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GCE Economics
Course Companion
Unit A2 2: The Global Economy
GCE Economics Course Companion
A2 2: The Global Economy
“No nation was ever ruined by trade.” Benjamin Franklin
What is this unit about?
In this unit you will develop the knowledge you gained in AS 1 and AS 2 by looking
at international trade and payments in more detail and exploring some of the issues
that arise from increasing globalisation.
You will:
 explore the reasons for trade and examine why countries, from time to time, adopt
protectionist measures;
 analyse the structure of the UK Balance of Payments Account, consider the
problems caused by payment imbalances and look at ways in which these can be
corrected;
 examine how a currency’s exchange rate is determined, consider the effects of rate
changes and explore how exchange rate fluctuations might be stabilised;
 explore the economic role of the European Union and consider how effectively it
operates;
 investigate the main features and effects of globalisation;
 analyse the different stages of economic development that countries experience
and examine the factors that affect development; and
 consider how government macroeconomic policy is affected by the growing
openness of the world economy.
What are the main topics I need to study?
The exact number and sequence of topics you will study in this unit will depend on
how your teacher decides to organise the course. However the content is organised,
you should always try and relate the concepts and theories you study to real world
events and issues. It is likely that this unit will follow a structure similar to the one
below.
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1. International trade and protection
In this section you will:
 investigate the reasons why countries trade;
 use the theory of comparative advantage to explain the gains from trade;
 evaluate the usefulness of this theory;
 consider arguments for and against free trade;
 explore how countries may protect themselves from foreign competition; and
 examine the role and effectiveness of the World Trade Organisation (WTO).
2. The UK balance of payments and the exchange rate
Here you will:
 learn about the main sections of the UK balance of payments and recent trends in
the UK’s trade and investment flows;
 learn why the overall balance of payments account must balance;
 explore the nature of balance of payments’ problems and examine different ways
in which these may be corrected;
 learn how a currency’s exchange rate is determined;
 analyse the effects of changes in the exchange rate;
 consider the pros and cons of floating and stable exchange rates; and
 examine the different ways in which a currency’s exchange rate can be stabilised.
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3. The European Union (EU)
In this section you will:
 learn about the distinctions between free trade areas, customs unions, common
currency areas and full economic and monetary union;
 examine how the EU can both create and divert trade;
 consider the effects of EU enlargement;
 consider the pros and cons of joining the eurozone;
 examine the role and effects of the European Central Bank (ECB); and
 consider the effects of the Common Agricultural Policy (CAP).
4. Globalisation and economic development
Here you will:
 examine the meaning and main features of globalisation;
 consider the impact of globalisation on developed and less developed economies;
 examine the effects of international groupings and organisations on the global
economy;
 learn about the main stages of economic development;
 examine the factors which may promote or hold back economic development;
 learn about ways in which foreign aid to less developed economies may be
provided;
 examine the roles of the International Monetary Fund and World Bank; and
 consider the arguments for trade versus aid as a way of helping economies to
develop.
5. Macroeconomic policy in an open economy
In this section you will consider:
 explore the international pressures on countries to protect the environment; and
 examine the ways in which international factors may affect the operation of a
country’s economic policies.
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What areas cause students particular problems?
Though most students find the content of this unit to be topical and interesting, there
are certain areas which some students find particularly challenging. These problem
areas are discussed below:
The theory of comparative advantage
The theory (or law or principle) of comparative advantage is one of the most
important economic ideas. It provides the basis for specialisation and exchange
between individuals and firms and it is central to the explanation of why countries
trade and the process of globalisation. However, students often have difficulty in
explaining this idea as it seems to suggest the opposite to what their intuition tells
them.
In international economics, the theory of comparative advantage states that all
countries can benefit from specialisation and trade provided that they specialise in
goods in which they have a comparative advantage and trade those goods for other
goods in which they have a comparative disadvantage. The theory is usually
associated with the 19th century economist David Ricardo. It is normally illustrated
through a very simple two-country, two-product model.
A comparative advantage exists when a country is able to produce a good at a lower
opportunity cost than another country. For example, assume that there are just two
countries, Joyland and Sadland producing and consuming two goods, bread and fish.
Before any specialisation and trade, we assume that both countries have equal
amounts of resources and divide these equally in producing both goods. This gives the
following situation:
Production before specialisation
Bread (tonnes) Fish (tonnes)
Joyland
400
200
Sadland
200
150
Total
600
350
Joyland is more efficient than Sadland at producing both products, ie it has an
absolute advantage in both bread and fish. This could be because it has better factor
endowments such as more fertile wheat fields or more skilful fishers. However, it has
a comparative advantage in the production of bread. This can be seen by looking at
the opportunity cost of producing one tonne of bread in each country.
If Joyland used all its resources to produce bread, it could produce 800 tonnes of
bread and no fish. If it used all its resources to produce fish, it could produce 400
tonnes of fish and no bread. Therefore, for each tonne of bread it produces the
opportunity cost is the 0.5 tonne of fish it could have produced instead.
If Sadland used all its resources to produce bread, it could produce 400 tonnes of
bread and no fish. If it used all its resources to produce fish, it could produce 300
tonnes of fish and no bread. Therefore, for each tonne of bread it produces the
opportunity cost is the 0.75 tonne of fish it could have produced instead.
