Economics and Business Studies A level quiz, 2010. Unit 3 International Business more resources on this course from geraldwood.com. How to revise. Use your own notes as your basis for revision.
Unit 3 International Business
more resources on this course from geraldwood.com
This section of Unit 3 looks at why some companies wish to sell overseas, looking at the product or market conditions which may encourage a business to trade internationally
Q1: What is the simplest way of describing the aims of most large businesses?
A: Profit maximisation
Comment: Most large firms are public limited companies whose shares may be bought by anyone. Unless such firms pursue the path of maximising the profit made on its assets, it is vulnerable to being taken over by companies which are more profit-orientated
Q2: Why does the aim of maximising profits lead most large companies to trade internationally?
A: The UK with a population of 60 million has just 1% of the world’s population. Very few large firms can afford to ignore the other 99%
Comment: The skills which large companies acquire are in many respects transferable across the globe. It makes no sense to confine their use to just one corner of it
Q3: Why is growth essential if profits are to be maximised?
A: There is a limit to the amount of profit that can be squeezed out of static revenue – the only long-term way to grow profits is to grow revenue
Comment: And ultimately this means selling overseas
Q4: If a company manages to double its sales levels together with sales revenue what will normally happen to profits?
A: They will more than double. Any business has fixed costs, so doubling output does not normally double costs – there are ‘economies of scale’ (size)
Comment: Selling overseas is often the fastest path to doubling sales
Q5: Why might selling overseas enable a company to extend its product life cycle?
A: While there is always a market in rich countries for the latest products at relatively high prices, in ELDCs (Economically Less Developed Countries) demand for older products persists
Comment: For example, in the 1990s Trevor Bayliss reinvented the windup radio, which sold to people without access to mains power
Q6: Why might selling overseas enable a company to launch an innovative new product?
A: Most people who buy the latest products (the ‘first adopters’) do not live in the UK. Innovative new products may have a greater chance of success if launched first in the larger markets of Japan or the USA rather than the UK
Comment: Or they may be launched close together in Japan, the USA and Europe e.g. the Xbox 360
Q7: Why might selling overseas be a sensible response to increased domestic competition?
A: Any static business model is always in danger from potential competitors, whether based in the UK or overseas. ‘The best form of defence is attack.’
Comment: However, expansion should not be seen as a solution to any company suffering from underlying problems which make it uncompetitive
Q8: Why might buying in supplies from overseas be a means of growing a business?
A: By confining itself to UK suppliers, a company rules out the vast majority of potential partners, many of whom may offer better (or cheaper) products
Comment: Nonetheless, domestic suppliers will normally be able to deliver more quickly (with a shorter ‘lead time’), and without any exchange rate risk
Q9: What is the long-term trend with respect to the transport and communication costs of doing business internationally?
A: These costs are falling, with telephone and email costs essentially the same internationally as nationally
Comment: These technological advances remove one of the traditional costs associated with international trade
Q 10: What is meant by ‘trade liberalisation’?
A: The process by which international trade is made easier through a relaxation of the rules which govern it
Comment: To ‘liberalise’ anything is to reduce the legal constraints on the activity. While this is not always a good thing, there are powerful economic arguments in favour of liberalised international trade (also known as ‘free trade’)
Q11. What are trade barriers?
A: Any arrangements that make international trade more difficult, such as taxes on imports (known as ‘tariffs’) or restrictions on the amount of imports (known as ‘quotas’) – see 3.3.4
Comment: The process of trade liberalisation does, therefore, consist in the removal of trade barriers
Q12: What is the work of the World Trade Organisation (WTO)?
A: To encourage trade liberalisation by operating a system of trade rules and by providing a forum for the negotiation of trade disputes
Comment: While every country stands to benefit from free trade taken as a whole, every country also faces situations where they would like an exception to be made – normally to protect a domestic producer who is not competitive
Q13: What is a trade bloc?
A: A group of countries which have agreed to operate by the same rules with respect to international trade
Comment: Depending on how closely the members wish to integrate their economies they may form different types of trade bloc – such as free trade areas, customs unions, common markets and full economic and monetary union
Q14: What is a free trade area?
A: A group of countries, which have agreed not to impose any trade barriers between themselves
Comment: There are many such regional blocs around the world, including the North American Free Trade Association (NAFTA), consisting of Mexico, Canada and the USA. The European Economic Area (EEA) consisting of non-EU states is another example – now small, the main members being Norway and Iceland
Q15: What is a Customs Union?
A: A free trade area where all the members impose the same import taxes on all other countries – the level of import taxes being known as the Common External Tariff (CET)
Comment: The benefit of a CET is that once goods have been imported into one of the countries in the Customs Union they may then be moved freely within it without the owners of the goods avoiding tariffs
Q16: What is a Common Market?
A: A customs union where the members also have the same rules on product regulation, and seek to implement free movement of capital and labour between member states
Comment: The Eurasian Economic Community, whose members consist of many former states within the Soviet Union such as Russia, Belarus, andKazakhstan is one example
Q17: What is Economic and Monetary Union (EMU)?
A: A common market where the members also use the same currency
Comment: Many examples of EMU consist of one major state with satellite states e.g. EMU between South Africa and Swaziland, Lesotho & Namibia
Q18: Do trade blocs always fit neatly into one of the above categories?
