Econ a2 2 Course Companion

8/3/2019 Econ a2 2 Course Companion

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GCE Economics

Course Companion

Unit A2 2: The Global Economy


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GCE Economics Course Companion

A2 2: The Global Economy

No nation was ever ruined by trade. Benjamin Franklin

What is this unit about?

In this unit you will develop the knowledge you gained in AS 1 and AS 2 by looking

at international trade and payments in more detail and exploring some of the issues

that arise from increasing globalisation.

You will:

explore the reasons for trade and examine why countries, from time to time, adoptprotectionist measures;

analyse the structure of the UK Balance of Payments Account, consider theproblems caused by payment imbalances and look at ways in which these can be

corrected;

examine how a currencys exchange rate is determined, consider the effects of ratechanges and explore how exchange rate fluctuations might be stabilised;

explore the economic role of the European Union and consider how effectively itoperates;

investigate the main features and effects of globalisation; analyse the different stages of economic development that countries experience

and examine the factors that affect development; and

consider how government macroeconomic policy is affected by the growingopenness of the world economy.

What are the main topics I need to study?

The exact number and sequence of topics you will study in this unit will depend on

how your teacher decides to organise the course. However the content is organised,

you should always try and relate the concepts and theories you study to real world

events and issues. It is likely that this unit will follow a structure similar to the one

below.


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1. International trade and protectionIn this section you will:

investigate the reasons why countries trade; use the theory of comparative advantage to explain the gains from trade; evaluate the usefulness of this theory; consider arguments for and against free trade; explore how countries may protect themselves from foreign competition; and examine the role and effectiveness of the World Trade Organisation (WTO).2. The UK balance of payments and the exchange rate

Here you will:

learn about the main sections of the UK balance of payments and recent trends inthe UKs trade and investment flows;

learn why the overall balance of payments account must balance; explore the nature of balance of payments problems and examine different ways

in which these may be corrected;

learn how a currencys exchange rate is determined; analyse the effects of changes in the exchange rate; consider the pros and cons of floating and stable exchange rates; and examine the different ways in which a currencys exchange rate can be stabilised.


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3. The European Union (EU)In this section you will:

learn about the distinctions between free trade areas, customs unions, commoncurrency areas and full economic and monetary union;

examine how the EU can both create and divert trade; consider the effects of EU enlargement; consider the pros and cons of joining the eurozone; examine the role and effects of the European Central Bank (ECB); and

consider the effects of the Common Agricultural Policy (CAP).

4. Globalisation and economic developmentHere you will:

examine the meaning and main features of globalisation; consider the impact of globalisation on developed and less developed economies; examine the effects of international groupings and organisations on the global

economy;

learn about the main stages of economic development; examine the factors which may promote or hold back economic development; learn about ways in which foreign aid to less developed economies may be

provided;

examine the roles of the International Monetary Fund and World Bank; and consider the arguments for trade versus aid as a way of helping economies to

develop.

5. Macroeconomic policy in an open economyIn this section you will consider:

explore the international pressures on countries to protect the environment; and examine the ways in which international factors may affect the operation of a

countrys economic policies.


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What areas cause students particular problems?

Though most students find the content of this unit to be topical and interesting, there

are certain areas which some students find particularly challenging. These problem

areas are discussed below:

The theory of comparative advantage

The theory (or law or principle) of comparative advantage is one of the most

important economic ideas. It provides the basis for specialisation and exchange

between individuals and firms and it is central to the explanation of why countries

trade and the process of globalisation. However, students often have difficulty in

explaining this idea as it seems to suggest the opposite to what their intuition tells

them.

In international economics, the theory of comparative advantage states that all

countries can benefit from specialisation and trade provided that they specialise ingoods in which they have a comparative advantage and trade those goods for other

goods in which they have a comparative disadvantage. The theory is usually

associated with the 19th

century economist David Ricardo. It is normally illustrated

through a very simple two-country, two-product model.

A comparative advantage exists when a country is able to produce a good at a lower

opportunity cost than another country. For example, assume that there are just two

countries, Joyland and Sadland producing and consuming two goods, bread and fish.

Before any specialisation and trade, we assume that both countries have equal

amounts of resources and divide these equally in producing both goods. This gives the

following situation:

Production before specialisation

Bread (tonnes) Fish (tonnes)

Joyland 400 200

Sadland 200 150

Total 600 350

Joyland is more efficient than Sadland at producing both products, ie it has an

absolute advantage in both bread and fish. This could be because it has better factor

endowments such as more fertile wheat fields or more skilful fishers. However, it hasa comparative advantage in the production of bread. This can be seen by looking at

the opportunity cost of producing one tonne of bread in each country.

If Joyland used all its resources to produce bread, it could produce 800 tonnes of

bread and no fish. If it used all its resources to produce fish, it could produce 400

tonnes of fish and no bread. Therefore, for each tonne of bread it produces the

opportunity cost is the 0.5 tonne of fish it could have produced instead.

If Sadland used all its resources to produce bread, it could produce 400 tonnes of

bread and no fish. If it used all its resources to produce fish, it could produce 300

tonnes of fish and no bread. Therefore, for each tonne of bread it produces theopportunity cost is the 0.75 tonne of fish it could have produced instead.


