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ECON 2610 Weeks 1-3 Reading Notes

by: Alexandra Tilton

ECON 2610 Weeks 1-3 Reading Notes Econ 2610

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Alexandra Tilton
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Here are reading notes for weeks 1-3 including textbook and other assigned materials
International Economics
Daniel Zuchegno
Study Guide
International Economics, Econ, trade, Ricardo, Smith
50 ?




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This 33 page Study Guide was uploaded by Alexandra Tilton on Monday January 18, 2016. The Study Guide belongs to Econ 2610 at University of Denver taught by Daniel Zuchegno in Summer 2015. Since its upload, it has received 79 views. For similar materials see International Economics in Economcs at University of Denver.


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Date Created: 01/18/16
ECON 2610:
 International Economics Reading Notes Weeks 1-3 Essentials of Economics Chapter 1 • Introduction • Worldwide Financial Crisis: • 2007-2008 • Most painful since Great Depression in 1930s • 13% decline in industrial output • 25% drop in world goods exports • Exchange rates fluctuated • International flows of capital disrupted • Many countries ran up debt • -> 6 years later • Output and employment still below potential • Disappointing growth in advanced e1onomies • Slumps in many parts of Eurozone • Trade is somewhat recovered • Protectionist policies largely avoided • Good example of the idea of a global economy - how countries affect one another • Trading - models, reasons, types • All types of trade flows are extremely common • Products (goods and services) • People • Capital European Union nations with the euro as their national currency 2Policies that restrict trade through tariffs, restrictive quotas, and other regulations by government Alexandra Tilton Page ▯1 of ▯33 • International Trade • Beluga Fraternity and Beluga Foresight • 2009 voyage from South Korea to Novy • One of the first successful voyages through Arctic Circle • Global warming believed to open shipping lanes through Arctic Ocean • Shorter than route through Suez Canal (by 4,000 nautical miles) • Definition • International Trade: movement of goods and services across borders • Economic Forces of International Trade • Determine: • What products are traded • Who trades them • What quantities and prices • Benefits and costs of trade • Policies used to shape trade • Why we should care • Creates opportunities for growth in countries • Large and small countries potentially benefit • Broad Picture of International Trade • Largest exporter of goods in 2012 - China • $2 trillion in goods to other countries • 2nd place: United States • 3rd place: Germany • Exporting services • US exported $.6trillion in services in 2012 • Combined goods and services makes US largest exporter Alexandra Tilton Page ▯2 of ▯33 • The Basics of World Trade • Imports and Exports • Imports - product bought by one country from another • Exports - product sold by one country to another • Services can occur on-site in the importing country • Example: Money spent on travel from U.S. to France is a service export of France • Trade Balances • Trade Balance - the difference between a country’s total value of exports and imports (both goods and services) • Trade Surplus - countries that export more than they import (ex. China) • Trade Deficit - countries that import more than they export (ex. U.S.) • Bilateral Trade Balance - the difference between exports/ imports of two countries • Models • Models assume that each country has balanced trade because: • Overall trade deficit/surplus is a matter of macroeconomic conditions • Problematic when dealing with bilateral trade between two countries • Value-added - the difference between the cost of parts and materials produced in a country to make a good and the value of the good when leaving that country • Example: iPhone leaves China with value of $179, but many parts and materials actually came from other countries, putting China’s contribution somewhere around $6.50 Alexandra Tilton Page ▯3 of ▯33 • Offshoring - products being shipped back and forth between different countries during the manufacturing process • Factors That Explain Trade Patterns • Low Tariffs • Tariffs: taxes on international trade • Low tariffs promote more trade • European Union trade so much with zero tariffs • Trade Between Similar Countries • Countries which are similar in industrialisation have similar consumption and production patterns • Enough variety in goods of production lead similar countries to trade with one another • Labor, Capital, and Natural Resources • Amounts of labor (including levels of productivity), capital, and natural resources affect trading • Trade Compared with GDP • Gross Domestic Product (GDP) - value of all final goods produced within a country in a year • Measure ratio of trade to a country’s GDP • U.S. is only about 15%, China is about 216& • U.S. % is smaller because much of its trade happens within its own borders, and its GDP is so large • Hong Kong (China) % is