Ib Econ Unit 3 Pyszczek

IB
Economics SL: City Honors School
IB Economics SL
Unit 3: Interna4onal Economics
Mr. R.S. Pyszczek, Jr.
City Honors School
IB Economics SL: City Honors School

3.1 Interna+onal Trade
Free Trade
The Benets of Trade
l
Explain that gains from trade include lower prices for consumers, greater choice for
consumers, the ability of producers to benet from economies of scale, the ability to
acquire needed resources, a more ecient alloca4on of resources, increased
compe44on, and a source of foreign exchange.

Free Trade
The Benets of Trade
l Lower Prices: Countries like individuals can specialize in
par4cular areas of exper4se. This means they can produce

more eciently than if each country tried to produce enough
of everything for all its needs

Free Trade
The Benets of Trade
l Taking Advantage of Dierent Factor Endowments: No two
countries share the exactly the same resource base. Trade

takes advantages of these dierences between countries

Free Trade
The Benets of Trade
l Economies of Scale: As produc4on levels grow ever larger to
meet interna4onal demand, the specializa4on of managers and

the introduc4on of expensive technology can improve the
produc4vity of a given business sector.

3.1
Interna+onal Trade
Free Trade
The Benets of Trade
l Increased Variety/Choice: We are an interdependent wordl economy.
As the number of countries in the global market has grown, so has

the amount of choice. While some nd these choices overwhelming,
others enjoy the power it gives to consumers to make decisions
about their purchases

Free Trade
The Benets of Trade
l Acquisi4on of needed resources: Some countries lack cri4cal
goods to improve their standard of living. In some cases,

produc4on of a needed good is simply impossible. Trade is the
only way to get it.

3.1
Interna+onal Trade
Free Trade
The Benets of Trade
l Compe44on can improve eciency: When a company controls a
market, it lacks compe44ve incen4ve to provide good service and

lower costs. When domes4c markets are opened to foreign
compe44on, companies are pressed into lowering prices and
improving service or they suer from foreign compe44on.

Free Trade
The Benets of Trade
l Poli4cal Benets: Economists and Poli4cal thinkers generally
agree that trade and integra4on have consistently encouraged

compromise and resolu4on over conict and antagonism.

3.1
Interna+onal Trade
Free Trade
The Benets of Trade
l Eciency and Exports = growth and development: Development
economists have concluded that exports can be a path to signicant

economic growth. When countries develop their compara4ve
advantages, they become compe44ve and export to world markets

Free Trade
The World Trade Organiza4on (WTO)
l
Describe the objec4ves and func4ons of the WTO.

Free Trade
Aims of the World Trade Organiza4on (WTO)
l Trade without discrimina4on
l Freer Trade through nego4a4on

3.1
Interna+onal Trade
Free Trade
Aims of the World Trade Organiza4on (WTO)
l Predictability through binding and transparency
l Promo4ng fair compe44on
l Encourage development

3.1
Interna+onal Trade
Free Trade
Func4ons of the World Trade Organiza4on (WTO)
l Provide a forum for trade nego4a4on
l Execute WTO agreements
l Evaluate and rule on trade complaints by member countries

Free Trade
Func4ons of the World Trade Organiza4on (WTO)
l Provide technical assistance to developing countries on
trade issues
l Track changes in member trade policies

3.1
Interna+onal Trade
Free Trade
Supporters View of the World Trade Organiza4on (WTO)
l The WTO Promotes peace.
l The WTO provides a place to handle disputes construc4vely
l The WTO is based on rules rather than power

3.1
Interna+onal Trade
Free Trade
l Free Trade cuts the cost of living
l Trade provides greater consumer choice and variety
l Trade boost incomes

3.1
Interna+onal Trade
Free Trade
l Trade increases economic growth.
l The WTO system encourages eciency and simplicity
l WTO agreements shield countries from narrow interests

