1
Q
International Trade
A
The exchange of goods and services across international borders.
2
Q
Emerging economies
A
Economies which are making the transition from a low income/developing country to a high income developed country.
e.g China, India, Brazil ,Mexico
Often have high economic growth
3
Q
A developing country
A
A country with less developed industrial base and a low Human development index (HDI) relative to other countries.
Also have low gdp per capita and low standards of living.
Export more primary goods then manufactured goods and services.
4
Q
A developed country
A
Relatively high economic growth and security. Standard of living is high, they also have high gdp per capita, are industrialised and have high standard of technological infrastructure
High hdi
5
Q
HDI
A
Human development index.- measures economic and social welfare of countries over time. 0-1, higher value = more developed the country is.
- Life expectancy at birth (long and healthy life)
- Expected years of schooling. (Knowledge)
- GNI per capita (decent standard of living)
6
Q
Reasons for changing patterns of trade
Cost advantages:
A
Cost advantages: Some countries have cost advantages in the production of some goods and services, so they can product them (and export them) at lower costs.
7
Q
Reason for changing patters of trade:
Growth of trading blocs and bilateral agreements, (definitions)
A
A trading blocs are groups of countries that form agreements to promote trade among themselves.
Bilateral trading agreements are agreements between two countries to facilitate (make trade easier) trade.
8
Q
Reason for changing patters of trade:
Changes in relative exchange rates:
A
Changing exchange rates determine the price of exports and imports and so can affect the competitiveness of a country’s exports
9
Q
Advantages of Trade
A
Higher quality of goods as countries specialize.
Increased variety of goods and services produced and consumed, increasing living standards.
Lower average costs as market becomes more competitive.
PPC outwards as specialisation increases productivity
10
Q
Disadvantages of Trade
A
Developing countries may use up resources to quickly, so growth is not sustainable
If production moves abroad, because labour is cheaper, there could be structural employment.
Countries that are export led economies are more vulnerable to changes in world demand for the goods and services they export
11
Q
The exchange rate
A
The price of one currency in terms of another.
12
Q
Bilateral exchange rate
A
Measures the exchange rate for two countries. e.g the value of the pound sterling against the dollar
13
Q
Nominal exchange rate
A
Measures the actual monetary value and the amount of currency you can get e.g. £1 = $1.5
14
Q
Real Exchange rate
A
Takes into account inflation and measures the amount of goods you can exchange
15
Q
A trade weight Index
A
Means that we measure the value of the British Pound against a basket of currencies. (most important currencies are weighted)
16
Q
Floating exchange rate
A
The value of an exchange rate in a floating system is determined by the market forces of supply and demand
17
Q
Factors that affect a exchange rate:
Inflation
Interest Rates
A
Inflation: Countries with low inflation rate tend to see a appreciation in the value of their currency. Exports become cheaper (+ more competitive) if inflation falls.
Interest Rates: If UK interest rates rise relative to elsewhere, it’ll become more attractive to deposit money (due to higher return). Therefore demand for the sterling rises, causing “hot money flows”
18
Q
Factors that affect a exchange rate:
Speculation:
Balance of payments:
A
Speculation: If investors anticipate a country’s economy will improve, they will buy its currency, increasing demand and its value. Conversely, if they expect a decline, they will sell the currency, causing its value to fall.
Balance of payments: If a country has a large current account deficit (meaning it imports more than it exports) , it may cause depreciation because there is a net outflow of currency
19
Q
A fixed change rate
A
A fixed exchange rate has a value determined by the government compared to other currencies.
Monetary authorities control the exchange rate through buying and selling of the country’s currency on the foreign exchange market, and through changes in interest rates.
20
Q
Devaluation
A
This is when the value of a currency is officially lowered in a FIXED exchange rate system.
21
Q
Revaluation
A
This is when the value of a currency is officially raised in a FIXED exchange rate system
Deliberate to strengthen the currency’s value.
Makes exports more expensive but imports cheaper
22
Q
Competitive devaluation
A
Occurs when a country deliberately intervenes to drive down the value of their currency to provide a competitive raise to demand and jobs in their export industries.
May do this when faced with deflationary recession
23
Q
Factors that determine the supply and demand of a currency.
Relative interest rates:
Relative inflation rates:
A
Relative interest rates: Higher interest rates encourage “hot money flows” (increases demand for the currency), causes an appreciation
Relative inflation rates: A higher inflation rate in the UK compared to other countries will tend to reduce the value of the pound sterling. (goods + services become more expensive)
24
Q
Hot money
A
Is the flow of funds from one country to another to another in order to earn a short term profit on interest rate differences or anticipated interest rate shifts
25
Effect of exchange rates on AD (consequences)
Exchange rates affects AD because it affects the price of exports and imports. If the exchange rate appreciates, AD is likely to fall since imports becomes cheaper to domestic consumers and exports will become more expensive to foreign consumers.
