📄 Ib Economics Unit4 Global Economy

Benefits of free trade

• Greater choice of goods and services for consumers
• Lower prices through specialisation and competition (access to world price)
• Increased productive efficiency — firms face global competition; must minimise costs
• Economies of scale — larger markets allow more efficient production
• Technology transfer and knowledge spillovers
• Employment in export sectors
• Countries can access goods they cannot produce domestically

Free trade diagrams must draw

Absolute vs Comparative Advantage HL: calculate & apply

HL: how to calculate from data. Given output data (e.g. Country A: 10 wheat OR 5 cloth; Country B: 6 wheat OR 6 cloth): opportunity cost of wheat for A = 5/10 = 0.5 cloth; for B = 6/6 = 1 cloth. A's OC of wheat is lower → A has comparative advantage in wheat. B's OC of cloth = 6/6 = 1 wheat vs A's = 10/5 = 2 wheat → B has comparative advantage in cloth. Both specialise and trade → both can consume more of both goods.

Limitations of comparative advantage evaluation

• Assumes constant opportunity costs (in reality: increasing OC)
• Ignores transport costs
• Assumes factors of production are perfectly mobile between industries
• Ignores economies of scale and dynamic comparative advantage (learning by doing)
• Does not consider distribution of gains — some countries/workers may be worse off
• Structural unemployment when countries restructure towards comparative advantage sectors
• Assumes two countries, two goods — unrealistic in practice
• Ha-Joon Chang critique: developed nations used protectionism to build their industries before advocating free trade for others ("kicking away the ladder")

Tariff full diagram required HL calculations

• A tax on imported goods that raises the domestic price above the world price
• On the diagram: world price P_w rises to P_w + tariff = P_t. Qs increases (domestic producers gain), Qd decreases, imports fall.
• Area a — consumer loss transferred to domestic producers (producer surplus gain)
• Area b — production inefficiency (deadweight loss — domestic production of units costing more than world price)
• Area c — government revenue (tariff × quantity of imports after tariff)
• Area d — consumption inefficiency (deadweight loss — units not consumed because price too high)
• Net welfare loss = b + d. Consumers lose a + b + c + d. Government gains c. Producers gain a.

Administrative barriers (non-tariff barriers)

• Rules, regulations, and standards that discriminate against imports without being formal tariffs
• Examples: excessive health/safety standards applied only to imports; complex customs procedures; domestic content requirements; voluntary export restraints (VERs); embargoes
• Harder to challenge at WTO than tariffs; increasingly used

Arguments FOR protection exam essay staple

• Infant industry argument — new industries need protection while they build economies of scale to compete internationally. Temporary protection justified (Hamilton, List). Risk: protection may become permanent.
• Strategic trade policy — protect industries with positive externalities or security importance (defence, food security, advanced technology)
• Protect jobs — prevent structural unemployment when domestic industries are undercut by cheap imports
• Correct balance of payments deficits — reduce imports to improve current account
• Prevent dumping — anti-dumping duties when foreign firms sell below cost to destroy domestic competition
• Revenue — tariff revenue for government (especially relevant for developing countries with limited tax bases)
• Environmental/labour standards — protect domestic industries from "unfair" competition by countries with lower environmental or labour standards

Arguments AGAINST protection evaluate both sides

• Reduces global allocative efficiency (prevents comparative advantage gains)
• Higher prices for domestic consumers (welfare loss)
• Retaliation — trading partners impose counter-tariffs (trade wars; e.g. US-China 2018–present)
• Infant industries may never grow up — protection becomes entrenched (political economy problem)
• Reduces competition → domestic firms have less incentive to innovate or reduce costs
• Reduces export revenues of exporting countries, especially developing nations whose comparative advantage lies in primary commodities
• Misallocation of resources toward inefficient protected sectors

Levels of economic integration (spectrum)

Trade creation vs trade diversion HL only

Whether a customs union increases welfare depends on whether trade creation > trade diversion. If the member country is the world's most efficient producer, no diversion occurs.

Monetary union — costs & benefits HL: OCA conditions

Optimal Currency Area (OCA) conditions (Mundell): a group of countries is a good candidate for monetary union if they have: (1) high labour mobility between members; (2) flexible wages/prices; (3) high degree of economic integration; (4) synchronised business cycles; (5) fiscal transfer mechanism. The Eurozone does not fully meet these — explains the Greek crisis 2010–2015: Greece could not devalue; wages were rigid; no EU-wide fiscal transfers.

The WTO (World Trade Organisation)

• Multilateral body overseeing global trade rules; 164 members (2024)
• Promotes free trade via negotiating rounds (e.g. Doha Development Round)
• Dispute settlement mechanism — countries can challenge other members' trade barriers
• Key principles: non-discrimination (MFN — Most Favoured Nation), national treatment, reciprocity, transparency
• Criticisms: slow progress on Doha Round; rich countries maintain agricultural subsidies (CAP, US Farm Bill) that harm developing country exporters; power imbalance favours wealthy nations

Floating exchange rate demand/supply diagram

• Freely determined by market forces (supply & demand for the currency)
• Demand for £ comes from: UK exports, foreign investment into UK, foreign tourists, speculation
• Supply of £ comes from: UK imports, UK investment abroad, UK tourists abroad, speculation
• Appreciation — exchange rate rises (£ buys more foreign currency). Exports dearer → X↓; imports cheaper → M↑
• Depreciation — exchange rate falls. Exports cheaper → X↑; imports dearer → M↓ (if Marshall-Lerner holds)