3.1
Interna+onal Trade
Free Trade
Cri4cs View of the World Trade Organiza4on (WTO)
l Poor countries some4mes cannot aord trade representa4ves.
l Rich countries and individuals are ge^ng richer faster than
everyone else

3.1
Interna+onal Trade
Free Trade
l Agricultural subsidies in rich countries hav not been reduced.
l The protec4on of intellectual property rights. (lack of
protec4on)

3.1
Interna+onal Trade
Free Trade
l Despite claims to equalize the trade environment, WTO
nego4a4ons favor rich countries
l It is argued that most of the gains in trade have come from
trade between rich countries

3.1
Interna+onal Trade
Restric+ons on Free Trade: Trade Protec+on

Types of Trade Protec4on
l
Explain, using a tari diagram, the eects of imposing a tari on imported goods on
dierent stakeholders, including domes4c producers, foreign producers, consumers and
the government.
Explain, using a diagram, the eects of se^ng a quota on foreign producers on dierent
stakeholders, including domes4c producers, foreign producers, consumers and the
government.

3.1
Interna+onal Trade

l
Explain, using a diagram, the eects of giving a subsidy to domes4c producers on

dierent stakeholders, including domes4c producers, foreign producers, consumers and
the government.
Describe administra4ve barriers that may be used as a means of protec4on.
Evaluate the eect of dierent types of trade protec4on.

3.1
Interna+onal Trade

l
Taris
Quotas
Voluntary Export Restraints (VERs)
Subsidies

l Administra4ve Barriers
l Exchange Rates
l Na4onalis4c Campaigns

Arguments for and Against Trade Protec4on (arguments against and for free trade)
l
Discuss the arguments in favour of trade protec4on, including the protec4on of

domes4c jobs, na4onal security, protec4on of infant industries, the maintenance of
health, safety and environmental standards, an4-dumping and unfair compe44on, a
means of overcoming a balance of payments decit and a source of government
revenue.

Arguments for and Against Trade Protec4on (arguments against and for free trade)
l
Discuss the arguments against trade protec4on, including a misalloca4on of

resources, the danger of retalia4on and trade wars, the poten4al for corrup4on,
increased costs of produc4on due to lack of compe44on, higher prices for domes4c
consumers, increased costs of imported factors of produc4on and reduced export
compe44veness.

3.1
Interna+onal Trade

Arguments for Trade Protec4on (arguments against and for free trade)
l
To protect domes4c employment
To protect sunrise or infant industries
To counteract rela4ve domes4c tax dierences

3.1
Interna+onal Trade

l
To prevent dumping of foreign goods onto the domes4c market
To diversify the produc4on base of a developing country
To enforce product standards

3.1
Interna+onal Trade

l
To raise government revenue
To protect against unfairly low labor costs
To protect strategic industries

Arguments for Trade Protec4on (arguments against and for free
trade)
l To overcome a balance of payments decit
l To improve the terms of trade

3.1
Interna+onal Trade

Arguments Against Trade Protec4on (arguments against and for free
trade)
l
Misalloca4on of resources
Escala4on to a trade war
Protec4onism as a corrup4on magnet

3.1
Interna+onal Trade

Arguments Against Trade Protec4on (arguments against and for free
trade)
l
Domes4c complacency causes higher prices and costs
Higher import costs
Reduced export compe44veness

Theory of Knowledge: Poten+al Connec+ons
Are there moral as well as economic arguments in favor of free
trade?

3.2
Exchange rates
Freely Floa+ng Exchange Rates

Determina4on of freely oa4ng exchange rates
l Explain that the value of an exchange rate in a oa4ng system
is determined by the demand for, and supply of, a currency.
l Draw a diagram to show determina4on of exchange rates in a
oa4ng exchange rate system.

