4.1 International Economics (Edexcel A Level Economics A)

Structural unemployment is unemployment resulting from processes like deindustrialisation typically due to technological change. Workers existing skills are no longer required so they need to retrain.

The World Trade Organisation (WTO) promotes global free trade.

David Ricardo's law of comparative advantage states that a country should specialise in the goods and services that it can produce at the lowest opportunity cost.

A country has an absolute advantage when it can produce a product using fewer factors of production than another country.

The assumptions of comparative advantage are that:

• there are zero transport costs

• there is perfect knowledge

• factors can be easily substituted

• production costs are constant

• products are homogenous across different countries.

A production possibility frontier is used to illustrate the concept of comparative advantage by showing the opportunity cost of producing one good in relation to another.

False.

A country may have an absolute advantage but will not always have a comparative advantage.

Opportunity cost is calculated using the formula:

Specialisation is the concentration of production on a narrow range of products.

The benefits of international specialisation and trade include:

• lower prices

• a greater variety of goods and services

• more competition

• economies of scale

• higher economic growth

• improved living standards.

False.

Specialisation can lead to an overdependence on some industries and a greater vulnerability to economic shocks, such as the financial crisis in 2008.

The main limitation of comparative advantage theory is that it does not account for transport costs.

Specialisation can lead to structural unemployment as some industries, like steel manufacturing in the UK, begin to shut down. This creates unemployment for workers who may not have the required skills to move into other occupations.

Specialisation can lead to greater income inequality. Richer sections of the population often gain disproportionately more advantage.

The factors influencing the pattern of trade are:

• comparative advantage

• the impact of emerging economies

• the growth of trading blocs and bilateral trading agreements

• changes in relative exchange rates.

Emerging economies are developing countries that are becoming more engaged with global markets as they grow.

A trading bloc is a group of countries that agree to reduce or eliminate barriers to trade between themselves.

False.

Patterns of trade can change significantly over time.

A bilateral trading agreement is a trade deal between two countries to reduce barriers to trade.

Exchange rates affect the pattern of trade by influencing the relative prices of exports and imports.

Trade creation occurs when the frequency of trade between the member countries of a trading bloc increases because trade barriers are removed.

Trade diversion occurs when there is a shift in trade from a non-member country to a member country of a trading bloc even if the non-member is more efficient.

False.

Until the 1980s the UK traded predominantly with Commonwealth Countries.

46% of UK trade was with EU countries in 2020.

China's role in global trade has increased significantly, obtaining a much higher share of world trade.

The World Trade Organisation influences trade patterns by facilitating trade agreements and promoting free trade between countries.

The terms of trade refer to the ratio of a country's average price of exports to the country's average price of imports.

The terms of trade are calculated using the formula:

An improvement in the terms of trade means that the revenue from exports can buy a greater value of imports compared to the previous year.

False.

The impact of an improvement in terms of trade depends on factors such as the price elasticity of demand for exports and imports.

Price elasticity of demand measures the percentage change in quantity demanded of a good in response to the percentage change in the price of that good.

Relative inflation rates affect the terms of trade by changing the relative prices of exports and imports.

Productivity improvements can lower the average costs and prices of exports. This can lead to a deterioration in the terms of trade.

An exchange rate is the price of one currency in terms of another currency.

False.

In reality the terms of trade never balance perfectly and the difference is called 'net error & omissions'.

Changes in the terms of trade can affect the country's GDP by influencing the value of exports and imports. This leads to changes in real national output.

The terms of trade can impact a country's standard of living by affecting the purchasing power of a country's exports in terms of its imports.

Changes in exchange rates affect a country's terms of trade by altering the relative prices of exports and imports.

A trading bloc is a group of countries who come together and agree to reduce or eliminate any barriers to trade that exist between them.

A free trade area is a type of trading bloc where member countries agree to abolish trade restrictions between themselves. They can maintain their own restrictions with other non member countries.

A customs union is a type of trading bloc where an agreement exists between member countries that all goods and services produced by members are traded with no barriers. Members also agree to set common tariff rates on imports from all non-member countries.

False.

A common market allows free movement of all factors of production including labour.

A monetary union is the most integrated type of trading bloc where members establish a common central bank. Members share a common currency and the common central bank controls the monetary policy for all member countries.

There were more than 420 regional trade agreements in effect globally in 2022.

Trade creation occurs when the frequency of trade between the member countries of a trading bloc increases because trade barriers are removed.

Trade diversion occurs when there is a shift in trade from a non-member country to a member country of a trading bloc even if the non-member is more efficient.