26
Effect of exchange rates changes on firms (consequences)
Effect?
Depends on?
A depreciation in the pound means that UK exports become more price competitive but cheaper to foreign eyes.
Depends on elasticity of demand for Exports
Depends on the rate of economic growth in the export market
Depends on disposable income/confidence to see whether they'll actually buy the exports
27
The Marshall-Lerner Condition
The Marshall-Lerner Condition is an economic condition that states the circumstances under which a depreciation or devaluation of a country's currency will lead to an improvement in its balance of trade (or Current Account).
PEDx + PEDm > 1
28
What is the J curve and how do you draw it?
J Curve shows the time lags between a falling currency and a improved trade balance.
29
Factors that determine the supply and demand of a currency.
The current account of the balance of payments:
UK exports create a demand for the sterling whereas imports into the UK create a supply of sterling on the foreign exchange market; therefore an increasing trade surplus would cause an increase in the value of sterling
30
Factors that determine the supply and demand of a currency.
Speculation:
Hot money flow is the flow of funds (or capital) from one country to another in order to earn a short term profit on interest rate differences and anticipated exchange rate shifts. If speculators feel that the exchange rate of a currency will rise they will increase the demand for that currency and take advantage of expected future rises, they search for the best return.
31
Effect of exchange rate changes on the current account deficit on balance of payments. (consequences)
Depreciation vs appreciation.
A depreciation or devaluation will increase the competitiveness of a country's goods and services by causing a fall in the foreign currency price of its exports and an increase in the domestic price of imports, therefore current account position should improve
32
Evaluating the effects of a currency depreciation: (depends on?)
Time lags?
Scale?
The length of the time lags as consumers and businesses respond.
The scale of any change in the exchange rate e.g 5%, 10%
33
Evaluating the effects of a currency depreciation: (depends on?)
PED?
Multiplier effect/ accelerator
Type of economy?
PED: Price elasticity demand for imports and exports
The size of any second round multiplier and accelerator effects.
The type of economy (e.g small developing, hic?)
34
Advantages of a fixed exchange rate
Helps reduce inflation:
Helps to reduce inflation:
If a country has a fixed exchange rate, it must keep inflation low. If inflation rises, the currency will fall below its target value. This makes exports more expensive compared to other countries, so demand for them decreases. To keep the exchange rate stable, the country needs to control inflation
35
Advantages of a fixed exchange rate.
Helps reduce uncertainty and increase investment
A fixed exchange rate helps reduce uncertainty for businesses and encourages them to invest. When the exchange rate stays stable, firms know what to expect when they buy or sell goods abroad. This makes it easier for them to plan for the future.
36
Disadvantages of a fixed exchange rate
Wrong value:
If you join an exchange rate at the wrong value, it can cause certain problems. If the value of the exchange rate is too high, then exports will become uncompetitive; this can lead to lower demand and lower growth
37
Disadvantages of a fixed exchange rate:
Current account imbalance
If an economy joins an exchange rate at the wrong level, it can cause current account imbalance. For example, in 2007 economies like Spain and Greece were overvalued, but in the euro they could've devalue, so it led to large current account deficits
38
Disadvantages of a fixed exchange rate:
Conflict with other macroeconomic objectives:
To keep a fixed exchange rate, a country may need to raise interest rates or use reserves if the currency is overvalued.
Higher interest rates defend the exchange rate but reduce spending and growth, creating a conflict with objectives like low unemployment.
39
Disadvantages of a fixed exchange rate:
Less flexibility:
With a fixed exchange rate, a country cannot devalue to absorb shocks.
If something like oil prices rises, an oil-importing country faces higher import costs and a worsening current account, with no exchange-rate adjustment available.
40
Floating exchange rate advantages:
Monetary policy autonomy
Have the freedom to set monetary policy, interest rates and / or quantitative easing to meet domestic objectives such as economic growth, inflation and unemployment without being constrained by exchange rate considerations
41
Floating exchange rate advantages:
Insulation for an economy after an external shock especially for export dependent countries
allows countries to absorb external shocks more effectively, if a country faces a crisis such as a recession, the exchange rate acts as a shock absorber by helping rebalance the economy (automatic stabiliser)
e.g the recession may lead to a central bank lowering interest rates as expansionary monetary policy which means less hot money flows into the country = less D for the currency = depreciation = exports cheaper to foreign eyes
Ad wouldn't have moved leftwards by as much
42
Floating exchange rate advantages:
Partial automatic correction for a current account deficit.
