Flashcards · IB Diploma Programme Economics · Topic 4

The global economy flashcards

59 cards on Topic 4, subtopics 4.1 to 4.10. Pick a subtopic or study them all.

Study mode needs JavaScript. Every card is listed below, so you can still cover the answers and test yourself.

All 59 cards

For a quick read-through or printing. Cover the right-hand side to test yourself.

4.1 Benefits of international trade (includes HL-only sub-topics and calculation)

Benefits of international trade: Increased competition, lower prices, greater choice, acquisition of resources, more foreign exchange earnings, access to larger markets, economies of scale, more efficient resource allocation and more efficient production.
Diagram in words: free trade when the world price is below the domestic price: Axes: price and quantity, with domestic D and S and a horizontal line at the world price Pw. At Pw, quantity demanded exceeds domestic supply; the gap Qd − Qs is imported. Consumers gain more surplus than producers lose, so there is a net gain.
Free trade when the world price is above the domestic price: The country exports Qs − Qd at Pw. Producers receive more and sell more; consumers pay more and buy less. Producers gain more than consumers lose, so there is a net gain. The curves do not shift: quantities move along D and S.
Absolute versus comparative advantage: Absolute advantage: producing a good with fewer resources (or more output from the same resources) than another country. Comparative advantage: producing a good at a lower opportunity cost than a trading partner. (HL only)
Country J makes 12 shirts or 4 machines; Country K makes 10 shirts or 5 machines. Who has the comparative advantage in machines?: One machine costs J 12 ÷ 4 = 3 shirts and K 10 ÷ 5 = 2 shirts, so K has the comparative advantage in machines and J in shirts. Any price between 2 and 3 shirts per machine benefits both. (HL only)
Limitations of the theory of comparative advantage: It assumes constant opportunity costs, no transport costs, full employment and mobile resources, and perfect competition. Over-specialisation brings price risk, gains are uneven, and environmental costs are left out. (HL only)

4.2 Types of trade protection (includes HL-only calculations)

Tariff (specific and ad valorem), quota and quota rent: Tariff: a tax on imports; specific is a fixed sum per unit, ad valorem a percentage of value. Quota: a legal limit on the quantity imported. Quota rent: (domestic price − world price) × quota, collected by licence holders.
Who gains and who loses from a tariff?: Domestic consumers lose (higher price, lower consumption). Domestic producers gain (higher price and output). The government gains revenue. Foreign producers lose. The country as a whole has a net welfare loss (two triangles).
Tariff versus quota: A tariff fixes the price gap and gives revenue to the government; if demand rises, imports rise. A quota fixes the import quantity and gives the rent to licence holders; if demand rises, imports stay capped.
Tariff versus a production subsidy to domestic producers: Tariff: the consumer price rises, consumers pay, the government gains revenue. Subsidy: the consumer price is unchanged, taxpayers pay, and the government budget pays out.
Administrative barriers to trade: Standards, regulations, licences or procedures that make importing harder or dearer. No government revenue is collected, and compliance uses resources. They may serve real safety or consumer goals, so ask whether a less restrictive rule would do.
Tariff calculation: Qd = 140 − 2P, Qs = 3P − 10, Pw = 20, tariff 4: Free trade: Qd 100, Qs 50, imports 50. With the tariff, P = 24: Qd 92, Qs 62, imports 30. Revenue = 4 × 30 = 120. Welfare loss = 24 + 16 = 40. (HL only)

4.3 Arguments for and against trade control/protection

Arguments for trade protection: Infant (sunrise) industry, national security, health and safety, environmental standards, anti-dumping, unfair competition, balance of payments correction, government revenue, protection of jobs, and economic diversification for ELDCs.
Arguments against trade protection: Misallocation of resources, retaliation, increased costs of imported inputs, higher prices, less choice, a lack of incentive to become efficient, and reduced export competitiveness.
Dumping: Selling exports at a price below the cost of production, or below the price charged in the exporter's home market. A low price may instead reflect real efficiency, so dumping is hard to prove.
Evaluate the infant industry argument: Sheltering a new industry until it reaches efficient scale can work if protection is temporary and costs really fall. But the industry may never become efficient, picking winners is hard, and protection without an end date removes the incentive to improve.
Cost per job saved: a tariff raises the price by 10 on 300,000 pairs of shoes and saves 150 jobs: Extra cost to consumers = 10 × 300,000 = 3,000,000. Cost per job = 3,000,000 ÷ 150 = 20,000. Jobs lost elsewhere through dearer inputs and retaliation must also be counted.

