Unit 18: Globalisation

Question 1

Definition of Comparative Advantage:

Answer 1

When one country can produce a good at a lower opportunity cost then another country (give up producing less of another good)

Question 2

Definition of Absolute Advantage:

Answer 2

A country’s ability to produce a good more efficiently than another country using the same amount of resources (can make more of a good with the same FOP resources). Means they are more productive.

Question 3

Definition of Exchange Rate:

Answer 3

the value of one currency in terms of another currency

Question 4

Definition of Balance of Trade:

Answer 4

difference between value of exports and imports

Question 5

Definition of Trade Surplus:

Answer 5

when export revenue is greater than import spending, this leads to a higher GDP

Question 6

Definition of Trade Deficit:

Answer 6

when import spending is greater than export revenue, this leads to a lower GDP

Question 7

Definition of Globalisation:

Answer 7

the process of greater integration and inter-connectedness between countries

Question 8

What is the IMF’s definition of Globalisation?

Answer 8

The international monetary fund (IMF) defines globalisation as “the process through which an increasingly free flow of ideas, people, goods, services and capital leads to the integration of economies and societies”

Question 9

What are the characteristics of Globalisation?

Answer 9

1) Growth of international trade
2) Trade liberalisation
3) Enhanced mobility of labour
4) Enhanced mobility of capital
5) Increased cultural exchange
6) Increased outsourcing
7) Failing transport costs (the death of distance
8) Increased international capitalism
9) Growth of size and influence of multinational corporations (MNC’s)

Question 10

Why do countries trade goods and services?

Answer 10

1) They cannot produce the goods themselves
2) They cannot produce them as cheaply or as well as others
→ If they have a greater comparative advantage for a good, they would export the good
→ If they have a greater comparative disadvantage for a good, they would import the good
3) Selling to foreign market improves economies of scale = becoming more competitive and better able to sell abroad

Question 11

Definition of Terms of Trade:

Answer 11

the ratio at which a country trades domestic products for imported products

Question 12

Terms of Trade formula:

Answer 12

(Px / Pm) x 100

Px = price of exports
Pm = price of imports

Question 13

Definition of Balance of Payments:

Answer 13

A record of all the transactions between the residents of that country and the rest of the world
→ Includes the sale of exports and any other receipts earn foreign currency
→ The purchase of imports or any other payments abroad requires foreign currency
→ This is used to view the economic relationship between a country and other economies

Question 14

What is the Exchange Rate regime from left to right?

Answer 14

1) Monetary Union
2) Fixed Exchange Rate
3) Crawling Peg
4) Dirty Float
5) Flexible Exchange Rate

Question 15

What are the determinants of Exchange Rates?

Answer 15

1) An increased demand for exports can cause an appreciation of the exchange rate, as it means increased demand for the domestic currency (maybe due to domestic goods becoming more competitive + cheaper)

2) A decreased demand for imports can cause an appreciation of the exchange rate, as it means a lower supply of the domestic currency in the economy (maybe due to foreign goods becoming less competitive + expensive)

Question 16

When do Balance of Payments balance?

Answer 16

In a floating exchange rate regime, the Balance of Payments always balances
→ A current account surplus means a financial account deficit
→ A current account deficit means a financial account surplus

Question 17

What are the 4 Macroeconomic Policy Objectives?

Answer 17

1) High and stable economic growth
2) Low unemployment
3) Low and stable inflation
4) Avoidance of Balance of Payments deficits and excessive exchange rate fluctuations

Question 18

What do the objectives depend on?

Answer 18

In the short run, all the objectives depend on aggregate demand

In the short run, all the objectives vary with the business cycle

Question 19

Can all 4 objectives be achieved at the same time?

Answer 19

The 4 objectives cannot all be achieved at the same time in the same “satisfactory” way
So, the government will face trade offs amongst objectives

→ high output and low unemployment means high inflation and a current account deficit too (economic boom)
→ low inflation and current account surplus means low output and high unemployment too (recession)

Question 20

Definition of International Competitiveness:

Answer 20

The ability of firms in a country to successfully compete with foreign firms. Refers to the sustained ability to sell goods and services profitably at competitive prices in a foreign country.

