INTERNATIONAL ECONOMICS

IMPORTANT GRAPHS
- PPC graph to illustrate consumption beyond limits due to international trade
- Non-inflationary graph to illustrate benefits of free trade
- Trade creation when consumption shifts to lower cost producers due to FTAs (world price
drops after removing tariffs)
- Trade diversion when trading with higher cost producers due to FTAs
- Tariff graph
1. INTERNATIONAL TRADE AND FREE TRADE AGREEMENTS
Based on the theory of competitive advantage
- All countries benefit when they specialise in the production of a good which they have a
comparative advantage in
o Example:
Assume the following
There are 2 countries trading 2 goods
There is perfect factor mobility within each country (so that
countries can change between the production of different goods
easily)
There is imperfect factor mobility between countries (so that
countries can retain their CA and so that they even have a CA in the
first place)
Negligible transport costs (to prevent the benefits of CA from
international trade from being negated)
No protectionism exists that affects prices of goods and the
exchange of goods (i.e. trade between countries)
No reasons for countries to engage in the production of a good they
have no CA in
Before specialisation
Textile
Car
USA
20
30
Vietnam
15
10
Total
35
40
Before specialisation, when both countries spend half their
resources on the production of each good, (state the numbers)
Opportunity cost table
1 unit of textile
1 unit of car
USA
3/2 car
2/3 textile
Vietnam
2/3 car
3/2 textile
The USA has to give up 3/2 of a car for the production of a unit of
textiles
Vietnam has to give up 3/2 of a textile for the production of a unit of
car
Therefore the USA has a comparative advantage in producing cars as
it has to give up lesser units of textiles in doing so, and Vietnam has

a comparative advantage in producing textiles, because it has to

give up lesser units of cars to do so
After partial specialisation
Textile
Car
USA
10
45
Vietnam
30
0
Total
40
45
Due to the law of CA, the USA undergoes partial specialisation in the
production of cars and Vietnam undergoes full specialisation
The resultant output for each country is (state), and the resultant
total output is 40 textiles and 45 cars, therefore total world output
has increased
Terms of trade
Countries engage in trade at rates determined by their TOT
(refer to below)
After trade
Textile
Car
USA
23
32
Vietnam
17
13
As can be seen from the table, both countries have gained from the
specialisation as their consumption has exceeded their individual
Production Possibility Curves (PPCs)hence they have received
greater material SOL
Draw graph of PPC
(insert graph)
o Terms of trade
The rate at which a good can be exchanged for another (using the previous
example, the trade of textiles for cars)
The USA will not accept less than 2/3 units of textiles for a car, and similarly
Vietnam will not pay anything more than 3/2 units of textiles (based on their
opportunity cost) hence the TOT for cars in textiles is:
2/3 textiles < 1 car < 3/2 textiles
The corresponding is the same for the trade of cars for textiles
The exact TOT however is determined by the governments of each country
Sources of CA
o Dynamic CA
The CAs of countries can change over time due to improvements in
technology and training
Countries can invest in better machinery or knowledge based
economies that give them an advantage over other countries
Countries can re-train their workers to be more highly skilled, or be
more efficient and produce goods at a faster rate
o International differences in factor endowments
Climate ant resource environments
Availability and abundance of natural resources geographical
location and composition, arable land, skilled/unskilled labourers

