Understanding the Global Economy

The Global Economy

• Nations export goods/services, creating an inflow of money or injection.
• Nations import goods from foreign producers, resulting in an outflow or leakage.
• The level of income for an open economy is Y = O = E = C + I + G + (X-M).
• Leakages reduce income flows.
• Leakages = S + T + M (Savings + Taxes + Imports).
• Injections increase the flow of money.
• Injections = I + G + X (Investment + Government spending + Exports).
• At equilibrium, S + T + M = I + G + X
  • If S + T + M > I + G + X, income will fall.
  • If S + T + M < I + G + X, income will rise.
• National income is determined by aggregate demand.
• Total Expenditure = E = C + I + G + (X-M).
• At equilibrium Y = O = E, thus Y = C + I + G + (X-M).
• An open economy trades with other nations.
• The circular flow model incorporates income flows generated by the external sector.
  • Leakages occur through expenditure on imports.
  • Injections occur through exports.

Complexities of International Trade

• Trade involves different currencies.
• Purchasing power differences necessitate exchange rates.
• Production methods vary globally affecting labor-capital mix.
• Capital-intensive production is generally cheaper but labor may be preferred for some products.
• Domestic market size can limit economies of scale
• Transport costs can be substantial and isolating.
• Social differences include language, customs, and religion.
• Multinational corporations greatly influence trade.
• Intra-corporate trade and transfer pricing can distort competition.
• Multinationals operate across countries.
• Governments prioritize their citizens, influencing national policies.
  • Governments intervene to pursue economic aims.
• Social structures and income distribution affect affordability.
• Technical specifications like voltage vary across countries.
• Producers adjust processes to enter markets, raising production costs.
• International trade expands markets and provides access to goods/services.
  • It also provides job opportunities and cheaper products.
• Adam Smith: Import if cheaper to buy than produce.

Winners and Losers of Trade

• Overall, international trade has net benefits.

• Winners: Consumers, exporters, workers in export industries

• Losers: Domestic companies, workers in uncompetitive industries

• International trade depends on: Demand, location, stability, interest. exchange rates, and peace.

Theories of International Trade

• Mercantilism focuses on maximizing exports and minimizing imports to maintain a favorable trade balance that increases the states gold and silver deposits.

• Absolute Advantage: A nation can produce a commodity more efficiently than others.

  • Mutual benefit if each specializes in producing goods with an absolute advantage.

• Comparative Advantage: Nations trade based on opportunity costs.

• Opportunity cost is the potential profit lost from choosing one alternative over another.

Calculating Comparative Advantage

• Divide cloth by wine to find the opportunity cost of wine.

• Divide wine by cloth to find the opportunity cost of cloth.

• Nations tend to export goods which have abundant factors of production, and import goods that are scarce.

• Australia exports its' abundant resources and imports goods it has less of.

• Specialization leads to economies of scale which lowers costs

• Production Possibility Frontier (PPF) illustrates the possible quantities that can be produced of two products

  • Increasing productivity shifts the PPF outward, representing economic growth.

• Economies of scale are cost advantages from increased production volume.

• Leontief Paradox: Heckscher-Ohlin predictions are not based on empirical evidence.

  • Human capital is now factored into production

Competitive Advantage (Michael Porter)

• A nation's competitiveness depends on its industry's capacity to innovate and upgrade.

• Continual innovation fosters competitive advantage.

• Four factors for competitive advantage:

  • Factor Conditions, skilled labor or infrastructure.
  • Demand Conditions, understanding buyer needs.
  • Related and Supporting Industries, efficient suppliers which supports factor inputs.
  • Firm Strategy, Structure and Rivalry, domestic competition

• International competitiveness is the ability of industries to compete.

  • Reflected in endowments, geography, efficiency, and currency.

• The elements of competitiveness are productivity and innovation.

• International product life cycle theory explains exports becoming imports over time.

Australian in the Global Economy

• Trade relates to one in five Australian jobs.
• Both exports and imports create jobs.
  • Export jobs pay higher wages.
• The 1980s policy was designed to integrate Australia into the global economy.
• Increased exports stimulate the economy and national income.
• Decreased exports restrain economic activity and national income.
• Increased imports restrain economic activity.
  • Unless economy is already experiencing higher growth
• Decreased imports stimulate economic activity.

Trade Balance

• Net exports affect Australia's GDP growth rate.
• A trade deficit occurs when imports exceed exports.
• A trade surplus is when exports exceed imports.

