Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Currency War of 2009–11 wikipedia , lookup
Monetary policy wikipedia , lookup
Currency war wikipedia , lookup
Global financial system wikipedia , lookup
Foreign-exchange reserves wikipedia , lookup
Protectionism wikipedia , lookup
Balance of payments wikipedia , lookup
Balance of trade wikipedia , lookup
International Competitiveness What is international competitiveness? International competitiveness is the ability of firms in an economy to match the price and quality of other nation’s output. List the main factors affecting international competitiveness. International competitiveness is largely determined the relative price and quality of domestic goods and services relative to foreign products. Identify factors which influence the relative price of imports and exports. Relative costs of production eg wage between different countries Relative productivity of labour. A rise in productivity reduces labour costs and so improves competitiveness Exchange rates impact on the price of imports and exports. A depreciation lowers the price of exports in terms of foreign currency and increase the price of imports How can quality factors affect competitiveness? Price is just one factor affecting demand. The relative design, appearance and functionality of a product affect competitiveness. What is a competitiveness pyramid? The competitiveness pyramid is a model that shows sustainable growth as an outcome of competitiveness. At the base of the pyramid are policy inputs that impact on the essential conditions for competitiveness, hence sustainable growth. State action to make it easier to do business (deregulation) or improve education and training eventually provides the conditions necessary for sustainable growth. Note the link between this model, developed by Ireland’s Competitiveness Council, and the Treasury’s productivity drivers. Supply side policies require state funding and are long term Trade and integration Distinguish between open and closed economies. A closed economy is self-sufficient and there is no intentional trade. An open economy engages in international trade. Define trade. Trade is the exchange of goods and services. Why do regions and countries trade? Different countries trade because they have different factor endowments eg climate, skilled labour force, and natural resources vary between nations. This means some countries are better placed in the production of certain products than others. Explain specialisation. Specialisation is when individuals, firms, regions or countries concentrate in the production of particular good and services. What are the benefits of specialisation? Concentrating on a particular product or task means: Increased total output so that more wants can be satisfied A greater variety of products ie more choice An increase the size of the market offering opportunities for economies of scale 24 International Competitiveness | What are the risks of specialisation? Specialisation makes individuals, firms, regions or countries interconnected and interdependent, relying on others to supply key products Explain interdependence. Trading partners become mutually dependent on one another. How are specialisation, trade and interdependence linked? Specialisation creates surpluses. These surpluses are traded. Each party in exchange becomes dependent on the other. specialisation surpluses trade interdependence Absolute and comparative advantage Define international trade. International trade is the exchange of goods and services across national borders. Define absolute advantage. Absolute advantage occurs when a country can make more of a given product using fewer resources than another nation. Unit cost of production is lower. Define comparative advantage. Comparative advantage occurs when a country can make a product at relatively lower opportunity cost than another nation. How do countries acquire a comparative advantage? Different factor endowments mean countries have different opportunity costs. Countries with abundant supplies of low wage workers have a comparative advantage in labour intensive industries. How is absolute advantage identified? Productivity is an indicator of absolute advantage. Give a worked example of absolute advantage. Assume that with 10 workers, Country A can produce either 40 computers & zero bikes or zero pcs & 100 bikes. Country B can produce either 200 pcs and zero bikes or no computers and 40 bikes. In country A each worker makes 40/10 = 4 computers or 100/10 = 10 bikes In country B, each worker makes = 200/10 = 20 computers and 40/10 = 4 bikes Country A has an absolute advantage in making bikes because labour productivity is 10 bikes and only 4 in B. Nation B has an absolute advantage in making computers where each worker, on average, produces 20 pcs while labour in nation A make only make 4 pcs. Give a worked example of comparative advantage. Using the data in the previous question: Computers In Country A one worker makes either 4 pcs or 10 bikes so the opportunity cost of one extra pc is 10/4=2.5 bikes. In Country B the opportunity cost = 4 bikes lost for 20 extra pcs ie only 4/20 = 0.2 bikes for one more