International Economics Fiches

8/16/2019 International Economics Fiches

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International economics

Introduction:

International economics give answers about imports, exports, trading (who

are we trading with? What are we trading?). The world merchandise trade had known an important increase since the5!s (manu"actures# multiplied b$ 5, agricultural products# multiplied b$%).

I) Major Issues of International Economics:

International economics# It is part o" economics, which "ocuses on issuesraised b$ the special problems o" economic interaction between sovereignstates.

It "ocuses on & ma'or issues#

1) The gains from trade:

ains "or Trade# When countries sell goods and services to each other, thisexchange is almost alwa$s to their mutual benets. *ven with one countr$more e+cient in the production o" all goods and services, an$ othercountr$ that trades with it will gain.We will stud$ models which explain this phenomenon#- The icardian /odel ("rom icardo, %0%&)

- The 1eckscher-2hlin /odel (%344)

ut, some groups within the nation can loose which means internationaltrade changes the distribution o" the national income.

This distribution can change#-6rom one industr$ to another (exports industries to local producers)-6rom a geographic area to another (countr$ side to seaside)-6rom Workers to owners o" capital-6rom a class o" workers to another (unskilled-'ob to highl$ trained 'ob)

2) The Pattern of trade:

The pattern o" Trade explains who sells what to whom.It can be "or obvious reasons# 7atural resources (oil in the /iddle *ast),climate (co8ee in ra9il): or "or more subtle reasons# ;< exportingaircra"ts, 6rance exporting weapons.

To understand the decision process, we will have to look at di8erentelements (=apital, >abour, >ands).

3) Protectionism:

Trading is not onl$ about economic prosperit$, it also promotes worldpeace, because when $ou trade with someone, $our economic growth (and


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in a certain wa$, the wel"are o" $our population) is linked to the othercountr$!s economic growth. /oreover, it changes the perception we haveo" that population.

There are two wa$s to protect $our national econom$#

-Tari8s (import)# Taxes levied on imports.*xample# I" pple wants to sell an I@hone in 6rance, it has to pa$ a taxeAual to 5B o" the product value.-


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-Trade between the ;< and elgium (or 7etherlands) is higher than thegravit$ model prediction.Wh$?1) -istance .in the model): Trade is higher when $ou have closepersonal contact. The model uses distances as an indicator o"

transportation costs but it misses the personal relation part o" business.2) Barriers .anything that #re(ents trade ,eteen countries): Themodel does not take them into consideration and it can onl$ be used toassess an agreement (e.g. 76T greement between /exico, the ;< and=anada).3) Borders: orders have a negative e8ect on trade (e.g. There is muchmore trade between =anadian provinces than between =anadianprovinces and ;<


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It!s in each countr$!s best interest to speciali9e in producing the goods "orwhich it has an absolute advantage. /oreover, the global e+cienc$ o" production improves.

II) las .dfauts) in the theory:

What i" none o" these countries has an absolute advantage? =an the$ $etbenet "rom trading?

This is wh$ the theory of com#arati(e ad(antages of icardo isrecogni9ed as a "undamental in international trade theor$.

6undamental idea o" the theor$# even i" a countr$ has no absoluteadvantage in the production o" all goods, it will benet "rom speciali9ing inthe productions "or which it is the most e+cient.Because of di5erences in o##ortunity costs6 such a country canstill ,ene7t from trade b$#-*xporting the goods that were produced at a low opportunit$ cost.- Importing the goods that would have been produced at a highopportunit$ cost.

Part 2: The model of -a(id icardo:

1) The com#arati(e ad(antages:

utark$# When a countr$ provides ever$thing "or itsel".

If a country has an a,solute ad(antage in all the #roductions6 eloo% at the o##ortunity costs& The opportunit$ costs give in"ormation on the comparative advantages o" each countr$. It is the cost o" producing product instead o" product "orinstance.


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There is an eAuilibrium i" and onl$ i" the international price lies in therange dened b$ relative prices in autark$.

nal$sing international trade anal$sis is more consistent when using themodel o" comparative advantages (instead o" absolute advantages)# It

states that trade is built on benets "rom the di8erences betweencountries in terms o" costs o" production.In icardo!s theor$, the comparative advantages are determined b$ thecompared productivities (under the h$pothesis that the wages are thesame in each industr$).

The$ can also be determined b$ the relative prices o" one production (inunits o" the other production) b$ countr$: and b$ the productions!opportunit$ costs (in terms o" resources used).


