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IB Economics SL Unit 3: Interna4onal Economics

Mr. R.S. Pyszczek, Jr. City Honors School

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics 3.1 Interna+onal Trade Free Trade

The Benefits of Trade

l  Explain that gains from trade include lower prices for consumers, greater choice for consumers, the ability of producers to benefit from economies of scale, the ability to acquire needed resources, a more efficient alloca4on of resources, increased compe44on, and a source of foreign exchange.


Unit 3: Interna4onal Economics 3.1 Interna+onal Trade

Free Trade


l  Lower Prices: Countries like individuals can specialize in par4cular areas of exper4se. This means they can produce more efficiently than if each country tried to produce enough of everything for all its needs



Free Trade


l Taking Advantage of Different Factor Endowments: No two countries share the exactly the same resource base. Trade takes advantages of these differences between countries



Free Trade


l Economies of Scale: As produc4on levels grow ever larger to meet interna4onal demand, the specializa4on of managers and the introduc4on of expensive technology can improve the produc4vity of a given business sector.



Free Trade


l  Increased Variety/Choice: We are an interdependent wordl economy. As the number of countries in the global market has grown, so has the amount of choice. While some find these choices overwhelming, others enjoy the power it gives to consumers to make decisions about their purchases



Free Trade


l Acquisi4on of needed resources: Some countries lack cri4cal goods to improve their standard of living. In some cases, produc4on of a needed good is simply impossible. Trade is the only way to get it.



Free Trade


l  Compe44on can improve efficiency: When a company controls a market, it lacks compe44ve incen4ve to provide good service and lower costs. When domes4c markets are opened to foreign compe44on, companies are pressed into lowering prices and improving service or they suffer from foreign compe44on.



Free Trade


l Poli4cal Benefits: Economists and Poli4cal thinkers generally agree that trade and integra4on have consistently encouraged compromise and resolu4on over conflict and antagonism.



Free Trade


l  Efficiency and Exports = growth and development: Development economists have concluded that exports can be a path to significant economic growth. When countries develop their compara4ve advantages, they become compe44ve and export to world markets


Unit 3: Interna4onal Economics 3.1 Interna+onal Trade Free Trade

The World Trade Organiza4on (WTO)

l  Describe the objec4ves and func4ons of the WTO.



Free Trade

Aims of the World Trade Organiza4on (WTO)

l Trade without discrimina4on

l Freer Trade through nego4a4on



Free Trade

Aims of the World Trade Organiza4on (WTO)

l Predictability through binding and transparency

l Promo4ng fair compe44on

l Encourage development



Free Trade

Func4ons of the World Trade Organiza4on (WTO)

l Provide a forum for trade nego4a4on

l Execute WTO agreements

l Evaluate and rule on trade complaints by member countries



Free Trade

Func4ons of the World Trade Organiza4on (WTO)

l Provide technical assistance to developing countries on trade issues

l Track changes in member trade policies



Free Trade

Supporters View of the World Trade Organiza4on (WTO)

l The WTO Promotes peace.

l The WTO provides a place to handle disputes construc4vely

l The WTO is based on rules rather than power



Free Trade


l Free Trade cuts the cost of living

l Trade provides greater consumer choice and variety

l Trade boost incomes



Free Trade


l Trade increases economic growth.

l The WTO system encourages efficiency and simplicity

l WTO agreements shield countries from narrow interests



Free Trade

Cri4cs’ View of the World Trade Organiza4on (WTO)

l Poor countries some4mes cannot afford trade representa4ves.

l Rich countries and individuals are ge^ng richer faster than everyone else



Free Trade


l Agricultural subsidies in rich countries hav not been reduced.

l The protec4on of intellectual property rights. (lack of protec4on)



Free Trade


l Despite claims to equalize the trade environment, WTO nego4a4ons favor rich countries

l  It is argued that most of the gains in trade have come from trade between rich countries


Unit 3: Interna4onal Economics 3.1 Interna+onal Trade Restric+ons on Free Trade: Trade Protec+on

Types of Trade Protec4on

l  Explain, using a tariff diagram, the effects of imposing a tariff on imported goods on different stakeholders, including domes4c producers, foreign producers, consumers and the government.

l  Explain, using a diagram, the effects of se^ng a quota on foreign producers on different stakeholders, including domes4c producers, foreign producers, consumers and the government.




l  Explain, using a diagram, the effects of giving a subsidy to domes4c producers on different stakeholders, including domes4c producers, foreign producers, consumers and the government.

l  Describe administra4ve barriers that may be used as a means of protec4on.

l  Evaluate the effect of different types of trade protec4on.



