INSTRUCTIONAL MATERIAL

ECON 30093

INTERNATIONAL ECONOMICS

Compiled by:

Nicetas P. Sison
Alyssa Dale I.Ahorro
 COURSE DESCRIPTION

ECON 30093, INTERNATIONAL ECONOMICS, is a course in economics that presents

an exposition of the theories and principles in international trade and international finance that are
essential for understanding applying, analyzing, criticizing, and evaluating proposed and
implemented economic policies and ultimately creating alternative solutions to international
economic problems and issues.
 COURSE OVERVIEW

The course covers topics in international economics from the micro and macroeconomic
perspectives. Firstly, chapters 1-4, discuss international trade theory and international trade
policy which represent the microeconomics aspect of international economics simply because
they deal with individual countries that are treated as single economic units together with the
relative prices of commodities produced by them. Secondly, chapters 5 and 6 discuss the foreign
exchange rate market and exchange rates, and the balance of payments (BOP) which are topics
that concern macroeconomics. Finally, a discussion of past and present international problems
that have affected international trade, and international finance, has been included.
LEARNING OUTCOMES:

After this course, the student is expected to:

1. Maximize the use of microeconomic and macroeconomic tools of analysis to understand

international trade theories and to evaluate international trade policies that address global
trade problems;

2. Explain and discuss the various international trade theories, policies, and issues through
the preparation and presentation of concept papers, position papers, and reaction papers;

3. Engage in debate over global economic issues that affect the Philippine economy and the
global economy.
 TABLE OF CONTENTS

Contents
CHAPTER I INTRODUCTION .................................................... Error! Bookmark not defined.
1.1 Definition of International Economics .............................. Error! Bookmark not defined.
1.2 Components of International Economics ........................ Error! Bookmark not defined.
1.3 Internal Trade vs. International Trade ............................. Error! Bookmark not defined.
1.4 The Index of Openness ..................................................... Error! Bookmark not defined.
1.5.a .World Trade Situationer ( Mohtadi,2019) ................... Error! Bookmark not defined.
1.5.b Foreign Trade in the 21st century ( Klasen,2020) ...... Error! Bookmark not defined.
1.6 The Relevance of the Study of International Economics ............ Error! Bookmark not
defined.
EXERCISES............................................................................... Error! Bookmark not defined.
CHAPTER 2 THEORIES ON INTERNATIONAL TRADE...... Error! Bookmark not defined.
2.1 Mercantilism and Regulated Trade (Salvatorre,2001) .. Error! Bookmark not defined.
2.2 Adam Smith’s doctrine of absolute advantage .............. Error! Bookmark not defined.
2.3.a Illustration of Comparative Advantage ......................... Error! Bookmark not defined.
2.4 Comparative Advantage Using Opportunity Cost ......... Error! Bookmark not defined.
2.5. Assumptions of the Ricardian Model .............................. Error! Bookmark not defined.
2.6 Application of Absolute and Comparative Advantage (Mohtadi, 2019) ............ Error!
Bookmark not defined.
EXERCISES............................................................................... Error! Bookmark not defined.
2.4. The Hecksher - Ohlin ( H-O) Model (Factor Endowments Theory) Error! Bookmark
not defined.
2.4.a The Leontief Paradox ..................................................... Error! Bookmark not defined.
2.4. b. H-O-S Model ( Factor - Price Equalization Theorem- a corollary of the H-O
model) ......................................................................................... Error! Bookmark not defined.
2.4.c. Stolper- Samuelson Model ( Specific Factor Model) Error! Bookmark not defined.
2.5 Other Trade Theories ......................................................... Error! Bookmark not defined.
2.5.a Economies of Scale and International Trade ............. Error! Bookmark not defined.