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Joyland
Sadland
Opportunity costs
Bread (tonnes) Fish (tonnes)
1
0.5
1
0.75
In this situation, Joyland therefore has a comparative advantage in the production of
bread and Sadland has a comparative advantage in producing fish.
If both countries specialise in the production of their goods of comparative advantage,
then it is possible to increase production of both goods. For example, if Joyland
produced 650 tonnes of bread it could still produce 75 tonnes of fish whereas if
Sadland specialised exclusively in producing fish, it could produce 300 tonnes. Thus
compared with the situation before specialisation, more of both goods are produced:
50 extra tonnes of bread and 25 extra tonnes of fish.
Production after specialisation
Bread (tonnes) Fish (tonnes)
Joyland
650
75
Sadland
0
300
Total
650
375
By trading, it is possible for both countries to gain. For this to happen, terms of trade
need to be agreed that are within the limits of the countries’ opportunity cost ratios,
that is, somewhere between 1 tonne of bread = 0.5 tonnes of fish and 1 tonne of bread
= 0.75 tonnes of fish.
For example, suppose that the countries agreed to trade at an exchange rate of 1 tonne
of bread = 0.64 tonnes of fish. Joyland could trade 225 tonnes of its bread for 225 x
0.64 = 144 tonnes of Sadland’s fish. This would give a situation after trade in which
both countries could enjoy more of both products than they did before they
specialised in their products of comparative advantage. This is shown below:
Joyland
Sadland
Total
Situation after trade
Bread (tonnes) Fish (tonnes)
425
219
225
156
650
375
Compared with the situation before specialisation, the happy inhabitants of Joyland
can enjoy an extra 25 tonnes of bread and an extra 19 tonnes of fish while their less
fortunate trading partners in Sadland are now a little less sad as they have 25 tonnes
more bread and 6 tonnes more fish – a ‘win-win’ outcome!
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The essential steps in using a model like this are to:
 make clear your assumptions;
 make sure that the opportunity cost ratios are different in each country;
 remember that a country has a comparative advantage in the product in which it
has the lower opportunity cost;
 appreciate that both countries do not necessarily have to specialise completely in
their products of comparative advantage; and
 make sure that the terms of trade fall between the opportunity cost ratios if
beneficial trade is to take place.
You should practice applying this model of comparative advantage with different
figures until you are confident that you have grasped how it works.
The effects of specialisation and trade can also be illustrated by the use of production
possibility frontiers. Specialisation and trade allow the achievement of combinations
of goods that would previously have been unattainable, that is outside the countries’
production possibility frontiers, when the countries were self-sufficient.
Production and consumption possibilities
Fish (tonnes)
Sadland
(after trade)
400
Joyland
(after trade)
300
Joyland
(before spec)
200
150
Sadland
(before
spec)
Bread
(tonnes)
200
400
800
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The theory of comparative advantage is often criticised as being too simplistic
because it relies on unrealistic assumptions such as:
 a very uncomplicated model two-country, two-product model;
 the ignoring of transport costs;
 perfect occupational mobility of factors of production within a country;
 full employment of factors of production;
 perfectly competitive markets;
 constant returns to scale; and
 no externalities from production or consumption.
Some commentators also point out that the theory was formulated at a time when
capital was largely immobile between countries and that this is no longer the case in
today’s sophisticated, global economy.
However, some of these assumptions are only used to create a workable model; they
do not destroy its ability to illustrate an essential economic truth. For example,
increasing the number of countries and products involved only increases the
opportunities to benefit from specialisation and trade, and the existence of increasing
returns to scale may actually increase the gains from specialisation. It should also be
remembered that comparative advantage is a dynamic concept – a country can gain or
lose a comparative advantage in a particular product over a period of time. This will
happen when there is a change in relative efficiency and opportunity cost ratios, for
example, because one country invests more in new technology or training.
Trade barriers
Though most students understand the nature of overt trade barriers such as tariffs and
quotas, many have difficulty in analysing and evaluating their impact on the economy.
They are also less sure about the nature of ‘hidden’ or ‘covert’ trade barriers.
Tariffs
A tariff is a tax on imports. It may also be referred to as an import duty or customs
duty. Tariffs are normally imposed as a deliberate attempt to reduce the demand for
imports by raising their price to the consumer and thereby making domestically
produced goods more competitive.
The effects of a tariff can be analysed with the aid of a supply and demand diagram.
In the absence of foreign trade, the market price and quantity would be fixed by the
interaction of domestic demand and supply: Pd and Qd. We then assume that a
country can obtain as many imports as it wishes at the prevailing world price below
the domestic market price, Pw. The world supply curve Sw is therefore perfectly
elastic at this price. In this situation, domestic production will fall to Q1 whereas
domestic demand will rise to Q4; the difference being made up of imports of Q1Q4.