Restric+ons on Free Trade: Trade Protec+on


l  Tariffs

l  Quotas

l  Voluntary Export Restraints (VERs)

l  Subsidies





l Administra4ve Barriers

l Exchange Rates

l Na4onalis4c Campaigns



Arguments for and Against Trade Protec4on (arguments against and for free trade)

l  Discuss the arguments in favour of trade protec4on, including the protec4on of domes4c jobs, na4onal security, protec4on of infant industries, the maintenance of health, safety and environmental standards, an4-‐dumping and unfair compe44on, a means of overcoming a balance of payments deficit and a source of government revenue.



Arguments for and Against Trade Protec4on (arguments against and for free trade)

l  Discuss the arguments against trade protec4on, including a misalloca4on of resources, the danger of retalia4on and “trade wars”, the poten4al for corrup4on, increased costs of produc4on due to lack of compe44on, higher prices for domes4c consumers, increased costs of imported factors of produc4on and reduced export compe44veness.




Arguments for Trade Protec4on (arguments against and for free trade)

l  To protect domes4c employment

l  To protect sunrise or infant industries

l  To counteract rela4ve domes4c tax differences





l  To prevent dumping of foreign goods onto the domes4c market

l  To diversify the produc4on base of a developing country

l  To enforce product standards





l  To raise government revenue

l  To protect against unfairly low labor costs

l  To protect strategic industries





l  To overcome a balance of payments deficit

l  To improve the terms of trade




Arguments Against Trade Protec4on (arguments against and for free trade)

l  Misalloca4on of resources

l  Escala4on to a trade war

l  Protec4onism as a corrup4on magnet




Arguments Against Trade Protec4on (arguments against and for free trade)

l  Domes4c complacency causes higher prices and costs

l  Higher import costs

l  Reduced export compe44veness



Theory of Knowledge: Poten+al Connec+ons

Are there moral as well as economic arguments in favor of free trade?


Unit 3: Interna4onal Economics 3.2 Exchange rates

Freely Floa+ng Exchange Rates

Determina4on of freely floa4ng exchange rates

l Explain that the value of an exchange rate in a floa4ng system is determined by the demand for, and supply of, a currency.

l Draw a diagram to show determina4on of exchange rates in a floa4ng exchange rate system.




Determina4on of freely floa4ng exchange rates*

Forex Market (Foreign Exchange)

l  The Forex market is an interna4onal over-‐the-‐counter market (OTC). It means that it is a decentralized, self-‐regulated market with no central exchange or clearing house, unlike stocks and futures markets. This structure eliminates fees for exchange and clearing, thereby reducing transac4on costs.




Determina4on of freely floa4ng exchange rates*

Forex Market (Foreign Exchange)

l  The Forex OTC market is formed by different par4cipants – with varying needs and interests – that trade directly with each other. These par4cipants can be divided in two groups: the interbank market and the retail market.




Determina4on of freely floa4ng exchange rates: Forex Market The Interbank Market

The interbank market designates Forex transac4ons that occur between central banks, commercial banks and financial ins4tu4ons.





l  Central Banks -‐ Na4onal central banks (such as the US Fed and the ECB) play an important role in the Forex market. As principal monetary authority, their role consists in achieving price stability and economic growth. To do so, they regulate the en4re money supply in the economy by se^ng interest rates and reserve requirements. They also manage the country's foreign exchange reserves that they can use in order to influence market condi4ons and exchange rates.





l  Commercial Banks -‐ Commercial banks (such as Deutsche Bank and Barclays) provide liquidity to the Forex market due to the trading volume they handle every day. Some of this trading represents foreign currency conversions on behalf of customers' needs while some is carried out by the banks' proprietary trading desk for specula4ve purpose.





l  Financial Ins+tu+ons -‐ Financial ins4tu4ons such as money managers, investment funds, pension funds and brokerage companies trade foreign currencies as part of their obliga4ons to seek the best investment opportuni4es for their clients. For example, a manager of an interna4onal equity porfolio will have to engage in currency trading in order to buy and sell foreign stocks.




