Global Economic Activity

The exchange rate is the value at which one currency trades against another on the foreign exchange market. It is the value of a currency in terms of another.

The foreign exchange market is where foreign currencies are traded and the value of a currency is determined by its demand and supply.

Exchange rate index- measure of a currency against a trade weighted basket of currencies. It is expressed as an index, where the value of the index will be 100 in the base year.

Floating exchange rate- when the value of a currency is determined by market forces- supply and demand for currency.

Fixed exchange rate- where the government seeks to keep the value of a currency fixed at a certain level compared to other countries.

WIDEC:

Weak pound Imports Dearer Exports Cheaper

A weakened pound makes imports more expensive as British consumers get less foreign currency when they exchange £1, while exports are cheaper as foreign consumers get more £ when they exchange the same amount of their own currency.

SPICED:

Strong Pound Imports Cheaper Exports Dearer

A stronger pound makes imports cheaper as British consumers get more foreign currency when they exchange £1, while exports are more expensive as foreign consumers get less £ when they exchange the same amount of their own currency.

Importing stock to UK. Price is $200,000 strong exchange rate is £1:$2 and weak exchange rate is £1:$1.50

Strong: 200,000/2 = £100,000

Weak: 200,000/1.5 = £133,333

The strong exchange rate is better as importing is cheaper as you get more foreign currency when exchanging £1. To convert into £ divide by exchange rate.

Exporting stock to America. Price is £10,000 strong exchange rate is £1:$2 and weak exchange rate is £1:$1.50

Strong: 10,000*2 = $20,000

Weak: 10,000*1.5 = $15,000

The weak exchange rate is better as Americans get more £ when they exchange $1, so it is cheaper for them. To convert from £ multiply by exchange rate.

Weak £ could lead to inflation- imports more expensive, raw materials cost more, COPs go up, cost-push inflation; exports cheaper so it increases, more money in economy, increased disposable income and spending power, demand-pull inflation.

Strong £ could cause loss of competitiveness- exports more expensive so demand from foreign countries falls.

Strong £ could cause unemployment- exports more expensive, less demand for British goods, derived demand for labour drops as a result.

Weak £ could benefit national income- exports cheaper, more demand for British goods, multiplier effect.

Weak £ could improve balance of trade- (value of UK exports- value of foreign imports), importing more expensive so it decreases, exporting cheaper so it increases, balance of trade improves.

Weak £ makes it cheaper for tourists to come to the UK, more money being spent in economy.

Exchange rate determined by market conditions i.e. supply and demand.

Demand for sterling determined by three major factors:

Demand from foreigners who buy British goods.

Demand from foreign businesses wishing to invest in UK (FDI).

Demand from speculators, foreign companies and governments who want sterling in reserves.

Factors that cause an increase in supply of sterling:

UK consumers and companies purchasing imports will supply pounds to foreign exchange market for conversion into required currency. UK companies investing overseas do the same thing.

High demand for sterling strengthens the pound. If demand for foreign exports falls, the other currency weakens so the pound will also strengthen by comparison. A high interest rate also increases demand for the pound as foreign savers will save in British banks.

Value of currency is determined only by market demand and supply and there is no target for the exchange rate so there is no intervention in the currency market by the central bank.

Advantages: No need for frequent central bank interventions meaning money isn't wasted on this

Useful instrument of macroeconomic adjustment e.g. WIDEC stimulates AD for UK goods

Partial automatic correction for trade deficit- wide trade deficit means excess supply of sterling, leading to WIDEC, making exports more attractive, reducing trade deficit

Allows the country to use their interest rate to achieve economics aims such as inflation control

Disadvantages: Higher volatility- exchange rate can change a lot making it hard for business to predict import and export price which can lead to them being unprofitable

Scarce resources are allocated in order to predict the exchange rate

Floating exchange rate may aggravate existing problems e.g. if there is high inflation, a sudden depreciation of the currency (WIDEC) can drive it higher as more AD for goods

Means a currency is pegged to another currency e.g. Dollar or Euro and there are no daily fluctuations from the agreed central rate.

Advantages: Avoids currency fluctuation meaning there are no sudden changes in exchange rates which can make firms uncompetitive

Stable exchange rate encourages investment as they can more easily predict currency movements which can have a negative impact on price elastic exports

Keeps inflation low

Disadvantages: Can conflict with other objectives as interest rates are changes constantly

Less flexible making it difficult to respond to temporary shocks

Could join at the wrong rate- if it's high it makes exports uncompetitive, too low causes inflation

Current account imbalances e.g. overvalued exchange rate causes current account deficit

Absolute advantage refers to the situation where some countries are more efficient at producing some good/service given their present resources. Therefore, they should each specialise in the product in which they are more efficient in and then trade to acquire the other product.

