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4. The Global Economy

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International trade: exchange of goods and services between countries.
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Mechanism: It involves both exports (selling domestically produced goods and services to foreign markets) and imports (buying goods and services produced in foreign markets).
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Freedom: International trade is considered "free" when there is no government intervention such as quotas, tariffs, or other restrictions imposed to reduce or limit trade.

Benefits of free trade

The benefits of free trade can be seen for a country where the world price for a good/service is above the domestic price thus allowing for exports
To consumers
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Lower prices
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Greater choice
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Increased competition
To firms
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Economies of scale due to access to larger markets
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Access to different resources
To the economy
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Increased economic efficiency
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Source of foreign exchange
4.1 Benefits of international trade
Trade protection: policies by a country to reduce imports from other countries and/or increase exports.

Tariffs

Tariff: tax imposed on an imported good.
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Increases the cost of the imported good → decreases demand for the imported good.
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Domestic producers
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Domestic consumers
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Foreign producers
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Government revenue
Evaluating Tariff for Import substitution
The impact of a tariff depends upon the elasticity of demand for the import and the size of the tariff
4.2 Types of trade protection

Arguments in favour of protection

Infant industry argument

Infant industry: a new domestic industry that has not yet established itself to compete with more ‘mature’ foreign rivals.
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Infant firms have a higher unit cost than existing firms (since they gain fewer economies of scale), thus they are higher up on the LRAS curve. Thus, an infant industry might struggle to compete with a mature industry.
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If an infant industry is protected from foreign competitors,competition then it will be able to grow, gain economies of scale, and be able to compete with foreign rivals.
Evaluation
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It’s difficult for the government to identify which industries have the potential to grow and compete in global markets.
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Protection can disincentivise infant industries to operate efficiently (since they are provided with production subsidies already) which disables them to compete internationally.
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It’s difficult for the government to know when it’s appropriate to remove the protection.

National security

Certain industries (e.g. aircraft, weapons) are essential for national security. These industries should be protected.
Evaluation
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It is difficult to decide which industries are essential to national security.

Health, safety and environmental standards

Many countries wish products to conform to certain minimum standards and thus impose regulations to ensure that all imported products meet these standards. These minimum standards can help protect the public.
4.3 Arguments for and against trade control and protection
Economic integration: economic interdependence between countries is usually achieved by agreement between countries to reduce or eliminate trade barriers between them.

Preferential trade agreements

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Preferential trade agreements: the agreement between 2 or more counties to lower trade barriers between them on particular products.
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Bilateral trade agreement: the agreement to lower trade barriers between 2 trading partners.
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Regional trade agreement: the agreement to lower trade barriers between countries within a region.
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Multilateral trade agreement: the agreement to lower trade barriers between many countries.

Trading blocs

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Free trade area (FTA): members of the trading bloc agree to free trade between themselves.
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Customs union: free trade amongst bloc members and they agree to set the same tariffs against non-bloc in bloc member countries.
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Common market: free trade between bloc members.

Advantages and disadvantages of trading blocs

Monetary union

Monetary union: free trade between bloc members.
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Common external tariff and common product standards.
4.4 Economic integration
Exchange rate: the value of one currency expressed in terms of another currency.

Exchange rate systems

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Free floating exchange rate system: the value of a currency is determined by market forces.
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Fixed exchange rate system: exchange rate set by the government and is maintained through appropriate central bank intervention.
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Managed exchange rate system: exchange rate is allowed to float but there is periodic intervention by the central bank
Evaluating free floating exchange rate system

Appreciation, depreciation, revaluation, devaluation

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Appreciation: increase in the value of a currency in terms of another currency in a floating exchange rate system.
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Depreciation: fall in the value of a currency in terms of another currency due to market forces in a floating exchange rate system.
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Revaluation: increase in the value of a currency (fixed exchange rate system).
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Devaluation: decrease in the value of a currency (fixed exchange rate system).
Investment and factors affecting investment
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Inward foreign direct investment (FDI).
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Inward portfolio investment.
4.5 Exchange rates
Balance of payments: the record of all financial transactions between one country and the rest of the world in one year.
Accounting in BoP
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Credits (+): Money flowing into an account.
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Debits (-): Money flowing out of an account.
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Surplus: More money flows in than out.
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Deficit: More money flows out than in.

The Current Account

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The Current Account is often considered to be the most important account in the BoP
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This account records the net income that an economy gains from international transactions

The Capital Account

The Capital Account records small capital flows between countries and is relatively inconsequential
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Capital transfers
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Smaller flows of money between countries
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E.g. Debt forgiveness payments by the government toward developing countries
4.6 Balance of payments

Sustainable development

Sustainable development: development involving the use of resources in the present to meet present needs and wants in ways that do not deplete or degrade them, so that future generations will have enough resources to meet their own needs.

Sustainable development goals

Sustainable development goals: 17 goals developed by the United Nations in 2012
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Measure progress towards poverty reduction and sustainable development.
1. No poverty
2. Zero hunger
3. Good health and well-being
4. Quality education
5. Gender equality
6. Clean water and sanitation
7. Affordable and clean energy
8. Decent work and economic growth
9. Industry, innovation and infrastructure
10. Reducing inequality
4.7 Sustainable development

Single indicators

GDP / GNI per capita at purchasing power parity (PPP)
PPP exchange rates are used to resolve the issue of different countries having different purchasing powers of the same amount of money.
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Eliminate the effect of differing price levels.
Health indicators
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Infant mortality rate: number of deaths before age 1 per 1,000 live births.
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Maternal mortality rate: number of women who die per year as a result of pregnancy-related related causes, per 100,000 births.

Composite indicators

Human development index (HDI)
Composite indicator of development that includes 3 indicators that measure 3 dimensions of development equally to give a score between 0 and 1.
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Income per capita: measured by GNI per capita at PPP.
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Healthcare: measured by life expectancy at birth.
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Education: measured by mean and expected years of schooling.
Inequality adjusted HDI (IHDI)
Measures development in the same way as HDI but each of the 3 dimensions are adjusted to take into account inequality.
4.8 Measuring development

Poverty cycle / trap

Poverty cycle / trap: circular chain trapping individuals / societies in poverty.
Fig 4.9.1 The poverty cycle

Economic barriers

Rising income inequality

Decrease in access to education, healthcare, and nutrition → decreases the ability of the country to develop.
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Higher income inequality → disincentivise workers → lower productive efficiency → lower production → misallocation of resources.
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Higher income inequality → higher relative poverty → lower access to quality education → lower access to future jobs = barrier to development.

Lack of access to infrastructure and appropriate technology

Low levels of human capital - lack of access to healthcare and education

Human capital: skills, abilities, knowledge acquired by people and good health
Low-qualityLow quality human capital → low productivity → low incomes → low tax revenue / corrupt government → minimal spending on public goods → poor education and healthcare system.

Dependence on primary sector production

4.9 Barriers to economic growth and / or economic development

Trade strategies

Import substitution industrialisation (ISI)
Import substitution industrialisation (ISI): a strategy to reduce imports using protectionism to allow domestic industry to grow.
Export led growth
Outward looking growth strategy based on increased international trade.
Growth achieved by focusing on exports and increasing export revenue → increase AD.
Economic integration
Economic integration: economic interdependence between countries usually achieved by agreement between countries to reduce or eliminate trade barriers between them.

Diversification

Diversification: reallocation of resources into new activities that broaden the range of goods or services produced by a country.
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Sustained increase in exports.
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Development of technological capabilities and skills.
4.10 Economic growth and / or economic development strategies