International Economics
1. Chapter: Introduction
Globalization
...implies
- Abolishing barriers for trade in goods and services that achieve common markets
with unique prices
- Abolishing barriers for factor movement (labor and capital) with the implication of
equalization of factor costs
- Abolishing cultural and social differences and barriers for communication
Waves of Globalization:
1) 1820-1914→surprisingly far reaching
2) 1960-present
→in between: WW 1 and WW 2 →globalization backlash →trade betw. Countries stops
at the moment: US thinking about changing their trade behavior→reduces imports?
Effects of globalization:
Social and cultural exchanges, environmental issues, general exchange in knowledge
→businesses make use of where they can produce the cheapest →trade-offs
→distributional aspects of globalization→factor allocation
Why do we trade with other countries?
- Other countries have a comparative advantage in producing certain goods
→China has a large supply of labor at low costs->manufacturing industry->exporting
- Preference for variety, differences in tastes
Why do we work in other countries?
- Wage differentials: other technologies, produce other goods/services, wage different
- Other skill demands: higher demand for certain skills
Why do we study in other countries?
- Different study conditions, different supply of study opportunities
Why do we invest in other countries?
- Interest differentials: rate of interest might be higher abroad, risk also
- Portfolio diversification: offer different investment objects (assets, firms, sectors),
diversification of business cycle risks
- Foreign investments/multinational enterprises: firms expand in other countries,
building up plants, demands, investments
Dimensions of globalization
1) Trade
World Trade Monitor as trade index, volume of total trade every month
Compare world trade with GDP→at constant prices? An estimate on total global production
→1991-2015: GDP gtowth→total production more than doubled, trade more than tripled
→trade has become more important to us than 20 years ago
2) Factor flows
Factor allocation, investment flows, one of the factors: capital
3) Capital flows
International capital flows, categorized based on their purpose, balance of payments: trade
balance (exports-imports), steady in- and outflow of goods and services
2. Trade theory
,Why do countries remove borders for trade? World marketing, different ways—exchange of
products?
1)production possibilities, gains from trade, implications:trade patterns and directions,
effects on wage +production +prices
Historical background:
Mercantilism 1500-1750
Emphasis on exporting more than importing, economic goal: positive net exports, →claims
on other countries, gains from trade are losses for another: zero sum game, implications for
trade policy: promote exports, restrict imports
Adam Smith 1723-1790
Trade is a positive sum game, exports and imports are beneficial, government should not
intervene in markets but should only guarantee good functioning of the market economy,
trade because of absolute advantages of countries, invisible hand, 1776 wealth of nations
David Ricardo 1772-1823
Shares Smith’s view in general, trade happens because of relative or comparative
advantages
The Ricardian model of trade
General Assumptions
- A stylized model of a world with trade in goods and services: old economic trade
model, simplified version of reality (does not render the model useless), basic
mechanism applies to reality!
- A general equilibrium model: considers the total economy of several countries
- General assumptions: world consists of 2 countries, 2 different goods can be
produced in either of the 2 countries, only 1 production factor: labor, the 2 goods can
be treated freely (no costs in trade)
Assumptions on production
- Constant returns to scale in production (twice as much workers produce twice as
much output)
- The 2 countries are differently talented in production, differences in productivity of
labor, productivity for each good is different in each country
Assumptions on labor
- Workers are perfectly mobile across sectors, can work for production of good 1 or 2
- Workers are perfectly immobile across countries, no migration and factor mobility
- All labor supplied is employed, no unemployment, medium run point of view (macro)
Assumptions on goods market
- Perfect competition, producers have no market power→ no monopolies + oligopolies
Notation
Country 1 = domestic economy
L: total labor supply
L1 and L2: labor employed for production 1 and 2 → L= L1+L2
B1 and b2: productivity of labor in producing good 1 and 2→ Y1=b1*L1