so large because its GDP is relatively small and it trades with closely neighboured countries • Barriers to Trade • Trade Barriers • Import tariffs • Transportation costs • Wars, natural disasters Alexandra Tilton Page ▯4 of ▯33 • Application - Tariffs in the Interwar Period • After WWI • Ratio of trade to GDP fell in all countries • Great Depression started in 1929 • WWII began in 1939 • Smoot-Hawley Tariff Act • Adopted by U.S. in Great Depression • Raised tariffs to 60% on many imports • Intended to protect farmers and other U.S. industries • Backfired in many ways: • Canada applied high tariffs against U.S. • France used import quotas (limiting quantity of an imported good) against U.S. • Britain gave preference to goods available from its former colonies • Smoot-Hawley ultimately lead to more and more increases in worldwide tariffs during the period between World Wars • This led to a big fall in world trade • Allied countries then met together after World War II to form international agreements that keep tariffs low • Now known as: World Trade Organisation • Migration and Foreign Direct Investment • Migration • Movement of people across borders • Majority of immigration occurs outside of Organisation for Economic Cooperation and Development (OECD) countries, because countries not in OECD are less wealthy • OECD countries fear low-wage country immigrants will drive down wages in their own countries • Trade acts as a sub for migration, because it can help raise the standard of living Alexandra Tilton Page ▯5 of ▯33 • Foreign Direct Investment • FDI occurs when one country owns part or whole of a company or property in another country • Largest FDI stocks are in Europe • Majority of FDI is owned by OECD countries • Horizontal FDI: FDI between developed countries • Vertical FDI: FDI from industrial to developing countries to take advantage of low-wages • International Macroeconomics • Focuses on link between economic issues in interdependent economies • Three Elements: • The world has many monies • Countries are financially integrated • Economic policy choices are made in light of these • Foreign Exchange: Currencies and Crises • An understanding of different currencies and exchange rates is important to understand global economics • How Exchange Rates Behave • Two categories of countries: • Fixed (pegged) exchange rates: officially set to fluctuate within a very narrow range • Floating (flexible) exchange rates: moves up and down over a much wider range • Exchange Rate Crisis: when a currency experiences a very sudden loss of value against another currency • Example: Argentina from Dec. 2001 - Jan. 2002 • 1 Argentinian peso had been worth $1 • Fell in value to just $0.25 • Government declared default on $155 billion of debt • Country had 5 presidents in span of 2 weeks Alexandra Tilton Page ▯6 of ▯33 • Crisis episodes usually follow the same pattern of banking/debt problems, housing suffering, etc., but it is worse in poorer countries • Why Exchange Rates Matter • Changes affect economy in two ways: • International relative price of goods will fluctuate and affect a country’s ability to import depending on price • Causes a change in the international relative price of a country’s assets • Globalisation of Finance: Debts and Deficits • In previous years, countries were not linked financially • Now some countries are very much linked financially • Deficits and Surpluses: The Balance of Payments • The global economy cannot have deficits or surpluses, but individual countries can - the world must be balanced • Debtors and Creditors: External Wealth • Acountry’s net worth is its external wealth • Difference between foreign assets and foreign liabilities • Positive external wealth = creditor nation • Negative external wealth = debtor nation • Government & Institutions: Policies and Performance • Influence of government actions • Exchange rates • Macroeconomic policies • Policies: direct government actions • Regimes: broader context of rules and norms that form policies • Institutions: overall legal, political, cultural, social structures Alexandra Tilton Page ▯7 of ▯33 • Three important features • Rules a government applies to restrict or allow trade • Fixed or floating exchange rate • Institutional foundations (quality of government) • Independence and Monetary Policy: Choice of Exchange rate regime • Choice of exchange rate regime is a major policy • Transactions would be easier if everyone was on fixed rate regime or even same currency • Unique currency is seen as a sign of independence • Common Currency: currency with control over shared policies (ex. Eurozone) • Dollarization: Adopting a currency that a country has no control over (El Salvador and Ecuador adopting the U.S. Dollar) • Institutions and Economic Performance: The Quality of Governance • Legal, political, social, cultural, ethical, religious structures of society all contribute to the economic status • Poor governance over a country usually leads to poverty and instability • Not all policies will fit all countries • Better institutions correlate with more income per person in a country • Inequality between countries known as “The Great Divergence” • Better institutions lead to less income volatility or fluctuations • Developing countries are less able to prevent internal economic fluctuations • Institutions take a very long time to change • Veblen: “Institutions…are therefore never in full accord with requirements of the present.” Alexandra Tilton Page ▯8 of ▯33 International Monetary Fund • Chapter 1 • Global Trade Landscape • Dramatic shifts over last several decades • World trade has grown since WWII • World Gross Exports approx. 