L1 flash cards economics (ss6)


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L1 flash cards economics (ss6)

  1. 1. International Trade: Benefits Exchange and specialization Greater economies of scale Greater product variety Increased competition Efficient allocation of resources Liberalization can lead to increased real GDPStudy Session 6, Reading 19
  2. 2. International Trade: Costs Greater income inequality Loss of jobs in some economies which specialise in lowintensity of labour production. Import competition may reduce the profitability of localproducers. Less efficient firms may need to exit the market and reallocateresources to other more efficient areas of the economy.Study Session 6, Reading 19
  3. 3. International Trade: ComparativeAdvantage A country will have a comparative advantage if it has a loweropportunity cost of production of a particular product. Comparative advantage can still provide trade benefits in theabsence of absolute advantage. The benefits of trading driven by comparative advantage are akey argument for increased trade.Study Session 6, Reading 20
  4. 4. International Trade: AbsoluteAdvantage A country will have an absolute advantage if it can produce agreater quantity of output products with the same factorinputs. An absolute advantage may be driven by a comparisonbetween labour productivity. A country with an absolute advantage will have a lower cost ofproduction.Study Session 6, Reading 20
  5. 5. Ricardian Model The Ricardian Model suggests that differences in labourproductivity reflect difference in technology. It assumes: Firms cannot effect the market individually Firms choose output to maximize profits Homogenous outputs Labour only variable Differences in labour productivity underline the differencesin technologyStudy Session 6, Reading 20
  6. 6. Heckscher–Ohlin Model Heckscher and Ohlin argues that countries have differentfactor endowments of labour, land and capital inputs. It suggests that countries will specialise in and export thoseproducts which intensively use the factors of production whichthey are most endowed. Capital and labour are variable factors of production.Study Session 6, Reading 20
  7. 7. Trade and Capital Restrictions A Trade Restriction is a policy measure designed to limitexports or imports. Tariffs are taxes which are imposed on goods imported intothe country. Import quotas restrict the quantity of goods that can beimported into the country. Export subsidies given by the government for export of a good. A Voluntary Export Restraint is a a trade restriction on thequantity of a good that an exporting country is allowed toexport to another country.Study Session 6, Reading 20
  8. 8. Economic Implications of Trade andCapital Restrictions Tariffs create deadweight loss as they give rise toinefficiencies. The following chart highlights the deadweight loss caused bytariffs and import quotas.Study Session 6, Reading 20
  9. 9. Characteristics, Motivations andAdvantages of Trading Blocs Members typically share common trade restrictions for non-member nations and have lower/no barriers among themembers of trading blocs. They allow for the free movement of resources towards themost economic efficient uses. Economic unions have a greater degree of integration in that itincorporates the aspects of a common market and economicinstitutions. Regional integration through blocs and economic unionspromotes trade, and hence the benefits of comparativeadvantage.Study Session 6, Reading 20
  10. 10. Components of the Balance ofPayments The Balance of Payments (BOP) compares the dollar differenceof the amount of exports and imports in an economy. It includes all financial exports and imports. The Current Account includes all transactions which give riseto or use national income. The Capital Account consists of short- terms and long-termcapital transactions.Study Session 6, Reading 20
  11. 11. Impacts of Consumers, Firms, andGovernments Influence Firms exporting more can create a positive balance ofpayments and vice versa. Firms importing capital equipment can negatively affect thebalance of payments. National savings is a sum of private saving and public saving. Ifnational savings is less than domestic investment, a countrywill borrow from abroad. An increase in foreign debt increases the current accountdeficit as the interest costs are recorded in the currentaccount.Study Session 6, Reading 20
  12. 12. World Bank The original purpose of the World Bank was to lend money toWestern European governments to help them rebuild theircountries after WW2. By imposing terms on these loans, it encourages developingcountries to: Fight corruption Develop its financial system which can help microfinance aswell as mega capital ventures Protect individual and property rights Improve the legal and judicial systemStudy Session 6, Reading 20
  13. 13. International Monetary Fund The initial focus of the IMF was to regulate currency exchangerates to facilitate orderly international trade. It is a lender of last resort when a member countryexperiences balance of payments difficulties and is unable toborrow money from other sources. ‘Structural Adjustment Programs’ (SAPs) are designed toincrease money flow into the country by promoting exports sothat the country can pay its debts. Provides a forum for cooperation in international monetaryproblems.Study Session 6, Reading 20
  14. 14. World Trade Organization The World Trade Organization (WTO) deals with the rules oftrade between nations. WTO agreements are negotiated and signed by the bulk of theworld’s trading nations and ratified in their parliaments. The goal is to help producers of goods andservices, exporters, and importers conduct their business.Study Session 6, Reading 20
  15. 15. Nominal & Real Exchange Rates Nominal exchange rates are established on currency financialmarkets called "forex markets". The relationship between nominal and real exchange rates canbe described as:e .Pi=Pi* where:e denotes the nominal exchange rate of the domestic currencyin terms of the foreign currencypi denotes the price of good i in domestic in domestic currencypi* denotes the price of the same good in the foreign inforeign currencyStudy Session 6, Reading 21
  16. 16. Spot & Forward Exchange Rates The spot exchange rate is the rate of a foreign-exchangecontract for immediate delivery. It is also known as"benchmark rates", "straightforward rates" or "outright rates". Spot rates represent the price that a buyer expects to pay for aforeign currency in another currency at time 0. The globally accepted settlement cycle for foreign-exchangecontracts is two days.Forward Rate = Spot Rate of FC x (1 + Interest Rate of FC)(1+ Interest Rate of DC)Study Session 6, Reading 21
  17. 17. Participants in Foreign ExchangeMarkets Retail clients Commercial banks Foreign exchange brokers Central banks Corporations Speculators and arbitragersStudy Session 6, Reading 21
  18. 18. Functions of Foreign ExchangeMarkets Transfer of purchasing power Provision of credit instruments and credit Coverage of riskStudy Session 6, Reading 21
  19. 19. Direct Quotes A Direct Quotes expresses the domestic currency per unit ofthe foreign currency. In the US, a direct quote for Canadian dollar will be . It involves quoting in fixed units of foreign currency againstvariable amounts of the domestic currency. In a direct quote, the domestic currency is always listed as thebase currency .Study Session 6, Reading 21.