Any disequilibrium in the balance of payments would be automatically corrected by a change in the exchange rate. For example, if a country suffers from a deficit in the balance of payments then, other thing being equal, the country's currency should depreciate as the deficit highlights a lack of demand for / oversupply of the currency
This would make the country's exports cheaper, thus increasing demand, while at the same time making imports expensive and decreasing demand, therefore restoring the balance of payments equilibrium.
43
Floating exchange rate advantages:
Currency reserves
The central bank does not need to hold large foreign currency reserves because there is no specific currency target, financial capital can flow freely across countries seeking the best returns.
44
Floating exchange rate disadvantages:
Exchange rate volatility
Exchange rates are subject to the forces of supply and demand and so can experience rapid and unpredictable currency fluctuations.
This means exporting firms may see the demand for their exports change so revenues change and firms who import raw materials may see the price of those raw materials change so costs change, both of these affect the profitability of firms who import and export.
This uncertainty may also deter inward investment as costs and profits become less certain. These factors affect the balance of payments on current account and AD.
45
Floating exchange rate disadvantages:
Inflation pass through:
Exchange rate fluctuations can lead to changes in import prices which increases the cost of imported raw materials so increases business costs.
This pushes SRAS inwards so causes cost-push inflation
46
Floating exchange rate disadvantages:
Loss of exchange rate as a policy tool.
Whilst floating exchange rates mean countries have monetary policy autonomy, they cannot use exchange rates as a policy tool
47
Globalisation
Globalisation is the increasing integration of the world economies.
48
Factors contributing to globalisation in the last 50 years.
Transportation and communication costs.
The efficient forms of transport make it easier and cheaper to transfer goods across international borders, this means global firms can locate labour intensive production where labour is plentiful and so cheap, and then they transport goods and markets.
Containerisation means that goods are distributed in standard sized containers, so its easier to load and cheaper to distribute using rail and sea transport.
This helps meet world demand, cargo moves faster, economies of scale can be exploited and less labour required. causes prices to fall keeping markets competitive.
also tech, easier to communicate
49
Factors contributing to globalisation in the last 50 years.
Trade liberalisation
The growing strength and influence of organisations such as the world trade organisation (WTO), which advocates free trade, has contributed to the decline of trade barriers.
There has also been a trend towards creating free trade areas and custom unions e.g the EU Removal of protectionist measurers and the creation of free trade areas makes trade easier and cheaper, so firms trade more and globalisation increases.
50
Factors contributing to globalisation in the last 50 years.
Deregulation of financial markets.
Over time there has been a lessening of financial regulations which means its easier for financial capital to move between countries. This makes it easier for firms to operate globally.
For example, the flow of capital and FDI across international borders has increased. China and Malaysia have financed their growth with capital flows.
Also the ownership of firms has increased and there has been more investment in factories abroad. The removal of capital controls has facilitated this increase
51
International competitiveness
International competitiveness means the ability of a country's producers to compete successfully in world markets.
International competitiveness is a way of measuring productivity and the relative costs of goods and services produced in a nation.
52
Measurements of international competitiveness.
Relative unit labour costs (cost to make a unit):
Relative unit labour costs (cost to make a unit): Which compares the costs of labour in one country to another
Unit labour costs = total labour cost / output
Generally the cheaper the relative labour costs, the more competitive the country in manufacturing. e.g china and bangladesh have lower labour costs ten countries such as the uk and us, so production for textiles, clothes and technology has been moved abroad.
However higher prices could compete if a niche market is targeted or by using product differentiation: Quality is also important, german and Japanese cars are famous for their quality, therefore less elastic.
53
Measurements of international competitiveness.
Relative export prices:
Relative export prices: Which compares the price of exports in one country to another
the lower the relative export prices, the more competitive the country as a country's products are more attractively priced in international markets
54
Factors affecting international competitiveness:
Ability to attract FDI from MNCs,
Ability to attract entrepreneurs.
MNCs may bring more productive processes, thus reducing costs of production which my be passed on as lower export prices.
Entrepreneurs may help develop new ideas and stimulate innovation, cutting costs of production which may also be passed on as lower export prices.
Particularly important for developing countries who may lack the capital and production expertise to be able to compete internationally.
55
Factors affecting international competitiveness:
Ability to attract (skilled) labour from abroad:
This might fill a skills gap in, for example IT or biotechnology improves the quality of the labour force.
If there is a skills gap, firms face higher costs. A higher skilled and more flexible labour force (one that can easily move between jobs) could lower unit labour costs.
An increase in the labour force should lower wages, ceteris paribus, and therefore lower unit labour costs
56
Factors affecting international competitiveness:
Unit labour costs
Unit labour costs rise when wages increase at a faster rate then productivity. Chinas large population means wages are generally low, but the rise of the middle class and consumer spending is pushing wages up.