computer. Bicycles In Country B the opportunity cost of one extra bike is 20 pcs for 4 extra bikes = 20/4 = 5 pcs. Country A gives up 4 computers for 10 extra bikes so the opportunity cost of one extra bike is just 0.4 pcs Construct a worked example to demonstrate the benefits of specialisation and trade Assume a simple two country, two product world with no trade. Using the data in the previous two questions, if each nation allocates half its resources to the production of both goods, the production possibilities are as shown in the table opposite. World output is 120 pcs and 70 bicycles. Position Pre Specialisation Country Computers Bicycles A 20 50 B 100 20 Total 120 70 Countries benefit if they specialise in a product in which they have a comparative advantage ie a lower opportunity cost. It makes sense for County A & B to specialise in the production of the product in which they have the comparative advantage & trade: | Absolute and comparative advantage 25 Country A is relatively efficient in making bicycles because it has a lower internal opportunity cost than Country B. A gives up just 0.4 of a computer for one extra bike while B gives up 5 computers. Country A has the comparative advantage in bicycles. Country B is relatively efficient in making computers because it has a lower internal opportunity cost than Country A. B gives up just 0.2 of a bicycle for one extra PC while B gives up 2.5 bikes. Country B has the comparative advantage in computers. Position Post Specialisation Now assume complete specialisation, where each country specialises in the products in which it has the comparative advantage. Total output of both products increases representing a potential gain in economic welfare. The two countries must now trade to acquire products they are relatively inefficient at making If County’s A & B trade half the surpluses created through specialisation both nations are better off than when they were self-sufficient and produced all products, themselves. This assumes an appropriate exchange rate that lies between the opportunity cost ratios. Country Computers Bicycles A 0 100 B 200 0 Total 200 100 Gain 80 30 Position Post trade Country Computers Bicycles A 60 65 B 140 35 Total 200 100 Good Y Use production possibility curves to show the potential gains from international trade K: after 40 30 20 J: before PPC for Country B PPC for Country A 10 Good X 0 20 40 60 80 The diagram shows production possibility curves (PPCs) for two countries, A and B, mapping combinations of good X and good Y that can be produced when all resources are used. The slope at each PPC reflects the pattern of opportunity cost for each country. For simplicity assume each country devotes half its resources to producing each product. Total world output is given by point J. 30Y and 50X is made. Assume now complete specialisation in the production of items in which a country has a comparative advantage. Country A produces 80 of good X. Country B makes 40 Y. total world output moves to point K. Both countries can benefit from specialisation and trade. List factors that might limit specialisation and trade The benefits of trade are reduced by transaction costs and transport costs which may be as to cancel out the benefits of specialisation based on comparative advantage. Interdependence: countries become reliant on imports of essentials from other countries. Eg a strike in the French electricity industry can mean power cuts for the UK. Structural change: trade increases competition Declining industries may need protection from overseas competitors to give them time to restructure and regain competitiveness Infant industry argument. An infant industry has a potential comparative advantage which is currently underdeveloped. Infant industries need protection from overseas competitors to allow them time to acquire that competitive advantage Trade Restrictions such as tariffs and quotas restrict trade Acceptable term of trade The ToT must lie within the relative opportunity cost ratio of the trading nations 26 Absolute and comparative advantage | What is the Heckscher-Ohlin model? Specialisation reflects factor endowments. Eg the USA with highly skilled work force and high tech capital exports aircraft to China who specialise in exporting products that make use of abundant labour and low tech capital eg toys and shoes Is comparative advantage a static concept? Comparative advantage can be acquired. Eg, investing in latest technologies improves the productivity of labour, reducing opportunity cost. How can comparative advantage change over time? Nations lose or acquire comparative advantage overtime if there is a change in relative efficiency in making products. Comparative advantage can be gained in given products through Human investment in education and training and, Capital investment in new equipment, infrastructure, and research & development to improve competitiveness ie lower unit costs, better product design, and reliability Lower inflation rates than competitors Explain dynamic efficiencies Dynamic efficiencies are improvements in productivity causing lower unit costs that occur over time as a result of eg investment trade or knowledge transfers The