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Opportunity costs


Joyland 1 0.5

Sadland 1 0.75

In this situation, Joyland therefore has a comparative advantage in the production ofbread and Sadland has a comparative advantage in producing fish.

If both countries specialise in the production of their goods of comparative advantage,

then it is possible to increase production of both goods. For example, if Joyland

produced 650 tonnes of bread it could still produce 75 tonnes of fish whereas if

Sadland specialised exclusively in producing fish, it could produce 300 tonnes. Thus

compared with the situation before specialisation, more of both goods are produced:

50 extra tonnes of bread and 25 extra tonnes of fish.

Production after specialisation


Joyland 650 75

Sadland 0 300

Total 650 375

By trading, it is possible for both countries to gain. For this to happen, terms of trade

need to be agreed that are within the limits of the countries opportunity cost ratios,

that is, somewhere between 1 tonne of bread = 0.5 tonnes of fish and 1 tonne of bread

= 0.75 tonnes of fish.

For example, suppose that the countries agreed to trade at an exchange rate of 1 tonneof bread = 0.64 tonnes of fish. Joyland could trade 225 tonnes of its bread for 225 x

0.64 = 144 tonnes of Sadlands fish. This would give a situation after trade in which

both countries could enjoy more of both products than they did before they

specialised in their products of comparative advantage. This is shown below:

Situation after trade


Joyland 425 219

Sadland 225 156

Total 650 375

Compared with the situation before specialisation, the happy inhabitants of Joyland

can enjoy an extra 25 tonnes of bread and an extra 19 tonnes of fish while their less

fortunate trading partners in Sadland are now a little less sad as they have 25 tonnes

more bread and 6 tonnes more fish a win-win outcome!


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The essential steps in using a model like this are to:

make clear your assumptions; make sure that the opportunity cost ratios are different in each country; remember that a country has a comparative advantage in the product in which it

has the lower opportunity cost;

appreciate that both countries do not necessarily have to specialise completely intheir products of comparative advantage; and

make sure that the terms of trade fall between the opportunity cost ratios ifbeneficial trade is to take place.

You should practice applying this model of comparative advantage with different

figures until you are confident that you have grasped how it works.

The effects of specialisation and trade can also be illustrated by the use of production

possibility frontiers. Specialisation and trade allow the achievement of combinations

of goods that would previously have been unattainable, that is outside the countries

production possibility frontiers, when the countries were self-sufficient.

Production and consumption possibilities

Joyland(before spec)

Fish (tonnes)

Sadland(beforespec)

400

300

200

150

Joyland

(after trade)

Sadland(after trade)

Bread

(tonnes)800400200


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The theory of comparative advantage is often criticised as being too simplistic

because it relies on unrealistic assumptions such as:

a very uncomplicated model two-country, two-product model; the ignoring of transport costs; perfect occupational mobility of factors of production within a country; full employment of factors of production; perfectly competitive markets; constant returns to scale; and

no externalities from production or consumption.

Some commentators also point out that the theory was formulated at a time when

capital was largely immobile between countries and that this is no longer the case in

todays sophisticated, global economy.

However, some of these assumptions are only used to create a workable model; they

do not destroy its ability to illustrate an essential economic truth. For example,

increasing the number of countries and products involved only increases the

opportunities to benefit from specialisation and trade, and the existence of increasing

returns to scale may actually increase the gains from specialisation. It should also be

remembered that comparative advantage is a dynamic concept a country can gain orlose a comparative advantage in a particular product over a period of time. This will

happen when there is a change in relative efficiency and opportunity cost ratios, for

example, because one country invests more in new technology or training.

Trade barriers

Though most students understand the nature of overt trade barriers such as tariffs and

quotas, many have difficulty in analysing and evaluating their impact on the economy.

They are also less sure about the nature of hidden or covert trade barriers.

TariffsA tariff is a tax on imports. It may also be referred to as an import duty or customs

duty. Tariffs are normally imposed as a deliberate attempt to reduce the demand for

imports by raising their price to the consumer and thereby making domestically

produced goods more competitive.

The effects of a tariff can be analysed with the aid of a supply and demand diagram.

In the absence of foreign trade, the market price and quantity would be fixed by the

interaction of domestic demand and supply: Pd and Qd. We then assume that a

country can obtain as many imports as it wishes at the prevailing world price below

the domestic market price, Pw. The world supply curve Sw is therefore perfectly

elastic at this price. In this situation, domestic production will fall to Q1 whereas

domestic demand will rise to Q4; the difference being made up of imports of Q1Q4.


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If the government now imposes a specific tariff of PwPt per unit, the world supply

curve shifts upwards to Swt by the amount of the tariff. In this situation, domestic

demand falls to Q3 whereas domestic supply rises to Q2. Imports therefore fall to

Q2Q3. Compared with the situation before the imposition of the tariff, consumer

surplus has been reduced by the total of all the shaded areas on the diagram as

consumers now have to pay a higher price for a smaller quantity of goods. Thegovernment receives PwPwt x Q2Q3 in tax revenue. Of the remainder of the lost

consumer surplus, part has gone in the cost of the extra factors of production

employed by domestic producers and part to producers in the extra profits that have

boosted their producer surplus. However, part of the lost consumer surplus has not

been reallocated to any other group; this is the net loss to society as a whole and is

referred to as the deadweight welfare loss.

