International Economics [Weston]

8/2/2019 International Economics [Weston]

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Trade Theory-

Theory

Instituti onal description

Finance-

International Economics

A movement in an integrated world economy-

Mutual interdependence-

We benefit from knowledge that we do not personally poses-

The existence of international borders is the only difference

Labor cannot cross borders

International trade theory= market theory-

Movement of Goods

Movement of capital >> Across International BordersMovement of labor

Globalization:

People will be able to take their productive power and labors and be prosperous anywhere

International trade acts as a substitute as a movement of factors such as labor (we buy Japanese labor

indirectly by buying Japanese vehicles)

Adam Smith: 1776 Wealth of Nations

Late colonial period was very globalized and international

Britains were on the gold standard, so the pound was very powerful and i nfluential

The gold standard fixes ex change rates and makes international trade easier

1870-1914: The golden age (bri tish gold standard pound)-

The great depression made a very big impression on the world powers establishment of

economic standards for the world

After WWII the world powers got together and established the way the international relations

are today

Winding down of European colonial empires

The new mission of the world bank was to develop the economy in colonized locations

They wanted to get globalization established again in the new world order

World Tariffs on average were brought down

1845-1980:-

Transportation costs get cheaper

The internet

Success in china, India, etc started to grow when they became involved in international trade

1980-present-

Three Waves

Tariff= tax on imported goods

IMF= international monetary fund

To an integrated world economy

Floating exchange rates

Legal barriers such as (Tariffs, Quotas)

Transportation costs

Financial Complications

Barriers

How are gains possible?

Who gains?

Gains from trade-

Vs. absolute advantage

Recognizing in a numerical example

Comparative advantage-

Trade Theory

Official of the East India company

Mercantilism

Thomas Mun:

Tuesday, September 07, 2010

10:59 AM

International Econ Page 1


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Ex>Im

Favorable balance of trade-

To get people to get more of what they want, to increase utility

Improve psychic states

What is the purpose of economic activi ty:

P= value

Q= quantity

Record of a nations transactions with foreignersCurrent account + Financial account= 0-

CA= -FA-

Balance of Payments

How does a nation gain from trade specifically?

Vs absolute advantage-

Average product of labor-

Oportunity cost-

Be able to recognize in numerical eample-

Effect of a 1-unit movement toward specialization-

Gains from trade-

Comparative advantage

Increase productivi ty of labor due to specialization-

Indirectly (A. Smith)-

Water is good for clenching my thirst

Army rations, people can trade to make everyone better off

If you allow that value is subjective-

Directly (Menger)-

We are taking an idea that applies to individuals and applying it to nations

Exchange Creates Wealth

70 10

40 80

sheep Wine

Scotland

Spain

APL=Q/L

Average product

of laborHow productive a country is at a specific labor

The nations that can produce more with their labor should and not produce the thi ngs

they are not good at

Absolute Advantage

80 60

50 20

Food Machines

Germany

France

The value of the best alternative sacrificed when you made a

choice

Opportunity Cost- what did you sacrifice when you did something

Oc oc

3M

4 F

2m

5F

4F

3m

5f

2m


*

*

F M

Germany -1 +3

4

France + 15

8

-3

4

Total 7

8

0



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How a particular nation fairs in this depends on the trade

Identi fying comp adv

Limiting terms of trade

Gains from trade

Eercise I-

Trade =alternate means of production-

Relative factor abundance

Relating factor intensity

Heckscher-ohlin version of comp adv-

Trade Theory:

HB oc Pie oc

Bob 25* 1 p/ab 25 1 hb/p

Mary 30 5/3 p/hb 50* 3/5 hb/p

Bob's limit: terms of trade < 1hb/ p

Mary's l imit: Terms of trade< 5p/3hb

1hb/p > Tt > 3/5 hb/p

Tt>3/5 hb/p

Transforming inputs into outputs

Inputs Outputs

Less valuable More valuable

Production:

Suppose there i s a company (like walmart) xmart came out of no ware and gains power quickly

Whats the difference between trade and production?

Is there value in work itself?

All of their central activitie s are on an island on the coast of north caroli na. No one knows much about

what goes on there they just bring in raw materials and produce goods. They are taking out all the

competition. An investigator goes in and sees the raw materials are being traded with foreign markets

and they are importing goods in.