Question 21

What does the international competitiveness depend on?

Answer 21

International competitiveness is determined by the relative prices of goods traded and the exchange rate

International competitiveness = real exchange rate

Domestic firm is more internationally competitive = Appreciation of exchange rate (more demand for domestic currency)

Domestic firm is less internationally competitive = Depreciation of exchange rate (less demand for domestic currency)

Question 22

International Competitiveness formula:

Answer 22

(UK price index / Foreign currency price index) x nominal exchange rate

→ This is the nominal exchange rate adjusted for changes in aggregate prices in the 2 trading economies

Question 23

What do the demand for imports and exports depend on?

Answer 23

The demand for imports is determined by the real exchange rate

The demand for exports is determined by the real exchange rate and the level of income of the foreign country

Question 24

What are the steps involved in Kalecki’s Demand Driven Approach to growth?

Answer 24

1) Domestic markets driven by large firms who want to increase their mark-ups (profits) by reducing production costs

2) To reduce costs, variable costs (such as labour costs) can be more easily decreased

3) Since workers consume more of their income than capitalists, lower wages mean total (effective) demand also decreases
→ this creates underconsumption as domestic markets can’t consume all of the output, so the solution is to export to foreign markets (this shifts the problem globally)

Question 25

What is Kalecki's Marxist Demand Driven Approach?

Answer 25

The idea that increased trade allows domestic industries of advanced industrial countries (which today are dominated by giant firms aka MNEs), to jointly attempt to charge the joint profit maximising monopoly price → This pricing policy generates a tendency for deficient effective demand by reducing consumers expenditure. → This in turn reduces the incentive for domestic investment, leading outwards investment as a distinct possibility

Question 26

Definition of Specialisation:

Answer 26

When an individual, company or nation focuses on producing one good → Countries can benefit from trade if they specialise → countries specialise in the good they have a comparative advantage in as they produce the good more efficiently and cheaply

Question 27

Definition of Merchandise Trade:

Answer 27

→ Trade in goods → Trade in tangible products that are physically shipped across borders.

Question 28

How do we measure the extent of globalisation in goods and services?

Answer 28

1) measure the amount of trade in a country, or region, or the world as a world. → if it increased, we conclude that the country is becoming more globalised → we measure trends in the share of imports, exports, or total trade (imports + exports) in GDP as an indicator of globalisation → growth of GDP is taken into account as well trade to show globalisation 2) measure the additional costs associated with exporting goods relative to selling them domestically → when the costs of trading between countries fall, then the world is becoming more globalised (cheaper to trade + travel)

Question 29

What is the law of one price?

Answer 29

Holds when a good is traded at the same price across all buyers and sellers. If a good were sold at different prices in different places, a trader could buy it cheaply in one place and sell it at a higher price in another.

Question 30

What is a price gap?

Answer 30

A difference in the price of a good in the exporting country and the importing country. It includes transportation costs and trade taxes. When global markets are in competitive equilibrium, these differences will be entirely due to trade costs.

Question 31

Definition of Production Possibility Frontier:

Answer 31

maximum output with different combinations of 2 goods, using all the resources in the economy

Question 32

How can globalisation benefit exporting producers and importing consumers?

Answer 32

It leads to an increase in both the supply of exports and the demand for imports. → exporting firms will get greater revenue and importers will get cheaper and better quality goods

Question 33

What is Arbitrage?

Answer 33

The practice of buying a good at a low price in a market to sell it at a higher price in another. Traders engaging in arbitrage take advantage of the price difference for the same good between two countries or regions. As long as the trade costs are lower than the price gap, they make a profit.

Question 34

What are the 3 elements in the Balance of Payments?

Answer 34

1) Current Account 2) Capital Account 3) Financial Account

Question 35

What is included in the Current Account?

