IB Economics Teacher Resource eBook: The Global Economy - International Economics

The Global Economy : International Economics - Digital resource book

The Global economy: international economics

UNIT 1: The global economy and benefits of international trade Foreword by Brad Cartwright .................................................................................1 international economics & free trade: Key Terms and Concepts .......2 REAL WORLD ISSUE: Who are the winner and losers of the integrations of the world's economies? .........................................................................................................3-6 Lesson 1: Introduction to Gains from Free Trade...................................................... 7-9 Lesson 2: Comparative Advantage Theory..............................................................10-13 Lesson 3: The World Trade Organization (WTO).....................................................14-16 Review Questions ..................................................................................................17 IB Exam Practice Questions .............................................................................18

The Global economy: international economics

UNIT 2: Free trade and protectionism free trade and protectionism: Key Terms and Concepts ..........................19 Lesson 1: Arguments for Protectionism...................................................................20-24 Lesson 2: Arguments for Free Trade (Against Protectionism)................................25-26 Lesson 3: The Free Trade Diagram..........................................................................27-29 Lesson 4: The Protectionist Tariff Diagram.............................................................30-32 Lesson 5: The Protectionist Subsidy Diagram.........................................................33-35 Lesson 6: The Protectionist Quota Diagram ..........................................................36-38 Lesson 7: Administrative Barriers to Free Trade.....................................................39-40 Review Questions ...................................................................................................41 IB Exam Practice Questions .............................................................................42

The Global economy: international economics

UNIT 3: exchange rates exchange rates: Key Terms and Concepts .........................................................43 Lesson 1: The Exchange Rate Diagram..................................................................44-47 Lesson 2: The Fixed Exchange Rate System.........................................................48-53 Lesson 3: The Floating Exchange Rate System....................................................54-60 Lesson 4: Impact of an Increase in Demand of a Currency ................................61-63 Lesson 5: Impact of an Increase in Supply of a Currency....................................64-66 Lesson 6: Managed Exchange Rates....................................................................67-68 Lesson 7: Strong Exchange Rates ........................................................................69-71 Lesson 8: Weak Exchange Rates .........................................................................72-74 Lesson 9: Government Measures to Intervene in the Currency Market...........75-78 Review Questions ...............................................................................................79 IB Exam Practice Questions .........................................................................80

The Global economy: international economics

UNIT 4: balance of payments balance of payments: Key Terms and Concepts ................................................81 Lesson 1: Preview - A Visual Understanding of Balance of Payments....................82-83 Lesson 2: The Current Account..............................................................................84-87 Lesson 3: The Financial Account ...........................................................................88-92 Lesson 4: The Reserve Assets ................................................................................93-95 Lesson 5: Relationship Between Balance of Payments and Exchange Rate.........96-98 Review Questions .................................................................................................99 IB Exam Practice Questions .........................................................................100

The Global economy: international economics

UNIT 5: economic integration Economic integration: Key Terms and Concepts ..........................................101 Lesson 1: Six Stages of Economic Integration......................................................102-107 Review Questions ................................................................................................108 IB Exam Practice Questions ...........................................................................109 Sources ......................................................................................................................110

Foreword – by Brad Cartwright -Hey! Thank you so much for purchasing these teaching resources! In here, you will find Vocabulary Lists, Review Questions, IB Exam Practice Questions, and lesson specific Slides for the entirety of The Global Economy – International Economics.

The idea is to provide you with the critical pieces of your teaching resources so that you can teach with confidence and calm. With your purchase comes the right to use these resources with your students, whether that by using the Slides to guide class discussions, by sharing the Vocabulary Lists with your students in preparation for a quiz, or by embedding the IB Exam Practice Questions into your assessments.

I’ve come to discover that these resources have been exceptionally useful with my own students here in Santiago, Chile. These resources follow the videos available in both the student and teacher monthly subscriptions.

Good luck and take care of yourselves out there!

1

The global economy – international economics unit 1: the global economy & benefits of international trade

International Economics and Free Trade Fundamental Vocabulary and Concepts

International Trade Gains from trade Specialization Economies of Scale Division of Labor World Trade Organization (WTO)

Most Favored Nations Status Absolute Advantage Comparative Advantage

2

real world issue #1 - the big picture -

3

real world issue #1 who are the winners and losers of the integration of the world’s economies? source: ib economics subject guide, 2020

4

conceptual understandings • the increased interdependence of economies has benefits and costs • increased economic integration may result in efficiency, welfare gains and improvements in economic wellbeing but the benefits may not result in equity

source: ib economics subject guide, 2020

5

the nine central concepts • • • • • • • • •

scarcity choice efficiency equity economic well-being sustainability change interdependence intervention

source: ib economics subject guide, 2020

6

why do countries trade? the gains from international trade

7

gains from international trade • lower prices – the ability to buy goods and services at a lower price than the domestic one – consumers are able to buy less expensive products – producers are able to purchase less expensive raw materials