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We can nd the comparative advantages also b$ the "ollowingrelationship# =ountr$ has a comparative advantage over countr$ in aproduct i"#K>i (o" ) x W (o" ) is loer than K>i (o" ) x W (o" ).>?i .of 0) ! ' .of 0): .ours of la,our #er unit of i) ! .cost of 1

hour of la,our) hich is cost of la,our #er unit of i in the country0&

Fi8erences in productivit$ levels (in icardo!s theor$)#%) The$ have an inLuence on the structure o" international trade (andconrm the conclusions drawn b$ the theor$ o" comparative advantages).) The$ help explaining the di8erences in terms o" standard o" livingbetween countries (and conrm some conclusions drawn b$ the theor$ o" absolute advantages). countr$ that has no absolute advantage is less productive and realwages are lower.4) The$ do not support the h$pothesis under which western countries losetheir comparative advantages on the account o" countries o" low wages.

?o salaries are associated ith lo #roducti(ity: 'ages rise ith#roducti(ity&

Producti(ity and international trade:

-s an$ model, the theor$ o" the comparative advantages o" icardoproposes a schematic vision o" the economic realit$.

*ach trade partner exports onl$ some goods and "ull$ depends on theother partner "or the other goods.

-In realit$, the world!s production is not per"ectl$ divided betweencountries.


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I" a countr$ has a lower productivit$ than another, the di8erence o" wages should be su+cient (low) to allow this countr$ to be competitive.Part 3: E!tensions to the model and ris%s to s#eciali+ation:

/om#arati(e ad(antages for more than 2 goods:

The model o" icardo is based on onl$ goods: we can extend it to thewhole range o" goods a countr$ can produce. We establish a scale o" comparative advantages b$ sorting the goods ("rom % to n) according tothe relative productivities.

To get a more precise sharing out o" the speciali9ations, we must thenconsider that a country s#eciali+es in the #roduction for hich therelati(e #roducti(ity is higher than relati(e ages.


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-The production "actors are not per"ectl$ mobile between the di8erentindustriesJproductions.-The labour "orce is neither per"ectl$ geographicall$ mobile nor technicall$mobile (reAualication is needed), especiall$ in the developing countries.

) 1eav$ exploitation o" a comparative advantage (ver$ narrowspeciali9ation# spPcialisation trQs accrue) ma$ generate a dependence onthe global market prices and demanded volumes, because some countr$won!t produce an$ o" some goods.

4) The productions in which the countr$ has a comparative advantage ma$not be supported b$ the global demand.

RFutch diseaseS in the &!s# sudden increase in natural gas production exports in the 7etherlands#-elocation o" the "actors o" production# 2ther productions are a8ected.-1igher demand "or the currenc$# This damages competitiveness o" othersectors "or exports.-@ossible decline o" whole sectors o" the econom$ that could totall$ o8setthe benets o" the increase in the price o" the production in which thecountr$ has speciali9ed.

The model of icardo does not e!#lain the reason of thedi5erences in #roducti(ity and costs of la,our ,eteen countries&

/ha#ter 2: /om#arati(e ad(antages and di5erences in factorsendoment

Fi8erences in "actors endowment G Fi8Prences dans les "acteurs dedotation

Part 1: The model of ec%scher ;hlin .2!2!2 model): (exchangesare due to the di8erences in "actors endowment)

0ssum#tions:%) goods, countries, "actors o" production (U (capital) and > (labour)).) @er"ect competition in the market o" goods and in the market o" "actors(no transportation costs)4)


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3) @roduced goods have di8erent "actor intensities (the Auantit$ o" "actorbeing used)

When the returns to scale are constant, the production variesproportionall$ with the "actors o" production being used. The cost also

remains constant.

The tol#eramuelson theorem is a basic theorem in 1eckscherC2hlintrade theor$. It describes the relationship between relative prices o" outputand relative "actor rewards (which are real wages and real returns tocapital).

The theorem states thatVunder specic economic assumptions (constantreturns, per"ect competition, eAualit$ o" the number o" "actors to thenumber o" products)Va rise in the relative price o" a good will lead to arise in the return to that "actor which is used most intensivel$ in theproduction o" the good, and conversel$, to a "all in the return to the other"actor.

6or a given technolog$, entrepreneurs select the production that will allowthem to produce at the lower cost (which means the more intensive inlabour i" labour is relativel$ cheaper). It implies#

The Auantit$ o" "actors to produce "ood (6) will depend on labour wages (>)and the cost o" use o" soil (s). The choice o" the production techniAue willthen depend on the relative "actors price >Js.I" > increases relati(ely to s, the rm will choose techniAues that use lesslabour and more soil to produce "ood. The$ will minimi9e their costs and

still produce the same goods. The Auantit$ o" soil and labour to produce "ood is not a linear curve in the12 model, and producers have to choose the best combination o" "actors.

