Business and the international economy

1. Overview

The international economy is the global environment in which businesses operate, characterized by the movement of goods, services, and capital across national borders. For a modern business, the "market" is no longer just their local town or country; it is the entire world. Success in this environment requires businesses to exploit the opportunities of globalisation and international trade while managing the risks of exchange rate fluctuations and government protectionism.

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Key Definitions

• Globalisation: The process by which countries and economies around the world are becoming more interconnected and interdependent through increased trade, communication, and cultural exchange.
• Multinational Company (MNC): A business that has operations (factories, offices, or shops) in more than one country. It has a headquarters in a "home" country and operations in "host" countries.
• International Trade: The exchange of goods and services between different countries.
• Exports: Goods and services produced in one country and sold to buyers in another country, resulting in an inflow of money.
• Imports: Goods and services bought from other countries, resulting in an outflow of money.
• Exchange Rate: The price of one currency in terms of another currency (e.g., $1 = €0.92).
• Tariff: A tax placed on imported goods to make them more expensive, designed to protect domestic producers.
• Quota: A physical limit on the quantity of a specific good that can be imported into a country during a specific time period.
• Protectionism: Government policies (like tariffs or quotas) that restrict international trade to help domestic industries compete against foreign firms.
• Free Trade: When countries agree to trade with each other without any barriers like tariffs or quotas.

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Core Content

A. Globalisation: Drivers and Impact

Globalisation is not a single event but a continuous trend toward a more integrated global economy.

Main Drivers of Globalisation:

1. Improved Transport: Containerization and air freight have made moving goods faster and significantly cheaper.
2. Information Technology: The internet allows for instant communication, online ordering, and the ability to manage global supply chains in real-time.
3. Trade Liberalisation: Governments are reducing tariffs and joining Trade Blocs (e.g., ASEAN, EU) to encourage free trade.
4. Growth of MNCs: Large firms seeking new markets and lower costs spread their operations globally.

Impact on Business Decision-Making:

• Opportunities: Access to billions of new customers; ability to achieve economies of scale by producing in massive quantities; access to cheaper raw materials and labor.
• Threats: Intense competition from foreign firms who may have lower costs; risk of "brain drain" where skilled local workers move to international firms.

Worked example 1 — Impact of Globalisation on a Local Manufacturer

Question: Describe and explain two ways globalisation might affect a small domestic clothing manufacturer.

Model Answer:

1. Increased Competition: Globalisation allows large foreign retailers to enter the domestic market. These firms often have lower unit costs due to mass production in low-wage countries. This may force the local manufacturer to lower prices, reducing their profit margins.
2. Access to Global Suppliers: The manufacturer can now source high-quality fabrics or specialized machinery from abroad at lower prices than local suppliers. This reduces their variable costs, potentially making their final products more competitive or increasing their profit per unit.

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B. Multinational Companies (MNCs)

A business becomes an MNC to be closer to its customers, to lower production costs (labor/land), or to bypass trade barriers like tariffs.

Impact on the Host Country (The country where the MNC sets up):

Benefits to Host Country	Drawbacks to Host Country
Job Creation: Direct employment in factories and indirect jobs in local supply chains.	Competition: Large MNCs can use their size to underprice local firms, potentially driving them out of business.
Increased GDP: Production by the MNC adds to the country's total output and economic growth.	Profit Repatriation: The MNC may send all its profits back to its home country rather than reinvesting them locally.
Tax Revenue: The host government collects corporate taxes from the MNC’s profits.	Resource Depletion: MNCs might exploit local natural resources or cause environmental damage if local laws are weak.
Technology Transfer: Local workers learn advanced production techniques and management skills.	Influence: Large MNCs may have too much power over small governments, demanding subsidies or tax breaks.

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C. Exchange Rates

The value of a currency is rarely stable. It fluctuates based on the demand and supply for that currency.

1. Depreciation (The currency becomes "weaker")

• Mnemonic: WPIDEC (Weak Pound, Imports Dearer, Exports Cheaper).
• Effect on Exporters: Their goods become cheaper for foreign customers. Sales volume usually increases.
• Effect on Importers: Raw materials from abroad become more expensive. This increases the Cost of Goods Sold (COGS).

2. Appreciation (The currency becomes "stronger")

• Mnemonic: SPICED (Strong Pound, Imports Cheaper, Exports Dearer).
• Effect on Exporters: Their goods become more expensive for foreign customers. Sales volume may fall.
• Effect on Importers: Buying components or stock from abroad is cheaper. This can lead to higher profit margins or lower prices for consumers.

Worked example 2 — Calculating the Impact of Currency Appreciation

Question: A German car manufacturer sells a vehicle for €40,000. The exchange rate changes from €1 = $1.10 to €1 = $1.30. Calculate the new price in Dollars and explain the likely impact on the manufacturer's sales in the USA.

