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A2 Economics- Global Economy
Extract 1: The UK Economic Recovery
1
...

Economic growth
Economic growth: in the short run, an increase in real GDP, and in the long run, an
increase in productive capacity of an economy
...

GDP growth 3% (2014)
...
7tn in 2014
GDP per head 2
...

Inflation
Inflation: a sustained rise in the price level of goods and services in an economy
...

-Measured in the UK by changes in the cost of a basket of goods and services bought
by a typical household (Consumer Price Index), weighted according to the
expenditure of each item in the basket (percentage increase in price level over time)
...

0
...

Unemployment
Unemployment: a situation where people are out of work but are willing and able to
work
...

Claimant count: a measure of unemployment that includes those receiving
unemployment-related benefits
...

5
...
3% employed (January 2015)
More than 5 million workers (record number) are in low-paid work (2014)
700,000 job vacancies (January 2015) and 1
...

Balance of payments (usually the current account):
Balance of payments: a record of money flows into and out of a country over a
period of time
...

Aim: Favourable balance of payments
...
9bn trade in goods a services (February 2015)
...
Distinguish between short- and long-run growth
...


-The point „Z‟ shows the economy is at spare capacity
...

-To achieve actual growth the government should use expansionary demand side
policies (fiscal and monetary)
...


-A shift to the PPC curve from PPC1 to PPC2 is an increase in the productive
capacity of the economy, and therefore long-run growth
...

Long-run supply curve:
Long-run aggregate supply curve: The relationship between output and the price
level in the long-run (the maximum possible output for the whole economy)
...
Classical LRAS curve:
Classical economists: economists who believe that the markets will „clear‟, that
prices and quantities adjust to changes in the forces of supply and demand so that
theeconomy produces its potential output in the long-run
...


-The only way to increase output is by shifting the LRAS curve to the right
...

-LRAS curve is therefore vertical
...
The Keynesian LRAS curve:
Keynesian economists: economists who believe that market failures will result in
price and quantity rigidities such that the economy‟s equilibrium output in the longrun may be less than its potential output
...

-In the long-run output is not always at its productive potential as not always all
factors of production are fully employed in the long-run
...


3
...

Causes of short-run growth
1
...

AD = C + I + G + (X – M)

2
...

-A decrease in the cost of production allows firms to lower prices and shift SRAS
curve to the right
...
Lower costs of factors of production
 Labour e
...
decrease in minimum wage
 Capital e
...
decrease in price of machinery
 Land e
...
decrease in price of raw materials
2
...

3
...


Causes of long-run growth
Changes in LRAS (productive capacity):
-Quantity and quality of factors of production:
1
...

 Increases in the size of population
...

-Quality of labour force:
 Increase in productivity (output per person)
...

2
...

 Productivity of investment depends on rate of technological advance
...
Describe & understand the different stages of the economic cycle
...

Trend growth rate: the average rate of economic growth measured over a period of
time, normally over the course of the economic cycle
...
Recession:
 When the rate of economic growth becomes negative and real GDP actually
falls
...
Recovery:
 When economic growth becomes positive after a recession
...
Boom:
 When the rate of economic growth exceeds the rate of growth of potential
GDP so that the output gap is narrowed
...
Slowdown:
 When the rate of economic growth begins to fall and approach 0
...

Human capital: the knowledge and skills of the labour force
...

-More reluctant to increase output by investing, so instead they will sell their stocks
...

Boom:
-As the demand continues to rise firms‟ confidence increases and stock is limited
...

-The growth of output will exceed the growth of demand (output growth will be fast)
...

-This will bring about the end of the growth phase of the economic cycle
...


5
...

Multiplier:
Multiplier effect: an increase in a component of aggregate demand, causing a higher
level of Real GDP
...

-There are three leakages (or withdrawals):
Leakages: withdrawals of possible spending from the circular flow of income
...

 Investment (I)
 Government spending (G)
 Spending on exports (X)
Marginal propensity to withdraw (MPW):
Marginal Propensity to Save: the proportion of additional income that is saved
...

Dt
MPT =
DY
Marginal Propensity to Import: the proportion of additional income that is used for
imports
...
Discuss the interaction of the multiplier and accelerator as
determinants of the economic cycle
...

-An increase in national income increases consumption
...

-Firms will then want to increase supply to benefit from higher demand, but if they
are at full capacity they will have to increase their investment (induced investment)
...

-In a boom…
 An increase in „I‟ (or any component of AD) will increase GDP, which will
cause a proportionally larger increase in GDP due to the multiplier effect
...

 This is known as the combined multiplier/accelerator effect and can explain
the upward momentum in the recovery phase of the business cycle
...

• This leads to a fall in investment, which leads to a negative multiplier effect
and the cycle repeats
...

However:
-If the firm is at spare capacity rising demand can be met without rising investment
...

-Investment is planned well in advance of changes in economic activity and can be
difficult to halt or postpone
...


7
...

Output Gap
Output gap: the difference between the actual and potential output of an economy
...


