IB Economics/International Economies

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[edit] International Economies

[edit] Reasons for Trade

  • Differences in factor endowments: Factor endowments is defined as the total amount of land, labour, capital, and entrepreneurship a country possess. Countries have different factor endowments. Saudi Arabia may have a lot of oil, but perhaps not enough lumber. It will thus have to trade for lumber.
  • Variety and quality of goods: Japan may have a superior quality of technological devices (e.g T.V. or camera) but lacks many natural resources; hence, it may trade with Indonesia for inputs.
  • Gains from specialization: Countries may gain economies of scale where long run average costs fall as output increases.
  • Political: Countries may wish to bring two countries together culturally and politically and this can be done through trade.
  • Absolute and comparative advantage (numerical and diagrammatic representations): Absolute advantage occurs when a country can produce more of one good than another using the same amounts of resources.
  • Efficiency: Domestic firms will be forced to be competitive to continue in the market and thus become more efficient.

For example: (Costs per unit in manpower)

Wheat----------------

England| 10 Portugal|20

It costs 20 units of manpower to produce one unit of wheat in Portugal, while it only costs 10 for England to produce the same unit of wheat. England is said to have an absolute advantage in wheat production.

Comparative advantage is where a country has a lower opportunity cost in the production of a good than another, for example

(costs per unit in man hours)

Wheat-----Wine

England| 15 30 Portugal| 10 15

The opportunity cost of producing 1 more unit of wheat for England is 2 units of Wine. The cost of producing 1 unit of wheat in Portugal is 1.5 units of Wine. Portugal thus has a comparative advantage in the production of wheat because it can produce it at a lower opportunity cost.

  • Opportunity cost: The value of the next best alternative foregone.
  • Limitations of the theory of comparative advantage: There are however limitations, comparative advantage holds numerous simplistic assumptions.
  • There are no transport costs.
  • Costs are constant and there are no economies of scale
  • There are only two economies producing two goods.

[edit] Free Trade and Protectionism

  • Definition of free trade: The unobstructed trade between two goods with no restrictions on imports and exports.
  • Types of protectionism
  • tariffs: Tax on imports
  • Quotas: A restraint on imports
  • Subsidies: A grant given to producers of a good.
  • Voluntary Export Restraints (VERS): Political pressure placed on a country not to export a good.
  • Administrative obstacles: Bureaucracy. VERs, voluntary export restraints, through pressuring country e.g. Japanese export restraints of vehicles to UK.
  • Health and safety standards: Not accepting goods because of possible health risks.
  • Environmental standards: Not accepting goods due to pollutive biproducts, e.g. certain chemicals, not being handled correctly.
  • Arguments for protectionism
  • Infant industry argument: This argument suggests that an industry needs times to develop. This takes into account that it needs to develop economies of scale and a learning curve.
  • Efforts of a developing country to diversify
  • Protection of employment
  • Source of government revenue: The consumer has the burden
  • Strategic arguments
  • Means to overcome a balance of payments disequilibrium
  • Anti-dumping: Dumping is known as the selling of goods on the international market below the normal market price
  • Arguments against protectionism
  • Inefficiency of resource allocation
  • Costs of long-run reliance on protectionist methods
  • Increased prices of goods and services to consumer
  • The cost effect of protected imports on export competitiveness
  • Less choice for the consumer

[edit] Economic Integration

  • Globalization- political, social, and economic integration.
  • Trading blocs: a large free trade area formed by tax, tariff, and trade agreements.
  • Free trade Areas: (NAFTA) a group of countries that agree to free trade.
  • Custom unions: A free trade area with a common external tariff (The EU is an example of a customs union)
  • Common markets
  • Trade creation and trade diversion:
  • Trade creation: greater specialisation according to comparative advantage
  • Trade diversion: Firms may have to pay more for products they would have paid less for.
  • Obstacles of achieving integration:
  • Reluctance to surrender political sovereignty
  • reluctance to surrender economic sovereignty
  • World Trade Organization
  • Aims: attempts to increase international trade by lowering trade barriers.
  • Success and failure viewed from different perspectives
  • Balance of Payments: Record of all financial dealings over a period of time between one country and the rest of the world. (Current account + capital account)
  • current account: Composed of the visible and invisible
  • balance of trade: Visible exports - visible imports
  • invisible balance: Invisible exports - invisible imports
  • capital account: Composed of profits, interest, dividends, and hot money.
  • Exchange Rates

An exchange rate is the value of one currency expressed in the value of another.