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If the government now imposes a specific tariff of PwPt per unit, the world supply
curve shifts upwards to Swt by the amount of the tariff. In this situation, domestic
demand falls to Q3 whereas domestic supply rises to Q2. Imports therefore fall to
Q2Q3. Compared with the situation before the imposition of the tariff, consumer
surplus has been reduced by the total of all the shaded areas on the diagram as
consumers now have to pay a higher price for a smaller quantity of goods. The
government receives PwPwt x Q2Q3 in tax revenue. Of the remainder of the lost
consumer surplus, part has gone in the cost of the extra factors of production
employed by domestic producers and part to producers in the extra profits that have
boosted their producer surplus. However, part of the lost consumer surplus has not
been reallocated to any other group; this is the net loss to society as a whole and is
referred to as the deadweight welfare loss.
Effect of the imposition of a tariff
Price
Sd
Revenue from
tariff
Extra
costs
Deadweight
welfare loss
Pd
Pwt
Swt
Pw
Sw
Inc in prod
surplus
Q1
D
Q2
Qd
Q3
10
Q4
Quantity
Quotas
A quota is a quantitative restriction on the amount of goods allowed into a country.
Quotas can be set in terms of the number of units or value of goods imported.
The effect of a quota is to restrict the total supply to the domestic market and thereby
increase the price to consumers. This can be analysed in a similar way to the effect of
a tariff shown above. In a situation in which there is free trade, domestic suppliers
would have to compete at the world price.
Initially, at the prevailing world price, domestic consumers demand Q4. Of this
quantity, domestic suppliers provide Q1 and the remainder, Q1Q4, is supplied from
imports. When a quota of Q1Q2 is imposed, the new effective supply curve is Sd + q
at every price above Pw. The price that consumers have to pay therefore rises to Pq
and quantity demanded falls to Q3. Of this quantity, domestic suppliers provide Q5
and the remainder of Q5Q3 is supplied from imports. Overall, consumer surplus has
fallen by the total shaded area. Domestic producers have received an increase in
producer surplus, there are increased payments to domestic factors of production and
foreign suppliers are now receiving a higher price for the goods they supply to the
domestic market. Again there is an overall deadweight welfare loss but, unlike with
the tariff, there is no import tax revenue for the government.
Effect of the imposition of a quota
Price
Sd
Sd + q
Inc in prod
surplus
Deadweight
welfare loss
Pq
Pw
a
Sw
D
Q1
Q5
Q2
Q3
11
Q4
Quantity
Subsidies
Another method by which domestic suppliers can be helped to compete with foreign
producers is through the payment of government subsidies. This effectively tops-up
the price received in the market by domestic producers and makes it profitable for
them to supply a greater amount than was previously the case. Again the effect of the
payment of the subsidy can be analysed with the aid of a similar diagram.
Initially, without the subsidy and with the ruling world price at Pw, domestic
producers would only be prepared to supply Q1 and the rest of the domestic demand
for the good, Q1Q3, would have to be met from imports. If a specific subsidy of
PwPs is paid to domestic producers, then the domestic supply curve shifts to the right
to Sds. Domestic producers are now able to supply Q2 at the prevailing world price
and the amount of imports falls to Q2Q3. In this case, there is no reduction in
consumer surplus, as the market price and quantity remain the same at Pw and Q3.
However, domestic producers have received an increase in producer surplus, there
have been increased payments to domestic factors of production and the government
has to pay out a total subsidy of PwPs x Q2. There has therefore effectively been a
re-distribution of income from domestic taxpayers to domestic firms and factors of
production.
Effect of the payment of a subsidy to domestic producers
Price
Sd
Amount of
subsidy
Sds
Ps
Pw
a
Sw
D
Q1
Q3
Q2
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Quantity
Other trade barriers
There are a number of other ways in which domestic producers can be protected from
foreign competition. These include:
 embargoes: complete bans on imported goods;
 exchange controls: limits on the amount of foreign currency that domestic
residents can use to purchase foreign goods and services;
 voluntary restraint of export agreements: countries mutually agree to restrict their
exports to one another;
 import licenses: importers are required to obtain a license before they can legally
purchase goods from abroad; and
 administrative barriers: sometimes countries can use excessive bureaucracy,
unnecessarily strict health and safety regulations and/or customs checks, and
government procurement policies that favour domestic producers to restrict
imports. As these restrictions are normally presented as being imposed for reasons
other than trade protection, they are often referred to as ‘covert’ or ‘hidden’
barriers.
All trade barriers tend to cause some efficiency losses as they encourage less efficient
domestic production at the expense of restricting domestic consumers’ access to
cheaper imports. However, trade barriers are sometimes defended on economic and
non-economic grounds. The following is a brief outline of some of these arguments.
Arguments for trade barriers
 The infant industry argument: This states that short-term protection can sometimes
be justified, particularly in less developed economies, in order to allow recently
established industries to develop and take advantage of as yet unexploited
economies of scale. Once these industries have developed sufficiently, it is argued
that the protection can be withdrawn. However, the danger is that industries may
become dependent on trade barriers and never learn to become fully efficient.
 Anti-dumping: Sometimes countries may need to take action to protect their
industries from unfair competition from goods being ‘dumped’ from abroad.
These goods may be sold in the export market at prices lower than they would
normally be sold domestically, perhaps due to government subsidy. Dumping is
outlawed by World Trade Organisation (WTO) rules but it can often be difficult to
prove.