Point „C‟ represents a negative output
gap
...

potential
...

capacity or scarce resources there will be
However, Ye can be achieved if existing a negative output gap
...

Evaluation:
In reality it is incredibly difficult to estimate the potential output of the economy and
so it is difficult to accurately measure the size of the output gap
...
Evaluate the consequences of economic growth for:
 Inflation
 Employment
 Unemployment
 The balance of payments
 Government‟s fiscal position
Exogenous growth: this is growth occurring outside an economy
...

e
...
China, India and Germany are export-led countries
...
It may arise from
higher consumption, investment or government spending
...

e
...
UK is a consumption-led country
...
Inflation:
Inflation:
-Increase in aggregate demand causes the price level to rise and demand-pull
inflation
...

-Lower price level increases international competitiveness
...
Employment:
Higher employment:
-Higher output means higher derived demand for labour
...

Lower employment:
-Higher productivity may lower employment in the short-run as firms may chose to
produce the same output with fewer workers
...
Unemployment
Lower unemployment:
-High employment from high output should reduce unemployment:
 Short-run economic growth will reduce cyclical unemployment
...

Higher unemployment:
-Increases of the labour force can mean that rising employment coincides with rising
unemployment
...
Balance of payments:
a) Current Account:
-Trade in goods/services
-Government transfers
...

Trade deficit:
-An increase in real GDP means higher disposable income, so consumers have more
money to import, causing higher imports
...

-If there is inflation and the price goes up, exports will go down, as products are more
expensive for other countries
...

-For export-led economies they may import raw materials (decreased trade balance) in
order to produce higher value finished products for exporting
...

-For the UK higher growth may lead to more investment in technology which may
mean more machinery is purchased from abroad (e
...
Germany) improving it in the
long term
...
g
...

-Portfolio investment:
 Buying shares in a company
...

-Strong domestic growth will attract more FDI:
 They may import raw materials (higher imports)
...

-High and/or volatile inflation will discourage FDI
...

 Many FDI firms produce goods for the export markets (higher exports)
...
Government‟s Fiscal Position
-The fiscal position refers to fiscal policy (government spending and taxes) and
whether the government has a budget deficit of surplus
...

Government debt for the UK is approximately £1
...

Lower budget deficit:
-Higher disposable income means that the government gains more from income and
corporation tax (direct tax) whilst higher consumer spending causes higher indirect
tax through VAT
...

-Higher growth should lead to higher standard of living so there is less demand on the
government to provide merit goods
...


What does it depend on?
-Whether standard of living goes up:
 Possible increase in number of working hours
...

-Where the economy is at on the LRAS curve:
 If at spare capacity then long-run growth will just increase negative output
gap
...

-How much growth increases by:
 If only by a small amount there will be no large benefits
...

-Whether growth in demand is in labour or capital intensive industries:
 If in capital intensive industries then there will be no large decrease in
unemployment
...

-What kind of growth it is:
 Growth in AD is unsustainable and causes demand-pull inflation
...


9
...

 A lack of consumer confidence discourages consumption which may make
recessions last longer
...


Fiscal Policy
Fiscal policy: the taxation and spending decisions of a government to influence AD
...

-A cut in income tax will increase people‟s disposable income, which will raise
consumption and therefore increase AD
...

-An increase in AD causes an increase in real GDP and therefore economic growth
...

Reflationary: policy measures designed to increase aggregate 
 demand
...

-The aim is to balance government‟s budget over the course of the economic cycle:
 If the governments raise spending and cut taxes because the budget is in
surplus they run the risk of raising AD during the boom
...

Problem with UK‟s approach:
-It requires accurate estimation of the productive capacity and long-term rate of
growth (difficult to estimate)
...

-If fiscal policy is not run independently of government, there is a risk that politicians
will take risks with fiscal policy and destabilise the economic cycle
...

-Fiscal policy rules may encourage „creative fiscal accounting‟ where the government
find ways around the rules by changing the way in which expenditure is measured:

Monetary Policy
Monetary policy: central bank and/or government decisions on the rate of interest,
the money supply and the exchange rate in order to influence AD:
Economic growth (demand-side policy):
a) Rate of interest:
-A lower interest rate tends to encourage borrowing and increase consumption and
firms‟ investment
...

 A higher exchange rate will make exports more expensive and imports
cheaper
...

b) Money supply:
-An increase in the money supply is likely to increase AD:
 If the government prints more money or makes it easier for banks to lend more
money, people will have more money to spend
...

c) Exchange rate:
-Reflationary or expansionary monetary policy:
 If a government wants to reduce the exchange rate, it can lower interest rate or
sell pounds
...

-Deflationary or contractionary monetary policy:
 If the central bank wants to raise the exchange rate, it can increase the rate of
interest and/or buy foreign currency
...

Economic stability:
-In a boom, where there is high economic growth and accelerating inflation, an
increase in interest rates will stabilise it
...

-The primary objective of monetary policy is to deliver price stability
...

-Low and stable inflation provides a framework for economic stability
...

-Monetary policy works with time lags
...