3x 1950s • Non-commodity trade rising • Three Important Trends: • Rise of Emerging Market Economies (EMEs) as trading partners • Growing importance of regional trade • Shift of higher-tech exports toward dynamic EMEs • Growing Trade Interconnectedness • Global supply chains becoming more prevalent • Lower tariffs and lower transportation/communication costs • Vertical specialisation - each part of a product produced in a different location • Outsourcing is reaching more EMEs • Three approaches to investigate trade interconnectedness • Network analysis • Input-output-based analysis • Partial equilibrium to analyse implications of sectoral trade • Chapter 2 - Evolving Structure of Global Trade • Diffusion of Key Players in Global Trade • EME’s are becoming bigger players in global trading (They represent at least 2% of world trade) • China has grown rapidly due to its industrialisation and growing trade openness Alexandra Tilton Page ▯9 of ▯33 • Growth in trade strongest in Europe and Asia • Intraregional trade especially strong • Change in Exports • High-tech and medium-high-tech exports have increased (machinery, equipment, etc.) • Low-tech products have declined (textiles) • Technology adoption is capability driven - a nation has to have the ability to harness and adapt technologies (different from other trade that relies on a country’s endowment of resources) • Countries with an aim of attracting FDI can create a comparative advantage between them and others • Trade Liberalisation • Tariff costs have come down in major western countries, resulting in more trade • Tariffs in developing countries started to decline only in the 1980s • Increase in Vertical Specialisation in Production • Declines in transportation and communication costs allow for location-based specialisation • Foreign Value Added exports (versus Domestic Value Added) have almost doubled since 1970 • Convergence in Income Levels • Volume of trade in relation to GDP increased • Intraindustry trade higher in countries integrated in supply chains (China, Thailand, Mexico) • Official trade stats measured in gross terms, including intermediate inputs and final goods • Growing Trade Interconnectedness • Shift in ranking of individual countries - China moved from 9th to 1st from 1999 to 2009 • China has grown in size and amount of trading partners • China and Japan shift to strategic export destinations Alexandra Tilton Page▯ 0 of ▯33 • European countries still central to trade due to interconnectedness • Strong correlation between trade and financial sectors of systematic importance • Strong financial and trade sectors have the highest potential to disturb global markets or other jurisdictions • The Growing Role of Global Supply Chains • Vertical specialisation has increased since mid-1990s • Particularly for China, Germany, Japan • Contributes to the rise of major exporting countries • Advanced economies further upstream in global supply chain • EMEs further downstream • Relatively large imported contents in their exports • Smaller share of indirect exports sent do third countries • Advanced economies typically see exports come back to them after going through one step on supply chain in an EME • EMEs typically do not see export come back after their part in the supply chain • Sectoral Evidence of Global Supply Chains • Role of global supply chain in high-technology goods has increased - especially in China • China has largest imported content in its high-tech exports compared to U.S., Japan, and Germany • FVAcontributes about 37% to growth in advanced countries’ exports • Growth in high-tech exports driven by FVA • China contributes to growth in manufacturing • Imports of Services • Contribute about 12% of FVAin advanced countries’ manufacturing Alexandra Tilton Pag▯ 1 of ▯33 • Important to include China in free flow of inputs and outputs to avoid disruptions to supply chain • The Diffusion of High-Technology Exporters • Different countries are contributing to high-technology exports depending on whether you consider DVAor FVA • FDI driven by market access considerations (U.S.) or factor-price differentials (Japan) • EME upgrade technology content of exports due to: • Proximity to advanced countries • Educated workforce • Favourable business environment • Rising Export Similarity • Export structures of EMEs becoming similar to advanced economies • Partly due to global supply chains • Competitive pressure has also increased • Export Similarity Index (ESI) shows country pairs with similar shares of each product category in overall exports • Rising export similarity can