Effect of the imposition of a tariff

Sd

Swt

Sw

Q1 Q3Q2

Pd

Pw

Pwt

Revenue from

tariff

Deadweight

welfare loss

D

Extra

costs

Inc in prodsurplus

QuantityQd Q4

Price


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Quotas

A quota is a quantitative restriction on the amount of goods allowed into a country.

Quotas can be set in terms of the number of units or value of goods imported.

The effect of a quota is to restrict the total supply to the domestic market and thereby

increase the price to consumers. This can be analysed in a similar way to the effect ofa tariff shown above. In a situation in which there is free trade, domestic suppliers

would have to compete at the world price.

Initially, at the prevailing world price, domestic consumers demand Q4. Of this

quantity, domestic suppliers provide Q1 and the remainder, Q1Q4, is supplied from

imports. When a quota of Q1Q2 is imposed, the new effective supply curve is Sd + q

at every price above Pw. The price that consumers have to pay therefore rises to Pq

and quantity demanded falls to Q3. Of this quantity, domestic suppliers provide Q5

and the remainder of Q5Q3 is supplied from imports. Overall, consumer surplus has

fallen by the total shaded area. Domestic producers have received an increase in

producer surplus, there are increased payments to domestic factors of production andforeign suppliers are now receiving a higher price for the goods they supply to the

domestic market. Again there is an overall deadweight welfare loss but, unlike with

the tariff, there is no import tax revenue for the government.

Effect of the imposition of a quota

Sd

Sw

Q1 Q3Q2

Pw

Pq

Sd + q

D

Inc in prod

surplus

QuantityQ5

Deadweight

welfare loss

Q4

Price


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Subsidies

Another method by which domestic suppliers can be helped to compete with foreign

producers is through the payment of government subsidies. This effectively tops-up

the price received in the market by domestic producers and makes it profitable for

them to supply a greater amount than was previously the case. Again the effect of the

payment of the subsidy can be analysed with the aid of a similar diagram.

Initially, without the subsidy and with the ruling world price at Pw, domestic

producers would only be prepared to supply Q1 and the rest of the domestic demand

for the good, Q1Q3, would have to be met from imports. If a specific subsidy of

PwPs is paid to domestic producers, then the domestic supply curve shifts to the right

to Sds. Domestic producers are now able to supply Q2 at the prevailing world price

and the amount of imports falls to Q2Q3. In this case, there is no reduction in

consumer surplus, as the market price and quantity remain the same at Pw and Q3.

However, domestic producers have received an increase in producer surplus, there

have been increased payments to domestic factors of production and the government

has to pay out a total subsidy of PwPs x Q2. There has therefore effectively been are-distribution of income from domestic taxpayers to domestic firms and factors of

production.

Effect of the payment of a subsidy to domestic producers

Sd

Sw

Q1 Q2

Pw

Ps

Sds

D

Quantity

Amount of

subsidy

Q3

Price


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Other trade barriers

There are a number of other ways in which domestic producers can be protected from

foreign competition. These include:

embargoes: complete bans on imported goods; exchange controls: limits on the amount of foreign currency that domestic

residents can use to purchase foreign goods and services;

voluntary restraint of export agreements: countries mutually agree to restrict theirexports to one another;

import licenses: importers are required to obtain a license before they can legallypurchase goods from abroad; and

administrative barriers: sometimes countries can use excessive bureaucracy,unnecessarily strict health and safety regulations and/or customs checks, and

government procurement policies that favour domestic producers to restrict

imports. As these restrictions are normally presented as being imposed for reasons

other than trade protection, they are often referred to as covert or hidden

barriers.

All trade barriers tend to cause some efficiency losses as they encourage less efficient

domestic production at the expense of restricting domestic consumers access to

cheaper imports. However, trade barriers are sometimes defended on economic and

non-economic grounds. The following is a brief outline of some of these arguments.

Arguments for trade barriers

The infant industry argument: This states that short-term protection can sometimesbe justified, particularly in less developed economies, in order to allow recently

established industries to develop and take advantage of as yet unexploited

economies of scale. Once these industries have developed sufficiently, it is argued

that the protection can be withdrawn. However, the danger is that industries may

become dependent on trade barriers and never learn to become fully efficient.

Anti-dumping: Sometimes countries may need to take action to protect theirindustries from unfair competition from goods being dumped from abroad.

These goods may be sold in the export market at prices lower than they wouldnormally be sold domestically, perhaps due to government subsidy. Dumping is

outlawed by World Trade Organisation (WTO) rules but it can often be difficult to

prove.

Demerit goods: Protectionist measures may sometimes be used to safeguardsociety from the over-consumption of demerit goods such as alcohol, tobacco and

narcotics that might arise from the availability of cheap foreign supplies of these

goods.

