Chapter 5 AS Level Essay

Factors of production are land, labour, capital and enterprise and they occur irregularly around the world. Examples are oil and mineral reserves, technology, skilled labour. Factor endowment is the basis of international trade theory, which suggests specialisation in line with lower opportunity cost so reflecting factor distribution. In some cases it may be absolute rather than comparative advantage at work. Other influences such as trade agreements, unequal bargaining power, political issues and the unrealistic assumptions ofC A theory may mean that trade does not reflect factor distribution. For understanding of the diverse distribution of factors up to 4 marksFor application of comparative advantage up to 4 marksFor discussion of comparative advantage and alternativeexplanations up to 4 marks

A fixed exchange rate is set by the government’s use of currency reserves, buying on the prospect of depreciation and selling with a prospective appreciation. There are variations in which systems have an element of fixing e.g. the adjustable peg. A fixed rate, such as the gold standard, brings stability and certainty which should encourage trade. It brings discipline to the government’s internal economic policy (particularly inflationary pressure) and forces firms to control costs to remain competitive. It should discourage destabilising speculation. Against this is the need to keep large currency reserves, the need to introduce deflationary policies which may harm other economic aims, the tendency to maintain an overvalued rate and the limits on using monetary policy. Fixed rates have become less common because of the lack of an automatic adjustment and the move to a more robust market system.For understanding of the operation of a fixed system up to 4 marksFor analysis of the benefits of fixed rates up to 4 marksFor discussion of the drawbacks of fixed rates up to 4 marks

A rapid rate suggests an undesirable rate. A floating exchange rate is fixed by market forces. Assuming other countries have lower rates of inflation the country will lose competitiveness as exports become relatively expensive and imports become relatively cheap. Lack of confidence will deter investment flows. Demand for the currency will fall while supply will rise causing a depreciation.Knowledge of rapid inflation rate and floating system up to 2 marksLink of inflation to direction of flows up to 3 marksExplanation of depreciation up to 3 marks

An infant industry is one which has a potential comparative advantage. Currently it is too small to gain economies of scale and too young to have trading experience. A tariff will allow time to grow and become efficient, at which point the tariff will be removed. Dumping is the selling of goods below the cost of production, possibly due to government support, it may lead to monopolisation of the market. This is deemed unfair competition and restriction of free trade so can be offset by a tariff.Meaning of a tariff up to 2 marksExplanation of infant industry argument up to 3 marksExplanation of anti-dumping argument up to 3 marks

Free trade encourages competition and efficiency, lowers prices, increases choice and raises living standards. Trade arrangements may vary from relatively loose free trade areas to very structured economic unions. The effects of membership involve trade creation and trade diversion. As a member a country would hope to benefit although this may involve the need for restructuring with short-term costs. The number of trading arrangements has been increasing so extending the benefits. For non- members there is reduced opportunity to experience free trade and its benefits although some countries may feel that the benefits of free trade are not shared equally among participants and may undermine domestic industriesand employment.Understanding of the types of trade arrangement up to 4 marksDiscussion of the benefits of trade up to 6 marksDiscussion of the drawbacks of trade arrangements up to 6 marks to max 10 marks

A free trade area aims to achieve free trade between it members by the abolition of internal barriers but the retention of individually set barriers to non-members. There is no integration beyond this. An economic union aims at major integration, includes a common external tariff, free movement of factors of production, harmonisation of economic policies and taxes and a common currency. This involves the loss of national sovereignty. The latter is a morecomprehensive and ambitious project.Explanation of a free trade area 4 marksExplanation of economic union 4 marks

The terms of trade measure the average price of a country’s exports against the average price of its imports. This is presented as an index number. A rise in export prices relative to import prices is said to be favourable and may arise from a number of different changes in the two components. This gives the ability to purchase more imports with a given quantity of exports. This may help to raise living standards. The changes in prices may not be favourable from a trade balance perspective. Higher export prices and lower import prices will help more if the goods involved have inelastic demand as net revenue should increase. Elastic demand will worsen the position.Understanding of measurement of changes in terms of trade 4 marksDiscussion of favourable outcomes 4 marksDiscussion of unfavourable outcomes 4 marks