Determina4on of freely floa4ng exchange rates: Forex Market The Retail Market

l  Individuals -‐ Individual traders or investors trade Forex on their own capital in order to profit from specula4on on future exchange rates. They mainly operate through Forex plaforms that offer 4ght spreads, immediate execu4on and highly leveraged margin accounts.





l  Specula+on/Hedge Funds -‐ Hedge funds are private investment funds that speculate in various assets classes using leverage. Macro Hedge Funds pursue trading opportuni4es in the Forex Market. They design and execute trades ager conduc4ng a macroeconomic analysis that reviews the challenges affec4ng a country and its currency. Due to their large amounts of liquidity and their aggressive strategies, they are a major contributor to the dynamic of Forex Market. (Remember George Soros?)





l  RemiNance Companies/Corpora+ons -‐ They represent the companies that are engaged in import/export ac4vi4es with foreign counterparts. Their primary business requires them to purchase and sell foreign currencies in exchange for goods, exposing them to currency risks. Through the Forex market, they convert currencies and hedge themselves against future fluctua4ons.





l  Individuals -‐ Individual traders or investors trade Forex on their own capital in order to profit from specula4on on future exchange rates. They mainly operate through Forex plaforms that offer 4ght spreads, immediate execu4on and highly leveraged margin accounts.




Causes of Changes in the Exchange Rate

l  Describe the factors that lead to changes in currency demand and supply, including foreign demand for a country’s exports, domes4c demand for imports, rela4ve interest rates, rela4ve infla4on rates, investment from overseas in a country’s firms (foreign direct investment and porfolio investment) and specula4on.




Causes of Changes in the Exchange Rate*

l  A country's exchange rate regime where its currency is set by the foreign-‐exchange market through supply and demand for that par4cular currency rela4ve to other currencies. Thus, floa4ng exchange rates change freely and are determined by trading in the forex market. This is in contrast to a "fixed exchange rate" regime.





l  In some instances, if a currency value moves in any one direc4on at a rapid and sustained rate, central banks intervene by buying and selling its own currency reserves (i.e. Federal Reserve in the U.S. & ECB in the EU) in the foreign-‐exchange market in order to stabilize the local currency. However, central banks are reluctant to intervene, unless absolutely necessary, in a floa4ng regime.




Causes of Changes in the Exchange Rate

l  Dis4nguish between a deprecia4on of the currency and an apprecia4on of the currency.

l  Draw diagrams to show changes in the demand for, and supply of, a currency.




Apprecia4on: An increase in the exchange rate.

l The home currency becomes rela4vely more expensive for foreigners to buy. Apprecia4on also means that foreign currency becomes rela4vely cheaper for you to buy.




Apprecia4on: An increase in the exchange rate.

l  If prices in both countries remain the same, an apprecia4on will make foreign goods rela4vely cheaper to you, leading to an increase in imports. It also means that, even if prices remain the same, your goods will be more expensive to foreigners. They will buy less of your goods and exports will fall. As a result, your country's net exports will fall.

l  This change to net exports causes a legward shig of the aggregate demand curve.




Apprecia4on: Figure

2a Demand Increase

2b Supply Decrease




Deprecia4on: A decrease in the exchange rate.

l  The home currency becomes rela4vely cheaper for foreigners to buy. Deprecia4on also means that foreign currency becomes rela4vely more expensive for you to buy.




Deprecia4on: A decrease in the exchange rate.

l  If prices in both countries remain the same, deprecia4on will make foreign goods rela4vely more expensive to you, leading to a fall in imports. It also means that, even if prices remain the same, your goods will be cheaper to foreigners. They will buy more of your goods and exports will rise. As a result, your country's net exports will increase.

l  This change to net exports causes a rightward shig of the aggregate demand curve.