• greater choice – international trade allows consumers to have greater choice of products

• differences in resources – the differences in natural resources between countries will encourage trade for either consumption, production, or both

source: jocelyn blink

8

gains from international trade

• economies of scale

– when producing for both an international market, as well as for a domestic one, the size of the market (and therefore demand) will increase – increased specialization and expertise in certain sectors

• increased competition – trade leads to increased competition because foreign firms will be allowed to enter domestic market-places

• more efficient allocation of resources – when international trade creates a more efficient global allocation of resources

• source of foreign exchange source: jocelyn blink

9

comparative advantage theory understanding what it is

10

absolute advantage theory • definition: a country is said to have an absolute advantage in the production of a good if it can produce it using fewer resources than any other country.

source: jocelyn blink

11

comparative advantage theory it’s all about opportunity costs

• definition: a country is said to have a comparative advantage in the production of the good if it can produce the good at a lower opportunity cost then another country – whichever country has to give up less to produce the good has the comparative advantage – example: a web designer and a Tommy, the kid who cut his lawn

source: jocelyn blink

12

comparative advantage theory it’s all about opportunity costs

• the value of comparative advantage theory – comparative advantage is at the core of international trade – it is the reason why countries do trade – countries that specialize in producing the things that they are best at— those that have a lower opportunity cost to them—can capture great gains from trade

source: jocelyn blink

13

world trade organization understanding its role in international trade

14

world trade organization • definition: the WTO is an international organization that sets rules for global trading and resolve disputes between its member countries.

• it was established on January 1, 1995 and now has 150 members • creates a“most favorite nations status” to one another • the WTO aims to increase international trade by lowering trade barriers and providing a forum for negotiation

source: jocelyn blink

15

functions of the WTO 1.

2.

3.

4.

5.

administered WTO trade agreements be a forum for trade negotiations handle trade disputes among the member countries monitor national trade policies provide technical assistance and training for developing countries 6. cooperate with other international organizations

source: jocelyn blink

16

Introduction to International Economics and Free Trade Review Questions: What you should be able to do!

Benefits of Free Trade Explain that gains from trade include lower prices for consumers, greater choice for consumers, the ability of producers to benefit from economies of scale, the ability to acquire needed resources, a more efficient allocation of resources, increased competition, and a source of foreign exchange.

Describe the objectives and functions of the WTO. Absolute and Comparative Advantage Define absolute advantage.

Explain the theory of absolute advantage.

Using a diagram, explain the gains from trade arising from a countr s absolute advantage in the production of a good.

Define comparative advantage.

Explain the theory of comparative advantage.

Describe the sources of comparative advantage.

Draw a diagram to show comparative advantage.

Draw a diagram to illustrate comparative advantage from a set of data.

Discuss the real-world relevance and limitations of the theory of comparative advantage,

17

Introduction and Free Trade IB Exam Practice Questions Paper 1 & 2

Paper 1 & 2: Analysis Questions 1. Discuss the benefits of gains from international trade.

2. Describe the objectives and functions of the WTO. 3. Explain the theory of comparative advantage.

4. Using a diagram, explain he gain f om ade a i ing f om a co n absolute advantage in the production of a good.

5. Using a data set, draw a diagram to illustrate comparative advantage.

Paper 1 & 2: Evalation Questions 1. Discuss two possible shortcomings of comparative advantage theory.

2. Evaluate the benefits of a country that participates in free trade with other nations.

3.

In e na ional ade contributes to more friendly political relationships be

een co n ie

E al a e he alidi

of hi

a emen

18

The global economy – international economics unit 2: free trade and protectionism

Free Trade and Protectionism Fundamental Vocabulary and Concepts

Free Trade Protectionism Sunrise Industry Sunset Industry Over-Specialization Dumping Anti-Dumping Measures Balance of Payments Deficit

Types of Protectionism Tariffs Subsidies Quotas Red Tape Embargo

19

arguments for protectionism why governments protect their economies

20

arguments for protectionism • arguments for protectionism rest on two main points – why is it that countries do not trade freely if it is good for all countries involved?

– why is it that countries often protect their economies from imports?

• the arguments for protectionism 1.

2.

3.

4.

5.

6.

7.

8.

