UNIT 8: International aspects Firms get specialised to those goods that they can product best.

 describe the benefits and disadvantages of specialisation at regional and national levels
 describe the structure of the current account of the balance of payments
 discuss the causes and consequences of current account deficits and surpluses
 define exchange rates
 discuss the causes and consequences of exchange rate fluctuations
 describe methods of trade protection
 discuss the merits of free trade and protection
SPECIALISATION
 Firms that specialise in narrow range of products can get to know their markets
well and build up a reputation.
 It is easier to control firms that produce only a few products
 The nature of resources available to producers may influence their decision on
what to specialise in.
 Location and the demand in that location also affects the decision of
specialisation.
However, some firms choose diversification over specialisation.

 It means the concentration on particular products or tasks. Eg: doctors specialised  They diversify to spread the risks across a number of products.
on specific areas, like gynaecologist (women doctor), paediatrics (baby doctor), If demand for one product is falling, the risks of it can be offset by the increase in
different subject teachers. the demand for at least one of its products.

Diversification means concentration of various products or tasks. (Opposite of 3) Specialisation of workers

specialisation) This is also referred as division of labours, instead of producing the whole product or
service, a worker carries out one particular task.
TYPES OF SPECIALISATION
 This can reduce the cost per unit produced.
1) International specialisation
 Workers can specialise on the task they are best at and they can become very
International specialisation occurs when Countries get specialised on goods that they
good at it by by doing this task repeatedly (practice makes perfect). This can
are good at producing.
increase the output per worker.
This is influenced by the availability of quality resources in good quantity (eg: country  The worker can be trained more quickly if they concentrate on a particular task.
with good climate, good beaches and good supply of labour may concentrate on  Time can be saved as workers do not have to move from one task to the other
tourism)  Breaking down the production process into a number of tasks can make it easier
to design machinery, and enabling the workers alongside.
Due international specialisation:
 countries would be able to produce higher output at lower prices, and hence However, there is no guarantee that specialisation can reduce unit cost, it may result
their standard of living would increase. in higher unit cost.
 Producing a relatively narrow range of products would mean that countries will
 Workers may get bored doing same task repeatedly, this can result of workers not
have to export some of their outputs and import other country’s outputs.
taking care of their work and make more mistakes.
 Export revenue can help them to buy the products from other countries.
 Boredom may also result in workers taking more days off due to sickness and
The risks of international specialisation: staying in jobs for shorter time period.
 Concentration on fewer products can be risky when the demand for those goods  Having specialised staff may make it difficult for other workers to cover up for those
fall and cost of production increases. absent.
 Producing wide range of products can be beneficial as the risks can be shared
between these goods.
2) Specialisation of firms
 REGIONAL SPECILIASATION  As income increases, and as more trade takes place, it gives the possibility for
Certain regions have specialised in certain industrial production e.g. coal mining in the government to increase the revenue through income tax and indirect taxes
Yorkshire, pottery in Stoke. In Maldives, R.Alifushi is specialised in local boats  increased choice for the consumers, increased income, increased output,
construction and carpentry. increased infrastructure means a better quality of life for the people, therefore
Advantages of Specialisation at Regional Level standard of living will improve
 Efficient use of resources – A region could specialise in a particular industry due to
Disadvantages of specialisation at national levels
availability of resources. Therefore these resources efficiently used.
 As the country moves towards specialisation, the workers in the declining
 Creates jobs to residents – When an industry develops in a particular region, it
industries may loose jobs reducing their income leading to poverty.
helps the residents of that area since they can find work nearby their homes
 output maybe increased by over-exploiting resources. In this case todays output is
 Infrastructure development – When a region is specialised in a particular industry,
increased at the cost of the future generations (future standard of living might
infrastructure will be built to support that industry, therefore, it develops the
decrease)
region.
 There could be external costs like damage to the environment which will increase
Disadvantages of Specialisation at Regional Level
social cost and affect more people in the process.
 Risk of low demand – Even though specialisation increases output, its benefits will
TRADE
not be achieved if there is no matching demand.
 Rising costs – Costs will increase if labour and raw materials have to be  Trade means buying and selling of goods and services with the aim of making
profit.
transported from other regions
TYPES OF TRADE:
NATIONAL SPECIALISATION
Certain countries have advantages in producing certain goods. They may have natural Types of trade
resources or they may be able to produce goods more cheaply.
e.g. Sri Lanka Tea, Japan electronics. They then trade these goods for those produced
in other countries.
Advantages of specialisation at national level Domestic/ internal International /
 Countries can specialise in what they do best, and this leads to efficiency and trade External trade
economies of scale. It can therefore increase output of the country. When more
and more countries specialise, it increases world output.
 Specialisation leads to increased output and therefore it could lead to more Wholesale Retail Import Export
investment and thus jobs are created. Moreover, it requires skilled labour and trade trade trade trade
thus earnings are higher achieving economic growth and high living standard.
 National level specialisation allows more international trade to take place and
DOMESTIC TRADE
therefore more goods that other countries produce can be imported as well.
Therefore it increases choice for the people of the country
Domestic trade means buying and selling of goods and services inside the country.
(exchange of goods and services inside the country)
INTERNATIONAL TRADE
International trade means buying and selling of goods and services between countries.
