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International Economics: International Economics deals with topics concerning the economic
interactions of sovereign nations.
Determinants of trade volume:
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Economic size of the countries under consideration Distance
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Legal restrictions (e.g. Tariffs)
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Geography
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Infrastructure (e.g. havens)
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Culture and language
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Multinational firms
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Currency arrangements (e.g. Eurozone)
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Political factors (e.g. civil war)
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Historical factors (e.g. trade of former colonies with former colonial power)
Jean Baptiste Colbert : Mercantilism, Argued for strong Protectionist trade measures
Adam Smith: Absolute Advantage, Founder of modern economics, argued against protectionism
Absolute Advantage: A country exhibits an absolute advantage in the production of a good if the
costs of its production are lower than in the other country.
David Ricardo: Comparative Advantage, Founder of modern trade theory. Explained why
countries with low production may still benefit from participation the world market
Comparative Advantage: A country has a comparative advantage in the production of a good if
the opportunity costs of production measured in terms of the other good are lower than
in the other country.
Opportunity costs: The cost of an alternative that must be forgone in order to pursue a certain
action.
Labor coefficient: Labor hours required to produce 1 unit of a good.
Relative price: The relative price of good X (cheese), measured in units of good Y (wine)
equals the quantity of good Y which can be exchanged against one unit of X
Example
Price of coke=0.5$
Price of rum=10$
Then the relative price of rum measured in units of coke is 20.
Production Possibility Frontier (PPF): shows the maximum amount of one good which can
produced for any given amount of the other. Formally: QW =L/aL,W–(aL,C/aL,W)QC
Ricardo model: Autarky equilibrium:
Demonstration:
PC ... price of cheese
PW ... price of wine
wW ... wage - wine sector
wC ... wage - cheese sector
With perfect competition this implies in autarky:
PW /aW < wW , no production of QW
PW /aW = wW , production of QW
PC /aC < wC , no production of QC
PC /aC = wC , production of QC
value produced with 1 unit of labor: PW /aW , PC /aC
With perfect competition, equilibrium hourly wages must be the same in both sectors:
PC/aL,C =Pw/aL,W
PC/PW =aL,C/aL,W
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If wage payments were e.g. higher in the wheat sector, workers would want to
work there which increases the supply of workers in the wheat sector and puts
downward pressure on the wage payments in the wheat sector.
Relative prices in autarky are therefore determined by the ratio of labour
coefficients which in turn reflect opportunity costs of production.
Normative analysis: Normative analysis typically involves some form of value judgement about
the desirability of particular economic policies. Example: Should Austria impose
protectionist measures?
Positive analysis: Deals with causes and consequences of economic events/policies
independent of whether those consequences are warranted. Example: (Why) Does free
trade based on technological differences lead to sectoral reallocation of factors of
Production?
Slides 3
Production Possibility Frontier: Slope reflects the opportunity costs of production, the
higher the production of a good, the higher the additional costs of producing an
additional unit (x > y), Opportunity costs are not constant.
Isovalue Line: Line which represents different combinations of goods which give the same value
of output for given relative prices
Relative Supply Curve: is derived from firm’s profit maximization. It shows the profit maximizing
combinations of the two goods for different relative prices
Demand
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Demand is not included in the Ricardo-model, the Standard model derives consumption
demand explicitly from consumer’s preferences and choices.
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In a perfect competition setup, the value of consumption equals the value of production.
(PCQC +PFQF =PCDC +PFDF =V)
Law of declining marginal utility: the higher the volume of consumption of one good already is,
the lower the additional utility of consuming an additional unit of this good
Indifference curve: Line which represents various combinations of goods which give the same
level of utility
Relative Demand Curve: is derived from consumer’s utility maximization. It shows the utility
maximizing combinations of the two goods for different relative prices.
Equilibrium: relative price/relative quantity allocation
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In autarky equilibrium Production= consumption in both sectors
Trade integration
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Relative supply and relative demand on the world market result from the ratio of the
sums of domestic supply and demand in both countries. The relative world market price
lies in between the two domestic relative prices.
Welfare gains from trade: Free trade reduces the relative price of textiles. Isovalue lines become
flatter. Point of production changes from P1 to P2. Country A exports food due to its
comparative advantage and imports textiles. New point of consumption lies on a higher
indifference curve.
Terms of Trade (TOT): The ”Terms of trade öf a country equals the ratio of the price of the
exported good to the price of the imported good.
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a reduction of this ratio is called a worsening of the TOT
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an increase is called an improvement in the TOT
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an improvement in the ToT increases welfare
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a worsening of the ToT reduces welfare
Slides 4
The transfer problem: War reparations or international loans have a negative impact on the
welfare of the donor nation. Their TOT will worsen and the transfer will be used by the recipient
to buy domestic products, causing two types of welfare loss.
Slides 5
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Personal income distribution: distribution among people in society
Functional income distribution: distribution among production factors
Factor intensity: shows how important production factors are in relative terms (i.e. a
labour or land-intensive production)
Factor abundance/endowment: shows how rich in a factor a country is in relative terms,
is a source of a comparative advantage.
Stopper-Samuelson theorem: If relative price of a labor-intensive good increases, real
wage of labor will increase while real wage of land will decrease. And vice versa.
=> Owners of abundant factors win from international trade
=> Owners of scarce factors lose from international trade
Slides 6
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Inter-industry trade: trade of products from different sectors (cheese and wine)
Intra-industry trade: trade of products in the same sector (japanese and german cars)
Economies of scale: the cost advantages that enterprises obtain due to their scale of
operation, leading to decreased unit costs
○ External economies of scale: size of the industry induced
○ Internal economies of scale: size of the firm induced
○ Specialized suppliers: Specialized equipment only supplied to large and
concentrated firms (like silicon valley)
○ Labor market pooling: More attractive to applicants, reducing search and hire
costs
○ Knowledge spillover: Workers from different firms share ideas that benefit both
firms
Monopolistic competition: lots of competitors act as monopolists with their differentiated
products: increases welfare and decreased price
Slides 7
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Specific tariffs: fixed charge
Ad valorem: percentage of the value
Import demand: difference between domestic demand and supply
Export supply: difference between foreign supply and foreign demand
Tariff: acts as added cost of transportation, making producers less willing to ship goods.
Export subsidy: raises price in exporting country and lowers them in importing country
Consumer surplus: measures welfare gain for consumers as difference between
willingness to pay and actual price
Producer surplus: measures welfare gain for producers as difference between price at
which he was willing to sell minus actual price
Import quota: restriction of the quantity of a good that may be imported