-Supply-side policies aim to increase the economy‟s productive capacity, to prevent
inflation, reduce structural and frictional unemployment and to improve the
economy‟s long-run rate of economic growth and its international competitiveness
...

1
...

 Education and training

 Subsidies
 National minimum wage
 Investment in infrastructure
 Changing the working age
2
...

-Examples:
 Lowering corporation tax
 Deregulation
 Lower protectionism
 Lower income taxes
 Reduce unemployment benefits
-The increase in UK unit labour costs poses threats to government efforts to try and
rebalance the economy (from endogenous to exogenous growth), especially in the
manufacturing industry
...

-Problems:
 There is no point increase productive capacity if there is insufficient demand
in the economy
...

 Supply-side policies are generally expensive
...

 A change in the productivity (output per unit of labour) compared to other
countries
...

Unit labour costs: the cost of labour per unit of output (including the social security
costs, pensions and wages)
...

-Problem:
 A country may improve its relative unit labour costs but its current balance my
still worsen if the quality of its goods and services worsens relative to that of
its competitors
...
Define the following:
Real GDP: the volume of national output of goods and services adjusted for changes
in inflation
...

Annual rate of growth: the rate of change of real GDP over a 12-month period
...

Long-term unemployment: When someone fails to find work for at least 1 year and
is willing and able to work
...

Hysteresis: when a sustained period of low aggregate demand can lead to permanent
damage to the supply side of the economy
e
...
long-term unemployment causing structural barriers and structural disincentives
to successfully get back into formal paid work
...

(net business lending falling could be an indicator of low business confidence)
...
g
...

Talking down of the economy: pessimistic statements by government ministers
about growth prospects and the depressing effect these would have had on consumer
and business confidence
...
e
...

Re-balancing: the UK shifting the balance of the economy from consumer spending
to higher exports (improve balance of payments) and investment (increasing
productive capacity)
...
Explain the significance of the fact that the service sector makes up 80% of the UK
economy
...
However, the pessimistic view of the UK economy is thatoverdependence on
the service sector is undesirable and we need more growth in the manufacturingsector
...
Explain how a fall in unemployment could occur at the same time as a fall in the
employment rate
...

4
...

-Increasing supply-side competitiveness
...
This not only drives up consumption and therefore
AD but it also increase the productive capacity as there is a potentially higher quantity
of labour
...

-UK must „rebalance‟ away from consumption and towards exports and investment
...

 15% investment,
 22% government spending
Exogenous short-run growth is -2% of GDP:
 32% exports
...

5
...


If we run a deficit on our current account then the excess of imports has to be paid for,
and this usually means increasing borrowing and therefore increasing debt
...
Explain how the 2012 Olympic Games brought about a 0
...

The games boosted the economy as a result of investment in infrastructure (new
stadia),consumer spending by British visitors to the games (tickets for the games) and
spending by overseas visitors
...

7
...

-Debt acts as a constraint on future spending
...

-Any increase in debt imposes an interest burden on the UK economy in further years
...
What are the long term effects of the recession? (3)
-Rising structural long-term unemployment rates
...

-Persistent budget (fiscal) deficit and rising national debt
9
...

 Low business capital investment (low business confidence)
...

 Falling labour productivity
...
What are the consequences of a fall in GDP per head? (4)
 Average living standards decline
...

 Higher consumer debt due to low incomes
...
Which policies can rebalance the economy?
-Currency depreciation (A fall in sterling):
 A boost to export price competiveness, thereby improving net trade balance
...

-Protectionist measures:
 Tariffs on goods imported from abroad to lower imports
...
If GDP increases this will increase accelerator theory and increase investment
in that way
...
Analyse possible reasons for the disappointing export performance at a time of
currency depreciation
...

-Falling demand from overseas markets:
 The EU was experiencing an economic crsis:
 Falling demand from
-Competiveness is not just about cost and price:
 Did UK have enough non-price advantages?
13
...
A rise in labour should
mean more people are employed and therefore unemployment should go down
...
What affect does falling real wages have on the recovery of the UK economy?
A fall in real wages means a reduction in the spending power
...
This also means that on average
people have lower diving standards
...
Distinguish between absolute and comparative advantage:
ABSOLUTE ADVANTAGE
Absolute advantage: where one country is able to produce more of a good or service
with the same amount of resources, such that the unit cost of production is lower
...

Reciprocal absolute advantage: where, in a theoretical world of two countries and
two products, each country has an absolute advantage in one of the two products
...


Relative opportunity cost: the cost of production of one good or service
...

If you have not got an absolute but a comparative advantage, you would only produce
the product you have a comparative advantage in
...
Factor endowments:
Factor endowments: the mix of land, labour and capital that a country possesses
...
g
...

2
...

Heckscher-Ohlin theory of international trade: a theory that a country will export
products produced using factors of production that are present in great quantity and
import products whose production requires the use of scarce factors (Do what you do
best)
...
Government investment:
The government can help determine comparative advantage by investing in education
to improve the quality of labour (encourage labour-intensive production), or
investment in R&D to improve capitol or infrastructure, such as transport (encourage
capital-intensive labour)
...