( exchange of goods and services between countries)
When one country buys goods or services from another country, commodities flow in
and money flows out as a payment for these commodities.
Import trade: buying goods from other countries (money goes out from the country)
Export trade: selling goods to other countries (money comes into the country)
ADVANTAGES OF INTERNATIONAL TRADE:
1. It makes foreign goods available: (due to international trade, foreign goods will be
available in our home market)
2. It provides a market for products. (due to international trade, firms can reach a
wider market abroad)
3. It leads to better allocation of resources. (due to international trade, resources
can be allocated in an efficient manner so to maximise profit)
4. It brings in the advantages of international specialisation. (the countries can
specialise in their best area of expertise and can enjoy the benefits of it, and the
economies of scale)
5. It enables the transfer of technology from developed countries to developing
countries. (international trade will help to bring in the new technology from
developed countries to developing nations)
6. It creates employment opportunities in export related industries. (more jobs will
be available in the firms producing the goods and services for exports, eg: tourism
industry)
7. It promotes friendship and cooperation among countries. (due to international
trade, the relationship between countries will be improved)
8. It brings fame and prestige. (due to international trade, countries can become
famous and enjoy the prestige of becoming the best in production, eg: Maldives
in tourism)
DISADVANTAGES OF INTERNATIONAL TRADE:
1. There is the danger of overspecialisation. (the disadvantages of overspecialisation
can be possible due to international trade)
2. Foreign competition kills domestic infant firms. (the competition from outside
companies may kill the firms, specially new firms of the home country )
3. It worsens the balance of payments position if exports are less than imports.
(when the exports are lower than imports, then balance of payment will have a
deficit)
4. Developed countries may follow dumping. (dumping = selling products at a price
below cost of production, due to international trade, the developed countries
may sell the products below cost price, to remove some industries of home
country from the market)
5. It makes harmful goods available (international trade can allow the import of
harmful goods like drugs, etc)
6. It may lead to the imposition of foreign cultures. (sometimes, the international
trade can help to impose the foreign cultures in the home country, for eg:
wearing western dresses)
7. The sale of goods to other countries involve travelling greater distance and speak
in different languages.
Free Trade
Free trade: it refers to the free flow of goods and services between countries without
any kind of trade restrictions.
Free trade can allow countries to concentrate on what they are best at producing and
allow for an efficient allocation of resources. This can increase world output,
employment and also the standard of living compared to inefficient allocation of
resources.
Selling freely to global market can take greater advantage of economies of scale,
increase competition and countries get the access to more sources of raw materials.
This can reduce the prices for consumers, who can also gain from a greater choice of
products.
PROTECTIONISM
It refers to the imposition of trade restrictions on imports by law, in order to protect
the countries from external competition.
Reasons for Protectionism (ADAVANTAGES
 It raises the government revenue: (the tax on imports is a form of revenue for the
government)
 It protects domestic infant industries. (restricting trade from other countries can help - To maintain a local product base
new industries from home country to survive and avoid external competition) - To prevent job loss
 It reduces the balance of payment deficit (restricting imports will reduce imports - To improve balance of payment position
improving balance of payment position) - To increase the revenue for the government.
 It protects the declining industries. (restricting trade from other countries can help the
declining / sunset industries to improve as foreign competitors can be reduced) Economic Effects (consequences) of increasing Tariffs:
 It protects the strategic industries (the industries needed for survival of the country - It increases the price of imports
need to be protected from foreign influences, eg: defence industry) - It reduces the demand for imports
 It promotes and secures employment at home. (trade restrictions can reduce outside - It increases the demand for home-made substitutes
competition, which can increase the performance of domestic firms and create - It raises the government revenue
employment of the country) - It reduces foreign competition and guarantees the market for domestic firms
 It leads to reallocation of resources in favour of the country (trade restrictions
would mean the resources of the country would be used in a way that benefit the
domestic country)
 It prevents unfair competition from low wage countries (the restriction of imports
can avoid the unfair competition from those countries that have a very low labour cost)
 It prevents dumping. (some countries sell at a price below the cost of production and
this can affect the infant industries. The protectionism can protect these industries from
dumping)
 It prevents the import of harmful products. (some harmful goods like cigarette, drugs
can be imported through international trade, but restricting trade can help to prevent the
import of these goods)

Methods of Protectionism

1) Tariff
2) Quota
3) Embargo - D is the domestic demand curve, and S is the domestic Supply curve.
4) Exchange control - P is the price of imports, and WS is the world supply .
5) Subsidies - At the price P, domestic supply is J is less than domestic demand M. Therefore JM
is the amount of imports.
1) TARIFF: It refers to the taxes levied on imports. - Due to the imposition of tariff world supply shifted from WS to WS1, increasing
a) Advalorem Tariff: it is the percentage of the money value of imports. Eg: 2% of the price to P1.
the total value of rice imported. - At the price P1, the domestic demand reduce to L from M, but domestic supply
b) Specific Tariff: it is the tax per unit of goods imported. Eg: Rf. 100 per each increased from J to K.
television set imported. - Due to the imposition of tariff, the imports reduced from JM to KL.
- Shaded area is the revenue for the government from tariff.

Reasons for imposing tariff: (ADVANTAGES) 2) QUOTA

- To protect domestic industries from foreign competition
 It refers to the physical limit on the quantity of an import allowed to the country.