Y1 and Y2: production quantity of good 1 and 2 →Y2=b2*L2
Country 2 = the foreign economy
, L *= L 1* +L 2*
Y 1*=b 1* *L 1* a1=1/b1
Y 2*=b 2* * L 2* a2=1/b2
Numerical example
Country 1 which we call domestic (simple example)
Labor supply: 100 workers, each working 40h, L=100*40h=4000h
Workers split between producing good 1 and 2: L1=2500h, L2= 1500h
Unit labor requirements: it takes 0,5h to produce 1 unit good 1, a1= 0,5h/pc
It takes 3h to produce 1 unit good 2, a2=3h/pc
Labor productivity: for good 1: b1= 2pc/h. for good 2: b2=0,33pc/h
→production of good 1 and 2:
Y1=b1*L1=2pc/h*2500h=5000pc
Y2=b2*L2=0,33pc/h*1500h=500pc
Production possibilities for good 1 and 2 (hypothetical)
=theoretical production in case everyone works either in production for good 1 or 2
Y1=b2*L= 2pc/h*4000h=8000pc
Y2=b1*L=0,33pc/h*4000h=1333pc
Country 2 which we call foreign (simple example)
Labor supply: 100 workers, each working 40h, L=100*40h=4000h
Workers split between producing good 1 and 2: L1=2500h, L2= 1500h
Unit labor requirements: it takes 1h to produce 1 unit good 1, a1= 1h/pc
It takes 4h to produce 1 unit good 2, a2=4h/pc
Labor productivity: for good 1: b1= 1pc/h. for good 2: b2=0,25pc/h
→production of good 1 and 2:
Y1=b1*L1=1pc/h*2500h=2500pc
Y2=b2*L2=0,25pc/h*1500h=375pc
Production possibilities for good 1 and 2 (hypothetical)
=theoretical production in case everyone works either in production for good 1 or 2
Y1=b2*L= 1pc/h*4000h=4000pc
Y2=b1*L=0,25pc/h*4000h=1000pc
→country 1 is more productive in producing either of the 2 goods!-->has the absolute
advantage in producing
→industrialized countries are more productive, can both gain from this or is one the winner?
Summary numerical example
Autarky= two isolated countries which are not connected and do not trade with each other
Production under autarky:
Labor force is split between production of 2 goods, full employment→nobody unemployed,
increasing production of one good requires reduction in production of the other
→classical trade-off->less units of one industry to gain more units of the other->how much
do I have to give up of something to get another thing?
Defining opportunity costs formally
1. Chapter: Introduction
Globalization
...implies
- Abolishing barriers for trade in goods and services that achieve common markets
with unique prices
- Abolishing barriers for factor movement (labor and capital) with the implication of
equalization of factor costs
- Abolishing cultural and social differences and barriers for communication
Waves of Globalization:
1) 1820-1914→surprisingly far reaching
2) 1960-present
→in between: WW 1 and WW 2 →globalization backlash →trade betw. Countries stops
at the moment: US thinking about changing their trade behavior→reduces imports?
Effects of globalization:
Social and cultural exchanges, environmental issues, general exchange in knowledge
→businesses make use of where they can produce the cheapest →trade-offs
→distributional aspects of globalization→factor allocation
Why do we trade with other countries?
- Other countries have a comparative advantage in producing certain goods
→China has a large supply of labor at low costs->manufacturing industry->exporting
- Preference for variety, differences in tastes
Why do we work in other countries?
- Wage differentials: other technologies, produce other goods/services, wage different
- Other skill demands: higher demand for certain skills
Why do we study in other countries?
- Different study conditions, different supply of study opportunities
Why do we invest in other countries?
- Interest differentials: rate of interest might be higher abroad, risk also
- Portfolio diversification: offer different investment objects (assets, firms, sectors),
diversification of business cycle risks
- Foreign investments/multinational enterprises: firms expand in other countries,
building up plants, demands, investments
Dimensions of globalization
1) Trade
World Trade Monitor as trade index, volume of total trade every month
Compare world trade with GDP→at constant prices? An estimate on total global production
→1991-2015: GDP gtowth→total production more than doubled, trade more than tripled
→trade has become more important to us than 20 years ago
2) Factor flows
Factor allocation, investment flows, one of the factors: capital
3) Capital flows
International capital flows, categorized based on their purpose, balance of payments: trade
balance (exports-imports), steady in- and outflow of goods and services
2. Trade theory
,Why do countries remove borders for trade? World marketing, different ways—exchange of
products?