Employment: Countries may wish to maintain certain industries in which they donot have a comparative advantage in order to protect against the damage to

employment that might be caused by over-specialisation. If a country is heavily


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dependent on a small number of industries and these become subject to increased

competition from developing foreign producers with lower costs, then heavy

structural unemployment may be experienced.

Strategic reasons: A country may justify the use of trade barriers to protectindustries that it may depend upon in times of war or national emergency, forexample, steel, arms or agriculture.

Culture: It may be argued that protection of certain industries is justified in orderto maintain a certain way of life which is part of a countrys tradition and heritage.

When evaluating the effects of trade barriers, be sure that you weigh up the pros and

cons carefully. Use the tools of consumer and producer surplus to help you analyse

how different groups are affected and examine the overall effect on economic welfare.

Some students tend to neglect or underplay the effects on consumers.

Trade creation and trade diversion

Though students are normally able to understand the nature of the free trade area and

customs union formed by a trading bloc such as the EU, some find difficulty in

explaining the trade creation and diversion effects of these arrangements.

Trade creation refers to the effect on domestic consumer spending of the abolition of

tariffs between member countries. As domestic consumers are now able to find

cheaper foreign alternatives they will switch expenditure away from higher cost

domestic producers.

This effect is illustrated in the following diagram. It is the reverse of the effect of the

imposition of the tariff illustrated earlier. Initially, with the tariff in existence,

domestic consumers pay a price of Pt for Q3 goods. Q2 of this quantity is supplied by

domestic producers with Q2Q3 provided by imports. When the tariff is removed the

price falls to the EU level of Peu. Domestic consumers now consume Q4, with Q1

being provided from imports from other EU countries. The total shaded area

represents the increase in consumer surplus as a result of the removal of the tariff.

Part of this gain is accounted for by the loss of producer surplus, part by the reduction

in domestic costs of production through the unemployment of some domestic factors

of production and part by the reduction in the governments tax revenue. The

remainder represents the net welfare gain from the removal of the tariff.

Trade creation effect of removal of a tariff


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Trade diversion refers to the shift in domestic consumer expenditure from lower cost

suppliers of imports from outside the trading bloc to higher cost producers within the

trading bloc when a common external tariff is imposed. As illustrated previously, the

effects of the imposition of a tariff results in a loss of consumer surplus due to higher

prices being paid for a smaller quantity of goods. It also results in an increase in

producer surplus, an increase in costs of production, extra tax revenue and a

deadweight welfare loss.

The overall effect therefore on a countrys citizens of joining a free trade area and

customs union like the EU will therefore depend on the balance between trade

creation and trade diversion.

Sd

St

Seu

Q1 Q3Q2

Peu

Pt

Revenue lost

from removal of

tariff

Net welfare

gain

D

Reductionin costs

Reduction in

prod surplus

QuantityQ4

Price


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The balance of payments

The balance of payments is a record of all of a countrys financial transactions with

other countries over a given period of time. Students sometimes find difficulty in

explaining why the balance of payments as a whole must balance and tend to

misunderstand or ignore the nature of financing through drawing on or additions tothe official reserve assets which consist mainly of holdings of foreign currencies.

The UK Balance of Payments forms an important part of its national accounts. The

account is made up of two main sections.

Current account

The current account is principally a measure of payments and receipts generated by

international trade in goods and services. In the UK, the current account is divided

into four parts.

Trade in goods: exports of goods minus imports of goods. Trade in services: exports minus imports of invisibles such as financial services,

transport, travel and tourism, royalties and license fees.

Income: earnings from UK investments abroad and the repatriation of incomefrom UK nationals abroad minus earnings of other countries from their

investments in the UK and the repatriation of income from foreign nationals

working in the UK.

Current transfers. These are government, private and charitable sector transfersthat represent resources which are consumed within a short period after the

transfer is made, for example, food aid given to help deal with a famine in a less

developed country. Most of the transfers in this section relate to the UKs

membership of the EU. The UK pays part of its tax revenues to the EU but

receives payments such as agricultural subsidies and regional grants

If current account outflows are greater than inflows, then there is said to be a current

account deficit. If inflows exceed outflows, then there is said to be a current account

surplus.

Capital account and financial accounts

The capital account records all UK capital transfers. These are mainly associated with

debt forgiveness (debts owed by developing countries to the UK which have been

written off) and migrants transfers of capital assets as a result of immigration and

emigration. The capital account normally represents a very small proportion of the

total value of UK balance of payments transactions.


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The financial account records all inflows of capital into the UK and outflows of

capital from the UK. These include:

direct investment such as the provision of funds by major shareholders for thesetting up or expansion of factories and offices, mergers of companies and

acquisitions of businesses;

portfolio investment such as the purchase of stocks and shares by investors who donot have an important say in the running of the businesses concerned;

the purchase and sale of financial derivatives, that is, financial instruments theprice of which depends on the value of another (normally financial) asset or assets;

other investment including longer term foreign aid through the provision of tradecredits and loans; and

changes in reserve assets resulting from drawing on or adding to foreign currencyreserves and the borrowing from, or repaying debts to, foreign central or

commercial banks or the IMF.