Factors shifting exchange rate (demand/supply of currency)

Fixed exchange rate system

• Government or central bank pegs the currency to another currency (or gold) at a set rate
• To maintain when market rate falls below peg (excess supply of currency): central bank buys own currency using foreign reserves, OR raises interest rates to attract capital inflows
• To maintain when market rate rises above peg (excess demand): central bank sells own currency (buys foreign reserves), OR lowers interest rates
• Devaluation — deliberate official reduction of a fixed exchange rate
• Revaluation — deliberate official increase of a fixed exchange rate
• Requires large foreign exchange reserves; vulnerable to speculative attacks (e.g. 1992 ERM crisis; 1997 Asian financial crisis)

Managed (dirty float) exchange rate

• Essentially floating but with government/central bank intervention to smooth volatility or keep within a target range
• Most real-world "floating" currencies are managed to some degree
• China historically managed its currency to keep it undervalued, supporting exports

Floating vs Fixed — evaluation common essay

Exchange rate effects on macroeconomic objectives

• Depreciation → exports cheaper (X↑), imports dearer (M↓) → net exports improve → AD rises → GDP↑, unemployment↓ but inflation↑ (import cost-push)
• Appreciation → exports dearer (X↓), imports cheaper (M↑) → net exports fall → AD falls → GDP↓, unemployment↑ but inflation↓
• Effect on inflation: depreciation is inflationary (imported inflation); appreciation is deflationary
• Countries with large import dependence (energy, food) are especially vulnerable to depreciations

Three accounts of the BOP

The BOP always balances: Current Account + Capital Account + Financial Account = 0 (with statistical discrepancy). A current account deficit is financed by a financial account surplus (net capital inflows).

Current account deficit — causes & concerns

• Causes: strong domestic demand for imports; uncompetitive exports; high exchange rate; relatively high domestic inflation; comparative disadvantage in goods
• Concerns: may indicate lack of competitiveness; reliance on foreign borrowing (unsustainable); currency depreciation pressure; loss of domestic jobs in manufacturing
• Not always bad: UK has run persistent current account deficit for 40+ years — offset by financial account surplus (foreign investment into UK)

Marshall-Lerner condition HL — key concept

• If PED_x + PED_m = 1 → no change in current account
• If PED_x + PED_m < 1 → depreciation WORSENS the current account (both demands are inelastic — volume response too small to offset price effect)
• In the short run, elasticities tend to be low (contracts are fixed, habits don't change instantly) → M-L condition often fails short-term → explains the J-curve
• In the long run, elasticities are higher → M-L condition more likely to hold → current account improves

J-curve effect HL — draw diagram

After a depreciation, the current account initially worsens before it eventually improves. When plotted over time, the current account balance traces a J-shape.

• Short run — import/export volumes don't change immediately (contracts, habits, limited supplier switching). Imports are now more expensive → import bill rises. Exports are cheaper but volume hasn't risen yet → export revenue stays similar. Current account worsens.
• Long run — firms and consumers respond to new prices. Export volumes rise; import volumes fall. If M-L holds → current account improves, eventually exceeding pre-depreciation level.
• The time before improvement depends on elasticity of demand and structural flexibility

Policies to correct a current account deficit

• Expenditure-switching — redirect spending from imports to domestic goods: depreciation (if M-L holds), tariffs, subsidies to domestic industries
• Expenditure-reducing — cut domestic demand via contractionary fiscal/monetary policy → reduces imports but risks recession and unemployment
• Supply-side policies — improve competitiveness and quality of exports long-term (most sustainable but slow)
• Evaluation: expenditure-reducing creates domestic pain. Depreciation requires M-L to hold and faces J-curve delay. Supply-side takes years. No quick fix.

4.7 Sustainable development

• Economic development — sustained improvement in living standards, including income, health, education, freedom, and environment. Broader than GDP growth.
• Sustainable development (Brundtland, 1987) — development that meets the needs of the present without compromising the ability of future generations to meet their own needs
• UN Sustainable Development Goals (SDGs) — 17 goals, 169 targets by 2030: no poverty, zero hunger, good health, quality education, clean water, affordable energy, decent work, reduced inequality, climate action, etc.
• Tension: growth vs environment (carbon emissions, resource depletion). Green growth, circular economy, and carbon pricing aim to decouple.
• Common pool resources and intergenerational equity are key sustainability concerns

4.8 Measuring development

4.9 Barriers to economic development

4.10 Development strategies

Key evaluation: market vs intervention debate. Ha-Joon Chang (Bad Samaritans) argues developed nations used protection and state intervention to industrialise, then "kicked away the ladder" by demanding free markets from developing countries. Evidence is mixed — East Asian Tigers used state-directed industrial policy, not pure free markets.

Role of international organisations

• IMF — lender of last resort; balance of payments support; conditionality (SAPs). Criticised for austerity conditions worsening poverty.
• World Bank — long-term development loans; poverty reduction; infrastructure. IDA branch for poorest countries.
• WTO — promotes free trade; disputes mechanism. Criticised for slow progress and rich-country bias in agricultural subsidies.
• UNCTAD — UN body advocating for developing country trade interests
• NGOs — Oxfam, Médecins Sans Frontières — targeted poverty reduction; independent of government conditionality