International trade is usually over greater distance which raises transport costs. The use of different currencies involves transaction costs and risks in exchange. Obstacles to trade such as tariffs, quotas, subsidies and the existence of trade areas reduce free and fair competition. The larger size of the market attracts a wide range of competitors which mayundercut domestic producers. Different cultures, languages and tastes may make judgment of the market more difficult.For knowledge of the differences between international anddomestic trade up to 2 marksFor understanding of the differences up to 3 marksFor explanation of the significance of the differences up to 3 marks

Regional blocs may be free trade areas, customs unions ior economic unions. They encourage free trade between member states and can be bilateral or multilateral. Thebenefits should be more trade, more choice, lower costs and higher living standards. However small scale agreements may have limited impact, may prevent more beneficial,large scale agreements and cause trade diversion. Smaller members may be at a disadvantage, as may infant industries, to more powerful members and there may be problems with complicated regulations. While these agreements may be better than facing global barriers they may be inferior to wider global agreements.Understanding of regional trade blocs up to 4 marksAnalysis of the effects of agreements up to 6 marks} max ofDiscussion of the overall impact of agreements up to 6 marks} 10 marks

Disequilibrium involves persistent deficit or surplus problems, which are not sustainable. Switching intends to move domestic and foreign expenditure more towards domestic production. It includes tariffs, quotas and subsidies and should mean more exports and fewer imports. Dampening involves reducing the level of total spending so reducing imports and forcing domestic producers to export. Deflationary fiscal and monetary policy would be used.Understanding of the terms (4)Details of the two types of policy (4)

The position on trade in goods and services, income and transfers needs to be identified in terms of surplus or deficit. Policies to improve competitiveness through price and quality, to introduce new exports and reduce imports, to gain access to new markets, to influence income and transfer flows need to be specified. The ability to implement these policies successfully depends upon the background conditions, theeffectiveness of the policies, costs, expertise, influence and external obstacles. Cases may vary markedly between countries. Analysis of current account position (4)Consideration of policies for improvement (4)Discussion of ability to effect an improvement (4)

A floating exchange rate is set by market forces and may fluctuate freely. An appreciation is an increase in its international value and a depreciation a fall. An appreciation improves the purchasing power of the currency, may boost foreign confidence in the currency and inhibits inflation. It makes exports dearer and importsrelatively cheaper which may worsen the balance of trade and cause unemployment. A depreciation works in the opposite direction. Which is preferable depends on thecountry's position and priorities.For knowledge of the exchange rate terms [up to 2 marks]For discussion of the effects of appreciation [up to 3 marks]For discussion of the effects of depreciation [up to 3 marks]For a conclusion comparing the two cases [up to 4 marks]

Absolute advantage exists when a country can produce a good with fewer resources than another country. Comparative advantage exists when a country can produce a good at a loweropportunity cost, meaning it has to give up less of another good compared to the other country. This can be shown numerically, assuming 2 countries have the same resources and divide them equally between 2 goods with factor mobility etc:
Output of good X Output of good YCountry A 100 25Country B 40 20
Country A has absolute advantage in production of both goods (250% and 125% more output) but country B has comparative advantage in the production of good Y because of lower opportunity cost (1Y costs 2X against 4X for A). This can also be shown by a diagram.For definitions of the terms up to 4 marksFor explanation of the terms and assumptions up to 6 marks

The theory predicts that gains will arise from trade in line with a country's comparative advantage. Candidates may outline a pattern of trade e.g. exports of primary produce, reliance on tourism, export of manufactures, import of capital goods etc. for their economy and relate this to the country's factors of production. They may challenge the theory on the basis of its assumptions (no transport costs, 2 countries, mutual demands etc.) or on ‘real world’ problems e.g. unequal trade arrangements, obstacles to trade, inability to exploit resources etc. For application of C.A. to a pattern of trade up to 6 marks ] For discussion of limitations of C.A. theory up to 3 marks ] max ] 10For discussion of other explanations of trade up to 4 marks ]

Inflation may make export prices uncompetitive and import prices more attractive. With reduced demand for exports and increased demand for imports the trade balance may worsen. The extent will depend on the elasticities of demand which need to be examined. Confidence in the economy may be reduced with an impact on FDI and outflows on the financial account. The rate of inflation compared to rival producers is also important as is its stability. Changes in the exchange rate may offset price differences. Trade only makes up part of the balance of payments position, income flows, capital flows, service income etc. may compensate forweakness in the trade position. For explanation of the link between inflation and B of P up to 5 marks ]] toFor discussion of conditions for B of P problem up to 5 marks ] max] 12For discussion of conditions for no problem up to 5 marks ]