International Economics Course Content Summary PDF

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International Economics International Economy generates interdependence: Economic growth in the US increases US demand for imports Increased imports in the US generates economic growth in other countries that export to the US Economic growth in these countries due to higher exports leads Etc. Source...

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International Economics International Economy generates interdependence:   

Economic growth in the US increases US demand for imports Increased imports in the US generates economic growth in other countries that export to the US Economic growth in these countries due to higher exports leads to….. Etc.

Sources of potential gain from international trade:   

Access to items not available domestically Access to lower cost products Access to greater product variety

Does it always lead to gains?  

Imports from other countries leads to higher levels of domestic competition and so domestic industry may experience production losses or job losses This loss is offset by gains in the exporting sector

Anti-globalisation movement:  

A loose coalition of groups opposed to globalisation Concerned about environmental damage, loss of domestic jobs, erosion of domestic sovereignty and poverty

International flow of labour:   

People migrate mainly for economic reasons such as poor standard of living or to seek better opportunities for their children Most nations put restrictions on immigration of low skilled people while at the same time encouraging the immigration of highly skilled workers Migration is the most regulated international flow, ahead of goods, services and capital

International flow of capital:   

Capital flows more freely than people Financial capital moves to nations and markets where interest rates are higher FDI in plants and firms flows towards higher expected profits and leads to more efficient use (Money usually goes to the best run businesses)

Current International Economic Problems:       

Brexit: Has created massive uncertainty New US Government (Trump): Greatly effecting trade agreements Problems in emerging economies: The economies are slowing down and this may affect us Refugee crisis: Major challenge to the absorptive capacity of EU economies and labour markets Financial crisis in Europe High structural employments and low inflation Deep poverty in many developing countries

World Trade Organisation (WTO):    

Authority over international trade in goods and services Deals with rules of trade between nations Negotiates new trade agreements All member countries have to adhere to WTO agreements

World Bank:   

Internationally supported bank that provides loans to developing countries for development programmes Overall goal is to reduce poverty Gives out loans after natural disasters and in times where emergency rehabilitation is necessary

International Monetary Fund (IMF):    

Ensures member nations follow a set of agreed upon rules of conduct in international finance Provides loans to nations when they have trouble repaying loans Oversees global financial systems by following the macroeconomic principles of member countries International lender of last resort

United Nations (UN): 

International org. whose aims are to facilitate cooperation of international law, security, economic development, social progress and human rights issues

Gains from Trade:  

Models of absolute and comparative advantage Gains from trade are increased consumption gained through specialisation in production and trade

What is wealth? 

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Mercantilist view – The stock of precious metals held by a country. You can either mine for precious metals or earn them though exports of goods and services. Therefore exports must exceed imports for a country to become wealthy therefore the wealth of one country must come at the expense of another. Modern view – Measures of wealth are based on a country’s ability to produce the goods and services that improve quality of life

Absolute Advantage:   

Built on the ideas of Adam Smyth Absolute advantage exists between nations when they differ in their ability to produce goods I country A is good at producing cotton and country B is good at producing wheat then they should specialise at what they are good at and they can both have more of each

Comparative Advantage:

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Built on the ideas of David Ricardo Tries to answer the question ‘What if one country is better at producing everything?’ The law of comparative advantage says a nation should specialize in and export the commodity in which its absolute disadvantage is smaller and should import the other commodity Commodity in which its absolute disadvantage is smaller = The commodity of its comparative advantage The weaker country should completely specialise in whatever they are good at and then trade with the stronger country in order for both to benefit

Production Possibility Frontier (PPF):  

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Identifies the maximum combinations of two products that a nation can produce by fully utilizing all factors of production with the best technology available Regions of the PPF:

International trade leads to increased production which allows countries to consume at a point outside of its normal PPF. This increased consumption is the gains from trade.

Increasing Opportunity Costs:   

Also known as Marginal Rate of Transformation (MRT) Increasing amounts of another item must be given up in order to release sufficient resources to produce one more unit of a given item Caused by non-homogenous factors of production and factors that are not used at constant fixed proportions in production

Implications of Increasing Opportunity costs on the PPF:   

Makes the PPF concave as it has to represent the increasing opportunity costs of switching production The MRT increases as more units of the good on the X axis are produced Value of the MRT is given by the slope of the curve

Community Indifference Curves:

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A community indifference curve displays the combinations of two products that offer the community the same level of satisfaction They are negatively sloped, convex to the origin and the different curves do not cross Marginal Rate of Substitution (MRS): The amount of one commodity that must be given up as one gains additional units of another commodity

The Autarky Equilibrium:    

Autarky exists in the absence of international trade The autarky equilibrium occurs when maximum societal satisfaction has been obtained from available production This will occur when one community indifference curve is tangent to the PPF Given the convex, downward sloping, and non-intersecting nature of community indifference curves, only one such tangency will exist

