Definitions
Absolute advantage exists when one country is able to produce a good more cheaply in absolute terms than another country.
Comparative advantage exists when one country is able to produce a good more cheaply, in comparison to other goods produced domestically, than another country.
Free trade is trade that occurs between countries without any barriers or hindrances.
A tariff is a tax on imports, which can either be specific (so much per unit of sale) or ad valorem (a percentage of the price of the product).
Quotas have the effect of restricting the maximum amount of imports allowed into an economy.
Export subsidies allow exporters to supply the market with more product than the natural equilibrium would have allowed.
Globalisation essentially means a trend towards much more global production and a greater degree of interdependence between the various countries of the world.
Trade creation is the increased trade that occurs between member countries of trading blocs following the formation or expansion of the trading bloc.
Trade diversion is the decrease in trade following the formation of a trading bloc as trade with low cost non-trading bloc members is replaced by trade with relatively high cost trading bloc members.
The current account records imports and exports of goods (sometimes known as the ‘balance of trade’ or ‘visible trade’) and imports and exports of services (sometimes known as ‘invisible trade’). It often also records income flows (flows of interest, profits and dividends that may have arisen from investment flows) and transfers of money.
The capital account of the balance of payments records the flows of money into and out of a country for investment and other purposes. There will be inflows of money (credits) and outflows of money from a country (debits).
Exchange Rates
- Fixed – this is an exchange rate system where one currency is fixed in value against another. It involves the government working to keep the parity via intervention on the currency markets. These give certainty but can cost vast sums of foreign exchange from national reserves.
- Floating – this is an exchange rate which accepts that market forces will determine rates based on how they view a country’s trade performance and its economic and political stability. These systems cost less to maintain but can result in vast swings and changes in currency values. This can seriously affect trade performance and confidence.
- Managed or dirty float – which is where the rate is floating but between upper and lower limits that the domestic government keeps it to. It brings more stability but at less cost to the national reserves.
Appreciation – this describes an upward movement in a freely floating exchange rate.
Revaluation – this also describes an upward movement in an exchange rate, but in a fixed exchange rate system.
Depreciation – this describes a downward movement in a floating exchange rate.
Devaluation – this means that the government has changed the fixed rate of a fixed exchange rate downwards.
