Chapter 13: Demand-side and supply-side policies

13.1: Introduction to macroeconomic policies

● Demand-side policies (or demand management): focused on changing AD

○ Monetary Policy and Fiscal Policy: attempt to reduce the short-run fluctuations of
the business cycle - stabilization policies
● Supply-side policies focus on LRAS or Keynesian AS to increases potential output and
long term economic growth
○ Increase quantity and quality of factors of production rather than stabilizing the
business cycle
○ Market-based policies and interventionist policies

13.2: Demand management and monetary policy

● Role of central banks

○ Government’s bank
○ Bank’s bank
○ Regulator of commercial banks
○ Conduct monetary policy
● Central bank is an independent institution - no government interference and ideally free
from political pressure
● Goals of monetary policy
○ Low and stable rate of inflation
○ Low unemployment
○ Reduce business cycle fluctuations
○ Promote a stable economic environment for long-term growth
○ Current account balance
● Inflation targeting

Chapter 14: International Trade: Part 1

14.1: The benefits of international trade:

● Why do countries benefit from international trade?

○ Increased competition: domestic firms are forced to compete with foreign firms
■ Firms are forced to become more efficient - better resource use, etc.
■ Lower prices for consumers - undercutting/more efficient foreign
producers
○ Greater choice: Countries can import higher quality products and even products
that they do not produce locally
○ Acquiring resources: Many countries do not naturally produce necessities such as
oil and some minerals - trading solves this
○ Foreign exchange: When countries export, they acquire foreign currencies
 ○ Access to larger markets: Without trade, the output of a firm is limited by the size
of its domestic market - trade expands the market and potential sales for the firm
○ Economies of scale: access to larger markets could lead to lower average costs
and thus, economies of scale - greater competitiveness
○ Specialization: With trade, countries have the liberty to specialize and thus,
increase efficiency in one sector
○ New ideas and technologies: flow with goods and services
○ Reduces hostility and violence: economic relations means less international
conflict
○ Economic growth
● When should a country import/export?
○ World price > Domestic equilibrium price = Export
■ Domestic producers gain - higher prices and higher quantities sold
■ Domestic consumers lose - lower quantities at higher prices
○ World price < Domestic equilibrium price = Import
■ Domestic producers lose - produce less and lower prices
■ Domestic consumers gain - larger quantities at lower prices

14.2:

● Absolute vs comparative advantage:

○ Absolute advantage: one country can produce more of a good than another with
the same resources - if countries specialize in goods that they have absolute
advantages in, there will be increased production and consumption everywhere
○ Comparative advantage: one country has a lower opportunity cost in the
production of a good than another
○ The country that has a flatter PPC has a comparative advantage in the good
measured on the horizontal axis
○ Parallel PPC means equal opportunity costs
● Limitations of the theory of comparative advantage
○ Assumes that factors of production and technology are fixed (does not move + no
chance in quality)
○ Assumes that there is perfect mobility of factors of production within a country
○ Assumes that there is full employment of all resources
○ Assumes that there is free trade
○ Assumes that there are homogeneous products
○ Ignores transportation costs
○ Specialization according to comparative advantage may not allow the necessary
structural changes in an economy