China has a large supply of labour and so unit labour costs used to be low; however labour costs have been rising so no long has this cost advantage. Labour productivity can also be improved by having an effective mix of labour and capital.
57
Factors affecting international competitiveness:
Inflation:
High relative inflation to other countries makes a country's exports relatively more expensive so reduces international competitiveness
58
Factors affecting international competitiveness:
Regulation
Excessive regulation (red tape) can make it hard for firms to invest and it could raise their average costs of production.
In France, there are excessive employment laws that make costs of production higher and reduce the flexibility of the labour force, this increases wage costs.
Therefore, excess regulation increases the costs of production, which can mean high prices so exports are more expensive and international competitiveness falls.
59
Absolute advantage definition.
Absolute advantage means that an economy can produce a greater total of goods for the same quantity of inputs.
This means that a country has absolute advantage in the production of a good or service if it can produce it using fewer resources and at a lower cost than another country
60
Absolute advantage example.
61
Comparative advantage
Comparative advantage occurs when a country can produce both goods at a lower absolute cost than another country. This means that a country can produce both goods relatively cheaper than another country
62
Problems with the theories comparative and absolute advantage.
Assumes 2 countries and 2 goods
Assumes double coincidence of wants
Ignores transport costs
Ignores negative externalities of production
Doesn't consider who benefits from trade/ We need to consider terms of trade
63
Terms of trade
Terms of trade measures the volume of imports an economy can receive per unit of exports.
It helps us understand who gains from trade. It is calculated by the index price of exports over the index price of exports.
Terms of trade= Index of export prices / Index of import prices X 100
64
Why do emerging economies affect world trade patterns?
Growing countries import and export more as their economies expand.
They take up a larger share of global trade (e.g., China).
Trade is more important for developing countries (20% of GDP) than developed ones (8% for the U.S.).
After communism collapsed, more developing nations joined global trade
65
How do trading blocs and bilateral agreements affect world trade patterns?
They reduce trade barriers → increasing trade between member countries.
Trade with non-members tends to decrease.
UK example:
Joining EU → more trade with EU, less with others.
Leaving EU → UK–EU trade fell (imports fell more than exports).
66
How do exchange rate changes affect world trade patterns?
Exchange rate shifts change the prices of exports and imports.
A weaker currency → imports more expensive, exports cheaper (but effect may be delayed: J-curve).
China example: keeps currency weak to boost exports, but now cautious due to fear of retaliation.
Exchange-rate movements change global trade flows.
67
How can government policy affect trade patterns in developing countries?
Some countries remain stuck exporting primary goods due to comparative advantage traps.
Diversifying is difficult because of limited capital, skills, and resources.
Government policy can either help diversification or keep economies dependent on primary exports
68
What is globalisation and how does it affect living standards overall?
Globalisation increases interdependence between countries.
Leads to more specialisation and trade, increasing world output.
Higher output → economic growth, which can improve living standards.
Effects vary between developed, emerging, and developing economies.
69
How does globalisation affect living standards in developed countries?
Greater access to a wide range of goods/services.
Increased consumer choice and consumer welfare.
Cheaper imports → firms produce at lower cost → consumers buy more with same income.
Overall: higher living standards, though some local industries may face competition.
70
How does globalisation affect living standards in emerging economies?
Can use comparative advantage to export goods/services to rich countries.
Leads to economic growth and falling unemployment.
Rising incomes → creation of a middle class.
Overall: significant improvements in living standards.
71
How does globalisation affect living standards in developing countries?
New export markets for primary and secondary goods.
Generates some economic growth.
Absolute poverty has fallen as more trade opportunities open up.
BUT many remain stuck exporting low-value goods and struggle to diversify.
72
Why hasn’t globalisation benefited everyone in emerging economies?
Globalisation can increase income and wealth inequality.
Example: China — urban areas have seen big rises in living standards, but large rural populations remain poor.
Growth is often uneven: cities benefit most, while rural areas lag behind.
Result: improvements in living standards are not shared equally.
73
Why do many developing countries experience limited improvements in living standards
Their comparative advantage is usually in low-value primary goods and commodities.
Commodity prices are volatile, making growth unstable.
Difficult to boost growth through exports of low-value goods.
Low incomes mean many imports are unaffordable, limiting access to better goods/services.
Overall: only limited improvement in living standards.i
74
How has globalisation caused structural change in developed countries?
As countries specialise, economies shift their structure.
In developed countries, manufacturing has declined because production moves to emerging economies with lower costs and comparative advantages.
This can cause regional economic decline and unemployment (e.g., North-East UK).
Loss of manufacturing → lower living standards in affected regions.
75
How have emerging and developing economies been affected by structural change?
