Chapter 1

Introduction

Preview

• What is international economics about?

• Gains from trade

• Explaining patterns of trade

• The effects of government policies on trade

• International finance topics

• International trade versus international

finance What Is International Economics About?

• International economics is about how nations interact

through trade of goods and services, through flows of

money and through investment.

• International economics is an old subject, but it

continues to grow in importance as countries become

tied to the international economy.

• Nations are more closely linked through trade in

goods and services, through flows of money, and

through investment than ever before.

What Is International Economics

About? (cont.)

• International trade as a fraction of the national

economy has tripled for the U.S. in the past

40 years.

• Compared to the U.S., other countries are

even more tied to international trade.

Fig. 1-1: Exports and Imports as a

Percentage of U.S. National Income

Source: U.S. Bureau of Economic Analysis Fig. 1-2: Exports and Imports as

Percentage of National Income in 2005

Source: Organization for Economic Cooperation and Development Gains from Trade

• Several ideas underlie the gains from trade

1. When a buyer and a seller engage in a voluntary

transaction, both receive something that they want and both can be made better off.

• 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.

Gains from Trade (cont.)

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.

Gains from Trade (cont.)

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).

Gains from Trade (cont.)

• 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. Patterns of Trade

• Differences in climate and resources can explain why

Brazil exports coffee and Australia exports iron ore.

• But why does Japan export automobiles, while the

U.S. exports aircraft?

• Differences in labor productivity may explain why

some countries export certain products.

• How relative supplies of capital, labor and land are

used in the production of different goods and services

may also explain why some countries export certain

products.

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 (ex., product specifications)

that exclude foreign products from the market, but still allow domestic products.

• What are the costs and benefits of these policies? 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? International Finance Topics

• Governments measure the value of exports and imports, as well

as the value of financial assets that flow into and out of their

countries.

• Related to these two measures is the measure of official

settlements balance, or the balance of payments: the balance of

funds that central banks use for official international payments.

• All three values are measured in the government’s national

income accounts.

International Finance Topics (cont.)

• Besides financial asset flows and the official

settlements balance, exchange rates are also an

important financial issue for most governments.

 Exchange rates measure how much domestic currency can

be exchanged for foreign currency.

 They also affect how much goods that are denominated in

foreign currency (imports) cost.

 And they affect how much goods denominated in domestic

currency (exports) cost in foreign markets.

International Trade

Versus International Finance

• International trade focuses on transactions

of 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 U.S. dollars or financial assets

by Europeans.

A Road Map

• International trade topics

 International trade theory (chapters 2–7)

 International trade policy (chapters 8–11)

• International finance topics

 Exchange rates and open economy macroeconomics

(chapters 12–17)

 International macroeconomic policy (chapters 18–22)