 Quota can (EFFECTS);  An exchange rate means the price of one currency expressed in terms of another
- Reduce the volume of imports currency. Eg; $1 = RF 15.42
- It raises the price of imports
An exchange rate of Eg; $1 = RF 15.42 means that it will cost RF 15. 42 to buy 1$
- It promotes demand for home-made substitutes
amount of goods or services. And it will cost $1 to buy Rf. 15.42 amount of goods and
- It reduces foreign competition and protects domestic industries
services.
3) EMBARGO
 It refers to a complete ban on imports. These are usually imposed for political Determination of Exchange rate:
reasons. Rate of exchange is determined by the market forces of demand for and supply of the
4) EXCHANGE CONTROL currency in the foreign exchange market.
 Currency restrictions can prevent domestic residents getting sufficient foreign Foreign exchange market is a market engaged in the buying and
currency to pay for imports. selling of foreign currencies. The main role is played by the central
Changing the exchange rate by depreciation/devaluing the currency is one method bank.
to reduce imports.
- Decreasing the price of countries currency can make imports expensive and In Maldives, the value of Maldivian rufiyaa is determined by the
exports cheap demand and supply at the post office established by the Maldives
- Eg: appreciating the currency rate from 1$ = RF 15.45 to 1$ = RF 19 means that Monetary Authority.
Maldives has to pay 19 rufiya now instead of paying 15.45 for buying 1 dollar
Reasons for the Demand for Maldivian rufiyaa
products. This can reduce imports and increase exports.
 To buy goods and services from the Maldives.
5) SUBSIDIES  Foreign-based Maldivian firms sending back profits to Maldives
 It refers to the government assistance given to domestic producers to increase  To invest in Maldives;
domestic production and to enable to compete with foreign producers. o To buy properties in the Maldives and setting up business
There are two forms of subsidies. o To buy shares from Maldivian companies
1. Financial subsidy  To advance loans to Maldivian residents
2. Material subsidy  To deposit and save money in the Maldivian Banks
Subsidies can;  Foreign banks paying interest on money deposited by Maldivian residents
- Reduce the cost of production  Maldivian working abroad wishing to send money back to home to relatives
- Increases the domestic supply
- Reduces the prices of domestic products Reasons for the Supply for Maldivian rufiyaa
- Reduces foreign competition
 To buy goods and services from abroad
 Multinational companies in Maldives sending back
- The cost of subsidy fall on tax payers. The government get the money to subsidize
 To save money abroad
firms from the taxation.
 To invest in other countries
o To buy properties abroad
o To buy shares from foreign companies
 To grant loans to overseas residents
EXCHANGE RATE
APPRECIATION AND DEPRECIATION
i) A fall in the price of a country’s currency in terms of other currency is known as
depreciation.
ii) A rise in the price of a country’s currency in terms of other currency is known as
appreciation.
Due to Depreciation:
Eg: $1 = RF 15.42 changed to
$1 = RF 12. 42
- Initially, 1 dollar can buy 15.42 rufiyaa things, due to the change 1$ can buy
only 12.42 rufiyaa things. The dollar value has depreciated (Price of dollar
has decreased). This can reduce exports from Maldives. (exports become
expensive)
- Also initially 15.42 rufiyaa has to be supplied to buy $1 things, due to the
change only 12.42 rufiyaa has to be given to buy $ 1 things. The value of
rufiyaa appreciated (Price of rufiyaa risen). This can increase imports from
Maldives( imports become cheaper)
- The reduction in exports and the rise in imports means the domestic output
would fall
- The fall in output would mean that there is a fall in employment level of the
country
- Exports price fall, this would increase the level of exports
- Import price will increase, this would reduce the level of imports
- The increase in exports and reduction in imports can lead to balance of payment
surplus
- The increase in exports and the fall in imports means that the investment in the
country would increase
- The increase in exports and reduction in imports can increase savings
- Depreciation of the currency means price of the country falls, this means the
inflation in the country would decrease.

However if $1 = RF 15.42 changed to

$1 = RF 19.42

- Initially, 1 dollar can buy 15.42 rufiyaa things, due to the change 1$ can buy
19.42 rufiyaa things. The dollar value has appreciated (Price of dollar has
increased). This can increase exports from Maldives. (exports become
cheap)

- Also initially 15.42 rufiyaa has to be supplied to buy $1 things, due to the
change 19.42 rufiyaa has to be given to buy $ 1 things. The value of rufiyaa
depreciated (Price of rufiyaa fallen). This can reduce imports from Maldives
(imports become expensive)
When Maldivian citizens want to buy goods and services from USA, the country will
EFFECTS/ CONSEQUENCES of a change in Exchange rate on imports and exports demand for US dollar and supply Maldivian Rufiyaa. As a result, the demand curve for
Due to Appreciation: US dollar would increase and shift from D to D1, leading to a fall in the Maldivian
- Exports price will increase, this would reduce the level of exports Rufiyaa and rise price of US dollar.
- Import price will fall, this would increase the level of imports
- The reduction in exports and increase of imports can create balance of payment TYPES OF EXCHANGE RATE
deficit 1. Fixed Exchange Rate
 It is an Exchange Rate that is fixed by the government through its agent, the
central bank.
- When the government reduces the value of the currency, it is known as
devaluation.