4.4 Economic integration

Bilateral, regional and multilateral trade agreements: Bilateral: between two countries. Regional: between several countries in one area. Multilateral: between many countries worldwide, through the WTO.
Free trade area, customs union, common market and monetary union: Free trade area: no barriers between members; each sets its own outside tariffs. Customs union: adds a common external tariff. Common market: adds free movement of labour and capital. Monetary union: adds one currency and one central bank.
Advantages and disadvantages of trading blocs: Advantages: access to larger markets, freedom of labour movement, bargaining power, political stability. Disadvantages: loss of sovereignty, and a possible challenge to multilateral trade talks.
The WTO: objectives, functions and limits: Objectives: lower trade barriers, fair competition, predictable rules. Functions: negotiation forum, administering agreements, settling disputes, monitoring trade policy. Limits: difficulty of agreement on services and primary products; unequal bargaining power.
Trade creation versus trade diversion: Trade creation: joining a bloc switches supply from a high-cost domestic producer to a lower-cost partner (efficiency gain). Trade diversion: supply switches from a low-cost outsider to a higher-cost partner (efficiency loss). (HL only)
Monetary union: advantages and disadvantages: Advantages: no conversion costs or exchange rate risk between members, easy price comparison. Disadvantages: one interest rate for all members, no exchange rate adjustment after a shock that hits one member. (HL only)

4.5 Exchange rates (includes HL-only sub-topic)

Floating, fixed and managed exchange rate systems: Floating: set by demand and supply with no official target. Fixed: the government sets an official rate and the central bank defends it. Managed: the rate floats but the central bank intervenes to influence it.
Depreciation versus devaluation: Depreciation (appreciation): a market-driven fall (rise) in a floating currency. Devaluation (revaluation): an official cut (rise) in a fixed rate.
What happens to a currency when its interest rates rise relative to other countries?: Financial inflows rise, so demand for the currency shifts right and it appreciates. Other causes of appreciation: more foreign demand for exports, inward FDI, remittances sent in, speculators expecting a rise.
An 80-pel good sells at 1.50 duns per pel. The rate falls to 1.35. What happens?: Change = (1.35 − 1.50) ÷ 1.50 × 100 = −10%: the pel depreciates. The good's price in duns falls from 80 × 1.50 = 120 to 80 × 1.35 = 108.
Consequences of a depreciation: Exports cheaper abroad and imports dearer at home. Inflation tends to rise (dearer imports and inputs); growth rises and unemployment falls if net exports rise (AD right); the current account improves only if trade responds enough.
Fixed versus floating exchange rates: evaluation: Fixed: more certainty if believed, but needs large reserves, ties monetary policy to the peg, and risks speculative attack. Floating: monetary policy free for domestic goals and imbalances adjust through the rate, but rates are volatile. (HL only)

4.6 Balance of payments (includes HL-only sub-topics)

The three accounts of the balance of payments: Current account: trade in goods and services, income, current transfers. Capital account: capital transfers and non-produced, non-financial assets. Financial account: FDI, portfolio investment, reserve assets and official borrowing.
Why does the balance of payments always sum to zero?: Every transaction has two sides, so every debit has a matching credit: current + capital + financial account = 0. A deficit on one account is matched by a surplus on another, so always name the account.
Current account: goods −25, services +22, income −6, current transfers −5: Current account = −25 + 22 − 6 − 5 = −14, a deficit. With a capital account of +1, the financial account must be −(−14 + 1) = +13.
FDI versus portfolio investment: FDI: a lasting stake with control, such as building a factory abroad. Portfolio investment: buying shares or bonds without control; can be withdrawn quickly.
Expenditure switching versus expenditure reducing policies to correct a current account deficit: Switching (tariffs, quotas, subsidies, depreciation) redirects spending to home output; risks retaliation and dearer imports. Reducing (tax rises, spending cuts, dearer borrowing) cuts total demand and imports; costs output, jobs and growth. (HL only)
Marshall-Lerner condition and the J-curve: Marshall-Lerner: a depreciation improves the current account only if the price elasticities of demand for exports and imports, ignoring signs, add up to more than 1. J-curve: demand is less elastic in the short run, so the balance worsens first, then improves. (HL only)
Consequences of a persistent current account deficit: Downward pressure on the exchange rate, interest rates that may rise to attract inflows, more foreign ownership of domestic assets, rising debt and interest payments, weaker credit ratings, and limits on demand management. Judge by size relative to GDP, duration and what the imports are used for. (HL only)