Deprecia4on: Figure

3a Demand Decrease

3b Supply Increase




The effects of Exchange Rate Changes

l Evaluate the possible economic consequences of a change in the value of a currency, including the effects on a country’s infla4on rate, employment, economic growth and current account balance.




Determinants of Exchange Rates:

l  Numerous factors determine exchange rates, and all are related to the trading rela4onship between two countries. Remember, exchange rates are rela4ve, and are expressed as a comparison of the currencies of two countries.

l  The following are some of the principal determinants of the exchange rate between two countries. Note that these factors are in no par4cular order; like many aspects of economics, the rela4ve importance of these factors is subject to much debate.:



Freely Floa+ng Exchange Rates: Determinants of Exchange Rates

Demand for Goods and Services:

l  The rela4ve demand for imports can directly influence the purchase of currencies, and so alter the exchange rate. When the demand for a country’s exports increases it increases demand for the currency itself. To buy the exports, the importers first need to buy the expor4ng country’s currency to pay for them.


Unit 3: Interna4onal Economics 3.2 Exchange rates Freely Floa+ng Exchange Rates: Determinants of Exchange Rates

Demand for Foreign Direct Investment:

l  Foreign investors may find it necessary to to buy foreign currency to make par4cular kinds of investment in that country. To make any kind of significant foreign direct investment (FDI) by opening a branch loca4on, star4ng a new firm, or crea4ng a joint venture in another country, requires that country’s currency to buy the factors of produc4on (land, labor & capital).




Demand for Financial Investments and Capital Flows:

l  Financial investment such as buying of foreign company shares, or interest-‐earning deposits in a foreign bank, are likely to require purchase of the home currency. In other words, demand for a country’s financial investments appreciates a currency.




Rela4ve Infla4on Rates:

l As the prices of one country rise faster than those of another, its exports become more expensive and therefore, less desirable. At the same 4me, imports will be rela4vely cheaper than before and more anrac4ve.




Specula4on:

l  The holders of foreign currencies can also speculate on future values. As with the buying and selling of shares, speculators may buy a currency hoping it will appreciate, sell it when they believe it has reached peak value, and taking the resul4ng profits.




Central Bank Interven4on on the Forex Market:

l The Central Banks may buy or sell large amounts of foreign exchange with several goals in mind. They may seek to prop up the value of their currency by using foreign currency reserves to buy up their own.




Central Bank Interven4on on the Forex Market:

l The Central Banks may also sell their own currency if they seek to reduce its value, perhaps to increase the desirability of their exports and reduce domes4c consump4on of imports.



Freely Floa+ng Exchange Rates: Effects of Exchange Rates

Apprecia4on; Advantages to Apprecia4on:

l  Less expensive imports. The increased value of the currency means that buying imported goods is now rela4vely less expensive than before


Unit 3: Interna4onal Economics 3.2 Exchange rates Freely Floa+ng Exchange Rates: Effects of Exchange Rates

Apprecia4on; Advantages to Apprecia4on:

l  Compe44ve pressure on domes4c exporters: An indirect effect of the higher exchange rate is that domes4c firms expor4ng to other countries are at a price disadvantage rela4ve to their foreign compe4tors. As the exchange rate adjusted price of their exports rises, they are compelled to seek out new ways of cu^ng costs and innova4ng.




Apprecia4on; Disadvantages to Apprecia4on:

l  Exporter levels reduced: The dis4nc4on between pressure and compe44ve disadvantage is blurred, and companies anemp4ng to export at consistently high exchange rates may come to believe that while their import cost are low, it may not compensate for the challenge of selling at the higher exchange rate.




Apprecia4on; Disadvantages to Apprecia4on:

l  Greater imports hurt domes4c produc4on: Rela4vely cheap imports may hurt even non-‐expor4ng domes4c industries. Those industries cannot match the exchange rate discount now available on imported goods. This could also result in unemployment in those industries




Apprecia4on; Effects on Major Goals:

l  To Summarize, apprecia4on reduces infla4onary pressure where the demand for imports is rela4vely inelas4c (e.g. energy resources). This may eventually help with economic growth. The more immediate impact on growth is to reduce exports and decrease real GDP.