- When the government rises the value of the currency, it is known as revaluation.
ADVANTAGES / DISADVANTAGES:
Fixed exchange rate creates certainty, that is the Firms that buy and sell abroad
will know the exact amount they will pay or receive in terms of their own
currency if the rate does not change)
However
the government has to use up a considerable amount of foreign currency if the
country has a fixed exchange rate.
2. Floating / Flexible Exchange rate
It is an Exchange rate determined by the market forces of demand for and supply
for the currency in the foreign exchange market. It is known as clean floating.
- If the demand for the currency rises or the supply decreases, the value of the
currency will rise, which is known as the appreciation.
- If the demand for the currency falls or the supply increases, the value of the
currency will fall, which is known as the depreciation.
ADVANTAGES / DISADVANTAGES:
Floating exchange rate can help to eliminate a growing current account deficit
However:
- Floating exchange rate would be changing, making it difficult to for firms to
plan ahead.
3. Managed Exchange Rate
It is an exchange rate determined by the market forces of demand for and supply
of the currency in the foreign exchange market, but managed by the central bank
of the country. It is known as dirty floating.
CAUSES for the change in Exchange rate
1. Changes in demand and supply
- If the demand for the currency rises or the supply decreases, the value of the
currency will rise
- If the demand for the currency falls or the supply increases, the value of the
currency will fall
2. Changes in Exports : An increase in the exports would tend to cause the value of
the currency to rise.
3. Changes in Imports : An increase in imports would tend to cause the value of the
currency to fall.
4. Investments : An increase in investments in the country can increase the price of
the currency leading to an appreciation.
5. Savings
- Increase in savings can cause an appreciation of the currency because in order to
save, the currency would be demanded.
- If citizens of the country choose saving instead of spending on imports, then
supply of the currency would fall causing a depreciation of the currency
6. Inflation : During the inflation period, the citizens of the country may choose
imports instead of domestic products. This can increase the supply of the
currency leading to a depreciation.
7. State of the economy : The political and social instabilities can reduce investors
confidence, so new investment decreases. Also existing investments may move
out. This can cause the currency to depreciate.
8. Business activities : When a new business is opened, lots of new infrastructure
work would be carried out, which is an inward of foreign currency. This can
increase the demand for the currency, causing appreciation.
9. Interest rates :An increase in the interest rate would want more people to invest
money into the country (FDI = Foreign Direct Investment), this can increase
demand for the currency and increase the price of the currency.
EFFECTS of currency Depreciation.
- A fall in the exchange rate can reduce the export prices and raise import prices.
This can increase the demand for domestic products increasing the aggregate
demand.
- The increase in aggregate demand can increase output and employment if it is not
operating in the full capacity.
However:
- The fall in the exchange rate can cause increase in domestic demand, which can
cause inflation to increase (demand pull inflation).
- A fall in the exchange rate can increase inflationary pressure. The imported raw
materials would become expensive which can increase the price of the products
(imported inflation).
- Also finished imported goods will be expensive, and this can increase the inflation
in the country.
International Competitiveness and the currency
International competitive means beig able to compete with other countries. This can
be possible if the country provides the goods and services desired by the consumers as
a price acceptable by them.
An internationally competitive economy must have:
- Stable economic growth rate
- Reasonable share of the world trade
- High levels of investment and expenditure on research and development
- Good quantity and quality of education and training
- Good infrastructure in the economy
In the short term, the changes in the countries exchange rate and inflation rate can
affect international competitiveness.
- A fall in both the exchange rate and the inflation rate would make the
countries products more attractive to buyers at home and abroad.
Devaluation and the balance of payment
Reducing the value of a country’s currency can increase its exports while reducing its
imports. This can improve balance of payment position of the country.
BALANCE OF PAYMENT
A) Terms of Trade
 The terms of trade refers to the rate at which country’s exports are exchanged
for imports.
 It is commonly expressed in terms of as a ratio between the index of export
prices and the index of import prices.
Index of export prices
Terms of trade = ×100
Index of import prices
i) Favourable terms of trade
An improvement in the terms of trade occurs if export prices rise
relative to import prices. In this case, a given quantity of exports will
be exchanged for a greater quantity of imports.
ii) Unfavourable terms of trade
An unfavourable terms of trade occurs if export prices fall relative to
import prices. In this case, a given quantity of exports will be
exchanged for a lesser quantity of imports.
Impacts of changes in terms of trade
The impacts of a change in terms of trade depends on mainly on the
causes of price change.
-If export prices rise due to an increased demand for the country’s
products, then the country will be selling more products for a higher
price and will be able to afford to buy more imports.
-If , however, the exports prices rose because of inflation, demand is likely
to fall. Each export would be exchanged for more imports but fewer
exports would be sold. Export revenue would fall, and in the end fewer
imports could be bought.
B) Balance of Trade
 The balance of trade is a statement of the country’s trade in tangible goods
(services not included) with the rest of the world over a time period.
C) BALANCE OF PAYMENT
Balance of statement is a statement of a country’s economic transactions with the
rest of the world over a particular time period (usually one year).
- It includes trade in goods, trade in services, income received, aids from other
countries and investments by individuals, firms and government bodies.
- Money coming into the country is recorded as credit item, and money going
out the country as debit item.