The goods produced have di8erent concentration (or intensit$) in "actorso" production (di8erent technologies).


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%) The notion o" ph$sical a,undance o" the "actors (in relative terms).=hina has more soil and workers than 6rance because it is bigger.

The 6rench econom$ is relati(ely abundant in soil compared to theeconom$ o" i"#() 6 N () ()

) The notion o" #rice o" the "actors (in relative terms). The 6rench econom$ is relati(ely abundant (because it is cheap) in soilcompared to the econom$ o" countr$ i"#(WJ


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-The more the relative cost o" labour increases, the more the relative priceo" the good that is labour-intensive increases (but in a lower proportion).- rise o" the relative price o" the good that is labour-intensive will lead toan increase o" the relative remuneration o" labour.

The relative price o" clothing (vertical axis, @=J@W) is an increasing"unction o" the relative price o" labour (hori9ontal axis, WJc (labour times the Auantit$ o" labour"or % unit produced o" clothing)-sGwG % euroJunit o" labour or soil-w G Y: c G &5I" there is an increase in wheat price o" %B (while the price o" clothingand Auantities remain unchanged), what!s the impact on the remuneration

o" "actors?

@w increases The wheat production increases The remuneration o" the "actor "or which wheat production is relativel$ abundant increases soil is the "actor relativel$ "or which wheat production is relativel$abundant, so s increases.

There"ore, i" the wheat production increases and s increases, while @cremains unchanged, we will observe that# The clothing productiondecreases, the remuneration o" the "actor "or which clothes production isrelativel$ abundant decreases (which is labour w), so w decreases.

We can nd s and w to balance the eAuations#%% G Ds XYw and % G 5s X&5w: we obtain sG%,5 and wG5JY

=hanges in the price o" goods are bordered b$ the changes o" "actorprices#6or labour# w was eAual to %, now 5JY, so decrease o" %&B@c remains the same@w increase b$ %B6or soil# s was eAual to %, now %,5, so increase o" 5B

0n increase of P=Pc .


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nother notable result emerges "rom this example# n$ change in therelative price o" goods "rom one countr$ has an impact on the realremuneration o" population groups a8ected b$ changes in the goodsprices.

6actor whose relative wage increases sees his actual earnings (orpurchasing power) increase: the other "actor sees its real wages decline.n$ variation o" the relative price o" a good has conseAuences on theincome distribution among workers or beneciaries o" the di8erent sectorsinside the countr$ (because it a8ects the remuneration o" the "actors o" production).

There"ore, international trade can change the income distribution in acountr$.

Theorem of tol#er amuelson: n increase in the price o" a goodincreases the relative and real remuneration o" the "actor o" productionthat is relativel$ intensivel$ used in the production o" this good. It ma$decrease "or the other "actor (so "or instance, an increase in the price o" clothing increase the relative and real remuneration o" labour, and ma$decrease the relative and real remuneration o" soil).

Thus, the more a "actor o" production is speciali9ed (concentrated) in theproduction o" a good whose relative price increases, the more this "actortends to benet "rom the price change o" the good (opposite is true).

This is wh$ workers in declining industr$ in a countr$ lose in terms o" purchasing power.

2verall, the theor$ predicts a gain "rom trade# The factor of #roductionhich gains from o#enness has an increase of income higher thanthe reduction e!#erienced ,y the other&


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The 12< model has two basic implications#%) ;nder "ree trade, countries tend to export the good that uses theirrelativel$ abundant "actor$ relativel$ intensivel$.) ;nder "ree trade, relative "actor prices will be the same in all countries.

There is not per"ect eAualit$ in realit$, because the h$pothesis o" themodel cannot be "ull$ respected in the real world#-overnment impose trade barriers.-Technologies are not exactl$ the same in ever$ countr$.-There are transportation costs.- countr$ that benets "rom a certain advance in technolog$ has a higherproductivit$ and there"ore a higher remuneration o" all its "actors o" production.

ll this prevents the existence o" a single international price and there"oreweakens the conclusion o" an eAuali9ation o" prices o" the 12< theorem.

1-2-< theorem gives a trend#-6ore example, be"ore the nd world war, the trade expansion between*urope, merica and ustralia led to a stagnation o" the high incomes o" landowners in *urope and an increase o" the low incomes o" landowners inmerica and ustralia.-n increase o" the real wages in


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;#ening to trade and non@uali7ed la,our in de(elo#edeconomies:

The "actor model is used to anal$se the e8ects o" trade betweendeveloped countries (F=) and developing countries (>F=) on emplo$ment.