2.5.b. Imperfect Competition and International Trade ( Trade based on Product

Differentiation)............................................................................ Error! Bookmark not defined.
2.5.b.1 Measurement of intra-industry trade ......................... Error! Bookmark not defined.
 2.5.c Trade Based on Dynamic Technological Differences ( Salvatorre, 2001) ..... Error!
Bookmark not defined.
2.5.c.1 Technological Gap Model (Posner model)............... Error! Bookmark not defined.
2.5.c.2 Product Cycle Model (Vernon model) ...................... Error! Bookmark not defined.
2.6 The Gravity Model (Mohtadi, 2019) ................................. Error! Bookmark not defined.
EXERCISES: ............................................................................. Error! Bookmark not defined.
CHAPTER 3 INTERNATIONAL TRADE POLICY .................. Error! Bookmark not defined.
3.1 Free trade vs. Regulated trade......................................... Error! Bookmark not defined.
3.2 Trade (Commercial) Policy ............................................... Error! Bookmark not defined.
3.3 Nontariff Barriers (NTBs) ................................................... Error! Bookmark not defined.
3.4 Arguments Against Protectionism .................................... Error! Bookmark not defined.
EXERCISES............................................................................... Error! Bookmark not defined.
CHAPTER 4 MULTILATERALISM and REGIONAL INTEGRATION Error! Bookmark not
defined.
4.1 Trade Policy Reforms ........................................................ Error! Bookmark not defined.
4.2 General Agreement on Tariffs and Trade (GATT) ........ Error! Bookmark not defined.
4.3 World Trade Organization (WTO) .................................... Error! Bookmark not defined.
4.4 Economic Integration ........................................................ Error! Bookmark not defined.
4.5 Attempts at Economic Integration Among Developing Countries ..... Error! Bookmark
not defined.
EXERCISES: ............................................................................. Error! Bookmark not defined.
CHAPTER 5 THE BALANCE OF PAYMENTS ...................................................................... 8
5.1 Balance of Payments ........................................................................................................ 8
5.2 Accounts in the BOP ......................................................................................................... 8
5.3 Balance of Payments Accounting Principles ............................................................... 10
5.4 Overall BOP Position ...................................................................................................... 11
5.5 The International Investment Position (IIP) ................................................................. 11
5.6 Uses of the BOP and the IIP.......................................................................................... 11
EXERCISES: ............................................................................. Error! Bookmark not defined.
Chapter 6 THE FOREIGN EXCHANGE MARKET and EXCHANGE RATES .......... Error!
Bookmark not defined.
6.1 The foreign exchange market ........................................... Error! Bookmark not defined.
6.2. Participants in the foreign exchange market ................. Error! Bookmark not defined.
6.3. Functions of the foreign exchange market .................... Error! Bookmark not defined.
6.4. The Exchange Rate .......................................................... Error! Bookmark not defined.
6.5.. Exchange Rate Ssystems/Regimes .............................. Error! Bookmark not defined.
6.6 Nominal vs Real Exchange Rate ..................................... Error! Bookmark not defined.
6.7. Other Transactions in the Foreign Exchange Market .. Error! Bookmark not defined.
EXERCISES: ............................................................................. Error! Bookmark not defined.
CHAPTER 7 CURRENT ISSUES IN INTERNATIONAL ECONOMICS Error! Bookmark
not defined.
REFERENCES .......................................................................... Error! Bookmark not defined.
 CHAPTER 5
THE BALANCE OF PAYMENTS

Learning Outcomes:
After this chapter the student is expected to:
1. Define the balance of payments;
2. Understand the different accounts in the balance of payments;
3. Distinguish the current account from the capital and financial accounts;
4. Understand the Overall BOP position of a country; and
5. Understand the International Investment Position(IIP) and compare it to the BOP.

In 2020, the country experienced adversities that challenged not only its people, but also
the economy. GDP growth rate experienced the lowest level for the past years. Aside from the
GDP, economists look into the balance of payments (BOP) position of a country to determine its
economic performance vis-a-vis its international transactions with the rest of the world (ROW)
over a given period of time. The BOP provides an introduction into the macroeconomic aspect of
international economics.
Due to the pandemic, the Philippines recorded a BOP surplus because of the country’s
excessive borrowing. What does this indicate of the economic performance of the country?

5.1 Balance of Payments

The balance of payments (BOP) is a summary statement in which all transactions of the
residents of a nation with the residents of all other nations are recorded during a specific period
of time, usually within a calendar year. An international transaction refers to the exchange of a
good, service, or asset (for which payment is usually required) between the residents of one nation
and the residents of other nations. However, gifts and certain other transfers (for which no
payment is required) are also included in a nation’s balance of payments.

The question of who is a resident of a nation also requires some clarification. A person is
considered as a resident of a nation when he has stayed or intends to stay in that country for one
year or more. Thus an overseas Filipino worker (OFW) can remain a resident of the Philippines
or can become a non-resident depending on the length of his job contract abroad. Similarly, a
business enterprise is considered a resident of a country if it engages for a year or more, in the
production of goods or services in a significant scale in that country. Branches and subsidiaries
of foreign companies are treated as residents of countries where they operate their business.
However, a liaison or a representative of a foreign company, regardless of its length of stay, does
not qualify as a resident enterprise. Government instrumentalities like embassies, consulates,
military establishments stationed abroad remain as residents of the country they represent.
 Also, the balance of payments has a time dimension. Thus, it is the flow of goods, services,
gifts, and assets between the residents of a nation and the residents of other nations during a
particular period of time, usually a calendar year.