Countries can have absolute advantages because of:

Their natural resources e.g. Saudi Arabia- oil

Their climate e.g. India- tea

Specialist labour e.g. Japan- robotics/ A.I.

Cheap labour e.g. China

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There are three benefits from this: more of both products are made, they will be buying from the country who is best at producing the good and the price they should pay should be the cheapest due to increased efficiency in production

Comparative advantage refers to the situation where some countries have an absolute advantage in both goods. The theory states that countries should specialise in the good where they have the lowest opportunity cost. This results in rising world output and increased living standards.

Example:

Using all their resources, South Africa can produce 40 bags of wheat or 8 DVDs, while Japan can produce 8 bags of wheat or 4 DVDs.

South Africa has the absolute advantage in both products, however they should each specialise in one to make full use of their resources.

Japan should specialise in producing DVDs as they have the lowest OC (2 bags of wheat compared to South Africa's 5) and South Africa should specialise in wheat as they have the lowest OC producing it (0.2 DVDs compared to Japan's 0.5).

Current Account:

Trade in Goods Balance- value of exports of goods minus value of imports of goods

Trade in Services Balance- value of exports of services minus value of imports of services

Investment Income- interest, profit and dividends from UK owned businesses overseas

Transfers- government transfers (e.g. aid and EU budget) and private transfers

Capital Account: transfer of ownership of fixed assets

Financial Account: short and long-term monetary transactions between UK and other countries:

Direct investment in land, premises and equipment

Portfolio investment is investment to buy stocks and shares

Other investment including bank lending and borrowing and bank deposits (hot money)

Reserve assets such as foreign currencies kept and managed by BofE

Countries can benefit from absolute advantage meaning specialisation results in greater world output

Each country is able to sell to a larger market and benefit from economies of scale caused by mass production

Countries can get goods and services which they cannot produce themselves but are required in manufacturing or construction processes

Countries can get goods which are made more cheaply elsewhere

Developing countries can trade with developed countries who may be willing to pay more for products/resources than their poor population

Trading surpluses can create an injection into the CFI increasing national income

Consumers: more choice of goods; access to cheaper goods; goods can be of better quality

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Countries: benefit from economies of scale- produce more and lower AC per unit; increased competition acts as an incentive for firms to become more efficient; can improve balance of trade if they export more; can keep inflation low as imports may reduce COPs and prices; smaller economies can generate income from larger, wealthier economies; can consume outside their PPC while producing goods they have advantages in

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Businesses: larger market- opportunities for economies of scale increases with the greater number of consumers; more than one market gives diversification as a company facing a recession at home can still hope to sell and make profits through exports; firms can move to lowest cost locations to increase efficiency and lower costs; raw materials can be sourced at a lower price

Protect infant industry: small firms need to be protected to give them time to grow and they may not be able to compete with large MNEs

Prevent dumping: prevent foreign firms selling goods cheaply in order to destroy domestic industry

Deficit in Balance of Payments: a government may wish to eliminate leakages from CFI

Protect a way of life e.g. farming and cottage industries which are essential but vulnerable

Prevent import of harmful goods e.g. drugs, weapons and counterfeit goods which support organised crime

Strategic reasons: countries need farming and defence industries in case of war

Support other economics aims e.g. to recover from recession a government might promote a "buy local" policy

To put pressure on other countries e.g. to make North Korea stop producing nuclear weapons countries stopped trading with them

Quotas: a limit on the quantity of a good allowed into a country, decreases supply so prices rise e.g. limit on fishing industries to ensure there is enough for future generations

Tariffs: tax on imported goods

Embargoes: trade ban placed on all goods from a country or just one key good that a country makes

Subsidies: government grants to manufacturers to give them a cost advantage

Currency devaluation: deliberately lowering the value of your currency to benefit from WIDEC

Product standard regulations: add additional time and costs onto a business before their products can be sold- keep consumers safe as they are of the same quality as UK goods

A multinational enterprise is a company which has its headquarters in one country but has assembly and production facilities in another while having a global consumer base.

Firms become MNEs because to:

Increase market share- they may find they are at saturation point (when the good they produce in no longer needed) in the domestic market and need a new outlet

Secure cheaper premises and labour- cost of land and labour is cheaper in developing countries, allowing them to have lower COPs and lower prices

Avoid tax or trade barriers- different nations have different levels of corporation tax and may have barriers to entry

Benefit from government grants- some countries give grants to attract investment in their economies

Create wealth and jobs around the world

Inward investment offers much needed foreign currency for developing economies as it is more stable than their own

The size and scale of their operations allows them to benefit from economies of scale, enabling lower average costs and prices

They make large profits which can be used for research and development e.g. oil exploration is costly so only large businesses with significant resources and profits can do it

