Flashcards · 9708 · AS Topic 6

International economic issues (AS Level) flashcards

28 cards on AS Topic 6, subtopics 6.1 to 6.5. Pick a subtopic or study them all.

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6.1 The reasons for international trade

Absolute advantage and comparative advantage: Absolute advantage: producing a good with fewer resources, or more of it from the same resources. Comparative advantage: producing a good at a lower opportunity cost.
Per worker-day, C makes 12 rice or 8 fabric; D makes 6 rice or 3 fabric. Who has the comparative advantage in each good?: Opportunity cost of 1 rice: C 8 ÷ 12 = 0.67 fabric, D 3 ÷ 6 = 0.5 fabric, so D has the comparative advantage in rice. Of 1 fabric: C 1.5 rice, D 2 rice, so C has it in fabric (C has the absolute advantage in both).
Terms of trade: formula and meaning of a rise: Terms of trade = (index of average export prices ÷ index of average import prices) × 100. A rise is an improvement: each unit of exports buys more imports. Example: 108 ÷ 90 × 100 = 120.
The terms of trade index falls from 120 to 108. What is the percentage change, and is it always bad news?: (108 − 120) ÷ 120 × 100 = −10% (a fall of 12 points, not 12%). Not always bad: if it comes from productivity gains lowering export prices, competitiveness improves. Effect on revenue depends on PED for exports.
Trading possibility curve (TPC): The combinations of two goods a country can consume after specialising and trading at given terms. Its slope is set by the terms of trade, and it lies outside the PPC whenever the terms differ from the home opportunity cost.
Limitations of the theory of comparative advantage: Transport and trade costs, increasing opportunity costs, imperfect factor mobility, a static view (advantage changes over time), dependence on a narrow range of exports, unrealistic assumptions (perfect competition, full employment), uneven distribution of gains and unpriced environmental costs.

6.2 Protectionism

Tariff, import quota, export subsidy, embargo and red tape: Tariff: a tax on imports. Quota: a cap on imports by volume or value. Export subsidy: a payment per unit sold abroad. Embargo: a ban on trade in a product or with a country. Red tape: excessive paperwork, inspections and delays.
Tariff diagram for a small country, in words: Home demand slopes down, home supply up; the world price is a horizontal line, and the tariff adds a higher line. At the higher price home output rises, demand falls and imports shrink. Consumers lose surplus; producers gain; the government gets revenue on the imports; two triangles are the net loss.
The world price is 50 and a tariff of 10 is applied. Imports fall from 60 to 45 thousand units. Find the revenue.: Revenue = tariff per unit × imports after the tariff = 10 × 45 = 450 thousand. The tariff is 20% of the price and imports fell 25%, so the import response is elastic (−1.25).
Dumping and infant industries: Dumping: selling abroad below cost or below the home price. Infant industry: a new industry with high costs while it is small. The argument: protect it until economies of scale bring costs below the world price; it fails if protection never ends or costs never fall.
Arguments against protectionism: Higher prices and less choice for consumers, inefficiency in protected firms, retaliation, higher input costs for other firms, a high cost per job saved, risk of corruption, and the lost gains from trade.
Tariff versus quota: one key difference: A tariff taxes the price and raises revenue automatically. A quota limits the quantity; the gap between home and world price on the quota quantity is licence value, which goes to whoever holds the licences (possibly foreign exporters).

6.3 Current account of the balance of payments

Current account of the balance of payments: The record of a country's trade in goods, trade in services, primary income and secondary income with the rest of the world over a period.
Primary income versus secondary income: Primary income: income from employment and investment abroad (wages, interest, profit, dividends). Secondary income: transfers with nothing given in return (remittances, aid, contributions to international bodies).
Goods 64 credits, 71 debits; services 30, 22; primary income 9, 14; secondary income 5, 3. Find the current account balance.: Goods −7, services +8, so goods and services +1. Primary −5, secondary +2. Current account balance = 1 − 5 + 2 = −2, a deficit.
Causes of a current account deficit: Domestic income growing faster than partners' (high YED for imports), higher costs or inflation than rivals, poor quality, recession among trading partners, a fall in the price of a main export, an overvalued currency, and income outflows on foreign debt or to foreign-owned firms.
Consequences of a persistent current account deficit: Net exports lower AD, with possible loss of output and jobs in traded sectors; downward pressure on the exchange rate; it must be financed by borrowing, asset sales or reserves. It matters less if small, short-lived, or funding investment rather than consumption.

6.4 Exchange rates

Floating exchange rate, depreciation and appreciation: Floating rate: determined by demand and supply in the foreign exchange market. Depreciation: a fall in a floating currency's value against another. Appreciation: a rise in its value. Always name the unit (e.g. tarns per senn).
Demand for senns D = 400 − 50r, supply S = 100r − 200. Demand falls by 60 at every rate. Find the old and new rate.: Before: 150r = 600, so r = 4.00 tarns per senn and 200 m traded. After: 340 − 50r = 100r − 200, so r = 3.60 and 160 m traded: a 10% depreciation.
What shifts demand for a currency right, and what shifts its supply right?: Demand right (appreciation): rising foreign demand for exports, inward investment, higher relative interest rates, speculation on a rise. Supply right (depreciation): rising demand for imports, outward investment, lower relative interest rates, speculation on a fall.
The senn rises from 4.00 to 4.40 tarns. By how much has the tarn changed against the senn?: Senns per tarn fall from 0.25 to 0.2273, so the tarn depreciates by 9.09% while the senn appreciates by 10%. Use the inverse rate for the partner.
Effect of a depreciation on AD and AS: Exports cheaper abroad, imports dearer at home → net exports rise → AD shifts right → real output, the price level and employment tend to rise. But imported inputs cost more, which can shift SRAS left.
Depreciation versus devaluation: Depreciation is a fall in a floating rate through market forces. Devaluation is a government decision to lower a fixed rate.

6.5 Policies to correct imbalances in the current account of the balance of payments

Why is current account stability a policy objective?: It avoids a large, lasting deficit that needs risky finance and a falling currency, and a large surplus that signals weak domestic demand and invites retaliation. The aim is stability, not a balance of exactly zero.
Contractionary fiscal policy to cut a deficit: mps 0.1, mpt 0.2, mpm 0.2. Government spending falls by 6. By how much do imports fall?: Withdrawals = 0.5, so the multiplier is 2. Income falls 6 × 2 = 12, so imports fall 0.2 × 12 = 2.4. It works by cutting output and jobs, and is weak if the mpm is low.
Using supply-side policy to correct a current account deficit: Education, infrastructure and research raise productivity, lower unit costs and improve quality, so exports become more competitive without cutting output. Example: wages +2%, productivity +5% gives unit labour cost 1.02 ÷ 1.05 = 0.971, a 2.9% fall. But it is slow, costly and uncertain.
Monetary and protectionist policies for a current account deficit: one weakness each: Monetary (higher interest rates): lowers consumption and investment, but may raise the exchange rate, hurting exports. Protectionist (tariffs, quotas): cut imports directly, but risk retaliation, raise prices and may break trade rules; the effect depends on PED.
A 10% tariff lifts an import's price from 50 to 55. PED is −2 and 300 units were bought. What happens to payments to foreign suppliers?: Quantity falls 20% to 240. Payments fall from 300 × 50 = 15,000 to 240 × 50 = 12,000, a fall of 3,000. The tariff itself goes to the home government, not the foreign supplier.