INTERNATIONAL ECONOMICS
SUMMARY CHAPTER 1/12,14
Jelle te Vruchte
,Contents
Chapter 1 Introduction to International Economics / The United State in a global economy and
Chapter 2 International Economic Institutions Since World War II ........................................................ 2
Chapter 3 Comparative advantage and the gains from trade................................................................. 7
Chapter 4 Comparative Advantage and Factor Endowments ............................................................... 10
Chapter 5 Beyond comparative advantage ........................................................................................... 14
Chapter 6 The theory of tariffs and quotas ........................................................................................... 18
Chapter 7 Commercial Policy ................................................................................................................ 23
Chapter 8 International trade and labor and environmental standards............................................... 26
Chapter 9 Trade and the balance of payments ..................................................................................... 30
Chapter 10 Exchange rates and exchange rate systems ....................................................................... 33
Chapter 11 An introduction to open economy Macroeconomics......................................................... 38
Chapter 12 International financial crises .............................................................................................. 41
Chapter 14 The European Union: Many markets into one ................................................................... 43
Glossary ................................................................................................................................................. 47
1
Copyright ©2014 Pearson Education, Inc. All rights reserved
,Chapter 1 Introduction to International Economics / The United State in a global economy and
Chapter 2 International Economic Institutions Since World War II
Trade-to-GDP ratio = (Exports + Imports) / GDP
This ratio does not tell us about a country’s trade policies and countries with higher ratios do not
necessarily have lower barriers to trade, although that is one possibility. In general, large countries
are less dependent on international trade because their firms can reach an optimal production size
without having to sell to foreign markets. Consequently, smaller countries tend to have higher ratios
of trade-to-GDP.
Criteria or measures for judging the degree of integration:
1. Trade flows
2. Capital flows
3. People flows
4. Similarity of prices in separate markets.
As national economies become more interdependent, labor and capital generally move more easily
across international borders.
Types of capital flows:
1. flows of financial capital representing paper assets such as stocks, bonds, currencies, and
bank accounts.
2. flows of capital representing physical assets such as real estate, factories, and businesses -
foreign direct investment (FDI).
Important quality differences in capital flows today:
1. Many more financial instruments available
2. Role of foreign exchange transactions
3. Costs of foreign transactions has fallen significantly (transaction costs)
There are three features of contemporary international economic relations:
1. Deeper integration (tariffs and quotas)
2. Multilateral organizations
3. Regional trade agreements
Deeper integration (tariffs and quotas) two trends the second half of 20th Century:
1. Lower trade barriers exposed most countries with domestic policies as obstacles to
international trade
2. Labels such as “Made in China” or “Made in the USA” are less and less meaningful
Shallow integration reduction of tariffs and the elimination of quotas
Deep integration negotiations over domestic policies that impact international more
contentious and harder to accomplish
2
Copyright ©2014 Pearson Education, Inc. All rights reserved
,Economists remain convinced the benefits of trade outweigh the costs pointing to three kinds of
evidence:
1. Casual empirical evidence of historical experience
2. Evidence based on economic models and deductive reasoning
3. Evidence from statistical comparisons of countries
While none of these is conclusive by itself, together they provide:
1. The Gains from Trade and New Trade Theory
2. Wages, Jobs and Protection
3. Trade Deficits
4. Regional Trade Agreements
5. The Resolution of Trade Conflicts
6. The Role of International Institutions
7. Exchange Rates and the Macroeconomy
8. Financial Crisis and Global Contagion
9. Capital Flows and the Debt of Developing Countries
10. Latin America and the World Economy
11. Export-Led Growth in East Asia
12. The Integration of the BRICs into the World Economy
Globalisation refers to the trend towards a more integrated global economic system.