Capital-intensive labour: where the production of a good or service requires large
amount of capital relative to other factors of production
...
Does not accurately reflect the real world:
-Workers are not all of them same skill level
...

-The model assumes only 2 countries and 2 products
...

2
...

3
...

4
...
g
...

5
...

6
...

Trading possibility curve (TPC):
Trading possibility curve: a representation of all the combination of two products
that a country can consumer if it engages in international trade
...


2
...


EFFECTS OF INTERNATIONAL TRADE
Advantages:
1
...

 Increased productivity
...

2
...

3
...

-This allows countries to benefit from existing technology innovations:
 Increases productive capacity
...
Direct benefits of increased exports:
-Short-run exogenous growth (exports are a component of AD)
...

-Macroeconomic objective of favourable balance of payments
...
Higher consumer surplus:
-Increased competition will put downward pressure on domestic firms‟ prices and
increase the product range (allocative efficiency)
...

2) Direct disadvantages from increase imports:
-Higher imports lead to leakages from the circular flow of income
...

3) Unequal distribution of income:
-MEDCs benefit more from trade than LEDC
...

5) Higher unemployment:
-Domestic firms may produce less as they lose market share to foreign firms:
 This may result in a lower derived demand for labour
...
Define, measure and analyse the significance of the terms of trade, and
changes in the terms of trade over time
TERMS OF TRADE
Terms of trade: an index that shows the price of a country‟s exports relative to the
price of its imports (also known as real exchange rate)
...

-It gives some indication of the extent to which an economy will benefit from
international trade
...

 A rise in terms of trade is an improvement in terms of trade
...

 A fall in terms of trade is called a deterioration in terms of trade
...

Since 2000, there have been dramatic decreases in the price of primary
commodities
...

Prebisch-Singer Hypothesis
Prebisch-Singer Hypothesis: the argument that countries exporting primary
commodities will face declining terms of trade in the long-run, which will trap them
in a low level of development as more and more exports will need to be sold to „pay
for‟ the same volume of imports of secondary sector or capital goods
...
Training costs
...
Need more infrastructure
...
Risk for unemployment
...
Import costs of primary goods
...
Costs of importing capital goods to produce secondary goods
...
Occupational immobility
...

 If PES is inelastic, firms can‟t produce more to take advantage of higher
prices
...

-Changes in terms of trade reveal nothing about volume of exports and imports:
 These determine the effects on the current account of the balance of payments
and AD
...
Outline the patterns of global trade
...
g
...

 Inequality of the distribution of the gains from trade
...

-Developing economies trade with labour-intensive products (low price)
...
g
...

-However, this is changing due to liberalisation of world trade and greater
exploitation of comparative advantage
...

Intra-regional trade:trade between countries in the same geographical area e
...
the
UK and France
...
g
...

Intra-industry trade:trade involving the exchange of goods and services producedby
the same industry
...

Main changes in the Global Economy:
1
...

-The EU and NAFTA have led to trade creation between members, whilst countries
outside the bloc have suffered from trade diversion
...
A change in specialisation:
-Like several advanced economies, the UK‟s trade in manufactured goods has fallen
compared to its trade in commercial and financial services
...

3
...

-These countries have increased their share of world trade by taking advantage of
their low production costs (low wage levels)
...
Newly industrialised countries:
-India and China have increased their share of the world trade (manufacturing
exports)
...

e
...
in 1995, the USA had 25% of global trade in hi-tech goods and China only had
3%
...


5
...

e
...
A capital abundant economy gains by exporting capital intensive products and
importing labour intensive products
...

-The opportunities for specialisation and trade based on comparative advantage
increases within the trading bloc but is only restricted to member countries
...
g
...


6
...

FREELY FLOATING EXCHANGE RATE
Freely floating exchange rate: an exchange rate system that is determined by the
forces of demand and supply
...

 Long-term capital transactions
Long-term capital transactions:flows of money related to buying and selling assets
such as property (direct investment) or shares in companies (portfolio investment)
...
This
should lower the exchange rate (depreciation), causing the relative price of
exports in overseas markets to fall (exports more competitive), whilst the
relative price of imports in the home markets goes up (imports appear more
expensive)
...

 This can allow the government to increase AD and come out of a recession
...

FIXED EXCHANGE RATE
Fixed exchange rate: an exchange rate system in which the value of one currency
has a fixed value against other countries (often set by the government)
...

-Strong discipline on domestic firms to keep their costs low in order to remain
competitive in international markets:
 Helps the government maintain low inflation, which should in the long-run
bring interest rates down and stimulate increased trade and investment
...


7
...

-High levels of investment:
 Capital goods being imported from abroad
...

-A high exchange rate:
 Makes imports cheaper and means consumer switch away from domestically
produced goods and services
...

-Low output due to low productivity:
 Domestic firms have less output to be exported
...


8
...

1
...

2
...

3
...

Issues:
-An increase in the price of imports will add to domestic inflation by raising both
retail prices and the cost of production
...