effects of international trade Give examples of changing patterns of trade. Comparative advantage in the production of lower valued added manufactured goods has shifted away from developed countries to developing economies such as China where unit labour costs are lower. Explain the gains from international trade in general terms. Trade allows Specialisation that increases total output thereby increasing economic welfare. Firms have greater scope for economies of scale. Trade opens up foreign markets and allows firms to increase production. Resultant lower unit costs reduce prices Improves consumer choice. Domestic consumers have access to overseas goods Increased competition reduces the power of domestic monopolies and encourages firms to become world-class and adopt best practice product and process innovations to reduce unit costs. FDI, licensing and outsourcing result in technology and knowledge transfers. | The effects of international trade 27 The terms of trade What are the terms of trade? The terms of trade (ToT) is the ratio of export prices to import prices expressed as an index value. The ToT show the volume of imports one unit of export buys. How are the terms of trade measured? The ToT is measured using the formula: Terms of trade = index of export prices/ index of import prices x 100 What is an improvement in the terms of trade? An improvement in the ToT comes about when export prices rise faster than import prices. Eg a rise in the ToT eg from 110 to 115 means a country has to give up fewer exports for the imports it receives. Why are the terms of trade important? The terms of trade are an indicator of the benefits of trade. A fall in the ToT means a country must export a larger amount of exports to pay for a given amount of imports What is the Presbisch-Singer hypothesis? The Presbisch-Singer hypothesis states the terms of trade between primary products and manufactured goods tend to deteriorate over time. This limits the benefits of developing economies whose main exports are primary commodities eg coffee, bananas and metals. Explain the development trap. The Presbisch-Singer hypothesis suggests that by specialising in primary commodities, deteriorating terms of trade mean that more and more exports are required to pay for the same volume of imports What are the implications of the Presbisch-Singer hypothesis? To avoid the development trap, developing economies must change the structure of the economy and acquire a comparative advantage introduction of non-primary products eg textiles Outline limitations of the terms of trade. Movements in the terms of trade reflect relative price changes but give no information about import and export volumes. The impact on the current account depends on the price elasticity of demand for imports and exports. Pattern of global trade What is a bloc? A bloc is a group of countries in alliance eg the EU Distinguish between intra and inter regional trade. Intra-regional trade is the exchange of products between nations in the same geographical area eg the UK and France. Inter-regional trade is the exchange of products between nations in different geographical areas eg UK and USA Distinguish between intra and inter industry trade. Intra-industry trade is the exchange of products made by the same industry. Inter-industry trade is the exchange of products made by different industries Identify the main features of global trade: Developed economies dominate international trade. International trade typically takes place within regional trading blocs such as the EU so as to minimise transport costs. Inter industry rather than intra industry trade. Does the theory of comparative advantage explain the pattern of global trade? The potential benefits of comparative advantage are negated by: Regional trade blocs which establish trade barriers such as tariffs and quotas which restrict specialisation and trade Transport costs which encourage intra-regional trade between nations in the same geographical area Intra industry trade where nations trade the same type of product eg the car industry 28 The terms of trade | Exchange rate systems Floating exchange rates Define the exchange rate. An exchange rate is the price of one currency expressed in terms of another eg $2/£ What is the value of sterling? The pound is also known as sterling. The value of the pound is measured in terms of the amount of foreign currency it can buy. Give an example of exchange rates. There are many exchange rates eg the £ against the US$, euro, yen, etc. For the UK, the dollar exchange rate means the number of dollars ($) one pound (£) can buy and is determined by the supply and demand for sterling (pounds). If the exchange rate is, say, $2 then one £ buys two $ - the buyer must give up $2 for every £1 required. What is an exchange rate system? An exchange rate system is the method selected by government for determining the value of the currency against another currency. What does the term effective exchange rate mean? The effective exchange rate is the weighted average of a currency’s exchange rates with its major trading partners' currencies. The weightings reflect the proportion trade with each trading