Key factors
- The globalization of markets
- The globalization of production
- 1. Technological change
- 2. Declining trade and investment barriers
1. Low cost transportation have enabled firms to create global markets, and have facilitated the
movement of people from country to country promoting a convergence of consumer tastes
and preferences. Low cost communications networks have helped create electronic global
marketplaces
2. Thanks to the WTO (previously the GATT) average tariffs have been reduced from 43 per cent
in the late 1940s to less than 5 per cent today
WTO promotes trade by negotiating, setting and implementing rules of trade. The trade system
should be:
- Without discrimination
- National treatment
- Most-favoured nation (threat every nation as your most favoured nation)
- Free
- Exception to principles RTA
IMF is founded by 29 countries (1945) at the Bretton Woods conference in July 1944 and it ensures
the stability of the international monetary system. Responsibilities:
- promoting international monetary cooperation;
- facilitating the expansion and balanced growth of international trade;
3
Copyright ©2014 Pearson Education, Inc. All rights reserved
, - promoting exchange stability;
- assisting in the establishment of a multilateral system of payments; and
- Making its resources available (under adequate safeguards) to members experiencing
balance of payments difficulties.
The most visible role for the IMF is to intercede, by invitation, whenever a nation experiences a crisis
in its international payments. For example, if a country imports more than it exports, then it may run
out of foreign exchange reserves.
World bank reduces global poverty and its mission: “To fight poverty with passion and
professionalism for lasting results. To help people help themselves and their environment by
providing resources, sharing knowledge, building capacity and forging partnerships in the public and
private sectors.”
The IMF and World Bank
Foreign exchange reserves are dollars, yen, pounds, euros, or another currency (or gold) that is
accepted internationally. In the event of a financial crisis, Members borrow against IMF quotas. IMF
conditionality: Requirement for the borrowing member to carry out economic reforms in exchange
for a loan. The IMF has its own currency, called an SDR, or special drawing right. SDRs are based on a
country’s quota and are a part of its international reserves.
Free flows of capital has certain types: FDI, Portfolio Investments, Bank loans
“Foreign direct investment (FDI) is a category of investment that reflects the objective of
establishing a lasting interest by a resident enterprise in one economy (direct investor) in an
enterprise (direct investment enterprise) that is resident in an economy other than that of the direct
investor. The lasting interest implies the existence of a long-term relationship between the direct
investor and the direct investment enterprise and a significant degree of influence (a minimum
equity stake of 10%) on the management of the enterprise.”
5 types of reginal agreements
- Proponents of RTAs view them as building blocks toward freer, more open, world trade
- Opponents view RTAs as undermining progress toward multilateral (worldwide) agreements
4
Copyright ©2014 Pearson Education, Inc. All rights reserved
,Public Goods
By definition, public goods are nonexcludable and nonrival or nondiminishable . Nonexcludability
means that the normal price mechanism does not work as a way of regulating access. For example,
when a signal is broadcast on the airwaves by a television station, anyone with a TV set who lives in
its range can pick it up. (Of course, this is not the case with cable stations, which are granted
permission to scramble their signals. Signal scrambling is a clever technological solution to the
problem of nonexcludability.) The second characteristic of public goods is that they are nonrival or
nondiminishable. This refers to the attribute of not being diminished by consumption. For example, if
I tune in to the broadcast signal of a local TV station, my neighbors will have the same signal amount
available to them. Most goods get smaller, or diminish, when they are consumed, but public goods
do not. Private markets often fail to supply optimal levels of public goods because of the problem of
free riding . Free riding means that there is no incentive to pay for public goods because people
cannot be excluded from consumption. Given this characteristic, public goods will not be produced
optimally by free markets unless institutional arrangements can somehow overcome the free riding.
In most cases, governments step in as providers and use their powers to tax as a means to force
people to pay for the goods.
5
Copyright ©2014 Pearson Education, Inc. All rights reserved
,Institutions are the “rules of the game.” They can be formal, as in a nation’s constitution, or informal,
as in a custom or tradition. In both cases, we depend on institutions as mechanisms for creating
order and reducing uncertainty.
International institutions receive three types of criticism:
1. Sovereignty and Transparency
- International institutions can violate national sovereignty by imposing unwanted domestic
economic policies.
- Transparency concerns are based on questions about the mechanism with which decisions
are made within an international institution.
2. Ideology
- Critics argue that the advise and technical assistance provided to developing countries are
often a reflection of the biases and wishes of developed country wishes.
3. Implementation and adjustment costs
When agreements are reached that combine developed and developing countries, there are
often asymmetries in the ability to absorb the costs associated with them that favor
developed nations.