create more competitiveness • Data cannot capture quality differences within same product category • Income Level in Exports • EXPY measures export sophistication • Assigns a weighted average income level of countries producing the same product • China still considered lower-income due to less export sophistication Alexandra Tilton Pag▯ 2 of ▯33 Issues in Trade and Protectionism • Introduction • Concern that there is a trend toward protectionism and trade war • Similar to what was seen in the Great Depression • Concern should be placed on promoting an increase in demand • Freer trade in new areas offer more gains than reductions in hindering trade • The Short Term Picture • “Buy American” • American stimulus package (2008) • Worth $787 billion • Estimated GDP growth of $787 billion means an import increase of about $160 billion • Designed to improve economy following recession (2007-2008) • “Buy American” aspect referred to purchasing steel and other manufactured goods • Only a small part of the entire package (less than $80 billion) • In reality may only exclude $7-$8 billion of imports, as we would likely get some things here without the “Buy American” incentive • Mainly aiding small gov. so they wouldn’t have to cut back due to lower tax revenues • Made some worry about protectionism • In reality it should really make trading partners glad to have a stimulus package • Obama needed “Buy American” in order to pass stimulus Alexandra Tilton Pag▯ 3 of ▯33 • U.S. Trade Deficit • Around 6% of GDP before 2007 recession • This means either public or private saving is low • Trading partners concerned with U.S. trade deficit and debt • Concerns about the value of the U.S. dollar • U.S. can’t get to desired levels of output when there is a trade imbalance • Value of the Dollar • Dollar has been over-valued • Needs to lower in value to become consistent with the U.S.’s trade position • The Long Term • Service industries are becoming more common • Therefore merchandise trading restrictions are less harmful • Intellectual Property • U.S. patents on prescription drugs • Prescription drug spending in the U.S. would be much lower if all drugs were sold as generics (not under patent) • Cost of drugs is passed on to patients, but the drugs are most advertised to doctors • Drug companies in almost full control of what information goes out about their product, allowing them to distort perceptions • U.S. has put a lot of focus on intellectual property when discussing trade • More implications from intellectual property conditions than merchandise trade barriers Alexandra Tilton Pag▯ 4 of ▯33 • Professional Barriers • Highly paid services (doctor, lawyer, accountant, etc.) • Firms are limited to hiring U.S. citizens for fear that foreigners would work for lower wages • U.S. and foreign countries could both gain from allowing free flow of professionals into and out of the country • Perhaps have a tax on earnings of professionals that would be sent back to their country where training and education happened A Flat World, a Level Playing Field…A Review of Thomas L. Friedman’s The World is Flat • Introduction/Prologue • Geography • Determines the relationship between a buyer and seller of goods and services • Friedman suggests a flat world • Every country competes for each transaction • Wages set in Shanghai • Innovation and education reinforce relationships • Metaphors • World is flat, world too small • Starting to suggest that the world is already very connected to the point that location doesn’t matter • Important to understand the implications of metaphors perhaps more than the literal meaning • Implications of a Flat World • Limited competition • Long-term relationship between buyer and seller • Von Thünen - father of economic geography - selling crops to down in the centre of concentric circles Alexandra Tilton Pag▯ 5 of ▯33 • Weber - processing of materials should be done where materials are found or where product is sold, depending on what is cheaper • Lösch - the most efficient shape between consumer and supplier is circle (hexagons) - supply in the middle • Hotelling - competitors will gather at the centre - inefficient for customers, but leaves them less vulnerable • Geography limit competition by creating cost-advantaged relationships between buyers/sellers located near each other • Relationships • Friedman suggests flatness eliminates relationships • Not necessarily - just changes geography of them • More about lowering transportation costs/difficulties • Also worth considering language and cultural barriers • Level Playing Field • The normal phrase used to imply limited favour to one competitor over another • Model Example • Two countries - one up hill (A) one down hill (B) • If Awants B’s goods, goods have to be carried up • If B wants A’s goods, goods can be sent down a chute by gravity • May seem simply unfair, but depends on who wants how much of each other’s goods • Forces that Caused a Flat World • Listed by Friedman, these seem to mean more change than flattening 1. Fall of Berlin Wall 2. Birth of Internet 3. Work Flow Software (task coordination) 4. Open-Source software 