Relative Prices:  

The equilibrium relative commodity price in isolation (or autarky) is given by the slope of the tangent (In red) The slope of the tangent is the price of good X divided by the price of good Y (Px/Py)

Trade in the standard model:

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Trade in the standard model is driven by differences in the opportunity costs of production In the example underneath nation two’s opportunity cost for producing X is lower than that of nation one so nation two has a comparative advantage in the production of X

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Because of this, nation two will start to produce more of X and nation one will start to produce more of Y as the specialise and trade This movement of production and trade will mean that production will move from point A to point B in both countries

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At the new production point, both countries will be able to trade to a final consumption point on a higher community indifference curve than the original curve (Point C) At this point, nation one’s exports of Y are matched by nation two’s imports of Y and nations two’s exports of X match nations one’s imports of X Basically proves trade can allow a nation to consume on a higher indifference curve than in autarky

At the final production points (B) and consumption points (C), the marginal rates of transformation and marginal rates of substitution are the same in both economies Neither country completely specialises in the production of X or Y as this would result in constant opportunity costs

The Terms of Trade:

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The terms of trade is the ratio of the index price of a nation’s exports to the index price of its imports The relative price of X and Y determine the terms of trade in a two country, two commodity setting An improvement in a country’s terms of trade are typically viewed as beneficial as it indicates that fewer export goods will need to be provided to purchase the same number of import goods

Changing the employment mix:  

The examples of trade demonstrate that specialization and trade will result in job losses in some sectors, but job gains in others The expected movement of employment is from manufacturing to the service sector as there are several industrialised nations that have a comparative advantage when it comes to manufacturing

Different theories of International Trade:      

The Heckscher-Ohlin model of trade An economy of scale model of trade A product differentiation model of trade A product cycle model of trade A transportation cost model of trade An environmental standards model of trade

The Heckscher-Ohlin theory is based on two theorems: 1. The H-O Theorem:  A nation will export the commodity whose production requires the intensive use of the nation’s relatively abundant (and therefore, cheap) factor and import the commodity whose production requires the intensive use of the nation’s relatively scarce (and therefore, expensive) factor  Factor intensity is determined by the ratio of capital (K) to labour (L) required for the production of the commodity  The country with the greater K/L ratio is determined as being capital abundant  The commodity requiring the greater K/L ratio per unit of production is defined as being capital intensive 2. The Factor Price Equalisation Theorem:  International trade will bring about equalization in the relative and absolute returns to homogenous factors across nations. In other words, wages and other factor returns will be the same after specialization and trade has occurred  Exported commodities experience an increase in their price relative to the autarky situation  Thus, the labour abundant country will see an increase in wages, but a fall in the return to capital while the capital abundant country will experience the opposite pattern of change  Diagram on next page

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Country 1 = Capital intensive Country 2 = Labour intensive Country 1 produces commodity A on isoquant ‘aa’ Country 2 produces commodity B on isoquant ‘bb’ Country 1 exports A and imports B while country 2 exports B and imports A In country 1, the price of capital will increase and the price of labour will decrease In country 2, the price of capital will decrease and the price of labour will increase Factor price line AB gradually rotates clockwise along isoquant aa Factor price line CD gradually rotates clockwise along isoquant bb They will continue to do this until factor prices coincide at PL PL is tangent to aa at point T and tangent to bb as point S This indicates that factor prices in both countries are the same

Key Assumptions for FPE:   

Both countries produce both goods Both countries have the same technologies in production Both countries have the same prices of goods due to trade

Empirical Tests of the H-O Theory: 

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The Leontief Paradox: Tested the H-O theory in 1951 and found that the pattern of trade did not fit with the theorem however technology varies so this assumption may have biased the test North-South Trade: Developing and developed country trade in manufacturing seems to fit the theory better than the overall pattern of international trade Most researchers agree that the H-O model but don’t believe that is differences in resources alone that determines the patterns of trade

Economy of scale model of trade:  

Some productive relationships are characterised by increasing returns to scale In this situation, production on a larger scale lowers per unit costs of production and provides a new source of cost advantage on which to base exports

Product Differentiation Based Trade:  

Intra-industry trade may arise from product differentiation as it allows producers to exploit product specific economies of scale Allows consumers to benefit from a variety that would not have existed without the existence of international trade

The Product Cycle Model of Trade:   

Advanced industrialised countries develop and introduce new products and they then have a comparative advantage in that product As the technology becomes more widespread, production will spread to other nations Over time the original introducer of the product loses its technologically based comparative advantage in the production of the product and becomes an importer of the product

Transportation Costs Model of Trade: 

