Flashcards · 9708 · A Level Topic 11

International economic issues (A Level) flashcards

37 cards on A Level Topic 11, subtopics 11.1 to 11.6. Pick a subtopic or study them all.

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11.1 Policies to correct disequilibrium in the balance of payments

The components of the balance of payments: Current account (goods, services, primary and secondary income); capital account (capital transfers such as debt forgiveness, non-produced non-financial assets); financial account (direct, portfolio and other investment, reserve assets); and net errors and omissions as a balancing item. The total is zero.
Direct investment, portfolio investment and hot money: Direct investment: a lasting stake in a foreign business, e.g. a new plant; stable and adds capacity. Portfolio investment: shares and bonds without control; more mobile. Hot money: short-term funds that move for interest rate or exchange rate gains.
Current account −11 and capital account +1, with zero errors and omissions. What must the financial account balance be?: +10, because −11 + 1 + 10 = 0 (with financial inflows counted as positive). The financial account shows how a current account deficit is funded.
Expenditure-reducing versus expenditure-switching policies for a current account deficit: Reducing: cut total spending, including on imports (contractionary fiscal policy, higher interest rates); output and jobs fall; suits a deficit from excess demand. Switching: move spending from imports to home goods (depreciation, devaluation, tariffs, quotas); suits weak competitiveness.
Why might higher interest rates improve the financial account but not the current account?: Higher rates attract hot money, raising demand for the currency. The higher exchange rate makes exports dearer and imports cheaper, which works against the fall in import spending from lower incomes.
A currency falls 5%. Export PED 1.0, import PED 0.8; exports 100, imports 120. What happens to the trade deficit?: Exports rise to about 105. Imports become 120 × 1.05 × 0.96 = 121.0 in home currency. The deficit narrows from 20 to about 16, because the elasticities sum to more than 1.

11.2 Exchange rates

Nominal, real and trade-weighted exchange rates: Nominal: the price of one currency in another, as quoted. Real: nominal rate adjusted for relative price levels (nominal × home price index ÷ foreign price index). Trade-weighted: an index against a basket of partner currencies, weighted by trade shares.
The nominal rate rises from 2.50 to 2.60 while home prices rise 1% and the partner's 4%. What happens to the real rate?: Real rate = 2.60 × 101 ÷ 104 = 2.525, a rise of 1.0%, not 4%. The nominal rise overstates the real rise because the partner's prices rose faster.
Fixed, managed and floating exchange rate systems: Fixed (pegged): official rate set and defended with reserves and interest rates; certainty, but risk of speculative attack. Managed: mainly market-set, with intervention to smooth or steer it. Floating: set by the market; interest rates are free for domestic aims, but the rate can be volatile.
Devaluation and revaluation: Devaluation: a deliberate cut in the official value of a fixed rate. Revaluation: a deliberate rise. (Depreciation and appreciation are market moves under a floating rate.)
Marshall-Lerner condition: A fall in the exchange rate improves the trade balance if PEDx + PEDm > 1 (absolute values). Each elasticity need not exceed 1; only their sum must.
J curve: describe the shape and explain it: Balance on the vertical axis, time on the horizontal. After a fall in the currency the balance first worsens, because volumes barely move while import prices rise. As elasticities rise over time and their sum passes 1, the balance crosses zero and improves.
Demand for a pegged currency D = 400 − 100r, supply S = 100r − 60, peg 2.50. What must the central bank do?: Equilibrium is 2.30, below the peg. At 2.50, demand 150 and supply 190, an excess supply of 40. The central bank must buy 40 of its currency, costing 40 × 2.50 = 100 of reserves.

11.3 Economic development

Economic growth versus economic development: Growth: a rise in real output over time. Development: a rise in living standards and capabilities: health, education, lower poverty and a changing economic structure.
Purchasing power parity (PPP): The exchange rate at which a basket of goods costs the same in two currencies. A basket costing 90 cu in A and 600 units in C gives a PPP rate of 6.67. An income of 24,000 units is 3,600 cu at PPP, against 2,400 cu at a market rate of 10, because prices are lower in C.
Human Development Index (HDI): A composite index of health (life expectancy), education (schooling) and standard of living (income per head, in logarithms). Each dimension is indexed 0 to 1 and combined by a geometric mean. Criticisms: equal weights, ignores inequality and the environment.
Measure of Economic Welfare (MEW) and Multidimensional Poverty Index (MPI): MEW: GDP adjusted for non-market output, leisure, regrettable necessities and externalities (e.g. 200 + 25 + 18 − 14 − 11 = 218). MPI: poverty as overlapping deprivations; MPI = H × A (headcount × intensity), e.g. 30% × 45% = 0.135.
Limitations of real GDP per capita as a measure of living standards: It is an average, ignoring distribution; misses informal, subsistence and unpaid output and leisure; ignores externalities and resource depletion; does not show the composition of output; and is distorted by exchange rates and data quality.
Kuznets curve: An inverted U between income per head and inequality: inequality rises as industrialisation widens urban-rural and skill gaps, then falls as education spreads and taxes and welfare expand. It is not a law; policy can bend it and data fit only partly.

