International trade
What is meant by international trade?
International trade refers to the exchange of goods and services between countries. It allows countries to access products they do not produce themselves and to specialize in what they produce best.
What is meant by economic integration?
Economic integration refers to an agreement between countries to reduce or eliminate trade barriers between themselves in order to increase trade and economic cooperation.
What is meant by an exchange rate?
An exchange rate is the price of one currency in terms of another currency, determined in the foreign exchange market.
What is meant by the balance of payments?
The balance of payments is a record of all economic transactions between a country and the rest of the world over a given period of time.
Explain the concept of comparative advantage.
Comparative advantage occurs when a country can produce a good or service at a lower opportunity cost than another country. Even if a country is less efficient in absolute terms, it can still benefit from trade by specializing in goods where its opportunity cost is lowest.
Distinguish between a free trade area and a customs union.
A free trade area removes tariffs and quotas between member countries, but each country maintains its own external trade policies toward non-members.
A customs union also removes internal trade barriers but adopts a common external tariff against non-member countries.
Distinguish between an appreciation and a depreciation of a currency.
An appreciation is an increase in the value of a currency under a floating exchange rate system due to market forces.
A depreciation is a decrease in the value of a currency under a floating exchange rate system.
Identify two components of the current account.
Trade in goods and services (exports and imports)
Primary income (income from investments and wages)
Draw a graph and explain how a tariff affects domestic producers, consumers, and the government.
A tariff raises the price of imported goods:
Domestic producers benefit because they face less competition.
Consumers are worse off due to higher prices and reduced choice.
Government gains revenue from the tariff.
Overall, tariffs cause a loss of economic efficiency (deadweight loss).
Using the graph, explain the difference between trade creation and trade diversion.
Trade creation occurs when economic integration leads to the replacement of high-cost domestic production with lower-cost imports from member countries, increasing efficiency and welfare.
Trade diversion occurs when lower-cost imports from non-member countries are replaced by higher-cost imports from member countries due to preferential treatment, reducing efficiency.
Using the graph, explain two factors that could lead to an appreciation of a currency.
Increased demand for exports, raising demand for the domestic currency.
Higher interest rates, attracting foreign capital inflows and increasing demand for the currency.
Using a graph, explain one possible cause of a current account deficit.
A current account deficit may be caused by strong domestic economic growth, which increases demand for imports. As imports rise faster than exports, the value of imports exceeds exports, leading to a deficit.
Define terms of trade and explain one factor that may cause a country’s terms of trade to improve.
Terms of trade measure the ratio of export prices to import prices, calculated as:
ToT: Export prices/Import prices x 100
A country’s terms of trade may improve if demand for its exports increases, allowing it to raise export prices relative to import prices.
Explain two potential benefits and one cost of economic integration for member countries.
Benefits:
Increased competition, leading to lower prices and greater efficiency.
Economies of scale due to access to a larger market, lowering average costs.
Cost:
Loss of national sovereignty, as member countries may need to follow common trade policies that may not suit their individual economic interests.
Using the graph, explain the Marshall–Lerner condition.
The Marshall–Lerner condition states that a depreciation of a currency will improve the balance of trade if the sum of the price elasticities of demand for exports and imports is greater than one.
Explain how a financial account surplus can offset a current account deficit.
A financial account surplus occurs when capital inflows (such as foreign direct investment or portfolio investment) exceed outflows. These inflows provide the foreign currency needed to finance a current account deficit, allowing the balance of payments to balance overall.
Using a diagram, evaluate the impact of trade protectionism on economic growth in a developing country.
Trade protectionism may help developing countries protect infant industries, allowing them to grow without foreign competition and potentially increasing employment. However, protectionism can also lead to inefficiency, higher prices, and reduced consumer welfare. In the long run, it may limit access to foreign markets, reduce competitiveness, and slow economic growth. Therefore, while protectionism may offer short-term benefits, it often hinders long-term economic development.
Using a diagram, evaluate the impact of economic integration on the economic growth of developing member countries.
Economic integration can promote growth in developing countries by increasing market access, attracting foreign direct investment, and encouraging specialization based on comparative advantage. However, developing countries may struggle to compete with more developed members, leading to deindustrialization, job losses, and increased income inequality. The overall impact depends on the country’s level of development, labor mobility, and the extent of supportive government policies.
Using a diagram, evaluate the impact of a currency depreciation on inflation in an economy.
A depreciation increases the domestic price of imports, leading to imported inflation and higher costs of production for firms using imported inputs. This can cause cost-push inflation. However, if the economy has spare capacity and demand is weak, the inflationary impact may be limited. Additionally, increased export competitiveness may raise output and employment, potentially increasing demand-pull inflation. The overall effect depends on the elasticity of demand, the share of imports in consumption, and the state of the economy.
Using a diagram, evaluate the significance of a persistent current account deficit for an economy.
A persistent current account deficit may indicate structural competitiveness problems, leading to rising external debt and increased reliance on foreign capital. However, if the deficit is financed by foreign direct investment and reflects strong investment and growth prospects, it may not be problematic. The significance depends on factors such as the source of financing, the economy’s growth rate, and confidence in the currency.