Answer 35

Current Account = records payments for trade in goods and services, plus net flows of primary and secondary income. It's a sum of the net balance of trade (imports and exports) in goods and services, net income payments received or paid to abroad (remittances), and government transfers like international aid.

Question 36

What is included in the Financial Account?

Answer 36

Financial Account = tracks changes in ownership of financial assets and liabilities between residents and non residents → net balance of foreign direct investment flows → net balance of portfolio investment flows → balance of banking flows (hot flows) → changes to the value of reserves of gold and foreign currency

Question 37

What will a greater supply of pounds lead to?

Answer 37

It will lead to a depreciation of the pound

Question 38

What will a decreased supply of pounds lead to?

Answer 38

It will lead to an appreciation of the pound

Question 39

What does an appreciated exchange rate mean for international competitiveness?

Answer 39

An appreciated exchange rate means a currency's value has increased against another currency → this makes exports more expensive → this makes imports cheaper

Question 40

What does a depreciated exchange rate mean for international competitiveness?

Answer 40

An depreciated exchange rate means a currency's value has decreased against another currency → this makes imports more expensive → this makes exports cheaper

Question 41

What are the 2 classes of society?

Answer 41

1) The Bourgeoisie (who control the means of production and wealth) 2) The Proletariat (who operate the means of production and are controlled by the Bourgeoisie) → the Bourgeoisie own the means of production and so control 'the money'

Question 42

What is a Monetary Union?

Answer 42

A monetary union is an arrangement where multiple countries adopt a single shared currency and a common monetary policy, eliminating exchange rate fluctuations between member states.

Question 43

What is a Fixed Exchange Rate?

Answer 43

A fixed exchange rate system is one in which a country’s currency value is officially pegged to another currency or basket of currencies and maintained through central bank intervention.

Question 44

What is a Crawling Peg exchange rate?

Answer 44

A crawling peg is an exchange rate regime where a currency is pegged to another but adjusted gradually and periodically to reflect inflation or economic conditions.

Question 45

What is a Dirty Float exchange rate?

Answer 45

A dirty float is an exchange rate system where a currency generally floats in the market but the central bank occasionally intervenes to stabilize or influence its value.

Question 46

What is a Flexible exchange rate?

Answer 46

A flexible exchange rate system is an exchange rate system where a currency generally floats in the market but the central bank occasionally intervenes to stabilize or influence its value.

Question 47

What does a high and low price gap represent?

Answer 47

High Price Gap = trade in expensive and globalisation Low Price Gap = more globalised world where trade is cheap

Question 48

Why does the price gap tend to equal the sum of all trade costs?

Answer 48

Because of Arbitrage. → By buying at a low price in export markets and selling at a higher price in import markets, traders can make a profit as long as the price gap is higher than the total costs of trade. → When traders engage in arbitrage in this fashion, they lower the supply of the good in the export market, driving up its price, and they increase the supply of the good in the import market, lowering its price. Both of these effects cause the price gap to decline. This should continue until price gaps have been driven down to the trade cost, and further arbitrage is unprofitable

Question 49

What are protectionist policies?

Answer 49

Measures taken by a government to limit trade; in particular, to reduce the amount of imports in the economy. These are designed to protect local industries from external competition. They can take different forms, such as taxes on imported goods or import quotas.

Question 50

Definition of Tariff:

Answer 50

A tax on a good imported into a country.

Question 51

Definition of foreign direct investment (FDI):

Answer 51

Ownership and substantial control over assets in a foreign country.

Question 52

What does a Current Account deficit mean?

Answer 52

a CA deficit means the value of imports is greater than the value of exports, and this is balanced by a surplus on the financial account (by selling off assets and bonds for foreign investors to buy, and more FDI). CA and FA added together must equal 0

Question 53

What does a Current Account surplus mean?

Answer 53

a CA surplus means the value of exports is greater than the value of imports.

Question 54

Why does Specialisation lead to international trade?

Answer 54

Specialisation⁠ entails trade because by producing a narrower range of goods and services than you use, you must engage in trade to acquire the ones you do not produce. International trade is the outcome of specialisation among countries.