3.2
Exchange rates

Determina4on of freely oa4ng exchange rates*
Forex Market (Foreign Exchange)
l
The Forex market is an interna4onal over-the-counter market (OTC). It

means that it is a decentralized, self-regulated market with no central
exchange or clearing house, unlike stocks and futures markets. This
structure eliminates fees for exchange and clearing, thereby reducing
transac4on costs.

3.2
Exchange rates

Determina4on of freely oa4ng exchange rates*
Forex Market (Foreign Exchange)
l The Forex OTC market is formed by dierent par4cipants with
varying needs and interests that trade directly with each other.
These par4cipants can be divided in two groups: the interbank
market and the retail market.

3.2 Exchange rates
Determina4on of freely oa4ng exchange rates: Forex Market
The Interbank Market
The interbank market designates Forex transac4ons that occur
between central banks, commercial banks and nancial
ins4tu4ons.

3.2
Exchange rates
Determina4on of freely oa4ng exchange rates: Forex Market The Interbank

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

3.2 Exchange rates
Determina4on of freely oa4ng exchange rates: Forex Market The Interbank
Market
l
Commercial Banks - Commercial banks (such as Deutsche Bank and Barclays) provide liquidity
to the Forex market due to the trading volume they handle every day. Some of this trading
represents foreign currency conversions on behalf of customers' needs while some is carried
out by the banks' proprietary trading desk for specula4ve purpose.

3.2
Exchange rates

Determina4on of freely oa4ng exchange rates: Forex Market The
Interbank Market
l
Financial Ins+tu+ons - Financial ins4tu4ons such as money managers,

investment funds, pension funds and brokerage companies trade foreign
currencies as part of their obliga4ons to seek the best investment opportuni4es
for their clients. For example, a manager of an interna4onal equity porfolio will
have to engage in currency trading in order to buy and sell foreign stocks.

3.2
Exchange rates

The Retail Market
l
Individuals - Individual traders or investors trade Forex on their own capital in

order to prot from specula4on on future exchange rates. They mainly operate
through Forex plaforms that oer 4ght spreads, immediate execu4on and
highly leveraged margin accounts.

3.2
Exchange rates

Determina4on of freely oa4ng exchange rates: Forex Market The
Retail Market
l
Specula+on/Hedge Funds - Hedge funds are private investment funds that speculate in
various assets classes using leverage. Macro Hedge Funds pursue trading opportuni4es in
the Forex Market. They design and execute trades ager conduc4ng a macroeconomic
analysis that reviews the challenges aec4ng a country and its currency. Due to their
large amounts of liquidity and their aggressive strategies, they are a major contributor to
the dynamic of Forex Market. (Remember George Soros?)

3.2
Exchange rates

The Retail Market
l
RemiNance Companies/Corpora+ons - They represent the companies that are

engaged in import/export ac4vi4es with foreign counterparts. Their primary
business requires them to purchase and sell foreign currencies in exchange for
goods, exposing them to currency risks. Through the Forex market, they convert
currencies and hedge themselves against future uctua4ons.

3.2
Exchange rates

The Retail Market
l
Individuals - Individual traders or investors trade Forex on their own capital in

order to prot from specula4on on future exchange rates. They mainly operate
through Forex plaforms that oer 4ght spreads, immediate execu4on and
highly leveraged margin accounts.

3.2
Exchange rates

Causes of Changes in the Exchange Rate
l Describe the factors that lead to changes in currency demand and
supply, including foreign demand for a countrys exports, domes4c

demand for imports, rela4ve interest rates, rela4ve ina4on rates,
investment from overseas in a countrys rms (foreign direct
investment and porfolio investment) and specula4on.

3.2
Exchange rates

Causes of Changes in the Exchange Rate*
l A country's exchange rate regime where its currency is set by the
foreign-exchange market through supply and demand for that

par4cular currency rela4ve to other currencies. Thus, oa4ng
exchange rates change freely and are determined by trading in the
forex market. This is in contrast to a "xed exchange rate" regime.