Trade between F= and F>= results b$#F= export goods, intensive in skilled labour and import good intensive inunskilled labour. These goods are purchased and there"ore produced b$ F=at price lower than the one be"ore trade.Impact on purchasing power# ccording to 12


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Part 4: Em#irical testing of the model:

?eontief #arado!: The ;


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/onclusion: The model o" "actors endowment explains#-The link between benets "rom trade and the Auantit$ o" "actors.-The e8ects o" trade on the remuneration o" "actors.

-The "actors endowment o" trade Lows.-The conseAuences o" 7orthJ


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The #roduction #ossi,ilities frontier .P) of each country isre#resented ,y a decreasing conca(e cur(e&The #roduction constraint o" a countr$ is given b$#

L< Pc>c Pf>f (p et c en indices en bas droite). This "unction represents the iso(alue straight lines# 6or given relative

prices, it indicates the maximum Auantit$ that can be produced, in"unction o" K" and Kc.

The optimal production o" a countr$ corresponds to the point o" tangenc$between the @@6 and the "arthest "rom origin isovalue straight line (theisovalue straight lines are diagonal lines, the "arthest one that crosses the@66 is the optimal production o" a countr$). t this point, the relative priceo" clothing (@cJ@" eAuals the opportunit$ cost o" the production o" clothingin terms o" "ood.We have now to determine the relative suppl$ ("or instance, o" clothing,compared to "ood).eneral principle# The relative suppl$ o" a good depends on the relativeprice o" this good.

The relative price o" clothing (@cJ@") corresponds to the slope o" theisovalue lines. The slope is rise over run (H-H%J-%).I" there is an increase o" the relative price o" clothing, the slope (inabsolute terms) increases.

The relati(e #rice of 0 hen e ha(e 2 goods 0 and B is P0=PB&

When there is an increase in the relative price o" clothing, the production

o" "ood decreases, and the production o" clothing increases. The optimummoves along the @@6 curve, with higher Kc and lower K".6or the suppl$ curve o" clothing "or example, we have on the hori9ontalaxis the relative Auantit$ o" cloth (K=JK6) and on the vertical axis therelative price o" cloth (@=J@6).

The rise o" the price o" clothes leads to an increase in the relativeproduction o" clothes, there"ore, there is a relationship between the @66and the relative suppl$ curve.

>et!s now anal$se the relative demand# The value o" the consumption o" an econom$ must be Aual to the value o"

its production (suppl$ G demand).Pc-c Pf-f < Pc>c Pf>f < L The choices of #roduction are determined ,y the PP and therelati(e #rices of goods&/onsumerCs #references and relati(e #rices determine the choicesof consum#tion .hich means demand)&

=onsumers! pre"erences (o" a representative consumer) are representedb$ indi5erence cur(es# The$ are all the bundles (combinations) o" goodsthat give the same level o" satis"action (the same utilit$).Indi8erence curves are Rwell-behavedS# -ecreasing marginal rate of su,stitution .M) and con(e!ity&


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(The /< is the slope o" the indi8erence curve. It is the rate at which theconsumer is willing to substitute one good "or the other (how much o" the consumer reAuires in order to be compensated "or a one-unit reductionin consumption).

The indi8erence curves are not straight lines, so the /< is not the same

at all points on a given indi8erence curve. The /< depends on theamounts o" the goods he is alread$ consuming).

Indi8erence curves are decreasing# I" a consumer consumes less 6, heneeds more = to obtain the same level o" satis"action (to remain on thesame indi8erence curve). shi"t o" the indi8erence curves to the rightcorresponds to a higher level o" satis"action# =onsumers alwa$s pre"erconsuming more o" the two goods.Indi8erence curves are convex# I" an individual alread$ has a big Auantit$o" = and a small Auantit$ o" 6, he will value more the marginal utilit$ o" 6.=onseAuentl$, he will need more and more = to compensate a reduction o" his consumption o" 6.

There is one @@6 and man$ indi8erence curves, and the$ have theAuantities o" goods in the axis.K is the optimal level o" production, and F is the optimal level o" consumption (where the budget constraint and an indi8erence curve cross.

The slope o" the budget constraint is the relative price and the slope o" theindi8erence curve is the /


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/ore generall$, the terms of trade are de7ned ,y the ratio of thegood that the country e!#orts and the good that the countryim#orts.When a countr$ exports clothing and when the relative price o" clothingincrease, the terms of trade im#ro(e.