Question 55

Definition of Economies of Scale:

Answer 55

These occur when doubling all of the inputs to a production process more than doubles the output. The shape of a firm’s long-run average cost curve depends both on returns to scale in production and the effect of scale on the prices it pays for its inputs. → when increasing production leads to lower unit costs and higher output

Question 56

Definition of Economies of Agglomeration:

Answer 56

The cost reductions that firms may enjoy when they are located close to other firms in the same or related industries.

Question 57

What does Specialisation do to the feasible consumption?

Answer 57

Specialisation has enlarged the feasible consumption set for both countries and allowed consumers to reach a higher level of utility (higher indifference curve), so trade is mutually beneficial → Because both countries are now specializing in the good in which they have a comparative advantage, the new consumption frontiers are above their production frontiers. For each country, the two frontiers meet at the point at which they do not trade, which given full specialization, correspond to each axis.

Question 58

What determines the extent to which trade increases the feasible set?

Answer 58

The relative price determines the extent to which trade increases the feasible set. This in turn, depends on how the price is determined → the relative price of the two goods affects how the gains from trade are divided between the countries

Question 59

Definition of bargaining power:

Answer 59

The extent of a person’s advantage in securing a larger share of the economic rents made possible by an interaction.⁠

Question 60

In the case of specialisation and international trade, who are the winners and losers?

Answer 60

Winners: 1) Domestic firms that produce the specialised goods 2) Foreign consumers that can get cheaper imported goods 3) Foreign firms that produce the good they specialise in Losers: 1) Domestic firms that produce the good that foreign countries specialise in 2) Workers that work in firms that produce the good that other countries specialise in

Question 61

Why do owners of relatively scarce factors of production in their own country prior to trade lose from specialization and trade, and the owners of relatively abundant factors gain?

Answer 61

Factors that are relatively scarce in their own countries, compared with in the rest of the world, are relatively expensive compared to prices elsewhere when there is no trade. When their economies start trading with the rest of the world their price is dragged down towards the world average, because they are effectively competing with their abundant counterparts in the rest of the world.

Question 62

What is an example of how there are winners and losers from specialisation and trade?

Answer 62

If a rich economy, relatively abundant in skilled labour, starts trading with a poor, unskilled, labour-abundant country, then unskilled workers in rich countries (and skilled workers in poor countries) will lose out relative to skilled workers in rich countries (and unskilled workers in poor countries), who will gain.

Question 63

Why might the disadvantaged group still be in favour of trading?

Answer 63

If the gains from trade are large enough it could still be the case that the members of the group that is relatively less well off within a country are made better off in absolute terms by the specialization and trade.

Question 64

How does specialisation affect the economy in the long run?

Answer 64

Specialising in the production of the good in which it has a comparative advantage increases the productivity of labour (workers have moved from producing electronics to producing aircraft, where they are more productive). This shifts up the price-setting curve and output per worker. → real wage increases

Question 65

How does immigration affect the economy in the short run?

Answer 65

When new people arrive in a nation they are unemployed, so it increases unemployment. This means that immigration also increases the cost of job loss for residents, because the worker who loses a job is now in a larger pool of unemployed workers. Workers have more to fear from losing their jobs, and firms will be able to make employees work effectively at a lower wage. → Firms are now getting work at lower wages, and so are more profitable. → In the short run, immigration is bad for existing workers in that country: wages fall and the expected duration of unemployment increases.

Question 66

How does immigration affect the economy in the long run?

Answer 66

Firms are now getting work at lower wages, and so are more profitable. As a result they will seek to expand production. To do this, they will invest in new machinery. This will increase labour demand in the rest of the economy, and when the new capacity is ready, firms will hire more workers. → In the longer run, the increased profitability of firms leads to expanded employment that eventually will restore the real wage and return the economy to its initial rate of unemployment → Immigrants will also consume, which will increase demand

Question 67

What is the trilemma of the world economy?