3.2
Exchange rates

Causes of Changes in the Exchange Rate*
l In some instances, if a currency value moves in any one direc4on at a
rapid and sustained rate, central banks intervene by buying and

selling its own currency reserves (i.e. Federal Reserve in the U.S. &
ECB in the EU) in the foreign-exchange market in order to stabilize
the local currency. However, central banks are reluctant to intervene,
unless absolutely necessary, in a oa4ng regime.

3.2 Exchange rates
Freely Floa+ng Exchange
Rates
Causes of Changes in the
Exchange Rate*

3.2
Exchange rates

Causes of Changes in the Exchange Rate
l Dis4nguish between a deprecia4on of the currency and an
apprecia4on of the currency.
l Draw diagrams to show changes in the demand for, and supply of, a
currency.

3.2 Exchange rates
Apprecia4on: An increase in the exchange rate.
l The home currency becomes rela4vely more expensive for
foreigners to buy. Apprecia4on also means that foreign

currency becomes rela4vely cheaper for you to buy.

3.2
Exchange rates
Apprecia4on: An increase in the exchange rate.

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

3.2 Exchange rates
Freely Floa+ng
Exchange Rates
Apprecia4on: Figure
2a Demand Increase
2b Supply Decrease

3.2 Exchange rates
Deprecia4on: A decrease in the exchange rate.
l
The home currency becomes rela4vely cheaper for foreigners to buy.

Deprecia4on also means that foreign currency becomes rela4vely more
expensive for you to buy.

3.2
Exchange rates

Deprecia4on: A decrease in the exchange rate.
l
If prices in both countries remain the same, deprecia4on will make foreign goods
rela4vely more expensive to you, leading to a fall in imports. It also means that, even if
prices remain the same, your goods will be cheaper to foreigners. They will buy more of
your goods and exports will rise. As a result, your country's net exports will increase.
This change to net exports causes a rightward shig of the aggregate demand curve.

3.2 Exchange rates
Freely Floa+ng
Exchange Rates
Deprecia4on: Figure
3a Demand Decrease
3b Supply Increase

3.2 Exchange rates
The eects of Exchange Rate Changes
l Evaluate the possible economic consequences of a change in
the value of a currency, including the eects on a countrys

ina4on rate, employment, economic growth and current
account balance.

3.2
Exchange rates

Determinants of Exchange Rates:
l
Numerous factors determine exchange rates, and all are related to the trading
rela4onship between two countries. Remember, exchange rates are rela4ve,
and are expressed as a comparison of the currencies of two countries.
The following are some of the principal determinants of the exchange rate
between two countries. Note that these factors are in no par4cular order; like
many aspects of economics, the rela4ve importance of these factors is subject
to much debate.:

3.2
Exchange rates
Freely Floa+ng Exchange Rates: Determinants of Exchange Rates

Demand for Goods and Services:
l The rela4ve demand for imports can directly inuence the purchase
of currencies, and so alter the exchange rate. When the demand for a
countrys exports increases it increases demand for the currency
itself. To buy the exports, the importers rst need to buy the
expor4ng countrys currency to pay for them.

3.2
Exchange rates

Demand for Foreign Direct Investment:
l Foreign investors may nd it necessary to to buy foreign currency to
make par4cular kinds of investment in that country. To make any

kind of signicant foreign direct investment (FDI) by opening a
branch loca4on, star4ng a new rm, or crea4ng a joint venture in
another country, requires that countrys currency to buy the factors
of produc4on (land, labor & capital).

3.2
Exchange rates

Demand for Financial Investments and Capital Flows:
l Financial investment such as buying of foreign company shares, or
interest-earning deposits in a foreign bank, are likely to require

purchase of the home currency. In other words, demand for a
countrys nancial investments appreciates a currency.

3.2 Exchange rates
Rela4ve Ina4on Rates:
l As the prices of one country rise faster than those of another,
its exports become more expensive and therefore, less

desirable. At the same 4me, imports will be rela4vely cheaper
than before and more anrac4ve.