Apprecia4on; Effects on Major Goals:

l The trade balance of exports to imports is likely to move towards a deficit, as exports slow down and cheaper imports increase.




Deprecia4on; Advantages to Deprecia4on:

l Expansion of Domes4c Industries: Foreign consumers view exports as rela4vely cheap, and are unlikely to import more. This raises revenues in those expor4ng companies and could increase employment.




Deprecia4on; Disadvantages to Deprecia4on:

l  Imported Infla4on: Where countries need to import significant levels of raw materials or resources, a decrease in the exchange rate can bring on a certain amount of imported infla4on.




Deprecia4on; Effects on Major Goals:

l  To Summarize, apprecia4on increase infla4onary pressure where the demand for imports is rela4vely inelas4c (e.g. energy resources). This may slow down economic growth. The more immediate impact on growth is to increase exports and increase real GDP.




Government Interven4on

Fixed Exchange Rates

l  Describe a fixed exchange rate system involving commitment to a single fixed rate.

l  Dis4nguish between a devalua4on of a currency and a revalua4on of a currency.

l  Explain, using a diagram, how a fixed exchange rate is maintained.


Unit 3: Interna4onal Economics 3.2 Exchange rates Freely Floa+ng Exchange Rates

Government Interven4on: Fixed Exchange Rates

l  In a fixed exchange rate system, most of the transac4ons of one currency for another will take place in the private market among individuals, businesses, and interna4onal banks. However, by fixing the exchange rate the government would have declared illegal any transac4ons that do not occur at the announced rate. However, it is very unlikely that the announced fixed exchange rate will at all 4mes equalize private demand for foreign currency with private supply.


Unit 3: Interna4onal Economics

3.2 Exchange rates Freely Floa+ng Exchange Rates


l  In a floa4ng exchange rate system, the exchange rate adjusts to maintain the supply and demand balance. In a fixed exchange rate system, it becomes the responsibility of the central bank to maintain this balance.




l  For example, the United States fixes its currency to the Bri4sh pound (the reserve), when there is excess demand for pounds in exchange for U.S. dollars on the private Forex, the U.S. central bank would immediately sa4sfy the excess demand by supplying addi4onal pounds to the Forex market. By doing so, it can maintain a credible fixed exchange rate.

l  For example, the United States fixes its currency to the Bri4sh pound (the reserve), when there is excess demand for dollars in exchange for Bri4sh pounds on the private Forex, the U.S. central bank would immediately sa4sfy the excess demand by supplying dollars to the Forex market. By doing so, it can maintain a credible fixed exchange rate.




Government Interven4on:

Fixed Exchange Rates



Managed Exchange Rates (Managed Float)

l  Explain how a managed exchange rate operates, with reference to the fact that there is a periodic government interven4on to influence the value of an exchange rate.

l  Examine the possible consequences of overvalued and undervalued currencies.




Managed Exchange Rates (Managed Float)

l  A managed float exchange rate system is an interna4onal financial arrangement, whereby central banks intervene only periodically, not necessarily to support a country's currency, but rather to stabilize vola4le fluctua4ons in foreign exchange rates. A managed float is some 4mes called a "dirty float" because exchange rates are free to fluctuate, but central banks are commined to intervene under condi4ons of perceived instability. The central bank steps in to offset only so much of a change in demand or supply to bring the exchange rate back into an acceptable "band" or range of exchange rates.




Managed Exchange Rates (Managed Float): Advantages

l  The managed float anempts to combine the advantages of both the fixed and flexible exchange rate systems, depending on the degree of instability. The less instability, the less interven4on is necessary by central banks and they can pursue quasi-‐independent domes4c monetary policies to stabilize their own economies. The greater the instability, the more interven4on is necessary by central banks and the less free they are to pursue independent domes4c monetary policies because they are frequently required to use their money supplies to calm disturbances in the foreign exchange markets.



