International Trade and Finance

Essay “of The Balance of Trade” by David Hume

A written work discussing the relationship between a country's exports and imports, highlighting how this balance affects its economy and trade policies.

Adam Smith “The Wealth of Nations”

A seminal book that lays the foundations of classical economics, discussing concepts like the division of labor, free markets, and the benefits of trade.

Trade theory of David Ricardo

An economic theory that emphasizes comparative advantage, suggesting that countries should specialize in producing goods where they have a lower opportunity cost, thus benefiting from trade.

Absolute advantage

When a country is more efficient than the other at producing a certain good (resource that are locally abundant). The ability of an actor to produce more of a good or service than a competitor

The pattern of Trade

Refers to the way in which countries exchange goods and services, influenced by factors such as comparative advantage, resource availability, and market dynamics. Who sells to whom

International differences in labor productivity (DR)

Variations in efficiency with which labor can produce goods across different countries, affecting trade patterns and economic performance.

Free Trade

The unrestricted exchange of goods and services between countries without tariffs, quotas, or other trade barriers, promoting economic efficiency and competition.

Backlash against “globalization”

A reaction or opposition to the increasing interconnectedness and interdependence of global economies, often driven by concerns over job losses, cultural homogenization, and economic inequality.

Conflict of interest within nations (in trade)

A situation where individuals or groups within a country have competing interests that may influence their decisions or actions in trade, potentially leading to biased outcomes that do not benefit the overall economy.

trade surpluses

occurs when a country exports more goods and services than it imports, resulting in a positive balance of trade.

International monetary policy

Refers to the strategies and actions taken by a country's government or central bank to manage its currency value, control inflation, and influence economic stability in relation to international trade and finance.

International currency war

A situation where countries competitively devalue their currencies to gain an advantage in international trade, often leading to trade tensions and economic instability.

How is an exchange rate determined?

An exchange rate is determined by the supply and demand for currencies in the foreign exchange market, influenced by factors such as interest rates, inflation, and economic stability.

Free floating

exchange rates that fluctuate based on market forces without direct government or central bank intervention.

The Gravity Model

Economic theory that predicts bilateral trade flows based on the economic sizes of two countries and the distance between them, suggesting that larger economies have a greater trade volume and that distance negatively impacts trade.

Gravity model theory helps to…

Identify anomalies in trade patterns and predict trade volumes between countries.

Factors limiting International trade (gravity model)

include tariffs, trade barriers, transportation costs, and differences in regulations.

Gravity Model Graph

Vertical disintegration

A process where a company reduces its involvement in the supply chain by outsourcing (to be done by outside or foreign workers) production or services to external suppliers. This can enhance efficiency and reduce costs.

Vertical disintegration rose since…

after 1970s

The main trade currently in the world is…

Manufactured goods

The changing pattern of world trade

Refers to the shifts in the types and volumes of goods and services traded internationally, often influenced by globalization, technology, and economic policies. Growing.

Developing countries, in particular, have shifted from being mainly exporters of primary products to…

being mainly exporters of manufactured goods.

Comparative advantage

The ability of an actor to produce a good or service for a lower opportunity cost than a competitor.

Opportunity cost

The cost of forgoing the next best alternative when making a decision (trade offs).

Economy with just One factor of production

A simplified economic model where only one type of resource, such as labor or land, is used to produce goods and services.

Labor productivity

The amount of goods and services produced per hour of labor. It reflects the efficiency of labor in the production process. how many units per hour of labor.

Production possibilities

curve showing the maximum output combinations of two goods that can be produced with available resources and technology.

Production possibility graph

One- factor economy graph

In international trade prices will no longer…

be determined purely by domestic considerations

Countries whose relative labor productivity differ across industries will…

Specialize in the production of different goods

Relative labor productivity

is the amount of output produced per unit of labor input, varying between different industries in a country.

Two ways to understand the benefits from trade

1. Trade as an indirect Method of production

2. Trade expands consumption possibilities

Trade as an indirect Method of production

Instead of making everything themselves, countries can trade to obtain goods more efficiently.

Trade as Indirect Method of Production

Without trade, a country can only consume what it produces. With trade, a country can consume a mix of goods that differs from what it produces.