-Policy not directed at the cause of imbalance in the balance of payments:
 Raising productivity, increasing investment and reducing unit labour costs
would be more appropriate (they tackle the problem)
...

-PED of exports:
 If exports are price inelastic (domestic products are low substitutes) a decrease
in price of imports will cause a proportionally smaller increase in the volume
of exports demanded, having little effect on the balance of payments
...

1
...

2
...

Issues:
-Have a large effect on AD and therefore on growth:
 Requires a sustained period of recession in order to bring it under control
...


Questions relating to Extract 2:
1
...

Net trade: the volume of exports minus the volume of imports (net exports)
...

Global competitiveness Index: measures the factors that facilitate or drive
productivity (the set of institutions, factors and policies that set the sustainable
current and medium-term levels of economic prosperity)
...

Unit labour costs: the cost of labour per unit of output (including social costs as well
as wage costs)
...

Plan for growth:centred around supply-side reforms and policy interventions
designed to improve business competitiveness and labour market flexibility
...

2
...

A country may seek to specialise in the good/service it has a comparative advantage
in as it has a lower relative opportunity cost in that good/service, in order to produce
at a low cost of production to be price competitive and therefore internationally
competitive
...
Identify and explain the various factors that can contribute to the UK‟s
international competitiveness
...

-Productivity/technology advance/infrastructure improvement:
 If UK performs better and therefore at a better value relative to other
countries, this will result in higher demand for exports and reduced domestic
demand for foreign imports
...
Explain the relevance for international competitiveness of each of the nine
indicators included in the Global Competitive Index (GCI)
...
g
...

-The quality of infrastructure:
 Transport links, telecommunications, energy etc
...

-Health and primary education:
 E
...
mortality rate
...

-The efficiency of goods and labour markets:



The extent to which allocative efficiency is achieved and how occupationally
and geographicallymobile the labour is (include barriers)
...

-Business sophistication:
 The quality of management of business and supply chains
...

5
...

-Rebalance the economy:
 Encourage exports
...

-Tax reforms:
 Reducing tax and simplifying tax systems
...

 Replace the business enterprises that are not efficient
...

5
...

2
...

Price and non-price competitiveness
...
g
...

-Increasing access to finance for business:
 Makes it easier for new firms to enter the market and produce new products,
which can then be exported (increased aggregate supply)
...

-Cutting corporation tax:
 Reduces tax burden, increases profits and therefore increases retained profits
for investment (increases aggregate supply)
...

-Creating an educated workforce:
 Improves the quality of labour and therefore the productivity (output per
hour), allowing this extra output to be exported through increased AS
...
Explain how the government might expect to achieve growth by reforming the tax
system
...
This
causes the SRAS curve to shift to the right and aggregate supply to go up, causing
short-run growth as real GDP goes up
...
Explain why an improvement in the terms of trade is not necessarily desirable
...
If UK prices are rising more rapidly than prices
abroad, it will reduce the quantity of UK exports demanded by freoign countries and
by UK buyers who will find overseas goods relatively cheaper (meaning net exports
may still go down)
...
Analyse the possible explanations for the negative trade balance
...

9
...

 Encouraging inward migration of skilled workers
...
g
...
g
...

 Incentives for business innovation and invention
4) Macroeconomic Stability:
 Maintaining low inflation / price stability
...
Distinguish between the balance of trade & the terms of trade:
Terms of trade only looks at the price of exports and imports and divides them whilst
balance of trade looks at the value of exports sold minus the value of imports bought
...
To what extent has the UK achieved an improvement in compe88veness in recent
years?
It is 8th in the league for competitiveness, however it was 107th in terms of
macroeconomic performance in 2014
...
Analyse how improvements in labour market flexibility can aid competitiveness
...

-Flexibility makes the UK economy more attractive for inward investment
...
Why locate to UK?
-Few trade unions and strikes
-EU location
-Stable economy
-Useful language
...
Why are many developing nations still limited by growth? (6)
-Primary commodity dependency
...

-Conflict and corruption
...

-Insufficient savings
...

15
...

16
...

-Severe job crisis especially among the young
...

-Deepening social and political crisis
...
How do you explain the rise in trade between developing countries?
-Rising number of Preferential Trade Agreements:
 Lower tariffs and relaxation of quotas between members
...
g
...

-Investment in large-scale infrastructure
...
How can you explain rising intra-industry trade?
-Demand-side explanations:
 Strong Consumer preferences for variety and choice from different countries
...

-Supply-side explanations:
 Advantages of economies of scale and rising intra-firm trade within
multinational businesses
...

 Foreign direct investment and improving human capital allows more countries
to produce similar intermediate and final products
...
What are the problems with primary product dependence?
-Volatility of demand for commodities:
 Economy vulnerable to external shocks
...

-Risk of resource degradation/depletion:
 Risk of long run scarcity of primary commodities
...
Understand & explain the stages of economic integration
Economic integration: the process of blurring the boundaries that separate economic
activity in one country from that in another
...
Free Trade Areas:
Free Trade Areas: an agreement between two or more countries to abolish tariffs
and quota barriers on trade between them
-There is a problem with trade deflection
...