partner. Explain a strong pound. A strong pound suggests a historically high exchange rates eg $2:£1. Sterling is appreciating relative to other currencies. How are exchange rates determined? The value of a nation’s currencies against other currencies can be set by the government or market forces. What is purchasing power parity (PPP)? Purchasing power parity occurs when the price of identical products sold in different countries are the same, when expressed in terms of a common currency eg the $. This assumes no transaction costs or trade barriers. What is the purchasing power parity exchange rate? The PPP is the exchange rate that equalises the prices of a given basket of products in two countries. Eg if a bar of chocolate priced at £1 in the UK sells for $2 in the USA, then PPP exchange rate is $2/£. $2 buys the same bar of chocolate in the UK and USA. What happens if the market and PPP exchange rates diverge? If the market and PPP exchange rates diverge, the $ price of products is different in the two countries. Economic agents can make a profit by buying products one country and reselling them in another. Define arbitrage. Arbitrage is the practice of exploiting price differences in different markets. A profit is made by buying cheap and selling dear – assuming low transaction and transport costs. What is the law of one price? The impact of arbitrage and international trade results in one common $ price’ for products in different nations. Assumes floating exchange rates $/£ What is a freely floating exchange rate? The value of the currency is determined in markets called Foreign Exchange Market (Forex), without any government intervention S£ FXM for £:$ $2 D£ £Bn Draw a diagram to illustrate a market set exchange rate. The exchange rate for eg the pound against the dollar is determined by the interaction of the forces of supply and demand Demand for £s: the demand curve for sterling D£ shows the amount of pounds demanded at each and every exchange rate. Holders want to exchange dollars for pounds to buy UK products (exports X) or buy UK assets (inward investment) or put deposits in UK banks. | Floating exchange rates 29 Supply of £s: the supply curve for sterling S£ shows the number of pounds supplied at each and every exchange rate. Holders want to exchange pounds for dollars to buy US made products (imports M) or buy UK assets (outward investment) or put deposits in UK banks. There is only one exchange rate, two dollars to the pound, where the number pounds supplied equals the number pounds demanded. Why do exchange rates fluctuate? The price of a currency is determined in Forex markets. A change in any factor affecting supply and demand for a currency affects the clearing price What factors determine the demand and supply of a currency? International trade in goods and services ie imports and exports ie the relative competitiveness in terms of price and quality of UK products Long term Capital flows from the purchase of assets eg FDI and shares ie the relative the merits of inward investment or loans in to the UK (capital account) Short-term capital flows in and out of bank accounts ie hot money largely affected by relative interest rates and expected movements in future exchange rates Explain an appreciation of sterling An increase in demand, or fall in supply, of sterling causes an increase or appreciation in the exchange rate: one pound buys more foreign currency. UK price competitiveness deteriorates as the price of UK imports fall whilst UK export prices rise. What is a depreciation of sterling? A fall in demand, or rise in supply of pounds causes a decrease or depreciation in the exchange rate: one pound buys less foreign currency. UK price competitiveness improves as the price of UK imports rises & UK export prices fall. What are the effects of a fall in exchange rate? Exchange rate changes have wide impact on key economic variables. Assume the demand for imports and exports is price elastic: The price of UK imports rise in terms of sterling while the price of UK exports falls in terms of foreign currencies Depreciation of sterling exerts inflationary pressure because of higher import prices that increase costs to UK firms using overseas raw materials & components; The terms of trade deteriorate as export prices have fallen and import prices have risen. As demand is elastic, the UK has to give up more exports for the imports it receives. Net exports eventually rise stimulating aggregate demand and improving the BoP Structural change occurs as UK firms respond to price changes brought about by the depreciation. Is a stable exchange rate desirable? Frequent and significant changes in the exchange rate are destabilising. Uncertainty and increased risk reduces confidence, investment and stability How are exchange rates and the balance of payments linked? When Forex markets are in equilibrium, the demand for pounds to pay for UK products and assets exactly matches the supply of pounds to pay for overseas products and assets. The balance of payments is in balance Explain how balance of payments problems are automatically corrected by floating exchange rates. Suppose the current account and capital and finance account are