IB Economics/International Economics/Economic integration

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Economic Integration[edit]


Types of 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: a group of countries that agree to free trade (e.g. NAFTA).
  • Custom unions: A free trade area with a common external tariff (e.g. MERCOSUR).
  • Common markets: A custom union with free transport of goods and services amongst members. (e.g. European Union)
  • Full Integration: Common market with uniform fiscal and monetary policies. Often, a central bank is shared, and political unification exists as well.

Trade creation and trade diversion

  • Trade creation: greater specialization 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

The balance of payments is the record of all financial dealings over a period of time between one country and the rest of the world. It consists of two components, the current account and the capital account.

Current account
The current account records an economy's transactions with foreign economies. These transactions include international trade, transfer payments and returns on foreign investments. The current account is calculated by adding the value of exports, transfer payments from abroad into the country and foreign investment returns, and subtracting the value of imports, transfer payments from the domestic economy to foreign economies and the investment returns in the domestic economy for foreign investors. Below are listed the main components of the current account.
  • Balance of trade: Visible exports - visible imports.
  • Invisible balance: Invisible exports - invisible imports.
Capital account
The capital account is the record of the net inflow of capital into an economy. The value of capital investments in an economy is subtraced by the value of the capital investments by the economy in foreign economies.

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.
It is important to make the following distinctions.
  • 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.
Causes of changes in exchange rates
  • 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: Can lead to either an appreciation or a depreciation in a country's currency..
  • 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. A government can pursue its own domestic policies. On the other hand, it can cause instability in prices, and may lead to inflation. Furthermore, speculation can lead to major changes in the rate.
A fixed exchange rate is advantageous because it provides stability of prices, and can restrain domestic inflation or even prevent it. However, a government must have sufficient reserves. Furthermore, a country's firms may become uncompetitive as they do not have to produce at lower costs to reduce prices but simply devaluate the currency. And of course, 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.