eco - unit 6

• Specialisation is when a nation concentrates its productive efforts on producing a limited variety of goods and services in which they are efficient and have an advantage over other economies
• Specialisation can be determined based on resource allocation or cost of production
• Absolute advantage: when one country can produce more efficiently than another by producing more with the same resources or producing the same with fewer resources
• Comparative advantage: when one country can produce a good at a lower opportunity cost than another
• Advantages of international specialisation:

  • Economies of scale and efficiency
  • Job creation
  • Increased international trade
  • Revenue to the government
  • Wider markets
  • Consumer sovereignty
• Disadvantages of international specialisation:

  • Structural unemployment
  • Over-exploitation of resources
  • Threat of foreign competition
  • Risk of over-specialisation
  • Strategic vulnerability
• Multinational Corporations (MNCs) have operations in more than one country

  • Advantages to home country:
  • Marketing opportunities
  • Employment creation
  • Economic growth
  • Favourable balance of payments
  • Advantages to host country:
  • Employment and training
  • Transfer of skills
  • GDP contribution
  • Competition improvement
  • Consumer choice
  • Efficient business practices
• Disadvantages to home country:

  • Capital transfer
  • Lack of employment opportunities
  • Neglect of industrial development
• Disadvantages to host country:

  • Competition with domestic firms
  • Unethical practices
  • Imposition of culture
  • Profit remittance
  • Tax avoidance
• Free trade allows countries to benefit from specialisation and increases consumer choice

  • Advantages:
  • Increased output, incomes, and living standards
  • Competition and efficiency
  • Business opportunities
  • Access to best workforces, resources, and technologies
  • Economic inter-dependency
  • Disadvantages:
  • Threat to growth in less-developed economies
  • Rapid resource depletion
  • Exploitation of workers and environment
  • Worsening income inequality
• Protection involves trade barriers like tariffs, subsidies, quotas, embargo, and quality standards

  • Reasons for protection:
  • Protect infant industries
  • Protect sunset industries
  • Protect strategic industries
  • Limit over-specialisation
  • Protect from dumping
  • Correct trade imbalance
• Consequences of protection:

  • Restriction of consumer choice
  • Restriction of new opportunities
  • Cost-push inflation
  • Protection of inefficient domestic firms
  • Possibility of retaliation
  • Lagging behind in global growth
• Foreign exchange rate is the value of a currency expressed in terms of another currency

  • Determined by market demand and supply
  • Fluctuations caused by changes in demand for exports and imports, inflation, interest rates, FDI/MNCs, speculation, and government intervention
• Government intervention in the foreign exchange market can affect the exchange rate
• Appreciation:

  • A rise in demand for the domestic currency causes its exchange rate to rise
• A fall in demand for the domestic currency causes its exchange rate to fall
• Consequences of foreign exchange rate fluctuations:

  • A fall in the foreign exchange rate causes import prices to rise and export prices to fall
  • A rise in the foreign exchange rate causes import prices to fall and export prices to rise
• When PED > 1 (elastic), a fall in foreign exchange rate will improve the trade balance of the country as exports will rise relative to imports
• When PED < 1 (inelastic), a rise in foreign exchange rate will worsen the trade balance of the country as imports will rise relative to exports
• Floating Foreign Exchange Rate:

  • Exchange rate determined freely by market demand and supply conditions
  • Appreciation: rise in the value of one currency against others
  • Depreciation: fall in the value of one currency against others
• Advantages of a floating exchange rate:

  • Automatic Stabilisation
  • Frees up internal policy
  • Insulated from external changes
  • Don’t need too much foreign reserves
• Disadvantages of a floating exchange rate:

  • Uncertainty
  • Lack of Investment
  • Speculation
  • Lack of Discipline
• Fixed Foreign Exchange Rate:

  • Exchange rate fixed and controlled by the central bank
  • Devaluation: deliberate fall in the value of a fixed exchange rate
  • Revaluation: deliberate rise in the value of a fixed exchange rate
• Advantages of a fixed exchange rate:

  • Certainty
  • Stability encourages investment
  • Keep inflation low
  • Balance of Payments stability
• Disadvantages of a fixed exchange rate:

  • Conflict with other macroeconomic objectives
  • Less flexibility
  • Risk of overvaluation or undervaluation
• The Balance of payments is a record of all the monetary transactions between residents of a country and the rest of the world over a given period of time
• The Current Account records:

  • The visible trade (in goods)
  • The invisible trade (in services)
  • Net income received or made in payment for the use of factors of production
  • Net current transfers
• Current Account Deficit:

  • Causes include higher exchange rate, economic growth, decline in competitiveness, inflation, recession in other countries, and borrowing money
  • Consequences include low growth, unemployment, lower standard of living, capital outflow, loss of foreign currency reserves, increased borrowing, and lower exchange rate
• Correcting a current account deficit:

  • Do nothing because a floating exchange rate should correct it
  • Use contractionary fiscal policy
  • Use contractionary monetary policy
  • Protectionist measures
• Current Account Surplus:

  • Causes include improved competitiveness, growth in foreign countries, high foreign direct investment, depreciation, high domestic savings rates, and closed economy
  • Consequences include economic growth, appreciation, employment, better standards of living, and inflation
• Correcting a current account surplus:

  • Do nothing because a floating exchange rate should correct it
  • Use expansionary fiscal policy
  • Use expansionary monetary policy
  • Remove protectionist measures