Economics International Economics Syllabus

Differentiate a free trade area from a customs union.

Free Trade Area: members remove internal tariffs but each keeps its own external tariffs (e.g., NAFTA/USMCA). Customs Union: members remove internal tariffs and adopt a common external tariff against non-members (e.g., the EU customs union).

What additional freedoms define a common market and an economic union?

Common market: a customs union plus free movement of factors of production (labour and capital) across members. Economic union: a common market plus harmonized economic policies and often a single currency (monetary union).

Distinguish trade creation from trade diversion in a customs union.

Trade creation: high-cost domestic production is replaced by cheaper imports from an efficient member, raising welfare. Trade diversion: imports switch from a low-cost non-member to a higher-cost member because of the common external tariff, reducing welfare.

When was the WTO established and what did it replace?

The World Trade Organization was established on 1 January 1995, replacing the General Agreement on Tariffs and Trade (GATT) of 1947. It emerged from the Uruguay Round negotiations.

State the main functions of the World Trade Organization.

To administer trade agreements, provide a forum for trade negotiations, settle trade disputes, monitor national trade policies, provide technical assistance to developing countries, and promote progressive liberalization of world trade.

Explain the 'most favoured nation' (MFN) principle of the WTO.

Under MFN (non-discrimination), any favourable trade term a member grants to one country must be extended to all other WTO members equally, so no member is treated less favourably than another.

Define the current account and list its four components.

The current account records the flow of goods, services, income, and transfers. Components: (1) trade in goods (visible balance), (2) trade in services (invisibles), (3) primary income (investment income and compensation), (4) secondary income (current transfers).

Give the formula for the current account balance.

$$CA = (X - M) + \text{Net primary income} + \text{Net secondary income}$$ where $X - M$ is net exports of goods and services. A positive value is a surplus; a negative value is a deficit.

Distinguish the visible (trade in goods) balance from the invisible (services) balance.

Visible balance: exports minus imports of tangible goods (e.g., cars, oil). Invisible balance: exports minus imports of services (e.g., tourism, banking, insurance, shipping). Together with income and transfers they form the current account.

What does the capital account record in the balance of payments?

The capital account records transfers of capital assets and non-produced, non-financial assets: e.g., debt forgiveness, capital transfers by migrants, and transactions in patents, copyrights, and trademarks. It is usually small relative to the financial account.

What does the financial account record, and name its main components?

The financial account records cross-border transactions in financial assets and liabilities: foreign direct investment (FDI), portfolio investment (shares and bonds), other investment (loans and deposits), and changes in official reserve assets.

State the balance of payments identity.

$$\text{Current account} + \text{Capital account} + \text{Financial account} = 0$$ (allowing for a balancing item/errors and omissions). A current-account deficit must be matched by a net inflow on the capital and financial accounts.

What are the main causes of a current account deficit?

Strong domestic demand pulling in imports; loss of international competitiveness (high relative costs/inflation); an overvalued exchange rate; low productivity; high consumer spending and low saving; and structural decline of exporting industries.

List possible policy measures to reduce a current account deficit.

Expenditure-reducing policies (tighter fiscal/monetary policy to cut demand for imports); expenditure-switching policies (devaluation/depreciation, tariffs); and supply-side policies to raise productivity and competitiveness in the long run.

Explain how a current account surplus can be problematic.

A large persistent surplus may signal weak domestic demand and low living standards, cause upward pressure on the currency (reducing competitiveness), generate inflationary reserve inflows, and provoke trade tensions and protectionist retaliation from deficit partners.

How is a nominal exchange rate defined?

The nominal exchange rate is the price of one currency in terms of another, e.g., $\$1.25/\pounds$ means one pound exchanges for 1.25 US dollars. It determines the domestic-currency price of imports and foreign-currency price of exports.

Under a floating system, what determines the equilibrium exchange rate?

The interaction of demand for and supply of the currency in the foreign exchange market. Equilibrium is where quantity demanded equals quantity supplied; shifts arise from trade flows, capital flows, interest rates, speculation, and relative inflation.

List the main factors that increase demand for a country's currency (causing appreciation).

Higher demand for its exports; higher relative interest rates attracting capital ('hot money'); inward FDI and portfolio investment; speculation of future appreciation; lower relative inflation; and stronger economic prospects.

Define appreciation and depreciation of a currency.

Appreciation: a rise in a currency's value under a floating system (each unit buys more foreign currency). Depreciation: a fall in its value. These market-driven terms contrast with devaluation/revaluation, which are deliberate under a fixed regime.

Distinguish devaluation/revaluation from depreciation/appreciation.

Devaluation and revaluation are deliberate downward or upward adjustments of a fixed (pegged) exchange rate by the authorities. Depreciation and appreciation are market-determined falls and rises under a floating regime.

Explain the effect of a currency depreciation on exports and imports (competitiveness).

Depreciation makes exports cheaper in foreign currency (boosting demand) and imports dearer in domestic currency (reducing demand). This tends to improve the trade balance, subject to the Marshall-Lerner condition and J-curve lags.

State the Marshall-Lerner condition.

A depreciation improves the trade balance only if the sum of the absolute price elasticities of demand for exports and imports exceeds one: $$|PED_{X}| + |PED_{M}| > 1$$ Otherwise the balance may worsen.

Describe the J-curve effect following a depreciation.

After a depreciation the current account first worsens then improves, tracing a J shape. In the short run trade volumes are inelastic (contracts, habits), so higher import prices dominate; over time volumes adjust and the balance improves.

Compare fixed and floating exchange rate systems.

Fixed: currency pegged to another currency/gold, maintained by intervention; gives certainty and imported price stability but requires large reserves and sacrifices monetary independence. Floating: market-determined; allows automatic BoP adjustment and monetary autonomy but brings volatility and uncertainty.

What is a managed float (dirty float)?

A hybrid system in which the exchange rate is broadly market-determined but the central bank intervenes occasionally (buying/selling currency or adjusting interest rates) to smooth fluctuations or steer the rate toward a desired range.

Define a currency union and give a leading example.

A currency union is an arrangement where several countries share a single common currency and a single central bank/monetary policy. The leading example is the Eurozone, whose members use the euro under the European Central Bank.

List the main advantages and disadvantages of joining a currency union.

Advantages: no exchange-rate risk between members, lower transaction costs, price transparency, more trade and investment. Disadvantages: loss of independent monetary policy and the exchange rate as an adjustment tool, plus one-size-fits-all interest rates unsuited to asymmetric shocks.

Define a multinational corporation (MNC).

A multinational corporation is a firm that owns or controls production, distribution, or service facilities in more than one country, coordinating operations across borders while headquartered in a home country.

State the main characteristics and causes of MNC expansion.

Characteristics: large scale, global brand, cross-border production, transfer pricing. Causes: seeking lower costs/cheaper labour and resources, access to new markets, avoiding trade barriers, exploiting economies of scale, and spreading risk geographically.

Distinguish foreign direct investment (FDI) from portfolio investment.

FDI is long-term investment giving lasting control/management interest in a foreign enterprise (e.g., building a factory or acquiring a controlling stake, conventionally 10% or more of voting shares). Portfolio investment is passive holding of foreign shares/bonds without control.

Summarize the impact of MNCs and FDI on developing versus developed economies.

Developing hosts gain jobs, capital, technology transfer, exports, and tax revenue, but risk exploitation, profit repatriation, environmental damage, and loss of sovereignty. Developed home economies gain cheaper goods and overseas profits but may lose manufacturing jobs through offshoring.