9.

protecting domestic employment protecting the economy from low-cost labor protecting an infant (sunrise) industry avoid the risks of over-specialization strategic reasons prevent dumping protect product standards raise government revenue correct a balance of payments deficit source: jocelyn blink

21

arguments for protectionism • protecting domestic employment – industries that are in decline because they cannot compete with foreign competition—sunset industries – judgment (evaluation) of argument…

• protecting the economy from low-cost labor – lower cost of labor in exporting countries and the economy should be protected – judgment (evaluation) of argument…

• protecting an infant (sunrise) industry – an industry that is just developing may not have the economies of scale advantages that larger industries in other countries may enjoy – judgment (evaluation) of argument… source: jocelyn blink

22

arguments for protectionism • to avoid the risks of over-specialization – governments may want to limit overspecialization – judgment (evaluation) of argument…

• strategic reasons – certain industries need to be protected in case they are needed at times of war, for example, agriculture, steel, or electricity – judgment (evaluation) of argument…

• to prevent dumping – definition: dumping is the selling of large quantities of a commodity by one country, at a lower price than its production costs, in another country – judgment (evaluation) of argument…

source: jocelyn blink

23

arguments for protectionism • to protect product standards – to impose safety, health, or environmental standards on goods being imported into its domestic market – judgment (evaluation) of argument…

• to raise government revenue – in many developing countries, it is difficult to collect taxes and so government impose import taxes or tariffs on products in order to raise revenue – judgment (evaluation) of argument…

• to correct a balance of payments deficit – governments sometimes impose protectionist measures to attempt to reduce import expenditure and thus improve a current account deficit judgment (evaluation) of argument…

source: jocelyn blink

24

arguments against protectionism also, the argument for free trade

25

arguments against protectionism • these are free trade arguments in disguise!

• the arguments against protectionism include the following: – protectionism may raise prices to consumers and producers of the inboards that they bought – protectionism would lead to fewer choices for consumers – protectionism would diminish competition if foreign firms are kept out of a country, and so domestic firms may become inefficient without the incentive to minimize costs – protectionism distorts comparative advantage, leading to the inefficient use of the world’s resources – protectionism may hinder economic growth source: jocelyn blink

26

free trade diagram the basis of drawing a protectionist diagram

27

micro demand and supply diagram

28

free trade diagram

29

the protectionist tariff diagram 30

the free trade diagram 31

32

the protectionist subsidy diagram 33

the free trade diagram 34

35

the protectionist quota diagram 36

m e diagra d a r t e e r the f

37

38

administrative barriers to free trade understanding what they are

39

administrative barriers • red tape – when goods are imported, there can be administrative processes that have to be undertaken, which may be known as “red tape” – lengthy and complicated = restriction on imports

• health and safety standards and environmental standards – restrictions may be placed on the types of goods that can be sold in the domestic market or in the methods used in the manufacture of certain goods

• embargoes – definition: an embargo is a complete ban on imports and is usually put in place as a form of political punishment – an embargo is an extreme quota, and is rare—economic sanctions are more common

• nationalistic campaigns source: jocelyn blink

40

Free Trade and Protectionism Review Questions: What you should be able to do!

and unfair competition, a means of overcoming a balance of payments deficit and a source of government revenue.

Discuss the arguments for free trade, including a misallocation of reso rces the danger of retaliation and trade ars the

Types of Trade Protection Define protective tariff.

Using a diagram, explain the effects of imposing a tariff on imported goods

potential for corruption, increased costs of production due to lack of competition, higher prices for domestic consumers, increased costs of imported factors of production and reduced export competitiveness.

on different stakeholders, including domestic producers, foreign producers, consumers and the government.

Define protective subsidy.

Adopted from the IB Economics Subject Guide

Using a diagram, explain the effects of giving a subsidy to domestic producers on different stakeholders, including domestic producers, foreign producers, consumers and the government.

Define protective quota.

Using a diagram, explain the effects of setting a quota on foreign producers on different stakeholders, including domestic producers, foreign producers, consumers and the government.

Describe administrative barriers that may be used as a means of protection.

Evaluate the effect of different types of trade protection.

Arguments For and Against Free Trade and Protectionism Discuss the arguments in favor of trade protection, including the protection of domestic jobs, national security, protection of infant industries, the maintenance of health, safety and environmental standards, anti-dumping

41

Free Trade and Protectionsim IB Exam Practice Questions Paper 1 & 2

Paper 1 & 2: Analysis Questions 1. Using a diagram, illustrate the impact of protective tariff on the market for corn.

2. Using a diagram, illustrate the impact of protective subsidy on the market for wheat.

3. Using a diagram, illustrate the impact of protective quota on the market for barley.

4. Explain two arguments for protectionism.

Paper 1 & 2: Evaluation Questions 1. Evaluate the impact of a protective tariff on domestic producers of corn in the United States.