THE SECTIONS OF BALANCE OF PAYMENT
There are 3 sections in a balance of payment.
 1) Current account This records two categories of income flows, the compensation of employees
a) Trade in goods and investment income.
b) Trade in services i) Compensation of employees include wages, salaries and other benefits
c) Income earned by residents working abroad minus that earned by foreigners
d) Current transfers working in the home country.
2) Capital and financial account ii) Investment income covers profits, dividends, and interest received from
a) Capital account abroad minus profits, dividends and interests paid abroad.
b) Financial account - Investment income is earned on direct investment, portfolio
c) Official reserves investment and loans.
3) Net errors and omissions - Eg: if a multinational company sends back profits out of the country
back to its home country, it will appear as a debit item.
1) CURRENT ACCOUNT - And the receipts of dividend on shares in foreign companies, and
Current account shows the income earned by the country and the expenditure interest on loans made to foreign firms will be credit items.
made by it in its dealings with other countries.
It is usually divided into four sub sections. d) Current transfers
These are transfers of money, goods or services which are sent out of the
a) Trade in goods country or come into the country, not in return for anything else.
This covers the imports and exports of tangible goods like cars, foods and - Items include gifts, charitable donations, money sent to and received from
machinery. relatives abroad and aid from one government to other governments.
- Such transactions are sometimes referred as visible imports and exports, or
merchandised imports and exports. The balance of the four sub-sections is known as the current account balance
- if revenue from exports of goods is greater than the expenditure on imports of (sometimes called as current balance).
goods, then the country is said to have a trade in goods surplus (or visible
- A current account surplus arises when the value of credit items is greater than the
trade surplus)
value of debit items.
- in contrast, a visible trade deficit occurs when export revenue is less than the
- If the value of debit items is greater than the value of credit items, then it is
import expenditure.
current account deficit.
b) Trade in services
This part records the payments for services (intangibles) sold abroad and 2) THE CAPITAL ACCOUNT and FINANCIAL ACCOUNT
expenditure on services bought from foreign countries. a) The capital account
- It is also referred as invisible trade or invisible balance. The capital account includes funds bought into the country by new immigrants,
- The items include in this section are banking construction services, financial funds sent abroad by emigrants, transfer of funds associated with the acquisition
services, travel and transportation of goods and passengers between and disposal of fixed assets and the purchase and sale of patents.
countries.
b) The financial account
- A trade in services surplus (invisible trade surplus) would mean that export
This records the transactions in assets and liabilities. These can involve substantial
revenue of services are greater than import expenditure of services.
investment flows.
The three components of this section are direct investment, portfolio investment
c) Income and other investments.
 i) Direct investment covers the purchase of businesses or the establishment of
new businesses.
ii) Portfolio investment includes the purchase of shares and government bonds.
iii) Other investments includes trade credits and loans.
- When the countries citizens buys assets abroad, it is recorded as debit items as
they involve money going out from the country. (of course, later these 6. Domestic GDP: if the income level of the firms and the household increases, then
purchases will generate investment income in the form of profit, interest and
dividends, which will appear as credit items in the current account)
- In contrast, when foreigners buy assets in the country , they will be recorded
as credit items but their liabilities as they will later generate debit items in the 7. Foreign GDP: if income abroad rise, foreigners will buy more products, which can
current account.
c) Official Reserves (reserve assets)
These are the items held to settle debts with other countries. They include foreign
exchange special drawing rights issued by the International Monetary Fund (IMF), THE CAUSES AND EFFECTS OF FINANCIAL ACCOUNT DEFICIT
reserve position at the IMF and gold.
3) NET EROORS and OMMISSIONS (balancing item)
 If all the items in the balance of payment are recorded accurately, debit and
credit items should be equal.
 If the country has a deficit on the current account, it would have to be matched
by an equal surplus on its capital and finance account.
 However, because of the mistakes and the failure to record all items (in part due
to time delay), the balance of payments does not balance.
 So the net errors and omissions figure (or balancing item / unrecorded
transactions) is included to ensure that the debit gets equal to credit.
FACTORS THAT CAN AFFECT EXPORT , IMPORTS AND CURRENT ACCOUNT DEFICIT
1. The country’s inflation rate: if the country has a high inflation rate, domestic
household and firms re likely to buy more imports. The country’s firms would face
the difficulty in exporting which will reduce exports. This can lead to a deficit
balance of trade.
2. The country’s exchange rate: A fall in exchange rate (depreciation) will reduce the
export prices and increase exports, while raise import prices reducing imports. This
can create balance of trade surplus.
3. Productivity: if the workers are productive, the labour cost per unit can be
reduced. This can reduce the price of the product and increase exports. Also,
demand for domestic products can increase due to the increase in labour
productivity, and reduce the imports.
4. Quality: A fall in the country’s quality of goods and services can decrease the
exports and increase the imports of them. This can lead to balance of trade deficit.
5. Marketing: if the domestic firms have an effective marketing which help to increase
the demand for its product, can increase exports. The Quantity of imports is
affected by the efficiency of the marketing of foreign firms.
the imports can increase in buying raw materials and more goods and services.
The rise in domestic demand may also encourage some domestic firms to
switch to domestic market, which can reduce the exports.
increase the exports of the home country.
8. Trade restrictions: A relaxation of trade restriction in other countries can make it
easier for home country to sell their goods, helping to increase exports.