 Demerit goods: Protectionist measures may sometimes be used to safeguard
society from the over-consumption of demerit goods such as alcohol, tobacco and
narcotics that might arise from the availability of cheap foreign supplies of these
goods.
 Employment: Countries may wish to maintain certain industries in which they do
not have a comparative advantage in order to protect against the damage to
employment that might be caused by over-specialisation. If a country is heavily
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dependent on a small number of industries and these become subject to increased
competition from developing foreign producers with lower costs, then heavy
structural unemployment may be experienced.
 Strategic reasons: A country may justify the use of trade barriers to protect
industries that it may depend upon in times of war or national emergency, for
example, steel, arms or agriculture.
 Culture: It may be argued that protection of certain industries is justified in order
to maintain a certain way of life which is part of a country’s tradition and heritage.
When evaluating the effects of trade barriers, be sure that you weigh up the pros and
cons carefully. Use the tools of consumer and producer surplus to help you analyse
how different groups are affected and examine the overall effect on economic welfare.
Some students tend to neglect or underplay the effects on consumers.
Trade creation and trade diversion
Though students are normally able to understand the nature of the free trade area and
customs union formed by a trading bloc such as the EU, some find difficulty in
explaining the trade creation and diversion effects of these arrangements.
Trade creation refers to the effect on domestic consumer spending of the abolition of
tariffs between member countries. As domestic consumers are now able to find
cheaper foreign alternatives they will switch expenditure away from higher cost
domestic producers.
This effect is illustrated in the following diagram. It is the reverse of the effect of the
imposition of the tariff illustrated earlier. Initially, with the tariff in existence,
domestic consumers pay a price of Pt for Q3 goods. Q2 of this quantity is supplied by
domestic producers with Q2Q3 provided by imports. When the tariff is removed the
price falls to the EU level of Peu. Domestic consumers now consume Q4, with Q1
being provided from imports from other EU countries. The total shaded area
represents the increase in consumer surplus as a result of the removal of the tariff.
Part of this gain is accounted for by the loss of producer surplus, part by the reduction
in domestic costs of production through the unemployment of some domestic factors
of production and part by the reduction in the government’s tax revenue. The
remainder represents the net welfare gain from the removal of the tariff.
Trade creation effect of removal of a tariff
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Price
Sd
Revenue lost
from removal of
tariff
Reduction
in costs
Net welfare
gain
Pt
St
Peu
Seu
Reduction in
prod surplus
Q1
D
Q2
Q3
Q4
Quantity
Trade diversion refers to the shift in domestic consumer expenditure from lower cost
suppliers of imports from outside the trading bloc to higher cost producers within the
trading bloc when a common external tariff is imposed. As illustrated previously, the
effects of the imposition of a tariff results in a loss of consumer surplus due to higher
prices being paid for a smaller quantity of goods. It also results in an increase in
producer surplus, an increase in costs of production, extra tax revenue and a
deadweight welfare loss.
The overall effect therefore on a country’s citizens of joining a free trade area and
customs union like the EU will therefore depend on the balance between trade
creation and trade diversion.
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The balance of payments
The balance of payments is a record of all of a country’s financial transactions with
other countries over a given period of time. Students sometimes find difficulty in
explaining why the balance of payments as a whole must balance and tend to
misunderstand or ignore the nature of financing through drawing on or additions to
the official reserve assets which consist mainly of holdings of foreign currencies.
The UK Balance of Payments forms an important part of its national accounts. The
account is made up of two main sections.
Current account
The current account is principally a measure of payments and receipts generated by
international trade in goods and services. In the UK, the current account is divided
into four parts.
 Trade in goods: exports of goods minus imports of goods.
 Trade in services: exports minus imports of ‘invisibles’ such as financial services,
transport, travel and tourism, royalties and license fees.
 Income: earnings from UK investments abroad and the repatriation of income
from UK nationals abroad minus earnings of other countries from their
investments in the UK and the repatriation of income from foreign nationals
working in the UK.
 Current transfers. These are government, private and charitable sector transfers
that represent resources which are consumed within a short period after the
transfer is made, for example, food aid given to help deal with a famine in a less
developed country. Most of the transfers in this section relate to the UK’s
membership of the EU. The UK pays part of its tax revenues to the EU but
receives payments such as agricultural subsidies and regional grants
If current account outflows are greater than inflows, then there is said to be a current
account deficit. If inflows exceed outflows, then there is said to be a current account
surplus.
Capital account and financial accounts
The capital account records all UK capital transfers. These are mainly associated with
debt forgiveness (debts owed by developing countries to the UK which have been
written off) and migrants’ transfers of capital assets as a result of immigration and
emigration. The capital account normally represents a very small proportion of the
total value of UK balance of payments transactions.
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The financial account records all inflows of capital into the UK and outflows of
capital from the UK. These include:
 direct investment such as the provision of funds by major shareholders for the
setting up or expansion of factories and offices, mergers of companies and
acquisitions of businesses;
 portfolio investment such as the purchase of stocks and shares by investors who do
not have an important say in the running of the businesses concerned;
 the purchase and sale of financial derivatives, that is, financial instruments the
price of which depends on the value of another (normally financial) asset or assets;
 other investment including longer term foreign aid through the provision of trade
credits and loans; and
 changes in reserve assets resulting from drawing on or adding to foreign currency
reserves and the borrowing from, or repaying debts to, foreign central or
commercial banks or the IMF.