6
Copyright ©2014 Pearson Education, Inc. All rights reserved
, Chapter 3 Comparative advantage and the gains from trade
Access to foreign markets helps create wealth:
- If no nation imports, every company will be limited by the size of its home country market.
- Imports enable a country to obtain goods that it cannot make itself or can make only at very
high costs.
- Trade barriers decrease the size of the potential market, hampering the prospects of
specialization, technological progress, mutually beneficial exchange, and, ultimately, wealth
creation.
Trade barriers decrease specialization, technological progress, and wealth creation.
A basic model, often referred to as the Ricardian model, named after economist David Ricardo
Assumptions:
- Markets are competitive: Firms are price takers
- Static world: Technology is constant and there are no learning effects
- Labor is perfectly mobile: It can easily move back and forth between industries but perfectly
immobile across national borders.
Absolute productivity advantage: The advantage held by a country that produces more of a certain
good per hour worked than another
Question: What happens if a country does not have an absolute productivity advantage in anything?
Answer: Even if a country does not have any goods with an absolute productivity advantage, it can
still benefit from trade. The idea that nations benefit from trade has nothing to do with whether a
country has an absolute advantage in producing a particular good
A production possibilities curve (PPC) shows the tradeoffs a country faces when choosing between
two goods.
Output per hour worked example
The U.S. opportunity cost of bread is 1.5 tons of steel: each unit of bread produced requires the
economy to move labor out of steel production, forfeiting 1.5 tons of steel that it could have
produced instead.
3 tons tons loaves loaves
P
S
b
PUS 1.5 3.0 0.67
2 loaves loaves ton W
ton
In sum, trade between U.S. and Canada will occur at a price between two limits. ↑
Without trade, the U.S. would forgo 0.67 loaves of bread for an additional ton of steel. This is the
opportunity cost of steel, or the relative price of steel.
Why relative price? Because the price is not in monetary units but in units of the other good.
Relative price of steel is the inverse of the price of bread: if 0.67 loaves of bread is the price of a ton
of steel in the U.S., then 1.5 tons of steel is the price of one loaf of bread.
7
Copyright ©2014 Pearson Education, Inc. All rights reserved
SUMMARY CHAPTER 1/12,14
Jelle te Vruchte
,Contents
Chapter 1 Introduction to International Economics / The United State in a global economy and
Chapter 2 International Economic Institutions Since World War II ........................................................ 2
Chapter 3 Comparative advantage and the gains from trade................................................................. 7
Chapter 4 Comparative Advantage and Factor Endowments ............................................................... 10
Chapter 5 Beyond comparative advantage ........................................................................................... 14
Chapter 6 The theory of tariffs and quotas ........................................................................................... 18
Chapter 7 Commercial Policy ................................................................................................................ 23
Chapter 8 International trade and labor and environmental standards............................................... 26
Chapter 9 Trade and the balance of payments ..................................................................................... 30
Chapter 10 Exchange rates and exchange rate systems ....................................................................... 33
Chapter 11 An introduction to open economy Macroeconomics......................................................... 38
Chapter 12 International financial crises .............................................................................................. 41
Chapter 14 The European Union: Many markets into one ................................................................... 43
Glossary ................................................................................................................................................. 47
1
Copyright ©2014 Pearson Education, Inc. All rights reserved
,Chapter 1 Introduction to International Economics / The United State in a global economy and
Chapter 2 International Economic Institutions Since World War II
Trade-to-GDP ratio = (Exports + Imports) / GDP
This ratio does not tell us about a country’s trade policies and countries with higher ratios do not
necessarily have lower barriers to trade, although that is one possibility. In general, large countries
are less dependent on international trade because their firms can reach an optimal production size
without having to sell to foreign markets. Consequently, smaller countries tend to have higher ratios
of trade-to-GDP.
Criteria or measures for judging the degree of integration:
1. Trade flows
2. Capital flows
3. People flows
4. Similarity of prices in separate markets.
As national economies become more interdependent, labor and capital generally move more easily
across international borders.
Types of capital flows:
1. flows of financial capital representing paper assets such as stocks, bonds, currencies, and
bank accounts.
2. flows of capital representing physical assets such as real estate, factories, and businesses -
foreign direct investment (FDI).
