International Economics

International Economics

1. Trade

   • Why is it beneficial?
     • encourages economic growth (Xup)
     • Specialization --> more efficient production
     • cheaper products (greater competition)
     • greater variety of goods
     • new technology
     • economies of scale
   • disadvantages
     • vulnerability to external shocks
   • infant industry argument
     • protect infant industries so they can grow and benefit from economies of scale
   • absolute advantage
     • if a country can produce a g/s more efficiently than another
   • free trade
     • countries can trade freely without barriers
   • protectionism
     • the use of trade barriers to protect economy from foreign competition
       • tariff (tax on imports)
       • Quota (physical limit on the amount of imports that is allowed into an economy)
       • subsidy (money grant from gov't to producer to decrease the cost of production)
       • technical barrier (border control, safety/health standards)

2. Exchange rates

   • The rate at which one currency can be exchanged for another
   • Fixed: the currency value is fixed to another
     • Devaluation: loses value
     • Revaluation: gains value
   • Floating: value is determined by D & S
     • Depreciation: loses value
     • Appreciation: gains value
   • Demand for a currency increases when:
     • increased inflow of money (X)
     • higher interest rates (more savings)
     • speculation of future appreciation
     • FDI increase
   • Supply of currency increases when:
     • imports increase
     • more FDI in other countries
     • higher interest rates in other countries
     • speculation of appreciation of other currency
     • speculation of depreciation of domestic currency
   • Managed exchange rate
     • mostly determined by d/s and is allowed to fluctuate within a price band --> otherwise CB intervenes
   • Dirty float
     • managed rate and artificially undervalued
   • Pegged currency
     • weaker currency fixed to a stronger
   • Consequences of undervalued currency
     • D-pull inflation (Xup)
     • expensive imports (imported inflation)
     • loss of purchasing power
     • "trade barrier"
     • economic growth + employment opportunities
   • Consequences of overvalued currency
     • recession (Mup)
     • cheap imports, expensive exports
     • more unemployment
     • current account deficit

3. The balance of payments

   • Record of a country's all transactions with the world
   • Outflow of money = debit
   • Inflow of money = credit
   • BoP = 0
   • BoP = current account + capital account + financial account
   • deficit
     • Use reserve assets (sell foreign currency and buy domestic)
     • borrow from WB (debt)
     • Reduce current account by:
       • limiting imports (trade protectionism), less outflow
       • devaluation = Xup (imported infl.)
   • If floating, BoP will always balance
     • current account deficit -> S up -> depreciation -> X rev. -> D up -> M down -> S down
   • The Marshall Lerner condition
     • Applies in LR
     • states that a devaluation will improve the current account deficit if the combined PED for X and M is greater than 1
     • only applies to MEDCs (manufactured goods)