Errors and omissions

As it is not possible to record all payments and receipts accurately, a figure is

included for net errors and omissions which result from inaccuracies in recording or

the failure to record certain transactions.

Why the balance of payments must balance

In an accounting sense the balance of payments must, by definition, balance because

it is based on a system of double-entry recording in which all economic transactions

have two sides: a credit and a debit. For example, when a UK importer buys a car

from abroad, the imported car is represented by a debit entry and the payment for it is

represented by a credit. A debit entry represents a change in UK ownership of other

countries assets and a credit entry represents a change in other countries ownership

of any sort of UK asset (real or financial).

Inflows of foreign exchange are required to enable outflows to occur. If there is a UK

balance of payments current account deficit, then this has to be matched by a capital

and financial account surplus. If capital inflows from other sources are less than the

current account deficit, then the Bank of England has to finance this through drawing

on its reserve assets or borrowing from foreign central or commercial banks or the

IMF. Similarly, if there is a current account surplus which is not matched by capital

outflows from other sources, then the Bank of England will add to its reserve assets or

pay off foreign debts.

The following is a summary of the 2008 UK Balance of payments accounts. All

figures are in billions and have been rounded for simplicity.


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UK Balance of Payments Account, 2008 (bn)

Credit Debit

Current Account:

Trade in goods 251 344

Trade in services 170 116

Income 264 237

Current transfers 15 29

Current account total 700 726

Capital and financial accounts

Capital account 6 2

Financial account:

Direct investment 52 73

Portfolio investment 241 -129

Financial derivatives (net) -18Other investment -930 -580

Reserve assets (net) -1

Capital and financial accounts total -631 -653

Current, capital and financial accounts

total

69 73

Net errors and omissions 4


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How will I be assessed?

Assessment at A2 is a step up from what you experienced at AS level. It is intended

to stretch you and be more challenging. You are expected to deal with less familiar

contexts and more complex information. There is a greater emphasis on analysis and

evaluation and less on pure knowledge and understanding. Questions are lessstructured and more open-ended giving you scope to answer in a variety of ways.

Some of the questions may require you to make links with other sections of the

course.

Assessment for this unit consists of a 2 hour examination which you will sit either in

January or in June. The examination will consist of two sections: an unseen case

study section and an essay section, each of which will carry 40 marks (50% of the

total marks for the paper).

While there is no hard and fast rule, it is suggested that you should spend at least half

the examination time on the case study section. You need to take into account thatyou have more material to read on this section. However, you still need to leave

sufficient time to choose which essay question you are going to attempt, and to plan

and write your essay. It is suggested that you spend at least 50 minutes on the essay

section of the paper.

Case study

The case study consists of a small number of pieces of source material about a

particular topic, theme or issue. The source material may be a mixture of written

information such as newspaper or magazine articles and/or charts or graphs.

You will be asked four questions which relate to the source material. One of the

questions in this part of the paper will require a relatively short answer while others

will require you to write at greater length.

In this part of the paper you may be required to analyse and interpret written,

numerical, diagrammatic and graphical data. This may require you to make

calculations such as percentages and percentage changes and to handle index

numbers. The final question will normally require you to demonstrate your ability to

evaluate a particular viewpoint or opinion.

Essay

In the essay section you will be required to answer one structured essay from a choice

of three. Each essay will be broken down into two parts.

Part (a) will assess knowledge and understanding and application and analysis will

carry 15 marks.

Part (b) will also test application and analysis but will have a particular emphasis on

evaluation andjudgement and will carry 25 marks.


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Quality of written communication

All questions, other than the first in the case study section, will require you to write

extended answers. Assessment of your answers to these questions will take into

account the quality of your written communication. This does not mean that you have

to write elegant phrases with long words to earn high marks. It does mean, however,that you should take care with your spelling, punctuation and grammar and that you

should use economic vocabulary accurately.

You should try to express your ideas clearly and concisely and present your

arguments logically and coherently. You should always write in sentences and

paragraphs and avoid lists of bullet points unless you are short of time to complete a

question.

Diagrams can be a valuable feature of many answers, helping to clearly illustrate the

points you are making. However, you must make sure that you draw and label your

diagrams accurately and clearly and that you explain what they are showing.

How can I make the most of my ability?

Economics affect the lives of everybody. To develop real understanding you need to

relate what you study in class to national and international economic events and issues

that are reported in the media. Following the tips below will help to develop your

interest and understanding of the content of this unit.

Follow the news: International economics features most days on TV, radio and in the

papers. Paying attention to the economics sections of the news will not only increaseyour understanding but give you examples you can use in exams.

Use the Internet: There is a great deal of valuable information about the global

economy on the internet but you need to be selective in how you use websites.

Tutor2u has very useful sections and good discussions in its Economics Blog. The

BBC and Guardian economics sites are also very helpful with illuminating

discussions, debates and examples. There are many other useful web addresses in the

CCEA Resource List.

Read around the subject: There are a number of excellent textbooks, magazines and

journals available which cover the content of this unit in detail. The resource list thatfollows covers some of the most commonly used textbooks and other sources of

information which are available. However, this should not be interpreted as

prescribing particular resources. For more advice, consult your teacher. Reading

around what you discuss in class is an excellent way of broadening and deepening

your understanding.