Consumers like to buy goods where they can rely on minimum standards like McDonald's

Local businesses can learn from MNEs and become more competitive and increase productivity

The firm can help increase the value of exports

Companies are often interested in profit at the expense of the consumer so there may be higher prices

Their market dominance makes it difficult for small firms to compete and thrive

In developing economies, MNEs can use economies of scale to push local firms out of business

While pursuing profit, they may contribute to pollution and use of non-renewable resource which is putting the environment under threat

Their profits are returned home so they may not be re-invested in the country they are located in

Cheaper labour than in other developed countries with skilled labour force

Good quality universities which help increase number of skilled workers

Lower rents and relatively cheap land compare to London

Government incentives such as tax breaks

To get access to large and wealthy UK market

To benefit from reduced transport cost and efficient infrastructure

Share a common language with many countries

Stable currency and stable economy making it easy to plan ahead

Cultural events and golf courses are used as venues to arrange great business deals

Access to EU single market and its benefits

A group which establishes a European Union Single Market among its 28 member countries.

There are 4 main features to the Single Market:

Free flow of goods

Free flow of services

Free flow of capital and labour

There is a common external tariff to non-EU members

Increased trade

EU countries are on average 12% richer a decade after joining than they would have been

Economies of scale- access to over 500 million people

Increased competition may lead to improved choice and quality with lower prices

Increased number of joint projects e.g. AirBus has facilities in various countries

Lower COPs with zero tariffs

FDI from Japan and US increased as they want access to Single Market

Increased mobility of labour and capital could lead to lower business costs and lower unemployment

UK now dependent on trade and capital integration from EU and are now vulnerable to their economics downturns

Net membership costs €8.5 billion a year

UK can't negotiate favourable deals with countries like US and New Zealand due to CET

Firms move to central and eastern Europe to cut costs

Must comply with all EU rules and policies

Taxation rates aren't harmonised so some countries can still have a competitive advantage

Two main features:

A single currency (the Euro) and a European Central Bank which sets the interest rate for the 19 member countries. Inflation is targetted at 2% CPI.

Convergence Criteria:

Stable price- inflation can't be more than 1.5% higher than the average in the three member countries with the lowest inflation

Stable exchange rate- currency must be stable relative to other EU currencies for 2 years

Total government debt can't be more than 60% of GDP and annual budget deficit can't be greater than 3% of GDP

Interest rate must not be more than 2 percentage points higher than average of EZ members

Advantages:

Removes transaction costs and allows greater price transparency

Exchange rate stability- easier to plan ahead

Increased inward investment due to exchange rate stability and access to EU Single Market

Forces government to control inflation and budget deficit before joining

Disadvantages:

Loss of sovereignty and removes benefits of floating exchange rate

Loss of monetary policy- leaves only fiscal policy to achieve economic aims

Menu costs- cost of having to change price lists, tills, vending machines

Central European Bank may not choose an interest rate which works for every country

Most members experience 1% GDP growth per year

Increase flow of capital into economies and therefore raises each country's productive potential

Raise productivity through increased trade, competition and investment

Improved consumer choice

Access to EU funds

Access to Single Market

Lower unemployment

FDI improves balance of trade

System of EU agricultural subsidies and programmes that represents 48% of EU's budget.

It supports farming by:

Guaranteeing minimum prices

Export subsidies

Common external tariff on food imports from non-EU countries

Subsidies to switching to organic farming methods

Set-aside payments for leaving land fallow

Advantages:

More efficient than any other system of farm subsidies

EU very self-sufficient due to this

Preserved small cottage industries, ways of life and prevented rural depopulation

Allows UK farmers to compete more fairly with overseas farmers

Output and prices are stable

Disadvantages:

Wealthy landowners receive subsidies even though they don't need it- could be used elsewhere

Only 10 million people employed in agriculture and generate only 1.6% of EU GDP

Dominated the budget for many years

Uses protectionism preventing fair and free trade with developing countries

Uneven distribution of income: poorest can't afford to save money or train themselves

Rural and agriculture dependency: 70% of population live off land, basic level so threatened by natural disasters, not a stable market globally so money made varies greatly

Inadequate savings and banking facilities: can't save to gain interest, low level of savings for loans

Inadequate capital investment: lower productivity meaning less to export

Limited education provision: not highly skilled workforce, can't specialise, unattractive to FDI

Weak infrastructure: high COPs due to transporting costs

Debt accumulation: large amount of government revenue spent on debt interest repayment

Political instability: civil wars destroy agricultural sectors, other countries don't trade with them

Africa has 50 countries- most are landlocked: trade is slow and unreliable and expensive

Examples: Malawi, Congo

High levels of economic growth over short period of time: economy getting wealthier, higher value of goods being produced, more attractive to investors

