International Economics Summary
Week 1: Chapter 1 and 2
What is international economics about?
How nations interact through trade of goods and services, flows of money, and investment.
Countries have become more deeply connected to the global economy, nations are now more
closely linked than ever before.
US exports and imports as shares of gross domestic product have been on a long-term upward
trend.
Both imports and exports feel in 2009 due to the recession, it became less attractive and there
were barriers of trade.
Compared to the United States, other countries are more tied to international trade because of
positive externalities and it can raise their GDP. The US, due to its size and diversity of
resources, relies less on international trade than almost any other country.
The US has a trade deficit, imports are higher than exports, but this is not a bad thing as long as
importing the goods is cheaper than producing them domestically.
Gains from trade
Countries selling goods and services to each other almost always generates mutual benefits:
When a buyer and seller engage in a voluntary transaction, both can be made better off.
Countries can import goods that they would have a hard time producing.
When a country is inefficient with producing it can benefit from trade. If the country would
produce domestically the goods will have a higher price than if the country imports them.
Countries can specialize in production, while consuming many goods and services through
trade. When countries specialise, they may be more efficient due to larger-scale production.
Trade benefits countries by allowing them to export goods made with relatively abundant,
plentiful resources and import goods made with relatively scarce resources.
Countries may also gain by trading current resources for future resources (international
borrowing and lending) and due to international migration.
International trade might hurt some groups within nations; wages of high and low-skilled workers.
Trade is predicted to benefit countries as a whole in several ways, but trade may harm particular
groups within a country. International trade can harm the owners of resources that are used
relatively intensively in industries that compete with imports; trade may therefore affect the
distribution of income within a country. Moreover, it can adversely affect the owners of resources
that are "specific" to industries that compete with imports.
Patterns of trade
The pattern of trade describes who sells what to whom. Why some countries export certain
products can stem from differences in labour productivity or relative supplies of capital, labour and
land and their use in the production of different goods and services. Climate and resources often
explain why certain economies trade in certain goods. On top of this, it is about which country
produces the goods most effectively: producing more with the same amount of inputs or producing
the same with less inputs. A large amount of world trade occurs between countries that are similar
,International Economics Summary
in their levels of industrialisation. Although in general climate and resources determine the trade
pattern of several goods, in manufacturing and services the pattern of trade is more difficult.
There are two types of trade:
Inter-industry trade depends on differences across countries. Inter-industry trade is a trade of
products that belong to different industries. Countries usually engage in inter-industry trade
according to their competitive advantages (e.g. raw materials with technology).
Intra-industry trade depends on market size and occurs among similar countries. Intra-industry
trade, on the other hand, is a trade of products that belong to the same industry, that is trade
of similar products. This happens within the European Union.
Many governments are trying to shield certain industries from international competition. Advanced
countries' policies engage in industrial targeting, developing countries' policies promote
industrialisation: import substitution versus export promotion industrialisation.
Effects of government policies on trade
Policy makers affect the amount of trade through:
Tariffs: a tax on imports or exports,
Quotas: a quantity restriction on imports or exports,
Export subsidies: a payment to producers that export,
Or through other regulations that exclude foreign products from the market, but still allow
domestic products.
Trade policies are often chosen to cater to special interest groups, rather than to maximize national
welfare. Governments tend to adopt tariffs, then negotiate them down in exchange for reduction in
trade barriers of other countries.
Size matters: The Gravity Model
The gravity model relates the trade, volume of imports and exports, between two countries to the
sizes of their economies. Larger economies produce more and this generates more income, so they
have more to sell in the export market and are able to buy more imports. The United States trades
more with Germany, the U.K., and France than with other European countries because these
countries have the largest GDP, the value of goods and services produced in an economy, in Europe.
Each European country's share of US trade is roughly equal to its share of European GDP.
The gravity model assumes that size and distance are important for trade in the following way:
𝐴 × 𝑌𝑖 × 𝑌𝑗
𝑇𝑖𝑗 =
𝐷𝑖𝑗
𝑇𝑖𝑗 is the value of trade between country i and country j
𝐴 is a constant
𝑌𝑖 is the GDP of country i, 𝑌𝑗 is the GDP of country j
𝐷𝑖𝑗 is the distance between country i and country j
, International Economics Summary
Using the Gravity Model: Looking for Anomalies
The gravity model fits rather well the data on US trade with European countries but not perfectly.