Be organised: There is quite a lot of content in this unit, but you should already be

familiar with some of the key ideas and concepts from your study of Units AS 1 and

AS 2. Make sure that you organise your notes effectively so that you cover each of the

main sections. There are more detailed Study Tips on the CCEA Economics micro-

site: www.ccea.org.uk/economics/.


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Develop good examination technique: Exams can be stressful but by being well

prepared and confident of how you are going to approach the paper, you can minimise

the stress and make sure you give of your best on the day. Following the advice

below will help.

Make sure that you thoroughly revise all aspects of the unit content. Do not avoidstudying difficult topics or try to spot questions. This might mean that you

cannot answer some questions and restrict your choice.

Understand fully what the examiners expect you to be able to do. Familiariseyourself with the specimen questions and mark schemes that CCEA has produced.

Write practice answers to the different types of question and check them againstyour notes. Make sure you practise using examples to illustrate your points and

arguments.

Remember that the time spent on each question should reflect the mark allocation.Dont spend half an hour on a five mark question and leave yourself short of time

to answer questions with much higher mark allocations.

Only do what the question asks you to do - there are no marks for includinginformation that the question doesnt ask for.

Make sure you use the case study information and refer to it in answeringQuestion 1.

Remember that the final case study question and part (b) of the essay questionswill normally require balanced answers that address both sides of the issue. Youneed to think critically and evaluate before coming to a reasoned overall

judgement.

This unit is partly about economic theories but it is also about how these theoriesapply to the real economy. Be sure to include realworldexamples and provide

evidence to support your arguments.

The exam is not just a test of your knowledge and understanding. It assesses howwell you interpret questions and select relevant information. It examines how

effectively you can analyse and evaluate and how clearly you can communicateyour ideas.

Remember! To score highly, you must answer the questions directly. Read andre-read the questions and make sure you know exactly what they are asking before

you start writing. Think carefully about the command words and what they

require you to do, for example, explain, analyse, critically examine, compare,

discuss and evaluate.


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Further resources

Text books

Anderton A:Economics (5thed), Pearson Education

Beardshaw, J et al:Economics: A Students Guide, Pearson EducationBegg D, Fisher S & Dornbusch R:Economics (9th

ed), McGraw Hill

Cramp, P: Understanding Economic Data, Anforme

Cramp, P:Development Economics (4th

ed), Anforme

Grant S & Bamford C: Studiesin Economics and Business: The European Union(5

thed), Heinemann

Krugman P and Oldfield M:International Economics: Theory and

Policy(7th

ed), Pearson Education

Lipsey, R & Chrystal, K:Economics (11thed), Oxford University Press

Sloman, J:Essentials of Economics (4th

ed), Prentice Hall

Magazines and journals

Economic Review: www.philipallan.co.uk

Economics Today: www.anforme.co.uk

The Economist: www.economist.com

Websites

Tutor2U www.tutor2u.net/

BIZED http://www.bized.co.uk/learn/economics/index.htm

UK Treasury www.hm-treasury.gov.uk

The Bank of England www.bankofengland.co.uk

The Office for NationalStatistics

www.ons.gov.uk

European Central Bank www.ecb.int

The International Monetary

Fund

www.imf.org

Organisation for Economic

Cooperation and Development

www.oecd.org

The Institute for Fiscal

Studies

www.ifs.org.uk

The World Bank www.worldbank.org

Department of Enterprise,

Trade and Investment

www.detni.gov.uk

Office of National Statistics www.statistics.gov.uk/

Organisation of the Petroleum

Exporting Countries

www.opec.org/home/

The Financial Times www.ft.com

The Times www.the-times.co.uk

The Independent www.independent.co.uk

The Guardian www.guardian.co.uk

The Daily Telegraph www.telegraph.com

The Economist www.economist.com

BBC Business News http://news.bbc.co.uk/1/hi/business/default.stm

David Smith Economic Blog www.economicsuk.com/blog

Freakonomics Blog freakonomics.blogs.nytimes.com/


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Glossary

Absolute advantage: A situation in which one country is able to produce a good

more efficiently than another country. This means that it can produce the good using

fewer resources.

Appreciation (of a currency): A risein the exchange rate of a currency so that a

given amount of this currency now buys more of another currency.

Balance of payments account: A recordof one countrys financial transactions with

the rest of the world over a given period of time, normally a year.

Capital and financial accounts (of the balance of payments): The sectionsof the

balance of payments that record all capital transfers and capital flows into and out of

the UK.

Common Agricultural Policy (CAP): The agricultural policies of the EU designed

to support and stabilise farmers incomes and guarantee the supply of food at a

reasonable price.

CAP reform: In recent years, there have been attempts to reform the CAP which had

proved to be a very large drain on the EU budget and had resulted in high agricultural

prices and surpluses of certain food products. Reforms have included the decoupling

of payments to farmers from the amount they produce, reductions in guaranteed

minimum prices, the rewarding of farmers for protecting and improving the

environment, cutting payments to the largest farms and providing funds for rural

development.

