Economic Development and Globalisation: Economics 9708 (Cambridge International AS & A Level)

Vezmoor operates a managed exchange rate for its currency, the vezo, against the US dollar. Facing a persistent current account deficit, Vezmoor's central bank decides to devalue the official value of the vezo. Economists estimate the price elasticity of demand for Vezmoor's exports at $-0.7$ and the price elasticity of demand for Vezmoor's imports at $-0.5$.

(a) Distinguish between a devaluation and a depreciation of a currency. [2]

(b) State the Marshall-Lerner condition. Using the two elasticity values given, determine whether this condition is satisfied following Vezmoor's devaluation. [3]

(c) Using J-curve analysis, explain why Vezmoor's current account balance might initially worsen immediately after the devaluation, even though your answer to (b) suggests the devaluation should eventually improve it. [4]

(d) Explain ONE way in which the determination of Vezmoor's exchange rate under its managed system differs from how the exchange rate would be determined under a freely floating system. [3]

Bellwood and Astria are two developing economies. To compare their levels of human development, economists construct a simplified version of the Human Development Index (HDI), which combines a health dimension, an education dimension and an income dimension by taking their geometric mean (the cube root of their product). To keep the arithmetic straightforward, each dimension index here is calculated using the same linear formula:

$\text{dimension index} = \frac{\text{actual value} - \text{minimum value}}{\text{maximum value} - \text{minimum value}}$

(Note: the real-world HDI actually uses a logarithmic scale for its income dimension; this question uses a linear scale for all three dimensions for simplicity.)

The table below gives the data, together with the minimum and maximum values used to construct the indices.

(a) Using real GNI per capita alone, explain one reason why this monetary indicator on its own might give a misleading picture of the relative development of Bellwood and Astria. [2]

(b) Using the formula and data given, calculate the life expectancy index, the education index and the income index for Bellwood. [3]

(c) Hence calculate the simplified HDI for Bellwood, giving your answer to three decimal places. [2]

(d) The equivalent calculation for Astria gives a life expectancy index of $0.846$, an education index of $0.833$ and an income index of $0.199$, combining to a simplified HDI of $0.520$. Compare the two countries' simplified HDI scores, and explain what this comparison reveals about their relative levels of human development that real GNI per capita alone would not show. [3]

The table shows the share of total national income received by each fifth (quintile) of the population, ranked from the poorest fifth to the richest fifth, in two developing economies, Kolvara and Estenia.

(a) Calculate the cumulative percentage of national income received by the poorest 40% of the population (the poorest two fifths) in each country. [2]

(b) Explain how the cumulative income shares calculated in (a), together with the rest of the data, would be used to construct a Lorenz curve for each country, and state which country's Lorenz curve would lie closer to the line of perfect equality. [3]

(c) Without calculating its exact value, explain whether Kolvara or Estenia would have the higher Gini coefficient, justifying your answer using the data in the table. [3]

(d) Explain ONE reason why data on income shares, even combined with a calculated Gini coefficient, may not give a complete picture of a country's level of economic development. [3]

Kelewa is a low-income developing country. Its government is deciding between two strategies for bringing in the capital it needs to support economic development: attracting more foreign direct investment (FDI) from multinational companies (MNCs), and applying for a new International Monetary Fund (IMF) loan with attached policy conditions.

(a) Define foreign direct investment (FDI), and state ONE way in which FDI from multinational companies could help Kelewa's economic development. [3]

(b) Explain TWO possible drawbacks for Kelewa of relying heavily on multinational companies and FDI to support its development. [4]

(c) Discuss the extent to which attaching conditions to an IMF loan (such as requirements to cut government spending or liberalise trade) is likely to help, rather than hinder, Kelewa's long-run economic development. [5]

Which of the following best describes a customs union?

Sarnovia's central bank operates a fixed exchange rate for its currency, the saro, against the US dollar. The official rate has been held at 1 saro = $0.50. Facing persistent upward pressure on the saro, the central bank deliberately announces a new, higher official rate of 1 saro = $0.60, and commits to defending this new rate.

Which term correctly describes this deliberate policy action by Sarnovia's central bank?

Doverlan is a developing country with a mid-year population of 8,000,000. During the year:

• There were 240,000 live births and 96,000 deaths.
• 30,000 people immigrated into Doverlan and 10,000 people emigrated from Doverlan.

(a) Calculate Doverlan's birth rate and death rate, each expressed per 1,000 of the population. [2]

(b) Calculate Doverlan's rate of natural increase, expressed as a percentage of the population. [2]

(c) Calculate Doverlan's net migration (in people) and net migration rate (per 1,000 of the population), and state whether Doverlan experienced net immigration or net emigration this year. [3]

(d) Explain ONE reason why a developing country such as Doverlan might experience net immigration rather than net emigration. [2]

Halvorne's currency, the hal, has appreciated in nominal terms against a basket of its trading partners' currencies. Economists want to know whether Halvorne has really become more or less price-competitive internationally, so they also calculate a real exchange rate index, using:

$\text{Real exchange rate index} = \text{Nominal exchange rate index} \times \frac{\text{Domestic price index}}{\text{Foreign price index}}$

where the nominal exchange rate index is defined so that a rise indicates the hal has appreciated. The table below gives Year 1 (the base year) and Year 2 index values (Year 1 $=100$ for all three series).

(a) Explain the difference between a nominal exchange rate and a real exchange rate. [2]

(b) Using the formula given, calculate Halvorne's real exchange rate index in Year 2. [3]

(c) Compare what the nominal exchange rate index alone suggests about the change in Halvorne's international price competitiveness between Year 1 and Year 2 with what your answer to (b) suggests. [3]

(d) State what a trade-weighted exchange rate index measures, and explain why it may give a more accurate picture of a currency's overall value than a single bilateral exchange rate. [2]

Meridor is a low-income developing country. It receives international aid from wealthier countries, and it has also built up a large stock of external debt from past borrowing to finance infrastructure projects. Meridor's external debt currently stands at $18 billion. This year, Meridor's total export earnings are $4.5 billion, of which $0.9 billion is spent servicing (paying interest on and repaying) its external debt.

(a) Distinguish between bilateral aid and multilateral aid, giving an example of who provides each. [2]

(b) Calculate Meridor's debt service ratio for this year, and comment on what your answer suggests about the burden its external debt places on the economy. [3]

(c) Explain ONE reason why a country such as Meridor might have accumulated a high level of external debt, and ONE consequence for its economic development if this debt burden continues to grow. [4]

(d) Discuss whether receiving more international aid is necessarily the best way to help Meridor reduce the burden of its external debt. [3]

Trevalia is considering joining "the Consortium," a customs union of several neighbouring countries, as part of a wider process of globalisation affecting its economy. Trevalia currently imports a good from Farlow, a low-cost producer outside the Consortium, and could alternatively import the same good from Nearbridge, a Consortium member.

(a) Identify TWO causes of globalisation, i.e. factors that have enabled deeper international economic integration between countries in recent decades. [2]

(b) If Trevalia joins the Consortium, it abolishes tariffs on trade with fellow members (such as Nearbridge) while keeping its $10 common external tariff on non-members (such as Farlow). From which country would Trevalia now import this good, and would this switch represent trade creation or trade diversion? Explain your reasoning. [4]

(c) Explain ONE reason why the effect identified in (b) might still be more than offset by other benefits of Trevalia joining the Consortium. [3]

(d) Discuss the extent to which increased trade openness of the kind described above is likely to benefit all groups within Trevalia's economy equally. [3]