A: No. Trade blocs tend to be very fluid. They form, break down, gain members and lose them – and often evolve from one type of trade bloc into another over time
Comment: Nonetheless there appears to be a global trend towards more, and more tightly knit, trade blocs – and this is in turn one of the factors driving the increase in international trade
Q19: What type of trade bloc is the European Union (EU)?
A: The EU is an example of Economic and Monetary Union. Although only 16 out of the current 27 member countries have adopted the Euro, all except the UK and Denmark are committed to adopting it in due course
Comment: The other 9 (mainly recent members) are expected to join when their economies become more closely integrated with the EU
Q20: Is the EU essentially a trading bloc?
A: The EU has a strong political dimension: it is not merely an economic arrangement. The original aim of the 1957 Treaty of Rome was ‘ever closer union’. This is interpreted by many to mean a single state should be the aim
Comment: Indeed for many the economic arrangements within the EU are secondary to the political project
Q21: What are the benefits of trading within the EU?
A: As a free trade area, there are no import duties, and as a common market what is sold in one country may be sold in another. With monetary union there are fewer costs involved in changing currencies, and it is easier to compare prices
Comment: Almost all multinational companies including those based in the UK would like Britain to adopt the Euro
Q22: What are the constraints on trading within the EU?
A: The UK is not part of the Euro zone, so we still face the exchange rate risk and transactions costs of dealing in another currency. Different languages and cultures also form trade barriers
Comment: Additionally, while the EU is a vast market of 500 million mainly wealthy people, rapidly growing markets in Asia and elsewhere will for many offer more opportunity
This section of Unit 3 looks at how firms and businesses may be affected by the growing economic power of India and China and how a national business may seek to trade with them.
Source: CIA Factbook 2009. Figures are for 2008, or the latest available estimates. Figures converted into US dollars using Purchasing Power Parity exchange rates
Q23: Does GDP or GDP/head give a better guide to economic power (see previous tables)?
A: GDP gives the better guide
Comment: A country is economically powerful if it produces more goods than others. This is measured by GDP. By contrast, GDP/head is a guide to the standard of living as it measures output per person. Because of wildly different population sizes there is little connection between the two measures, as the previous tables show
Note: World GDP in 2008 was US$70.1 trillion (PPP exchange rates) Sources: CIA Factbook 2009 and UNData websites
Q24: What is the difference between market exchange rates and Purchasing Power Parity (PPP) exchange rates?
A: Market rates are the rates at which currencies may be traded in the open market. PPP rates are the rates at which you could buy the same typical basket of goods in different countries
Comment: If all products could be freely traded the two rates would be very similar. In practice, most services cannot be traded internationally
Q25: Why does it matter which rate we use?
A: PPP exchange rates give a much better indication of purchasing power, and so of economic power
Comment: If you compare China and Japan in the previous set of tables Japan appears to produce almost double the GDP (10.3/6.4) using the market exchange rate whereas in reality it is producing roughly half the GDP (6.2/11.4)
Q26: Why does using PPP exchange rates show countries with low standards of living narrowing the gap with rich countries?
A: Because poor countries have low wages which are reflected in low prices for labour-intensive services. Market exchange rates do not reflect this because most services cannot be traded internationally
Comment: For example, a porter in India cannot sell his services at the going rate in a rich country
Q27: How can we summarise the relative economic strength of the major economies in 2008?
A: Using PPP exchange rates, the USA on 21% of world GDP is well ahead of China (11%), Japan (6%), India (5%) and Germany (4%)
Comment: Another way of looking at it is to say that the USA on 21% is roughly matched by all 27 EU countries (also on 21%) and by the top three Asian countries combined on 22%
Note: While PPP exchange rates give a better guide to current economic power, economic growth rates are normally expressed using GDP based on market exchange rates. For this reason, the subsequent slides are based on comparisons using market exchange rates. As China and India catch up with the developed world, so the difference between their PPP and market exchange rates will diminish
Source: UNData website
Q28: The ‘rule of 70’ states that a variable growing at x% pa will double in approximately 70/x years. Using this rule and the data from Table 3.5, how long will it take for a) China b) India and c) Britain/USA to double their GDP?
A: China – 70/9.7 = 7.2 years India – 70/8.0 = 8.8 years USA/Britain = 70/2.6 = 26.9 years
Comment: The ‘rule of 70’ is pretty accurate. The actual times are a)7.5 b)9.0 c)27.0 years
Q29: What does a country need to challenge for the top spots in world economic power?
A: A level of GDP that is already high, and a future long-term annual rate of growth of GDP that will be higher than the existing leaders
Comment: From Table 3.5, both India and China are likely to meet these criteria with growth rates over the past decade far in excess of anything produced by the other 8 largest economies
Q30: From Table 3.5, how does the forecast relationship between China’s and the USA’s GDP change between 2008 and 2030?
A: In 2008, the USA’s GDP is almost exactly four times that of China’s. By 2030, China will have just pulled ahead – on this forecast
Comment: We might guess that by 2030, the USA and China will have roughly the same GDP – and roughly three times more than Japan and India, who may be fighting for third place
Source: UNData website, and CIA Factbook