International Economics

Reasons for trade

• Factor endowments are the factors of production that a country has available to produce goods and services.
• Specialization exists where a country specializes in the production of goods and services where they have a comparative advantage in production. They will then trade to get the goods and services in which they do not specialize.
• Absolute advantage for a good exists where a country is able to produce more output than other countries using the same inputs of factors of production.
• Comparative advantage for a good exists where a country is able to produce a good at a lower opportunity cost of resources than another country.

Free trade and protectionism

• Free trade is international trade that takes place without any barriers, such as tariffs, quotas, or subsidies.
• Protectionism happens when countries adopt policies to protect their domestic industries from foreign competition. Usually good for developing countries with many sunrise industries. Can lead to inefficiency however.
• A tariff is a duty (tax) that is placed upon imports to protect domestic industries from foreign competition and to raise revenue for the government.
• A quota is an import barrier that set upper limits on the quantity or value of imports that may be imported into a country.
• A subsidy is an amount of money paid by the government to a firm, per unit of output, to encourage output and to give the firm an advantage over foreign competitors.
• A Voluntary Export Restraint (VER) is a voluntary agreement between an exporting country and an importing country that limits the volume of trade in a particular product.
• The infant industry argument proposes that new industries should be protected from foreign competition until they are large enough to compete in international markets.
• Dumping the selling a good in another country at a price below its unit cost of production.
• Anti-dumping is legislation to protect an economy against the import of a good at a price below its unit cost of production.

Economic integration and the World Trade Organization (WTO)

• A free trade area (FTA) exists when an agreement is made between countries, where the countries agree to trade freely among the members of the group, but are able to trade with countries outside the free trade area in whatever ways they wish.
• A customs union is an agreement made between countries, where the countries agree to trade freely among themselves, and they also agree to adopt common external barriers against any country attempting to import into the customs union.
• A monetary or currency union is an agreement between countries to share the same currency.
• A common market is a customs union with common policies on product regulation, and the free movement of goods, services, capital, and labor.
• Trade creation occurs when the entry of a country into a trading bloc leads to the production of a good moving from a high-cost producer to a low-cost producer.
• Trade diversion occurs when the entry of a country into a customs union leas to the production of a good moving from a low-cost producer to a high-cost producer.
• The World Trade Organization (WTO) is an international body that sets the rules for global trading and resolves disputes between its member countries. It also hosts negotiations concerning the reduction of trade barriers between its member nation.

Balance of payments and its problems

• The balance of payments is a record of the value of all the transactions between the residents of a country with the residents of all other countries over a given time period.
• The balance of trade is a measure of the revenue received from the exports of tangible goods minus the expenditure on the imports of tangible goods over a given time period.
• The invisible balance is a measure of the revenue received from the exports of services minus the expenditure on the imports of services over a given time period.
• The current account is a measure of the flow of funds from trade in goods and services, plus net investment income flows (profit, interest, and dividends) and net transfers of money (foreign id, grants, and remittances).
• The capital account is a measure of the buying and selling of assets between countries. The assets are often separated to show assets that represent ownership and assets that represent lending.
• A current account surplusexists where the revenue from the export of goods and services and income flows is greater than the expenditure on the imports of goods and services and income flows over a give time period.
• A current account deficit exists where the revenue from the export of goods and services and income flows is less than the expenditure on the imports of goods and services and income flows over a give time period.
• Expenditure-switching policies are policies implemented by the government that attempt to switch the expenditure of domestic consumers away from imports towards domestically produced goods and services.
• Expenditure-reducing policies are policies implemented by the government that attempt to reduce overall  expenditure in the economy, including expenditure on imports.
• The Marshall-Lerner condition states that reducing the currency exchange rate will only reduce the current account deficit when the PED of exports together with the PED of imports is greater than one.
• The J-curve theory suggest that in the short term, even if the Marshall-Lerner condition is fulfilled, a fall in the value of the currency will lead to a worsening of the current account deficit, before things improve in the long term.

Exchange rates and the terms of trade

• An exchange rate is the value of one currency expressed in terms of another.
• 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, or to the average value of a selection of currencies, or to the value of some other commodity, such as gold.
• A floating exchange rate is an exchange rate regime where the value of a currency is allowed to be determined solely by the demand for, and the supply of the currency on the foreign exchange market.
• Depreciation is a fall in the value of one currency in terms of another currency in a floating exchange rate system
• Appreciation is an increase in the value of one currency in terms of another currency in a floating exchange rate system.
• Devaluation is a decrease in the value of a currency in a fixed exchange rate system.
• Revaluation is an increase in the value of a currency in a fixed exchange rate system.
• Purchasing power parity (PPP) theory states that under a floating exchange rate system, exchange rates adjust to offset differential rates of inflation between countries that are trading partners in order to restore balance of payment equilibrium.
• The terms of trade is an index that shows the value of a country’s average export prices relative to their average import prices.
• Deteriorating terms of trade or adverse terms of trade exist where the average price of exports falls relative to the average price of imports.
• Elasticity of demand for exports is a measure of the responsiveness of the quantity demanded of exports where there is a change in the relative price of exports.
• Elasticity of demand for imports is a measure of the responsiveness of the quantity demanded of imports where there is a change in the relative price of imports.