2. Evaluate the impact on world producers of wheat if France imposes a protective subsidy in the wheat market.

3. Evaluate the impact of a protective quota on domestic producers of barley in the United States.

42

The global economy – international economics unit 3: exchange rates

Exchange Rates Fundamental Vocabulary and Concepts

Exchange Rate Foreign Exchange Market Central Bank Exchange Rate Regime Fixed Exchange Rate Revaluation Devaluation

Floating Exchange Rate Appreciation Depreciation Managed Exchange Rates

43

the exchange rate diagram 44

45

46

47

fixed exchange rate system understanding it, expressing it and advantages and disadvantages 48

fixed exchange rate • definition: a fixed exchange rate is an exchange rate regime where the value of a currency is fixed, or pegged, to the value of another currency, to the average value of a selection of currencies, or to the value of some other commodity, such as gold • carried out and maintained by the government or the central bank • two key terms used only when referring to a fixed exchange rate – revaluation of the currency • if the value of the currency is raised = revaluation

– devaluation of the currency • if the value is lowered = devaluation

source: jocelyn blink

49

fixed exchange rate system

example 1: supply of Barbadian dollars is increasing on the foreign market source: jocelyn blink

50

fixed exchange rate system

example 2: demand of Barbadian dollars is increasing on the foreign market source: jocelyn blink

51

advantages: fixed exchange rates • a fixed exchange rate should reduce uncertainty – businesses will be able to plan ahead with the knowledge that the predicted costs and prices will not change

• if exchange rates is fixed, then inflation may have a very harmful effect on the demand for exports and imports – because of this, the government is forced to take measures to ensure that inflation is as low as possible

• in theory, the existence of a fixed exchange rate should reduce speculation in the foreign exchange markets

source: jocelyn blink

52

disadvantages: fixed exchange rates • the government is compelled to keep the exchange rate fixed – manipulation of interest rates can do this – however, if the exchange rate is in danger of falling then the government will have to raise the interest rate in order to increase demand for the currency, but this will have a deflationary effect on the economy, lowering demand and increasing unemployment – this means the domestic macroeconomic goal of the low unemployment may have to be sacrificed

• the government has to maintain high levels of foreign reserves • setting the level is not simple – if the rate is set at the wrong level, then export firms may find that they are not competitive in the foreign markets – if this is the case, then the exchange rate will have to be devalued, but again, finding the exact right level is very difficult

• a country that fixes its exchange rate at an artificially low level may create international disagreement – this is because a low exchange rate will make the country’s exports more competitive on the world market and may be seen as an unfair trading advantage source: jocelyn blink

53

floating exchange rate system understanding it, expressing it, and advantages and disadvantages 54

floating exchange rate •

• •

definition: a floating exchange rate is an exchange rate regime where the value of a currency is allowed to be determined solely by the demand and supply of the currency on the foreign exchange market there is no government intervention to influence the value of the currency the diagram below represents the market for US dollars in terms of euros

value of currency rises = appreciation of the value value of currency falls = depreciation of the value source: jocelyn blink

55

floating exchange rate system

price of US $ in euros

Market for US Dollars

1.00

.80

D2

source: jocelyn blink

56

floating exchange rate system Market for Euros

Supply

price of Euros in US$

price of US $ in euros

(of Euros from EU)

S2

1.20 .80 1.00

Demand (of Euros from EU)

Quantity of Euros

source: jocelyn blink

57

floating exchange rate system

source: jocelyn blink

58

advantages of floating exchange rate • interest rates – interest rates are free to be employed as domestic monetary tools and can be used for demand management policies, such as controlling inflation

• self-adjusting – in theory, the floating exchange rate should adjust itself, in order to keep the current account balanced

• no need for high levels of foreign currency – because reserves are not used to control the value of the currency, it is not necessary to keep high levels of reserves of foreign currencies and gold source: jocelyn blink

59

disadvantages of floating exchange rate • create uncertainty on international markets – businesses trying to plan for the future find it difficult to make accurate predictions about what their likely costs and revenues will be – investment is more difficult to assess and there is no doubt that volatile exchange rates will reduce the levels of international investment, because it is difficult to assess the exact level of return and risk • impacted by more factors than simply demand and supply – such as government intervention, world events like 9/11, and speculation • may worsen existing levels of inflation

source: jocelyn blink

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floating exchange rates: increase in demand understanding it and expressing it

61

increase in demand

value of currency rises = appreciation of the value value of currency falls = depreciation of the value source: jocelyn blink

62

increase in demand for dollars Europeans will demand dollars to...

• • • •

buy US goods invest in US firms save in dollars speculate in dollars

If there is an increase in demand for US goods.