5. Outsourcing Alexandra Tilton Page▯ 6 of ▯33 6. Offshoring - low-wage manufacturing 7. Supply chains 8. Insourcing - companies fulfilling multiple roles 9. Internet searches 10.Virtual/mobile/digital communication • Suggested/Aleternative Forces that Caused a Flat World 1. More unskilled/uneducated workers 2. Equipment that raises productivity reducing need for labor 3. Communications innovation and progress - the strongest force for flattening (buying a product from another location rather than locally) • David Ricardo - Comparative Advantage • Debate about the value/cost of outsourcing • Some argue that the lower cost of production is the most important reason to outsource • Others point out that there are no shared winnings - some win and some lose • Immiserizing Growth • First proposed by Bhagwati • Acountry can grow too quickly and end up making themselves worse off • Production/Innovation • Moving Processing • Means that processing innovation is now in that location • Moving Innovation? • U.S. has focused more on keeping innovation of intellectual assets, but that may change • May be better to focus on immobile innovation - researchers and infrastructure Alexandra Tilton Pag▯ 7 of ▯33 • Markets/Relationships • Hypothetical market • Buyers and sellers can be close enough to hear each other’s offers, but too far from each other to know their true identity, culture, etc. • Real markets require a long-term relationship and trust to carry out a transaction • Raises questions about Friedman - even with new technology that brings us closer together, jobs in one location may not even have a market in others (jobs may be more secure than you’d be led to believe if world was truly flat) • Luddites • Prefer price set by artisan - preserve a relationship • In reality once a product is standardised, the price is set by the market • Contestability • Some jobs/areas of work are more prone to global competition than others • Measured by amount of import/export and value added • Example: editing a book requires a certain language between buyer/seller, so it is difficult to quickly outsource that when the foreign person would not understand what you mean when you ask them to edit something • Idea vs. Product Mobility • While jobs/products may be transported, idea mobility comes with different consequences • Market for ideas may be more important in terms of trading - allows for more innovation Alexandra Tilton Page▯ 8 of ▯33 • Movement of Ideas • The faster ideas move, the faster innovation can happen • The internet is a huge factor of expediting this process • Facts from Friedman • Income distribution is not becoming more levelled • Trade is still located closer to home • Trade isn’t primary reason for decline in manufacturing jobs • Intellectual work outsourcing isn’t very common • U.S. is well-positioned for internet part of economy • Global Work Force Levelling • Countries’ work forces have not become level • Some poorer countries have done better by supplying workers to low-skill job • Wealthier countries only get wealthier • Middle class countries stay the same • Location • Buying and selling declines with farther distances • Gravity Model • Commerce = GDP/distance^.9 • Each time distance doubles, trade lowers by 90% • Growth of a country’s GDP completely changes outcome of equation/amount of trade • Consumers also favour those in countries with similar tastes, cultures, customs. • Productivity and Demand • Relationship between the domestic demand for a product and the level of employment • This is also affected by the improvement in productivity • Commerce = G • Use of Internet Advantage • U.S. is the primary source of the Internet • U.S. controls the majority of hosts on the Internet Alexandra Tilton Pag▯ 9 of ▯33 • Postindustrial Age • Infrastructure and education for high-tech, high- knowledge jobs are more important than competing for low-skill manufacturing jobs • Transition from one age to another • Focus is less on what products are being made but more on how they are being made • This shows what transitional age may be coming next • Productivity and Demand • Relationship between the domestic demand for a product and the level of employment • Technology and Inequality • Computer acts against equality in the sense that some can do things like coding very well while others cannot • Computer acts toward equality because it aids those in low-skill jobs relying on basic computer skills The G20: Captive in the Prison of Mercantilism • Failure to take action on economic policies • Risks to global stability • G20: group of 19 countries and EU • Met in 2008 and admitted poor decision-making led to economic crisis • 2009 conference kept macroeconomic concerns at centre • Minimised role of International Monetary Fund • This led to failure of meeting in Seoul • Proposals put forward are not practical and will not lead to progress • Countries are denying their role in causing crisis • Countries’ decisions to harm their competitors end up coming back to hurt themselves Alexandra Tilton Pag▯ 0 of ▯33 • Both deficit and surplus countries must make efforts to correct the