High level of FDI- demand for resources, injection into CFI resulting in economic growth

Investment in infrastructure: lowers COPs as transporting is easier so prices decrease

Better institutional services: more secure economy to undertake FDI

Capital investment: more efficient, better quality goods for exporting, economic growth

High value added industries for exports: can be sold at a higher price meaning more money coming into economy

Large investment in education and training: more skillled workforce resulting in economic growth

Movement from low to high productivity industries: not as dependent on one sector, these industries are more stable, leading to rising GDP and GDP per capita

Examples: Singapore, Brazil, Mexico, Nigeria

Positive:

Benefit from 'brain drain' from these economies e.g. engineers, doctors (they may leave the country to make better use of their skills elsewhere)

Potential source of low cost imports especially food and textiles

Will grow and develop in the future becoming more valuable trading partners

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Negative:

UK committed to contributing 0.7% of GDP to these countries as aid- people want money spent on own economy

Contributed to migration crisis EU has found hard to manage

Will grow and develop in future causing a further strain on already scarce resources

Positives:

Capitalise on growth opportunities by investing- potential for high interest

Competitive activity- more demand for UK firms

Cost effectiveness and culture of innovation

High levels of discretionary income- spend more on UK goods

Negatives:

Political instability and government regulation- may be hard to get access to foreign markets

Existing competition

Hard to find skilled staff

Lack of communication and digital infrastructure

UK businesses may relocate contributing to structural unemployment

Food aid: humanitarian aid given in the aftermath of a disaster to save lives

Capital loans: a loan given to a country which must be paid back at commercial interest rate

Soft loans: a loan given to a country which must be paid back with lower interest rate than commercial interest rate combined with technical expertise to enable large-scale projects

Technical aid: providing technical assistance from experts around the world

Tied aid: a grant or loan given on the condition that the money received must be spent purchasing goods from the donating country

Education and training: providing education to improve skill level of workers

Bilateral aid: aid given directly from one country to another

Multilateral aid: money given to an international agency which disperses the aid

Debt relief: wiping out any outstanding loans or restructuring payments to make them cheaper to repay

Emergency aid can save lives

Aid helps rebuild livelihoods and housing after disasters

Provision of medical training, medicines and equipment can improve health and living standards

Aid for agriculture can help increase food production and so improve quality and quantity of food available

Encouraging industrial development can create jobs and improve transport infrastructure

Aid can support countries in developing their natural resources and power supplies

Projects that develop clean water and sanitation can lead to improved health

Low interest soft loan allows countries to borrow money without intervention from another country

Aid can increase the dependency of a country on donor countries and they may struggle to repay loans

Corrupt leaders can take the money for themselves and it may not reach the people who need it

It can put political or economic pressure on the receiving country

Food aid can put farmers out of business

Once money has been spent on capital projects, there isn't any left for part replacements or servicing

It may be a condition that projects are run by foreign companies or that profits be sent abroad

Even soft loans can result in debt accumulation which can worsen government finances

The World Trade Organisation is a multilateral organisation. Their main roles are to encourage trade, remove barriers, settle trade disputes, levy fines when trade agreements are breached and make trade transparent. Countries can complain to them about unfair restrictions taken by other countries and WTO can intervene.

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The International Monetary Fund lends money to governments to prevent disruption to international financial system. They help countries which experience foreign currency reserve shortages or need help to support exchange rates or because of a deficit.

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The World Bank provides financial and technical assistance to developing countries using loans and grants to help countries develop.

Devolution is the transfer of powers from a central to a regional authority.

The Scotland Act 1998 created a Scottish Parliament and passed to it the powers to make laws on a range of issues.

The issues upon which the Scottish Parliament can make laws are known as devolved matters.

Powers:

The power to alter the basic rate of income tax by 3p in the pound. Tax bands can also be altered.

The power to alter Stamp Duty, Landfill Tax plus Land and Buildings Tax.

Control over alcohol pricing (e.g. minimum price and permission to run alcohol promotions).

Control over the advertising of tobacco.

Budgeting decisions of health (e.g. free prescriptions) and education (e.g. no university fees).

Scotland has a £2.2bn cap on its current borrowing powers.

Scottish public sector revenue estimated as £58.0bn.

Total expenditure was £71.2bn. Equivalent to 9.2% of UK public sector expenditure.

Public spending is £13,175 per person which is £1,437 per person greater than UK average.

Scotland's budget deficit is worth £9.8bn (6.5% of GDP), higher than the UK government budget deficit of 2.4%.

This is because of the free prescriptions, free university and oil and gas tax revenue fell to £2.26bn in 2015 from £11bn in 2011.  Also, Scotland can change the tax bands and income tax rates so they could have decreased the tax rate so they earn less income tax revenue.