Chapter 1

Introduction

By: Zohaib Salman

 Chapter Organization

 Introduction
 What is International Economics About?
 International Economics: Trade and Money

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 Introduction
 The study of international economics has never been
as important as it is now.
• At the beginning of the 21st century, nations are more
closely linked through trade in goods and services,
through flows of money, and through investment in
each others’ economies than ever before.
• International trade as a fraction of the national
economy has tripled for the US in the past
40 years. Compared to the US, other countries are
even more tied to international trade.

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 Introduction
Figure 1-1: Exports and Imports as a Percentage of U.S. National Income

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 Introduction
Figure 1-2: Exports and Imports as Percentages of National Income in 1994

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 What is
International Economics About?
 International economics refers to a study
of international forces that influence the
domestic conditions of an economy and shape
the economic relationship between countries.
In other words, it studies
the economic interdependence between
countries and its effects on economy.

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 What is
International Economics About?
 International economics deals with the economic activities
of various countries and their consequences. It addresses
many topical issues, such as:
 How is the rapid growth of trade with China and India
likely to affect the structure of production and wages in
Europe? Does this matter in the face of the rise of
‘regionalism’? What are the effects of European Monetary
integration? How is the UK affected by its decision not to
join the Euro? How does financial crisis spread across
countries? What are the implications of the US sub-prime
crisis and resulting credit crunch likely to be for the UK?
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 What is
International Economics About?
 International economics deals with economic
interactions that occur between independent
nations.
• The role of governments in regulating international
trade and investment is substantial.
• Analytically, international markets allow governments
to discriminate against a subgroup of companies.
• Governments also control the supply of currency.
 There are several issues that recur throughout the
study of international economics.
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 Gains from Trade

• Many people are skeptical about importing goods

that a country could produce for itself.
1.When countries sell goods to one another, all
countries benefit.
– Norwegian consumers could buy oranges through
international trade that they otherwise would have
a difficult time producing.
– The producer of the oranges receives income that
it can use to buy the things that it desires.
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 Gains from Trade

2. How could a country that is the most (least)

efficient producer of everything gain from trade?
• With a finite amount of resources, countries can use
those 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.

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 Gains from Trade

3. Trade is predicted to benefit a country by making it

more efficient when it exports goods which use
abundant resources and imports goods which use scarce
resources.
4. When countries specialize, they may also be more
efficient due to large scale production.
5. Countries may also gain by trading current resources for
future resources (lending and borrowing).

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 Gains from 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 adversely affect the owners of
resources that are used intensively in industries that
compete with imports.
• Trade may therefore have effects on the distribution of
income within a country.
• Conflicts about trade should occur between groups within
countries rather than between countries.
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 Patterns of Trade

 The Pattern of Trade (who sells what to whom?)

• Climate and resources determine the trade pattern of
several goods.
 Differences in climate and resources can explain why
Brazil exports coffee and Australia exports iron ore.
 But why does Japan export automobiles, while the US
exports aircraft?
 Differences in labor productivity may explain why some
countries export certain products.
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 Patterns of Trade
 How relative supplies of capital, labor and land are used in
the production of different goods may also explain why
some countries export certain products.
• In manufacturing and services the pattern of trade is more
subtle. There are two types of trade:
– Interindustry trade depends on differences across
countries.  Trade between two countries where the goods
are from different sectors.
– Intraindustry trade depends on market size and occurs
among similar countries. when the traded goods are of the
same sector.
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The Effects of Government Policies
on Trade
 Policy makers affect the amount of trade through
• tariffs: a tax on imports or exports,
• quotas: a quantity restriction on imports or exports,
• export subsidies: a payment to producers that
export, or through other regulations (e.g., product
specifications) that exclude foreign products from
the market, but still allow domestic products.
 What are the costs and benefits of these policies?
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The Effects of Government Policies
on Trade (cont.)

 Economists design models that try to measure the

effects of different trade policies.
 If a government must restrict trade, which policy
should it use?
 If a government must restrict trade, how much
should it restrict trade?
 If a government restricts trade, what are the costs
if foreign governments respond likewise?
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 International Economics:
Trade and Money
 The Balance of Payments
• Some countries run large trade surpluses.
– For example, in 1998 both China and South Korea ran
trade surpluses of about $40 billion each.
• Is it good to run a trade surplus and bad to run a trade
deficit?
 Exchange Rate Determination
• The role of changing exchange rates is at the center of
international economics.

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 International Economics:
Trade and Money
 International Policy Coordination
• A fundamental problem in international economics is
how to produce an acceptable degree of
harmony/consistency among the international trade and
monetary policies of different countries without a world
government that tells countries what to do.

 The International Capital Market

• There are risks associated with international capital
markets:
– Currency depreciation
– National default
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 The International Capital Market

 International capital market is that financial market or

world financial center where shares, bonds, debentures,
currencies, hedge funds, mutual funds and other long
term securities are purchased and sold. International
capital market is the group of different country's capital
market.

 A capital market is a system that allocates financial

resources in the form of debt and equity according to
their most efficient uses. Its main purpose is to provide
a mechanism to borrow or invest money efficiently.
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 International Economics:
Trade and Money

 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 Europe over Europe’s subsidized
exports of agricultural products
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 International Economics:
Trade and Money

 International monetary analysis focuses on the

monetary side of the international economy.
• That is, financial transactions such as foreign
purchases of U.S. dollars.
– Example: The dispute over whether the foreign
exchange value of the dollar should be allowed
to float freely or be stabilized by government
action.

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 International Trade
Versus International Finance
 International trade focuses on transactions
of real goods and services across nations.
• These transactions usually involve a physical movement
of goods or a commitment of tangible resources like
labor services.

 International finance focuses on financial or

monetary transactions across nations.
• For example, purchases of US dollars or financial assets
by Europeans.
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