together, in deficit. This means the supply of pounds to pay for foreign products and assets exceeds the demands of pounds to pay for UK products and assets. The exchange rate automatically depreciates, lowering export prices while increasing import prices. Improved price competitiveness helps move the balance of payments, back into balance. Identify the merits of a floating exchange rate system. Automatic correction balance of payments problems The exchange rate is not a constraint on macroeconomic policy. Eg interest rates can be set to affect domestic AD, ignoring any potential impact on exchange rates Helps economies adjust to external economic shocks three exchange rate adjustment 30 Floating exchange rates | Reduces the ability of speculators to bet against government inability to maintain fixed exchange rates Reduces the need for governments to hold reserves of foreign currency Identify the limitations of a floating exchange rate system. The J curve effect means that exchange rate changes initially worsen any balance of payments problem Fixed exchange rates What is a fixed exchange rate system? In a fixed exchange rate system the value of one currency against other currencies is held constant. How can governments intervene to fix an exchange rate? Maintaining an official exchange rate requires government action to $/£ Restrict currency flows through exchange controls that limit the amount of the domestic currency that can be taken out of the country. The UK stopped exchange controls in 1979. Use reserves of gold and foreign currencies to buy and sell foreign currencies for sterling to maintain the fixed rate. Forex interventions are carried out by the central bank Use interest rates to encourage the purchase or sale of the currency S£ FXM for £:$ $2.2 In the diagram opposite, the Forex price of sterling is two dollars to the pound. $2.0 D£ Q1 Draw a graph to illustrate government intervention to maintain the value of sterling at a fixed rate. Q2 £Bn If the government wants to maintain the exchange rate at $2.20 to the pound then it must buy up excess supply of [Q2 -Q1] pounds using its reserves of US$s. Outline the benefits of a fixed exchange rate system. A fixed exchange rate system: Increases exchange rate certainty encouraging investment trade and growth Removes the need for firms who want exchange rate certainty to insure against exchange rate changes (hedge) Discipline for firms who can no longer rely on exchange rate corrections to restore international competitiveness Outline the drawbacks of a fixed exchange rate system. A fixed exchange rate system: Requires the government to hold adequate reserves of foreign currency. The opportunity cost of foreign reserves is foregone interest Linking domestic monetary policy to the exchange rate as interest-rate changes may cause the exchange rate move outside its target rate Can encourage speculation if speculators believe the government cannot maintain a fixed exchange rate. Read up on the UK’s Black Wednesday in 1992 for an example Identify other exchange-rate systems Managed float whether central bank intervenes to buy and sell foreign currency to maintain the value of sterling at some target rate Adjustable peg where the official exchange rate is fixed in the short term but can be revalued periodically in the long-term Exchange rate band where the currency is allowed to move a few percentage points around a central target before government intervenes to stabilise. For example a $2.20 to $1.80 ceiling and floor value of sterling | Fixed exchange rates 31 Exchange rate volatility Why do exchange rates change? Without government intervention, exchange rate fluctuations are caused by changes in the supply and demand for currency on the Forex markets In the short term exchange rate changes are mainly caused by speculators who buy and sell a currency having to make a capital gain In the longer run, exchange rates are determined by economic fundamentals What are economic fundamentals? Economic fundamentals are the underlying key characteristics of an economy including productivity and international competitiveness and Interest rates, growth rates and inflation rates How can depreciation affect net exports [X-M]? A fall in the value of the pound has an uncertain effect on X-M because price and quantity are inversely related. Depreciation means: The price of exports falls causing an expansion in demand. More exports are sold but at lower prices. The overall impact on revenue depends on the price elasticity of demand. Only if the percentage increase in quantity demanded is greater than the percentage fall in price does a fall in the value of the pound increase the value of exports The price of imports rises causing a contraction in demand. Fewer imports are bought but at higher prices. The impact on the value of imports is uncertain and can rise or fall depending on the price elasticity of demand The value of exports rises only if the demand for exports is relatively price elastic. The value of imports falls only if the demand for imports is relatively price elastic What is the Marshall-Lerner condition? This predicts that depreciation improves the current account only