But these may change over time due to dynamic CA and the intervention of
governments to preserve CA
o Differences in technology
Different intensities and degrees of R&D give rise to differing abilities to
produce higher quality, higher order, or more goods
However countries who possess technology based CA must continually
improve their technology and invest in better technology to retain their CA
as most likely other countries will be able to gain similar CA
- Limitations to the law of CA
o Prohibitive transport costs
When transport costs far exceed the benefits that stood to be gained from
the trade with a country that has a CA in a good and specialises in its
production, countries will not benefit
Hence, some countries may engage in the production of a good that they do
not possess a CA in
o Political reasons/ production security
Some countries may continue the production of a good to protect certain
industries, especially in the case of infant industries who are growing, or
traditional industries
o Protectionism
(See above)
o Increasing opportunity costs
As the production of a particular good increases, gradually higher
opportunity costs will be incurred due to finite resources, and a country may
then lose the CA for a good it is producing
Free trade
- The exchange of goods and services between countries without any restrictions (artificial) or
policies imposing restrictions on the movement of goods
- Benefits of free trade
o Trade as an engine of growth (important!)
Due to the high YED of goods, the increasing international demand of goods
provides a stimulus for production (as global incomes increase, the demand
for imports increases more than proportionally)
Larger scales of production reaping economies of scale have greater cost
savings reduced prices for consumers which translates to even greater
revenues (quantities sold)
Due to increased scale of production, cheaper raw materials can be
obtained as producers buy in bulk and can reduce unit as well as transport
costs
Increased competition globally results in reduced prices as well as the
increased quality of goods
Net exports of a country will also increase in this manner, and the increased
AD will cause a multiplier effect on the economy
o Higher standard of living
Due to the law of CA, the free trade of goods without restriction between
countries results in greater material SOL

Also, due to the wide variety of goods produced in diverse global markets,
the material SOL will also increase due to the diversity of goods
o Innovation and the transfer of technology
Fierce competition lower costs and better quality rapid economic growth
and development
With strong trade links, the transfer of technology from country to country
(typically DC to LDC) can boost economic growth via improved technological
processes
Insert graph on increased AD and AS non-inflationary growth
- Costs of free trade
o Unfair competition and dumping
Dumping is defined as selling goods to a country lower than their selling
price, and typically lower than the COP as well, so as to reduce the chance of
domestic companies being able to compete and thus driving them out and
gaining monopoly power
Happens especially often when governments of countries subsidise the
production of goods, which allows them to lower their prices even further
(lower/ subsidised COP)
o Structural unemployment
Changes in technology to gain CA or improve production processes can leave
workers unemployed if they lack the necessary skills to work in a new
environment when countries try to gain CA via technology
o Income inequality
CA generally lies in areas more accessible to upper income people
technology, R&D sectors of business usually when people are more welleducated, or have better entrepreneurial skills hence the poorer people
who are unable to compete or
o Susceptibility to cyclical unemployment
Complete specialisation narrows a countrys economic structure and creates
difficulty for it to recover from an economic crisis
Fall in demand of the good may cripple the economy
o Susceptibility to imported inflation
Rising costs of imports increased wages for workers to buy goods COP
will increase prices will subsequently increase and the cycle repeats itself
Pattern of trade
- The commodity composition of trade, including goods and services; the geographical
composition of trade trading partners
- Singapores POT
o Exports
Oil, non-oil, and re-exports
Capital intensive goods
Regional education hub and healthcare centre (services)
o Imports
Food, beverage, crude materials, electronic parts and components
- Reasons for Singapores POT
o Inter-industry trade
Explained by differences in CA

Intra-industry trade
Differences in tastes and preference will result in people desiring variations
of the same type of good
Gains from EOS due to scale of production
o Globalisation and FTAs
Trade with countries with different CA
Diversification of markets to cushion economy against impacts of contagion
and protectionism
o Limitations of CA
High transport costs may result in Singapore trading with countries due to
proximity reasons instead of their differences in CA
Protectionism may cut off some countries as trading partners
Free Trade Agreements
- Agreements between countries that remove tariff and non-tariff barriers for easier trade,
typically are legally binding
o Singapore maintains many FTAs because to Singapore trade is an important source
of economic wealth practically has no barriers preventing the free flow of goods
- Variations of FTAs
o Customs Union
Where FTAs are enacted as well as common tariffs on the goods of other
countries by the countries involved
o Common Market
A customs union as well as completely free flow of capital, labour, and
services
Countries involved have a common currency as well
- Benefits of FTAs
o Trade creation (trade as an engine of growth)
Consumption shifts to lower cost producers, and hence prices are lower and
more people benefit
Insert graph that has world price + tariff and world price, as well
as areas A, B, C, D
Improves BOT for exporting countries, which boosts their AD and NI,
creating a multiplier effect
Greater efficiency is had also due to the reaping of EOS, and positively
benefits consumers due to lower prices, higher quality, and greater variety
o Increases FDI
Thus improving the AS of countries and hence resulting in non-inflationary
growth
o Improves BOP
Assuming inflows outweigh outflows
- Costs of FTAs
o Structural unemployment
o Susceptible to external shocks
o Trade diversion
When consumption shifts to higher cost producers within the FTA
2. GLOBALISATION think in terms of trade, capital, and labour