Common currency area: A group of countries that agree voluntarily to adopt the

same currency, for example, the eurozone.

Comparative advantage: A situation in whichone country is able to produce a good

at a lower opportunity cost than another country.

Current account (of the balance of payments): The section of the balance of

payments account which records payments for the purchase and sale of goods and

services.

Customs union: A group or bloc of countries which agrees to impose a common

external tariff on imports from outside these countries.

Deficit: A situation in which expenditure is greater than earnings. A deficit on the

current account of the balance of payments would occur when expenditure on imports

of goods and services is greater than earnings from exports.

Depreciation (of a currency): A fall in the exchange rate of a currency so that a

given amount of that currency now buys less of another currency.

Devaluation: A decisionby a government to fixthe exchange rate of its currency at alower value than it held previously.


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Economic and Monetary Union (EMU): The adoption of a single currency by

certain members of the EU. The main effects of this on member counties are ease of

trade, transparency of prices and the need for a single monetary policy formulated by

the European Central Bank (ECB).

Economic development: The process by which a country is able to satisfy the basicneeds of its inhabitants, raise their living standards and widen the range of economic

and social choices open to them.

Enlargement (of the EU): The expansion of EU membership to include some of the

former Eastern bloc countries and other countries within Europe. Applicants for EU

membership have to prove that they can adopt the Unions economic policies, have

effective competition policies and are able to protect the rights of minority

communities within their countries.

Environmental policy: The plans and measures adopted by individual countries and

international economic groupings to protect the environment.

European Central Bank: This is the central bank of the eurozone. Through a

committee of representatives of member countries, it decides on monetary policy and

sets the official interest rate for the eurozone.

European Union (EU): The EU is a customs union and free trade area providing a

common market through which goods and people can travel between member

countries can move relatively unhindered by regulation and border controls.

Euro: The single European currency used by the majority of the member countries of

the European Union.

Eurozone: The trading area formed by the EU countries which have adopted the euro

as their single currency.

Exchange rate: The rate at which one currency exchanges for another, that is, the

price of one currency expressed in terms of another.

Fair trade: The purchase of goods from developing countries at prices which

guarantee a fair return for producers. The fair trade movement tries to encourage

importers and consumers to purchase designated fair trade goods and to discouragethe consumption of goods which are produced by very cheap labour.

Fiscal policy: All government measures involving taxation, other means of raising

revenue and expenditure.

Fixed exchange rate: Thisoccurs when the price of a currency is set at a particular

level in terms of another currency. The exchange rate is prevented from moving

outside of a very narrow margin either side of its set rate through intervention in the

foreign exchange market by the countrys central bank.


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Foreign aid: Assistance offered by wealthier economies to developing countries.

This may take the form of financial grants, the provision of technical expertise, loans

or tied aid which is linked to the recipient countrys purchase of goods and services

from the donor.

Floating exchange rate: An exchange rate that is determined by the market forces ofdemand and supply. The exchange rate will move in response to changes in exports,

imports and international capital movements.

Free trade: International trade which is free from barriers or import controls such as

tariffs and quotas.

Free trade area: A group or bloc of countries which encourages free trade amongst

its members. Members may retain their own trade barriers against other countries as

in the North American Free Trade Area (NAFTA) or also form a customs union and

impose a common external tariff as in the EU.

Globalisation: The process by which the international economy has become more

open and world markets for goods, services and capital have become more integrated.

Globalisation is often associated with economic growth and improvements in the

standard of living but has also been criticised for making large multinational

companies more powerful at the expense of the populations of the poorest countries.

The Group of 20(G20): This is a discussion forum for the Finance Ministers and

Central Bank Governors of the main industrialised and developing economies. It

meets to discuss issues related to global economic stability such as policies for

economic growth and the regulation, supervision and functioning of world financial

markets.

International Monetary Fund (IMF): The IMF attempts to coordinate the

international monetary system and ensure that there is sufficient liquidity to finance

the growth of world trade. Member countries make financial contributions to the fund

in proportion to the size of their economies. The IMF will provide loans to countries

which are experiencing persistent balance of payments problems but will usually

impose conditions designed to ensure that the underlying economic problems of the

country are addressed.

Less developed country (LDC): A country which has a relatively low GrossNational Product (GNP), a poorly developed economic infrastructure and which tends

to be economically dependent on agricultural production.

Marshall-Lerner condition: This states that a devaluation of a currency will only

improve a countrys balance of payments situation if the sum of the price elasticities

of demand for its exports and imports is greater than one.


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Monetary policy: Policy designed to influence the cost and availability of credit in an

economy. In an increasingly open global economy, the operation of monetary policy

may require international cooperation and coordination if it is to be effective in

combating problems like the credit crunch and recession. In the UK, monetary policy

is operated by the Monetary Policy Committee of the Bank of England. In the

eurozone, it is operated by the European Central Bank (ECB).

Open economy: Aneconomy which has few trade barriers and depends heavily on

international trade and the free movement of people and capital. Government macro-

economic policy in open economies may be difficult to operate without coordination

with trading partners as the economy may be destabilised capital movements.