Errors and omissions
As it is not possible to record all payments and receipts accurately, a figure is
included for net errors and omissions which result from inaccuracies in recording or
the failure to record certain transactions.
Why the balance of payments must balance
In an accounting sense the balance of payments must, by definition, balance because
it is based on a system of double-entry recording in which all economic transactions
have two sides: a credit and a debit. For example, when a UK importer buys a car
from abroad, the imported car is represented by a debit entry and the payment for it is
represented by a credit. A debit entry represents a change in UK ownership of other
countries’ assets and a credit entry represents a change in other countries’ ownership
of any sort of UK asset (real or financial).
Inflows of foreign exchange are required to enable outflows to occur. If there is a UK
balance of payments current account deficit, then this has to be matched by a capital
and financial account surplus. If capital inflows from other sources are less than the
current account deficit, then the Bank of England has to finance this through drawing
on its reserve assets or borrowing from foreign central or commercial banks or the
IMF. Similarly, if there is a current account surplus which is not matched by capital
outflows from other sources, then the Bank of England will add to its reserve assets or
pay off foreign debts.
The following is a summary of the 2008 UK Balance of payments accounts. All
figures are in £ billions and have been rounded for simplicity.
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UK Balance of Payments Account, 2008 (£bn)
Current Account:
Trade in goods
Trade in services
Income
Current transfers
Current account total
Capital and financial accounts
Capital account
Financial account:
Direct investment
Portfolio investment
Financial derivatives (net)
Other investment
Reserve assets (net)
Capital and financial accounts total
Current, capital and financial accounts
total
Net errors and omissions
Credit
Debit
251
170
264
15
700
344
116
237
29
726
6
2
52
241
73
-129
-18
-580
-1
-653
73
-930
-631
69
4
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How will I be assessed?
Assessment at A2 is a step up from what you experienced at AS level. It is intended
to stretch you and be more challenging. You are expected to deal with less familiar
contexts and more complex information. There is a greater emphasis on analysis and
evaluation and less on pure knowledge and understanding. Questions are less
structured and more open-ended giving you scope to answer in a variety of ways.
Some of the questions may require you to make links with other sections of the
course.
Assessment for this unit consists of a 2 hour examination which you will sit either in
January or in June. The examination will consist of two sections: an unseen case
study section and an essay section, each of which will carry 40 marks (50% of the
total marks for the paper).
While there is no hard and fast rule, it is suggested that you should spend at least half
the examination time on the case study section. You need to take into account that
you have more material to read on this section. However, you still need to leave
sufficient time to choose which essay question you are going to attempt, and to plan
and write your essay. It is suggested that you spend at least 50 minutes on the essay
section of the paper.
Case study
The case study consists of a small number of pieces of source material about a
particular topic, theme or issue. The source material may be a mixture of written
information such as newspaper or magazine articles and/or charts or graphs.
You will be asked four questions which relate to the source material. One of the
questions in this part of the paper will require a relatively short answer while others
will require you to write at greater length.
In this part of the paper you may be required to analyse and interpret written,
numerical, diagrammatic and graphical data. This may require you to make
calculations such as percentages and percentage changes and to handle index
numbers. The final question will normally require you to demonstrate your ability to
evaluate a particular viewpoint or opinion.
Essay
In the essay section you will be required to answer one structured essay from a choice
of three. Each essay will be broken down into two parts.
Part (a) will assess knowledge and understanding and application and analysis will
carry 15 marks.
Part (b) will also test application and analysis but will have a particular emphasis on
evaluation and judgement and will carry 25 marks.
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Quality of written communication
All questions, other than the first in the case study section, will require you to write
extended answers. Assessment of your answers to these questions will take into
account the quality of your written communication. This does not mean that you have
to write elegant phrases with long words to earn high marks. It does mean, however,
that you should take care with your spelling, punctuation and grammar and that you
should use economic vocabulary accurately.
You should try to express your ideas clearly and concisely and present your
arguments logically and coherently. You should always write in sentences and
paragraphs and avoid lists of bullet points unless you are short of time to complete a
question.
Diagrams can be a valuable feature of many answers, helping to clearly illustrate the
points you are making. However, you must make sure that you draw and label your
diagrams accurately and clearly and that you explain what they are showing.
How can I make the most of my ability?
Economics affect the lives of everybody. To develop real understanding you need to
relate what you study in class to national and international economic events and issues
that are reported in the media. Following the tips below will help to develop your
interest and understanding of the content of this unit.
Follow the news: International economics features most days on TV, radio and in the
papers. Paying attention to the economics sections of the news will not only increase
your understanding but give you examples you can use in exams.
Use the Internet: There is a great deal of valuable information about the global
economy on the internet but you need to be selective in how you use websites.
Tutor2u has very useful sections and good discussions in its Economics Blog. The
BBC and Guardian economics sites are also very helpful with illuminating
discussions, debates and examples. There are many other useful web addresses in the
CCEA Resource List.