Exchange Rates

• There are two types of exchange rates: Fixed and Floating
• Fixed exchange rates: Value is set to another currency.
  • Changes occur only with government intervention.
  • Governments intervene if fixed value differs from market value
• Currency devaluation is a downward adjustment under a fixed rate.
• Currency revaluation is an upward adjustment under a fixed rate.
• Overvalued A$: Supply exceeds demand. This requires government to buy A$ to reduce supply and maintain the rate.
• Fixed exchange rates provide stability and predictability.
• Disadvantages of Fixed exchange rates:
  • Requiring stock of reserves, leading to speculation, causing large economic impacts, creating internal instability and causing government to default.
• Floating exchange rates are determined by market forces.
• Appreciation: Demand increases or supply decreases
• Depreciation: Demand decreases or supply increases
• Floating exchange rates maintains equilibrium, money supply unnafected, but exchange rates fluctuate.
• Factors affecting A$ demand include demand for Aus exports and capital inflow
• Demand is influenced by inflation, income, tastes, and growth.
• Capital inflows are influenced by interest rates.
  • Speculation on future value fuels demand.

Effects of Exchange Rates

• A decline in value or if $A buys less $US or € or £:

  • Winners: Exporters, Tourists to Australia, Domestic competitors, property.
  • Losers: Australians going overseas, computer industry, The importer, The retailer, The car industry,

• An appreciation in value or if $A buys more $US or € or £:

  • Winners: retailers
  • Losers: Exporters and tourist industry

• Managed/Dirty Float: The central bank intervenes in the floating exchange market.

• Trade Weighted Index (TWI): The domestic dollar is measured against its trade partners.

Balance of Payments

• Balance of payments summarizes a nation's payments to and receipts from the world, consisting of: the current account and capital account.
• Debits are payments to the world.
  • In the current account, debits are merchandise imports, services performed by foreigners, income from foreign investments in Australia, and unrequited transfers
  • In the capital account, debits are government outflow
• Credits are payments received from the world
  • In the current account, credits are merchandise exports, services performed by Australians, income from investments overseas, and unrequited transfers
  • In the capital account, credits are government inflow
• A current account surplus means more exports and incoming payments.
• A capital account deficit means credits are worth less than debits.
• Current account and capital account are equal to give balanced payments

Terms of Trade

• Balance of Trade is the value difference between exports and imports.
• Terms of Trade relate export prices to import prices.
• Terms of Trade = (General Level of Export prices) / (General Level of Import prices).
• Terms of Trade Index measures price fluctuations.
• Terms of Trade index = (Export price index/Import price index) x 100
• Terms of trade increases if export prices increase more than import prices,
• Favorable outcome: when the price of exports rises and the price of imports remains stable or falls, it is possible to buy more imports.

Unfavorable Trade

• Export prices decrease and the price of imports can remain stable or rise.
• This decreases the standard of living.
• Persistent trade deficits affect the economy negatively.
• The government could devalue and import restrictions
• It can provide export incentives.

Globalization

• Globalization is the increasing integration of national economies.
  • Increased trade intensity
  • One Price Theory
  • integration of financial markets
  • Increased Foreign exchange turnover
  • Convergence of yields
  • Rise of Multinationals
• Globalization is faciltated by: Technologies, Resolutions of global conflicts, Changed development strategies
• Globalization requires: Trade and investment liberalization, Market potential in developing countries, Market-Friendly Policies
• Factors limiting globalisation: Difference in: Culture and economics.
• Other limiting factors: National sovereignty,, Strategy and costs.
• Globalization is driven by: Market Expansion, governments, and the economy.
• Globalization can produce Macroeconomic Management, domestic policy
• It can be De-industrialisation in developed economies.

Impacts of Globalization

• Positives: Trade, choice, competition
• Negatives: Monopoly and unemployment and tax avoidance.
• Trade exposure can cause industry collapse
• Positive: Increased variety of goods/services, cheaper prices, growth.
• Negative: Job losses, overseas ownership.
• Exposing local firms to international competition can cause businesses to shut down
• The government promotes effeciency. - Allocative Efficiency utilizes country's productive resources
  • Dynamic effeciency refers to an economy's flexibility in the face of changing needs.
• MNCs operate in many countries but managed one.
• Supply chains move products from supplier to consumer.
• MNCs integrate supply chains to reduce production costs and optimize for global economy.

Australia's International Trade

• Supply chains take advantage of economies (scale, technology, infrastructure, incentives).
• Globalization and international trade depends on the absence of conflict and pandemics.
• Exports are rising.
• Resources and Energy are exports.
• Principal partner is China is the most important trading partner with Australia
• Austraila is effected by: Disruptions of China through trade and COVID and shut border.
• Record high trade of milk exports from Australia to China in 2020.
• Higher Trade
  • Vaccine
  • Return to pre-covid
  • Re-establish relations Australia and China