3.2
Exchange rates

Specula4on:
l The holders of foreign currencies can also speculate on future values.
As with the buying and selling of shares, speculators may buy a

currency hoping it will appreciate, sell it when they believe it has
reached peak value, and taking the resul4ng prots.

3.2 Exchange rates
Central Bank Interven4on on the Forex Market:
l The Central Banks may buy or sell large amounts of foreign
exchange with several goals in mind. They may seek to prop up

the value of their currency by using foreign currency reserves
to buy up their own.

3.2 Exchange rates
Central Bank Interven4on on the Forex Market:
l The Central Banks may also sell their own currency if they seek
to reduce its value, perhaps to increase the desirability of their

exports and reduce domes4c consump4on of imports.

3.2 Exchange rates
Freely Floa+ng Exchange Rates: Eects of Exchange Rates
Apprecia4on; Advantages to Apprecia4on:
l Less expensive imports. The increased value of the currency
means that buying imported goods is now rela4vely less

expensive than before

3.2
Exchange rates

Apprecia4on; Advantages to Apprecia4on:
l Compe44ve pressure on domes4c exporters: An indirect eect of the
higher exchange rate is that domes4c rms expor4ng to other

countries are at a price disadvantage rela4ve to their foreign
compe4tors. As the exchange rate adjusted price of their exports
rises, they are compelled to seek out new ways of cu^ng costs and
innova4ng.

3.2
Exchange rates

Apprecia4on; Disadvantages to Apprecia4on:
l Exporter levels reduced: The dis4nc4on between pressure and
compe44ve disadvantage is blurred, and companies anemp4ng to

export at consistently high exchange rates may come to believe that
while their import cost are low, it may not compensate for the
challenge of selling at the higher exchange rate.

3.2
Exchange rates

Apprecia4on; Disadvantages to Apprecia4on:
l Greater imports hurt domes4c produc4on: Rela4vely cheap imports
may hurt even non-expor4ng domes4c industries. Those industries

cannot match the exchange rate discount now available on imported
goods. This could also result in unemployment in those industries

3.2
Exchange rates

Apprecia4on; Eects on Major Goals:
l To Summarize, apprecia4on reduces ina4onary pressure where the
demand for imports is rela4vely inelas4c (e.g. energy resources). This

may eventually help with economic growth. The more immediate
impact on growth is to reduce exports and decrease real GDP.

3.2 Exchange rates
Apprecia4on; Eects on Major Goals:
l The trade balance of exports to imports is likely to move
towards a decit, as exports slow down and cheaper imports

increase.

3.2 Exchange rates
Deprecia4on; Advantages to Deprecia4on:
l Expansion of Domes4c Industries: Foreign consumers view
exports as rela4vely cheap, and are unlikely to import more.

This raises revenues in those expor4ng companies and could
increase employment.

3.2 Exchange rates
Deprecia4on; Disadvantages to Deprecia4on:
l Imported Ina4on: Where countries need to import signicant
levels of raw materials or resources, a decrease in the exchange

rate can bring on a certain amount of imported ina4on.

3.2
Exchange rates

Deprecia4on; Eects on Major Goals:
l To Summarize, apprecia4on increase ina4onary pressure where the
demand for imports is rela4vely inelas4c (e.g. energy resources). This

may slow down economic growth. The more immediate impact on
growth is to increase exports and increase real GDP.

3.2
Exchange rates

Government Interven4on
Fixed Exchange Rates
l
Describe a xed exchange rate system involving commitment to a single xed rate.
Dis4nguish between a devalua4on of a currency and a revalua4on of a currency.
Explain, using a diagram, how a xed exchange rate is maintained.