Read around the subject: There are a number of excellent textbooks, magazines and
journals available which cover the content of this unit in detail. The resource list that
follows covers some of the most commonly used textbooks and other sources of
information which are available. However, this should not be interpreted as
prescribing particular resources. For more advice, consult your teacher. Reading
around what you discuss in class is an excellent way of broadening and deepening
your understanding.
Be organised: There is quite a lot of content in this unit, but you should already be
familiar with some of the key ideas and concepts from your study of Units AS 1 and
AS 2. Make sure that you organise your notes effectively so that you cover each of the
main sections. There are more detailed Study Tips on the CCEA Economics microsite: www.ccea.org.uk/economics/.
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Develop good examination technique: Exams can be stressful but by being well
prepared and confident of how you are going to approach the paper, you can minimise
the stress and make sure you give of your best on the day. Following the advice
below will help.
 Make sure that you thoroughly revise all aspects of the unit content. Do not avoid
studying difficult topics or try to ‘spot’ questions. This might mean that you
cannot answer some questions and restrict your choice.
 Understand fully what the examiners expect you to be able to do. Familiarise
yourself with the specimen questions and mark schemes that CCEA has produced.
 Write practice answers to the different types of question and check them against
your notes. Make sure you practise using examples to illustrate your points and
arguments.
 Remember that the time spent on each question should reflect the mark allocation.
Don’t spend half an hour on a five mark question and leave yourself short of time
to answer questions with much higher mark allocations.
 Only do what the question asks you to do - there are no marks for including
information that the question doesn’t ask for.
 Make sure you use the case study information and refer to it in answering
Question 1.
 Remember that the final case study question and part (b) of the essay questions
will normally require balanced answers that address both sides of the issue. You
need to think critically and evaluate before coming to a reasoned overall
judgement.
 This unit is partly about economic theories but it is also about how these theories
apply to the real economy. Be sure to include real world examples and provide
evidence to support your arguments.
 The exam is not just a test of your knowledge and understanding. It assesses how
well you interpret questions and select relevant information. It examines how
effectively you can analyse and evaluate and how clearly you can communicate
your ideas.
 Remember! To score highly, you must answer the questions directly. Read and
re-read the questions and make sure you know exactly what they are asking before
you start writing. Think carefully about the command words and what they
require you to do, for example, explain, analyse, critically examine, compare,
discuss and evaluate.
21
Further resources
Text books
Anderton A: Economics (5thed), Pearson Education
Beardshaw, J et al: Economics: A Student’s Guide, Pearson Education
Begg D, Fisher S & Dornbusch R: Economics (9thed), McGraw Hill
Cramp, P: Understanding Economic Data, Anforme
Cramp, P: Development Economics (4thed), Anforme
Grant S & Bamford C: Studies in Economics and Business: The European Union
(5thed), Heinemann
Krugman P and Oldfield M: International Economics: Theory and
Policy (7thed), Pearson Education
Lipsey, R & Chrystal, K: Economics (11thed), Oxford University Press
Sloman, J: Essentials of Economics (4thed), Prentice Hall
Magazines and journals
Economic Review: www.philipallan.co.uk
Economics Today: www.anforme.co.uk
The Economist: www.economist.com
Websites
Tutor2U
BIZED
UK Treasury
The Bank of England
The Office for National
Statistics
European Central Bank
The International Monetary
Fund
Organisation for Economic
Cooperation and Development
The Institute for Fiscal
Studies
The World Bank
Department of Enterprise,
Trade and Investment
Office of National Statistics
Organisation of the Petroleum
Exporting Countries
The Financial Times
The Times
The Independent
The Guardian
The Daily Telegraph
The Economist
BBC Business News
David Smith Economic Blog
Freakonomics Blog
www.tutor2u.net/
http://www.bized.co.uk/learn/economics/index.htm
www.hm-treasury.gov.uk
www.bankofengland.co.uk
www.ons.gov.uk
www.ecb.int
www.imf.org
www.oecd.org
www.ifs.org.uk
www.worldbank.org
www.detni.gov.uk
www.statistics.gov.uk/
www.opec.org/home/
www.ft.com
www.the-times.co.uk
www.independent.co.uk
www.guardian.co.uk
www.telegraph.com
www.economist.com
http://news.bbc.co.uk/1/hi/business/default.stm
www.economicsuk.com/blog
freakonomics.blogs.nytimes.com/
22
Glossary
Absolute advantage: A situation in which one country is able to produce a good
more efficiently than another country. This means that it can produce the good using
fewer resources.
Appreciation (of a currency): A rise in the exchange rate of a currency so that a
given amount of this currency now buys more of another currency.
Balance of payments account: A record of one country’s financial transactions with
the rest of the world over a given period of time, normally a year.
Capital and financial accounts (of the balance of payments): The sections of the
balance of payments that record all capital transfers and capital flows into and out of
the UK.
Common Agricultural Policy (CAP): The agricultural policies of the EU designed
to support and stabilise farmers’ incomes and guarantee the supply of food at a
reasonable price.
CAP reform: In recent years, there have been attempts to reform the CAP which had
proved to be a very large drain on the EU budget and had resulted in high agricultural
prices and surpluses of certain food products. Reforms have included the decoupling
of payments to farmers from the amount they produce, reductions in guaranteed
minimum prices, the rewarding of farmers for protecting and improving the
environment, cutting payments to the largest farms and providing funds for rural
development.
