Trade and integration

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  • Created on: 05-05-15 09:10

Trade and integration

World Trade Organisation (WTO): an international body responsible for negotiating trade agreements and 'policing' the rules of trade to which its members sign up. Trade disputes between members are settled by the WTO.

Absolute advantage: where one country is able to produce moer 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 2 countries and 2 products, each country has the absolute advantage in one of the 2 products.

Comparative advantage: where one country produces a good or service at lower relative opportunity cost than others.

Relative opportunity cost: the cost of production of one good or service in terms of the sacrificed output of another good or service in one country relative to another.

Terms of trade: the price of a country's exports relative to the price of its imports. Terms of trade = Index of average export prices/ Index of average import prices

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Trading possibility cruve (TPC): a representation of all the combinations of 2 products that a country can consume if it engages in international trade. The TPC lies outside the PPC showing gains in consumption possible from international trade.

Sources of comparative advantage:

  • Factor endowments: the mix of land, labour and capital that a country possesses. Factor endowments can be determined by, among other things, geography, historical legacy, economic and social development.
  • Factor intensities: the balance of land, labour and capital required in the production of a good or service.
  • Labour-intensive production: any production process that involves large amount of labour relative to other factors of production.
  • Capital-intensive production: where the production of a good or service requires a large amount of capital relative to other factors of production.

Heckschler-Ohlin Theory: a country will exports products produced using factors of production that are abundant and import products whose production requires the use of scarce factors.

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Economies of scale

Infantr industries: industries in an economy that are relatively new and lack the economies of scale that would allow them to complete in international markets against more established competitors in other countries.

Profin margin: the difference between a firm's revenue and costs expressed as a % of revenue.

Dynamic efficiencies: efficiencies that occur over time. International trade can lead to changes in behaviour over a period of time that can increase productive and allocative efficiency.

Knowledge and technology transfer: the process by which knowledge and technology developed in one country is transferred to another, often through licensing and franchising.

Licensing arrangements: an agreement that ideas and technology 'owned' by one firm can be used by another, often for a charge.

Regional trading bloc: countries in a region that have formed an 'economic club' based on abolishing tariffs and non-tariff barriers to trade e.g. EU, NAFTA, ASEAN.

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Terms of trade

Primary commodities: goods produced in the primary sector of the economy, e.g. coffee and tin.

Prebisch-Singer hypothesis: the argument that countries exporting primary commodities will face declining terms in trade in the LR, which will trap them in a low level of development as more exports will need to be sold to 'pay for' the same volume of imports of secondary or capital goods.

Developed economies: countries with a high income per capita and diversified industrial and tertiary sectors.

Developing economies: countries with relatively low income per capita, an economy in which the industrial sector is small or undeveloped and where primary sector production is relatively large part of total GDP.

Transition economies: economies in the process of changing from central planning to the free market.

Intra-regional trade: trade between countries in the same geographical area.

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International trade

Liberalisation: reductions in the barriers to international trade, in order to allow foreign firms to gain access to the market for goods and services that are traded internationally.

Inter-industry trade: trade involving the exchange of goods and services produced by different industries.

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

Short-term capital flows: flows of money in and out of a country in the form of bank deposits. Short-term capital flows are highly volatile and exist to take advantage of changes in relative interest rates.

Long-term capital flows': flows of money related to buying and selling of assets, e.g. land or property or production facilities (direct investment) or shares in a company (portfolio investment).

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Exchange rate

Freely floating exchange rate: a system whereby the price of one currency expressed in terms of another is determined by the forces of demand and supply.

Fixed exchange rate: an exchange rate system in which the value of one currency has a fixed value against other countries. This fixed rate is often set by the government.

Semi-fixed/semi-floating exchange rate: an exchange rate system that allows a currency's value to fluctuate within a permitted band of fluctuation.

FOREX market: a term used to describe the coming together of buyers and sellers of currencies.

External economic shocks: unexpected events coming from outside the economy that cause unpredicted changes in AD and AS.

