Lecture Week 1
When firms cross borders they are confronted with many uncertainties. E.g. currency values,
trade barriers, curbs on international investment, or the degree of macroeconomic stability.
There are a variety of economic theories that help to understand the market forces driving
the global economy, how this influences government policy choices and the consequences of
government policies for firms in the global economy.
Traditional and global production processes are describing the ‘route’ a product takes
before it is introduced into the market. The traditional production process is quite simple,
while the global production process makes use of many different companies/countries for
their product
Demand
How much of a product consumers want to purchase depends on many factors: price,
income, tastes, availability and prices of alternative products, etc.
Focus on key determinant: price
Demand for a good is falling in its price
The demand curve shows the highest price a consumer is willing to pay for a given unit
Price elasticity of demand = how strongly demand reacts to a price change (percent
change in demand due to 1 percent change in price)
→ Low elasticity = steep demand curve
→ High elasticity = flat demand curve
Supply
The product price is the key determinant of how much a product firms are willing to produce
and sell: supply an extra unit as long as the revenue from selling this unit exceeds the extra
cost of producing it
The supply curve shows the lowest price at which firms are willing to sell a given unit
The supply of a good increases in its price
Price elasticity of supply = how strongly supply reacts to a price change (percent change in
supply due to 1 percent change in price)
→ Low elasticity = steep supply curve
→ High elasticity = flat supply curve
Market equilibrium without trade
The market equilibrium is at the point where the demand and supply curve are equal to each
other
Consumer and producer surplus
Total welfare is consumer + producer surplus
,The effect of free trade on prices and wellbeing in important countries
Opening to free trade raises the consumer surplus and thus lowers the producer surplus, the
total welfare increases due to the consumer and producer effect: trade triangle
Production and consumptions effects of free trade
The net welfare gain can be separated into the consumption effect and the production
effect
Consumption effect → welfare gain due to increase in quantity consumed
Production effect → welfare gain due to shifting to cheaper foreign producers
The effect of free trade on prices and wellbeing in exporting countries
The excess supply in the domestic market will be exported
Producer surplus increases by D + E
Consumer surplus decreases by D
Total effect: net gain of E (trade triangle)
Determining the world price
If there are no transportation costs or other trade frictions,
free trade will result in both countries having the same price
(the world price Pw)
A higher price lowers the excess demand (imports) in the country and increases the excess
supply (exports) in the rest of the world. If demand>supply, the price rises. If
demand<supply, the price falls
The global market is in equilibrium when the demand for imports equals the supply of
exports
The demand for imports (MD) curve shows the excess of domestic demand over domestic
supply:
MD = 0 if P = P* MD > 0 if P < P*
The supply of exports (XS) curve shows the excess of
domestic supply over domestic demand:
XS = 0 if P = P* XS > 0 if P > P*
Global market equilibrium: MD = XS (P = Pw)
MD = XS is equivalent to global demand = global supply
The larger the price change from trade (difference between world price and autarky price),
the bigger the welfare gain: the country experiencing the larger price change gains more
from trade
In a country with a steep (less elastic) import demand or export supply curve, the price
change is bigger and the welfare gain from trade is larger
An increase in the world price of a product benefits exporting countries and hurts importing
countries
, Lecture Week 2
Absolute advantage = being able to produce something at lower costs than other producers
Comparative advantage = being able to produce a certain product at relatively lower costs
(compared to other products) than other producers
Opportunity costs of a good = how much of another good has to be given up in order to
produce this good
Relative price of product 1 compared to another → P1 / P2
A production possibility curve shows how much output can be produced with given inputs
Arbitrage means taking advantage of a price difference between two or more markets: by
striking a combination of matching deals that capitalize upon the imbalance, you can make a
profit equal to the difference between the market prices at which the unit is traded
Specialization according to comparative advantages is efficient → world production increases
The equilibrium international relative
price must fall within the two autarky
price ratios:
Absolute advantages
Absolute advantages determine real wages = wage expressed in units of a good (rather than
money)
Nominal wage: w = P x labor productivity
Real wage: w = w / P = labor productivity
The PPC shows all combinations of wheat and
cloth that can be produced with the available
resources
If opportunity costs of cloth is lower than relative
price of cloth, cloth production will increase
If opportunity costs is higher than the relative price,
cloth production will fall
Firms profits are maximized when slope of the PPC (opportunity costs) = slope of the price
line (relative price) → optimal production point
The amount of wellbeing consumer derive from different combinations of products can be
visualized in the consumers’ indifference curves: the combinations of consumption
quantities that yield the same level of utility (wellbeing)
Consumer’s goal is to maximize their utility, given their income and the relative price of the
two goods.
→ Budget constraint (BC): Y = Pw x Qw + Pc x Qc
→ Pc/Pw: Qw = Y/Pw – Pc/Pw x QC
Utility is maximized where the consumer indifference curve is tangent to the budget
constraint
Trade leads to an expansion of production of the now more expensive good and an
expansion of consumption of the now cheaper good
Excess production is exported and the excess demand is imported
When firms cross borders they are confronted with many uncertainties. E.g. currency values,
trade barriers, curbs on international investment, or the degree of macroeconomic stability.
