Real-world issue 1

Real-world issue 1 - Who are the winners and losers of the integration of the world’s economies?

Conceptual understandings

The increased interdependence of economies has benefits and costs.

• Increased economic integration may result in efficiency, welfare gains and improvements in economic well-being but the benefits may not result in equity.

• Key concepts: scarcity, choice, efficiency, equity, economic well-being, sustainability, change, interdependence, intervention.

4.1 Benefits of international trade

• Benefits of international trade, including:

  • increased competition

  • lower prices

  • greater choice

  • acquisition of resources

  • more foreign exchange earnings

  • access to larger markets

  • economies of scale

  • more efficient resource allocation

  • more efficient production

  • Diagram: free trade illustrating exports when world price is above domestic price

  • Diagram: free trade illustrating imports when world price is below domestic price

  • Calculation (HL only): from a diagram, the quantity of exports, quantity of imports, import expenditure, export revenue

• Absolute and comparative advantage (HL only)

  • Gains from trade

  • Sources of comparative advantage

  • Opportunity costs

  • Diagram (HL only): linear PPC showing differing opportunity costs and the potential gains from specialization and trade as a result of comparative advantage

  • Calculation (HL only): opportunity costs from a set of data in order to identify comparative advantage

• Limitations of the theory of comparative advantage (HL only)

4.2 Types of trade protection

• Tariffs

  • Effects on markets and stakeholders

  • Diagram: showing the effect of a tariff on price, production, consumption, expenditures, revenues, welfare

  • Calculation (HL only): from a diagram, the effects on stakeholders of tariffs

• Quota

  • Effects on markets and stakeholders

  • Diagram: showing the effect of a quota on price, production, consumption, expenditures, revenues, welfare

  • Calculation (HL only): from a diagram, the effects on stakeholders of quotas

• Subsidy/export subsidy

  • Effects on markets and stakeholders

  • Diagram: showing the effect of a subsidy on price, production, consumption, expenditures, revenues, welfare

  • Calculation (HL only): from a diagram, the effects on stakeholders of subsidies

• Administrative barriers

  • Standards and regulations

4.3 Arguments for and against trade control/protection

• Arguments for trade protection/advantages of trade protection, including:

  • protection of infant (sunrise) industries

  • national security

  • health and safety

  • environmental standards

  • anti-dumping

  • unfair competition

  • balance of payments correction

  • government revenue

  • protection of jobs

  • Economically least developed country (ELDC) diversification

• Arguments against trade protection/disadvantages of trade protection, including:

  • misallocation of resources

  • retaliation

  • increased costs

  • higher prices

  • less choice

  • domestic firms lack incentive to become more efficient

  • reduced export competitiveness

• Free trade versus trade protection

4.4 Economic integration

• Preferential trade agreements

  • Bilateral

  • Regional

  • Multilateral (the World Trade Organization)

• Trading blocs

  • Free trade areas/agreements

  • Customs unions

  • Common markets

• Advantages and disadvantages of trading blocs

• Advantages, including:

  • trade creation (HL only)

  • greater access to markets offer potential for economies of scale

  • with freedom of labour, there are greater employment opportunities

  • membership in a trading bloc may allow for stronger bargaining power in multilateral negotiations

  • greater political stability and cooperation

• Disadvantages, including:

  • trade diversion (HL only)

  • loss of sovereignty

  • challenge to multilateral trading negotiations

• Monetary union

• Advantages and disadvantages of monetary union (HL only)

• The World Trade Organization (WTO)

  • Objectives and functions

  • Factors affecting the influence of the WTO, including:

    • difficulties of reaching agreement on services/primary products

    • unequal bargaining power of members

4.5 Exchange rates

• Floating exchange rates

  • Determination

    • Depreciation and appreciation of a currency

  • Diagram: showing the exchange rate determination and changes in equilibrium in a floating exchange rate system

  • Calculation: using exchange rates, the price of a good in different currencies

• Changes in demand and supply for a currency—factors including:

  • foreign demand for exports

  • domestic demand for imports

  • inward/outward foreign direct investment

  • inward/outward portfolio investment

  • remittances

  • speculation

  • relative inflation rates

  • relative interest rates

  • relative growth rates

  • central bank intervention

  • Calculation: changes in the value of a currency from a set of data

• Consequences of changes in the exchange rate on economic indicators, such as:

  • the inflation rate

  • economic growth

  • unemployment

  • the current account balance

  • living standards

  • Diagram: AD/AS curves to show potential consequences of changes in the exchange rate on the economy

• Fixed exchange rate

  • Devaluation and revaluation of a currency

  • How fixed exchange rates are maintained

  • Diagram: showing how a fixed exchange rate is maintained

• Managed exchange rates

  • Overvalued currencies

  • Undervalued currencies

  • Diagram: showing the exchange rate determination and changes in equilibrium in a managed exchange rate system

• Fixed versus floating exchange rate systems (HL only)

4.6 Balance of payments

• Balance of payments

  • Credit and debit items

  • Surplus or deficit on an account

  • Calculation: elements of the balance of payments from a set of data

• Components of the balance of payments

  • Current account

    • Balance of trade in goods

    • Balance of trade in services

    • Income

    • Current transfers

  • Capital Account

    • Capital transfers

    • Transaction in non-produced, non-financial assets

  • Financial account

    • Foreign direct investment (FDI)

    • Portfolio investment

    • Reserve assets

    • Official borrowing

• Interdependence between the accounts

  • Zero balance in the balance of payments

  • Credits matched by debits

  • Deficits matched by surpluses

• Relationship between the current account and the exchange rate (HL only)

  • Diagram (HL only): on exchange rate showing the relationship between the current account balance and the exchange rate

• Relationship between the financial account and the exchange rate (HL only)

• Implications of a persistent current account deficit in terms of: (HL only)

  • exchange rates

  • interest rates

  • foreign ownership of domestic assets

  • debt

  • credit ratings

  • demand management

  • economic growth

• Methods to correct a persistent current account deficit (HL only)

  • Expenditure switching

  • Expenditure reducing

  • Supply-side policies

• Effectiveness of measures to correct a persistent current account deficit (HL only).

• The Marshall-Lerner condition and the J-curve effect (HL only)

  • Diagram (HL only): J- curve with reference to the Marshall Lerner condition

• Implications of a persistent current account surplus in terms of (HL only):

  • domestic consumption and investment

  • exchange rates

  • inflation

  • employment

  • export competitiveness

Inquiry—possible areas to explore (not an exhaustive list)

• The impacts of changes in the exchange rate on different stakeholders and the economy, for a chosen country.

• Why a government chooses to manage the exchange rate, for a chosen country.

• Methods a government uses to manage its exchange rate and why, for a chosen country.

• The patterns of current account deficits/current account surpluses for different countries.

Theory of knowledge questions

• Free trade is advocated on the grounds that it leads to greater efficiency. Yet it results in both winners and losers. Do economists have a moral responsibility toward the losers when they advocate free trade?

• To what extent would increased economic integration ever be considered undesirable?

• Is it ethically sound for economically developed countries to demand that less developed countries remove their trade barriers in the interests of free trade when they continue to provide income support to their farmers? Can one country know what is right for another to do?

• To what extent does possession of knowledge carry with it an ethical responsibility?