International Economic Theory & Policy EXAM STUFF

What is International Economics?

International economics studies how countries interact through trade, investment, money flows, and exchange rates.

Why is International Economics important?

Countries are connected.

If something happens in one country...

➡ everyone else feels it.

Examples:

• COVID → factories closed → supply shortages

• Russia–Ukraine war → energy prices increased

• Red Sea attacks → shipping costs increased

• US-China trade war → electronics became more expensive

Gains from Trade

Countries trade because both sides can become better off.

Benefits:

✅ lower prices

✅ more products

✅ specialisation

✅ higher efficiency

✅ larger markets

BUT...

Trade doesn't help everyone equally.

Winners:

• Export firms

• Consumers

• Efficient industries

Losers:

• Workers in import-competing industries

• Some local firms

• Certain regions

Government Interventions

Tariffs

Tax on imports.

Purpose:

• Protect local firms

• Raise government revenue

Quotas

Limit on how much can be imported.

Subsidies

Government gives money to domestic firms.

Makes local firms more competitive.

Non-tariff barriers

Rules instead of taxes.

Examples:

• safety standards

• environmental rules

• licensing

• inspections

These can also reduce imports.

Exchange Rates

The price of one currency in terms of another currency.

If Ringgit depreciates- example: 1 USD RM4 ↓ RM5

Then Exports ✅ cheaper for foreign countries

And Imports ❌ more expensive

opposite for appreciation

Gravity Model

The larger the economy...the more trade it attracts.

The farther away...the less trade.

Formula:

Trade increases when

• GDP ↑

Trade decreases when

• Distance ↑

Why?

Large economies:

✔ produce more

✔ consume more

✔ have bigger markets

Distance increases

• transport cost

• insurance

• delays

• communication costs

Example

USA trades heavily with Canada & Mexico

because

✔ close

✔ large economies

Other things affecting trade besides distance:

• common language

• culture

• trade agreements

• geography

• multinational companies

• borders

Globalisation phases

First Age (1870–1913)-

Trade grew quickly bc of low transport cost, wider markets, fewer exchange barriers

Collapse-

World Wars & Great Depression: disrupted production, reduced demand, increased protectionism, caused world trade collapse

Second age (1970 onwards)-

Huge globalisation growth bc of

• internet

• container shipping

• global supply chains

• cheaper transport

BUT Political conflicts can destroy trade faster than technology can improve it.

modern trade

Old trade mainly:

Agriculture & Minerals

↓

Modern trade now mainly:

Manufacturing, Services, minerals

Global value chains example

Example:

iPhone

Designed in USA

Chip from Taiwan

Memory from South Korea

Assembly in China

Sold worldwide

Absolute Advantage:

its which country produces MORE of a good?

Example:

Malaysia

100 cars

Thailand

70 cars

Malaysia has absolute advantage.

Comparative Advantage:

its which country produces a good at a LOWER opportunity cost than another (even if its not the most efficient producer in everything)

• based on opportunity cost, not output.

• this is the one that matters for trade.

Opportunity Cost:

Definition: What a country must give up to produce 1 more unit of a good.

Formula

Opportunity Cost

=

Other product given up

÷

Product produced

Ricardian Model:

Assumptions:

• Labour only

• Different technology

• Two countries

• Two goods

• Constant productivity

Countries specialise according to comparative advantage, then trade and consume beyond their own production possibility frontier (PPF).

income distribution.

Trade benefits the country overall, but not everyone benefits equally.

What are "Specific Factors"?

Some resources cannot easily move to another industry.

Imagine a textile factory closes.

Can the sewing machines suddenly become semiconductor machines?

❌ No.

Can cotton farmland suddenly become an airport?

❌ No.

These are specific factors.

Specific factors

A specific factor is a factor of production that is tied to one industry and cannot easily move to another industry in the short run.

Examples:

Specific:

• factory buildings

• mining equipment

• farmland

• machinery

Mobile:

• workers

SPECIFIC : capital (tied to cloth) & land (tied to food)

MOBILE/MOVES : labor (moves between sectors)

The Main Assumption has three factors:

• Labour (mobile)

• Capital (specific)

• Land (specific)

Labour can move.

Capital and land cannot.

Why this matters?

Suppose Malaysia exports semiconductors.

Demand increases.

So Semiconductor firms want more workers.

Workers move there.

Result?

Semiconductor wages increase.

Semiconductor factory owners become richer.

BUT...

Furniture factories lose workers.

So Furniture output falls.

Furniture owners lose.

Biggest takeaway:

Trade creates BOTH winners and losers.

Who usually wins vs who usually loses from trade?

Winners

✅ Export industries

✅ Capital owners in export industries

✅ Workers who move into expanding industries

Losers

❌ Import-competing industries

❌ Owners of specific capital in shrinking industries

❌ Workers who cannot adjust quickly

Why does the government sometimes protect industries?

Politicians/Govs often protect industries because:

• unemployment

• political pressure

• regional inequality

• strategic industries

That's why tariffs exist.

EXAMPLE 1: Lesotho's textile industry

US tariffs made Lesotho's clothing exports more expensive.

What happened?

Export demand ↓

Factory profits ↓

Workers lost jobs

Specific textile machinery couldn't be easily used elsewhere

=

Income inequality increased.

EXAMPLE 2: US-China soybean tariffs.

China bought fewer US soybeans.

US farmers lost income.

Brazilian farmers gained.

Trade shifted the winners and losers.

!!!!!! memorize: Free trade increases national welfare overall, but adjustment costs mean its benefits are unevenly distributed across sectors and workers.