The main role of the World Trade Organisation is to promote free trade.

False.

WTO judgements are not legally binding. Members voluntarily accept or reject them.

The WTO resolves trade disputes by acting as an adjudicating body. It runs hearings and makes judgements.

Regional trade agreements and the role of the WTO conflict because they divert trade. Trade switches from non-members who have a comparative advantage to members who do not. This goes against the WTO's aim of global trade liberalisation.

Protectionism is the practice of restricting free trade in order to protect domestic industries from overseas competition.

A tariff is a tax imposed on imported goods or services.

A quota is a physical limit on the quantity of a product that can be imported into a country.

False.

Subsidies decrease the costs of production for domestic firms.

Non-tariff barriers (NTBs) are strategies used to create barriers to trade using less transparent methods than tariffs, quotas and subsidies.

Tariffs allow domestic producers to increase their output and total revenue as they face less overseas competition.

Quotas result in higher prices and less choice for consumers.

True.

Domestic businesses are more competitive abroad when they receive subsidies.

Non-tariff barriers (NTBs) increase costs of production and act as a disincentive for overseas producers to sell into the market.

An infant industry is a new domestic industry that may need temporary government support to establish itself so it can compete effectively with overseas producers.

Dumping is the practice of selling exports at prices below the average cost of production to gain market share.

The main argument for protecting strategic industries is that they are essential for national security and self-sufficiency.

The balance of payments is a record of all financial transactions between a country and the rest of the world.

The current account is the section of the balance of payments that records trade in goods, services, income flows (primary income) and current transfers (secondary income).

The financial account records flows of money associated with changes in ownership of foreign financial assets and liabilities.

True.

A current account deficit must be balanced by a surplus on the financial account.

Visible exports are exports of physical goods. They are tangible.

A relatively high inflation rate worsens the current account balance. It makes exports more expensive and imports relatively cheaper. This reduces credits and increases debits to the current account.

Foreign direct investment (FDI) is the purchase of controlling ownership in a company by another company based in another country.

False.

Portfolio investment involves purchasing smaller stakes in foreign companies, not a controlling interest.

Supply-side policies can help to reduce a current account deficit by improving productivity and competitiveness of domestic industries. This should increase credits to the current account balance.

Reserve assets are held by a central bank. These can be used to influence monetary policy and exchange rates.

Expenditure switching policies are measures to encourage spending on domestic products rather than imports.

Persistent trade imbalances can lead to increasing foreign ownership of domestic assets and potential economic vulnerabilities to exogenous shocks.

A nominal exchange rate is the price of one currency expressed in the price of another currency. For example £1 = $1.30.

An appreciation is an increase in the value of a currency in a floating exchange rate system. It is often described as being stronger.

A fixed exchange rate system is where a currency's value is pegged to another currency or basket of currencies.

False.

In a managed exchange rate system the central bank intervenes to keep the exchange rate within a target range.

Hot money refers to funds that flow quickly between financial markets in search of the highest short-term interest rates.

Higher relative interest rates tend to cause a currency to appreciate as they attract more foreign investment. This increases demand for the currency.

The J-curve effect is when the balance of trade on the current account initially worsens after a currency depreciation before improving over time.

False.

A currency depreciation only improves the current account if the Marshall-Lerner condition is met.

Quantitative easing tends to depreciate a currency by increasing its supply in foreign exchange markets.

A competitive devaluation is the practice of intentionally lowering a currency's value to boost export competitiveness.

Revaluation means an increase in a currency's value in a fixed exchange rate system.

The forex market is the global marketplace for trading currencies.

International competitiveness refers to how well a country's products compete in international markets.

Relative unit labour costs are a country's total wage costs divided by total output compared to other countries.

Relative export prices are the prices of a country's exports compared to those of competitor countries.

False.

Higher relative inflation usually worsens international competitiveness by making exports more expensive.

Labour productivity is output produced from each unit of labour over a measured time period.

Higher non-wage costs like pensions or social security taxes can reduce competitiveness by increasing production costs.

Deregulation is the reduction or elimination of government regulations in an industry to encourage greater competition.

False.

Increased regulation often reduces international competitiveness by raising costs for firms.

Improved international competitiveness can lead to export-led economic growth.

Foreign direct investment (FDI) occurs when a firm or individual in one country purchases assets in another country.

Export-led growth is economic growth driven primarily by increases in the value of exports.

A potential problem of being internationally uncompetitive is persistent current account deficits.