Trade Expands consumption possibilities graph

Production and Wages

A country’s wage rate is roughly proportional to the countries productivity

Productivity and Wages graph

Myth 1: Free trade is beneficial only if your country is strong enough to stand up to foreign competition. Ricardo’s model

gains from trade depend on comparative rather than absolute advantage

Myth 2: Foreign competition is unfair and hurts other countries when it is based on low wages.

This argument, sometimes referred to as the pauper labor argument, is a particular favorite of labor unions seeking protection from foreign competition

Pauper labor argument

is the claim that low wages in foreign countries lead to unfair competition, harming domestic workers and industries.

Myth 3: Trade exploits a country and makes it worse off if its workers receive much lower wages than workers in other nations.

This argument is often expressed in emotional terms

Comparative advantage with many goods

is the economic principle that countries should specialize in producing goods for which they have a lower opportunity cost, leading to increased efficiency and mutual benefits in trade.

Unit labor requirement

refers to the amount of labor required to produce one unit of a good. It is used to assess productivity and efficiency in manufacturing processes. how many hours of labor to produce one unit.

Goods will always be produced where…

is cheapest to make them (and where the comparative advantage exists)

The “cut” in the lineup of goods (criterion for s

Refers to the point at which a country or firm decides to stop producing a certain good due to higher opportunity costs or lower comparative advantage, reallocating resources to more efficient production.

Comparative advantage with many goods graphs

Transportation cost do not change the fundamental principles of comparative advantage or the gains from trade

This principle asserts that even when transportation costs are considered, the basic tenets of comparative advantage remain intact, enabling countries to benefit from trade by specializing in goods they produce most efficiently.

main reasons why specialization in the real international economy is not extreme

• more than one factor of production

• protect industries (some countries do)

• Costly to transport goods and services

Ricardian model

A theory in international trade that explains how countries can gain from trade by specializing in goods they can produce at a lower opportunity cost, emphasizing the role of comparative advantage. Assumes an economy that produces 2 goods and can allocate its labor supply between the 2 sectors.

Ricardian Model graph

The Specific factors model (Samuelson and Jones)

A model in international trade that analyzes how different factors of production can affect trade patterns and income distribution, focusing on the impact of specific factors that are not easily transferable between industries (labor is mobile but capital and land are fixed).

Difference between Ricardian Model and Specific Factor Model

RV> only L (factor of production), Labor moves freely between sectors (factor mobility), Comparative advantage (reason to trade)

SFM> LKT (factors of production), L is mobile but K and T are fixed, Differences in resources endowments (reason to trade)

The Specific Factor Model graph

In the specific factor model trade affects…

the welfare of particular group and the country as a whole. International trade shift the relative price of the goods traded.

losers of trade according to the specific factor model

immobile factors in the import competing sector (especially low-skilled workers). Hard to transicion

Income distribution

refers to how a nation's total wealth is distributed among its population, affecting economic inequality and social stability.

Labor mobility

the ability of workers to move between jobs, regions, or sectors, influencing wage levels and employment opportunities.

If workers are able to move between two countries…

This movement will reduce the Home labor force and thus raise the real wage in Home, while increasing the labor force and reducing the real wage in Foreign

covergence of real wage rates

occurs as labor mobility leads to adjustments in wage levels across countries, promoting equality in wages.

International labor mobility leads to…

a covergence of real wage rates and it increases the world’s output as a whole

Labor force effects of restriction immigration (in teh US)

In the specific factors model…

factors specific to export sectors in each country gain from trade, while factors specific to import-competing sectors lose. Mobile factors that can work in either sector may either gain or lose.

Heckscher Ohlin Theory (two factor economy)

a theory in international trade that explains how countries export and import goods based on their factor endowments, suggesting that countries will specialize in producing goods that utilize their abundant resources.

Difference between HO model and Specific Factor Model

HO> L & K (factors); L&K can move btw industries; abundant factor gains and scarce loses; factor endowmnet determine trade

SFM. L, K&T; L is mobile but K and T are not; export sector gan and import sector lose (mobile factor can gai or lose)

Model of two factor economy (HO) graph

Effect of International trade between two factor economies

Since Country A has a higher ratio of labor to capital than Country B, Contry A is labor-abundant and Contry B is capital-abundant. Note that abundance is defined in terms of a ratio and not in absolute quantities

Skilled biased technological change and income inequality

refers to the phenomenon where advancements in technology disproportionately benefit skilled workers over unskilled workers, leading to increased income inequality. This change often results in higher wages for skilled labor while leaving unskilled labor with stagnant or declining wages.