This could be caused by the following…

• inflation rates in US is lower than EU inflation rates • increase in income in the EU • investment prospects in US improve • interest rates in US increase • speculators in the EU think the value of the US dollar will rise in the future

source: jocelyn blink

63

floating exchange rates: increase in supply understanding it and expressing it

64

increase in supply of dollars

value of currency rises = appreciation of the value value of currency falls = depreciation of the value source: jocelyn blink

65

increase in supply for dollars thus, the supply of US dollar will rise if there is an increase their demand for EU goods causing them to sell their dollars and buy Euros.

US citizens will supply dollars when they wish to..

• • • •

buy EU goods and services invest in EU firms save in EU banks speculate in euro

• • • • •

inflation rates in US is higher than EU inflation rates increase in income in the US investment prospects in EU improve. interest rates in EU increase speculators in the US think the value of the US dollar will fall in the future so they buy Euros

source: jocelyn blink

66

managed exchange rate system understanding what it is

67

managed exchange rate system • definition: managed exchange-rate systems are where the currency is allowed to float, but with some element of interference from the government • no currency in the world that is completely free-floating • at times, the central bank will intervene • frequent fluctuations are bad for foreign investment • upper and lower limits are set

source: jocelyn blink

68

strong exchange rate advantages and disadvantages

69

advantages of strong exchange rate example US$ 1 = CP$ 500

• downward pressure on inflation – strong = finished imported goods will be relatively low – strong = the price of imported raw materials = lower cost of production for firms = lower prices – strong = pressure on domestic producers to be competitive by keeping prices low

• more imports can be purchased – strong = the currency will buy more foreign-currency = more imports of everything

• forces domestic producers to improve their efficiency – strong = will threaten their international competitiveness = forced to lower costs and become more efficient in order to maintain competitiveness internationally = good in long run

source: jocelyn blink

70

disadvantages of strong exchange rate example US$ 1 = CP$ 500

• damage to export industries – strong = bad for export industries may find it difficult to sell their goods and services abroad, because of the relatively high prices

• damage to domestic industries – strong = greater levels of imports being purchased domestic producers may find that the increased competition causes of fall in the demand for their goods and services

source: jocelyn blink

71

weak exchange rate advantages and disadvantages

72

advantages of weak exchange rate example US$ 1 = CP$ 700

• greater employment in the export industries – weak = exports from the country will be relatively less expensive and so more competitive – weak = more employment in the export industries

• greater employment in domestic industries – weak = will make imports more expensive than they were – weak = may encourage domestic consumers to buy domestically produced goods, instead of imports, and this may also lower unemployment

source: jocelyn blink

73

disadvantages of weak exchange rate example US$ 1 = CP$ 700

• inflation – weak = will make imported final goods and services, imported raw materials, and importing components more expensive – weak = prices of raw materials needed by firms will rise = increase in cost of production = possibly leading to higher prices in the economy – weak = final goods and services will have higher prices.

– weak = a serious likelihood of inflation

source: jocelyn blink

74

government measures to intervene in the foreign exchange market understanding what they are

75

government measures to intervene in the foreign exchange market lower the exchange rate in order to increase employment raise the exchange rate in order to fight inflation maintain a fixed exchange rate avoid large fluctuations in a floating exchange rate achieve exchange rate stability in order to improve business confidence • improve a current account deficit, which is where spending on imported goods and services is greater than the revenue received from exported goods and services • • • • •

source: jocelyn blink

76

how governments attempt to manipulate the exchange rate • by using foreign reserve currencies to buy, or sell, their currency – to increase the value of currency, it can use its reserves of foreign currencies to buy its own currency on the foreign exchange market • impact: increase the demand for its currency and increase exchange rate

– to lower the value of its currency, then it simply buys foreign currencies on the foreign exchange market, increasing its foreigncurrency reserves • impact: increase supply for its currency and lower exchange rate

source: jocelyn blink

77

how governments attempt to manipulate the exchange rate • changing interest rates – this is not hard…interest rates are the price of money – if the government wishes to increase the value of the currency then it may raise the level of interest rates in the country – in the same way, if the government wishes to lower the value of the currency, then they may lower the level of interest rates in the country

source: jocelyn blink

78

Exchange Rates Review Questions: What you should be able to do!

Fixed Exchange Rate System Describe a fixed exchange rate system involving commitment to a single fixed rate.

Distinguish between a devaluation of a currency and a revaluation of a

Floating Exchange Rate Systems Explain that the value of an exchange rate in a floating system is determined by the demand for, and supply of, a currency.

Draw a diagram to show determination of exchange rates in a floating exchange rate system.

Calculate the value of one currency in terms of another currency.

Draw the exchange rate diagram.

Causes of Changes in Floating Exchange Rate Systems Explain the factors that lead to changes in currency demand and supply, incl ding foreign demand for a co n r s e por s domes ic demand for imports, relative interest rates, relative inflation rates, investment from o erseas in a co n r s firms and speculation.

Distinguish between a depreciation of the currency and an appreciation of the currency.

currency.