Integration or inter-connectedness of national economies through the trade of goods and

services, FDI, capital flows, the spread of technology and labour migration
o That is, the freer movement of goods and services, and people and resources across
national boundaries
Features of globalisation
o Openness to trade
Trade as an engine of growth
Trade liberalisation via FTAs
Outsourcing importing and exporting of cheaper business services to
countries that have CA cutting costs via services that are cheaper
o Openness to movement of capital
Offshoring many countries welcome the flow of FDI, and companies set up
production plants and factories to take advantage of cheaper labour present
International supply chain specialisations and productions of specific
goods, increases EOS
o Migration and movement of labour
Foreign talent is brought in to supplement and enhance the workforce of
countries embraced by many countries
Foreign labour is brought in to do the less desirable jobs that locals are
deign to take up
Causes of globalisation
o Economic
Trade as an engine of growth has spurred many to take it up
Law of CA
o Technologic

Communication and trade revolutionary breakthroughs in ICT and the

internet result in reduced costs for people to communicate, broker deals
Faster flow of information, e-commerce, -e-shipping
Online marketing and advertising is also cheaper than physical forms
Reduced transport costs (which is usually a prohibitive factor in reaping CA
Benefits of globalisation
o Engine of actual growth (important!)
Globalisation overcomes the physical constraints of countries, helps
producers reap substantial iEOS
Singapores export to GDP ratio is 1.5
$0.60 of Singapores exports comes from the raw materials from
imported goods
o Increase in capital/ technology
FDI increases the AD and AS of countries
Technology is shared more efficiently
Inflow of funds boosts PI and financial capital, thus lowering interest rates
o All in all,
Greater SOL from consumption outside of the PPC
Diversity of goods
Reaping of EOS cheaper and higher quality goods
Competition cheaper and higher quality goods
Acquisition of new CA, cheaper transport/technology/communications
Costs of globalisation the tide of globalisation can be reversed or can recede at any time
o (Openness to trade causes) externally induced cyclical unemployment
Contagion effect in times of recession, financial crises, investors will
rethink their actions and may choose to conserve funds
Mitigated by:
Decoupling: diversifying economies to reduce dependence
Inward-oriented growth via strong consumer base + natural
resources, usually more applicable to larger countries only
o (Openness to capital causes) structural unemployment
Fierce competition causes producers to continually try and boost their CA
Workers may not be properly skilled to keep up with changes
Mitigated by:
Constant training and retraining Singapore has the Continuing
Education and Training (CET) and Skills Programme for Upgrading
and Resilience (SPUR)
o (Openness to labour causes) a brain drain
Attracted by prospects of better futures, people may leave countries for
others for better jobs and standards of living
Cripple countries even further if they do not have a strong workforce to
propel the economy
Mitigated by:
Increasing attractiveness of work opportunities in home countries
o (Openness to labour causes) widening income disparities
As there is a starkly different demand for skilled workers than unskilled
workers, wages for skilled workers will rise to attract greater talent, while

wages for low skilled workers will not change as there will always be a large
pool of workers willing to take up the jobs
Mitigated by:
Wage income supplements for low income earners (people below
$1700 in Singapore)
o Unfair trade practices (trade)
o Trade imbalances (trade)
o Violation of intellectual property rights
o Environmental degradation
Globalisation and Singapore
o Comparative advantage
Previously had a CA in labour intensive, goods, the production of textiles
Now has gained considerable CA in capital intensive and knowledge based
industries,
o Trade partners
Singapore has signed FTAs with many overseas countries
o Pro-globalisation
Lack of natural resources
o Mitigation strategies
Maintenance of FTAs and pro-migration, which will benefit SG in the long run
Building resilience via diversification, training and retraining, wage income
supplement (WIS) for lower income workers, modest and gradual
appreciation of currency
In conclusion,
o There are valuable benefits and harmful detriments
o The more open countries are the more susceptible they are to risks
o These risks threaten the sustainability of globalisation for all countries due to the
high interconnectedness
o However, as Singapore and many countries as much dependent on it for growth, it is
used to boost economic growth and increase SOL