14.3: Types of trade protection: restrictions on free trade

● Tariffs
○ Or, customs duties
 ○ Tax on an imported good
○ Can be used to protect domestic producers or raise revenue for the government
○ Diagram: see notebook
○ Winners: domestic producers + domestic employment + government
○ Losers: domestic consumers + domestic income distribution + efficiency +
foreign producers + global allocation of resources
● Quotas
○ Legal limit on the quantity of a good that can be imported in a particular time
period
○ Implemented by issuing licenses with specific quantity limits - holders of licenses
are the only ones permitted to import
○ License holders receive “quota revenues” - they buy at world price and sell at the
higher, domestic price
○ Diagram: see notebook
○ Winners: domestic producers, domestic employment
○ No change: the government
○ Losers: domestic consumers, domestic income distribution, efficiency, global
allocation of resources
○ Winners/Losers: exporting country - loss of export revenue vs gain of quota
revenue
○ REAL WORLD FOCUS (US Sugar Quotas)
■ 40 countries are issued import licenses
■ Domestic price increases to double the world price
■ More efficient foreign producers are disadvantaged
■ 80% sugar consumption is produced locally and 20% is imported
■ Jobs are created in the sugar industry but are lost in industries that
depend on sugar - candy factories have relocated to Mexico because they
were not profitable in the US
■ Opportunity cost of sugar production + negative environmental impacts
● Production subsidies
○ Protect firms that compete with imports
○ Per-unit of output
○ Winners: Domestic producers + domestic employment
○ Neutral: Consumers
○ Losers: Government budget + taxpayers + efficiency + exporting countries +
global allocation of resources
● Export subsidies
○ Protect domestic firms that export
○ Per-unit for each unit that is exported
○ Winners: Producers + domestic employment
○ Losers: consumers + government budget + taxpayers + domestic income
distribution + efficiency + exporting countries + global allocation of resources
○ REAL WORLD FOCUS (WTO Success Story)
■ USA and EU have too much power in global trade
 ■ Export subsidies disproportionately affect farmers in developing, poorer
countries
■ Reduce market share of poor farmers in their own countries + create a
reliance on imports in developing countries
■ WTO banned export subsidies
■ Developing countries argue that they alone should be entitled to imposing
export subsidies
● Administrative barriers
○ Make red-tape checks time consuming and difficult
○ Packaging specifications
○ Technical standards
○ Health, safety and environmental conditions
○ Lengthy testing and inspections procedures

Chapter 15: International Trade: Part 2

15.1: Arguments for and against trade protection

● FOR
○ Justified arguments (under certain circumstances)
■ Infant industry argument: New, small domestic industries cannot
compete with efficient foreign producers who cant take advantage of
economies of scale - difficult for governments to estimate the potentials of
industries + lack of incentive for protected industries to grow
■ National security: Industries such as defense should be protected so that a
country can produce them itself - US placed tariffs on an industry that
defense depends on: steel and aluminum (was that essential?)
■ Health, safety and environmental standards: necessary but sometimes
used as administrative barriers
■ Efforts of a developing country to diversify: LEDCs employ trade
protection on industries that they want to diversify into - their
governments might not know which industries are the right ones to
diversify into
○ Questionable arguments
■ Anti-dumping: Difficult to prove when actual dumping is taking place
(used as an excuse for unnecessary protection)
■ Unfair competition: same as above
■ Correcting balance of payments deficit: Exporting countries might
retaliate + more effective solutions exist
■ Government revenue: Used in developing countries, should be phased out
as they develop - important to not that tariffs impact income distribution
■ Protection of domestic jobs: Import restrictions on goods that are used to
produce other goods cause lower production and more unemployment +
 import restrictions cause unemployment in exporting countries leading to
retaliation and thus, unemployment in the importing country
● AGAINST
○ Only domestic producers and workers always gain
○ Gain of producers is canceled out by higher costs of production and lower
efficiency
○ Customers almost always lose
○ Income distribution almost always loses
○ Foreign producers always lose
○ Resource allocation always worsens
○ Trade protection can negatively impact price level, real GDP and employment (in
the case of protection on industries that produce goods used to produce other
goods)
○ Trade protection can negatively impact a country’s export competitiveness (in the
case of protection on industries that produce goods used to produce exported
goods)
○ Trade protection may give rise to trade wards through retaliation
○ Trade protection created potential for corruption (bribes and smuggling)

