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International Economics
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Lecture notes of 11 pages for the course International Economics at UoEX
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Why trade?Trade brings the bene ts of cheaper goods, more choice and allows for specialisa on – there
is a clear economic advantage of opera ng as an open economy rather than being in
autarky. Autarky occurs when a country is closed to interna onal trade, hence the country
will only consume what it produces. Having said this, the advantages of trade come at the
cost of increased inequality which could lead to social unrest. It is always in the country’s
best interest to open up the economy and take advantage of the gains from trade as, with
trade, overall welfare for the country will increase – this is not to say that everyone gains,
but that the winners win more than the losers lose, i.e., there is a net gain.
As shown in historical data, levels of trade have been increasing with me (with a downturn
during the Great Depression). GRAPH 1
In autarky, the economy is closed to interna onal trade. The produc on possibility curve for
the economy is the curved line, with a slope of the marginal rate of transforma on,
MPB
MRT(A, B) = . Social indi erence curves represent consumer preferences,
MPA
where a higher indi erence curve means welfare is higher. The slope of the indi erence
−MUA
curve is the marginal rate of subs tu on, MRS(A, B) =
. The below graph
MUB
shows the economy in equilibrium, where MRT(A, B) = MRS(A, B) . In autarky,
there are no imports, so the only goods being consumed are those that are being produced
domes cally, i.e., A0 and B0. GRAPH 2
In an open economy, rela ve prices are likely to be di erent as they are worldwide prices
correla ng to worldwide equilibrium, as opposed to domes c.
A value chain comprises of all the parts required to make a nished product. This is an
important aspect of global trade, as value chains can span across the world, and the rising
importance of these links re ect the communica ve and technological developments
occurring throughout global economies.
The graph below compares open and closed economies. Welfare in the open economy is
higher than the welfare in the closed economy, hence SIC1 > SIC2. The graph shows the
gains from trade – with trade, both sectors grow. The gains from trade are unilateral and it is
always in the country’s best interest to open up the economy and take advantage of the
gains from trade. In this case, the consump on of good A increases but produc on of A falls,
the di erence being made up by imports. The consump on of good B falls, and produc on
of B rises, hence the country will export good B.
Acons − Aprod = impor ts
Bprod − Bcons = expor ts
The trade triangle (highlighted) shows that A2 A1 (imports) are exchanged for B2 B1
(exports). GRAPH 3
, The graph below displays a two-country world (country 1 and country 2), with two sectors (A
and B). Country 1 and country 2 have di erent produc on possibility curves, but the same
social indi erence curve. When both countries open up to interna onal trade, with a
common price line, there is a realloca on of resources in both countries but in di erent
direc ons. As country 1 increases its exports of A and imports more of B, the opposite
occurs in country 2. GRAPH 4
Globalisa on, the increasing connec vity of the world, leads to issues such as nega ve
environmental impacts such as pollu on, increasing inequality, rise of populist and
protec onist a tudes, sustainability issues and increased compe on levels.
Advantages of free trade are characterised by specialisa on, increased compe on, higher
quality of goods, improved e ciency, innova on and lower prices.
Inequality
• The Interna onal Monetary fund stated, “widening income inequality is the de ning
challenge of our me”.
• Income growth has stagnated due to globalisa on, immigra on, movement of labour
and technological change (machines taking over manual jobs).
The Speci c Factors Model
The Speci c Factors Model focuses on the labour market and the division of returns
between labour and capital in each of the two sectors of the economy. Capital is speci c to
each country hence is immobile in the short term, whereas labour can move between the
two countries at any period and is assumed to be unskilled. Assuming all markets are
compe ve, there is no unemployment and that there are diminishing marginal physical
products of labour, wages are the same across sector A and sector B, shown in the graph
below as wA = w B = w0. GRAPH 5
If the prices of both goods increase by the same amount, rela ve prices will stay the same
but nominal wages will increase. Real wages (purchasing power) will remain the same and
labour is no be er or worse o in terms of welfare. This is shown in the graph below. GRAPH
6
If the rela ve price of only good A changes, there will be more labour employed in sector A
and higher incen ves which signal to put more resources into and expand the output in the
sector. Hence, labour is drawn out of sector B and into sector A. The increase in prices
(shown in blue) is larger than the increase in wages (shown in green).
In terms of the price of good B, wages are higher, so labour is be er o . Rela ve to the price
of good A – the price of good A has changed more than wages, if the worker spends most of
their income on good A, then, in real terms, they would be worse o . Hence it cannot be
determined whether labour is be er or worse o as a result of globalisa on, as the
quan es of good A and good B are unknown. GRAPH 7
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