Answer 67

His trilemma refers to three things, all of which are valued, but which cannot all occur at the same time. → Rodrik's trilemma is a trade off between these 3 dimensions: 1) Hyper globalisation: A world in which there are virtually no political or cultural barriers to the location of goods and investment. 2) Democracy within nation states: This means that the government respects both individual liberty and political equality. 3) National sovereignty: Each national government can pursue policies that it chooses without any significant limits imposed on it by other nations or by global institutions.

Question 68

Why is there a trade off between Hyper globalisation, Democracy within nation states and National sovereignty?

Answer 68

Hyper globalisation⁠ means that countries have to compete with each other for investment, with the result that wealth owners will seek locations for their investments in which labour has fewer rights and the environment is less protected. This makes it difficult for national governments to adopt regulatory standards or other policies, or raise taxes on mobile capital or highly paid workers, even when citizens think that fairness requires this. Implementing hyper globalisation may be impossible in a democratic society. → Effective global governance is also inconsistent with complete national sovereignty

Question 69

What are the benefits of greater global economic integration?

Answer 69

1) Competition = international trade means an increase in competition for domestic firms. This means that firms that fail to adopt new technologies and other cost-cutting methods are more likely to fail and to be replaced by more dynamic firms. The result will be an increase in the rate of technological progress. 2) The Size of the Market = A firm that can export to the world market has the opportunity of selling far more than it could were it restricted to the domestic market. This allows lower-cost production, which benefits home-economy buyers, employees, and owners of these successful firms, as well as external buyers. → economies of scale

Question 70

What are the disadvantages of greater global economic integration?

Answer 70

1) Infant industries need the time to gain efficiency and stabilise before competing with international firms, as they will otherwise be outcompeted. → Tariffs protecting infant industries can give firms the time and possibly the scale of operation necessary to become competitive as costs of production typically fall over time as they learn by doing. 2) Disadvantageous specialisation = some countries may specialise in sectors will little growth potential. → Many Latin American countries, for example, slowed growth by specializing in low-innovation sectors such as natural resource extraction.

Question 71

What are some government policies to promote long run growth in living standards?

Answer 71

1) Close the national borders and withdraw from the world economy = protectionist policies like tariffs 2) Free trade, immigration and investment across national boundaries, without any government regulation

Question 72

Definition of Infant industry:

Answer 72

A relatively new industrial sector in a country that has relatively high costs, because its recent establishment means that it has few benefits from learning by doing, its small size deprives it of economies of scale, or a lack of similar firms means that it does not benefit from economies of agglomeration. Temporary tariff protection of this sector or other support may increase productivity in an economy in the long run.

Question 73

What is the relative price?

Answer 73

It is the opportunity cost

Question 74

Without trade, what would the feasible consumption frontier be?

Answer 74

The feasible consumption frontier would equal the PPF Consumption frontier = PPF → Countries must consume what they produce → Consumption choices limited by domestic technology → Any move outside PPF is impossible without trade

Question 75

When would countries be open to trade?

Answer 75

A country would specialise and sell a good if the world price is greater than their relative price A country would buy the specialised food from the foreign country if the world price is less than their relative price

Question 76

What is the world price?

Answer 76

Price of one good / Price of the other good

Question 77

What happens when 2 countries trade?

Answer 77

Both countries consume more of both goods → they both reach points outside of their PPFs → they both gain from trade → trade works because world prices differ from domestic opportunities cost

Question 78

Where can be the MRT be found?

Answer 78

The Marginal Rate of Transformation (MRT) is the slope of PPF → the MRT measures how much of one good must be given up to gain one more of another good

Question 79

How does MRT relate to comparative advantage?

Answer 79

A lower MRT means a lower opportunity cost, which means that the country may have a comparative advantage in the good

Question 80

What does the price setting curve reflect?

Answer 80

PS reflects firms’ real wage they can afford: W/P = 1/ (1+u) Determined by: → Productivity → Mark-ups → Input costs

Question 81

Definition of Return to Capital:

Answer 81

It is a financial ratio that measures how efficiently a company turns its capital into profit → it indicates the efficiency and profitability of a company's capital investment