ACJC International Trade Answers Case Study 1

Question 1: Looming Threats to Globalisation Questions & Suggested Answers Marks (a) (i) State what happened to the British pound sterling effective exchange rate between the Q1 2014 and Q4 2016. [2] • The British pound sterling effective exchange rate depreciated in value between Q1 2014 and Q4 2016. [1 mark]. • However, it was rising over the period Q1 2014 to Q3 2015 [1 mark] before decreasing thereafter. (ii) Using a demand and supply diagram, explain the cause of the trend observed in the Sterling Effective Exchange Rate Index in 2016. [4] • The main cause was a loss of investor confidence due to Britain’s decision to exit from the EU (Brexit). [1 mark] This resulted in capital flight from the UK. This caused an increase in SS of sterling pound [1 mark] from S 0 to S1 in the foreign exchange market. • At the same time, as fewer foreign investors would want to invest in the UK. This means a decrease in the demand for UK sterling pounds from D0 to D1. [1 mark] Figure 1: Market for Sterling Pound (b) With reference to Table 3, calculate and compare the net income flow (including transfers) in the UK current account balance with that of the US. [2] Note to students: current account comprises of both good and services balance (balance of trade) and income balance. Hence, to calculate the net income flow, we should subtract the current account balance from the balance of trade. • UK’s current account balance is -5.8% of GDP while its balance of trade is - 2% of GDP. Hence, its net income flow should be -3.8% of GDP. • US’s current account balance is - 2.4% of GDP while its balance of trade is - 2.8% of GDP. Hence its net income flow should be +0.4% of GDP. • This shows that UK experienced a net income outflow, while US had a net income inflow. S0 S1 D0 D1 E0 E1 0 Quantity of Sterling SEER

(c) Explain how a free trade agreement between the EU and Canada might affect a small dairy farmer in Belgium. [4] Effects on revenue • Since a free trade agreement would mean a removal or reduction of tariffs on imports, dairy farmers in Belgium will now have to compete with cheaper imports from Canada → likely fall in demand → lower prices and total revenue OR • Demand for Belgium milk producers would also become price elastic due to rising competition from imports, which mean more substitutes. This would cause prices to fall to compete, affecting revenue. [2 mark] Effects on costs • Moreover, small dairy farmers tend to have higher costs compared to large multi-nationals, due to their lack of economies of scale. [2 mark] (d) Given that membership in the EU means free movement of goods, labour and capital among member countries, assess the possible impact of Brexit on the UK economy. [8] Command Assess possible impact on economy • Negative impacts of Brexit on UK’s macro goals • Positive impacts of Brexit on UK’s macro goals Concepts AD/AS analysis 4 macro goals Context Brexit UK Economy (shown in suggested answer below) Requirement 1: Negative impact 1 Requirement 2: Negative impact 2 Evaluation: Possible positive impacts OR Requirement 1: Negative impact Requirement 2: Positive impact Evaluation: Factors that determine the extent of negative or positive impact Introduction: • The departure of UK from the EU (Brexit) would mean that firms in UK would no longer have free access to European markets and that labour and capital might not be allowed to move freely between UK and EU countries. Requirement 1 - Negative Impact on UK economy Loss of confidence and capital outflow – One of the major effects of Brexit is the loss of investor confidence, as mentioned in Extract 4. Brexit means that UK firms would no longer have free access to European markets and may thus face tariff barriers in exporting to EU countries. This

could cause a fall in exports as UK’s goods will be less price competitive. Assuming M remains the same, UK’s BOT will fall. This also cause investors to have a pessimistic outlook of the UK economy. This would thus cause a worsening of UK’s Balance of Payments. • Fall in AD and economic growth –The fall in X and I leads to a fall in AD, which results in a fall in real output and hence economic growth. With the fall in real output, less labour will be needed as it is a derived demand of growth, causing an increase in demand-deficient unemployment. As shown in Fig 2 below, the fall in AD due to fall in X and I causes real output to decrease from Y0 to Y1, resulting in lower or even negative economic growth. Evaluation: Greater autonomy to establish Free Trade Agreements with other countries as UK is free from the agreements due to their previous EU membership. This can allow UK to tap new opportunities in other foreign markets and expand its trade with the rest of the world. This can help to boost its exports, hence spurring economic growth and increasing employment opportunities. Evaluation: While the movement of UK firms to Europe or other countries may worsen its balance of payments in the short run, it can generate higher profits which are repatriated back to UK in future, thus improvement in its Balance of Payments. Requirement 2: Other negative impacts on UK economy • Labour outflow – In addition, the loss of confidence and negative outlook could also cause people in UK to relocate to the EU. The fall in LRAS can lead to a rise in general price level in the long term, as productive capacity becomes a constraint. This would make UK more susceptible to demand-pull inflation. Evaluation: Brexit also means that UK can now restrict the influx of immigrants into the country. This reduces the social problems caused by migrant workers, thus contributing to an improvement in non-material aspect of standard of living. • With poorer investor confidence, there would be capital flight, causing the demand for pound to fall significantly. This would cause the currency to depreciate. This would cause the price of imports in pounds to be more expensive. If UK imports many raw ma terials from the EU member states, this will cause an increase in the unit COP for firms, causing SRAS to decrease. Firms will pass on the increase in costs to households through and increase in GPL. There is a higher cost-push inflation in UK. Evaluation: Fall in exchange rate and improvement in BoT – This leads to an improvement in Balance of Trade and increase in AD, resulting in a more than proportionate increase in real national income via the multiplier effect, and hence an increase in economic growth rate. Conclusion • As discussed above, Brexit can have significant negative impacts on the UK economy. The impact is likely to be more negative in the short term as the loss of investor confidence as well as increase in barriers to trade with the EU could lead to a decline in UK’s economic growth and worsen its balance of payments position. • However, i n the longer term, UK economy might emerge more resilient if they manage to establish other trade relationships with economies outside of the EU.

• The government policies that the UK government implements can also mitigate some of these challenges, such as supply side measures to build the competitiveness and uniqueness of its exports. Mark Scheme Level Descriptors Level 2 4-6 For an answer that demonstrates knowledge, understanding, application and analysis:  EXCELLENT breadth that considers the following economic concepts in explaining multiple and balanced perspectives, viewpoints, relationships and factors. ALL points chosen should be of relevance and significance in answering the question.  EXCELLENT depth in economic analysis that reflects the following in ALL explanations.  Accurate use of economic concepts, clear elaboration, and precise use of economic terminologies, language and phrasin