5.2 Accounts in the BOP

The balance of payments can be divided into two accounts: Current Account and Capital
Account and Financial Accounts. Because the BOP is one reflection of a nation’s financial stability
in the world market, the International Monetary Fund (IMF) uses these accounts to make
decisions such as qualifying a country for a loan. The IMF also provides the information to its
members so that they can make informed decisions about investments and trade.
5.3.The current account presents receipts and payments from trade in goods and services,
transfer payments and income flows over a given time period. Thus, it includes all items of income
and outlay- imports and exports of goods and services, investment income and transfer payments
in the form of gifts received from or given to the foreign residents. It is conceptually similar to the
net exports in the national income/output accounts. Specifically, the current account is composed
of the balance on goods and services,which is commonly known as the trade balance, and which
is derived from adding net services and net goods together.Net primary income includes all
earnings from investment while the net secondary income refers to non-market transfers. Some
examples of transactions that can be found in this account are OFW remittances and
unconditional aid given by international institutions/organizations like the World Bank. These
transactions are irreversible; they cannot be undone in the future.

When total exports/receipts exceed total imports/payments, the current account is in

surplus. It is in deficit if the reverse is observed. If the current account balance is in surplus, the
country is a “net lender” to the ROW in the amount of the surplus or the excess in the current
account transactions. Net lending occurs when the national saving is more than the country’s
investment in real assets. If in deficit, the country is said to be a ”user of funds” and thus, is
considered as a net borrower from abroad in order to fill in the deficit/shortage. In this case, the
country invested more than what its national saving can finance.

CA(Current Account) = NET GOODS AND SERVICES + NET PRIMARY INCOME+ NET
SECONDARY INCOME

Thus, if CA> 0, the current account balance is positive, or the current account is in surplus,
while if CA<0, the current account is negative, or the current account is in deficit.

The other account is the capital and financial account. Capital Account has two
components: Purchase/ sale of non-financial assets such as intellectual property rights, and
capital transfers such as a conditional foreign aid given in developing countries. Capital transfers
are also grants and donations, the intention of which is for investment, which is in contrast to
grants and donations lodged under current transfers whose intention is for consumption. The
financial account shows the transactions in foreign financial assets and liabilities which include all
the inflows and outflows of investments. Financial account consists of direct investment and
portfolio investment. Direct investment refers to capital participation in a company in which the
investor has a lasting or permanent interest. This is manifested by ownership of at least 10% of
the company’s equity. Portfolio investment, on the other hand, is short term in contrast to direct
investment which is long term. Portfolio holdings maybe in the form of stocks, bonds and notes,
and money market instruments which are tradable and therefore, can be easily acquired or
disposed of. This include the transactions involving financial derivatives and reserve assets. In
case of stockholdings, a portfolio investor is differentiated from a direct investor if he owns less
than 10% of a company’s total equity. This account is reversible, it can be undone in the future.
CAFA (Current Account & Financial Account)= CAPITAL ACCOUNT + FINANCIAL ACCOUNT
Thus, if the CA (Capital Account) > 0, there is a surplus in the capital account, while if the CA< 0,
there is a deficit in the capital account.

So, BOP = CA + CAFA

To sum up, if the balance of payment is equal to zero, one account is in the negative or in
deficit and one is positive or in surplus. Mathematically,
If CA+CAFA=0
+CA = -CAFA -CA = +CAFA
Surplus Deficit Deficit Surplus

5.3 Balance of Payments Accounting Principles

International transactions are classified as credits or debits. Credit transactions are those
that involve the receipt of payments from foreigners. Debit transactions are those that involve the
making of payments to foreigners. Credit transactions are entered with a positive sign, and debit
transactions are entered with a negative sign in the nation’s balance of payments. The export of
goods and services, unilateral transfers (gifts) received from foreigners, and capital inflows are
entered as credits (+) because they involve the receipt of payments from foreigners. The import
of goods and services, unilateral transfers or gifts made to foreigners, and capital outflows involve
payments to foreigners and are entered as debits (–) in the nation’s balance of payments.

