The global economy Study Guide

International trade involves the exchange of goods and services across national borders, driven by principles such as specialisation and comparative advantage. Countries can achieve greater efficiency and access a wider range of products at potentially lower costs than if they produced everything domestically. Various factors influence these trade flows, including exchange rates, governmental policies like tariffs, quotas, and subsidies, as well as production costs and consumer preferences. Tariffs are taxes imposed on imported goods, which increase their price. While tariffs can protect domestic industries from foreign competition, they often lead to higher prices for domestic consumers and can diminish overall trade volume.

An exchange rate represents the value of one currency in terms of another. For instance, if 1 US dollar (USD) can be exchanged for 0.85 British Pounds (GBP), then the exchange rate is $1 = £0.85. Exchange rates are crucial in international trade and investment. A stronger domestic currency means that foreign goods and services appear cheaper to domestic consumers, which can increase imports. Conversely, a weaker domestic currency makes domestic goods and services cheaper for foreign buyers, potentially boosting exports. Exchange rates are determined by the forces of demand and supply in the foreign exchange market. Factors like interest rates, inflation, political stability, and economic growth can influence these demand and supply dynamics, leading to appreciation (strengthening) or depreciation (weakening) of a currency.