Model Answer:

• Step 1 (Calculation): $40,000 \times 1.30 = $52,000$.
• Step 2 (Explanation): The Euro has appreciated against the Dollar. The price of the car for US customers has risen from $44,000 ($40,000 \times 1.10$) to $52,000.
• Step 3 (Impact): Because the car is now more expensive in the US market, demand is likely to fall as customers switch to cheaper local competitors or other imports. The German manufacturer may see a decrease in total export revenue.

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D. Trade Barriers and Protectionism

Governments use protectionism to save local jobs, protect "infant" (new) industries, or prevent "dumping" (when foreign firms sell goods below cost to destroy local competition).

• Tariffs: These act as a tax on imports.
  • Business Impact: If a business relies on imported parts, a tariff increases their costs. If a business competes with imports, a tariff helps them by making the competitor's product more expensive.
• Quotas: These limit the supply of foreign goods.
  • Business Impact: Once the limit is reached, local firms face no further foreign competition for the rest of the year, allowing them to potentially raise prices.

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Extended Content (Extended Only)

Note: The IGCSE 0450 syllabus does not distinguish between Core and Supplement for this topic; all content above is required for all candidates.

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Key Equations

1. Converting Home Currency to Foreign Currency: $$\text{Home Amount} \times \text{Exchange Rate} = \text{Foreign Amount}$$ (Use this to find the price of your exports in a foreign market)

2. Converting Foreign Currency to Home Currency: $$\text{Foreign Amount} \div \text{Exchange Rate} = \text{Home Amount}$$ (Use this to find the actual cost of your imports in your own currency)

3. Percentage Change in Exchange Rate: $$\frac{\text{New Rate} - \text{Old Rate}}{\text{Old Rate}} \times 100$$

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Common Mistakes to Avoid

• Assuming Depreciation is "Bad": Students often think a "weak" currency is a sign of a weak economy. For a business that exports 90% of its goods, a weak currency is actually a major competitive advantage.
• Confusing Globalisation with MNCs: Globalisation is the trend/process of the world getting smaller. An MNC is a specific type of business that takes advantage of that trend.
• Ignoring the "Chain of Reasoning": When asked about the impact of a tariff, don't just say "prices go up." Explain the chain: Tariff added $\rightarrow$ Import price rises $\rightarrow$ Demand for imports falls $\rightarrow$ Demand for local substitutes rises $\rightarrow$ Local business revenue increases.
• Forgetting the "Host Country" Perspective: In exam questions about MNCs, check if the question asks for the impact on the MNC itself or the Host Country. These are very different answers.

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Exam Tips

• The "Depends On" Factor (Evaluation): When evaluating the impact of an MNC on a host country, always use a "depends on" statement for top marks.
  • Example: "The benefit of the MNC depends on whether they hire local managers (skill transfer) or only use local people for low-skilled manual labor."
• Case Study Context (Paper 2): If the case study business is a "Service Business" (like a hair salon), globalisation and exchange rates might matter less than for a "Manufacturing Business" that imports parts. Always link your answer to the specific industry in the text.
• Identify the Currency: In calculation questions, always include the currency symbol ($ or £). Marks are often lost for naked numbers.
• Trade Blocs: If a question mentions a business moving to a country within a "Trade Bloc," the primary advantage is the removal of tariffs when selling to other member countries.
• Quality vs. Price: If a currency appreciates (making exports dearer), a business can survive if its products have high brand loyalty or quality, as customers will be less sensitive to the price increase. Use this as a counter-argument in "Evaluate" questions.

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Exam-Style Questions

Practice these original exam-style questions to test your understanding. Each question mirrors the style, structure, and mark allocation of real Cambridge 0450 papers.

Exam-Style Question 1 — Short Answer [6 marks]

Question:

A small clothing manufacturer in Bangladesh is considering exporting its products to the UK.

(a) Identify two potential benefits to the clothing manufacturer of exporting. [2]

(b) Define the term 'international trade'. [2]

(c) Outline two potential problems the clothing manufacturer might face when exporting to the UK. [2]

Worked Solution:

(a)

1. Increased sales/revenue: Exporting to the UK allows the company to reach a larger customer base and increase its sales and revenue. [B1]
2. Economies of scale: With increased production for the UK market, the business can benefit from economies of scale, reducing average costs. [B1]

How to earn full marks: Make sure your benefits are distinct and clearly linked to the clothing manufacturer's situation.

(b)

1. International trade is the exchange of goods and services between countries. [B2] OR
2. International trade involves imports (goods/services brought into a country) and exports (goods/services sold to another country). [B1] + [B1]

How to earn full marks: Use precise business terminology in your definition, not just a general idea.

