4.3 Globalisation

Question 1

What is globalisation ?

+ causes

Answer 1

• Globalisation refers to the ever-increasing integration of the world’s local, regional and national economies into a single international market
• countries becoming more interdependent through:
  1. International trade in G.S
  2. Free movement of labour between countries
  3. Free movement of capital across countries (FDI, financial capital flows)
  4. Spread of technology and intellectual capital across national boarders

Question 2

What are the causes of globalisation ?

Answer 2

• improvements in the global transport (container ships) / fall in transport costs (volume economies)
• trade liberalisation and the reduction of trade barriers
• the rise of regional trading blocs that allow the free movement of labour and capital
• Deregulation and market reforms which all foreign ownership of domestic firms and encourage FDI flows
• increased exchange of services such as tourism and financial services across the world
• the rise of TNC’s and marketing techniques which has led to the rise of global brands and global supply chains

Question 3

Why do countries trade ?

Answer 3

• the Heckscher-Ohlin model says that a country will export goods and services that use its abundant factor intensively and it will import goods that use its scarce factor intensively
• Non-price theories of trade - while commodities (agricultural) tend to be fairly homogenous, manufactured goods/services are usually non-homogenous. Each product is slightly different price is not the only factor which determines demand. Some consumers may **import a Good even if it can be produced more cheaply somewhere else* *

Question 4

What is terms of trade ?

Answer 4

• terms of trade is defined as the ratio between average export prices and average import prices
• Terms of trade index (TOT) = (index of X price)/(index of M price) x 100
• An improvement in the terms of trade means that export prices rise relative to import prices (the same quantity of imports can be brought with a smaller quantity of exports)

Question 5

Why do terms of trade change ? (Short-run)

Answer 5

• changes in demand conditions - if the global demand for a product falls, its price on the world market will fall, this will lead to a decrease in the terms of trade for countries that export the good and an improvement for countries who import the good.
• changes in supply conditions - if global supply decreases, by factors like weather conditions or political reasons, then its price on the world market will increase. This means that countries who export the good will see an improvements in their TOT
• changes in relative inflation rates - if a country has a higher inflation rate relative to other countries its exports will be more expensive TOT improves
• changes in relative exchange rates - if a country experiences a depreciation Imports become more expensive and TOT worsens

Question 6

Why do terms of trade change in the long-run ?

Answer 6

• changes in productivity - a rise in productivity relative to a countries main trading partners will lead to a lower relative price of exports, this leads to the TOT worsening
• technological improvements - same as above
• changes in income levels - a rise in income leads to an increase in the demand for a good. However, income elasticity of demand for primary commodities - often produced and exported by developing countries - tend to be low < 1. Whereas YED for manufactured goods tend to be more elastic. This means that countries exporting goods with a higher YED will see a TOT improvement

Question 7

What happens to the TOT when trade balance changes ?

Answer 7

• terms of trade and trade balance move in the same direction
• this is because a shift in demand causes price and quantity to move in the same direction
• for exporting countries - TOT improves since exports are more expensive and trade balance also improves
• for importing countries - TOT worsens since imports are more expensive and trade balance also worsens

Question 8

What happens to the trade balance when supply changes ?

Answer 8

• a shift in the supply curve means price and quantity move in opposite direction
• suppose there is an increase in global supply - if PED < 1, then exporting countries’ TOT will worsen, export revenue falls and trade balance will worsen
• if PED > 1, exporting countries TOT will worsen, however export revenue rises and trade balance improves

Question 9

Why do developing countries often face worsening TOT ?

Answer 9

• In the long run, technological advances in agriculture lower the price of primary commodities, worsening terms of trade for developing countries
• As incomes grow, the demand for primary commodities grows less than proportionally (YED < 1) as people spend a larger fraction of their income of manufactured G/S thus countries who primarily export primary commodities are likely to face a worsening of TOT

Question 10

What are the consequences of persistently worsening TOT ?

Answer 10

A persistently declining TOT means that a country must keep exporting more in order to maintain the same quantity of imports this may lead to:
1. Difficulties in importing essential inputs for production
2. Growing and persistent trade deficit, and growing indebtedness
3. Reduced export earnings in agriculture, leading to greater poverty in rural areas and greater inequality
4. Lower income likely to worsen the governments budget
5. Need to keep exporting primary commodities, which makes it difficult to diversify
6. Growing inequality between developed and developing countries

Question 11

What is absolute advantage ?

Answer 11

• a country has absolute advantage in producing something if it can do so at a lower average cost than another country
• theory says both trading countries will benefit from producing G/S which they have an absolute advantage in

Question 12

What is an example of using specialisation and absolute advantage ?

Answer 12

Question 13

What is comparative advantage ?

Answer 13

• comparative advantage exists when one country can produce goods or services at a lower relative opportunity cost than other countries
• the theory predicts all countries can benefit from specialising in the production, and trade, of G/S which they have a comparative advantage in
• a country can have comparative advantage without having an absolute advantage

Question 14

What is an example of the diagram for showing comparative advantage ?

Answer 14

Question 15

Why does comparative advantage exist ?

Answer 15

• differences in labour productivity(Ricardo 1817) - costs of produuction are essentially labouur costs and differences in comparative costs shows differences in labour productivity
• differences in types of factors and availability - if a country has a large supply of capital relative to labour, the couuntry will have a comparative advantage in producing labour intensive goods.

Question 16

what are some limitations of comparative advantage ?

Answer 16

• the theory assumes no transport costs - in reality transport cost may otweigh gains from comparative advantage. However transport costs have fallen significantly over time
• the theory assumes no difference in quality of the goods
• the theory assumes costs do not change over time in reality economies of scale and technological progress may increase comparative advantage for a contry
• occupationally and geographical mobility of labour is ignored
• assmes free trade
• assuumes perfect knowledge and awarness of comparative advantage in trading partners