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IE Chp 1

What is international economics all
 Subject matter of international
 The effects of government policies on
 International finance topics
 International trade versus international
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
 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
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
 Economic Co-operation
◦ 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
◦ 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
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
◦ Tariffs: a tax on imports or exports
◦ Quotas: a quantity restriction on imports or exports
◦ Export subsidies: a payment to producers that
What are the costs and benefits of these
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
Governments measure the value of exports
and imports, as well as the value of financial
assets that flow into and out of their
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
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.