Purpose of trade

Nations can consume more due to trade

One factor of production= labor


Labor Capital(2x2x2)

A nation has comparative advantage in producing the good that uses

inventively the factor it uses abundantly

Factor A bundance- Nations

Factor intensity- Product processes

Heckscher-Ohlin

K K=Captal= produced means of production

L Factories, Equipment

requires an investment (saving)

K = $1B = 10

L 100M 1

K = $20M = 2L 50M 5



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Heckscher-Ohlin-a a nation will have Comparative Adavantage

Relative factor abundance-

Relative Factor Intensity-

In producing the good that uses intensively the factor that it possesses abundantly

Coparative Advantage:

Factor abundance is a characteristic of nations

Factor intensity i s a characteristic of production process



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-

Relative Factor Intensity-

China: K= 600M

L= 600M = 1

Japan: K=120M

L 60M =2

(K) > (K)

L j L c

Factor abundance is a characteristic of nations

Factor intensity i s a characteristic of production process

K

L

Ka

Kb

La Lb

Q=3

Q=2Q=1

0

ISOQUANT

Slope

Rise =K= Ka-Kb

Run L La- Lo

K

L

TC= rK+ wL

rK=Tc-wL

K=TC/r- W/r L

r=payment to capitol services as a payment for labor (paying a

rental price for equipment)TC

r

TC

w

ISOCOST

-W

r

Factor input

Price ratio

Relative factor abundance Vs Intensity

Input price ratio= wages

rent

Factor price

Three important theorems:

Factor-Price equalization

Stopler/Samuelson

Compensation Principle

Theorems

Heckscher-Ohlin-

Comparative Advantage

Labor intensive vs capitol intensive

Heckscher Ohlin- says what about comparative advantage?

Pc/Pt (Pc/Pt) (Pc/Pt)us 0 (K/L)t ind (K/L)t US (K/T)L ind (K/L)L US

a

c

b

(world)

Tetiles Cars

india

USA

W/T

(W/r) US

(w/r) ind



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In a movement from autarky to free trade, if there were no barriers. We would move to the

establi shment of one world price. So we have a movement to factor price equalization.

There are winners and losers from trade

Laborers lose in the stronger country

Wage is decreasing faster than prices are falling

Real wage= w/p

Scarce factor vs. abundant factor

-> Abundant factor is winner, scarce factor is the loser

Stolper Samulson

US: Pc ^ Pc

Pt v Tc

r

w

Its a trend that is not observed

There should be factor price equilization in a world of free trade

We dont have complete free trade-

Legal parameters-

Transportation cost-

Not everything is traded (hair cuts)-

What stops this?

Purchasing power parody is an issue

Factor price equilization

US is a Net importer

Intra-industrial trade

Product differentiation

Product life-cycle

Explinations

Economics of sale

Other sources of comparative advantage

Leontief Paradox-

N=land (natural resources)

L=labor

w= price per unit of labor

r= rental price per unit of land

Hekshier Ohlin:

(n/l )t= 100 = 5< (n/l)a= 2000 = 200

60 3 10

SL

DL

W/P

LL*

W/p*

P Demand for oil goes up the price increases

A process in which the existence of an opportunity for a net gain results in behavior that causes

that opportunity to disappear

Arbitrage:

In a world with complete free trade and no transportation cost

Factor price equalizati on:

There is a net gain for a nation as a whole

Compensation Principle:

Industry trade

Wine is both imported and exported: product differentiation

Countries import and export the same goods

The united states was without a question the most capitalisti c, and as a net importer of capital

intensive goods.

The world is changing, around 1980, US started to trade with more labor abundant low income

nations

Capital Mobility: Capitalists are investing every ware

Leontief Paradox



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Is the US still a capital abundant nation?

-most investors are investing overseas

a factor in economic life for observed patterns of trade (outside heckshire ohlin)it is

signifi cant for understanding the domestic economy. Something gets cheaper to produce

per unit the more you produce

Economies of Scale:

AC

$/Q

Q

AFC

$/Q

Q

AFC= FC/Q= constant/ increasing variable

Most governments inte rvene

The way a monopoly becomes profi table is to make their

goods more scarce

Natural monopoly

Video Rental

Product Life-Cycle

Leontief Paradox-

Product Differentiation

Border Trade

Intra-Industry Trade-

Definition

Internal

D of L

Bargaining

Machinery

Advertising

R+D

Large Fixe d Costs

External

Determination of number of firms in an industry

Implications

How firms get to be "too big to fail"

Explanation of trade patterns that does not depend on Factor abundance

Possible argument for government intervention

Reasons For

Demand

Management decisions

Product Life-Cycle

What Triggers Specialization?