issues at hand • China needs to keep its high rate of economic growth • Needs to reform domestic policies regarding investment and flexible currency Essentials of Economics Chapter 2 • Introduction • Manufactured Products • All are most likely traded from and to many countries • Why wouldn’t a country just make them? • Reasons: • Different technologies • Different resources • Lower costs • Proximity of the corresponding country • Different Technologies • Explained by Ricardian model • David Ricardo • Explains correlation between technology and wages • Explains trade patter: imports and exports • Reasons for Trade • Proximity • Affects cost for transportation • Example: Canada is top snowboard exporter to U.S. • Free-trade area: countries that have no barriers to trade between them • Resources • Products are usually developed in locations that give the natural resources needed Alexandra Tilton Pag▯ 1 of ▯33 • Example: Snowboards produced where they can be tested in snow • Natural Resources: resources gained from the earth • Labor resources: the skills and productivity of the labor force in a country • Capital: Machinery or other man-made things to help produce products/services • Factors of production: total resources available to a country • Offshoring may also happen, leaving the importing country to finish the product • Absolute Advantage and Comparative Advantage • Absolute Advantage • When a country has the best means of production for a particular product • Comparative Advantage • When a country has a relatively less difficult time manufacturing a product • Ricardian Model • The Home Country • Marginal Product of Labor: how much of a product can be produced by one unit of labor • Production Possibilities Frontier: a straight line between two products showing the trade off of producing one product over another • Slope is equal to quantity of x axis product over quantity of y axis product • All shows the opportunity cost of choosing to produce one good over another Alexandra Tilton Pag▯ 2 of ▯33 • Indifference Curve: a curve placed on the graph with the PPF that shows what an individual’s or country’s preference is between two goods • Home Equilibrium: the point on the PPF and IC where they meet at the highest possible amount of utility/ satisfaction • This assumes perfect competition resulting in the necessary amount of goods demanded by consumers • Opportunity Cost and Prices • Solve for the price of each product by looking at how wages are decided • People hired until one more unit of labor = goods produced in that unit • Wages must be equal in producing both good • Relative Price: how much of one good must be given up in order to achieve the other good • The Foreign Country • Comparative Advantage: achieved when a country has a lower opportunity cost than another country when producing a particular good • Production Possibilities Frontier: a straight line between two products showing the trade off of producing one product over another • Pattern of International Trade • International Trade Equilibrium • Countries will export goods in which they have a comparative advantage • Equilibrium occurs when relative price of goods is the same in both trading countries • This will affect how much a country produces when they can make more money selling a good to another country Alexandra Tilton Page▯ 3 of ▯33 • International Trade • World Price Line: shows consumption possibilities when a country specialises in one good • Shows the gains from trade a country receives when it can consume more than its original PPF • Pattern of Trade • Pattern of trade is determined by what countries have the comparative advantage in producing different goods • Finding Wages in Trading Countries • Wage determined in terms of how much good they produce • Absolute Advantage • Acountry with better technology is able to produce more with fewer labourers, then offering higher wages • Apoor tech country can only export at reasonable prices by having low wages • As trade increases, poor countries have the ability to raise their standard of living • Solving for International Prices • Export supply curve: amount a country decides to export at different prices • Import demand curve: amount a country decides to import at different prices • The point where they meet determines world price for a good • Terms of Trade • Terms of Trade: Price of exports divided by price of imports • Increase is generally good Alexandra Tilton Pag▯ 4 of ▯33 Essentials of Economics Chapter 3 • Introduction • Bolivia • Due to unhappy citizens complaining about poor distribution of gains • They believed more should have gone to citizens • Third president nationalised gas industry • Citizens were happy - other countries were not • Specific-Factors Model • Says that land is specific to agriculture and capital is specific to manufacturing • Labor is not specific to either • Model shows: • How trade affects earnings of land, labor capital • Focuses on relative prices • Capital and land earnings rise and fall, but labor finds other industries to make use of • The Home Country • Two industries • Manufacturing: uses labor/capital • Agriculture: uses labor/land • Labor is subject to diminishing returns (as more labor is used for production, output goes up but at slower and slower rates) • Production Possibilities Frontier • Because of diminishing returns with labor, PPF becomes bowed • Opportunity Cost and Prices • Labor should be able to move about freely without opportunity cost since wages should be equal in both industries Alexandra Tilton Pag▯ 5 of ▯33 • Overall Gains from Trade • Higher trade prices in one industry will attract more labor to that industry • Earnings of Labor • Because of trade gains, someone, not everyone, must be better off from trade • Determining Wages • Labor will be hired until they have reached a 1:1 ratio of labor input to product output • Equilibrium Wage • The point where the labor curves for both industries intersect and wages for both are equal • Change in Relative Price of Manufacturers • Increase in relative price of an industry will affect the real wage - what a worker can afford to buy • Real wage changes depend on the current price of goods labourers need to buy • Overall Effect on Labour • Depends on what a labourer needs to buy. Some may be better off, some may be worse off • Unemployment in the Specific-Factors Model • Does not include unemployment, and assumes that labourers find another job quickly if fired or laid off • Trade Adjustment Assistance: Compensation for workers who have lost their jobs due to imports • Earnings of Capital and Land • Payments to Capital and Land • Total Revenue - (Payments to Labor + Payments to Agriculture) = Payments to Capital Alexandra Tilton Pag▯ 6 of ▯33 • Rent on Capital: Amount of money the capital earns as a means of production • Rent on Land: Amount of money the land earns as a means of production • Increase in amount of labor in each industry will raise the marginal product of the factor in that industry • Change in the Real Rental on Land • Land owners are worse of when labour leaves agriculture, because their asset decreases in value, but manufacturing also increases in value, so they can’t purchase as much of the manufactured goods • What It All Means • Earnings of factors change the most when relative prices change from trading Essentials of Economics Chapter 4 • Introduction • Heckscher-Ohlin Model • Assumes trade occurs because companies don’t have the same resources • Developed during golden age of international trade (1890-1914) • Assumptions of the Model • Describes the economy in the long run • Assumption 1: Both factors can move freely because both industries are producing well • Assumption 2: Some industries are more labour-intensive than others • Assumption 3: Countries have different allotments of resources • Assumption 4: Final products can be traded freely, but labor and capital cannot Alexandra Tilton Pag▯ 7 of ▯33 • Assumption 5: Countries’ technologies are identical (different from the Ricardian Model) • Assumption 6: Preferences are the same in each country and don’t vary with increasing or decreasing income • Production Possibilities Frontiers • In this model they will be skewed in favour of what that country wants to produce • Indifference Curves • These will be the same in both countries since there is the assumption that each country has the same preferences of consumption • No-Trade Equilibrium Price • This price will be different for each country and even each industry within that country since there is a skew toward the production of one industry over another • Free-Trade Equilibrium • Equilibrium trade point will encourage a country to specialise in whatever industry will make them money • Free-Trade Equilibrium Price • This is reached when the home level of imports intersect foreign levels of exports • Leontief’s Paradox • Measured amount of labor/capital used to produce $1 million of U.S. exports/imports • Capital was measured by its depreciation • Assumed that foreign process of production/technology was the same as U.S. • Four that capital labor ratio for U.S. imports was higher than that of U.S. exports • Explanations • U.S./foreign technologies are not the same • He ignored amount of land in the U.S. • No distinction between high and low-skilled labor Alexandra Tilton Pag▯ 8 of ▯33 • WWII had just ended when he worked on this • U.S. was not engaged in completely free trade • Data in 2010 • Compare the factor in each country with its share of world GDP • If it is above share of GDP, that country is abundant in that factor • If it is below share of GDP, that country is scarce in that factor • Capital Abundance • 17.1% of physical capital located in U.S. in 2010 • Because U.S. had 17.1% of world’s capital but 19.1% of world GDP, U.S. is scarce • Labor and Land Abundance • More difficult to compare, as some workers are more productive, and some land is more useable • Differing Productivities Across Countries • Land and labor have different levels of productivity depending on usability, education, etc. • Measuring Factor Abundance Once Again • Effective Factor Endowment: Factor in a country times its productivity • Same measure of abundance and scarcity in factors as earlier • Effects of Trade on Factor Prices • How do changes in relative price of goods affect wage pay and rental earnings • Effect of Trade on Wage and Rental • Relative demand of labor is the weighted average of labor-capital ratio in each industry • Relative wage is at the intersection of relative supply and relative demand Alexandra Tilton Pag▯ 9 of ▯33 • Hypothetical Increase in Price of One Industry • Relative wage falls due to fall in relative demand • Both industries hire more labor, resulting in a rising labor- capital ratio • Because supply of labor has not changed, relative demand cannot change overall • Change in Real Rental • More labor going into same capital increases the value of the capital • Change in Real Wage • Real wage is reduced due to increase in price of computers • Stolper-Samuelson Theorem • Predicts that when one country faces a high relative price of one industry, real rental rises and real wages fall • In foreign country, the changes are the reverse • Workers in labor-abundant country gain from trade • Workers in capital-abundant country lose • Abundant factor wins, scarce factor loses • Magnification Effect • Equations that relate the change in product prices to change in factor prices International Trade: Why We Don’t Have More of It • Introduction • Over past 40 years, exports have doubled to almost 25% of world output • Still, barriers to trade exist • Why and How Trade Costs Reduce Trade • Core idea of trade lies in specialisation (Adam smith) • This potentially maximises efficiency • Costs to consumers are lower Alexandra Tilton Pag▯ 0 of ▯33 • Barriers to trade increase costs and force production with less efficiency • Two Main Types of Trade Costs • David Ricardo argued against Corn Laws in England - a historic example of a bad barrier to trade • Trade costs are all costs resulting from trading a good • Can be international or domestic • International Trade Costs • Boarder-Related • Costs incurred between countries • Tariffs, quotas, paperwork, customs, etc. • Currency, language, law differences • Transport Costs • Cost of delivering something internationally • Tariffs • Price of trade added to the actual price of the good • Nontariff • All other trade barriers from national government • Quantities that are allowed • Product standards • Non-Government policy • Cost to learn information about product • Linguistic/cultural differences • Freight-related • Shipping, trucking, flying • Measuring Trade Costs • Border-Related • Tariffs are easy to measure - collected by customs • Weighed by an average or by volume • More difficult to calculate non-tariff costs • Some non-government costs are measured using the gravity model (mentioned in notes above) • Some are shown as a reduction to trade rather than an actual price of product Alexandra Tilton Page▯ 1 of ▯33 • International Transport Costs • Direct shipping costs as well as travel time • Time can be turned into cost which can be expressed as a percentage of the cost of the good that is being transported • Estimates of Trade Costs • Tariffs • Calculate average tariff based on country • In 1999 this varied from 0%-30% across different countries • Developed countries’ tariffs tend to be lower • Non tariff Barriers • These are on the rise in comparison to tariffs • One example is a dumping law that some countries impose when prices of goods are significantly different from one country to another • Other Border-Related Barriers • Estimates from Anderson and van Wincoop • Language barrier - 7% of value of good • Different currency - 14% of value of good • Information costs - 6% of good • Security costs - 3% • TOTAL - 33% (using multiplicative formula) • With Government barriers = 44% • International Transport Costs • Estimate from Anderson and van Wincoop = 10.7% • Estimate of time cost = 9% • TOTAL for all = 74% of factory price • Conclusion • High costs and barriers to trade that are still in place reduce the amount of international trade that occurs in the world today Alexandra Tilton Page▯ 2 of ▯33 Resources Used Riad, Nagwa, Luca Errico, Christian Henn, Christian Saborowski, Mika Saito, and Jarkko Turunen. Changing Patterns of Global Trade. Washington, D.C.: International Monetary Fund, 2011. Feenstra, Robert C., and Alan M. Taylor. Essentials of International Economics. 3rd ed. New York, NY: Worth, 2012. Print. Leamer, Edward E. "AFlat World, a Level Playing Field, a Small World After All, or None of the Above? AReview of Thomas L. Friedman’s The World Is Flat." Journal of Economic Literature XLV (2007): 83-126. UCLA. Web. 9 Jan. 2016. mar07_leamer.pdf Ostapik, Edith, and Kei-Mu Yi. "International Trade: Why We Don't Have More of It." Business Review Q3 (2007): 20-28. Philadelphiafed. Web. 16 Jan. 2016. Baker, Dean. Issues in Trade and Protectionism. Rep. D.C.: Center for Economic and Policy Research, 2009. Print. World Knowledge Forum. Protectionism Zedillo, Ernesto. "The G20: Captive in the Prison of Mercantilism." Yale Global (13 November 2010). Yale Global Online, MacMillan Center. Web. 12 Jan. 2016. Alexandra Tilton Page▯ 3 of ▯33


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