This improvement o" the terms o" trade is elfare im#ro(ing# We reach ahigher indi8erence curve.Indeed, the increase o" the price o" exports corresponds to an increase o" the power o" importing good (in real terms).

emarks#-n improvement in the terms o" trade o" the countr$ that exports clothing(increase o" @cJ@") necessaril$ results in the deterioration o" the terms o" trade o" the countr$ that exports "ood ("all o" the relative price o" "ood@"J@c).-I" an improvement o" trade o" a countr$ increases wel"are, a degradationo" the terms o" trade reduces wel"are. 7evertheless, the wel"are can neverbe reduced below its autark$ level.

We can now "ocus on the determination o" the international relative prices,in our countries model# We suppose that the di8erences in theproduction capacities o" each countr$ are the cause o" their opening tointernational trade. Their relative suppl$ curves are thus di8erent.1owever, we suppose that consumers have the same pre"erences. Theirrelative demand curves are thus identical.


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6or the 12 model, the increase o" a "actor o" production will generate thesame phenomenon.

distorted growth in "avour o" a good alwa$s shi"ts the relative suppl$curve in the same direction.

6or instance, the biased growth in "avour o" clothing shi"ts the relativesuppl$ curve toward the axis o" clothing (with given relative prices, weproduce more clothing).

We call a groth ,iased in fa(our of e!#orts a growth that extends ina non-homothetic wa$ the @66 o" a countr$ in "avour o" the exported good.We call a growth ,iased in fa(our of im#orts a growth that "avours thegood imported b$ the countr$.

iased growth and its implications o" relative suppl$ cause a variation o" terms o" trade, the relative demand being given.iased growth in the clothing industr$ drives down the relative price o" clothing (in comparison to the "ood price) in both countries and will thusdeteriorate the terms o" trade "or the clothing exporting countries.

We can thus more generall$ stat that#-*xport biased growth reduces the terms o" trace o" a countr$ and,generall$, its wel"are, whereas it increases the wel"are o" "oreign countries.-t the contrar$, import biased growth improves the terms o" trade o" acountr$, together with its wel"are, whereas it reduces the wel"are o" "oreign countries.

Part 3: /ustoms tari5s and e!#ort su,sidies:

/ustom tari5s are taxes (or "ees) on imports.E!#orts su,sidies on exports are public trans"ers (allocations) paid todomestic producers who sell their products abroad.

=ustom tari8s and export subsidies create a (articial) di8erence betweenthe price at which the good is bought on the international market

(Re!ternal #riceS) and the price at which the good can be bought in thecountr$ (Rinternal #riceS).

I" the domestic countr$ imposes custom tari8s (tari"s douaniers) o" theimports o" "ood, the relative price o" "ood (relative clothing) will rise "or thedomestic consumers.In other words, the relative price o" clothing will decrease "or the domesticconsumers.

The domestic producers will earn relativel$ less on clothing, and are thusincited to reallocate their resources towards the production o" "ood# Therelative suppl$ o" clothing will "all.

The domestic consumers will pa$ a lower relative "or clothing, and will thusconsume more clothing# The relative demand increases.


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When the domestic countr$ imposes a custom dut$ (droits de douane), theterms o" trade and the countr$!s wel"are both improve.

The extent o" this positive e8ect depends on the si9e o" the domesticcountr$, in comparison to the world econom$.

I" the countr$ represents a negligible share o" the world trade, its customdut$ polic$ (or export subsid$ polic$) would hardl$ have an$ impact on theworld relative demand and suppl$, and, thus, on the terms o" trade.2n the contrar$, "or the countries with a bigger economic weight, we candetermine a rate o" taxation on imports that maximi9es their domesticwel"are, to the detriment o" "oreign countries.

I" the domestic countr$ imposes a subsid$ on exports o" clothing, the priceo" clothing will increase relative to the price o" "ood "or the domesticconsumers.

The domestic producers will benet "rom a high relative price o" clothingwhen the$ export, and will thus have tendenc$ to provide more clothingand less "ood "or their exports# The relative suppl$ "or clothing willincrease.

The domestic consumers will pa$ a higher relative price o" clothing to theproducers who are able to export, and will thus have a tendenc$ totrans"er part o" their consumption o" clothing to the consumption o" "ood,the relative demand "or clothing will diminish.

When the domestic countr$ imposes a subsid$ on exports, the terms o" trade diminish and the countr$!s wel"are will decrease, in "avour o" the

"oreign countr$.

/ustom tari5s and e!#ort su,sidies ha(e thus o##osite e5ects onthe terms of trade& custom dut$ implemented b$ the domestic countr$ can raise thedomestic wel"are, to the detriment o" the "oreign countr$.

The implementation o" subsidies on exports b$ the domestic countr$reduces its wel"are, "or the benet o" the "oreign countr$.

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International Economics Fiches

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