Economies of Scale-

Explaining Observed Trade Patterns

$/Q

ATC

AFC= FC

Q^

ATC=AFC+AVC

Minimum Efficient Scale (MES)



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Q

ATC

Q^

Minimum Efficient Scale (MES)

$/Q

Q

AFC

D

Fulfill the worlds

Demand with possibledecrease in cost

Once in this position

they can keep off

competitors

-

Natural Monopoly

The bigger the company the more specializati on within the company

Division of labor

Peopl e trust a good nameBranding is important (Advertising)

Research and development

What causes economies of scale?

Specific

Advalorem

Definition

Average Tariff

Effective Rate of Protection

Tarriff Escalation

Small country

Welfare Effects

Tariffs-

Definition

Comparison to tariff

Quotas-

Subsidy-

Protective Instruments

$40 -> $20 pretax

$22 -> $2 pretax

$20 specif ic tariff

Tariffs on specific goods in every country

Specific tariff: example- $1 a bottle per wine

Total Tariff Revenue

Total Imports

Average Tariff:

http://en.wikipedia.org/wiki/Smoot%E2%80%93Hawley_Tariff_Act

Smoot Howley Tariff- lead the world to a great depression

Tariff- tax on an imported good

Laffer Curve:

Tax

Revenue

0% 100%

Protectionism

Optimal rate

http://en.wikipedia.org/wiki/Smoot%E2%80%93Hawley_Tariff_Acthttp://en.wikipedia.org/wiki/Smoot%E2%80%93Hawley_Tariff_Act


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Tax rate

At a real high rate i ts possible to cut Government deficit by raising taxes (50%)



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Finish history

Tariff escalation

Effectove rate of protection

Small nation

Large nation

Gains and lossers from tariffs

Definition

Comparison with tariff

Quotas

Tariffs-

Protection:

e=n-ab



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e=effective rate-

n=nomnal tariff rate

a= value of imported inputs/ total value of product

b= nominal tariff on imported inputs

(1-a)

Polly Tariff-

Average rate of 61% which essentially stopped world trade-

World trade coll apse in 1930's

United nations-

Formed in order to rebuild Europe

Now is used to rebuild 3rd world countries

World bank-

After WWII the allies created a new world order

Formed world trade organization (WTO)-

Reduces transaction cost

It allows multi lateral negotiations-

GAT

Ch6. history of Tariffs

e=n-ab

e=effective rate-

n=nomnal tariff rate

a= value of imported inputs/ total value of product

b= nominal tariff on imported inputs

(1-a)

Effective Rate of Protection

In the making and designing of products are multi national-

The nationality of products are ambiguous

10% tariff is a 10% rate of protection

Nominal tariff:

But

Pcar=$10,000

a=.50

b=0n=10% on imported cars

Value steel = $5,000

.10-0/.50=0.1

What if a domestic manufacture is using a portion of imported inputs?

P

Q

S

D

SwPn

PA

E

Free Trade World price

Qd Qft

< Imports >

S

D

P

Q

Pa

C.S.

P.S.

Producer vs consumer

Sw +t^ TariffPn+t

a)Transfer from consumer to producer (from tariff)

(a) (c)(b) (d)

a+c= transfers

b+d= deadweight losses



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Exchange rate

Deadwei ght losses > pass-through effects

Lobbying costs-

Gains + Losers from Tariffs: $/E

Euros

SE

DE

Weak $

^

v

Strong $

Bc US goods are moreexpe nsive to foreigners

Strong Dollar hurts exporters

Tariff-

Large Nation-

Definition

Comparison with tariff

Quota-

Voluntary export restraints-

Subsidy

Other protective devices-

Protection:

Large countries have the ability to drive up world prices

Large vs. Small nation

p

s

Q

The burden of tax depends on the elasticity of the demand in the market for a particular

good being taxed

If you raise the tax too high people buy less then the government doesnt get the revenue

D

t

Pb

Pa

The total tax revenue is equal to the tariff times quantity b

p

sa

Q

D

t

Pb

Pbt

sb

Pa

tax paid by consumer

Tax paid by seller

Tax rev= (Pb-Pbt)Qb= tQb

t

A b c d e

Pw + t

Pw

S

P

Tariff Model

Q

D

Price restriction

Quota

Transfer of consumer surplus to

prooducer surplus

a)

Dead weightb)

Profit to foreign sellerc)

Dead weight lessd)



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Japanese Automobiles in the 1980's

It caused the Japanese to shift their focus to higher profit per car instead of high volume

The Japanese agreed to limit the amount of cars sent to the US

All protection (Stolper Samuelson) there is no question that protection can protect some jobs. But

the gains and losses from Autarky to free trade are at a smaller cost then the other way

Voluntary Export restraints

P-

Subsidy

Sa

D Sw

Q

Sb

Subsidy is a payment to a producer (as aposed to a tariff which is a tax on foreign producers

Generally economist like subsidies better than tariffs because there is no deadweight costs-

Secondly it is a cost on the government so the have an incentive to drop it bc its a cost on their budget-

Is it protection or something else?