2
...

-The problem of trade deflection is avoided by agreeing a common external policy
...

3
...

-Countries now have common policies towards key markets (industries)
...
Monetary Union:
Monetary Union: a single market with the addition of the same monetary policy
...

 Common exchange rate, interest rates and money supply
...

5
...

-A common fiscal policy:
 Harmonised tax rates
...


2
...

-Now made up of 28 countries
...

 Common policies on agriculture, fishing, the environment
...

Single European Market: a process adopted in the EU that promoted the free
movement of goods, services and capital by harmonising product standards and
removing remaining non-tariff barriers to trade
...

-Some members such as UK, Sweden and Denmark have not want to sacrifice their
monetary policy sovereignty
...

NORTH AMERICAN FREE TRADE AREA (NAFTA)
-Agreement between USA, Canada and Mexico since 1994
...

-Benefits:
 Increased trade between three countries
...

 Raised growth in Mexico in particular
...

 Mexican farmers unable to compete against cheap corn imports from USA
...

-Expanded to 10 members (Brunei, Vietnam, Laos, Burma and Cambodia added)
...

 Wants to create a single market by 2020
...

 Trade between non-ASEAN countries has grown much faster than trade
between members of ASEAN
...
Evaluate internal and external consequences of economic integration
and explain the roles of the World Trade Organisation
SHORT-RUN
Trade creation:
Trade creation: where economic integration results in high-cost domestic production
being replaced by imports from a more efficient source within the economically
integrated area
...

-Trade creation stimulates higher trade, and a more effective allocation of resources as
each country can more fully exploit their comparative advantage
...

-Domestic consumer gain as they benefit from lower prices and their demand
increases from QD1 to QD2
...

-The impact of trade creation depends upon PED and PES:
 If inelastic PED and inelastic PES the net gain will be much lower
...

-Depending on the industry and location, it may cause structural unemployment
...

Trade Diversion

Trade diversion: where economic integration results in trade switching from a lowcost supplier outside the economically integrated area to a less efficient source within
the area
...

-Trade diversion is considered undesirable because it concentrates production in
countries with a higher opportunity cost and lower comparative advantage
...


SFrance=SEU produces at a higher cost, but due to lack of tariffs on EU-members, other
EU members will higher import more from France than other non-EU members,
which produce at a lower cost (SNZ=Snon-EU)
...

Evaluation:
-The impact depends on whether the UK previously had protectionism on imports
from the non-EU member:
 If the UK did not previously have protectionism against the country then trade
diversion will occur
...

LONG-RUN: DYNAMIC EFFECTS
1
...

2
...

 Benefits for long-term economic growth (productivity)
...
A larger market and economies of scale:
-The removal of barriers to trade allows firms within that market to raise the scale of
production and benefit from economies of scale
...

-Result in the mergence of collusive oligopolies:
 Deeper levels of economic integration may require agreement on competition
policy to tackle the abuse of market power
...

-The overall effect on economic welfare of citizens in member states depends on
whether the economic integration mainly results in trade creation or trade diversion:
 Trade creation is mainly viewed as positive whilst trade diversion is mainly
viewed as negative
...

Transaction costs: the costs of trading, which includes costs of changing currencies
...

-Increased price transparency:
Price transparency: the ability to compare prices of goods and services in different
countries
...

-Short-term costs:
 Changing currency results in e
...
menu costs
...

-Loss of monetary policy sovereignty:
 The same interest rate may not suit the individual circumstances of a particular
country
...

-Constraint on fiscal policy:
 Likely that monetary union will need rules to limit government spending/taxes
as it might affect the monetary union
...

Fiscal transfers: occur where taxation raised in one country is used to fund
government expenditures in another country
...
Number of countries involved:

The more countries there are involved the more difficult it will be to agree on
common levels of protectionism (stage 3: customs union) and common monetary
policy (stage 5: economic and monetary union)
...
Single currency integration:
It is difficult to integrate countries with a single currency because they have the same
monetary policy, which is a problem if countries do not have identical business
cycles, as monetary policy can‟t then be used to achieve economic objectives
...
Reduction of flexibility:
Identical policies reduce the flexibility of an economy coping with asymmetric
external shocks
...
High level of immigration:
-Too much immigration could damage domestic labour markets threatening to cause
unemployment
...
Reliance on free trade:
-Countries may become too reliant on free trade between member states, which can
reduce self-sufficiency
...
Varying economic development between countries:
-Countries at different stages of economic development may benefit more from
common policies such as France receiving more farm subsidies than UK
...
More extremist voting patterns and social unrest:
-The situation in Greece suggests that trying to achieve greater levels of integration
may encourage more extremist voting patterns and social unrest
...
Potential tax revenue losses:
-Free migration between member states may lead to tax revenue losses if people move
to lower tax countries e
...
the top rate income tax in France caused many of the
richest people to emigrate
...
Increased negative externalities:
-Increased negative externalities due to greater travel and greater freight transport in
the EU
...