3. PROTECTIONISM
- Measures to restrict international trade direct opposite of free trade
- Methods of protectionism
o Tariffs
o Import quotas
o Subsidies
o Foreign exchange control
o Embargoes
o Prohibitive bureaucratic/ legislative procedures
o Volume export restraints (VERs)
o Political/ strategi protectionism
- Reasons for protectionism
o Protection against dumping
Hard to enforce due to differences in efficiencies in different countries, and
fundamental differences in CA

Contentious point as making domestic products cheaper may only be a

result of high iEOS
o Protection of infant industries
Infant industries may abuse their aid and produce low-quality goods, lacking
market incentives to improve (under long term protectionism)
Hard to identify infant industries as well and they must have high potential
CA to be globally competitive
o Protection to improve BOT
May result in beggar-thy-neighbour effects where countries have
corresponding BOT deficits, and may retaliate with their own protectionist
measures that will only close markets and harm the world economy
If the elasticity of demand and supply is low, regardless of price increases of
imports, there may be no change
o Protection of declining (sunset) industries
May only prolong inefficiency instead of removing them quickly inefficient
allocation of resources and welfare losses in the economy a trade off as
countries cannot push out new more vibrant sectors of the economy instead
Measures may be hard to remove as well if they are protecting traditional
industries that the people are in favour of keeping
Alternative solutions
o BOP disequilibrium
Should be solved by improving X instead, as it is the root problem, and
therefore solving the problem in a positive not negative manner
Sunset industries can be helped via retraining and compensation for
transition fees, and be offset by increased trade in the future
In conclusion,
o Protectionism is at best only a short term measure
o In the long run all countries should work towards free trade to benefit all countries
via the law of CA

4. BALANCE OF PAYMENT think in terms of current and financial (investment) accounts

- A summary statement of the monetary value of all economic transactions in and out of the
country within a specific time, usually a year
o Credit transaction getting foreign currency
o Debit transaction getting local currency
- Composition of a countrys BOP
o Current account
Trade in goods
Trade in services
Net current transfers
Net income flows
o Capital account
Records debt forgiveness, migrant transfers, and non-financial/nonproduced assets (patents)
o Financial account
Short term investments (usually less than a year)
Long term investments in the form of FDI and PI

Official reserves account (ORA)/ Official financing account (OFA)

To offset BOP surpluses and deficits
Contains reserves of gold and foreign currency to manipulate the currency
exchange
ORA in Singapore serves as a 100% backing for all currency issued
establishing confidence in many investors to invest in Singapore
Consequences of a surplus
o Current account
Economic growth due to increased NI
o Financial account
More employment and non-inflationary growth (investments)
More hot money and therefore loanable funds, inflation rate drops and
investment increases
More PI, buying government bonds, providing the government with more
spending power
Consequences of a deficit
o Current account
Contractionary effect on economy
Increased liability/ reduced ownership of domestic assets
o Financial account
Reduction in investment reduces the AS, and long term growth increases
unemployment
No investment money and interest rates fall
Outflow of PI means reduced money for governments
Causes of a deficit
o Current account
Loss of export competitiveness emergence of low cost producers
Higher inflation rate exports become more expensive and imports cheaper
Trading partners may undervalue currencies ML condition, they improve
o Financial account
Outflow of money for investment MNCs outsource production outside of
Singapore
Changes in relative interest rates better interest rates in other countries
cause money to flow out, and an increase in inflation rate locally
Cures for a deficit
o Expenditure switching measures (ESM)
Purchasing domestic goods both locals and foreigners
Done via devaluation of the dollar
ML condition
However, ML condition may not hold, worsening the BOP even
further, happens when demand for exports is inelastic as some
countries may be stuck in contracts and agreements
If CED is low (i.e. domestic products are bad substitutes), then X-M
will not improve
Done via protectionism
Makes imports less attractive
However detriments of tariffs