Managed Exchange Rates (Managed Float): Disadvantages

l  The big problem with a managed float comes in determining the 4ming and magnitude of the instability and the necessary interven4on. Does a one day drop (rise) in a currency warrant interven4on? A week? A month? A year? Five years? Is a 1% drop (rise) in a currency's exchange rate destabilizing? A 2% change? A 5% change? A 10% change? If the central banks are too quick to respond or if the amount of interven4on is inappropriate, their ac4ons may be further destabilizing. This increased instability has a tendency to dampen interna4onal flows and contract world trade. If they wait too long, permanent damage may be done to some countries' trade and investment balances.




Evalua4on of Different Exchange Rate Systems (HL Only)

l  Compare and contrast a fixed exchange rate system with a floa4ng exchange rate system, with reference to factors including the degree of certainty for stakeholders, ease of adjustment, the role of interna4onal reserves in the form of foreign currencies and flexibility offered to policy makers.



Current Account Deficits

The Rela4onship Between the Current Account and the Exchange Rate (HL Only)

l Explain why a deficit in the current account of the balance of payments may result in downward pressure on the exchange rate of the currency.



Current Account Surpluses

The Rela4onship Between the Current Account and the Exchange Rate (HL Only)

l Explain why a surplus in the current account of the balance of payments may result in upward pressure on the exchange rate of the currency.


Unit 3: Interna4onal Economics 3.3 The Balance of Payments

The Structure of the Balance of Payments

The Meaning of the Balance of Payments

l Outline the role of the balance of payments.

l Dis4nguish between debit items and credit items in the balance of payments.


Unit 3: Interna4onal Economics 3.3 The Balance of Payments The Structure of the Balance of Payments


l  A statement that summarizes an economy’s transac4ons with the rest of the world for a specified 4me period. The balance of payments, also known as balance of interna4onal payments, encompasses all transac4ons between a country’s residents and its nonresidents involving goods, services and income; financial claims on and liabili4es to the rest of the world; and transfers such as gigs.





l  The balance of payments classifies these transac4ons in two accounts – the current account and the capital account. The current account includes transac4ons in goods, services, investment income and current transfers, while the capital account mainly includes transac4ons in financial instruments. An economy’s balance of payments transac4ons and interna4onal investment posi4on (IIP) together cons4tute its set of interna4onal accounts.





The Current Account

l  The current account is used to mark the inflow and ouflow of goods and services into a country. Earnings on investments, both public and private, are also put into the current account.





l  Within the current account are credits and debits on the trade of merchandise, which includes goods such as raw materials and manufactured goods that are bought, sold or given away (possibly in the form of aid). Services refer to receipts from tourism, transporta4on (like the levy that must be paid in Egypt when a ship passes through the Suez Canal), engineering, business service fees (from lawyers or management consul4ng, for example) and royal4es from patents and copyrights. When combined, goods and services together make up a country's balance of trade (BOT).





l  The BOT is typically the biggest bulk of a country's balance of payments as it makes up total imports and exports. If a country has a balance of trade deficit, it imports more than it exports, and if it has a balance of trade surplus, it exports more than it imports.




The Capital Account

l  The capital account is where all interna4onal capital transfers are recorded. This refers to the acquisi4on or disposal of non-‐financial assets (for example, a physical asset such as land) and non-‐produced assets, which are needed for produc4on but have not been produced, like a mine used for the extrac4on of diamonds.





l  The capital account is broken down into the monetary flows branching from debt forgiveness, the transfer of goods, and financial assets by migrants leaving or entering a country, the transfer of ownership on fixed assets (assets such as equipment used in the produc4on process to generate income), the transfer of funds received to the sale or acquisi4on of fixed assets, gig and inheritance taxes, death levies and, finally, uninsured damage to fixed assets.





The Financial Account

l  In the financial account, interna4onal monetary flows related to investment in business, real estate, bonds and stocks are documented. Also included are government-‐owned assets such as foreign reserves, gold, special drawing rights (SDRs) held with the Interna4onal Monetary Fund (IMF), private assets held abroad and direct foreign investment. Assets owned by foreigners, private and official, are also recorded in the financial account.



The Components of the Balance of Payments Accounts

l  Explain the four components of the current account, specifically the balance of trade in goods, the balance of trade in services, income and current transfers.

l  Dis4nguish between a current account deficit and a current account surplus.