Back:
Emerging economies benefit most: manufacturing shifts to them →
Higher output
Economic growth
More employment
Developing economies benefit less because they often lack:
Capital
Finance
Skilled labour
Therefore, they cannot fully exploit industrialisation opportunities.
76
What is FDI and why do MNCs invest in other countries?
FDI: When multinational corporations invest directly in another country (factories, offices, infrastructure).
MNCs invest abroad to:
Access new markets
Use natural resources (oil, gas)
Access skilled or cheap labour
Reduce production costs
Globalisation has increased the scale of FDI worldwide.
77
What are the benefits and drawbacks of FDI for developing, emerging, and developed countries?
Benefits for developing countries:
More employment, higher incomes → better living standards
MNCs bring capital, technology, skills → boosts productivity
Higher tax revenue (income tax + corporation tax) → more gov spending → more growth
Benefits for emerging & developed countries:
Profits from MNCs often flow back to them (repatriated profits).
Problems for developing countries:
Profit outflows mean limited long-run benefit
MNCs may exploit workers (sweatshops, low wages) due to weak regulation
Living standards may not rise much if gains leave the country
78
What cultural, political, and competitive effects does globalisation create?
Cultural:
“Americanisation” — global spread of brands + culture.
Political:
MNCs may influence governments → loss of sovereignty.
Competition:
Firms face more competition, forcing them to cut average costs and become efficient.
They may relocate production to lower-wage countries.
Faster tech spread → more advanced production method
79
How does globalisation affect the environment and vulnerability to shocks?
Environmental:
More industrialisation + higher living standards increase pollution and resource use (cars, factories).
Environmental damage: deforestation, water scarcity, land degradation.
But rising incomes can also increase environmental awareness.
External shocks:
More integration → economies more vulnerable to global recessions.
Financial interconnectedness increases risk of financial crises spreading.
80
What is protectionism and what forms can it take?
Protectionism: Actions taken by a government to restrict international trade and protect domestic industries from foreign competition.
Tools include:
Tariffs
Quotas
Regulations/standards
Embargoes
Purpose: reduce imports, protect jobs, safeguard strategic industries
81
What is economic integration and why do countries form trading blocs?
Economic integration = countries reducing trade barriers between each other.
Forms include: Free Trade Areas, Customs Unions, Common Markets, Monetary Unions.
Trading blocs encourage free trade among members to gain from specialisation and comparative advantage.
Example: NAFTA, EU, EFTA
82
What is the difference between a Free Trade Area and a Customs Union?
Free Trade Area (FTA):
Members remove trade barriers between each other.
BUT each member sets its own tariffs against non-members.
Example: NAFTA, EFTA.
Customs Union:
Members remove internal trade barriers AND
Adopt a common external tariff against non-members.
Also coordinate rules and policies.
Example: the EU Customs Union.
83
What is the difference between a Free Trade Area and a Customs Union?
Free Trade Area (FTA):
Members remove trade barriers between each other.
BUT each member sets its own tariffs against non-members.
Example: NAFTA, EFTA.
Customs Union:
Members remove internal trade barriers AND
Adopt a common external tariff against non-members.
Also coordinate rules and policies.
Example: the EU Customs Union.
84
What is a common market and what are its key features?
Common market =
Free trade between members
Common external barriers (like a customs union)
Free movement of factors of production: labour, capital, goods, services
The EU Single European Market is a common market:
Makes trade cheaper/easier → higher productivity, lower prices, higher consumer surplus
Promotes investment and labour mobility → boosts growth
Differs from a monetary union (no shared currency) and from a customs union (adds factor mobility).
85
What is a monetary union and what are its key features?
Monetary union = countries adopt a single currency and share a common monetary policy.
Requires:
Same interest rate
Coordination of inflation, government debt, budget deficits
Usually built on top of a common market (free movement of labour, capital, goods, services).
Works best when member countries have similar economies and respond similarly to economic shocks
86
What are the key features of the Eurozone monetary union?
Euro introduced in 1999 → created the Eurozone.
All members use:
Same interest rate (set by ECB)
Same currency (Euro), which floats vs USD/GBP.
Members must meet convergence criteria, e.g.:
Budget deficits < 3% of GDP
Optimal conditions include:
Similar responses to shocks
Mobile labour + flexible wages
Ability to share fiscal transfers between regions
87
What happens in a tariff diagram when a tariff is imposed on imports?
Free trade (before tariff):
World supply curve = WS (perfectly elastic).
Price falls to Pw.
Domestic supply = Q1, domestic demand = Q2.
Imports = Q2 – Q1.
2. After tariff:
Tariff shifts world supply curve up to WS + Tariff.
Domestic price rises to Pw + Tariff.
Domestic supply increases to Q3.
Domestic demand falls to Q4.
