefits or specialisation and free trade
Trading possibility curve
Allows an efficient allocation of resources
Increases world output and employment - living standards rise
International competition keeps prices and costs down, and quality high.
Firms can take advantage of economies of scale
Exports & Imports
Terms of trade
Caused of changes
Favourable movement - rise in export prices relative to import prices
Changes in demand for and supply of exports and imports
Unfavourable movements - fall in export prices relative to import prices
Exchange rate
Changes in the price level
Impact of changes
Prebisch Singer hypotheses - terms of trade move against countries that produce primary products
A favourable movement can be unbeneficial if caused by a rise in cost of production, or beneficial if caused by a rise in demand
Measurement
It is a measure of the ratio of export prices and import prices
Terms of trade index = index of export prices/index of import prices x 100
As it increase, it is a favourable movement and means that fewer exports have to be sold to buy any given quantity of imports
Protectionism
Tools
Export subsidies
Reduce costs for domestic firms - increase their output and lower their price - capture more of the market
Embargoes
Complete ban on a particular product or on trade with a particular country
Import quotas
Limits on imports
Disadvantage consumers as they pay higher prices for fewer products
Excessive administrative burdens
Discourage imports as they have to fill out lengthy forms that are time-consuming - restricts consumer choice
Tariffs
Ad valorem
Specific
Impact
Raise revenue if demand is price inelastic
Protect the domestic industry if demand is price elastic
Exchange control
Limits on the amount of foreign exchange that can be purchased in order to buy imports
Arguments for protectionism
Protect strategic industries
Prevent dumping
Protect declining industries
Improve the balance of payments
Protect infant industries
Improve the terms of trade
Provide protection from cheap labour
Raise revenue
Arguments against protectionism
Reduces the variety of products available
Lowers the size of firms' markets
Reduces international competition
Reduce firms' choice of raw materials and capital goods
Prevents countries from specialising
Cause a trade war
Current account of the balance of payments
Finance account
Part of the balance of payments
Capital account
Part of the balance of payments
Current account
Trade in services
Exports and imports of services - invisibles
Tourism
Banking
Shipping
Insurance
Primary income
Interest
Dividends earned
Employees' compensation
Profits
Trade in goods
Imports
Exports
Known as the visible balance and the merchandise balance
Secondary income
Government transfers
Foreign aid
International organisations
Workers remittances
Balances and imbalances
Deficit
Causes
More debit items
A growing domestic economy
Declining economic activity in a country's trading partners
Structural problems
Consequences
Attract investment into the country, or borrowing money
Consume more products than produced - living beyond its means
Reduce aggregate demand, slow down economic growth and result in umeployment
Surplus
Causes
Increasing economic activity
Structural advantages
A declining domestic economy
Consequences
Countries residents aren't enjoying as high a standard of living as possible
High level of demand combined with additions to the money supply generate inflationary pressure
Balance
Sum of total credit items equals total debit items
Calculations
Money coming in - exports - created credit items +
Money going out - imports - creates debit items -
Exchange rates
Floating exchange rate
How it is determined
Market forces
Financial institutions that buy and sell foreign currency on behalf of private and business customers
Depreciation
A fall in the value of a currency
Caused by an increase in supply and or decrease in demand
Export prices in terms of foreign currencies fall
Import prices rise in terms of the domestic currency
Appreciation
Exports more expensive
Imports cheaper
Increase in demand and decrease in supply
Ride in the value of the currency
Causes of changes
Hot money flows
Foreigners want to open accounts in country's banks to get higher interest rates
Demand for currency increases as foreigners want to purchase shares
Foreigners wish to set up branches in the country
Changes in demand for and supply of a currency
Impact of changes on the economy
Depreciation
Domestic price level
Rise in net exports from a rise in net exports causes inflationary pressure
Resources become increasingly scarce
Imported products are more expensive
Costs of production increase due to costs of importing raw materials
Domestic firms feel less competitive pressure to keep prices low
Domestic economy
Higher aggregate demand
Firms can take on more workers to expand their output
Decrease in cyclical unemployment
National income and real output
Exports cheaper
Imports more expensive
Domestic firms can sell more products
Domestic firms become more internationally competitive
Increase aggregate demand, rising output and national income
Appreciation
Domestic inflation
Inflation rate is lower than otherwise
Lower costs of imported raw materials
Reduce growth of aggregate demand
Shift aggregate supply curve to the right
Rise in exchange rate
Price of imported goods falls
Competitive pressure on domestic firms
Unemployment
Firms don't replace workers who retire
May make some workers redundant
Aggregate demand decreases
National income and real output
Slowdown in economic growth
Imports cheaper
Fall in demand for domestic products
Exports more expensive
Lower output and falling incomes
The price of one currency in return for another currency
Policies to correct the imbalances in the current account of the balance of payments
Stability
Prevents the country getting into international debt
Residents aren;t givin up the opportunity to buy foreign products that they can afford
Governments seek to achieve balance of payments stability
Surplus
Boost aggregate demand
Provide funds to repay external debt
Deficit
Allows the economy to grow by spending on raw materials and capital goods
Allows the economy to consume more goods and services than they are producing
Fiscal policy
Tools to fix deficiit
Increase income tax
Reduce disposable income
Contractionary fiscal policy - reduce demand
Reduce government spending
Reduce imports and put pressure on domestic firms to increase their exports
Reduce demand for goods and services
Tools to reduce surplus
Expansionary fiscal policy - increase demand
Lower income tax and increase government spending on state pensions etc
Increase consumer expenditure
Products may be diverted from the export market to the home market
Work in the short term, but unlikely to be effective in the long run
Monetary policy
Money supply
Reduce the growth in spending on imports
Is difficult to control
Reducing the growth of the money supply
Interest rates
Higher interest rates...
Cut comsuner expenditure
However it may generate inflationary pressure
Reduce demand for imports
Domestic products become more internationally competitive
Reduce inflationary pressure
Downward pressure on the floating exchange rate
Raise a floating exchange rate that could reverse the fall in demand etc
Reduce the interest rate...
To correct a surplus
Increase consumer expenditure by using expansionary monetary policy
Cut interest rate
Raise money supply
Effectiveness
No long term effect on the imbalance of the current account
They do not tackle the structural weaknesses such as low productivity
Supply side policy
Reduce deficit
Make domestic products more competitive
Deregulation and privatisation
Increasing spending on training and education
Attract foreign MNCs
Contribute to countries exports
Makoe doesmstic markets more attractive to invest in
Increase competitive pressure to keep costs and prices low and improve quanity and more responsive to changes in consumer demand
Trade union reform
Labour force work with more flexibility
More responsive to changes in demand
Unlikely to be a quick way of correcting imbalances, and is not designed to reduce a current account surplus.
Protectionist policy
Can encourage domestic consumers and firms to switch to buying domestic products
Works effectively when high quality substitutes produced by domestic firms are available
This is not an option against trading partners in a trading bloc
This can provoke retaliation
IT can also reduce the pressure on domestic firms to become more effective