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International Economics Summary '18/'19 (Grade: 8.5/10)
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Extensive summary of International Economics (FEB12004) Lecture 1-6. My obtained grade: 8.5/10
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Internationale EconomieTable of contents
1 College 1: Chapter 2 World Trade: An Overview 2
1.1 Who Trades with Whom? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
1.1.1 Gravity model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
1.2 The Changing Pattern of World Trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.3 Do Old Rules Still Apply? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.4 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
2 College 2/3: Chapter 3 Labor Productivity and Comparative Advantage: The Ricardian Model 4
2.1 A One-Factor Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
2.2 Trade in a One-Factor World . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
2.2.1 Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
2.3 Misconceptions about Comparative Advantage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
2.3.1 Myth 1: Productivity and Competitiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
2.3.2 Myth 2: The Pauper Labor Argument . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
2.3.3 Myth 3: Exploitation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
2.4 Comparative Advantage with Many Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
2.4.1 Determining the Relative Wage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
2.5 Adding Transport Costs ad Nontraded Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
2.5.1 Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
2.6 Empirical Evidence on the Ricardian Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
2.6.1 Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
2.7 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
3 College 4: Chapter 4 Specific Factors and Income Distribution 11
3.1 The Specific Factors Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
3.1.1 Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
3.1.2 Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
3.1.3 Specific factors model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
3.2 International Trade in the Specific Factors Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
3.3 Income Distribution and the Gains from Trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
3.4 The Political Economy of Trade: A Preliminary View . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
3.5 International Labor Mobility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
3.5.1 Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
3.6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
4 College 5/6: Chapter 5 Resources and Trade: The Heckscher-Ohlin Model 24
4.1 Model of a Two-Factor Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
4.1.1 Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
4.2 Effect of International Trade Between Two-Factor Economies . . . . . . . . . . . . . . . . . . . . . . . 30
4.2.1 Heckscher-Ohlin Theorem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
1
,1 College 1: Chapter 2 World Trade: An Overview
1.1 Who Trades with Whom?
An empirical relationship known as the gravity model helps to make sense of the value of trade between any pair of
countries ans sheds light on the impediments that continue to limit international trade even in today’s global economy.
Total value of trade = exports + imports
Largest European economies: they have the highest values of gross domestic product (GDP). There is a strong
empirical relationship between the size of a country’s economy and the volume of both its imports and its exports.
GDP: measures the total value of all goods and services produced in an economy.
1.1.1 Gravity model
Yi × Yj
Tij = A × (1)
Dij
A A constant term
Tij The value of trade between country i and country j
Yi Country i’s GDP
Dij The distance between the two countries
The value of trade between any two countries is proportional, other things equal, to the product of the two countries’
GDPs and diminishes with the distance between the two countries.
Yia × Yjb
Tij = A × c (2)
Dij
This equation says that the three things that determine the volume of trade between two countries are the size of the
two countries’ GDPs and the distance between the countries, without specifically assuming that trade is proportional
to the product of the two GDPs and inversely proportional to distance. Instead, a, b and c are chosen to fit the actual
data as closely as possible.
Large economies tent to spend large amounts on imports because they have large incomes. They also tend to at-
tract large shares of other countries’ spending because they produce a wide range of products. So, other things equal,
the trade between any two economies is larger, the larger is either economy.
What other things aren’t equal? In practice countries spend much or most of their income at home. The US and EU
each account for about 25 percent of the world’s GDP, but each attracts only about 2 percent of the other’s spending.
To make sense of actual trade flows, we need to consider the factors limiting international trade.
One of the principal uses of gravity models is that they help us to identify anomalies in trade.
The large trade of Belgium and the Netherlands suggests an important role of transport costs and geography in
determining the volume of trade.
All estimated gravity models show a strong negative effect of distance on international trade; typical estimates say
that a 1 percent increase in the distance between two countries is associated with a fall of 0.7 to 1 percent in the trade
between those countries. This drop partly reflects increased costs of transporting goods and services. Economists also
believe that less tangible factors play a crucial role: Trade tends to be intense when countries have close personal
contact, and this contact tends to diminish when distances are large.
In addition to being US neighbors, Canada and Mexico are part of a trade agreement with the US, the North American
Free Trade Agreement (NAFTA), which ensures that most goods shipped among the three countries are not subject
to tariffs or other barriers to international trade.
If a trade agreement is effective, it should lead to significantly more trade among its partners than one would otherwise
predict given their GDPs and distances from one another.
It’s important to note, however, that although trade agreements often end all formal barriers to trade between coun-
tries, they rarely make national borders irrelevant. Even when most goods and services shipped across a national
2
, border pay no tariffs and face few legal restrictions, there is much more trade between regions of the same country
than between equivalently situated regions in different countries.
1.2 The Changing Pattern of World Trade
The progress of transportation and communication has made the world smaller. But history also shows that political
forces can outweigh the effects of technology. The world got smaller between 1840 and 1914, but it got bigger again
for much of the the 20th century.
There have been two great waves of globalization witht the first wave relying not on jets and the Internet but on
railroads, steamships, and the telegraph.
Vertical disintegration of production: before a product reaches the hands of consumers, it often goes through many
production stages in different countries.
What do we trade?
Manufactured goods Automobiles, computers, clothing
Mineral products Copper ore, coal, oil
Agricultural products Wheat, soybeans, cotton
Services Traditional transportation fees charged by airlines and shipping companies, Insurance fees
received from foreigners, spending by foreign tourists
In recent years, new types of service trade, made possible by modern telecommunications, have drawn a great deal of
media attention. The most famous example is the rise of overseas call and help centers. If you call an 800 number for
information or technical help, the person on the other end of the line may well be in a remote country (the Indian city
of Bangalore is a particularly popular location).
The terms third world and developing countries are applied to the world’s poorer nations, may of which were Eu-
ropean colonies before WW2. As recently as the 1970s, these countries mainly exported primary products. Since then,
however, they have moved rapidly into exports of manufactured goods. There has been an almost complete reversal
of relative importance. For example, more than 90 percent of the exports of China, the largest developing economy
and a rapidly growing force in world trade, consists of manufactured goods.
When a service previously done withing a country is shifted to a foreign location, the change is known as service offshoring
(sometimes known as service outsourcing). In addition, producers must decide whether they should set up a foreign
subsidiary to provide those services (and operate as a multinational firm) of outsource those services to another firm.
1.3 Do Old Rules Still Apply?
Even though much about international trade has changed, the fundamental principles discovered by economists at the
dawn of a global economy still apply.
The sources of modern trade are more subtle. Human resources and human-created resources (in the form of machinery
and other types of capital) are more important than natural resources. Political battles over trade typically involve
workers whose skills are made less valuable by imports - clothing workers who face competition from imported apparel
and tech workers who now face competition from Bangalore.
Economic models developed long before the invention of jet plans or the Internet remain key to understanding the
essentials of 21st century international trade.
1.4 Summary
1. The gravity model related the trade between any two countries to the sizes of their economies. Using the gravity
model also reveals the strong effects of distance and international borders - even friendly borders like that between
the US and Canada - in discouraging trade.
2. International trade is at record levels relative to the size of the world economy, thanks to falling costs of trans-
portation and communications. However, trade has not grown in a straight line: the world was highly integrated
in 1914, but trade was greatly reduced by economic depression, protectionism, and war, and took decades to
recover.
3. Manufactured goods dominate modern trade today. In the past, however, primary products were much more
important than they are now; recently, trade in services has become increasingly important.
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