The Netherlands, Belgium and Ireland trade much more with the United States than predicted by a
gravity model. The Netherlands and Belgium have transport cost advantages due to their location
and Ireland has strong cultural affinity due to common language and history of migration.
Impediments/obstacles to trade: Distance, barriers, borders
Many factors besides size matter for trade:
Distance between markets influences transportation costs and thus the cost of imports/exports.
Cultural affinity: close cultural ties, a common language, usually lead to strong economic ties.
Geography: ocean harbours and a lack of mountain barriers make transportation/trade easier.
Multinational corporations: corporations spread across different nations and import and export
many goods between their divisions.
Borders: crossing borders involves formalities that take time, often different currencies need to
be exchanged, and perhaps monetary costs like tariffs reduce trade.
Borders increase the cost and time needed to trade. Trade agreements between countries are
intended to reduce the formalities and tariffs needed to cross borders, and thus to increase trade.
The changing pattern of world trade
The negative effect of distance on trade according to the gravity model is significant, but has grown
smaller over time due to falling costs of transportation and communication. Technologies have also
increased trade: railroads, computers, telephones, internet, GPS satellites. Political factors, such as
wars, can change trade patterns much more than innovations in transportation and communication.
Vertical disintegration of production has contributed to the rise in the value of world trade through
extensive cross-shipping of components.
What do countries trade?
Manufactured products such as automobiles, computers, and clothing (53%)
Services such as shipping, insurance, spending by tourists (20% of the volume of trade)
Mineral products: petroleum, coal, copper (19% of the volume of trade)
Agricultural products are a relatively small (8%) part of trade.
More than 90% of the exports of China, the largest developing country and a rapidly growing force in
world trade, consist of manufactured goods. Developing countries have shifted from being mainly
exporters of primary products to being mainly exporters of manufactured goods.
Offshoring occurs when a firm that provides services moves its operations to a foreign location.
Service outsourcing can occur for services that can be transmitted electronically, a customer service
center whose telephone calls can be transmitted to a foreign location. Some jobs are "tradable" and
thus have the potential to be outsourced. Service outsourcing is currently not a significant part of
trade as most jobs (60%) need to be done close to the customer, making them non-tradable.
Week 1: Chapter 1 and 2
What is international economics about?
How nations interact through trade of goods and services, flows of money, and investment.
Countries have become more deeply connected to the global economy, nations are now more
closely linked than ever before.
US exports and imports as shares of gross domestic product have been on a long-term upward
trend.
Both imports and exports feel in 2009 due to the recession, it became less attractive and there
were barriers of trade.
Compared to the United States, other countries are more tied to international trade because of
positive externalities and it can raise their GDP. The US, due to its size and diversity of
resources, relies less on international trade than almost any other country.
The US has a trade deficit, imports are higher than exports, but this is not a bad thing as long as
importing the goods is cheaper than producing them domestically.
Gains from trade
Countries selling goods and services to each other almost always generates mutual benefits:
When a buyer and seller engage in a voluntary transaction, both can be made better off.
Countries can import goods that they would have a hard time producing.
When a country is inefficient with producing it can benefit from trade. If the country would
produce domestically the goods will have a higher price than if the country imports them.
Countries can specialize in production, while consuming many goods and services through
trade. When countries specialise, they may be more efficient due to larger-scale production.
Trade benefits countries by allowing them to export goods made with relatively abundant,
plentiful resources and import goods made with relatively scarce resources.
Countries may also gain by trading current resources for future resources (international
borrowing and lending) and due to international migration.
International trade might hurt some groups within nations; wages of high and low-skilled workers.
Trade is predicted to benefit countries as a whole in several ways, but trade may harm particular
groups within a country. International trade can harm the owners of resources that are used
relatively intensively in industries that compete with imports; trade may therefore affect the
distribution of income within a country. Moreover, it can adversely affect the owners of resources
that are "specific" to industries that compete with imports.
Patterns of trade
The pattern of trade describes who sells what to whom. Why some countries export certain
products can stem from differences in labour productivity or relative supplies of capital, labour and
land and their use in the production of different goods and services. Climate and resources often
explain why certain economies trade in certain goods. On top of this, it is about which country
produces the goods most effectively: producing more with the same amount of inputs or producing
the same with less inputs. A large amount of world trade occurs between countries that are similar
,International Economics Summary
in their levels of industrialisation. Although in general climate and resources determine the trade
pattern of several goods, in manufacturing and services the pattern of trade is more difficult.
