Evangel's IB Economics Blog

Question 1: Evaluate the effects of schemes aimed at stabilizing the prices of primary commodity on producers and consumers.

• In LDCs, money raised from sale of primary goods is used to pay for manufactured imports: very high (90%) for most African LDCs
• Primary have a high price volatility, meaning that they change in price very quickly; that makes dependant nations unstable
• To counter volatility, countries enter sellers’ agreement, which creates more stable prices; however this can lead to:
  • Overproduction
  • Failure to get all producers to join the ‘club’
  • Storage of some commodities (esp. agricultural; go bad)
  • ‘Floor prices’ are too high and encourage overproduction (funds have to be used to sponge up surplus, potentially retarding other projects)
• Further, sellers’ agreements are ineffective at helping against upward pressures in price
  • Leads to further dependence on the primary products
  • Puts an upward pressure on a country’s exchange rate
  • Leads to inflationary pressures
  • Worsens corruption
• A government could also use monetary policy to try and manipulate the exchange rate; however, developing countries tend not to have large amounts of foreign reserves and don’t have established financial systems like banks and credit systems that would make monetary policy effective

Question 2: Explain the reasons for the growth, and increasing importance, of MNCs over the last half century.
Foreign direct investment (FDI) refers to the net inflows of investment to acquire a lasting management interest in an enterprise operating in an economy other than that of the investor. It is mainly undertaken through multinational corporations (MNCs)—a company that possesses and controls the means of production or services outside the country in which it was established. (e.g. Nike)

• Reasons for the MDC to provide FDI
  • Economies of scale: any fall in long-run unit costs that come about as a result of a firm increasing its scale of production
  • Access to new markets
  • Access to cheap resources
  • Less regulation
• Positive:
  • More stable and long-term than aid
  • Stimulate export markets in the host nation
  • Transfer technology from developed countries to developing nations
  • Boosts economic growth
  • Provide employment in the host nation
  • Provides training and education for local employees
  • Contributes tax revenue to the local government
  • MNCs may contribute other funds to local development projects or invest in other related assets in the host country
  • Create multiplier effect (more money -> consume more -> provide jobs -> more consumption)
• Negative:
  • Loss of sovereignty to some extent
  • Dependency issue
  • May employ largely expatriate managers, ensuring that incomes generated are maintained within a relatively small group of people.
  • Exploit a large and cheap supply of local manual labor
  • Can have influence on governments to get tax breaks, grants, and subsidies
  • Drive out local businesses (Crowding out effect)
  • Environmental degradation
  • May worsen income distribution (Lorenz curve)

Question 3: “The benefits of economic growth will, without any government intervention, trickle down to benefit the poor.” Do you agree with this statement? Justify your answer.

I disagree to this statement. Although economic growth can benefit the whole society in general, there are always people that lose out. The benefits that can trickle down to the poor are things such as demand of employment from the rich. The firms and households will always need workers and the poor can fulfil this need. The rich will collect money, and the government will earn more revenue from this as they can tax the rich. This increased revenue will allow the government to renew infrastructure and build a better city. The poor may also have access to these benefits. These benefits seem to help all the members of society, but there are members that lose out. The poor with a low level of education may be exploited to work at lower pay rates than they deserve. As more advancements appear in the city, living costs will increase, and to sustain a adequate level of living, children may be forced to work at a young age. This will cause a negative spiral, causing the poor to stay poor. Without government intervention, the poor will be poor, the rich to be rich.

Question 4: Analyse the advantages and disadvantages of foreign direct investment for developing countries.

Advantages:

• causes a flow of money into the economy which stimulates economic activity
• more employment opportunities
• long run aggregate supply will shift right
• aggregate demand will also shift outwards as investment is a component of aggregate demand
• it may give domestic producers an incentive to become more efficient and competitive
• FDI allows the transfer of technology—particularly in the form of new varieties of capital inputs—that cannot be achieved through financial investments or trade in goods and services. FDI can also promote competition in the domestic input market.
• Recipients of FDI often gain employee training in the course of operating the new businesses, which contributes to human capital development in the host country.
• Profits generated by FDI contribute to corporate tax revenues in the host country.
• the government of the country experiencing increasing levels of FDI will have a greater voice at international summits as their country will have more stakeholders in it

Disadvantages:

• inflation may increase slightly
• domestic firms may suffer if they are relatively uncompetitive
• if there is a lot of FDI into one industry; the automotive industry then a country can become too dependent on it and it may turn into a risk

Question 5: Explain why a floating exchange rate may be considered as a market oriented growth strategy.

• Floating Exchange Rate
  • A system of exchange rate in which the exchange rate, the price of one currency in terms of another, is determined by the powers of supply and demand rather than government intervention
• The positive effects for growth are:

• The promotion of competition – LDCs specialize in the production and export of those goods and services where they hold a comparative advantage.
• Increases in efficiency as domestic exporters are forced to become more competitive.
• Increased profitability and higher incomes, inducing greater savings and investment.
• Encouraging foreign direct investment and inflows of overseas capital and enterprise.
• The freeing up of markets – the removal of subsidies and price controls reduces government costs, opportunities for corruption and growth in black markets.