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Transportation costs are the freight charges, warehousing costs, costs of loading and unloading, insurance premiums, and interest charges incurred while goods are in transit between nations The introduction of transportation costs into the standard model of trade may eliminate a country’s comparative advantage in the production of an item Transportation costs may provide an advantage for trade between geographically close countries

Environmental Standards and Trade:   

A nation’s environmental standards determine the level of acceptable pollution that may be generated from production Strict environmental standards are expected to raise the costs of production and may remove a country’s comparative advantage In order to maintain comparative advantage, a nation may reduce its environmental protections

Types of Tarrifs:     

Import tariff: A tax (or duty) on imported goods or services (Common) Export tariff: A tax on exported goods or services (This is rarely seen in developed countries but is occasionally practiced in developing countries to generate government revenue) Ad Valorem tariff: A fixed percentage tax on the traded commodity Specific tariff: A fixed sum tax per unit of a traded commodity Compound tariff: A combination of ad valorem and specific

Distinguishing between a ‘small’ and ‘large’ country: 

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A “small” country is one where changes in its domestic market do not alter the international price of the commodity. If they place a tariff it will not affect the international price and so they act as a price-taker A “large” country is one where changes in its domestic market do alter the international price of the commodity. If they place a tariff the international price will change and so they are a price-maker

Effects of a tariff by a small country:     

Take an example of a market where the autarky equilibrium occurs at a price of €50 and quantity of 50 In this market, if the international price is €20, then the country will obviously be an importer of the item Domestic production will fall from 50 to 20 Domestic consumption will rise from 50 to 80 These changes generate imports of 60 units (Black line with two arrows)

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If a 50% ad valorem tariff is placed on imports the domestic price will rise from €20 to €30 because of the extra cost of the tariff Domestic production will increase to 30 Domestic consumption will fall to 70 Imports fall to 40

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The government then collect the tariff revenue in this market (Blue shaded area) In this example its €10 x 40 units so €400 per unit of time

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Welfare effects of the tariff in the small country:  

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To show the welfare changes from the tariff the concepts of consumer and producer surplus must be considered Consumer surplus is the difference between what consumers are willing to pay for a specific amount of a commodity and what they actually pay for it (Area under the demand curve and above the price) Producer surplus is the extra payment received by producers above what needed to have been paid to cause them to produce the commodity (Below the price and above the supply curve)

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Consumer surplus at autarky is the dark purple region at the top Consumer surplus at free trade is the entire shaded region Consumer surplus with the tariff is the dark purple and light purple region at the top

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Producer surplus at autarky is given by the entire shaded region Producer surplus at free trade is the dark blue triangle Producer surplus with the tariff is the dark and light blue areas combined Deadweight loss is what could have been achieved in the economy through production and consumption should the tariff not have been imposed

Effects of a tariff on a large country:

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The effects of a tariff on a large country differ from that in a small country because the imposition of a tariff results in a fall in import demand that lowers the international price (Terms of trade effect) In this case, the 50% tariff results in a drop of the international price from €20 to €15 (Horizontal blue line) This means that the tariff price is €22.50 because its 50% of €15 (€7.50) and 15 + 7.5 = 22.5

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With the tariff production rises from 20 to 22.5 units Consumption falls from 80 to 77.5 units Imports fall from 60 to 55 units

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Government revenue increases by the shaded area This is an example of an optimum tariff which is a tariff rate that maximizes the benefit resulting from the imposition of a tariff

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Quotas: 

A quota is an example of a non-tariff barrier to trade

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A quota is a numerical limit on the number of allowed imports The initial effects of a quota will be very similar to a tariff and the price will change the same as it would with a tariff The level of production will be the same as if there was a tariff The level of consumption will be the same as if there was a tariff

The shaded region is quota rent collected by the government. The allocation of the quota rents depends on how the government allocates the licenses to import the product. The triangles on either side of the quota rent are the deadweight loss from the quota.

Concerns about quotas:   

The initial effects of a tariff and a quota are similar The effect of market changes The allocation of quota rent is ambiguous

Voluntary export restraints:   

A voluntary export restraint exists when the exporting nation voluntarily restricts its exports to a numerical limit Generally, this action is taken to reduce the likelihood of the importing country imposing some other form of barrier to trade In 1981, Japan and the US agreed to a VER of 1.68 million automobiles to be imported annually by the US from Japan

Regulations:

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Health and safety regulations may serve as barriers to international trade by raising the costs of imported products Government purchasing restrictions may be biased against foreign goods

International Cartels:  

An international cartel may form to limit sales For example, OPEC (the Organization of Petroleum Exporting Countries) acts to limit exports of petroleum

Dumping: 

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Dumping exists when 1. The sales price in the importing country is lower than the sales price in the exporting country 2. The...