Financial inflows can take either one of two forms: an increase in foreign assets in the
nation or a reduction in the nation’s assets abroad. Financial outflows can take the form of either
an increase in the nation’s assets abroad or a reduction in foreign assets in the nation because
both involve a payment to foreigners.

In recording a nation’s international transactions, the accounting procedure known as

double-entry bookkeeping is used. This means that each international transaction is recorded
twice, once as a credit and once as a debit of an equal amount. The reason for this is that in
general every transaction has two sides.

For example, suppose that a domestic corporation exports P800, 000 of goods to be paid
for in three months. The Philippines first credits goods exports for P800, 000 since this goods
export will lead to the receipt of a payment from foreigners. The payment itself is then entered as
a financial debit because it represents a financial outflow from the Philippines. That is, by agreeing
to wait three months for payment, the Philippine exporter is extending credit to, and has acquired
a claim on, the foreign importer. This is an increase in Philippine assets abroad and a debit. The
entire transaction is entered as follows in the Philippine balance of payments:

Credit (+) Debit (-)

Goods exports P800,000
Financial outflows P800,000

The International Transactions of the Philippines

Here is an example of the Balance of Payments in the Philippines for 2020.
5.4 Overall BOP Position
The overall BOP position is a summary measure of the performance of the country’s
external transactions. This can be estimated using two approaches: 1.) the sum of the current
account balance and capital and financial account balance, or 2.) the change in net international
reserves due to transactions. Ideally, these two approaches should yield the same result.
However, in reality, they do not equate due to data imperfections in the current account and in
the capital and financial account. The discrepancy in these two approaches is termed as the “net
unclassified items” or “errors and omissions” To maintain the identity of the two approaches, the
following presentation is adopted in the BOP.

+ Current Account Balance

+Capital and Financial Account Balance
+Net Unclassified Items
________________________________________
= Overall BOP Position
= Change in NIR ( Net International Reserves) due to transactions

The country’s balance of payments (BOP) position recorded a higher surplus of US$4.2
billion in Q2 2020 from the US$991 million posted in the same quarter last year. The BOP position
rose significantly due to the reversal in the current account to a surplus, following a substantial
reduction in the trade in goods deficit. The sluggish performance of both imports and exports of
goods reflected the adverse impact of the COVID-19 pandemic, including the disruptions in the
global demand and supply chains. Meanwhile, the financial account reversed to net outflows
mainly on account of the turnaround of portfolio investments to net outflows. This, however, was
tempered by the decline in net outflows of other investments and the increase in net inflows of
direct investments. (Source: Bangko Sentral ng Pilipinas)

5.5 The International Investment Position (IIP)

The IIP is a companion statistic to the BOP. The BOP is a flow estimate since it records
transactions within a given period of time. The IIP on the other hand, is a stock estimate as it
records the country’s foreign assets and foreign financial liabilities outstanding as of a certain
period. The stock is the result of all the past flows plus adjustments such as exchange rate
movements to account for the value of the financial asset /liability as of date of reporting. The IIP
links with the financial account of the BOP. Similar to the BOP, the categories of the IIP are direct
investments, portfolio investments, financial derivatives, and other investments. Assets and
liabilities are presented separately. International reserves are also part of the country’s assets.
The balance in the IIP that is, assets less liabilities, or the Net International Investment Position,
measures the country’s financial standing with the ROW. A net asset position reflects net claims
of residents on non-residents and thus may indicate some degree of stability. Meanwhile, a net
liability position reflects net exposure of residents to non-residents and thus to a certain extent ,
vulnerabilty.

5.6 Uses of the BOP and the IIP

The BOP and the IIP are important tools for national and international policy formulation
as countries have become increasingly interdependent. Policy makers are guided by the sources
of imbalances as presented in the BOP and IIP and therefore become better equipped in
determining and implementing adjustment measures. For instance, a deficit in the current account
may have stemmed from lower exports than imports. Given this scenario, national development
programs could be directed to increase competitiveness in the global market for local products
and/or develop new industries that will produce import substitutes. The use of these statistics, the
BOP and the IIP, is enhanced when taken together as the combined use of the BOP and IIP,
provides a glimpse of the relationship between flows and stocks. One example is the link between
trade in goods and direct investments, as this would reveal how dependent export earning
potential is on foreign capital and technology.

References:
IMF Statistics Department & IMF Committee on BOP Statistics.
Pilbeam, K. Ch 1.
Mohtadi, S. Ch 7.
Salvatorre, D. Ch 13.