Important quality differences in capital flows today:
1. Many more financial instruments available
2. Role of foreign exchange transactions
3. Costs of foreign transactions has fallen significantly (transaction costs)
There are three features of contemporary international economic relations:
1. Deeper integration (tariffs and quotas)
2. Multilateral organizations
3. Regional trade agreements
Deeper integration (tariffs and quotas) two trends the second half of 20th Century:
1. Lower trade barriers exposed most countries with domestic policies as obstacles to
international trade
2. Labels such as “Made in China” or “Made in the USA” are less and less meaningful
Shallow integration reduction of tariffs and the elimination of quotas
Deep integration negotiations over domestic policies that impact international more
contentious and harder to accomplish
2
Copyright ©2014 Pearson Education, Inc. All rights reserved
,Economists remain convinced the benefits of trade outweigh the costs pointing to three kinds of
evidence:
1. Casual empirical evidence of historical experience
2. Evidence based on economic models and deductive reasoning
3. Evidence from statistical comparisons of countries
While none of these is conclusive by itself, together they provide:
1. The Gains from Trade and New Trade Theory
2. Wages, Jobs and Protection
3. Trade Deficits
4. Regional Trade Agreements
5. The Resolution of Trade Conflicts
6. The Role of International Institutions
7. Exchange Rates and the Macroeconomy
8. Financial Crisis and Global Contagion
9. Capital Flows and the Debt of Developing Countries
10. Latin America and the World Economy
11. Export-Led Growth in East Asia
12. The Integration of the BRICs into the World Economy
Globalisation refers to the trend towards a more integrated global economic system.
Key factors
- The globalization of markets
- The globalization of production
- 1. Technological change
- 2. Declining trade and investment barriers
1. Low cost transportation have enabled firms to create global markets, and have facilitated the
movement of people from country to country promoting a convergence of consumer tastes
and preferences. Low cost communications networks have helped create electronic global
marketplaces
2. Thanks to the WTO (previously the GATT) average tariffs have been reduced from 43 per cent
in the late 1940s to less than 5 per cent today
WTO promotes trade by negotiating, setting and implementing rules of trade. The trade system
should be:
- Without discrimination
- National treatment
- Most-favoured nation (threat every nation as your most favoured nation)
- Free
- Exception to principles RTA
IMF is founded by 29 countries (1945) at the Bretton Woods conference in July 1944 and it ensures
the stability of the international monetary system. Responsibilities:
- promoting international monetary cooperation;
- facilitating the expansion and balanced growth of international trade;
3
Copyright ©2014 Pearson Education, Inc. All rights reserved
, - promoting exchange stability;
- assisting in the establishment of a multilateral system of payments; and
- Making its resources available (under adequate safeguards) to members experiencing
balance of payments difficulties.
The most visible role for the IMF is to intercede, by invitation, whenever a nation experiences a crisis
in its international payments. For example, if a country imports more than it exports, then it may run
out of foreign exchange reserves.
World bank reduces global poverty and its mission: “To fight poverty with passion and
professionalism for lasting results. To help people help themselves and their environment by
providing resources, sharing knowledge, building capacity and forging partnerships in the public and
private sectors.”
The IMF and World Bank
Foreign exchange reserves are dollars, yen, pounds, euros, or another currency (or gold) that is
accepted internationally. In the event of a financial crisis, Members borrow against IMF quotas. IMF
conditionality: Requirement for the borrowing member to carry out economic reforms in exchange
for a loan. The IMF has its own currency, called an SDR, or special drawing right. SDRs are based on a
country’s quota and are a part of its international reserves.
Free flows of capital has certain types: FDI, Portfolio Investments, Bank loans
“Foreign direct investment (FDI) is a category of investment that reflects the objective of
establishing a lasting interest by a resident enterprise in one economy (direct investor) in an
enterprise (direct investment enterprise) that is resident in an economy other than that of the direct
investor. The lasting interest implies the existence of a long-term relationship between the direct
investor and the direct investment enterprise and a significant degree of influence (a minimum
equity stake of 10%) on the management of the enterprise.”
