Introduction What is international economics all about? Subject matter of international economics The effects of government policies on trade International finance topics International trade versus international finance International economics is about how nations interact through ◦ flow of goods and services, ◦ flows of money ◦ Policies directed at regulating these flows ◦ Effect on nation’s welfare. International economics is an old subject, but it continues to grow in importance as countries become tied to the international economy. Open economy vs. closed economy Free trade vs. autarky The advantages realized from trade are called gains from trade. Interpersonal, interregional and international trade. Interpersonal Trade: ◦ Trade between individuals allow people to specialize in those areas that they can do relatively well and to buy from others the goods/services that they themselves cannot easily produce. ◦ Ex. A doctor and carpenter. Interregional trade ◦ With trade between regions, each regions are forced to specialize in those goods in which they have some natural or acquired advantages. ◦ Ex. Plain regions, mountain regions, cold regions. International trade is necessary to achieve the gains that international specialization makes possible. Trade allows each individual, regions and nations to specialize and concentrate on producing those goods that is produced relatively efficiently while trading to obtain goods and services that it would produce less efficiently than others. International economics deals with ◦ 1) International trade theory, International trade theory analyses the basis and gains from trade. ◦ 2) International trade policy, International trade policy examines the reasons for and the effects of trade restrictions Economic Co-operation EU, NAFTA, SAARC, SAFTA ◦ 1 & 2 are the microeconomic aspects of international economics ◦ 3) The balance of payments The balance of payments measures a nation’s total receipts from and the total payments to the rest of the world ◦ 4) Open-economy macroeconomics. It deals with the mechanisms of adjustment in balance of payments disequilibria (deficits and surplus) It also analyses the relationship between the internal and the external sectors of the economy of a nation, and how they are interrelated or interdependent with the rest of the world economy ◦ 3 & 4 are the macroeconomic aspects of IE. ◦ Also referred to as open economy macroeconomics or International Finance. Adam Smith David Ricardo Paul Samuelson W Leontief Bertil Ohlin Paul Krugman The trade theory develops models that provide different explanations or reasons why trade takes place between countries. The five basic reasons why trade may take place are summarized below. ◦ 1) Differences in Technology ◦ 2) Differences in Resource Endowments ◦ 3) Differences in Demand ◦ 4) Existence of Economies of Scale in Production ◦ 5) Existence of Government Policies 1) Greater Choice for Consumers : ◦ In an open economy, the domestic markets are merged with international markets and so the consumers are not limited to consume domestically produced goods and services. 2) Increased competition and Lower Prices: ◦ A related benefit of an open economy is that there is an increasing number of producers of goods and services competing for their business. ◦ Competition among producers results in lower prices and improved services. 3) Expanded markets and Customer bases : ◦ Global interaction allows companies to gain access to customers in other nations. ◦ This motivates them to produce world class products, expand their business and customer base. ◦ American brands such as McDonald's, Finnish communications giant Nokia, have established worldwide customer bases. 4) Global Investment Opportunities: ◦ For investors, an open economy expands the opportunities for investing capital. ◦ Investors large and small can choose to invest not only in known domestic companies, but they can also invest in established industrial giants of other nations. ◦ Investors with an appetite for risk, meanwhile, can invest in the emerging markets of Latin America, Africa and Southern Asia. 1) Trade can lead to over-specialisation, with workers at risk of losing their jobs can cause severe structural unemployment. 2) New infant industries which may find it difficult to establish themselves. 3) Local producers, who may supply a unique product tailored to meet the needs of the domestic market, may suffer because cheaper imports may destroy their market. ◦ One of the key principles of economics is that trade benefits all parties involved. ◦ International trade involves interactions with other economies and is therefore possible only among open economies. ◦ English economist David Ricardo, argued that trade allows nations to specialize in producing the goods in which they have comparative advantages and trade with other nations to obtain goods in which other nations specialize. 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 What are the costs and benefits of these policies? 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 other foreign governments respond likewise? 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. 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 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.