Imports fall to Q4 – Q3.
3. Overall effect:
Higher price for consumers
Increase in domestic output
Decrease in imports
Tariff achieves protectionist goal of supporting domestic producers
88
What are the main economic effects of a tariff? (Consumer, producer, government, current account, welfare)
Consumers:
Pay higher prices, buy fewer goods → consumer surplus falls → lower living standards.
Producers:
Domestic firms gain producer surplus.
Higher demand may increase investment & jobs (derived demand for labour/capital).
Government:
Gains tax revenue from the tariff; can use for public spending elsewhere.
Current Account:
Imports fall → improves the current account (imports are a debit).
Welfare:
Overall welfare falls because the loss in consumer surplus is larger than the gains to producers + government.
Deadweight loss means society is worse off.
89
Evaluate the effectiveness of tariffs as a protectionist policy.
Size matters: A small tariff won’t raise prices much → limited effect on imports.
Sunrise industries: Tariffs can help new industries grow and achieve economies of scale.
Sunset industries: Protecting declining industries is inefficient → resources should shift to newer sectors.
Retaliation risk: Other countries may impose tariffs in return → reduces exports → hurting living standards.
Reduced global trade: Retaliation + protectionism erode gains from trade → long-run welfare falls for all.
90
In a quota diagram, what happens to:
Price
Domestic supply
Domestic demand
Imports
(And what curve shifts?)
Before quota (free trade):
World price = P1
Domestic supply = Q2
Domestic demand = Q1
Imports = Q1 − Q2
After quota:
Quota forces a leftward shift of world supply available to the domestic market, shown as S → S1.
Domestic price rises to P2.
Domestic supply increases to Q3.
Domestic demand falls to Q4.
Imports = Q3 − Q2 (the quota amount), which is smaller than before.
Overall effect:
Price ↑
Domestic supply ↑
Domestic demand ↓
Imports ↓
Quota protects domestic producers but reduces consumer welfare.
91
What is trade creation, and what happens in the diagram when it occurs?
Trade creation = when free trade within a trading bloc leads to increased trade.
92
Draw a trade creation diagram.
Remove tariff = price falls = imports rise
Consumer surplus ↑ massively
Producer surplus ↓ (lose E)
Tax revenue disappears (lose G + H)
Deadweight loss (F + I) becomes welfare gain → trade creation improves total welfare.
93
What is trade diversion,
Trade diversion = when consumption shifts from a lower-cost producer outside the trading bloc to a higher-cost producer inside the bloc.
94
What are the main arguments for protectionism?
1. Infant Industry (sunrise industries)
New industries need protection until they gain economies of scale.
Tariffs/quotas shield them from foreign competition.
✔ 2. Declining Industry (sunset industries)
Protects industries that still employ many workers.
Helps manage decline to avoid mass unemployment.
✔ 3. Diversification Argument
Tariff revenue can be used to help a country diversify away from dependence on a few goods.
Reduces vulnerability to external shocks.
✔ 4. Balance of Payments
Tariffs reduce imports → improves current account (imports are a debit).
✔ 5. Market Failure Argument
Protection can be placed on demerit goods / negative externalities.
Reduces consumption and deadweight loss.
95
What are the main arguments against protectionism?
1. Allocative inefficiency
Protects inefficient firms that should exit.
Keeps resources in unproductive industries.
✔ 2. Higher prices for consumers
Tariffs raise prices → consumer surplus falls → living standards fall.
Consumers have less choice / buy less.
✔ 3. Retaliation + Trade Wars
Other countries may respond with tariffs.
Reduces exports → lower growth → possible job losses.
✔ 4. Loss of consumer sovereignty
Consumers forced to buy domestic goods even if they are worse/expensive.
✔ 5. Costs passed on to businesses
Domestic firms using imported raw materials face higher costs → lower profits → possible job losses.
96
What are the main arguments for free trade? (3 key points)
1. Specialisation & Comparative Advantage
Countries specialise in what they’re best at → higher output, lower costs.
Raises world GDP + living standards.
Removes tariffs → trade creation.
✔ 2. Competition Argument
Free trade increases competition → forces firms to reduce costs, improve efficiency, cut x-inefficiency.
Leads to lower prices and more consumer choice.
Larger markets → economies of scale.
✔ 3. Economic Growth Argument
Access to larger export markets → higher sales → higher profits → more investment.
More jobs, lower unemployment → higher economic growth.
97
What are the extended arguments against free trade? (3 key points)
✔ 1. Environmental Damage
Developing countries overuse scarce resources to produce exports → pollution + negative externalities.
Rich countries may “pollution shift” by importing from nations with weak environmental laws.
✔ 2. Job Losses & Structural Unemployment
Production shifts to low-cost countries → job losses in developed economies.