1)production possibilities, gains from trade, implications:trade patterns and directions,
effects on wage +production +prices
Historical background:
Mercantilism 1500-1750
Emphasis on exporting more than importing, economic goal: positive net exports, →claims
on other countries, gains from trade are losses for another: zero sum game, implications for
trade policy: promote exports, restrict imports
Adam Smith 1723-1790
Trade is a positive sum game, exports and imports are beneficial, government should not
intervene in markets but should only guarantee good functioning of the market economy,
trade because of absolute advantages of countries, invisible hand, 1776 wealth of nations
David Ricardo 1772-1823
Shares Smith’s view in general, trade happens because of relative or comparative
advantages
The Ricardian model of trade
General Assumptions
- A stylized model of a world with trade in goods and services: old economic trade
model, simplified version of reality (does not render the model useless), basic
mechanism applies to reality!
- A general equilibrium model: considers the total economy of several countries
- General assumptions: world consists of 2 countries, 2 different goods can be
produced in either of the 2 countries, only 1 production factor: labor, the 2 goods can
be treated freely (no costs in trade)
Assumptions on production
- Constant returns to scale in production (twice as much workers produce twice as
much output)
- The 2 countries are differently talented in production, differences in productivity of
labor, productivity for each good is different in each country
Assumptions on labor
- Workers are perfectly mobile across sectors, can work for production of good 1 or 2
- Workers are perfectly immobile across countries, no migration and factor mobility
- All labor supplied is employed, no unemployment, medium run point of view (macro)
Assumptions on goods market
- Perfect competition, producers have no market power→ no monopolies + oligopolies
Notation
Country 1 = domestic economy
L: total labor supply
L1 and L2: labor employed for production 1 and 2 → L= L1+L2
B1 and b2: productivity of labor in producing good 1 and 2→ Y1=b1*L1
Y1 and Y2: production quantity of good 1 and 2 →Y2=b2*L2
Country 2 = the foreign economy
, L *= L 1* +L 2*
Y 1*=b 1* *L 1* a1=1/b1
Y 2*=b 2* * L 2* a2=1/b2
Numerical example
Country 1 which we call domestic (simple example)
Labor supply: 100 workers, each working 40h, L=100*40h=4000h
Workers split between producing good 1 and 2: L1=2500h, L2= 1500h
Unit labor requirements: it takes 0,5h to produce 1 unit good 1, a1= 0,5h/pc
It takes 3h to produce 1 unit good 2, a2=3h/pc
Labor productivity: for good 1: b1= 2pc/h. for good 2: b2=0,33pc/h
→production of good 1 and 2:
Y1=b1*L1=2pc/h*2500h=5000pc
Y2=b2*L2=0,33pc/h*1500h=500pc
Production possibilities for good 1 and 2 (hypothetical)
=theoretical production in case everyone works either in production for good 1 or 2
Y1=b2*L= 2pc/h*4000h=8000pc
Y2=b1*L=0,33pc/h*4000h=1333pc
Country 2 which we call foreign (simple example)
Labor supply: 100 workers, each working 40h, L=100*40h=4000h
Workers split between producing good 1 and 2: L1=2500h, L2= 1500h
Unit labor requirements: it takes 1h to produce 1 unit good 1, a1= 1h/pc
It takes 4h to produce 1 unit good 2, a2=4h/pc
Labor productivity: for good 1: b1= 1pc/h. for good 2: b2=0,25pc/h
→production of good 1 and 2:
Y1=b1*L1=1pc/h*2500h=2500pc
Y2=b2*L2=0,25pc/h*1500h=375pc
Production possibilities for good 1 and 2 (hypothetical)
=theoretical production in case everyone works either in production for good 1 or 2
Y1=b2*L= 1pc/h*4000h=4000pc
Y2=b1*L=0,25pc/h*4000h=1000pc
→country 1 is more productive in producing either of the 2 goods!-->has the absolute
advantage in producing
→industrialized countries are more productive, can both gain from this or is one the winner?
Summary numerical example
Autarky= two isolated countries which are not connected and do not trade with each other
Production under autarky:
Labor force is split between production of 2 goods, full employment→nobody unemployed,
increasing production of one good requires reduction in production of the other
→classical trade-off->less units of one industry to gain more units of the other->how much
do I have to give up of something to get another thing?
Defining opportunity costs formally