Using a diagram, explain how a fixed exchange rate is maintained.

Managed Exchange Rates System Explain how a managed exchange rate operates, with reference to the fact that there is a periodic government intervention to influence the value of an exchange rate.

Examine the possible consequences of overvalued and undervalued currencies.

Evaluation of different exchange rate systems Compare and contrast a fixed exchange rate system with a floating exchange rate system, with reference to factors including the degree of certainty for stakeholders, ease of adjustment, the role of international reserves in the form of foreign currencies and flexibility offered to policy makers.

Draw diagrams to show changes in the demand for, and supply of, a currency.

Evaluate the possible economic consequences of a change in the value of a

Adopted from the IB Economics Subject Guide

currenc incl ding he effec s on a co n r s infla ion ra e emplo men economic growth and current account balance.

79

Exchange Rates IB Exam Practice Questions Paper 1 & 2

Paper 1 & 2: Analysis Questions 1. Explain the factor that may lead to the drop in the value of one currency in terms of another.

2. Explain the difference between the depreciation of the currency and an appreciation of the currency.

3. Using a diagram, explain the relationship between a high rate of infla ion and a na ion c rrenc 4. Explain what is meant by a fixed exchange rate system.

Paper 1 & 2: Evaluation Questions 5. Evaluate the possible economic consequences of a change in the value of a currency as a result of inflation.

6. Compare and contrast a floating exchange rate system a fixed exchange rate system.

7.

In he end all co n rie ac all ha e a managed exchange rate em

E al a e he alidi

of ha

a emen

8. Discuss the advantages and disadvantages of a fixed exchange rate system.

9. Evaluate the possible consequences of overvalued and undervalued currencies.

80

The global economy – international economics unit 4: balance of payments

Balance of Payments Fundamental Vocabulary and Concepts

Balance of Payments Current Account Capital Account Credit Item Debit Item Balance of Trade in Goods Visible Trade Balance Merchandise Account Balance Balance of Trade Balance of Trade in Services Invisible Balance Services Balance Net Services

Current Transfers Current Account Balance Capital Account Capital Transfers Financial Account Direct Investment Portfolio Investment Reserve Assets Net errors and Omissions

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balance of payments a visual understanding seeing it first helps a lot‌

82

balance of payments a visual understanding

current account goods & services

income

current transfers

financial account

imports

investment abroad

exports

investment into Italy

outflows

investment abroad

inflows

investment into Italy

portfolio investment

capital transfer abroad

outflows

capital transfer into Italy

inflows

if current account + financial account > 0 official reserves will rise

direct investment

official reserves account

if current account + financial account < 0 official reserves will fall

current account + financial account + capital account + change in reserves = 0 adapted from jason welker

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the current account understanding what it is

84

the current account â&#x20AC;˘ definition: the current account is a measure of the flow of funds from trade in goods and services, plus other income flows â&#x20AC;˘ it is usually subdivided into four parts: 1. the balance of trade in goods 2. the balance of trade in services 3. income 4. current transfers

source: jocelyn blink

85

1. the balance of trade in goods • definition: it is a measure of the revenue received from the exports of tangible, physical, good minus the expenditure of the importance of tangible goods over a given period of time • exports: – exports occur when international transactions relating to goods or services leads to an inflow of money into the country

• imports: – imports occur when international transactions relating to goods or services leads to an outflow of money from the country

• surplus: when export revenue is greater then import expenditure • deficit: when import expenditure is greater than export source: jocelyn blink

86

2. the balance of trade in services • definition: it is a measure of the revenue received from the export of services minus the expenditure on the imports of services over a given period of time • it includes the import and export of all services such as – banking – insurance – tourism

source: jocelyn blink

87

the financial account understanding what it is

88

the financial account • definition: the financial account measures the net change in foreign ownership of domestic financial assets • three components of financial accounts – direct investment – portfolio investment – the capital account

• financial account surplus – if ownership of domestic financial assets increases more quickly than domestic ownership of foreign assets

• financial account deficit – if domestic ownership of foreign financial assets increases more quickly than foreign ownership of domestic financial assets source: jocelyn blink

89

direct investment • direct investment: is a measure of the purchase of long-term assets, or the purchaser is aiming to gain a lasting interest in a company in another economy – this includes such things as buying a property, the outright purchasing of the business or the purchasing of stocks or shares in the business – in all cases, the asset is expected to have a positive return in the future, by making profits or by increasing in value over time – the investment does not have to be paid back and there is no guarantee that it will provide a positive return – much of the activity in this category is in the form of foreign direct investment or FDI by multinational corporations source: jocelyn blink