Opportunity cost ratio: The cost of producing one unit of a particular good or

service expressed in terms of the amount of another good that has to be foregone.

Protectionism: Policy measures which are designed to protect domestic producers

from foreign competition. These include tariffs, quotas and administrative barriers.

Quota: An import control which imposes a limit on the quantity of goods that can be

imported.

Stabilisation (of an exchange rate): The use of central bank foreign exchange

reserves to maintain a currencys exchange rate within a given band. If the exchange

rate is considered to have fallen too low, the currency can be purchased by the central

bank on the foreign exchange market using its reserves of other currencies. If the

exchange rate is considered to have risen too high, then the currency can be sold and

the proceeds added to the foreign currency reserves.

Surplus: A situation in which earnings are greater than expenditure. A surplus on the

current account of the balance of payments would occur when earnings from exports

of goods and services are greater than expenditure on imports.

Sustainable economic development: Development of an economy which occurs at a

pace which can be maintained over the long term because it does not produce

shortages of factors of production which will lead to high levels of inflation or lead to

the over-use of finite or non-renewable resources.

Tariff: A tax on imports or customs duty normally designed to raise the price ofimports and thereby reduce foreign competition to domestic production.

Terms of trade: The exchange rate or price of exports in terms of imports. The terms

of trade index expresses the price of exports relative to the price of imports and is

calculated by the following formula: index of export prices x 100.

index of import prices

A rise in the terms of trade index is referred to as an improvement as it means that

fewer exports have to be sold to purchase a given quantity of imports. Conversely, a

fall in the terms of trade index is referred to as a worsening or deterioration.

Trade barriers (or controls): Measures such as tariffs and quotas designed to protectdomestic producers from foreign competition.


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Trade creation: The increased specialisation and trade brought about by the

formation of a trading group or bloc that abolishes or reduces trade barriers between

member countries. Domestic consumers will tend to switch some expenditure from

higher cost domestic producers to lower cost imports.

Trade diversion: The effect of a trading group or bloc imposing a common externaltariff on goods entering from non-member countries whilst abolishing or reducing

trade barriers between member countries. Domestic consumers will tend to switch

expenditure away from the production of non-member countries to the production of

member countries.

Trade war: Asituation in which protectionist measures introduced by one country or

a trading bloc result in retaliatory measures being taken by other countries. In such a

situation all countries involved tend to lose as the efficiency and welfare gains of

specialisation and trade are lost.

Trade liberalisation: The process of making world trade more free by the reductionand, where possible, elimination of trade barriers.

World Bank: This is the informal name given to the International Bank for

Reconstruction and Development (IBRD). It borrows money in international capital

markets and lends this to developing countries to finance projects which are designed

to improve areas such as infrastructure, health and education provision, agriculture

and industry.

World Trade Organisation (WTO): The organisation which supervises and

regulates international trade. It aims to promote trade liberalisation by negotiating the

reduction of trade barriers between member countries. It also helps to resolve trade

disputes between members.


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Revision checklist

Section 1: International trade and protection

At the end of this section you should be

able to:

Notes

Explain why countries trade.

Apply the concept of specialisation and the

theory of comparative advantage to

illustrate the gains from trade.

Evaluate the usefulness of the theory of

comparative advantage.

Explain and evaluate arguments for andagainst free trade.

Explain the range of trade controls which

may be used and evaluate their effects.

Explain the main aims of the WTO and

evaluate how well it has achieved them.


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Section 2: The UK balance of payments and the exchange rate


able to:

Notes

Explain the main components of the UK

balance of payments accounts and howthey relate to one another.

Describe the main trends in the UK

balance of payments in recent years.

Explain the problems caused by large and

persistent balance of payments deficits and

surpluses.

Explain and evaluate the differentmeasures that might be used to correct

these imbalances.

Explain how exchange rate values are

determined when they are allowed to

float.

Analyse the effects of changes in the

exchange rate.

Explain how an exchange rate may bestabilised and the benefits of stable

exchange rates.


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Section 3: The European Union

At the end of this unit you should be able

to:

Notes

Explain the main features of the existence

of a free trade area, customs union andcommon currency area within the EU.

Explain the trade creation and trade

diversion effects of the EU.

Evaluate theeffects of EUenlargement

and the possible extension of the eurozone.

Explain the roles and analyse the impact of

the ECB.

Analyse and evaluate the effects of the

CAP and attempts to reform it.

Section 4: Globalisation and economic development


able to:

Notes

Explain the main features of globalisation.

Analyse and evaluate how globalisation

has affected developed and less developed

economies.

Explain how international organisations

such as the WTO and G20 may influence

the international economy.

Explain the process of economic

development and the factors that may help

or hinder it.

Explain the parts played by governments

and other bodies in providing aid to less

developed and developing economies.

Compare the effectiveness of foreign aid

and trade liberalisation in assisting

economic development.


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Section 5: Macroeconomic policy in an open economy


able to:

Notes

Explain the pressures in open economies

that may lead countries to develop policiesto protect the environment.

Analyse how a countrys fiscal and

monetary policies may be affected by

international factors.

Documents

Econ a2 2 Course Companion