15.2: Economic integration: trading blocs

● Preferential trade agreements

○ 2 or more countries agree to lower trade barriers on certain products
○ Co-operation on labor standards, environmental issues and IP laws as well
○ Free trade areas, customs unions, common markets, etc.
● Bilateral trade agreements: between two countries
● Multilateral trade agreements: many countries
● Regional trade agreements: 2 or more countries in a particular geographical area
● WTO trade agreements are multilateral: several countries
○ Non-discrimination = fundamental principle
● Trading bloc: group of countries agree to reduce trade barriers and encourage
cooperation
● Free Trade Agreement: group of countries agree to gradually eliminate trade barriers
○ Example: NAFTA (North America) or ASEAN (Southeast Asia)
○ Problems arise with conflicting trade barriers imposed on non-member countries
● Customs union: FTA + common policy towards non-members
○ Example: CEFTA (Central Europe) or SACU (South African)
○ Problems arise with potential disagreements over common policy measures
● Common market: customs union + absolutely no internal barriers, even on factor
movement
○ Example: EEC (European Economic Community - precursor to EU)
○ Higher potential efficiency but government must give up significant control
● ADVANTAGES of trading blocs
 ○ Trade creation: Higher cost products are replaced with lower cost imports -
disadvantages of trade protection are eliminated and there is higher social
welfare
○ Increased competition
○ Expansion into larger markets
○ Economies of scale
○ Lower prices + greater choice for consumers
○ Increased investment
○ Improved resource allocation + greater employment opportunities
○ Improved efficiency + greater economic growth
○ Stronger bargaining power
○ Political advantages - less conflict, more stability and cooperation
● DISADVANTAGES of trading blocs
○ Trade diversion: lower cost imports (from a non-member) are replaced by higher
cost imports following the formation of a bloc
○ Challenge multilateral (ex. WTO) negotiations and thus, trade liberalization
○ Unequal distribution of gains
○ Loss of sovereignty

15.3: Economic integration: monetary union

● Monetary union
○ Common market + common currency and central bank
○ Example: EU - Euro + European Central Bank
○ Fixed exchange rate among participating currencies but never possible to change
the value of one currency in relation to another

15.4: World Trade Organization

● Functions of WTO
○ Administers trade agreements
○ Forum for trade negotiations
○ Handles trade disputes
○ Monitors national trade policies
○ Provides technical assistance and training for developing countries
○ Facilitates cooperation with other international organizations - World Bank and
IMF
● WTO criticisms and challenges
○ Accused of not favoring developing countries
○ Unable to reach agreements on agricultural protection and services
■ Developed countries insistent on protecting their farmers
■ WTO did manage to ban export subsidies
○ Inability to distinguish between developed and developing countries
■ Treats all countries as the same (except LEDCs)
 ○ Ignores environmental and labor issues
■ Supports agreements that favor countries with low environmental and
labor standards
■ Developed countries, with higher bargaining power, care less about these
issues
○ Fragmentation of global trade
■ Global trade and the WTO are stagnating
■ Impatience with WTO (favoring agreements outside of it)
■ Plurilateral (voluntary) agreements undermine WTO
○ Blocking of its power
■ US blocked the appointment of new judges to WTO appellate body
■ Without appellate body, WTO cannot resolve trade disputes

Chapter 16: Exchange rates and the balance of payments

16.1: Floating exchange rates

● Exchange rate is determined by market forces

● Appreciation of a currency is caused either by a rightward shift in demand or a leftward
shift in supply - vice versa for depreciation
● Causes of changes in exchange rates
○ Change in currency demand
○ Exports and factors affecting exports
■ Foreign demand for exports
■ Foreign demand for exports of services (tourists from abroad)
■ Rate of inflation relative to other countries (lower comparative inflation
rate = higher demand for currency - exports are cheaper)
■ Relative growth rates (if a trade partner is experiencing high economic
growth, their incomes are increasing and so they demand more exports)
○ Investment and factors affecting investment
■ Outward FDI and portfolio investment (decreases supply of domestic
currency)
■ Relative interest rates (comparatively lower interest rate means outflow
and thus, higher supply - depreciation)
○

RLSs for P1

Concept Country Comments

Cost-push inflation US banned Russian oil Reduced imports and

 imports due to speculation of further
Russia-Ukraine crisis reduced supply lead to a
steep increase in prices -
Petroleum products were still
demanded at the same level
(suppliers pass off the
increased commodity prices
by increasing selling prices)

Deflation Great Depression in the US SIGNIFICANT drop in

and Europe demand - collapse of
companies and banks

Price ceiling Rent Control in the US Used as a price control to

combat hyperinflation and
protect renters in the 1970s

In the real world - said to

cause more problems than it
solves - quality and quantity
of housing reduced BUT it
protects tenants who already
have leases

Price floor National Minimum Wage in First introduced in the 1930s

the UK due to protests from outraged
workers

Set to minimize job loss while

preserving internal
competitiveness - reduces
demand for workers BUT has
been proven to improve living
conditions (cannot solve
poverty on its own)

Indirect taxes GST in India Absorbed