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Lecture Notes International Economics 1
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All notes of the pre-recorded video's and lectures given by Miriam Manchin for International Economics 1 year .
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This is a summary of information (including pictures) form thepre-recorded video’s & lectures given by prof. Miriam Manchin
2022-2023
International economics 1: Introduction
What makes trade interesting?
Nations are now more closely linked than ever before
o Exports and imports as shares of gross domestic product had been on a long-term upward trend.
o International trade has tripled in importance compared to the economy as a whole in the past 50
years
o Interesting potential ‘new’ phase of (de)globalization (war, covid, Brexit)
Trade policies will have an important impact
The smaller the country is, the less it can produce itself, so it’s more dependent on trade.
Basic concepts:
Gains from trade:
Countries selling goods and services to each other can generate mutuals benefits.
when a buyer and a seller engage in a voluntary transaction, both can be made better off
- Example: Norwegian consumers import oranges that they would have a hard time producing
How could a country that is the most (least) efficient producer of everything gain from trade?
Countries use finite resources to produce what they are most productive at (compared to their other
production choices), then trade those products for goods and services that they want to consume
Countries can specialize in production, while consuming many goods and services through trade.
Other advantages from trading:
Trade benefits countries by allowing them to export goods made with relatively abundant resources and
imports goods made with relatively scarce resources.
When countries specialize, they may be more efficient due to larger-scale production.
Countries may also gain by trading current resources for future resources (international borrowing and
lending) and due to international migration.
Effects of trade:
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
(If a product can be made and imported cheaper in another country, producers in own country could go
bankrupt -> China)
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, relative supplies of capital, labour and land and their use in the production of
different goods and services
Who trades with Whom?
More than 30% of world output is sold across national borders ($21 trillion in 2015)
The 5 largest trading partners with the U.S. in 2015 were China, Canada, Mexico, Japan, Germany
The largest 15 trading partners with the U.S. accounted for 75% of the U.S. trade in 2015
,Effects of Government Policies on Trade
Policy makers affect the amount of trade through:
Tariffs
=> a tax on imports/exports
Quotas
=> a quantity restriction on imports/exports
Export subsidies
=> a payment to producers that export
Through other regulations (ex product specifications) that exclude foreign products from the
market, but still allow domestic products.
What are the costs and benefits of these policies?
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.
International Finance Topics
Exchanging risky assets such as stocks and bonds can benefit all countries by diversification that reduces the
variability of income -> another source of gains from trade
Most international trade involves monetary transactions
Many monetary events have important consequences for international trade
The Gravity model
Size matters!
Bigger country -> more producing
Bigger country -> more consumers
What can we infer?
The size of an economy is directly related to the volume of imports and exports.
Larger economies produce more goods and services, so they have more to sell in the export market
Larger economies generate more income from the goods and services sold, so they are able to buy
more imports.
Trade between any two countries is larger, the larger is either country
The Gravity Model
The Gravity model assumes that size and distance are important for trade in the following way:
A∗Y i∗Y j
T ij =
D ij
T ij = the value of trade between country i and country j
A = constant
Y = the GDP of country i/j
D ij = the distance between country i and country j
a b
A∗Y i ∗Y j
Or more generally T ij = c (where a, b and c are allowed to differ from 1)
Dij
Looking for anomalies
A gravity model fits the data on US trade with European countries well, but not perfectly:
-> The Netherlands, Belgium and Ireland trade much more with the US than predicted by a gravity model,
but why?
Ireland has strong cultural affinity due to common language and history of migration. The
Netherlands and Belgium have transport cost advantages due location
Impediments to Trade (= obstruction)
, Other things besides size matter for trade:
Distance between market influences transportation costs and therefore the cost of imports and
exports
Cultural affinity close cultural ties (e.g. common language) usually lead to strong economic ties.
Geography ocean harbours and a lack of mountain barriers make transportation and trade easier
Multinational corporations corporations spread across different nation 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.
Trade agreements and tariffs reduce the formalities and tariffs needed to cross borders, and
therefore to increase trade.
The Changing Pattern of World Trade: Has the world gotten smaller?
The negative effect of distance on trade has grown smaller over time, due technologies that have increased
trade
o Wheels, sails, compasses, railroads, telegraph, automotives, telephones, internet, etc
Political factors, such as wars, pandemic, can change trade patterns much more than innovations in
transportation and communication.
o world trade grew rapidly from 1870 to 1913, then is suffered a sharp decline due wars and the Great
Depression
o it started to recover around 1945, but did not recover fully until around 1970
Since 1970, world trade as a fraction of world GDP has achieved unprecedented heights.
o Vertical disintegration of production has contributed to the rise in the value of world trade through
extensive cross-shipping of components
Nowadays (until covid) -> share of manufacturing in trade
(but because of covid more self production)
Service outsourcing
= services are provided in different countries (higher because COVID)
occurs when a firm that provides services moves its operations to a foreign location
-> can occur for services that can be transmitted electronically
A firm may move its customer service centers whose telephone calls can be transmitted electronically to a
foreign location (e.g. where wages are lower)
, 2. The Ricardian Model
Why trade occurs?
Differences across countries in labour, labour skills, physical capital, natural resources, and technology
Economies of scale (= larger scale of production is more efficient)
2 countries would trade if it is advantageous for both
Trade allows a country to export goods it’s relatively better at producing
Buy from abroad what would be produced at relatively higher price at home
Comparing the first two models
The Ricardian model says differences in productivity of labour between countries cause productive
differences, leading to gains from trade.
- Differences in productivity are usually explained by differences in technology
The Heckscher-Ohlin model says differences in labour, labour skills, physical capital and land between
countries cause productive differences, leading to gains from trade.
Comparative Advantage and Opportunity Cost
The Ricardian model uses the concepts of opportunity cost and comparative advantage.
The opportunity cost of producing something measures the cost of not being able to produce something
else with the resources used. (you’re giving up production to do something else)
Comparative advantage will be determined by comparing opportunity costs across countries.
Two country example
A country faces a trade off -> how many phones or hazelnuts to produce with the limited resources?
Suppose: in Italy 10 million hazelnuts or 100.000 phones can be produces (with same resources)
In Turkey 10 million hazelnuts or 30.000 mobile phones can be produced
- What is the opportunity cost for Turkey if it decides to produce 10 million hazelnuts?
30.000 mobile phones
Turkey has a lower opportunity cost of producing hazelnuts
Millions of hazelnuts Thousands of mobile phones
Italy -10 +100
Turkey +10 -30
Total 0 +70
How does Comparative Advantage and Opportunity Cost relate
A country has a comparative advantage in producing a good, if the opportunity cost of producing that good
is lower in the country than it is in other countries.
A country with a comparative advantage in producing good uses its resources most efficiently when it
produces that good compared to producing other goods.
A One Factor Ricardian Model: assumptions
1. Labour is the only resource important for production
2. Labour productivity varies across countries (labour productivity in each county is constant across time)
3. The supply of labour in each country is constant
4. Only two goods are important for production and consumption
5. Competition allows labourers to be paid a ‘competitive’ wage, a function of their productivity and the price
of the good that they can sell, and allows labourers to work in the industry that pays the highest wage
6. Only two countries are modelled: domestic and foreign
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