4.7 Sustainable development (includes HL-only sub-topic)

Sustainability and sustainable development: Sustainability: meeting present needs while leaving later generations able to meet theirs, by limiting resource depletion and degradation. Sustainable development: raising living standards in a way that can continue without running down what later generations need.
Renewable versus non-renewable resources; depletion versus degradation: Renewable resources regenerate; use is sustainable while the amount taken each year does not exceed regeneration. Non-renewable resources only fall. Depletion: the quantity used up. Degradation: a fall in quality (polluted water, exhausted soil).
The UN Sustainable Development Goals: 17 global goals agreed by UN member states in 2015, with a 2030 target date, for example 1 No poverty, 4 Quality education, 8 Decent work and economic growth, 13 Climate action. Goals can support each other (4 and 1) or conflict (8 and 13).
An aquifer holds 90 million m³, recharges 3 million a year, and 4.5 million is pumped. How long will it last?: Net draw = 4.5 − 3 = 1.5 million a year. Lifetime = 90 ÷ 1.5 = 60 years at the current rate, ignoring changes in recharge. Pumping must fall by one third to 3 million to stop the decline.
Why do markets over-use natural resources?: Where nobody owns a resource, or the user does not pay for the damage, the private cost is below the full social cost, so the resource is over-used. This is the main argument for intervention.
The two-way link between poverty and environmental sustainability: Poverty pressures the environment: short time horizons, direct dependence on local resources, few alternatives. Environmental damage deepens poverty: lower yields and catches, flood and drought exposure, health costs. Together they can form a vicious circle. (HL only)

4.8 Measuring development

Economic growth versus economic development: Growth: an increase in real output, measured by real GDP or GNI. Development: a wider improvement in living standards, including health, education, equity, choice, sustainability and income.
Single indicators of development, with an example of each: Income: GDP or GNI per capita at PPP. Health: life expectancy, infant or maternal mortality. Education: literacy, years of schooling. Inequality: Gini coefficient. Energy: access to electricity. Environment: CO₂ per person. Each shows only one aspect.
The Human Development Index (HDI): A composite of life expectancy, education (mean and expected years of schooling) and GNI per capita at PPP, combined by a geometric mean on a 0 to 1 scale. The income index uses logarithms, so a country ten times richer does not score ten times higher.
IHDI, GII and the Happy Planet Index: IHDI: the HDI adjusted for inequality within each dimension; never above the HDI. GII: gender inequality (reproductive health, empowerment, labour market); higher is worse. Happy Planet Index: relates life expectancy and reported well-being to ecological footprint.
Converting to PPP: a basket costs 1,500 locally and 500 in the reference economy. What is an income of 45,000 worth?: PPP rate = 1,500 ÷ 500 = 3. Income at PPP = 45,000 ÷ 3 = 15,000.
When does economic growth help development, and when does it fail to?: Helps: tax revenue funds health, schools and infrastructure, and household incomes are spent on needs. Fails: gains go to a small group, governments spend little on public services, growth causes pollution, or corruption wastes revenue. The link is positive but conditional.

4.9 Barriers to economic growth and/or economic development

The poverty cycle: Low income → low saving and low tax revenue → low investment in capital, health and education → low productivity → low income. Breaking it needs a large push at some point in the loop.
Economic barriers to growth and development: Rising inequality, lack of infrastructure and appropriate technology, low human capital, dependence on primary products, lack of access to international markets, the informal economy, capital flight, indebtedness, geography (being landlocked), climate and disease.
Political and social barriers to growth and development: A weak legal system, ineffective taxation, a weak banking system, insecure property rights, gender inequality, lack of good governance and corruption, and unequal political power.
Debt service ratio: debt service 0.5 billion and export earnings 2.0 billion: Debt service ratio = debt repayments (interest plus capital) ÷ export earnings × 100 = 0.5 ÷ 2.0 × 100 = 25%. A high ratio crowds out spending on health and education.
Why is dependence on primary products a barrier?: Prices are volatile, so export earnings and tax revenue swing; value added is low; and copper making up 60% of exports means a 40% price fall cuts export earnings by 0.60 × 40 = 24%.

4.10 Economic growth and/or economic development strategies

Import substitution versus export promotion: Import substitution: protect domestic industries to replace imports; builds industry and saves foreign exchange, but risks inefficiency and higher prices. Export promotion: support selling abroad; earns foreign exchange and scale, but relies on foreign demand.
Market-based versus interventionist development strategies: Market-based: trade liberalisation, privatisation, deregulation, inward FDI. Interventionist: redistribution (taxes, transfers, minimum wages) and provision of merit goods such as education, health and infrastructure. The best mix depends on the country.
Humanitarian aid, development aid and ODA: Humanitarian aid: short-term help in emergencies. Development aid: long-term funding for projects. ODA: official government aid flows to developing countries. Limits of aid: tied conditions, dependence, corruption.
World Bank versus IMF: World Bank: development lending, projects and technical advice. IMF: lending to countries with balance of payments problems, with advice and conditions. Criticism: loan conditions such as spending cuts may harm the poor.
Microfinance and institutional change as development strategies: Microfinance: small loans and savings services for people excluded from formal banks. Institutional change: better access to banking (including mobile banking), women's empowerment, reducing corruption, secure property and land rights. Slow but lowers risk and raises investment.
Inward FDI as a development strategy: Brings jobs, capital and technology. But profits may flow abroad: a plant earning 90 million that sends 70% home sends 63 million abroad and leaves 27 million. Dependence on a foreign firm is a further risk.