Outsourcing leads to unemployment in industries that can’t compete.
✔ 3. Dumping (from previous page)
Excess stock sold below cost → destroys domestic industries in importing countries.
➡️ Free trade can create negative side effects even if it raises global welfare overall.
98
What does the impact of free trade/protectionism depend on? (Evaluation points)
1. Size of Tariff / Trade Barriers
Large tariffs = bigger welfare loss & more trade diversion.
Small tariffs = limited effect.
✔ 2. Information Failure
Governments may not know the “right” tariff size → could be too high or too low → inefficiency.
✔ 3. Likelihood of Retaliation
High chance of retaliation = reduced exports + lower living standards.
Big tariffs make retaliation more likely.
✔ 4. Who Gains Depends on Terms of Trade
Developed countries gain more from free trade.
Developing countries may gain less (low-value exports → weaker terms of trade).
✔ 5. Distribution of Benefits
Free trade increases average living standards, but gains are unevenly distributed.
99
What is the role of the WTO in promoting free trade? (Functions & mechanisms)
1. Trade Liberalisation
WTO aims to reduce trade barriers (tariffs, quotas).
Organises trade negotiation “rounds” (e.g., Doha Round).
✔ 2. Ensures countries follow trade agreements
Enforces WTO rules (MFN — Most Favoured Nation).
MFN = treat all trading partners equally unless in a trade agreement.
✔ 3. Dispute Settlement Mechanism
Countries can file complaints.
WTO investigates → issues rulings.
If a country breaks rules, WTO can allow retaliatory sanctions.
Example: US tariffs on Airbus after ruling against EU subsidies (2018).
✔ 4. Encourages predictable global trade
Provides a legal framework for trade relationships.
100
Evaluate the effectiveness of the WTO in promoting free trade.
Freer trade → higher living standards, more specialisation & comparative advantage.
Significant increase in world trade since WTO began.
Helped reduce absolute poverty through trade growth.
Settles trade disputes and prevents trade wars.
✔ Arguments Against:
WTO may be seen as too powerful.
Developed countries influence rules more than developing nations.
Many trade disputes remain unresolved or move slowly.
Some argue WTO does not fully address developing countries' needs (market access, agricultural subsidies).
101
What are the main successes of the WTO? (3 key points)
1. Trade Liberalisation & Economic Growth
WTO has lowered tariffs and barriers worldwide → more accessible global trade.
Increased economic growth and helped integrate developing countries.
Contributed to poverty reduction and better global market access.
✔ 2. Dispute Settlement Mechanism (DSM)
Provides rules-based system for resolving trade disputes.
Adds predictability and structure to global trade.
Has handled hundreds of disputes.
✔ 3. Inclusive Membership
160+ member countries, including developing economies.
Gives developing nations a platform in global trade policymaking
102
What are the main criticisms of the WTO?
1. Conflict with Trading Blocs
Common external tariffs violate WTO “equal treatment” rules (MFN).
WTO struggles to prevent protectionism inside blocs.
✔ 2. Slow & Ineffective Negotiations
Doha Round has stalled for decades.
Resistance from large economies (USA, Japan, EU) slows progress.
✔ 3. Transitional Costs of Free Trade
Free trade causes short-term job losses, firm closures, and output loss.
Nations sometimes protect industries temporarily, conflicting with WTO rules.
✔ 4. Powerful Members Dominate
Developed countries shape rules more than developing ones.
Some argue the WTO doesn’t fairly support poorer nations.
✔ 5. “Who Gains?”
Free trade increases global welfare, but gains are unevenly shared.
103
What are the main limitations of the WTO? (Give 3–4 OCR points)
1. Unequal Benefits
Gains from trade are unevenly distributed.
Developing countries often cannot compete equally and may not benefit from trade liberalisation.
✔ 2. Dispute Resolution Crisis
WTO’s Appellate Body has nearly collapsed due to blocked appointments (mainly by the US).
WTO struggles to enforce rulings → more rule-breaking and protectionism.
✔ 3. Slow, Difficult Reform
Consensus-based decision-making = extremely slow.
WTO struggles to update rules for modern issues:
digital trade
data flows
environmental rules
cybersecurity
e-commerce
Developing countries often lack digital infrastructure → inequality widens.
✔ 4. Structural Problems Within WTO
Dispute Settlement Body → hears initial disputes.
Appellate Body → appeals system, now basically non-functional.
Weak enforcement reduces WTO effectiveness.
104
What is the main limitation on the effectiveness of the WTO?
It depends on countries’ political willingness to support free trade and follow WTO rules; when political costs of free trade rise, governments are less likely to cooperate, reducing the WTO’s effectiveness.
105
What is the medium of exchange function of money?