Empirical evidence of Heckscher-Ohlin Model example

includes studies showing how countries with abundant factors of production export goods that intensively use those factors. For instance, a labor-abundant country exports labor-intensive goods, supporting the model's predictions.

Patterns of trade between developed and developing countries

Developed countries often export high-value manufactured goods, while developing countries typically export raw materials and low-cost labor-intensive products.

Patterns of trade between developed and developing countries

perfectly competitive market

a market in which there are many buyers and sellers, none who represents a large part of the markets

In a perfectly competitive market firms are

price takers

Imperfect competition

a market structure where individual firms have some control over the price of their products, leading to price-setting behavior rather than price-taking.

Pure monopoly

a market structure where a single seller dominates the market, with no close substitutes for the product and significant barriers to entry for other firms.

In the monopolistic competition model, marginal revenue is…

always less than the price

Relationship between marginal revenue and price depends on two things:

• How much output the form is already selling

• Slope of the demand curve (which tell us how much the monopolist has to cut his price to sell one more unit of output)

Monopolistics pricing and production decision graph

Monopolistic competition model to trade

Trade increases market size and allows firms to achieve economies of scale.

Economies of scale

Cost advantages that firms experience as their production scale increases, leading to lower per-unit costs.

Monopolistic competition model can be used to…

show how trade improves the trade-off between scale and variety that individual nations face

Symmetry assumption

refers to the idea that all firms in the market have equal access to resources and face similar costs, impacting their competitive dynamics.

And increased market size generates…

both winners and losers among firms in an industry. The low-cost firms thrive and increase their profits and market shares, while the high-cost firms contract and the highest-cost firms exit

Trade costs associated with boarder corssing

expenses incurred when goods are transported across international borders, including tariffs, transportation fees, and regulatory compliance costs.

salient feature of firm-level trade patterns

is the ability of firms to compete internationally based on their unique capabilities and resources, influencing their export performance and market strategies.

Dumping

is the practice of selling goods in a foreign market at a price lower than their normal value, often to gain market share or eliminate competition.

When is a corporation multinational?

A corporation is considered multinational when it operates in multiple countries, managing production or delivering services in more than one nation while maintaining a centralized head office. (10 porcent or more held by foreign company)

Bretton Woods regime

was a system of monetary management established in 1944, creating rules for commercial and financial relations among the world's major industrial states, leading to fixed exchange rates and the establishment of the International Monetary Fund (IMF) and the World Bank.

Economic globalization

refers to the increasing interdependence and integration of economies worldwide, driven by trade, investment, and technology.

Hyperglobalization

is the accelerated integration of economies and societies across the globe, characterized by a significant increase in cross-border trade, investment, and cultural exchange.

Distance elasticity

measures how the quantity demanded of a good changes in response to changes in distance, reflecting the impact of transportation costs and consumer preferences on trade.

Geographic distance limits the convergence

of economic activity and trade between regions, as longer distances typically increase transportation costs and affect consumer choices.

Global citizen

is an individual who identifies as being part of the global community, transcending national borders and emphasizing social, economic, and environmental responsibilities on a worldwide scale.

Industrial revolution

was a period of significant industrial growth and technological advancement that began in the late 18th century, leading to major changes in manufacturing, transportation, and society.

Poor countries in a wealthy world

refers to nations with low income and limited resources that exist within a global economy dominated by affluent countries, highlighting disparities in wealth and access to opportunities.

Great Divergence

describes the period from the 18th century onward when Western Europe and parts of North America experienced rapid economic growth and industrialization, leading to a significant gap in wealth and development compared to other regions of the world.

Globalization and the great divergence

refers to the increasing interconnectedness of economies, cultures, and populations across the globe, which has contributed to the widening economic gap between wealthy and poorer nations, as highlighted by the Great Divergence.

deregulation

the reduction or elimination of government rules and restrictions on economic activity, often aimed at promoting competition and efficiency in markets.

Washington Consensus

a set of economic policy prescriptions for developing countries, emphasizing market-oriented reforms, fiscal discipline, and trade liberalization.