CAUSES (REASONS): A financial account deficit arises when the investment abroad in
the year is greater than the foreign investment which has come into the country.
- Domestic firms may decide to set up in foreign countries because of lower tax
rates, lower cost of production, expanding markets, good factors of production
and government subsidies.
- Domestic firms and individuals may buy foreign shares if profit levels and
dividends are high abroad.
- High interest rates may encourage them to buy foreign government bonds and
lend to foreign companies and individuals.
EFFECTS (RESULT):
- In the short run, financial account deficit involves money leaving the country.
- Firms investing in other countries instead of home countries may mean that
potential jobs and incomes are lost to the foreign economy.
- In the long term, however, investment abroad can generate income to the
home country if the investments turned out to be a profitable one.
EFFECTS OF CURRENT ACCOUNT DEFICIT (ADVANTAGES AND DISADVANTAGES)
- A current account deficit means that a country is consuming more than they are
producing. This is sometimes referred is a “country is living beyond its means”.
- A current account deficit means that there is a reduction in inflation, as there will
be a fall in domestic aggregate demand.
- The deficit caused by import of raw materials and capital goods is not a problem.
As they can be used to produce goods and service, and some of which would be
exported.
- Lower incomes abroad will not last, and when their income increases, a country
can export to foreign countries.
- A deficit in the current account may cause a depreciation in the currency. This can
make the exports cheaper and imports expensive, and as a result deficit can be
eliminated.
However:
- A current account deficit means that output and employment is lower than
possible. If more goods and services are made in the country, more workers
would be employed.
- A deficit arising due to international competitiveness is very serious as it will not
be self correcting.
The government has to worry if:
- the deficit arise due to increase firms cost of production as a result of lower
productivity
- the deficit arise due to poor quality of the products produced
- the deficit arise due to lower world demand for the products made
In these situations, the deficit may last long. Hence the government have to introduce
some policies, especially supply side policies to improve country’s trade performance.
CAUSES AND EFFECTS OF CURRENT ACCOUNT SURPLUS
CAUSES:
 A low exchange rate: this will make export cheap and imports expensive, having
current account surplus.
 High quality of domestic products: this will encourage foreign and domestic
citizens to purchase the home country’s products, hence current account surplus.
 High incomes abroad: this will enable foreigners to buy a high volume of the
country’s exports, and help to achieve current account surplus.
 Low costs of production: this may make home country’s product internationally
competitive, hence current account surplus can occur.
EFFECTS: (ADVANTAGES AND DISADVANTAGES)
- An increase in current account surplus can increase the country’s aggregate
demand, so may increase the real GDP and higher employment.
- More money will enter the economy than the money leaving it.
- It also means that the country is producing more than it is consuming it.
However
- If the country is operating a floating exchange rate, an increase in the current
account surplus may result in an appreciation in the exchange rate, due to the
increase in demand for the currency.
What is meant by specialization? [2] : The concentration of one person, one factory, one
company, one region or one country in a particular function or area of production to
increase output with a lower cost. This is due to advantages it has over others.
Discuss the advantages and disadvantages of specialization at the national level. [6]
This is when a certain country devotes itself mainly to produce certain products which are
produced to other countries. E.g. Malaysia specializing in producing and exporting rubber
and wood products. It has both benefits and disadvantages to the country.
 Initially, it leads to greater efficiency of production due to less wastage of resources.
 Besides it has the potential to increase the output that can be obtained from given
quantity of resources. It leads to increase in world output as it provide a market for
surplus products of countries.
 Moreover, it enables countries to enjoy production of better quality products at lower
prices by enjoying economies of scale.
HOWEVER, it may cause a country to be too much over dependent on a particular products
so, if a decline in demand for that particular good arises, the losses born will be huge.
Hence it may cause structural unemployment as workers find themselves jobless as they
are specialized in one of the production which would lead to fall in quality of life, living
standard of citizens in the country.
Describe the structure of the current account of a county’s balance of payments. [4]
There are mainly four structures in the current account of a country’s balance of
payments.
 First is the visible trade where trade in goods; imports and exports of goods is
recorded.
 Next is the invisible trade in which trade in services; imports and exports of services
such as insurance, transportation etc… is recorded. Then there is the income flows
 which records both income from employment such as wage, commission, bonus,
overtime etc.… and income from investment e.g. profit, interest, dividends etc…
 The last section of the current account of balance of payment is the current transfer in
which gifts, grants and donations exchanged between countries is recorded. This is the
structure of the current account of a nation’s balance of payment.
Explain the main causes of a current account deficit. [6]
Current account deficit occurs when the sum of exports of goods, services, income and
current transfer inflows is less than sum of import of goods, services, income and current
transfer outflows. It may be caused by a range of reasons.
 Initially it may be due to lack of factors endowment in the country. If it has lack of
agricultural products and need general rich resources e.g. oil, coal this has to be
imported from other countries so the country may have to depend on imports.
 Also, the country may have a fixed exchange rate system and the value of the currency
may be overvalued. This will make imports cheaper increasing volume of imports and
reducing volume of exports.
 Besides due to inefficient production of export items which are demanded by overseas
markets the volume of exports may be low leading to a current account deficit.