  20. 20. Indirect Quotes An Indirect Quotes expresses the foreign currency per unit ofthe domestic currency. Under an indirect quote, the foreign currency is a variableamount and the domestic currency is fixed at one unit. Indirect quotes indicate how many units of foreign currencyare needed to purchase one unit of domestic currency. In an indirect quote, the foreign currency is the base currencyand the domestic currency is the counter or quote currency.Study Session 6, Reading 21
  21. 21. Currency Cross Rates Currency cross rates measure the currency exchange ratebetween two currencies. Both of currencies may not be the official currencies of thecountry in which the exchange rate quote is given in. That is, itcan be expressed in terms of a third currency.Study Session 6, Reading 21
  22. 22. Calculate and Interpret Originating Currency, Amount, Target Currency and Market Maker AUD/EUR (Australian Dollar, Euro) with USD as the Cross RateCurrency: Originating Currency = EUR Target Currency = AUD Amount = 100000 AUD USD/EUR Exchange = 1.2474 Bid; 1.2478 Offer USD/AUD Exchange = 0.7296 Bid; 0.7299 Offer Denom = .7299 / 1.2474 = 0.585137 Result = 100000 / 0.585137 = 170900.1 AUStudy Session 6, Reading 21
  23. 23. Forward Discount and Premium The Forward Premium or Discount is measured as thedifference between the current spot rate and the forwardrate. A Forward Premium is when the forward price is higher thanthe spot price. A Forward Discount is when the forward price is lower thanthe spot price.Forward Rate = Spot Rate of FC x (1 + Interest Rate of FC)(1+ Interest Rate of DC)Study Session 6, Reading 21
  24. 24. Point Basis or Percentage Terms Forward rates usually quoted in terms of points, wherepositive points are quoted when the forward rate is greaterthan the spot rate. Forward rates are based on arbitrage relationship, consideringthe interest rate differential between two economies.Study Session 6, Reading 21
  25. 25. Forward Rates Based on Spot Ratesand Interest Rates The relationship between forward rates and spot rates can bedescribed as:Ff/d=Sf/d(1+if)/(1+id) Effectively, forward rates are just spot rates adjusted for theinterest rate differential between the two countries. This formula is based on the premise that two alternativeinvestments should have equal returns. That is, there is noarbitrage opportunity.Study Session 6, Reading 21
  26. 26. Exchange Rate Regimes An exchange rate regime is a policy framework to counterexchange rate volatility. There are three properties of an ideal currency regime: Fixed exchange rate between two countries All currencies would be fully convertible Each country will be able to have a fully independentmonetary policyStudy Session 6, Reading 21
  27. 27. Exchange Rate Regimes There are three types of pegged floats: Crawling Bands: the rate is permitted to fluctuate within aparticular band or limit and the movements are based on aparticular central value Crawling Pegs: exchange stay fixed Pegging with Horizontal Bands: the rate would be allowedto move within a specified limit or band.Study Session 6, Reading 21
  28. 28. Impact on International Trade andCapital Flows The impact of the exchange rates and other factors on thetrade balances must be mirrored by their impact on the capitalflows. A country with a trade deficit will have to borrow funds. A country with a trade surplus will need to lend funds. any factor that effects the trade balance must have an equaland opposite effect on the capital account (and vice versa).Study Session 6, Reading 21
  29. 29. The Elasticity Approach The effectiveness of devaluation for reducing the trade deficitdepends on the demand and supply curves for goods andservices. Elasticity is measured by: An increase in price decreases expenditure if (ie if demand iselastic). An increase in price decreases expenditure if (ie if demand isinelastic).Study Session 6, Reading 21
  30. 30. The Elasticity Approach Demand for imports and exports should be sufficiently pricesensitive.WxEx + WM(EM – 1)>0Study Session 6, Reading 21
  31. 31. The Absorption Approach Trade balances cannot improve in the case of full employment. The absorption approach only works if there is excess capacityin the economy. Increasing demand will increase income. If expenditure does not decline, devaluation will put upwardpressure on domestic prices. Trade balances can only improve if expenditures decline.Study Session 6, Reading 21