Money replaces bartering, removing the need for a double coincidence of wants and allowing easier exchange of goods and services.
106
What is the unit of account function of money?
Money provides a way to measure and compare the value of different goods and services
107
What is the store of value function of money?
Money can be saved and used in the future, allowing people to store wealth.
108
What is the standard of deferred payment function of money?
Money allows debts to be created and repaid later, enabling contracts for future payment.
109
What is Narrow Money (M0)?
M0 = physical notes and coins + deposits and very liquid assets held at the central bank.
Intended to measure money used for transactions.
Less meaningful today due to increased electronic payments.
110
What is Broad Money (M4) and what does it include?
M4 = M0 plus bank deposits, savings accounts, and short-term government securities (e.g., treasury bills).
These are near-money: less liquid than cash but still usable for transactions indirectly.
111
What is the Fisher Equation of Exchange and what does it imply about inflation?
the equation is MV = PY, where:
M = money supply
V = velocity of money
P = price level
Y = national income/output
The theory assumes V is constant and Y is constant (at the natural rate).
Therefore, an increase in M must cause an increase in P, meaning inflation is caused by growth in the money supply
112
What is the transactions demand for money?
It is the money people hold so they can buy goods and services in daily life. It mainly depends on income, because higher income means more spending. Interest rates matter very little for this type of demand.
113
What is the precautionary demand for money?
It is money held for unexpected expenses or emergencies. It depends on the interest rate, because holding money has a higher opportunity cost when interest rates are high.
114
What is the speculative demand for money?
It is money held when people expect interest rates to rise and bond prices to fall. When interest rates are low, people prefer to keep money instead of bonds, so speculative demand increases.
115
How are interest rates determined in the money market?
interest rates are determined by the equilibrium between money demand and money supply.
Money supply is fixed by the central bank, so it is shown as a vertical line.
Money demand slopes downward because people hold less money when interest rates are high (higher opportunity cost).
If interest rates are above equilibrium, there is excess supply of money, so people buy bonds → bond prices rise → interest rates fall back to equilibrium.
If interest rates are below equilibrium, there is excess demand for money, so people sell bonds → bond prices fall → interest rates rise back to equilibrium.
If the central bank increases the money supply, the vertical supply line shifts right and interest rates fall.
116
Diagram of the impact of an increase in the money supply on interest rates.
117
What is a liquidity trap?
An economic situation where consumers and investors hoard cash instead of spending or investing, even when interest rates are very low. Monetary policy becomes ineffective because lowering interest rates no longer stimulates demand.
118
Why can’t monetary policy work during a liquidity trap?
Because changes in the money supply do not change the interest rate—interest rates are already so low they cannot be reduced further, so consumption and investment do not increase.
119
What is the low-level equilibrium trap?
A cycle where low incomes lead to low savings, which limit investment. Low investment means little capital and low productivity, keeping incomes low. Financial institutions can’t lend much, so the economy stays stuck in low growth.
120
Why is investment hard to mobilise in developing countries?
Low per-capita incomes reduce saving; banks lack funds to lend; capital is scarce; human capital is weak; markets function poorly; and FDI flows are limited. These factors restrict the ability to finance productive investment needed for growth.
121
What is the Harrod–Domar model and why are savings/investment crucial for growth?
Growth requires savings → investment → capital accumulation.
Higher saving provides funds for investment.
Investment increases capital stock, raises productivity, expands output, boosts incomes, and leads to more saving (a positive growth cycle).
Developing countries struggle because low incomes → low savings → low investment → low growth (low-level equilibrium trap).
A strong financial sector is essential to transform savings into productive investment.
122
What stops developing countries from turning savings into investment?
Low incomes → most income spent on necessities → very little saving.
Weak financial markets → banks can’t assess credit risk; loans are limited.
Lack of collateral/property rights → households/firms can’t borrow.
Shortage of entrepreneurs to identify profitable projects and bear risk.
Capital shortages → limited domestic production of machinery.
Foreign exchange gap → countries can’t afford imported capital goods.
Human capital shortages → unskilled workforce reduces productivity of investment.
123
What external factors worsen investment problems in developing countries?
Capital flight: investors send money abroad for higher returns; worsened by MNC profit repatriation.
Dependence on imported capital: without sufficient exports or foreign currency, countries cannot buy the machinery needed for growth.
Technology gap: developing countries could grow faster by adopting already-developed technology, but poor human capital and weak institutions slow this process.
Highlights the need for education, skills, and health to support long-run development.
124
What is a foreign currency gap?
It is when a country’s need for foreign currency (to pay for imports, foreign debt, or other obligations) is greater than the foreign currency it earns from exports, remittances, or foreign investment.
c1 + c2 + c3/ macro + micro
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