 Moreover, real income (money) of people in the country might be high so there will be
more demand for imports increasing value of imports. While income of the people in
abroad in potential export market will be low so low volume of exports. So when
exports decrease in relative to increase imports the current account shows an
unfavourable balances.
Explain why the value of a currency may fall in a floating exchange rate system. [6]
The value of currency may fall in floating exchange rate due to many reasons.
 Firstly demand for the currency affects it. If the currency is not demanded for purposes
or its demand is low. It will lead to depreciation of the country’s currency.
 Besides, if the country’s currency is supplied well, or it’s high in supply this could lead
to lowering of the value of a nation’s currency.
 Also if there is low interest rates people won’t prefer saving so there will be high
demand resulting a decrease in value of a nation’s currency in floating exchange rate
system.
 Moreover, if there is high inflation in the economy it would consequent in this. This is
as a higher price will reduce demand for home currency which would further reduce
the value of home currency and lead to depreciation.
 Furthermore, the state of the economy, if the economy is in a recession, investments
will be less which results fall in demand for the currency which reduces the value.
 In addition, the level of business activities, investments and borrowing is low, which
leads to worsening of value of a nation’s currency.
Discuss whether a floating exchange rate system is always to be preferred to a fixed one.
[8]
Floating exchange rate system and fixed exchange rate systems are both advantageous as
well as disadvantageous.
 Initially there is no need for the government to keep a reserve for maintaining the
exchange rate as exchange rate is determined by the forces of demand and supply of
the currency, so that it can be used for other productive purposes such as government
welfare spending such as on education, housing and other development project
applying concept of opportunity cost. Hence it allows the government to be able to
target other aims.
 Additionally the exchange rate will automatically adjust making the current account
balance more stable. Because of these reasons floating exchange rate system may be
preferred over fixed exchange rate system although it may be difficult to plan and
speculation may occur.
 A floating exchange rate also may not be preferred over fixed exchange rate system. A
fixed system is beneficial as it has a greater degree of stability which encourage trade
and investment. Besides chance is there for speculators to seek profit is less.
 However for maintaining of fixed exchange rate, there is need for maintaining the
reserve for maintaining the fixed exchange rate system so this means, less will be
available for other needy aims of government applying theory of opportunity cost.
 Adding up, policies used to maintain the exchange rate may conflict with other
government aims. Furthermore, the rate may be too high or too low.
Explain the effects on an economy of a significant rise in the value of its exchange rate.
[6]
There are both positive and negative impacts on the economy due to significant rise in the
value of exchange rate of a country’s currency.
 First of all, it will make the exports more expensive therefore leading to a reduction in
the value and volume of exports.
 Moreover, it will make imports cheaper resulting a rise in value and volume of
imports. Hence, when imports of a nation exceeds exports of that particular nation it
will lead to a deficit in the country’s balance of payment or a reduced surplus if it
have been experiencing a high surplus before appreciation of the currency.
 As high imports take place of domestic goods, it will consequently lead to imported
inflation as well as a decrease in level of domestic output, employment rate, local
firm’s revenue and standard of living of the citizens of the country. So the rise in
value of rate of a currency (.e.g. from $1=15.42 MVR to $1= 10MVR) will create
investment. So appreciation of a currency has arrange of positive and negative
aspects on an economy.
What determines the value of a currency in a floating exchange rate system? [3]
 The value of a currency in a floating exchange rate is determined by the operation of
market forces of demand and supply of the currency. The central bank i.e. government
cannot interfere.
 Other factors such as inflation rate, interest rate can also effect the value of currency
in a floating exchange rate system which state of the economy is also influence.
What is meant by exchange rate? [2] Exchange rate or the rate of exchange is the price or
value of one country’s currency expressed in terms of another county’s currency. E.g.
$1=15.42MVR
Explain what is meant by trade protection. [4]
Trade protection or also known as protectionism is the protection of the country’s
industries from high competition from other country’s industries. It is imposing restriction
on international trade (imports by law).
 Different types of restriction such as tariff, quota, exchange control, production
subsidies etc.… on import of goods from other countries.
 Tariff is a tax placed on imports. Quota is a physical limit (quantity restriction) on the
quantity of the commodity which is allowed to import a country in a year.
 It is done for reasons such as raise revenue to the government, prevent dumping,
protection of strategic and infant industries etc.…
Explain two reason why a government might introduce trade protection. [4]
Trade protection is introduced by a government of a country for many reasons.
 These include protection of infant industries (sun rise industries) protection of
strategic industries, to raise revenue to the government, create more employment
opportunities and to avoid risk of over specialization etc…
 It is done by state aiming to protect industries essential to the survival of the
countries. So most government provide some protection on to their agricultural,
defense related industries to ensure regular supply.
 Also by reducing import from foreign countries, the country can protect their workers
interest and avoid situation of unemployment.
Discuss the extent to which free trade can be seen as a benefit to (i) all consumers and
(ii) all producers.
(i) Free trade or a policy of unrestricted trade with no restriction has both merits and
demerits to all consumers.
 Free trade can be seen beneficial by consumers as it increases variety of choices for
consumers. This is because they are able to purchase goods which is not made/
manufactured in their own country.
 As it creates large number of job opportunities in various areas like banking,
marketing, insurance, transportation and communication it increase the living
standard of people as their income increase, with the inflow of foreign currencies to
exchange of goods and services.
