Econ 355: International Economics. Econ 355: International Economics. Econ 355: International Economics

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1 Nisha Malhotra Office: Buchanan Tower 1005, Office Hours: Wednesday Web Address: Teaching Assistant Kang Shi, Office: ANSO 153, address: Copyright 2003 Pearson Education, Inc Slide 1-1 This course is not suited for you: If you are interested in learning more about Globalization Econ 255: Understanding Globalization If you are interested in International finance ECON 356: Introduction to International Finance Copyright 2003 Pearson Education, Inc Slide 1-2 Required Textbook: Krugman, PR and Obstfeld, M, International Economics: Theory and Policy (Sixth edition) The syllabus /Additional Readings: I may announce additional readings during the course -available on my web page under Courses Grading Scheme: There will be five assignments, one midterm examination and a final examination The 5 assignments- 15% The Midterm Examination-35% The Final Examination-50% Copyright 2003 Pearson Education, Inc Slide 1-3

2 1 International Economics: Introduction / Chapter 1 2 Why do Countries trade with each other? 1 Ricardian Model, Heckscher-Ohlin Model, Economies of scale 3 Income distribution: Who wins and who loses from trade? 4 Trade Policy: Basic Principle 1 Tariffs, Quotas and Voluntary Export Restraints 2 Export Subsidies 5 Political Economy of Trade Policy & International Institutions (ch 9 & TBA) 1 Antidumping and Countervailing Duties 1 Case Study-US and Canada Lumber Dispute 2 WTO 1 Dispute Settlement procedure, Case Study-A news item chosen from the WTO site would be studied in detail Copyright 2003 Pearson Education, Inc Slide Trade policy and Development Import Substitution and the Infant Industry Argument Export-oriented development strategies 7 Financial Crisis 1 Capital Markets 2 The channels through which it spreads across countries 3 Role of trade in the spread of financial crisis across countries If we have time we will also cover 8 Trade Policy: Regionalism versus Multilateralism 9 Strategic Trade Policy Strategic Export Promotion Copyright 2003 Pearson Education, Inc Slide 1-5 International Economics: Trade and Money (T-1) International trade analysis focuses primarily on the real transactions in the international economy These transactions involve a physical movement of goods or a tangible commitment of economic resources Example: The conflict between the United States and Canada over supposedly subsidized softwood Lumber International monetary analysis focuses on the monetary side of the international economy That is, financial transactions such as foreign purchases of US dollars Copyright 2003 Pearson Education, Inc Slide 1-6

3 International Trade The Gains from Trade Many people are skeptical about importing goods that a country could produce for itself When countries sell goods to one another, countries do benefit Trade and income distribution International trade might hurt some groups within nations Trade and wages of high and low-skilled workers Copyright 2003 Pearson Education, Inc Slide 1-7 International Trade between Countries (T-2) The Pattern of Trade (who sells what to whom?) Differences in Technology determine the trade pattern- Ricardian Model Climate and resources determine the trade pattern of several goods-heckesher-ohlin Model Economies of Scale The Ricardian model is based on technological differences across countries These technological differences are reflected in differences in the productivity of labor Copyright 2003 Pearson Education, Inc Slide 1-8 The Concept of On Valentine s Day say the demand for roses is about 10 million roses Growing roses in Canada in the winter is difficult Heated greenhouses should be used The costs for energy, capital, and labor are substantial Resources for the production of roses could be used to produce other goods, say computers Opportunity Cost The opportunity cost of roses in terms of computers is the number of computers that could be produced with the same resources as a given number of roses Copyright 2003 Pearson Education, Inc Slide 1-9

4 The Concept of A country has a comparative advantage in producing a good if the opportunity cost of producing that good in terms of other goods is lower in that country than it is in other countries Suppose that in the Canada 10 million roses can be produced with the same resources as 100,000 computers Suppose also that in Mexico 10 million roses can be produced with the same resources as 30,000 computers This example assumes that Canada has advanced technology / Mexican workers are less productive than Canada workers Copyright 2003 Pearson Education, Inc Slide 1-10 The Concept of If each country specializes in the production of the good with lower opportunity costs, trade can be beneficial for both countries Roses have lower opportunity costs in Mexico Computers have lower opportunity costs in the US The benefits from trade can be seen by considering the changes in production of roses and computers in both countries Copyright 2003 Pearson Education, Inc Slide 1-11 The Concept of Hypothetical Changes in Production Copyright 2003 Pearson Education, Inc Slide 1-12

5 The Concept of The example in Table 2-1 illustrates the principle of comparative advantage: If each country exports the goods in which it has comparative advantage (lower opportunity costs), then all countries can in principle gain from trade What determines comparative advantage? Answering this question would help us understand how country differences determine the pattern of trade (which goods a country exports) Copyright 2003 Pearson Education, Inc Slide 1-13 Assume that we are dealing with an economy (which we call Home) In this economy: Labor is the only factor of production Only two goods (say wine and cheese) are produced The supply of labor is fixed in each country The productivity of labor (Techonology) in each good is fixed Perfect competition prevails in all markets The economy s total resources are defined as L, the total labor supply (eg if L = 120, then this economy is endowed with 120 hours of labor or 120 workers) Copyright 2003 Pearson Education, Inc Slide 1-14 The constant labor productivity is modeled with the specification of unit labor requirements: The unit labor requirement is the number of hours of labor required to produce one unit of output Denote with a LW the unit labor requirement for wine (eg if a LW = 2, then one needs 2 hours of labor to produce one gallon of wine) Denote with a LC the unit labor requirement for cheese (eg if a LC = 1, then one needs 1 hour of labor to produce a pound of cheese) Copyright 2003 Pearson Education, Inc Slide 1-15

6 The production possibility frontier (PPF) of an economy shows the maximum amount of a good (say wine) that can be produced for any given amount of another (say cheese), and vice versa The PPF of our economy is given by the following equation: a LC Q C + a LW Q W = L (2-1) From our previous example, we get: Q C + 2Q W = 120 Copyright 2003 Pearson Education, Inc Slide 1-16 Figure 2-1: Home s Production Possibility Frontier Home wine production, Q W, in gallons L/a LW P Absolute value of slope equals opportunity cost of cheese in terms of wine L/a LC Home cheese production, Q C, Copyright 2003 Pearson Education, Inc in pounds Slide 1-17 F Relative Prices and Supply The particular amounts of each good produced are determined by prices The relative price of good X (cheese) in terms of good Y (wine) is the amount of good Y (wine) that can be exchanged for one unit of good X (cheese) Copyright 2003 Pearson Education, Inc Slide 1-18

7 Denote with P C the dollar price of cheese and with P W the dollar price of wine Denote with w W the dollar wage in the wine industry and with w C the dollar wage in the cheese industry Then under perfect competition, the non- negative profit condition implies: If P W / a W < w W, then there is no production of Q W If P W / a W = w W, then there is production of Q W If P C / a C < w C, then there is no production of Q C If P C / a C = w C, then there is production of Q C Copyright 2003 Pearson Education, Inc Slide 1-19 The above relations imply that if the relative price of cheese (P C / P W ) exceeds its opportunity cost (a LC / a LW ), then the economy will specialize in the production of cheese In the absence of trade, both goods are produced, and therefore P C / P W = a LC /a LW Copyright 2003 Pearson Education, Inc Slide 1-20 Why countries trade with each other? Instruments of trade policy Political economy of protectionism The role of the World Trade Organization (WTO),- emphasis its dispute settlement procedure The possible causes of financial crisis The channels through which the financial crisis spreads across countries Role of trade in the spread of financial crisis across countries Copyright 2003 Pearson Education, Inc Slide 1-21