11.4 Characteristics of countries at different levels of development

Birth rate, death rate and natural increase: population 500,000, births 9,000, deaths 6,000: Birth rate = 9,000 ÷ 500,000 × 1,000 = 18.0 per 1,000. Death rate = 12.0. Natural increase = 6.0 per 1,000, or 0.6% (3,000 people). Population growth = natural increase + net migration.
Infant mortality rate: Deaths under age one ÷ live births × 1,000. Note the base is live births, not the whole population (unlike the birth rate).
Optimum population: The population giving the highest output per head with given resources, capital and technology. Example: output per head 15, 18, 19, 16 at 10, 20, 30, 40 million, so the optimum is 30 million. It moves with technology and capital.
Lorenz curve and Gini coefficient: Lorenz curve: cumulative income share against cumulative population share, poorest first; the 45° line is equality. Gini = A ÷ (A + B), where A is the area between the line and the curve and B the area below the curve. 0 is equal; 1 is one person has everything.
How do economic structure and the pattern of trade change with development?: Primary sector jobs dominate at low income and fall as farm productivity rises; secondary rises through middle income; tertiary is largest at high income. Low-income countries export mainly primary products and import manufactures; high-income countries trade manufactures and services.

11.5 Relationship between countries at different levels of development

Bilateral, multilateral and tied aid: Bilateral: from one government directly to another. Multilateral: pooled by many donors and passed on through an international body. Tied: must be spent on the donor's goods or services (a tied grant of 90 at prices 20% above world prices is worth only 75).
Aid: one positive chain and two negative chains: Positive: aid for infrastructure and schools raises physical and human capital, so LRAS shifts right. Negative: a large inflow strengthens the currency and hurts exports; free food aid lowers local food prices and farm incomes; aid can replace tax revenue and weaken accountability.
Why are export earnings from primary products volatile?: Demand is price inelastic, so a supply change moves price a lot. With PED −0.25, a 5% rise in sales needs a 20% price fall, so revenue = 1.05 × 0.80 = 0.84, a 16% fall.
Multinational company (MNC) and foreign direct investment (FDI): MNC: a firm that owns or controls operations in more than one country. FDI: investment by a firm or person in one country in productive assets or a controlling stake in a business in another country.
Transfer pricing, and its effect on a host country: Prices set for sales between branches of the same MNC. A parent charging its subsidiary an extra 2.0 m moves profit to a low-tax country: host tax at 20% on 5.0 m falls from 1.0 m to 0.6 m, so the host loses 0.4 m.
Roles of the IMF and the World Bank: IMF: short-run payments and macroeconomic stability; surveillance, temporary balance of payments loans with conditionality, technical assistance. World Bank: long-run development and poverty reduction; project loans, very low-interest loans and grants for the poorest countries.
Causes and consequences of external debt: Causes: current account and budget deficits, low saving, falling export prices, rising interest rates, depreciation (foreign-currency debt costs more), waste and shocks. Consequences: debt service has an opportunity cost in health and education, higher taxes or cuts, pressure on the currency, a debt trap and loss of policy freedom.

11.6 Globalisation

Globalisation and its main causes: The growing integration and interdependence of economies through rising cross-border flows of goods, services, capital, labour, technology and information. Causes: cheaper transport, ICT, trade liberalisation, capital mobility, MNCs, growth of emerging economies and trading blocs.
Free trade area, customs union, monetary union and full economic union: Free trade area: no tariffs between members, own tariffs on outsiders. Customs union: adds a common external tariff. Monetary union: adds a single currency and monetary policy. Full economic union: adds harmonised fiscal and other policies.
Trade creation and trade diversion: Trade creation: domestic output replaced by cheaper imports from a partner, an efficiency gain. Trade diversion: imports from a cheaper outside producer replaced by dearer imports from a partner, an efficiency loss.
Domestic cost 80, outsider 60, partner 70, tariff 25%. A customs union removes the tariff on the partner only. Creation or diversion?: Before: outsider landed price 60 × 1.25 = 75, below 80, so imports come from the outsider. After: partner at 70 is cheapest. The source moves from outsider to partner, so it is trade diversion: the resource cost rises by 10 and the government loses 15 of tariff revenue per unit.
Monetary union: gains and losses for members: Gains: no currency conversion costs, no exchange rate risk among members, price transparency, more trade and investment. Losses: one interest rate for all, no devaluation to absorb a shock, adjustment falls on wages, prices and labour mobility.
Why does a free trade area need rules of origin?: Members keep different tariffs on outsiders, so goods could enter through the lowest-tariff member and move on tariff-free (trade deflection). Rules of origin decide which goods qualify for tariff-free movement.