 However, there are cases against free trade to all consumers. Initially it will create
unemployment in the country as imported goods takes place of home/ domestically
made goods. So the quality of life, living standard hinders as their income falls with the
rising unemployment.
 Besides, as it allows harmful goods to be imported such as drugs it affect health of
consumers.
(ii) free trade is both advantageous and disadvantageous to producers to certain extent.
 Firstly, it increases world output as it enables countries to produce maximum quantity
of goods and services by using the available resources and provide a market for
surplus products of other countries.
 It also leads to greater efficiency of production as free trade helps to reduce wastages
of resources.
 In addition it helps producers to benefit from improved technology of developed
country.
 HOWEVER it may be discouraged by producers for many reasons as well.
 Firstly, of all it makes an obstacle for new born/ infant/ sun rise industries to survive
with foreign competitive goods.
 Moreover it leads to problems in strategic industries such as defense related,
agricultural etc.…
Identify and describe two methods of trade protection which a government might use.
[6]
1) Quota: It is physical limit (quantity restriction) on the quantity of commodity, which is
allowed to import to the country in a given year. A quota is fixed when the government
feels the given quantity (determined by domestic demand and supply) is too high to be
allowed to import. Thus a quota is always fixed below equilibrium quantity. Its effect is
reducing volume of imported goods rising to price and encouraging home industries as
demand increases for home-made substitute goods.
2) Production subsidies: Financial aid given by the government to home producers who
exports certain goods in order to make their goods competitive in the home market as well
in foreign market. Its effects are lowering price of home produced goods, it increase
demand for foreign goods and cost of subsidy fall on tax payers and there is less reaches
from competitors
Discuss whether consumers would benefit from an increase in imports. [8]
Up to 5 marks for why they might:
• Imports may make available products not produced in the country (1) due to e.g.
differences in climate/resources (1).
• Imports may increase choice (1) provide differentiated products (1) provide good
quality products (1)
• Imports may be cheaper (1) this may also put pressure on domestic firms to
improve the quality of their products (1).
• The price of imported raw materials may be cheaper (1) this could lower costs of
production (1) lowering prices (1).
Up to 5 marks for why they might not:
• Imports may drive domestic firms out of business may be created and this may
increase prices in the long run (2)
• A monopoly may be created which may reduce quality in the long run (2)
• Foreign firms may be engaging in dumping (1).
• Imports may be of harmful products/demerit goods (1) example (1) such products
would harm people’s health (1).
Analyse how a fall in the value of a currency may increase a current account surplus on
the balance of payments. [6]
• A fall in the value would mean that more of the currency has to be sold to buy a
given unit of another currency (1).
• A fall in the value of the currency would reduce export prices (1) and increase
import prices (1).
• Demand for exports may increase/more exports (1) this may increase export
revenue (1) if demand for exports is price elastic (1).
• Demand for imports may fall/lower imports (1) this will reduce import expenditure
(1) if demand for imports is price elastic (1).
• A rise in export revenue and/or a fall in import expenditure will increase a trade in
goods/ and services surplus (1).
• Trade in goods and trade in services appear in the current account (1) credit items
in the current account would increase (1) while debit items would fall (1).
 Discuss whether a cut in the rate of interest would end deflation. (8)
A reduction in the rate of interest will reduce the return from saving/discourage saving
(1) instead of saving households may spend (1).
 A lower interest rate will cut the cost of borrowing (1) this may encourage households
to take out loans and spend (1).
 Firms may spend more on capital goods/invest (1) as it will be cheaper to borrow(1)
they may expect a rise in consumer expenditure (1).
 Higher total (aggregate) demand (1) may push up the price level (1).
HOWEVER:
 Households may be pessimistic about the future/may expect prices to fall further in
the future or that a recession will occur (1) and so may not spend more despite a
lower interest rate (1). May choose to repay past debts (1).
 Firms may be pessimistic about the future/may expect prices to fall in the future (1)
and so may not borrow/ invest more despite a lower interest rate (1).
 The interest rate may initially have been low (1) and so a cut may make little
difference (1).
 Households and firms may not expect the cut to last (1) and so will not alter their
spending and investment plans (1).
Explain two reasons why a country’s export revenue might increase when export prices
rise. [4]
One mark each for each of two reasons given:
• inelastic demand for exports would mean demand falling by less than the rise in price
• fall in exchange rate would make exports relatively cheaper
• demand may increase as a result of e.g. a rise in incomes abroad
• rise in investment may make exports more quality competitive
• removal of trade restrictions abroad may make exports cheaper in foreign markets
• prices may rise by more in other countries
Analyse how a government could increase the surplus on the country’s current account
of the balance of payments. [6]
• reduce the value of the currency (1) lower export prices (1) raise import prices (1)
increase demand for exports (1) decrease demand for imports (1)
• impose trade protection (1) e.g. a tariff would increase the price of imports (1) which is
likely to reduce the demand for imports (1)
• subsidise domestic output (1) lower price of exports (1) increase demand for exports (1)
lower demand for imports (1)
• increase income tax (1) lower demand for imports (1) put pressure on domestic firms to
export due to lower demand at home (1)
• improve education and training (1) raise productivity (1) cut costs of production (1) make
domestic products more internationally competitive (1)
• reduce inflation (1) may make domestic products more internationally competitive (1)