Expenditure reducing measures (ERM)

Only useful if overspending is the root cause, and there is demand-pull
inflation
However, necessities are YED<1 and may not reduce significantly, and
economic growth is compromised
Done via supply side measures
However these are long term measures that do not have immediate
effects, and people resistant to change will not recognise the full
benefits of SSP
Done via trade policies
Larger market for expansion
Improves attractiveness of exports
Revenue increases and productive capacity increases
In conclusion,
o Changes in BOP are more and more unpredictable due to globalisation
o But a more or less fool-proof method is to keep CA consistently relevant to benefit
the country
o Protection and contractionary measures are possible but not feasible (include
opposing views for a balanced view)

5. EXCHANGE RATE SYSTEMS AND POLICY

- Rate at which one currency is exchanged for another
o Nominal ER: based on nominal value
o Bilateral ER: rate between 2 countries
o Nominal Effective ER (NEER): value of currency against a basket of goods of its major
trading partners
- Having currency is extremely important as a country can only purchase goods from another
country using their currency, and hence must exchange local currency for that currency
the strength of ones currency then determines how much one can buy
- ER systems
o Demand for a currency
Determined by export revenue and size of capital inflows if export revenue
increases, it means that other people want to buy more local goods and
hence demand for local currency increases; capital inflows require local
currency, and hence if their demand increases so does demand for local
currency
o Supply of a currency
Determined by import expenditure and size of capital outflows
- Factors affecting equilibrium exchange rate
o Changes in relative real income
When a countrys income rises faster than another (2 countries only)
o Changes in domestic prices
Due to inflation rates, prices may increase or decrease comparatively
o Changes in relative interest rates
People may choose to invest where they have good marginal returns
- Purchasing power parity (PPP)
o Price of SGD in GBP = COP Malaysia/COP Singapore

Types of exchange rate systems

o Freely-Floating system
Where equilibrium exchange rate is determined solely by market forces
Advantages automatic correction of BOP dis-equilibriums; no need to hold
large amounts of reserves
Disadvantages lack of confidence due to volatility of exchange rate;
increased speculative activity
o Fixed Exchange system
Governments commit to a certain exchange rate, using its reserves to offset
changes where necessary
Advantages confidence and certainty for investment; no speculation
Disadvantages inability to use interest rate as an economic tool as changes
in the interest rate will affect capital flows and demand for goods, which will
have to be offset again by manipulation of the exchange; currency crises
may occur when governments lack capital to manipulate the market; BOP
disequilibrium; need to maintain large amount of reserves
o Managed Float system
A range of acceptable exchange rate is set in which the currency is allowed
to move on its own
Advantage some from freely floating
Disadvantage some from fixed exchange
Impact of exchange rate policies
o Devaluation of currency to improve BOP
o Appreciation of currency to tackle cost-push and demand-pull inflation
Singapores exchange rate policy
o Managed float regime
Goals of the Singapore exchange rate policy
o Keep inflation low
Protection against imported inflation via a gradual and modest appreciation
(GAMA)
o Maintaining export competitiveness
o Maintaining a strong economy during downturns
Reasons for exchange rate centred policy for Singapore
o Small size and open economy
Heavy reliance on trade for growth, helps to achieve the ME goals better
Stable inflation rates keeps out imported inflation, thus maintaining
reasonable costs of living, low production costs, and confidence in the
economy
o Good times
GAMA
o Bad times
Zero appreciation and maybe slight depreciation but wary because of fears
of imported inflation
When times are bad, fears of imported inflation are low, so to make exports
price competitive, depreciation is necessary
o Reluctance to use interest rate policy
Openness to capital makes it hard to control money supply

Will make the exchange rate very volatile affecting confidence and trade
Due to hot money coming in and out of the economy

WHAT IS A LIQUIDITY TRAP