if the combined elasticities of demand for imports & exports are greater than one. Does a fall in the exchange rate guarantee an improvement in the current account? If the Marshall-Lerner condition is met then a depreciation of sterling improves the current account providing there is spare capacity in the economy to increase output to meet extra demand. Explain the J curve effect. Following a fall in the value of a currency: Prices tend to adjust quickly. UK consumers face higher prices for imports while UK firms selling overseas can reduce prices. Quantities adjust slowly often after a time lag of up to 12 months. Consumers may be slow to notice relative price changes while firms may have fixed price contracts in place. X-M This means the price elasticity of demand of imports and exports is likely to be inelastic in the short run, but become more elastic over time Surplu s J Curve Effect 0 Deficit Time The initial impact of devaluation is to decrease import prices & raise export prices while volumes are largely unaffected - the current account deteriorates. After a period of about 12 months, economic agents have had time to adjust fully to relative price changes in foreign & domestic products. The volume of imports falls while the volume of exports rises. Given the combined elasticities of demand for imports and exports is greater than one, the current account begins to improve. Define the J curve effect. The J curve is the path followed by the current account following exchange rate depreciation where the trade balance initially worsens before it improves. What is the inverted J curve effect? The current account initially improves following an appreciation of a currency where the trade balance initially improves before it worsens. 32 Exchange rate volatility | What is the single currency? The single currency is a term used to describe the Eurozone where member countries have abandoned their own currency and adopted the euro. Advocates argue that a permanently fixed exchange rate in a regional trade bloc reduces the risk and uncertainty associated with volatile exchange rates and so encourages international trade and associated benefits Balance of payments problems What is external balance? External balance is when the balance of payments is in equilibrium Explain ‘a balance of payments problem’. A balance of payments problem arises when there is an imbalance between the two main sections: the current account and the capital account. Give an example of a balance of payments imbalance. China is running a $ 426,100,000,000 surplus on its current account while the USA is operating a $ -673,300,000,000 deficit (CIA) Identify the likely causes of a current account deficit: Excessive household spending on imported goods and services as a result of the loss of international competitiveness Domestic firms purchasing foreign-made capital goods to increase productive capacity An overvalued currency resulting in high priced exports and low-priced imports How is a current account deficit financed? The current account deficit is financed by a capital account surplus. For example the USA attracts large capital inflows from China Is a current account deficit sustainable? The USA can continue to finance its current-account deficit because overseas investors have confidence in the American economy. The economic fundamentals and future prospects of the American economy are viewed with confidence. How can a balance of payments imbalance be corrected? Where the imbalances are caused by the current account, there are two main options: Expenditure reducing policies cut GDP and so lower the demand for imports Expenditure switching policies that increase the price of imports and/or lower the price of exports so reducing net exports Identify potential expenditure reducing policies. Expenditure reducing policies reduce the level of aggregate demand eg increasing taxes or reducing cover spending and increasing interest rates. What are the drawbacks of expenditure reducing policies? Expenditure reducing policies to improve the current account reduce the level of GDP causing cyclical unemployment and threatening economic stability. What is free trade? Free trade occurs when a county abolishes any controls or restrictions on international trade such as tariffs or quotas. How can government restrict international trade? Methods of limiting imports and exports Tariffs: imposing a tax on imports Non-tariff barriers: impose trade restrictions other than tariffs eg foreign exchange controls Identify potential expenditure switching policies. Government action to cut exchange rate reduces the price of exports in foreign currency and increases the price of imports. A tariff also increases the price of imports while exports subsidies lower the price of exports. What are the drawbacks of expenditure switching policies? Engineering a fall in the value of currency simply invites retaliation from overseas governments leading to a damaging series of competitive devaluations. Similarly increasing tariffs or subsidising exports invites retaliation and breaks the rules of trading blocs such as the EU, and the World Trade Organisation | Balance of payments problems 33