Purchasing power of parity (PPP): the exchange rate that equalises the price of a basket of identical traded goods and services in 2 different countries. PPP is an attemptto measure the true value of a currency in terms of the goods and services it will buy.

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Exchange rates

J curve effect: shwos the trend in a country's balance of trade following a depreciation of the exchange rate. A fall in the exchange rate causes an initial worsening of the balance of trade, as higher import prices raise the value of imports and lower export prices reduce the value of exports due to short-run inelastic PED for imports and exports. Eventually the trade balance improves. An appreciation of the currency causes an inverted J-curve effect.

Marshall-Lerner condition: states that for a depreciation of the currency to improve the balance of the trade sum of the price elasticities of demand for imports and exports must be greater than 1 (elastic).

Hedging: business strategy that limits the risk  that losses are made from changes in the price of currencies or commodities.

Futures markets: markets where people and businesses can buy and sell contracts to buy commodities or currencies at a fixed date in the future.

Foreign currency reserves: foreign currencies held by central banks in order to enable intervention in the FOREX markets to affect the country's exchange rate.

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Exchange rate fluctuations

Bilateral exchange rate: the exchange rate of one currency against another.

Effective exchange rate: the exchange rate of one currency against a basket of currencies of other countries, often weighted according to the amount of trade done with each country.

Single market: a currency that is shared by more than one country.

Eurozone: combined economies of the countries using the euro.

Expenditure-switching policies: policies that increase the price of imports and/or reduce the price of exports in order to reduce demand for imports and raise the demands for exports to correct a current account deficit on the balance of payments.

Expenditure-reducing policies: policies that reduce the overall level of national income in order to reduce the demand for imports and correct a current account deficit on the balance of payments.

Economic integration: refers to the process of blurring boundaries that separate economic activity in one nation state from that in another.

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Economic integration

  • Non-tariff barriers: things that restrict trade other than tariffs e.g. regulation.Trade deflection: where one country in a free trade area imposes high tariffs on another to reduce imports but the imports come in from elsewhere in the free trade area.
  • Free trade area: an agreement between 2 or more countries to abolish tariffs on trade between them.
  • Customs union: an agreement between 2 or more countries to abolish tariffs on trade between them and place a common external tariff on trade with non-members.
  • Single market: deepens economic integration from a customs union by eliminating non-tariff barriers to trade, promoting the free movement of labour and capital and agreeing common policies in a number of areas.
  • Economic union: deepens integration in a single market, centralising economic policy at the macroeconomic level.
  • Monetary union: the deepest form of integration in which countries share the same currency and have a common monetary policy as a result.
  • 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
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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 diversion: where economic integration results in trade switching from a low-cost supplier outside the economically integrated area to a less efficient source within the area.

Effects of economic integration:

  • Reduction in monopoly power
  • Larger market and economies of scale
  • Greater innovation and R&D


  • Geographical concentration of industries - regions attract the majority of investment
  • Emergence of international collusion
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Monetary union

Impacts of a monetary union:

  • Reduced transaction costs
  • Elimination of exchange rate risk
  • Increased price transparency

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

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

Stability and growth pact: limits agreed to public sector borrowing and the national debt for those EU countries that are part of the euro area.

Optimal currency area: refers to conditions that need to be met to avoid the costs of monetary union. These conditions include: a high degree of labour market flexibility; mechanisms for fiscal transfers; absence of external shocks that impact differently on different economies (asymmetric shocks)

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Fiscal transfers

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

Automatic stabilisers: elements of fiscal policy that cushion the impact of the business cycle without any need for corrective action by government. E.g. higher spending on benefits and walfare payments and lower taxation receipts provide an automatic fiscal stimulus in times of economic slowdown.

Economic convergence: the process by which economic conditions in different countries become similar. Monetary convergence - similarities in inflation and interest rates. Real convergence - similarities in structure of economies. Membership to eurozone only requires monetary convergence.

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