Common currency area: A group of countries that agree voluntarily to adopt the
same currency, for example, the eurozone.
Comparative advantage: A situation in which one country is able to produce a good
at a lower opportunity cost than another country.
Current account (of the balance of payments): The section of the balance of
payments account which records payments for the purchase and sale of goods and
services.
Customs union: A group or bloc of countries which agrees to impose a common
external tariff on imports from outside these countries.
Deficit: A situation in which expenditure is greater than earnings. A deficit on the
current account of the balance of payments would occur when expenditure on imports
of goods and services is greater than earnings from exports.
Depreciation (of a currency): A fall in the exchange rate of a currency so that a
given amount of that currency now buys less of another currency.
Devaluation: A decision by a government to fix the exchange rate of its currency at a
lower value than it held previously.
23
Economic and Monetary Union (EMU): The adoption of a single currency by
certain members of the EU. The main effects of this on member counties are ease of
trade, transparency of prices and the need for a single monetary policy formulated by
the European Central Bank (ECB).
Economic development: The process by which a country is able to satisfy the basic
needs of its inhabitants, raise their living standards and widen the range of economic
and social choices open to them.
Enlargement (of the EU): The expansion of EU membership to include some of the
former Eastern bloc countries and other countries within Europe. Applicants for EU
membership have to prove that they can adopt the Union’s economic policies, have
effective competition policies and are able to protect the rights of minority
communities within their countries.
Environmental policy: The plans and measures adopted by individual countries and
international economic groupings to protect the environment.
European Central Bank: This is the central bank of the eurozone. Through a
committee of representatives of member countries, it decides on monetary policy and
sets the official interest rate for the eurozone.
European Union (EU): The EU is a customs union and free trade area providing a
common market through which goods and people can travel between member
countries can move relatively unhindered by regulation and border controls.
Euro: The single European currency used by the majority of the member countries of
the European Union.
Eurozone: The trading area formed by the EU countries which have adopted the euro
as their single currency.
Exchange rate: The rate at which one currency exchanges for another, that is, the
price of one currency expressed in terms of another.
Fair trade: The purchase of goods from developing countries at prices which
guarantee a fair return for producers. The fair trade movement tries to encourage
importers and consumers to purchase designated fair trade goods and to discourage
the consumption of goods which are produced by very cheap labour.
Fiscal policy: All government measures involving taxation, other means of raising
revenue and expenditure.
Fixed exchange rate: This occurs when the price of a currency is set at a particular
level in terms of another currency. The exchange rate is prevented from moving
outside of a very narrow margin either side of its set rate through intervention in the
foreign exchange market by the country’s central bank.
24
Foreign aid: Assistance offered by wealthier economies to developing countries.
This may take the form of financial grants, the provision of technical expertise, loans
or tied aid which is linked to the recipient country’s purchase of goods and services
from the donor.
Floating exchange rate: An exchange rate that is determined by the market forces of
demand and supply. The exchange rate will move in response to changes in exports,
imports and international capital movements.
Free trade: International trade which is free from barriers or import controls such as
tariffs and quotas.
Free trade area: A group or bloc of countries which encourages free trade amongst
its members. Members may retain their own trade barriers against other countries as
in the North American Free Trade Area (NAFTA) or also form a customs union and
impose a common external tariff as in the EU.
Globalisation: The process by which the international economy has become more
open and world markets for goods, services and capital have become more integrated.
Globalisation is often associated with economic growth and improvements in the
standard of living but has also been criticised for making large multinational
companies more powerful at the expense of the populations of the poorest countries.
The Group of 20 (G20): This is a discussion forum for the Finance Ministers and
Central Bank Governors of the main industrialised and developing economies. It
meets to discuss issues related to global economic stability such as policies for
economic growth and the regulation, supervision and functioning of world financial
markets.
International Monetary Fund (IMF): The IMF attempts to coordinate the
international monetary system and ensure that there is sufficient liquidity to finance
the growth of world trade. Member countries make financial contributions to the fund
in proportion to the size of their economies. The IMF will provide loans to countries
which are experiencing persistent balance of payments problems but will usually
impose conditions designed to ensure that the underlying economic problems of the
country are addressed.
Less developed country (LDC): A country which has a relatively low Gross
National Product (GNP), a poorly developed economic infrastructure and which tends
to be economically dependent on agricultural production.
Marshall-Lerner condition: This states that a devaluation of a currency will only
improve a country’s balance of payments situation if the sum of the price elasticities
of demand for its exports and imports is greater than one.
25
Monetary policy: Policy designed to influence the cost and availability of credit in an
economy. In an increasingly open global economy, the operation of monetary policy
may require international cooperation and coordination if it is to be effective in
combating problems like the credit crunch and recession. In the UK, monetary policy
is operated by the Monetary Policy Committee of the Bank of England. In the
eurozone, it is operated by the European Central Bank (ECB).
Open economy: An economy which has few trade barriers and depends heavily on
international trade and the free movement of people and capital. Government macroeconomic policy in open economies may be difficult to operate without coordination
with trading partners as the economy may be destabilised capital movements.