(c)

1. Exchange rate fluctuations: Changes in the exchange rate between the Bangladeshi Taka and the British Pound could make the clothing more expensive or less profitable. [B1]
2. Increased transportation costs: Shipping clothing to the UK will increase the company's transportation costs. [B1]

How to earn full marks: Focus on problems directly related to exporting, and explain why they are problems for the manufacturer.

Common Pitfall: When discussing benefits and problems, be specific to the business in the question. Don't just say "more profit"; explain how exporting leads to more profit for this clothing manufacturer.

Exam-Style Question 2 — Extended Response [8 marks]

Question:

Explain two reasons why a government might impose tariffs on imported goods.

Worked Solution:

1. To protect domestic industries: Tariffs increase the price of imported goods, making them less competitive compared to goods produced by domestic industries. This helps to protect jobs and support the growth of local businesses. [B1] For example, the government may impose a tariff on imported steel to protect its own steel industry. [B1] This allows domestic steel companies to sell more, generate higher profits, and employ more people. [B2]

2. To raise revenue for the government: Tariffs are a tax on imported goods, so the government collects revenue from these taxes. [B1] This revenue can then be used to fund government programs and services, such as healthcare, education, or infrastructure. [B1] For instance, the revenue generated from tariffs on imported cars could be used to build new roads. [B2]

How to earn full marks: Explain the reason, give a relevant example, and then explain the impact of the tariff in detail.

Common Pitfall: Make sure you explain the entire chain of events. Don't just say "tariffs protect jobs." Explain how tariffs lead to higher prices for imports, which then makes domestic goods more competitive, which then protects jobs.

Exam-Style Question 3 — Extended Response [12 marks]

Question:

ABC Ltd., a manufacturer of furniture in Vietnam, is considering becoming a multinational corporation (MNC) by opening a production facility in Germany.

Discuss the potential advantages and disadvantages for ABC Ltd. of becoming an MNC.

Worked Solution:

Advantages for ABC Ltd.:

1. Access to new markets: Opening a production facility in Germany allows ABC Ltd. to directly access the large European market. [B1] This can lead to increased sales and revenue. [B1] By being closer to its European customers, ABC Ltd. can better understand their needs and tailor its products to their preferences. [B2]

2. Reduced transportation costs: Manufacturing in Germany reduces transportation costs for products sold in Europe compared to shipping from Vietnam. [B1] This can improve profit margins and make the company more competitive. [B1] Lower transport costs can translate to lower prices for the consumer, increasing demand. [B2]

Disadvantages for ABC Ltd.:

1. Higher labor costs: Labor costs in Germany are significantly higher than in Vietnam. [B1] This could increase the company's production costs and reduce its profit margins. [B1] The business may have to invest in automation to offset these higher labour costs. [B2]

2. Cultural differences: Operating in Germany will require ABC Ltd. to adapt to a different business culture. [B1] This could lead to misunderstandings and difficulties in managing employees. [B1] The business may need to invest in cultural training for its managers and employees to ensure effective communication. [B2]

Conclusion:

Whether becoming an MNC is beneficial for ABC Ltd. depends on whether the potential advantages outweigh the disadvantages. While access to new markets and reduced transportation costs are attractive, the higher labor costs and cultural differences could pose significant challenges. If ABC Ltd. has the resources and expertise to manage these challenges effectively, then becoming an MNC could be a worthwhile investment. However, if the company is not prepared for these challenges, it may be better off focusing on its existing operations in Vietnam. [B2]

How to earn full marks: For each advantage/disadvantage, explain the point, develop it with how it affects ABC Ltd, and then give a further developed point.

Common Pitfall: In your conclusion, don't just summarize your points. Weigh the advantages and disadvantages against each other, and make a judgment about whether becoming an MNC is a good idea for this specific company.

Exam-Style Question 4 — Short Answer [4 marks]

Question:

The exchange rate between the US Dollar ($) and the Euro (€) has changed from $1 = €0.90$ to $1 = €0.80$. A US company exports goods to Europe.

(a) Explain what has happened to the value of the US Dollar relative to the Euro. [2]

(b) Outline the likely impact of this exchange rate change on the US company's exports to Europe. [2]

Worked Solution:

(a)

1. The US Dollar has depreciated (or weakened) against the Euro. [B2] OR
2. The US Dollar has become cheaper relative to the Euro. [B1] As it now takes fewer Euros to buy one US Dollar. [B1]

How to earn full marks: State the correct term (depreciation/weakening) and then explain what that means in the context of the exchange rate.

(b)

1. Exports to Europe will likely increase. [B1]
2. This is because US goods are now cheaper for European consumers (as they can buy more US Dollars with their Euros). [B1]

How to earn full marks: State the impact on exports, and then explain why that impact is likely to occur.

Common Pitfall: Don't just state that depreciation means a fall in the exchange rate. You MUST explain how this change in the exchange rate affects the business itself, in this case, the US company's exports.