Modern protectionism

Tariffs-

Quotas-

Subsides-

Domestic content required

Red Tape

Government Procurement plicies

Environmental and safety

Cabotage Laws

Export Credit subsidies

Other-

Protect jobs/wagesInfant industry argument

Strategic trade policy

Level playing field

Economic arguments

National defense

Cultural protection

Foreign policy objectives

Non economic

Free Trade Debate-

Protective Devices

You do it because you can produce a thing with less comparative advantage-

Exchange creates wealth-

Trade is an alternate means of production

You can always protect a job at a cost

Jobs and Wages:

Depends on gdp, which depends on demand-

People take different jobs and new jobs are created-

The jobs created by exports,-

Possible to protect some jobs; not all jobs (cost?, to whom?)

APL=Q/L

TC=rK+wL

AC= rK/6- wL/Q

High wage American labor cannot compete wi th low wage foreign labor-

Low wage labor not always cheap (productivity)

Protect Jobs/wages

Economic-

Free Trade Arguments

Unit labor cost



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=W/APL

Education

Infrastructure

Avail ability of capital/ investment

Cheap labor doesnt always mean the best because the quali ty is not as

good and the workers not as productive

Some jobs do not demand very much labor (oil )-

Labor not always the decisive factor

There is no reason to believe the number of jobs is fixed-

People higher people to make more money-

Number of jobs not fixed ("l ump of labor fallacy")

Comparative advantage in things that you can do at a lower cost to yoursel f-

But it is possible to have absolute advantage due to monetary imbalance-

A nation cannot have comparative advantage in everything

Infant industry argument

Strategic trade policy

Manufacturing is something special

National defense

French farming is French culture

Cultural protection

Foreign policy strategy (e.g. sanctions)

Non-economic

Level playing field

Economic (count'd)

Check out Blackboard

The ability of the government to know what should and should not be

encouraged.

Definition

Structure

Meaning

Balance of Payments-

Exchange Rates-

International Finance



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16/24

GNP= market value of the goods produced by the citizens of a nation in one year

Now they measure all goods produced within the nation.

The GDP is an attempt to measure the Nations income:

HH BUS

G+S

Prod

GDP

C+I+G+[XX-M]

C

F.I.

I

Does this look like it was a part of the handout? Because its NOT!

GOV

T Sp

ROWY=C+I+G+[X-M]

balance of trade

A(absorption-domestically)

A=C+I+G

Y=A+(X-M)

[X-M]=Y-A

Household Outlays: Firm's Revenues



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erv.

w,r,I,

National Income

ROW Y=C+S+T = C+I+G+[X-M]

[Sp-I]+[T-G]=[X-M]

Sn-I=[X-M]

there is a strong link between a national economy's current account balance

and its government budget balance.

Twin Deficit Theory

The US and the world

Exports and importsThe current account (CA)

Net changes in financial transactions

Financial Account (FA) [capitol account]

CA+FA=0

Two main components:

Balance of payments:

Payments Always Balance-

Current account

Financial account

Debts+Credits

Broad Structure-

Balance of payments

Every transaction needs a payment-

Credits must equal debits

CA+FA=0 (floating rates)

Ca=-FA

Balance of trade: Fa


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19/24

Payments always Balance-

Credits + Debits

Current account

Financial account

Structure-

Definition

Spot

Forward

Future

Types of Transaction

Exchange rate-

Balance of Payments

Gov deficit -trade deficit

Twin Deficit

Deficit-> deficit to the 1 year planned gov budget

FED: print money/monetize the debt

Public

Other Gov's

=> Then government Borrows:

National Debt-> accumulation of debt from all Budg deficits

Domestic or foreign

Philips Curve:



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Swap

Optioninflation

unemployment

Real interest rate= price of using money

Nominal interest rate= real interest rate+expected inflation

(Budget Defi cit)^ -> inflati on (US borrowing)^ => foreign lending => D$^ (demand for dollar)=> Trade defici t

Twin Deficit

Every transaction has a negative & positi ve

Exports of goods & services1)

Imports18)

Income payments29)

Balance of Trade + uni lateral transfers

Balance of Payments - imports & exports of IOU's

Current Account:

Definition-

Spot

Forward

Futures

Swap

Option

Types of Transaction-

Commercial/Financial

Hedging

Speculation

Arbitrage

Motives-

Retail level

Interbank

Market makers

Futures market

Institutions-

Exchange Rates:

In a world of floating rates

Exchange Rates:

Agree today to an exchange rate to be paid in the future

Product of a floating rate system

People enter into these contracts to hedge against exchange rate risks

Indivi dually tailored for specific purposes

Over The Counter (custom to particular situation)

Forward contract:

Exchange rated contracts

Exchange traded bundles of forei gn currency

Futures:

Simultaneous purchase and sell a currency at two different maturities

-not credit default swaps (these are insurance policies)

Swap:

Financial derivative

The right to buy/sell foreign currency at a price you agree to today

After the closing date expires the option is gone

Options:

The importer of wine will hedge with a foreign contract to hedge against an unknown future eve n

Hedgers

Stable

Bubble activity

Unstable

Speculation

The exchange is the same from london to new york as london to california

In foreign exchange

A process in which the exi stence of opportunity for net gain(profit) results in a behavior that

causes that opportunity to disappear (li nes in a grocery store)

Arbitrage

(X-M)us=(Sn-I)us=-(Sn-I)row= -(X-M)row

Sp+SG-I

(Sp+Tx-G-I)

ROW=rest of the world

Is it sustainable?-

Whats rong with a trade deficit?

Social security 20%-

Health 20%-

Military 20%-

Interest 10%-

US Government expenditure:



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Injecting cash into the economy-

Monetizing the debt by buying US government securities-

Quantitative easing:

Tax revenue - government spending

^I => budget deficit => national debt

Budget Deficit:

Commercial vs. financial

Supply + Demand for FX-

Market Fundamentals-

Expectations-

Uncovered

Covered

Interest Rate parity-

Exchange rate movement

Carry Trade-

Ultimately a currencies value i s

anchored by the currencies ability to

buy goods and services

Purchasing Power Parity (PPP)-

Exchange Rate Determination

$/F

F

Weaker $

Stronger $

DE

SE

a

b

c

Financial Flows: $3.2 t/day

US imports: $2.8 t/year

With open capital market there is enough flow of foreign capitol to effect the interest rate.-

Interest rate parity:

Ius

RODA (return on domestic assets)

Iuk + % [1/e]

E(%1/e)

Ef-es/ es

ROFA (return on foreign assets)

If a lot of people move their money to a foreign account the it e ffects the exchange rate and makes the

return make nothing



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Exchange rates follow supply and demand

No protection-

Interest in US = Foreign [return on domestic assets=return on foreign]-

The key to understanding micro economics

Any equilibrium is the result of an arbitrage process

An activity that seems will be profitable wont be profitable

Arbitrage

The process is interest rate arbitrage-

Uncovered interest rate

RODA=ROFA



23/24

The currency's value depends on the currencies abil ity to buy goods and services

$=100Y

tvPus=$500

Absolute purchasing power parity: goods are exchanged

We dont expect to see thi s all the time because the amount of services that are not traded

tvPtokyo=Y50,000

Purchasing Power Parity:

General Idea

Floating Exchange Rate-

BOP Adjustment



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If your currency weakens then that causes the price of US exports to become cheaper

and imports become more expensive. The volume of imports should decrease and

exports should decrease=> reducing the deficit

e=$/-

e^=> Pex^, PemV=> [Ex^, IMV]=> reducing the deficit-

Complications

Imported inputs increase cost and go against the benefi ts of decreasing the value of a

currency

-

Imported inputs

A numerical measure to a change in stimulus-

Percentage change in quantity demanded / percentage change in price

40%/-10%=-4

%Qd>%P=>TR^

Elastic:

+1%/-10%=.1

Inelastic:

pED=%Qd/%P

The price elasticity of demand-

Elasticity

The foreign elasticity plus the domestic elasticity of imports must be< 1-

Eex+Eim>1-

Depends on forei gn price elasticity of exports and domestic price elasticity for imports-

Marshall/Larner condition

J-curve

+

0

-

Weak $

Strong $

e

Time

Surplus

Deficit

The effect of the currency change effecting the price of goods

Currency Pass through:

Current account is almost the balance of trade, with unilateral transfers and foreign aid

Balance of payments= CA+FA=0 (floating rates)

CA=-FA

CA= Balance of trade + Unilateral transfers

>Basic balance

CA+FA=-ORT

(Fied rate) CA+FA+ORT=0

Higher Cost=> Higher prices => Exv, Im^=> Ex- Im=Deficit => Borrowing from Foreigners => Credit Crisis

Floating Exchange Rate, e^

e=I/DM

International Economics [Weston]

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Transcript of International Economics [Weston]