INTERNATIONAL ECONOMICS I
Practice sessions
Session 1
PRACTICE
SESSIONBosco
Maria Giovanna
- Politecnico di Milano
Outline
 Introduction
 Questions from Ricardo’s model and Gravity model
 Open questions
 Exercises
 Quiz
Class Structure
Open Questions, Exercises, Quiz
 Small groups
 The more you engage, the better!
Unclear issues from last lecture
 Think through which were the unclear points for you
 Make a list of these
 Discuss the most important ones in small groups
 Still unclear? -> post your question online
Question 1 for discussion
The Services sector has been steadily rising in relative
importance in GDP of Italy, as well as elsewhere around the
world. Since "services" have been identified as "nontradable" (e.g., it is difficult to export haircuts), it may be
argued that this trend will likely slow the rapid growth in
international trade. Discuss.
Possible answer to question 1
 This argument stands on questionable logical foundations.
 The past half century has seen a steady growth in the absolute and relative importance of
international trade. This trend has been reversed only by global conflicts, i.e. the two World Wars.
 This trend has remained steady and robust despite major compositional shifts (e.g., from primary
to manufacturing), and location shifts (e.g., the sudden rise of NICs as a significant group of
exporters).
 The trend will probably continue into the reasonable future, fueled by both super-regional
preferential trade regions and a growing impact of the multilateral forces, represented
institutionally by the World Trade Organization (WTO)—as illustrated by the recent abolishment of
the epitome cartelized trade, the world trade in textiles. Driven by technology—especially in the
areas of communication and transportation—a reversal of the growing trade trend is not likely in
the near future.
 Many "services" are in fact quite tradable. Examples would be financial services, long-distance
teaching, "help-desk" outsourcing, consulting and management services and others. In fact, when
a tourist gets a haircut, we see that even haircuts become a "tradable" service.
Question 2 for discussion
One of the major political developments of the past several
decades was the growing size and economic/monetary
integration of the European Union. What effect do you think
this had on international trade between countries?
Answer to question 2
 The growing economic integration meant that the barriers to trade were
steadily falling in a region.
 The common monetary unit also promoted inter-country trade within the EU
 The standardization of transportation (including railroad gauges, highway signs
etc.) and product codes also promoted expansion of intra-EU trade
 The decline in the probability of political conflict associated with this
comprehensive economic union, plus conscious attempts to cooperate in fiscal
and monetary policy stances again facilitated growing international trade,
allowing these countries to increasingly enjoy the fruits of potential positive
scale economies, and more traditional classical and neo-classical gains from
trade.
Question 3 for discussion
It is argued that small countries tend to have more open
economies than large ones. What are the logical
underpinnings of this argument?
Some possible answers to question 3
 They do not have sufficient resources to satisfy consumption needs; and also
do not have a sufficiently large market to enable their industries to avail
themselves of scale economy possibilities.
 Another answer would rely on a location argument. Assume that the “natural”
market for any given plant is a circle with a radius of n miles with the plant at its
center. Assuming that the production plants are located randomly throughout
the country, then the probability that the typical circular market will encompass
some foreign country is greater the smaller is the country.
Question 4 for discussion
Using the gravity model explain how trade relations of the
UK were likely to change after a no-deal Brexit.
Answer for question 4
 The (basic formulation of the) Gravity Model predicts trade size Ti,j between country i and country j
with the following equation:
,
,
 where Di,j measures the distance between country i and country j and Yi (Yj ) measures country i (j)
GDP.
 Before Brexit, trade flows between UK and Europe were significantly larger than what predicted by
the Gravity Model because of the benefits to international trade given by EU membership.
 Conversely, trade flows were significantly smaller between UK and the Rest of the World.
 No-deal Brexit will likely realign UK international trade on trade partners' size and proximity.
 See here the current EU-UK Trade and Cooperation Agreement
Exercise 1
Home has 1200 units of labour. It can produce two goods,
apples and bananas. The unit labour requirement in apple
production is 3, while in banana production it is 2.
a. Graph Home’s production possibility frontier
b. What is the opportunity cost of apples in terms of
bananas?
c. In the absence of trade, what would the price of apples in
terms of bananas be?
Exercise 1 - solutions