90

portfolio investment • portfolio investment: a measure of stock and bond purchases, which are not direct investment since they do not lead to a lasting interest in the company – they tend to consist of the buying and selling of things such as treasury bills and government bonds – we will also include savings account deposit in this category although in many countries that comes under the heading of “other investment” – in all the portfolio investments mentioned above, the investor is putting forward the money in order to purchase the assets in the expectation that interest will be paid on the investment and that money will be prepaid at a given point in time – these assets are simply borrowing and lending on the international market

source: jocelyn blink

91

the capital account • definition: the capital account is a relatively small part of the balance of payments and does not have a significant effect on the balance • the capital account has two components – capital transfers • definition: capital transfers are a measure of the net monetary movements gained or lost through actions such as the transfer of goods and financial assets by migrants entering or leaving the country, debt forgiveness, transfers relating to the sale of fixed assets, gift taxes, inheritance taxes, and death duties

– transactions in non-produced, non-financial assets • definition: this consists of the net international sales and purchases of non-produced assets, such as land or the rights to natural resources, and the net international sales and purchases of tangible assets, such as patents, copyrights, brand names, or franchises

source: jocelyn blink

92

the reserve assets understanding what it is

93

the reserve assets • reserve assets: the reserves of gold and foreign currencies that all countries have and that are itemized in the official reserve account – it is movements into and out of this account that ensure that the balance of payments will always balance to zero – if there is a surplus of all the other accounts combined, any official reserve account will increase – If there is a deficit on all of the other accounts combined, then the official reserve account total will decrease – it is net changes in the official reserve account, over time that balances the accounts source: jocelyn blink

94

special note on balance of payments • in reality, the balance of payments accounts will not actually balance • this is because there are simply too many individual transactions taking place for the measurement to be exact • there will always be some transactions that have not been recorded when the figures are being put together • to resolve this, a balancing item, which we will call “net errors and omissions” is put into the accounts to ensure that they do in fact, balance • as time goes by and the trading accounts are revised over the years, more data comes to light and the balancing item invariably gets smaller

source: jocelyn blink

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relationship between the balance of payments and the exchange rate understanding what it is 96

deficit = downward pressure • a deficit in the current account of the balance of payments may result in downward pressure on the exchange rate on the currency • this is worse in a fixed exchange rate system then in a floating exchange rate system

– fixed exchange rate system • the implication is that the exchange rate has been set too high • in the short run, the deficit may be covered by the government using reserve assets to balance the accounts • this cannot go on indefinitely, since the reserve assets will run out and so, in the end, the exchange rate will need to be depreciated

– floating exchange rate system • the deficit implies that there is an excess supply of the currency on the foreign-exchange markets • this may be because the demand for exports has fallen or the demand for imports has increased, leading to more demand for foreign currencies and so a greater supply of the domestic currency • key point!: in a freely floating exchange rate system, the exchange rate should fall, improving the competitiveness of the country’s exports and increasing the domestic price of imports source: jocelyn blink

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surplus = upward pressure • a surplus in the current account of the balance of payments may result in upward pressure on the exchange rate of the currency – fixed exchange rate system • the implication is that the exchange rate has been set too low • in the short run, by increases in the reserve assets • in the long run, however, it is likely that other countries will be unhappy with the artificially low exchange rate and will demand higher rates or will threaten protectionist measures against the country’s exports

– floating exchange rate system • the surplus implies that there is an excess demand for the currency on the foreign exchange markets • this may be because the demand for exports has risen or the demand for imports has fallen, leading to less demand for foreign currencies and so a lower supply of the domestic currency • key point!: in a freely floating exchange rate system, the exchange rate should rise, decreasing the competitiveness of the countries exports and lowering the domestic price of imports

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Balance of Payments Review Questions: What you should be able to do! o Evaluate the effectiveness of the policies to correct a persistent current account deficit.

The Structure of the Balance of Payments Define the balance of payments.

Explain the difference between debit items and credit items in the balance of payments.

Explain the four components of the current account, specifically the balance of trade in goods, the balance of trade in services, income and current transfers.

Current Account Surpluses The relationship between the current account and the exchange rate o Explain why a surplus in the current account of the balance of payments may result in upward pressure on the exchange rate of the currency. o Discuss the possible consequences of a rising current account surplus, including lower domestic consumption and investment.

Explain the difference between a deficit and a surplus.

Explain the two components of the capital account.

Adopted from the IB Economics Subject Guide

Explain the three main components of the financial account.

Explain that the current account balance is equal to the sum of the capital account and financial account balances.

Examine how the current account and the financial account are interdependent.

Current Account Deficits The relationship between the current account and the exchange rate o Explain why a deficit in the current account of the balance of payments may result in downward pressure on the exchange rate of the currency. o Discuss the implications of a persistent current account deficit. o Explain the methods that a government can use to correct a persistent current account deficit.

