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Summary International Trade and Investment chapter 1, 2, 3
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Summary of the first week of the course International Trade and Investment. Including Chapter 1, 2 and 3.
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Summary of the book 'International Trade: Theory and Policy' by Krugman, Obstfeld and Melitz
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Full Summary International Trade and Investment
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Full Summary International Trade and Investment
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Chapter 1: IntroductionSeven themes recur throughout the study of international economics
1. The gains from trade
When countries sell goods and services to each other, this exchange is almost always to their
mutual benefit.
2. The pattern of trade
Economists cannot discuss the effects of international trade or recommend changes in
government policies toward trade with any confidence unless they know their theory is good
enough to explain the international trade that is actually observed. As a result, attempts to
explain the pattern of international trade – who sells what to whom - have been a major
preoccupation of international economists.
3. Protectionism
If the idea of gains from trade is the most important theoretical concept in international
economics, the seemingly eternal debate over how much trade to allow is its most important
policy theme. The single most consistent mission of international economics has been to
analyze the effects of these so-called protectionist policies- and usually, though not always,
to criticize protectionism and show the advantages of freer international trade.
4. The balance of payments
Is it good to run a trade surplus and bad to run a trade deficit? This comparison highlights the
fact that a country’s balance of payments must be placed in the context of an economic
analysis to understand what It means.
5. Exchange rate determination
A key difference between international economics and other areas of economics is that
countries usually have their own currencies- the euro, which is shared by a number of
European countries, being the exception that proves the rule. The analysis of international
monetary systems that fix exchange rates remains an important subject. Some of the world’s
most important exchange rates fluctuate minute by minute and the role of changing
exchange rates remains at the center of the international economics story.
6. International policy coordination
The international economy comprises sovereign nations, each free to choose its own
economic policies. Unfortunately, in an integrated world economy, one country’s economic
policies usually affect other countries as well. A fundamental problem in international
economics is determining how to produce an acceptable degree of harmony among the
international trade and monetary policies of different countries in the absence of a world
government that tells countries what to do.
7. The international capital market
In any sophisticated economy, there is an extensive capital market: a set of arrangements by
which individuals and firms exchange money now for promises to pay in the future. The
growing importance of international trade since 1960s has been accompanied by a growth in
the international capital market, which links the capital markets of individual markets.
International capital markets differ in important ways from domestic capital markets. They
must cope with special regulations that many countries impose on foreign investment; they
also sometimes offer opportunities to evade regulations placed on domestic markets. Some
special risks are associated with international capital markets: currency fluctuations and
national default. The growing importance of international capital markets and their new
problems demand greater attention than ever before. Two issues arising from international
, capital are the functioning of global asset markets and foreign borrowing by developing
countries.
The economics of the international economy can be divided into two broad subfields: the study of
international trade and the study of international money. International trade analysis focuses
primarily on the real transactions in the international economy, that is, transactions involving a
physical movement of goods or a tangible commitment of economic resources. International
monetary analysis focuses on the monetary side of the international economy, that is, on financial
transactions such as foreign purchases of U.S. dollars. In the real world, there is no simple dividing
line between trade and monetary issues.
Chapter 2: World Trade: An Overview
The Gravity Model
There is a strong empirical relationship between the size of a country’s economy and the volume of
both its imports and its exports. Gross Domestic Product (GDP) measures the total value of all goods
and services produced in an economy.
T ij =A ×Y i × Y j / Dij
Where A is a constant term, T ij is the value of trade between country I and country j, Y i is country I’s
GDP, Y j is country j’s GDP, and D ij is the distance between the two countries. This equation is known
as a gravity model of world trade.
A more general gravity model:
T ij =A ×Y ai ×Y bj / D cij
Where a, b, and c are chose to fit the actual data as closely as possible.
The array of theoretical and practical determinants of trade flows between countries is extremely
large:
Economic size of countries.
Geographical distance between countries.
Infrastructure (road and railway infrastructure, (deepwater) ports, broadband, etc).
Differences in production costs (through differences in wages, productivity, climate, presence
of raw materials, etc).
Cultural links, cultural similarities and differences language.
Schooling.
Corruption.
Presence of multinational enterprises.
Presence of so-called preferential trade agreements (free trade agreements, customs unions,
etc).
Presence of a common currency.
….
Chapter 3: Labor Productivity and Comparative Advantage: The Ricardian Model
Countries engage in international trade for two basic reasons, each of which contributes to their
gains from trade. First, countries trade because they are different from each other. Nations, like
individuals, can benefit from their differences by reaching an arrangement in which each does the
things it does relatively well. Second, countries trade to achieve economies of scale in production.
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