There are a variety of economic theories that help to understand the market forces driving
the global economy, how this influences government policy choices and the consequences of
government policies for firms in the global economy.
Traditional and global production processes are describing the ‘route’ a product takes
before it is introduced into the market. The traditional production process is quite simple,
while the global production process makes use of many different companies/countries for
their product
Demand
How much of a product consumers want to purchase depends on many factors: price,
income, tastes, availability and prices of alternative products, etc.
Focus on key determinant: price
Demand for a good is falling in its price
The demand curve shows the highest price a consumer is willing to pay for a given unit
Price elasticity of demand = how strongly demand reacts to a price change (percent
change in demand due to 1 percent change in price)
→ Low elasticity = steep demand curve
→ High elasticity = flat demand curve
Supply
The product price is the key determinant of how much a product firms are willing to produce
and sell: supply an extra unit as long as the revenue from selling this unit exceeds the extra
cost of producing it
The supply curve shows the lowest price at which firms are willing to sell a given unit
The supply of a good increases in its price
Price elasticity of supply = how strongly supply reacts to a price change (percent change in
supply due to 1 percent change in price)
→ Low elasticity = steep supply curve
→ High elasticity = flat supply curve
Market equilibrium without trade
The market equilibrium is at the point where the demand and supply curve are equal to each
other
Consumer and producer surplus
Total welfare is consumer + producer surplus
,The effect of free trade on prices and wellbeing in important countries
Opening to free trade raises the consumer surplus and thus lowers the producer surplus, the
total welfare increases due to the consumer and producer effect: trade triangle
Production and consumptions effects of free trade
The net welfare gain can be separated into the consumption effect and the production
effect
Consumption effect → welfare gain due to increase in quantity consumed
Production effect → welfare gain due to shifting to cheaper foreign producers
The effect of free trade on prices and wellbeing in exporting countries
The excess supply in the domestic market will be exported
Producer surplus increases by D + E
Consumer surplus decreases by D
Total effect: net gain of E (trade triangle)
Determining the world price
If there are no transportation costs or other trade frictions,
free trade will result in both countries having the same price
(the world price Pw)
A higher price lowers the excess demand (imports) in the country and increases the excess
supply (exports) in the rest of the world. If demand>supply, the price rises. If
demand<supply, the price falls
The global market is in equilibrium when the demand for imports equals the supply of
exports
The demand for imports (MD) curve shows the excess of domestic demand over domestic
supply:
MD = 0 if P = P* MD > 0 if P < P*
The supply of exports (XS) curve shows the excess of
domestic supply over domestic demand:
XS = 0 if P = P* XS > 0 if P > P*
Global market equilibrium: MD = XS (P = Pw)
MD = XS is equivalent to global demand = global supply
The larger the price change from trade (difference between world price and autarky price),
the bigger the welfare gain: the country experiencing the larger price change gains more
from trade
In a country with a steep (less elastic) import demand or export supply curve, the price
change is bigger and the welfare gain from trade is larger
An increase in the world price of a product benefits exporting countries and hurts importing
countries
, Lecture Week 2
Absolute advantage = being able to produce something at lower costs than other producers
Comparative advantage = being able to produce a certain product at relatively lower costs
(compared to other products) than other producers
Opportunity costs of a good = how much of another good has to be given up in order to
produce this good
Relative price of product 1 compared to another → P1 / P2
A production possibility curve shows how much output can be produced with given inputs
Arbitrage means taking advantage of a price difference between two or more markets: by
striking a combination of matching deals that capitalize upon the imbalance, you can make a
profit equal to the difference between the market prices at which the unit is traded
Specialization according to comparative advantages is efficient → world production increases
The equilibrium international relative
price must fall within the two autarky
price ratios:
Absolute advantages
Absolute advantages determine real wages = wage expressed in units of a good (rather than
money)
Nominal wage: w = P x labor productivity
Real wage: w = w / P = labor productivity
The PPC shows all combinations of wheat and
cloth that can be produced with the available
resources
If opportunity costs of cloth is lower than relative
price of cloth, cloth production will increase
If opportunity costs is higher than the relative price,
cloth production will fall
Firms profits are maximized when slope of the PPC (opportunity costs) = slope of the price
line (relative price) → optimal production point
The amount of wellbeing consumer derive from different combinations of products can be
visualized in the consumers’ indifference curves: the combinations of consumption
quantities that yield the same level of utility (wellbeing)
Consumer’s goal is to maximize their utility, given their income and the relative price of the
two goods.
→ Budget constraint (BC): Y = Pw x Qw + Pc x Qc
→ Pc/Pw: Qw = Y/Pw – Pc/Pw x QC
Utility is maximized where the consumer indifference curve is tangent to the budget
constraint
Trade leads to an expansion of production of the now more expensive good and an
expansion of consumption of the now cheaper good
Excess production is exported and the excess demand is imported
