Transcript Trade_and_The_BOP

AS Economics
International Trade
Aims
• To recap the knowledge of Balance of Payments
• To understand the positive and negative implications of
international trade
• To consider short run & long impact of international trade
• To discuss whether a BoP deficit/surplus can cause problems
• How to resolve a BoP deficit/surplus
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What is meant by
Trade?
Trade
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Trade (2)
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What is Free Trade?
• Free trade represents trade between countries
without the introduction of artificial barriers
• International trade reflects exchange and
specialization
– Exchange: countries supply goods and services
that they can produce relatively cheaply and
buy products from other countries that they
would find relatively expensive to produce
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– Specialisation: benefits from trade are
increased if there are economies of scale from
production and if countries specialise their
resources in producing certain commodities
What is Free Trade?
• In an open economy, one nation trades
openly with other
– Trade in goods
– Trade in services
– Free flow of financial capital
– Free flow of labour resources
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Intra-Firm Trade
• Intra-firm trade is becoming increasingly important
– For example a USA fruit drinks manufacturer might
export some of its raw materials to the UK to produce
fruit juices that are manufactured / bottled and distributed
to the UK and Western European markets
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Why trade?
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The Potential Advantages from Trade (1)
• Competition:
– Increased competition for suppliers
– Greater pressure on businesses to keep their costs and
prices down
– Increased competition can lead to a dilution of monopoly
power – which reduces the potential for exploiting
consumers
– This leads to an improvement in the allocative efficiency
of scarce resources
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The Potential Advantages from Trade (2)
• Comparative Advantage:
– If other countries can supply certain goods and services
more efficiently – it makes economic sense for them to
do so
– This makes use of the principle of comparative
advantage
– It also leads to an improvement in overall productive
efficiency
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The Potential Advantages from Trade (3)
• Improvements in dynamic efficiency
– Trade tends to speed up the pace of technological
progress and innovation across different industries
– Trade provides more choice for consumers
– Dynamic efficiency gains become apparent over time –
for example improvements in the quality and
performance of products at a given price
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The Potential Advantages from Trade (4)
• Economies of scale (lower LRAC) – representing gains
in productive efficiency and leading to higher profits
and lower prices for consumers
Could you draw me an
economies of scale
diagram?
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Economies of scale
ILLUSTRATING ECONOMIES AND DISECONOMIES OF SCALE
Productive efficiency in the long
run is achieved when output is
produced at the bottom of the
long run average cost curve
Costs
SRAC1
SRAC3
SRAC2
AC1
LRAC
AC2
AC3
Q1
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Q2
Q3
Output (Q)
The Potential Advantages from Trade (5)
• Trade is seen as a stimulant to short term aggregate
demand and long run economic growth
– Exports are an injection of aggregate demand
– A boost to exports will have multiplier effects on the level
of equilibrium national income
– There may be extra supply-side improvements from
increased capital investment between companies and
countries engaged in international trade
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Micro and Macroeconomic Gains
Injection of AD –
Export led growth
– multiplier effects
Imports of new
technology –
LRAS effect
Employment
creation in growth
sectors
International Trade
Stimulates new
capital investment
and innovation
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Makes domestic
markets more
contestable
Transfer of ideas
and best practice “benchmarking”
Concept of Comparative Advantage
• First developed by David Ricardo, one of the founding
fathers of classical economics, in 1817
• Comparative advantage exists when for a country
– The opportunity cost of production is lower
– A country is more productively efficient than another
– Countries will tend to specialise in and then export
products which use intensively the factors which it is best
endowed
– Exports used to finance imports of other products
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Importance of trade for developing countries
Diversification
into
manufacturing
Less dependence
on volatile primary
industries
Imports of
investment goods
– boosts LRAS
Importance of trade for
developing countries
Exploitation of
comparative
advantage
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Transfer of
technology and
ideas
Employment and
higher real wages
in export sectors
Balance of Payments
Does a BoP Deficit cause problems?
• It depends on the size and nature of the deficit!
• The larger the deficit, over a longer period of time the
greater the problems will be!
• If it’s cheap imports & an increase in M???
• If it’s the UK not being competitive and there is a fall in
X???
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Short run V long run deficit!