WORLD TRADE ORGANISATION
World Trade Organization (WTO): a global organisation that regulates world trade
...
Non-discrimination:
-Countries can‟t grant a special favour to one WTO member over another
...

2
...

-Enable goods and services to flow more openly and fairly between members
...
Predictability:
-The purpose is to „bind‟ WTO members once they have agreed to open their markets
...

4
...

5
...


Questions relating to Extract 3:
1
...

Regionalisation of trade: increased intra-regional trade
...
g
...
Hence, trade occurs between one member
of a trading bloc and another member
...
g
...
It is the trade between one country or trading
bloc and another e
...
trade between the EU and NAFTA (North America Free Trade
Area) or ASEAN (Association of South East Asian Nations)
...

Inter-industry trade: the exchange of products between different industries
...

Quota: a limit on imports
...
g
...

2
...

b) The Common Agriculture Policy (CAP):
To protect European agriculture against outside competition and, at the same time,
ensure food supplies to European consumers
...

d) Competition Policy:
To prevent distortion of the market, either by dominant firms, or by collusion between
suppliers
...
Analyse the economic consequences of free movement of labour
...

-More flexible labour markets:
 There may be shortages in certain professions in an economy, which can be
filled by workers overseas
...

Disadvantages:
-Developing countries may lose best skilled labour:
 This could harm economic development in developing countries
...

4
...

Or else it could distort the market e
...
corporation tax concessions could be used to
attract capital in the country
...
Analyse and explain the advantages and disadvantages from joining the Euro
...

 Eliminating currency conversion costs boosts tourism
...

 Euro membership a confirmation of long-term political alignment with the
European Union
...

 Joining the Euro reduces the risks of taking out loans
...

 Exposure to continued weak growth in Euro Zone
...


Extract 5: Characteristics and impact of globalisation
1
...
This would mean there is
less money to invest
...
This causes a decrease in real GDP therefore a
decrease in income
...
A
reduction in health would reduce the quantity of human capital
...
This low level of human capital
reduces productivity, which again results in low incomes
...
FDI:
-Depends on the amount of FDI
...

-Depends on the level of job creation
...
demerit goods
...

-Depends on the effect on competition:
 FDI may force domestic firms out of production
...

-Depends whether FDI firms export the products made:
 More favourable balance of payments
...

2
...

-Depends whether the country currently relies on endogenous or exogenous growth:
 If currently endogenous, the benefits should be higher e
...
China in 1978
...

-Depends on the price elasticity of demand:
 If inelastic an increase in tariff causing an increase on the price of imports will
cause a proportionally smaller decrease in the quantity demanded of imports
...
Increased immigration:
-Depends on the level of skills and education of the immigrants
...

-Depends on their age:
 Ideally between 18 and 65
...

-Depends on the level of infrastructure in the country available to them
...

4
...

-Costly to implement in the short-run so may only benefit in the long-run
...

-Technology may require on-going maintenance costs
...

-Improved productivity (from increased technology) drives up wages meaning
countries lose their comparative advantage in low cost and low wage products
...
Specialisation:
-May lead to repetitive work that lowers motivation and therefore productivity
...

-Depends on global demand for your products
...
g
...

GENERAL MEASURES TO INCREASE ECONOMIC DEVELOPMENT
1
...

-Put tariff on imports to raise the price and reduce the imports demanded
...

-A reduction in balance of payments deficit that most developing economies have
...

-Become less reliant on primary commodities (new comparative advantage)
...
Export promotion:
-Adopted by „Easy Asian Tiger‟ economies in their expansion of hi-tech industries
...

Characteristics:
1
...

2
...

3
...


2
...

Sustainable development: development that “meets the needs of the current
generation without compromising the ability of future generations to meet their own
needs”
...
Economic objectives:
-Better use of scarce resources to increase goods and services available for
consumers:
 Increased output of primary, secondary and tertiary sectors
...

2
...

3
...

-Poverty major cause of environmental damage:
 Agricultural land being over farmed leading to soil degradation (reduces
productivity of land over time)
...


3
...

 Greater international trade
...

 Increased capital flows
...

 Spread of technology
...
Greater free trade:
-Specialisation of goods where countries have a comparative advantage in:
 Lower prices for consumers
...

 Bigger export markets for domestic manufacturers
...

 Greater competition (high incentive for domestic firms to improve efficiency)
...
Greater movement of labour:
-Can reduce unemployment (increased opportunities to look for work elsewhere)
...

-Can help with labour shortages
...

3
...

-Increase LRAS as productivity goes up:
 Higher real GDP results in higher living standards
...

 Sub-Saharan Africa have seen little change in poverty in 20 years
...

Costs:
1
...

2
...

-Increased pollution and global warming
...

3
...

4
...

5
...