The Current Account

l  The balance of the current account tells us if a country has a deficit or a surplus. If there is a deficit, does that mean the economy is weak? Does a surplus automa4cally mean that the economy is strong? Not necessarily. But to understand the significance of this part of the BOP, we should start by looking at the components of the current account: goods, services, income and current transfers.




The Current Account

l  The Flow of Goods -‐ These are movable and physical in nature, and in order for a transac4on to be recorded under "goods", a change of ownership from/to a resident (of the local country) to/from a non-‐resident (in a foreign country) has to take place. Movable goods include general merchandise, goods used for processing other goods, and non-‐monetary gold. An export is marked as a credit (money coming in) and an import is noted as a debit (money going out).





The Current Account

l  The Flow of Services -‐ These transac4ons result from an intangible ac4on such as transporta4on, business services, tourism, royal4es or licensing. If money is being paid for a service it is recorded like an import (a debit), and if money is received it is recorded like an export (credit).





The Current Account

l  The Flow of Income -‐ Income is money going in (credit) or out (debit) of a country from salaries, porfolio investments (in the form of dividends, for example), direct investments or any other type of investment. Together, goods, services and income provide an economy with fuel to func4on. This means that items under these categories are actual resources that are transferred to and from a country for economic produc4on.





The Current Account

l  The Flow of Transfers -‐ Current transfers are unilateral transfers with nothing received in return. These include workers' reminances, dona4ons, aids and grants, official assistance and pensions. Due to their nature, current transfers are not considered real resources that affect economic produc4on.





l  Explain the two components of the capital account, specifically capital transfers and transac4on in non-‐produced, non-‐financial assets.

l  Explain the three main components of the financial account, specifically, direct investment, porfolio investment and reserve assets.




The Rela4onships Between the Accounts

l  Explain that the current account balance is equal to the sum of the capital account and financial account balances (see the appendix, “The balance of payments”).

l  Examine how the current account and the financial account are interdependent.





l  The current account should be balanced against the combined-‐capital and financial accounts; however, as men4oned above, this rarely happens. We should also note that, with fluctua4ng exchange rates, the change in the value of money can add to BOP discrepancies. When there is a deficit in the current account, which is a balance of trade deficit, the difference can be borrowed or funded by the capital account.





l  If a country has a fixed asset abroad, this borrowed amount is marked as a capital account ouflow. However, the sale of that fixed asset would be considered a current account inflow (earnings from investments). The current account deficit would thus be funded. When a country has a current account deficit that is financed by the capital account, the country is actually foregoing capital assets for more goods and services. If a country is borrowing money to fund its current account deficit, this would appear as an inflow of foreign capital in the BOP.





l  Explain that the current account balance is equal to the sum of the capital account and financial account balances (see the appendix, “The balance of payments”).

l  Examine how the current account and the financial account are interdependent.



Current Account Deficits

The Rela4onship Between the Current Account and the Exchange Rate

l Explain why a deficit in the current account of the balance of payments may result in downward pressure on the exchange rate of the currency.



Current Account Surpluses

The rela4onship between the current account and the exchange rate

l Explain why a surplus in the current account of the balance of payments may result in upward pressure on the exchange rate of the currency.


Unit 3: Interna4onal Economics 3.4 Economic Integra+on

Forms of economic integra+on

Preferen4al trade agreements

l Dis4nguish between bilateral and mul4lateral (WTO) trade agreements.

l Explain that preferen4al trade agreements give preferen4al access to certain products from certain countries by reducing or elimina4ng tariffs, or by other agreements rela4ng to trade.




Trading Blocs

l  Dis4nguish between a free trade area, a customs union and a common market.

l  Explain that economic integra4on will increase compe44on among producers within the trading bloc.

l  Compare and contrast the different types of trading blocs.




Monetary Union

l  Explain that a monetary union is a common market with a common currency and a common central bank.

l  Discuss the possible advantages and disadvantages of a monetary union for its members.



Theory of Knowledge: Poten+al Connec+ons

What criteria can be used to assess the benefits and the costs of increased economic integra9on?

Might increased economic integra9on ever be considered undesirable?


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