ALTERNATIVE INTERNATIONAL MONETARY STANDARDS
topic 19.1
THE GOLD STANDARD 1880-1914
Currencies had a fixed rate of excahnge with gold.
For example $20.67 = 1 ounce of gold
So all countries had in effect fixed their rates of exchange against other countries' currencies.
The benefit was price and exchange rate stability.
If a country tried to inflate its currency it would lose gold as people turned in their money for gold at the fixed rate. Since no country has unlimited gold reserves this prevented inflation.
A disadvanatge was that growth in the world gold supply determined the rate that money could grow. If too much gold was supplied there would be inflation, too little and there would be deflation.
After the first world war there were attempts to restablish this system, but they failed. A strict gold standard was not sustainable as countries tried to print more mony. Eventually even the US gave up on the gold standard.
Wednesday, December 17, 2008
topic 15.1
EXCHANGE RATES, INTEREST RATES, AND INTEREST PARITY
topic 15.1
INTEREST PARITY
Countries trade goods and services at a point in time. They also trade over time through buying and selling financial assets.
Under free trade with costless arbitrage the price of 'bonds' is constrained in a manner similar to that of goods. Just as traded goods should (in theory) conform to the 'law of one price', so too assets should exhibit parity conditions. Assets are actually a much better candidate for parity conditions than goods because they are homogeneous and easily traded, unlike goods which are neither.
The best known parity condition applies to international trade in bonds: 'interest rate parity'.
Assume there are two bonds, a US bond denominated in dollars and a UK bond denominated in pounds. Assume both are risk free.
Then
(1 + i)$ = (1 + i) pounds * (F/E)
where:
i$ and ipounds are the returns on the US and UK bonds
F and E are future and spot exchange rates ($/pounds)
To explain this - consider a US person with $1 to spend on a US one-year bond or a UK one-year bond. Absent any risk differences or transaction costs the investor should be indifferent between:
topic 15.1
INTEREST PARITY
Countries trade goods and services at a point in time. They also trade over time through buying and selling financial assets.
Under free trade with costless arbitrage the price of 'bonds' is constrained in a manner similar to that of goods. Just as traded goods should (in theory) conform to the 'law of one price', so too assets should exhibit parity conditions. Assets are actually a much better candidate for parity conditions than goods because they are homogeneous and easily traded, unlike goods which are neither.
The best known parity condition applies to international trade in bonds: 'interest rate parity'.
Assume there are two bonds, a US bond denominated in dollars and a UK bond denominated in pounds. Assume both are risk free.
Then
(1 + i)$ = (1 + i) pounds * (F/E)
where:
i$ and ipounds are the returns on the US and UK bonds
F and E are future and spot exchange rates ($/pounds)
To explain this - consider a US person with $1 to spend on a US one-year bond or a UK one-year bond. Absent any risk differences or transaction costs the investor should be indifferent between:
- investing in a US bond today or
- investing in a UK bond today with the necessary use of the exchange rate to convert dollars to pounds today (E), and then back the other way one year from now (F)
Another way to express the equation is:
i$ - ipound = (F-E)/E
In this example (F-E)/E is the 'forward premium'
The intuition here is that if US bonds paid a higher nominal interest rate than UK bonds then the higher expected US return must be offset by an expectation that the dollar will depreciate against the pound (F is higher than E).
If the forward premium is insufficient to cover exchange rate risk the traders will move into US bonds, driving the US bond price up and theUS bond expected return down (and the opposite for the UK bond) - this will drive the system toward parity.
There are reasons why interest rate parity may not hold: different risks between the bonds or the forward rate is not certain - it is an expected rate.
We can extend a similar analysis to equities.
The advantage of parity conditions is that they allow us to cut through the complexity of international finace to establish core fundamental relationships.
topic 17.2
THE MONETARY APPROACH TO THE BALANCE OF PAYMENTS
Topic 17.2
The MABP emphasizes the monetary aspects of the balance of payments.
The MABP is based on the idea that any balance of payments disequilibrium is based on monetary disequilibrium.
Monetary disequilibrium is an imbalance between the amount of money people wish to hold and the amount supplied by the monetary authorities.
So the determinants of money demand and money supply also determine the balance of payments.
David Hume understood the concept of the MABP.
The MABP is based on fixed exchange rates. If there is a disequilibrium money must move because the exchange rate cannot adjust. In economics, if prices are not allowed to adjust, then quantities must carry all the burden of adjusting to exogeneous shocks.