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• In the Short run….
• In the Long run…
• A deficit might mean that
UK households have a
better standard of
living…
• A deficit might cause UK
businesses to suffer,
rising unemployment ….
and falling standards of
living!
Curing BoP deficit…
• Deflation
The 3 D’s
• Direct controls
All have issues
with use!
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• Devaluation
Can a surplus BoP cause problems?
• A surplus suggests lots of economic success
• Exporting more than Importing! Again it depends on the
size of the surplus!
• And if one country is more successful than others…
then this can cause other countries to act to reduce
their deficit … and use direct controls!
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• Surplus can cause inflation… as an increase in X = an
injection = outward shift in AD!
Curing BoP surplus…
• Reflation
The 3 R’s
• Remove import controls
All have issues
with use!
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• Revaluation
Who’s in the top 5 for ….
•
Surplus
•
Deficit
There are 164 countries
64 are in a surplus
&
100 in a deficit
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Surplus
• Rank Country Current account balance
(million US$)
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• 1China
$ 368,200,000,000 2008 est.
• 2Germany
$ 267,100,000,000 2008 est.
• 3Japan
$ 187,800,000,000 2008 est.
• 4Saudi Arabia
$ 141,000,000,000 2008 est.
• 5Russia
$ 97,600,000,000
Deficit
• Rank Country Current account balance
(million US$)
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• 5
Turkey
$ -51,680,000,000 2008 est.
• 4
Italy
$ -68,820,000,000 2008 est.
• 3
United Kingdom $ -72,540,000,000 2008 est.
• 2
Spain
• 1
United States $ -568,800,000,000 2008 est.
$ -152,500,000,000 2008 est.
Global Current account position
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Exchange rates
The value of the £
£££’s
£££’s
£££’s
£££’s
Learn this acronym….
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• Strong
• Pound
• Imports
• Cheap
• Exports
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• Dear
£££’s
£££’s
£££’s
£££’s
A strong pound – pros
• A high pound leads to lower import prices -
• How??????
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How does a fall in the pound / sterling affect
inflation?
(1) Weaker pound drives up import prices
–
Higher import prices drive up firms’ costs
–
But these are only one element (wages more important)
(2) Higher import prices feed directly into retail basket
–
E.g. prices of imported computers, cars, household furniture
(3) Weaker pound leads to stronger aggregate demand growth
–
Faster growth of exports and a slower growth of imports
(4) Negative income effect – lower real incomes for consumers
(5) Positive substitution effect – cheaper relative prices of UK output
•Stronger aggregate demand increases inflationary pressure – depending on the
amount of spare capacity in the economy
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A strong pound – pros
• A high pound leads to lower import prices • This boosts the real living standards of consumers at
least in the short run
• Cheaper to import raw materials, components and
capital inputs – good news for businesses that rely on
imported components or who are wishing to increase
their investment of new technology from overseas
countries
• A strong exchange rate helps to control inflation
because domestic producers face stiffer international
competition from cheaper imports and will look to cut
their costs accordingly
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A strong pound – cons
• Cheaper imports leads to rising import penetration and
a larger trade deficit
• Exporters lose price competitiveness and market share
– this can damage profits and employment in some
sectors.
• If exports fall, this has a negative impact on economic
growth. Some regions of the economy are affected by
this more than others
– In the North east for example, manufacturing
industry accounts for over 28% of regional GDP
whereas the percentage for the UK as a whole is
just 19%.
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EXAM SKILL
• EXAM PAPER FOR YOU TO DO!
• past papers\AQA-ECN22-W-QP-JAN08.pdf
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AQA old exam paper – Jan 2008.
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•
Using Extract C, identify two main
features in the balance of
payments on current account in the
economies shown for the period
2005 to 2007. (4 marks)
•
(b) Extract D (lines 22–24) refers
to deflation in the Japanese
economy allowing exports to
become ‘an important driver for
economic growth’. Explain how
falling prices might help to
stimulate the economic growth of a
country in this way. (6 marks)
•
(c) Using the data and your
economic knowledge, evaluate the
possible consequences for UK
macroeconomic performance if
the euro area and the US seek to
reduce their balance of payments
deficits on current account. (15
marks)