5 types of reginal agreements
- Proponents of RTAs view them as building blocks toward freer, more open, world trade
- Opponents view RTAs as undermining progress toward multilateral (worldwide) agreements
4
Copyright ©2014 Pearson Education, Inc. All rights reserved
,Public Goods
By definition, public goods are nonexcludable and nonrival or nondiminishable . Nonexcludability
means that the normal price mechanism does not work as a way of regulating access. For example,
when a signal is broadcast on the airwaves by a television station, anyone with a TV set who lives in
its range can pick it up. (Of course, this is not the case with cable stations, which are granted
permission to scramble their signals. Signal scrambling is a clever technological solution to the
problem of nonexcludability.) The second characteristic of public goods is that they are nonrival or
nondiminishable. This refers to the attribute of not being diminished by consumption. For example, if
I tune in to the broadcast signal of a local TV station, my neighbors will have the same signal amount
available to them. Most goods get smaller, or diminish, when they are consumed, but public goods
do not. Private markets often fail to supply optimal levels of public goods because of the problem of
free riding . Free riding means that there is no incentive to pay for public goods because people
cannot be excluded from consumption. Given this characteristic, public goods will not be produced
optimally by free markets unless institutional arrangements can somehow overcome the free riding.
In most cases, governments step in as providers and use their powers to tax as a means to force
people to pay for the goods.
5
Copyright ©2014 Pearson Education, Inc. All rights reserved
,Institutions are the “rules of the game.” They can be formal, as in a nation’s constitution, or informal,
as in a custom or tradition. In both cases, we depend on institutions as mechanisms for creating
order and reducing uncertainty.
International institutions receive three types of criticism:
1. Sovereignty and Transparency
- International institutions can violate national sovereignty by imposing unwanted domestic
economic policies.
- Transparency concerns are based on questions about the mechanism with which decisions
are made within an international institution.
2. Ideology
- Critics argue that the advise and technical assistance provided to developing countries are
often a reflection of the biases and wishes of developed country wishes.
3. Implementation and adjustment costs
When agreements are reached that combine developed and developing countries, there are
often asymmetries in the ability to absorb the costs associated with them that favor
developed nations.
6
Copyright ©2014 Pearson Education, Inc. All rights reserved
, Chapter 3 Comparative advantage and the gains from trade
Access to foreign markets helps create wealth:
- If no nation imports, every company will be limited by the size of its home country market.
- Imports enable a country to obtain goods that it cannot make itself or can make only at very
high costs.
- Trade barriers decrease the size of the potential market, hampering the prospects of
specialization, technological progress, mutually beneficial exchange, and, ultimately, wealth
creation.
Trade barriers decrease specialization, technological progress, and wealth creation.
A basic model, often referred to as the Ricardian model, named after economist David Ricardo
Assumptions:
- Markets are competitive: Firms are price takers
- Static world: Technology is constant and there are no learning effects
- Labor is perfectly mobile: It can easily move back and forth between industries but perfectly
immobile across national borders.
Absolute productivity advantage: The advantage held by a country that produces more of a certain
good per hour worked than another
Question: What happens if a country does not have an absolute productivity advantage in anything?
Answer: Even if a country does not have any goods with an absolute productivity advantage, it can
still benefit from trade. The idea that nations benefit from trade has nothing to do with whether a
country has an absolute advantage in producing a particular good
A production possibilities curve (PPC) shows the tradeoffs a country faces when choosing between
two goods.
Output per hour worked example
The U.S. opportunity cost of bread is 1.5 tons of steel: each unit of bread produced requires the
economy to move labor out of steel production, forfeiting 1.5 tons of steel that it could have
produced instead.
3 tons tons loaves loaves
P
S
b
PUS 1.5 3.0 0.67
2 loaves loaves ton W
ton
In sum, trade between U.S. and Canada will occur at a price between two limits. ↑
Without trade, the U.S. would forgo 0.67 loaves of bread for an additional ton of steel. This is the
opportunity cost of steel, or the relative price of steel.
Why relative price? Because the price is not in monetary units but in units of the other good.
Relative price of steel is the inverse of the price of bread: if 0.67 loaves of bread is the price of a ton
of steel in the U.S., then 1.5 tons of steel is the price of one loaf of bread.
7
Copyright ©2014 Pearson Education, Inc. All rights reserved
