IB Economics/International Economics/Economic integration

Economic Integration

• Globalization- political, social, and economic integration.

• Trading blocs: a large free trade area formed by tax, tariff, and trade agreements.
• Free trade Areas: (NAFTA) a group of countries that agree to free trade.
• Custom unions: A free trade area with a common external tariff (MERCOSUR).
• Common markets: A custom union with free transport of goods and services amongst members. (European Union)

Full Integration: Common market with uniform fiscal and monetary policies. Often, a central bank is shared, and political unification exists as well.

• Trade creation and trade diversion:

• Trade creation: greater specialization according to comparative advantage.
• Trade diversion: Firms may have to pay more for products they would have paid less for.

• Obstacles of achieving integration:

• Reluctance to surrender political sovereignty.
• reluctance to surrender economic sovereignty.

• World Trade Organization.

• Aims: attempts to increase international trade by lowering trade barriers.
• Success and failure viewed from different perspectives.

• Balance of Payments: Record of all financial dealings over a period of time between one country and the rest of the world. (Current account + capital account)

• current account: Composed of the visible and invisible.

• balance of trade: Visible exports - visible imports.
• invisible balance: Invisible exports - invisible imports.

• capital account: Composed of profits, interest, dividends, and hot money.

• Exchange Rates

An exchange rate is the value of one currency expressed in the value of another.

• Fixed exchange rates: fixed exchange rates are exchange rates which the government sets.
• Floating exchange rates: Exchange rates determined by the market forces of demand and supply.
• Managed exchange rates: Exchange rates which are floating exchange rates but controlled by the government by influence.
• Distinction between:

• Depreciation and devaluation - When the value of a floating currency decreases, it means the currency has depreciated. When the value of a fixed currency is set at a lower value, it means it was devaluated.
• Appreciation and revaluation - When the value of a floating currency increases, it means the currency has appreciated. When the value of a fixed currency is set at a higher value, it means it was revaluated.

• Effects on exchange rates of:
• Trade flows: If there is a greater demand for a country's imports there is thus a greater demand for a country's currency and the value of that currency will rise.
• Capital flow/ interest rate change: If interest rates rise, there will be a greater demand for a country's currency and thus it will appreciate.
• Inflation: Inflation may cause a fall in the value of a country's currency.
• Speculation: May do either.
• Use of foreign currency reserves: A country will use its foreign currency reserves.
• relative advantage and disadvantages of fixed and floating exchange rates.

• A Floating exchange rate has it advantages because it automatically adjusts so that supply equals demand. There is no need for a central bank to keep foreign reserves. It prevents inflation. A government can pursue its own domestic policies.
• Causes instability.
• May lead to inflation.
• Speculation can lead to major changes in the rate.

• A Fixed exchange rate is advantageous because it provides stability, it can restrain domestic inflation, it can prevent inflation.
• A government must have sufficient reserves, a country;s firms may be uncompetitive. The government must intervene as a priority.

• Advantages and disadvantages of single currencies/monetary integration.
• Purchasing power parity theory (PPP): The theory that floating system currency adjusts until a unit of currency can buy the exactly the same amount of goods and services as a unit of another currency.