Exercise 1 - solutions
LH=1200, aL,A=3. aL,B=2
a.
Graph Home’s production possibility frontier:
aL,AQA + aL,BQB = LH
QA = L/aLA =1200/3=400 when QB = 0
QB = L/aLB =1200/2=600 when QA = 0
The production possibility frontier is: QB = L/aLB – (aLA /aLB )QA
Plugging in numerical values: QB = 1200/2 – (3 /2 )QA = 600 – 1,5QA
Exercise 1 - solutions
LH=1200, aL,A=3. aL,B=2
a.
Graph Home’s production possibility frontier:
Banana production,Qb
L/aLB=600
L/aLB=400
Apple production,Qa
16
Exercise 1 - solutions
LH=1200, aL,A=3, aL,B=2
b.
What is the opportunity cost of apples in terms of bananas?
Opportunity Cost
aLA/aLB = 3/2
The opportunity cost of apples in terms of bananas is 3/2. It takes three
units of labor to harvest an apple but only two units of labor to harvest
a banana. If one foregoes harvesting an apple, this frees up three units
of labor. These 3 units of labor could then be used to harvest 1.5
bananas.
Exercise 1 - solutions
LH=1200, aL,A=3, aL,B=2
c.



In the absence of trade what would the price of apples in terms of bananas be?
Exercise 2
Home has 1200 units of labour. It can produce two goods, apples and
bananas. The unit labour requirement in apple production is 3, while
in banana production it is 2.
Foreign has a labour force of 800. Foreign’s unit labour requirement
in apple production is 5, in banana 1.
a. Graph Foreign’s production possibility frontier
b. Construct the world relative supply curve
Exercise 2 - solutions
L = 1200, aLA= 3, aLB= 2, L* = 800, a*LA= 5, a*LB= 1
H
a.
F
Graph Foreign’s (*) production possibility frontier:
a*LAQA + a*LBQB = L*
Q*A = L*/a*LA =800/5=160 when Q*B = 0
Q*B = L*/a*LB =800/1=800 when Q*A = 0
Q*B = L*/a*LB – (a*LA /*aLB )Q*A and plugging in values…
Q*B = 800/1 – (5/1) Q*B or Q*B = 800 – 5 Q*A
Exercise 2 - solutions
LH = 1200, aLA= 3, aLB= 2, L*F = 800, a*LA= 5, a*LB= 1
a.
Graph Foreign’s production possibility frontier:
Banana production,Q*b
L/aLB=800
L/aLB=160
Apple production,Q*a
Exercise 2 - solutions


Exercise 2 - solutions
Exercise 2 - solutions
Exercise 2 - solutions
Exercise 2 - solutions
Exercise 2 - solutions
Exercise 2 - solutions
Exercise 3
Given the information in the table above:
 What is the opportunity cost of Cloth in terms of Widgets in Foreign?
 What is the opportunity cost of Cloth in terms of Widgets in Home?
 If these two countries trade these two goods in the context of the
Ricardian model of comparative advantage, then what is the lower limit
of the world equilibrium price of cloth relative to widgets?
Exercise 3 -solution
What is the opportunity cost of Cloth in terms of Widgets in Foreign?
a*LC/a*LW=60/30=2
Exercise 3 -solution
What is the opportunity cost of Cloth in terms of Widgets in Home?
aLC/aLW=100/200=0.5
Exercise 3 -solution
If these two countries trade these two goods in the context of the Ricardian
model of comparative advantage, then what is the lower limit of the world
equilibrium price of cloth relative to widgets?
Quiz
1st quiz question
The gravity model suggests that over time
A. world trade will eventually be swallowed by a black hole.
B. the value of trade between two countries will be proportional to the product of the two
countries' GDP.
C. trade between Earth and other planets will become important.
D. trade between all countries will increase.
E. trade between neighboring countries will increase.
Answer:
B
2nd quiz question
The gravity model offers a logical explanation for the fact that
A.
B.
C.
D.
E.
trade between Asia and the U.S. has grown faster than NAFTA trade.
trade in services has grown faster than trade in goods.
trade in manufactures has grown faster than in agricultural products.
intra-European Union trade exceeds international trade by the European Union.
the U.S. trades more with Western Europe than it does with Canada.
Answer:
D
3rd quiz question
The gravity model explains why
A.
trade between Sweden and Germany exceeds that between Sweden and Spain.
B.
countries with oil reserves tend to export oil.
C.
capital rich countries export capital intensive products.
D.
intra-industry trade is relatively more important than other forms of trade between
neighboring countries.
E.
European countries rely most often on natural resources
Answer:
A
4th quiz question
The two neighbors of the United States do a lot more trade with the United States than European
economies of equal size.
A.
This contradicts predictions from gravity models.
B.
This is consistent with predictions from gravity models.
C.
This is irrelevant to any inferences that may be drawn from gravity models.
D.
This is because these neighboring countries have exceptionally large GDPs.
E.
This relates to Belgium's trade record with the U.S
Answer: B
5th quiz question
Approximately what percent of all world production of goods and services is exported to other
countries?
A.
10%
B.
30%
C.
50%
D.
100%
E.
90%
Answer: B