3.2 Exchange rates
Government Interven4on: Fixed Exchange Rates
l
In a xed exchange rate system, most of the transac4ons of one currency for
another will take place in the private market among individuals, businesses, and
interna4onal banks. However, by xing the exchange rate the government
would have declared illegal any transac4ons that do not occur at the announced
rate. However, it is very unlikely that the announced xed exchange rate will at
all 4mes equalize private demand for foreign currency with private supply.

3.2 Exchange rates
l
In a oa4ng exchange rate system, the exchange rate adjusts to maintain

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

3.2 Exchange rates
l
In a oa4ng exchange rate system, the exchange rate adjusts to maintain

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

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

3.2 Exchange rates
Government Interven4on:
Fixed Exchange Rates

3.2
Exchange rates

Managed Exchange Rates (Managed Float)
l Explain how a managed exchange rate operates, with reference to
the fact that there is a periodic government interven4on to inuence

the value of an exchange rate.
l Examine the possible consequences of overvalued and undervalued
currencies.

3.2
Exchange rates

Managed Exchange Rates (Managed Float)
l
A managed oat exchange rate system is an interna4onal nancial arrangement,

whereby central banks intervene only periodically, not necessarily to support a
country's currency, but rather to stabilize vola4le uctua4ons in foreign
exchange rates. A managed oat is some 4mes called a "dirty oat" because
exchange rates are free to uctuate, but central banks are commined to
intervene under condi4ons of perceived instability. The central bank steps in to
oset only so much of a change in demand or supply to bring the exchange rate
back into an acceptable "band" or range of exchange rates.

3.2
Exchange rates

Managed Exchange Rates (Managed Float): Advantages
l
The managed oat anempts to combine the advantages of both the xed and exible
exchange rate systems, depending on the degree of instability. The less instability, the
less interven4on is necessary by central banks and they can pursue quasi-independent
domes4c monetary policies to stabilize their own economies. The greater the instability,
the more interven4on is necessary by central banks and the less free they are to pursue
independent domes4c monetary policies because they are frequently required to use
their money supplies to calm disturbances in the foreign exchange markets.

3.2
Exchange rates

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

3.2
Exchange rates

Evalua4on of Dierent Exchange Rate Systems (HL Only)
l Compare and contrast a xed exchange rate system with a oa4ng
exchange rate system, with reference to factors including the degree

of certainty for stakeholders, ease of adjustment, the role of
interna4onal reserves in the form of foreign currencies and exibility
oered to policy makers.

3.2 Exchange rates
Current Account Decits
The Rela4onship Between the Current Account and the Exchange
Rate (HL Only)
l Explain why a decit in the current account of the balance of
payments may result in downward pressure on the exchange

rate of the currency.

3.2 Exchange rates
Current Account Surpluses
Rate (HL Only)
l Explain why a surplus in the current account of the balance of
payments may result in upward pressure on the exchange rate

of the currency.

3.3 The Balance of Payments
The Structure of the Balance of Payments
The Meaning of the Balance of Payments
l Outline the role of the balance of payments.
l Dis4nguish between debit items and credit items in the balance
of payments.

3.3
The Balance of Payments

l A statement that summarizes an economys transac4ons with the
rest of the world for a specied 4me period. The balance of

payments, also known as balance of interna4onal payments,
encompasses all transac4ons between a countrys residents and its
nonresidents involving goods, services and income; nancial claims
on and liabili4es to the rest of the world; and transfers such as gigs.

3.3

l
The balance of payments classies these transac4ons in two accounts the

current account and the capital account. The current account includes
transac4ons in goods, services, investment income and current transfers,
while the capital account mainly includes transac4ons in nancial
instruments. An economys balance of payments transac4ons and
interna4onal investment posi4on (IIP) together cons4tute its set of
interna4onal accounts.

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

3.3

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

l
The BOT is typically the biggest bulk of a country's balance of payments as it

makes up total imports and exports. If a country has a balance of trade
decit, it imports more than it exports, and if it has a balance of trade
surplus, it exports more than it imports.