 Seen as unfair competition for domestic firms
...
Does globalisation benefit consumers in both developed and
developing countries in the long run?
How globalisation is beneficial for LEDC‟s
Poverty Reduction and Inequality
-The IMF argues that globalisation has
contributed to a reduction in absolute
poverty (link to extract 5: % of people living
in extreme poverty cut in half)
-The trickle down effect should then also
lead to lower income inequality

How globalisation is harmful for LEDC‟s
Poverty Reduction and Inequality
-Globalisation has not remedied absolute
poverty, and could be argued due to
widening income inequality has exacerbated
relative poverty
...

-Higher FDI has resulted in higher
exogenous short-run and long-run growth
...


Economic Growth
-For LEDC lower economic growth due to
increase emigration from LEDCs to
MEDCs (lower long-run growth due to a
smaller less skilled workforce due to
possible brain drain of the best workers)
...

-Economies of scale due to domestic firms
having access to larger overseas markets (for
most LEDCs easier to sell as exports than
sell to domestic markets)
...

-Lower prices and higher choice leading to
high consumer surplus- allocative efficiency
...
g
...


Fiscal Position
-Increased tax revenue (corporation tax,
income tax, indirect tax from high spending
and tariffs) which can then be spent on merit
goods needed to help development
Technology
-Technology transfer means that LEDCs
benefit from new and more productive
technology from MEDCs (spread of
technology)

Technology
-LEDCs rely on MEDCs innovations and
become dependent on them
...


lead to higher employment rates
Sustainability Issues
-Growth often relies on the exploitation of
non renewable resources
...

-Environmental exploitation by MNC‟s
...


Evaluation:
-Extent of primary product dependency and declining terms of trade:
 Traps developing countries in a low level of economic development
...

-Inappropriate technology introduced to developing countries:
 No use of it
...

-High intra-regional and intra-industry trade in developing economies:
 Limits the benefits of inter-regional and inter-industry trade (extract 4)
...

-The extent to which economic growth generated from increased trade and FDI result
in greater human development
...
What are the main factors driving globalisation?
FACTORS PROMOTING GLOBALISATION
1
...

-Reduction in tariff levels
...

2
...

Foreign Direct Investment: investment made by a multinational corporation in a
country other than where its operation originate
...
Advances in technology:
-Reduced cost of communicating information has promoted global economic
relations
...
Decrease in transport costs:
-The cost of ocean shipping has come down due to containerisation and bulk
shipping
...

5
...

Multinational companies (MNCs): firms that produce goods and services in more
than one country
...
Differences in tax systems:
-There is s desire from multinational corporations to benefit from lower labour costs
and more favourable factor endowments abroad
...


Questions relating to Extract 5:
1
...

Outsourcing: when a firm contracts part of the production process to a firm in
another country
...

Emerging economy: rapidly growing economies in terms of net exports such as
China, Brazil, Russia and India
...

Dual economy: the existence of two distinct types of economic segments within an
economy (capital intensive manufacturing sector and labour intensive agricultural
sector)
...

2
...

-To promote international monetary co-operation
...

-To provide exchange stability
...

-To make resources more available to members experiencing balance of payment
difficulties
...
Analyse the meaning of development and its relationship to economic
growth
Poverty: when income is below the level that would allow someone to enjoy some
agreed minimum standard of living
...

Medium poverty: the World Bank defines it as living on less than US$2 per day
...

-Increase availability and distribution of basic life-sustaining goods:
 Food, shelter and health
...

 Enabling people and societies to feel a greater sense of worth and self-respect
...

COMPARING GROWTH WITH DEVELOPMENT
-Growth raises a nation‟s income:
 Making it easier to provide better healthcare, better education and more jobs
...

-Not enough:
 Economic growth may raise income but the additional income may be
unequally distributed (large number of people see no increase in their
individual income)
...

 Economic growth through capital-intensive methods may reduce job
availability (unemployment and poverty remains high)
...

Difference:
-Much easier to compare income levels than economic and human development
...


2
...

-Does not take into account:
 Distribution of income
...

 Leisure time or human freedom
...

 Life expectance at birth (indicator of health and longevity)
...

 GDP per capita in US$ at PPP (indicator of standard of living)
...
8 and above
...
5 and 0
...

Low human development: where HDI is less than 0
...

Benefits:
 Focuses attention on the outcomes of development, rather than just economic
growth
...

 Allows judgements to be made on a country‟s development over time
...

Limitations:
 Only gives 3 aspects of development
...

 There is an issue with the weighting of the three indicators
...

 It is only an indicator (should not be taken too literally)
...
Analyse the common and diverse characteristics of economies at
different stages of development
CHARACTERISTICS OF DEVELOPING COUNTRIES
Common characteristics:
1
...

 Made worse by low growth in income per capita, uneven distribution of
income and large amount of people living in absolute poverty
...
Low levels of labour productivity:
 Low output per worker compared to developed economies
...

 Low level of GDP limits investment in physical and human capital
...

3
...

4
...

 Make up a large percentage of exports, however are low value, have been
subject to declining terms of trade and in some cases face tariffs from
developed nations that protect their own agricultural sector
...
High degree of market failure
6
...

 Multinational companies are highly dominant

---