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Balance of Payments IB Exam Practice Questions Paper 1 & 2

Paper 1 & 2: Analysis Questions 1. Explain the importance of the components of the current account.

2. Explain the importance of the components of the financial account.

3. Explain the relationship between a current account surplus and the exchange rate.

4. Using a diagram, explain the impact of a current account deficit on the exchange rate.

Paper 1 & 2: Evaluation Questions 5. Discuss the possible consequences for of a rising current account surplus.

6. Evaluate the effectiveness of government policies to correct a sustained current account deficit.

7. Evaluate the impact of an increasing current account surplus on consumers and producers.

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The global economy â&#x20AC;&#x201C; international economics unit 5: economic integration

Economic Integration Fundamental Vocabulary and Concepts

Economic Integration 5. Economic and Monetary Bilateral Trade Agreement Union Multilateral Trade Agreement 6. Complete Economic Trading Blocs Integration Six Stages of Economic Integration North American Free Trade 1. Preferential Trading Areas Agreement (NAFTA) 2. Free Trade Areas 3. Customs Unions 4. Common Markets

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six stages of economic integration understanding what they are

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six stages of economic integration 1. preferential trading areas (PTA) – definition: a preferential trading area is a trading bloc that gives preferential access to certain products from certain countries – this is usually carried out by reducing, but not eliminating tariffs – an example of a preferential trading area is the one between the EU and the African, Caribbean, and Pacific (the ACP) group states

2. free trade areas – definition: a free-trade area is an agreement made between countries, where the countries agreed to trade freely among themselves but are able to trade with other countries outside of the free-trade area in whatever way they wish

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six stages of economic integration 3. customs unions â&#x20AC;&#x201C; definition: a customs union is an agreement made between countries, where the countries agreed to trade freely among themselves, and they also agreed to adopt common external barriers against any country attempting to import into the customs union â&#x20AC;&#x201C; all common markets and economic and monetary unions are also customs union, thus the EU is a customs union

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six stages of economic integration 4. common markets – definition: a common market is a customs union with common policies on product regulation, and free movement of goods, services, capital, and labor.

– the European Union is a common market

5. economic and monetary union – definition: an economic and monetary union is a common market with a common currency and a common central-bank – the best example of economic and monetary union is the Eurozone, which includes the member countries of the European Union that have adopted the euro as their currency and have the European Central Bank (ECB) as their central bank

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six stages of economic integration 6. complete economic integration â&#x20AC;&#x201C; definition: this is the final stage of economic integration at which point the individual countries involved would have no control of economic policy, full monetary union, and complete harmonization of fiscal policy â&#x20AC;&#x201C; this is what the eurozone is moving towards

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evaluation of trading blocs • advantages – the extent of the advantages and disadvantages of trading blocs clearly depends on the degree of integration – similar to those of free-trade arguments – larger market size – increased foreign investment – a trading bloc will foster greater political stability and cooperation – trade negotiations will be easier as there will be larger blocs of countries

• disadvantages – trading blocs favor increased trade among members, but act as a discriminatory policies against non-members – they may undermine the international trade rules and limit the potential gains of trade achievable with freer forms of world trade – more of a problem for small or poor economies that have little bargaining power source: jocelyn blink

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Economic Integration Review Questions: What you should be able to do!

Forms of Economic Integration Preferential Trade Agreements o Explain the difference between bilateral and multilateral trade agreements. o Explain that preferential trade agreements give preferential access to certain products from certain countries by reducing or eliminating tariffs, or by other agreements relating to trade.

Trading Blocs o Explain the difference between a free trade area, a customs union and a common market. o Explain that economic integration will increase competition among producers within the trading bloc. o Compare and contrast the different types of trading blocs.

Monetary Union o Explain that a monetary union is a common market with a common currency and a common central bank. o Discuss the possible advantages and disadvantages of a monetary union for its members.

Adopted from the IB Economics Subject Guide

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Economic Integration IB Exam Practice Questions Paper 1 & 2

Paper 1 & 2: Analysis Questions 1. Explain that preferential trade agreements give preferential access to certain products from certain countries of others.

2. Explain the benefits of a customs union over a free trade area.

3. Explain the difference between a customs union, common markets, and economic and monetary unions.

Paper 1 & 2: Evaluation Questions 4. Evaluate the advantages of a common market over the members of a customs union.

5. Evaluate the possible advantages of a monetary union for its members.

6. Evaluate the possible disadvantages of a monetary union for its members.

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Sources I am grateful for the work of my fellow IB Economics teachers Jocelyn Blink, Ian Dorton, Ellie Tragekes, and Jason Welker. Though they may not know it, each of them have accompanied me through my teaching of IB Economics over the years.

Thank you!

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