Econ 327 ch 1 - Lecture notes 1 PDF

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Introduction  In this course, we will study international trade in goods and services and the global macro economy.  We will develop models to help us understand the reasons that countries trade goods and services, that people move from one country to another, and that firms own companies in other countries.  We will also study the global macro economy and how it is defined by integrated markets for goods, services, and capital. The Basics of World Trade       

Countries buy and sell goods and services from one another constantly. An export is a product sold from one country to another. An import is a product bought by one country from another. A country’s trade balance is the difference between its total value of exports and its total value of imports (usually including both goods and services). Countries that export more than they import, such as China in recent years, run a trade surplus. Whereas countries that import more than they export, such as the United States, run a trade deficit. The bilateral trade balance is the difference of exports and imports between two countries.

Factors That Explain Trade Patterns    

The largest amount of trade shown in Figure 1-1 is the flow of goods within Europe, $3.9 trillion, or 23%, of world trade! Trade between European countries is high because import tariffs (taxes on international trade) are low. There are also large trade flows between the United States and Europe. The United States exported $303 billion of goods to Europe and imported $377 billion from Europe. This shows that a large amount of world trade occurs between countries that are similar in their levels of industrialization and great wealth.

Trade Compared with GDP • There is a second way that trade is often reported, as a ratio of trade to a country’s gross domestic product (GDP), the value of all final goods produced in a year. For the United States, the average value of imports and exports (for goods and services) expressed relative to GDP was 15% in 2010. Most other countries have a higher ratio of trade to GDP.

Trade Barriers

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Trade barriers refers to all factors that influence the amount of goods and services shipped across international borders.

Map of Foreign Direct Investment • The majority of foreign direct investment occurs between industrial countries, when a firm from one industrial country owns a company in another industrial country. We refer to these flows between industrial countries as horizontal FDI.

• The other form of foreign direct investment occurs when a firm from an industrial country owns a plant in a developing country, which we call vertical FDI. Low wages are the principal reasons that firms shift production abroad to developing countries.

• Countries have different currencies, therefore a complete understanding of how a country’s economy works requires that we study the exchange rate (the price of foreign currency).

• In later chapters, we see why exchange rates matter for economic outcomes and why they are an important focus of economic policy making.

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Based on observable differences in exchange rate behavior, economists divide the world into two groups of countries: those with fixed (or pegged) exchange rates and those with floating (or flexible) exchange rates.

Debtors and Creditors: External Wealth • Total wealth or net worth is equal to your assets (what others owe you) minus your liabilities (what you owe others).

• When you run a surplus, and save money (buying assets or paying down debt), your total wealth, or net worth, tends to rise.

• Similarly, when you have a deficit and borrow (taking on debt or running down savings), your wealth tends to fall.

• From an international perspective, a country’s net worth is called its external wealth and it equals the difference between its foreign assets (what it is owed by the rest of the world) and its foreign liabilities (what it owes to the rest of the world).

Government and Institutions: Policies and Performance • Government actions influence economic outcomes in many ways by making decisions about exchange rates, macroeconomic policies, debt repayment, and so on.

• To gain a deeper understanding of the global macro economy, economists study policies, rules and norms, or regimes in which policy choices are made.

• At the broadest level, research also focuses on institutions, a term that refers to the overall legal, political, cultural, and social structures that influence economic and political actions.

Three important features of the broad macroeconomic environment we’ll cover in this course are: • the rules that a government decides to apply to restrict or allow capital mobility,

• the decision that a government makes between a fixed and a floating exchange rate regime, and

• the institutional foundations of economic performance, such as the quality of governance that prevails in a country....