There are two types of trade:
Inter-industry trade depends on differences across countries. Inter-industry trade is a trade of
products that belong to different industries. Countries usually engage in inter-industry trade
according to their competitive advantages (e.g. raw materials with technology).
Intra-industry trade depends on market size and occurs among similar countries. Intra-industry
trade, on the other hand, is a trade of products that belong to the same industry, that is trade
of similar products. This happens within the European Union.
Many governments are trying to shield certain industries from international competition. Advanced
countries' policies engage in industrial targeting, developing countries' policies promote
industrialisation: import substitution versus export promotion industrialisation.
Effects of government policies on trade
Policy makers affect the amount of trade through:
Tariffs: a tax on imports or exports,
Quotas: a quantity restriction on imports or exports,
Export subsidies: a payment to producers that export,
Or through other regulations that exclude foreign products from the market, but still allow
domestic products.
Trade policies are often chosen to cater to special interest groups, rather than to maximize national
welfare. Governments tend to adopt tariffs, then negotiate them down in exchange for reduction in
trade barriers of other countries.
Size matters: The Gravity Model
The gravity model relates the trade, volume of imports and exports, between two countries to the
sizes of their economies. Larger economies produce more and this generates more income, so they
have more to sell in the export market and are able to buy more imports. The United States trades
more with Germany, the U.K., and France than with other European countries because these
countries have the largest GDP, the value of goods and services produced in an economy, in Europe.
Each European country's share of US trade is roughly equal to its share of European GDP.
The gravity model assumes that size and distance are important for trade in the following way:
𝐴 × 𝑌𝑖 × 𝑌𝑗
𝑇𝑖𝑗 =
𝐷𝑖𝑗
𝑇𝑖𝑗 is the value of trade between country i and country j
𝐴 is a constant
𝑌𝑖 is the GDP of country i, 𝑌𝑗 is the GDP of country j
𝐷𝑖𝑗 is the distance between country i and country j
, International Economics Summary
Using the Gravity Model: Looking for Anomalies
The gravity model fits rather well the data on US trade with European countries but not perfectly.
The Netherlands, Belgium and Ireland trade much more with the United States than predicted by a
gravity model. The Netherlands and Belgium have transport cost advantages due to their location
and Ireland has strong cultural affinity due to common language and history of migration.
Impediments/obstacles to trade: Distance, barriers, borders
Many factors besides size matter for trade:
Distance between markets influences transportation costs and thus the cost of imports/exports.
Cultural affinity: close cultural ties, a common language, usually lead to strong economic ties.
Geography: ocean harbours and a lack of mountain barriers make transportation/trade easier.
Multinational corporations: corporations spread across different nations and import and export
many goods between their divisions.
Borders: crossing borders involves formalities that take time, often different currencies need to
be exchanged, and perhaps monetary costs like tariffs reduce trade.
Borders increase the cost and time needed to trade. Trade agreements between countries are
intended to reduce the formalities and tariffs needed to cross borders, and thus to increase trade.
The changing pattern of world trade
The negative effect of distance on trade according to the gravity model is significant, but has grown
smaller over time due to falling costs of transportation and communication. Technologies have also
increased trade: railroads, computers, telephones, internet, GPS satellites. Political factors, such as
wars, can change trade patterns much more than innovations in transportation and communication.
Vertical disintegration of production has contributed to the rise in the value of world trade through
extensive cross-shipping of components.
What do countries trade?
Manufactured products such as automobiles, computers, and clothing (53%)
Services such as shipping, insurance, spending by tourists (20% of the volume of trade)
Mineral products: petroleum, coal, copper (19% of the volume of trade)
Agricultural products are a relatively small (8%) part of trade.
More than 90% of the exports of China, the largest developing country and a rapidly growing force in
world trade, consist of manufactured goods. Developing countries have shifted from being mainly
exporters of primary products to being mainly exporters of manufactured goods.
Offshoring occurs when a firm that provides services moves its operations to a foreign location.
Service outsourcing can occur for services that can be transmitted electronically, a customer service
center whose telephone calls can be transmitted to a foreign location. Some jobs are "tradable" and
thus have the potential to be outsourced. Service outsourcing is currently not a significant part of
trade as most jobs (60%) need to be done close to the customer, making them non-tradable.