  • Fixed exchange rates: fixed exchange rates are exchange rates which the government sets.
  • Floating exchange rates: Exchange rates determined by the market forces of demand and supply.
  • Managed exchange rates: Exchange rates which are floating exchange rates but controlled by the government by influence.
  • Distinction between:
  • Depreciation and devaluation - When the value of a floating currency decreases, it means the currency has depreciated. When the value of a fixed currency is set at a lower value, it means it was devaluated.
  • Appreciation and revaluation - When the value of a floating currency increases, it means the currency has appreciated. When the value of a fixed currency is set at a higher value, it means it was revaluated.
  • Effects on exchange rates of
  • Trade flows: If there is a greater demand for a country's imports there is thus a greater demand for a country's currency and the value of that currency will rise.
  • Capital flow/ interest rate change: If interest rates rise, there will be a greater demand for a country's currency and thus it will appreciate.
  • Inflation: Inflation may cause a fall in the value of a country's currency.
  • Speculation: May do either.
  • Use of foreign currency reserves: A country will use its foreign currency reserves
  • relative advantage and disadvantages of fixed and floating exchange rates
  • A Floating exchange rate has it advantages because it automatically adjusts so that supply equals demand. There is no need for a central bank to keep foreign reserves. It prevents inflation. A government can pursue its own domestic policies.
  • Causes instability
  • May lead to inflation
  • Speculation can lead to major changes in the rate.
  • A Fixed exchange rate is advantageous because it provides stability, it can restrain domestic inflation, it can prevent inflation.
  • A government must have sufficient reserves, a country;s firms may be uncompetitive. The government must intervene as a priority.
  • Advantages and disadvantages of single currencies/monetary integration
  • Purchasing power parity theory (PPP): The theory that floating system currency adjusts until a unit of currency can buy the exactly the same amount of goods and services as a unit of another currency.

[edit] Balance of Payments Problem

  • Consequences of a current account deficit or surplus
  • Methods of correction
      - Devaluation of currency
  • managed changes in exchange rates


  • reduction in aggregate demand/expenditure-reducing policies
      - Increases in taxes/interest rates to shore up spending within a country.
      - Protectionism: reduces imports
      - Currency controls: restricts the amount of foreign currency bought by domestic citizens 
      - Supply-side policies: aimed at reducing labor costs, increasing firms' competitiveness
  • change in supply-side policies to increase competitiveness
  • protectionism/expenditure-switching policies
      -
  • Consequences of a capital account deficit or surplus
  • Marshall-Lerner condition
      - States that running a current account deficit will benefit the trade balance of a country if the combined elasticity values of exports and imports (in absolute value) are greater than 1.
  • J-curve
      - A theory which indicates that running a current account deficit may prove to worsen the country's balance of payments situation before improvement is observed, possibly due to the time lag.


[edit] Terms of Trade

  • definition of terms of trade: Index of export prices/ index of import prices * 100
  • Consequences of a change in the terms of trade for a country's balance of payments and domestic economy
  • The significance of deteriorating terms of trade for developing countries
  • Measurement of terms of trade
  • Causes of changes in country's terms of trade in the short-run and long-run
  • Elasticity of demand for imports and exports
  • Possible inverse relationship between Terms of Trade and Balance of Payments - depends on elasticity for imports and exports (Price and Income elasticities)
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