Opportunity cost ratio: The cost of producing one unit of a particular good or
service expressed in terms of the amount of another good that has to be foregone.
Protectionism: Policy measures which are designed to protect domestic producers
from foreign competition. These include tariffs, quotas and administrative barriers.
Quota: An import control which imposes a limit on the quantity of goods that can be
imported.
Stabilisation (of an exchange rate): The use of central bank foreign exchange
reserves to maintain a currency’s exchange rate within a given band. If the exchange
rate is considered to have fallen too low, the currency can be purchased by the central
bank on the foreign exchange market using its reserves of other currencies. If the
exchange rate is considered to have risen too high, then the currency can be sold and
the proceeds added to the foreign currency reserves.
Surplus: A situation in which earnings are greater than expenditure. A surplus on the
current account of the balance of payments would occur when earnings from exports
of goods and services are greater than expenditure on imports.
Sustainable economic development: Development of an economy which occurs at a
pace which can be maintained over the long term because it does not produce
shortages of factors of production which will lead to high levels of inflation or lead to
the over-use of finite or non-renewable resources.
Tariff: A tax on imports or customs duty normally designed to raise the price of
imports and thereby reduce foreign competition to domestic production.
Terms of trade: The exchange rate or price of exports in terms of imports. The terms
of trade index expresses the price of exports relative to the price of imports and is
calculated by the following formula: index of export prices x 100.
index of import prices
A rise in the terms of trade index is referred to as an improvement as it means that
fewer exports have to be sold to purchase a given quantity of imports. Conversely, a
fall in the terms of trade index is referred to as a worsening or deterioration.
Trade barriers (or controls): Measures such as tariffs and quotas designed to protect
domestic producers from foreign competition.
26
Trade creation: The increased specialisation and trade brought about by the
formation of a trading group or bloc that abolishes or reduces trade barriers between
member countries. Domestic consumers will tend to switch some expenditure from
higher cost domestic producers to lower cost imports.
Trade diversion: The effect of a trading group or bloc imposing a common external
tariff on goods entering from non-member countries whilst abolishing or reducing
trade barriers between member countries. Domestic consumers will tend to switch
expenditure away from the production of non-member countries to the production of
member countries.
Trade war: A situation in which protectionist measures introduced by one country or
a trading bloc result in retaliatory measures being taken by other countries. In such a
situation all countries involved tend to lose as the efficiency and welfare gains of
specialisation and trade are lost.
Trade liberalisation: The process of making world trade more free by the reduction
and, where possible, elimination of trade barriers.
World Bank: This is the informal name given to the International Bank for
Reconstruction and Development (IBRD). It borrows money in international capital
markets and lends this to developing countries to finance projects which are designed
to improve areas such as infrastructure, health and education provision, agriculture
and industry.
World Trade Organisation (WTO): The organisation which supervises and
regulates international trade. It aims to promote trade liberalisation by negotiating the
reduction of trade barriers between member countries. It also helps to resolve trade
disputes between members.
27
Revision checklist
Section 1: International trade and protection

At the end of this section you should be
able to:
Explain why countries trade.
Apply the concept of specialisation and the
theory of comparative advantage to
illustrate the gains from trade.
Evaluate the usefulness of the theory of
comparative advantage.
Explain and evaluate arguments for and
against free trade.
Explain the range of trade controls which
may be used and evaluate their effects.
Explain the main aims of the WTO and
evaluate how well it has achieved them.
28
Notes
Section 2: The UK balance of payments and the exchange rate

At the end of this section you should be
able to:
Explain the main components of the UK
balance of payments accounts and how
they relate to one another.
Describe the main trends in the UK
balance of payments in recent years.
Explain the problems caused by large and
persistent balance of payments deficits and
surpluses.
Explain and evaluate the different
measures that might be used to correct
these imbalances.
Explain how exchange rate values are
determined when they are allowed to
‘float’.
Analyse the effects of changes in the
exchange rate.
Explain how an exchange rate may be
stabilised and the benefits of stable
exchange rates.
29
Notes
Section 3: The European Union
At the end of this unit you should be able
to:
Explain the main features of the existence
of a free trade area, customs union and
common currency area within the EU.

Notes
Explain the trade creation and trade
diversion effects of the EU.
Evaluate the effects of EU enlargement
and the possible extension of the eurozone.
Explain the roles and analyse the impact of
the ECB.
Analyse and evaluate the effects of the
CAP and attempts to reform it.
Section 4: Globalisation and economic development
At the end of this section you should be
able to:
Explain the main features of globalisation.
Analyse and evaluate how globalisation
has affected developed and less developed
economies.
Explain how international organisations
such as the WTO and G20 may influence
the international economy.
Explain the process of economic
development and the factors that may help
or hinder it.
Explain the parts played by governments
and other bodies in providing aid to less
developed and developing economies.
Compare the effectiveness of foreign aid
and trade liberalisation in assisting
economic development.
30

Notes
Section 5: Macroeconomic policy in an open economy

At the end of this section you should be
able to:
Explain the pressures in open economies
that may lead countries to develop policies
to protect the environment.
Analyse how a country’s fiscal and
monetary policies may be affected by
international factors.
31
Notes