Transcript AQA Economics Unit 4

3.4.3 The International Economy
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Globalisation
Trade
The Balance of Payments
Exchange Rate Systems
The European Union (EU)
Balance of Payments
Current account
Capital & Financial account
Terms
• Current account
– Part of the balance of payments that records
trade in goods and services mainly
• Capital and financial account
– Part of the balance of payments that records
capital flows in and out of the country
• Current account deficit
– When imports of goods and services exceed
exports
Terms
• Current account surplus
– When exports of gods and services exceed imports
• Balance of trade in goods
– Visible imports minus visible exports
• Balance of trade in services
– invisible imports minus invisible exports
• Net income flows
– The difference between inward and outward flows
of interest, profits and dividends
Terms
• Net current transfers
– The difference between government transfers to and from
overseas organisations
• Hot money
– Volatile capital movements in foreign exchange markets due
to interest rate changes
• Direct investment
– The purchase of productive assets (factories, offices etc)
– These can be foreign direct investment (FDI) or outward
direct investment
• Portfolio investment
– The purchase of financial assets (shares etc)
Current account revisited
• The balance of payments accounts include:
• Trade in goods (visible trade)
• Trade in services
• Income
– Compensation of employees
– Investment income
• Current transfers
– Central government transfers
– Other sectors
Capital and financial accounts
– FDI
• Long term
– Portfolio investment
• Shares, financial assets
• Long term
– Hot money
• Short term
• Interest rate
Problems of deficit
• It is persistent.
• It forms a large share of GDP.
• There are no compensating inflows of
investment income or inward capital
account flows.
• The Bank has low reserves.
• The economy has a poor record of
repaying debt.
Causes
Excessive growth
• If the economy grows too quickly, and rises above its own trend
rate, which in the UK is around 2.5%, then domestic output (AS)
may not be able to cope with domestic aggregate demand.
High export prices
• High export prices will occur if a country's inflation is higher
than that of its competitors, or if its currency is over-valued
which will reduce its price competitiveness.
Non-price factors
• Non-price factors can discourage exports, such as poorly
designed products, poor marketing or a worsening reputation for
reliability.
Poor productivity
• An economy might not be producing enough from its scarce factors of
production. Labour productivity, which is defined as output per worker,
plays an important role in a country’s competitiveness and trade
performance, and the UK has suffered from poor productivity. The
productivity gap is the gap between the UK’s relatively poor
productivity performance and that of the UK’s leading competitors.
Low levels of investment in real capital
• This could be caused by excessive long-term interest rates, or low
levels of research and development.
Low levels of investment in human capital
• This involves a lack of investment in education and training, which
reduce skill levels relative to competitor countries and force countries
to produce low value exports.
RNI and BoP
Policy options
Demand management:
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Reductions in government spending, higher interest rates and higher taxes could all have the effect of
dampening consumer demand reducing the demand for imports
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When domestic demand is low, this creates an incentive and the spare capacity for businesses to export
overseas to replace low spending in the home economy
Natural effects of the economic cycle:
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One would expect to see a trade deficit fall during a recession – so some of the deficit is partially selfcorrecting.
A lower exchange rate:
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A lower exchange rate provides a way of improving competitiveness, reducing the overseas price of exports
and making imports more expensive
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For those countries operating with a managed exchange rate, the government may decide to authorise
intervention in the currency markets to manipulate the value of the currency
Supply-side improvements:
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Policies to raise productivity, measures to bring about more innovation and incentives to increase investment
in industries with export potential are supply-side measures designed to boost exports performance and
compete more effectively with imports. The time-lags for supply-side policies to have an impact are long.
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Policies to encourage business start-ups – successful small businesses with export potential
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Investment in education and health-care to boost human capital and increase competitiveness in fastgrowing and high value industries such as bio-technology, engineering, finance, medicine
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Investment in modern critical infrastructure to support businesses and industries involved in international
markets
Protectionist measures such as import quotas and tariffs
Expenditure Reducing Policies
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These are policies that aim to reduce the real spending power of consumers
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Fiscal policy can be used (e.g. a rise income tax that reduces disposable income)
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Higher interest rates would dampen consumer spending and reduce economic growth
Expenditure Switching Policies
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These are policies that attempt encourage consumers to switch their spending away from
imports towards the output of domestic firms. ‘Expenditure-switching’ occurs if the relative
price of imports can be raised, or if the relative price of UK exports can be lowered.
Measures might include:
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A depreciation of the exchange rate which has the effect of increasing the UK cost of
imports and reduces the foreign price of UK exported goods and services. A lower exchange
rate also increases the profitability of exporting products overseas, and this profit signal
should, over time, act an as incentive for UK businesses to reallocate factor resources
towards potential export markets
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Tariffs or other import controls can occasionally be used – but the UK is bound by its
commitments to the World Trade Organisation. Protectionist policies are not a viable option
for an economy wishing to control its total trade deficit
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Policies that reduce the rate of inflation in the economy below that other international
competitors leading to a gradual improvement in price competitiveness
Good or bad?
• Promotes world
trade
• Generates finance
• Transfers
technology
– Supply side benefits
• Downturn can be
global
– Credit crunch
• Global domination
• Destabilise exchange
rates
BoP Equilibrium
• Short run – not a problem
• Long run – can be, depends on the size
and cause
Worksheet
Export and Import Volumes - the importance of Elasticity of Demand
Original exchange rate
£1 = $1.80
Exports of Pocket tablets from the UK
Imports of US i-pads
UK price (£)
£350
USA price ($)
US price ($)
$630
UK price (£)
Demand
40,000
Demand
Export revenue (£)
Import spending (£)

New exchange rate
Ped for UK exports =
UK price (£)
US price ($)
Demand
Export revenue (£)
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£1 = $1.60
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Ped for US imports =
USA price ($)
UK price (£)
Demand
Import spending (£)
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% change in ex rate
% change in demand
£350
$560
46,220
% change in ex rate
% change in demand
Net trade balance
Original exchange rate
New exchange rate
$450
£250
60000
£1 = $1.80
£1 = $1.60
Combined elasticity of demand for X and M =
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$450
£281.25
56670
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Deficit / surplus?
Deficit / Surplus ?
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Answers
Export and Import Volumes - the importance of Elasticity of Demand
Original exchange rate
£1 = $1.80
Exports of Pocket PCs from the UK
Imports of US DVD players
UK price (£)
£350
USA price ($)
US price ($)
630
UK price (£)
Demand
40,000
Demand
Export revenue (£)
14,000,000
Import spending (£)
450
250
60000
15,000,000
New exchange rate
£1 = $1.60
Ped for UK exports = 1.4
UK price (£)
£350
US price ($)
560
Demand
46,220
Export revenue (£)
16,177,000
Ped for US imports = 0.5
USA price ($)
UK price (£)
Demand
Import spending (£)
450
281.25
56670
15,938,438
% change in ex rate
% change in demand
% change in ex rate
% change in demand
Net trade balance
Original exchange rate
New exchange rate
11.1
15.55
£1 = $1.80
£1 = $1.60
Combined elasticity of demand for X and M + 1.4 + 0.5 = 1.9
-1,000,000 Deficit
238,562.50 Surplus
11.1
5.55
• To what extent would a significant fall
in the exchange rate of the pound
sterling achieve a sustained reduction in
unemployment in the UK? (25 marks)