Global economy

Summary Economics

Chapter 16 Global economy

- Economic: the law of comparative advantage ( economies should specialize in the goods that they are comparatively better at making, usually because of an abundance of a certain product)

- Globalization is a complex phenomenon which involves economics, culture and politics alike.

- Globalization is a consequence of comparative advantage.

- GDP: gross domestic product: measures the volume of goods and services produced by a nation

- Command GDP: describes the purchasing power of a nation’s output (= GDP adjusted for the terms of trade)

- Trade restrictions: 1) tariffs: act as a tax on imports. 2) Non-tariff: Quotas (Since quotas restrict international supply, then the price in the domestic market must increase.) Why? Protection of intellectual property rights (content created by the mind which can be protected by patent or copyright; Way of life; Defence of national interest

- Trade bloc: a region or group that have agreed to remove all trade barriers among themselves

- Why do firms become global?: revenue growth, cost reductions, exploit sources of international competitiveness (cheap labour, raw materials, capital)

- Foreign direct investment (FDI): purchase of foreign assets

- The terms of trade is a weighted average of a country’s export prices to its import prices. If a country’s terms of trade improve, then the price of its exports is rising relative to the price of its imports.

- Economies of scale are a source of intra-industry trade (source of comparative advantage)

- Subsidy is an example of tariff barrier / A quota restricts trade by limiting the amount of a product that can be imported into a country

• The imposition of a tariff/quota will: Increase price in the domestic market.; Reduce quantity consumed; Expand domestic production
• The cost of a tariff is borne by consumers, the cost of a subsidy is borne by tax-payers

- The transnationality index is: A measure of firms’ exposure to foreign markets

- Firm-specific sources of international competitiveness stem from the characteristics of the firm’s routines, knowledge and/or assets

Q1. Explain why internalisation allows firms to exploit economies of scope.

A: This specific nature of the asset is essential for an understanding of internationalisation by a firm. If, as discussed in Chapter 7 when analysing growth strategies, the firm’s specific advantage generates economies of scope, internationalisation provides a way of exploiting scope economies. Investment in a brand for the domestic market may present an economy of scope if the brand can also be used to enter an international market, thereby saving on the cost of developing a new brand. Research and development associated with a new product such as a microprocessor, a drug, or a plasma TV could represent an economy of scope if the product can be launched in more than one market

Q2. What is the difference between national sources of international competitiveness and firm-specific sources of international competitiveness?

A. National sources of international competitiveness are likely to stem from the characteristics of the national economy, for example low and stable inflation. Firm-specific sources of international competitiveness stem from the characteristics of the firm’s routines, knowledge and/or assets. 

Q3. Explain what a trade bloc is and give some examples of existing ones.

A. A trade bloc is a region or group of countries that have agreed to remove all trade barriers among themselves. The EU, NAFTA and ASEAN are all examples of existing trade blocs.

Q4. Explain what a quota is and what its effects are on the domestic market.

A. A quota restricts trade by limiting the amount of a product that can be imported into a country. Since quotas restrict international supply, then the price in the domestic market must increase. Those foreign firms that also manage to gain part of the quota can also sell inside the UK at the higher price. Under a tariff domestic consumers paid a tax to the government. Under a quota some of the price increase leaks out of the economy to foreign firms.

Q5. Explain the effects of a subsidy on the domestic market equilibrium.

A. A subsidy makes production cheaper for the domestic industry. The industry is more willing to supply and the supply curve shifts to the right. The domestic consumer pays the international price for the product, but a reduction in imports is brought about by the increase in domestic supply.

Chapter 15 Exchange rates and the balance of payments

- Forex market: where different currencies are traded

- Fixed exchange rate regime: the government sets an exchange rate between the domestic currency and another strong world currency, and then uses the CB to buy and sell currency to keep the market rate fixed

• Devaluation 🡪 speculative attack: a massive capital outflow from an economy with a fixed exchange rate
• Under a dirty float regime, the government claims that the currency floats, but in fact through the central bank the currency is secretly bought and sold to achieve a target exchange rate.
• Monetary policy is weak: interest rates have to be equal due to capital mobility
• Fiscal policy is powerful: fiscal expansion is not offset by an increase in interest rates

- Floating exchange rate regime: exchange rate is set purely by market forces, with holders of foreign currency demanding and selling various currencies (no government intervention)

• In the long-run:

Purchasing power parity = requires the nominal exchange rate to adjust in order to keep the real exchange rate constant ; a currency is worth the value of goods and services it will buy 🡪  it occurs when two quantities of money can buy the same quantity of goods and services; The real exchange rate will fluctuate around an equilibrium value

• Monetary policy is powerful: reduction in interest rates leads to a reinforcing reduction in exchange rate
• Fiscal policy is weak: fiscal expansion raises inflation, leads to offsetting increase in interest rates
• Floating exchange rates can accommodate inflationary differences between economies. This has led to some individuals taking the view that floating exchange rates do not provide any monetary discipline. Therefore, governments under floating exchange rates have little incentive to control inflation.

- Volatility: measure of variability. Concern over how much the exchange rate changes; Fixed exchange rate: no volatility; Floating: yes, cause it changes very hour

- Robustness: concern with flexibility or the ability to accommodate change; fixed is less flexible; floating accommodates changes

- Financial discipline: floating regime, limits need to control monetary policy and inflation; fixed regime requires monetary control and management of inflation

- Balance of payments: records all transactions between a country and the rest of the world

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