3.3

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

3.3

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

3.3

The Financial Account
l
In the nancial account, interna4onal monetary ows related to investment in business,

real estate, bonds and stocks are documented. Also included are government-owned
assets such as foreign reserves, gold, special drawing rights (SDRs) held with the
Interna4onal Monetary Fund (IMF), private assets held abroad and direct foreign
investment. Assets owned by foreigners, private and ocial, are also recorded in the
nancial account.

3.3

The Components of the Balance of Payments Accounts
l Explain the four components of the current account, specically the
balance of trade in goods, the balance of trade in services, income

and current transfers.
l Dis4nguish between a current account decit and a current account
surplus.

3.3

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

3.3

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

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

3.3

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

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

3.3

l
Explain the two components of the capital account, specically capital

transfers and transac4on in non-produced, non-nancial assets.
Explain the three main components of the nancial account, specically,

direct investment, porfolio investment and reserve assets.

The Rela4onships Between the Accounts
l
Explain that the current account balance is equal to the sum of the capital
account and nancial account balances (see the appendix, The balance of
payments).
Examine how the current account and the nancial account are
interdependent.

l
The current account should be balanced against the combined-capital and

nancial accounts; however, as men4oned above, this rarely happens. We
should also note that, with uctua4ng exchange rates, the change in the
value of money can add to BOP discrepancies. When there is a decit in the
current account, which is a balance of trade decit, the dierence can be
borrowed or funded by the capital account.

3.3

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

l
Explain that the current account balance is equal to the sum of the capital
account and nancial account balances (see the appendix, The balance of
payments).
Examine how the current account and the nancial account are
interdependent.

Current Account Decits
Rate
l Explain why a decit in the current account of the balance of
payments may result in downward pressure on the exchange

rate of the currency.

Current Account Surpluses
The rela4onship between the current account and the exchange
rate
l Explain why a surplus in the current account of the balance of
payments may result in upward pressure on the exchange rate

of the currency.

3.4
Economic Integra+on
Forms of economic integra+on

Preferen4al trade agreements
l Dis4nguish between bilateral and mul4lateral (WTO) trade
agreements.
l Explain that preferen4al trade agreements give preferen4al
access to certain products from certain countries by reducing

or elimina4ng taris, or by other agreements rela4ng to trade.

3.4
Economic Integra+on

Trading Blocs
l
Dis4nguish between a free trade area, a customs union and a common

market.
Explain that economic integra4on will increase compe44on among

producers within the trading bloc.
Compare and contrast the dierent types of trading blocs.

3.4 Economic Integra+on
Monetary Union
l
Explain that a monetary union is a common market with a common

currency and a common central bank.
Discuss the possible advantages and disadvantages of a monetary union for

its members.

3.4 Economic Integra+on
Theory of Knowledge: Poten+al Connec+ons
What criteria can be used to assess the benets and the
costs of increased economic integra9on?
Might increased economic integra9on ever be
considered undesirable?

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IB

Economics SL: City Honors School

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

par4cular areas of exper4se. This means they can produce

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

countries share the exactly the same resource base. Trade

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

meet interna4onal demand, the specializa4on of managers and

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

As the number of countries in the global market has grown, so has

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

goods to improve their standard of living. In some cases,

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

market, it lacks compe44ve incen4ve to provide good service and

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

agree that trade and integra4on have consistently encouraged

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

economists have concluded that exports can be a path to signicant

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

Describe the objec4ves and func4ons of the WTO.

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

l Track changes in member trade policies

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

nego4a4ons favor rich countries

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

trade between rich countries

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

Restric+ons on Free Trade: Trade Protec+on

IB Economics SL: City Honors School

Unit 3: Interna4onal Economics

Restric+ons on Free Trade: Trade Protec+on

Explain, using a diagram, the eects of giving a subsidy to domes4c producers on