Topic 17.2
The MABP emphasizes the monetary aspects of the balance of payments.
The MABP is based on the idea that any balance of payments disequilibrium is based on monetary disequilibrium.
Monetary disequilibrium is an imbalance between the amount of money people wish to hold and the amount supplied by the monetary authorities.
So the determinants of money demand and money supply also determine the balance of payments.
David Hume understood the concept of the MABP.
The MABP is based on fixed exchange rates. If there is a disequilibrium money must move because the exchange rate cannot adjust. In economics, if prices are not allowed to adjust, then quantities must carry all the burden of adjusting to exogeneous shocks.
Wednesday, November 19, 2008
topic 8.1 and topic 9.1
COMMERCIAL POLICY THEORY AND PRACTICE
Topic 8.1
Figure 8.1 depicts levels of tariffs for the U.S.. It has fluctuated between 60 percent and 5 percent.
The last general tariff bill was the Smoot-Harley tariff in 1930. This general tariff contributed to the Great Depression.
The General Agreement on Tariffs and Trade (GATT) was instituted after WWII. It served as a mechanism for setting rules of conduct in international commerce and an arena to resolve international commercial disputes.
Key GATT principles:
- trade barriers should be lowered in general and quotas eliminated
- trade barriers should be non-discriminatory
- no trade concession shouldbe rescinded without compensation
- trade disputes should be settled by consultation
GATT provided a forum for talks to lower protection.
There have been 9 rounds. The current Doha round has been inclusive.
The U.S. President has authority to negotiate trade agreements, which have to be ratified by Congress.
The World Trade Organization (WTO) is the successor to the GATT. The WTP has enforcement authority. Cases are brought to the WTO which can render decisions.
Currently the WTO rules prohibit trade restrictions aimed at changing another countries’ domestic policies (on the environment for example). For example U.S. prohibition of tuna imports to protect dolphins was disputed.
PREFERENTIAL TRADE ARRANGEMENTS
Topic 9.1
Free trade areas (FTA) are agreements to eliminate trade barriers between the members.
A customs union (CU) eliminates trade barriers between members and creates a common barrier against non members.
The European Union (EU) is a CU Founded in 1957. The EU has expanded its charter to become more like a United States of Europe.
The North American Free Trade Agreement links the U.S. Canada and Mexico. It is an FTA created in 1994.
Other trade agreements exist in Africa, Asia, Europe and Latin Europe.
There is a tension between “regionalism” and “multilateralism”. To the extent that trade agreements increase total world trade, this “trade creation” increases world welfare. Agreements that only divert trade from one nation to another - “trade diversion” - are actually distorting the natural pattern of trade and lowering world welfare.
There is an argument that trade diversion effects are small because trade agreements tend to follow the natural direction of trade - they tend to be “natural” trading areas.
Measuring the benefits of free trade areas is difficult because it involves calculating “what if” the agreement had not occurred. These agreements may generate dynamic benefits from technology diffusion and international movement of skilled people to where they are most productive.
At this point we have not addressed the free low of assets – international financial liberalization.
topic 17.1
BASIC THEORIES OF THE BALANCE OF PAYMENTS
Topic 17.1
The Elasticities Approach
The elasticities approach requires strong assumptions:
- there is no trade in assets
- there is no macroeconomic consideration of employment conditions - what if an economy is at full output and cannot increase output?
Relative price determines consumption patterns through substitution effects.
As relative demands and supplies for goods change, relative prices will adjust.
The elasticities approach is concerned with the way changing relative prices of domestic and foreign goods will change the balance of trade.
Elasticity measures the responsiveness of quantity to changes in price.
Ed = %ΔQd / %ΔP
Es = %ΔQs / %ΔP
where:
Ed = elasticity of demand
Es = elasticity of supply
Qd = quantity demanded
Qs = quantity supplied
The ‘law of one price’ is the concept that.
P = e.P*
where:
P = price of a good in domestic currency
P* = price of a foreign good in foreign currency
e = exchange rate
an example
If the good in questions is identical shoes that are produced and sold in Japan and also produced and sold the U.S.:
P = $50
P* = ¥500
E = 1/100 [units are $/¥]
Then P=eP* holds true
For the law of one price to hold there are strong assumptions:
- no transport costs
- these are traded goods
- these are identical goods
arbitrage is perfect
If we extend this relationship to all the goods in a country we call this ‘purchasing power parity’, PPP.
Under PPP the P, P* are the general price levels in the two countries:
P = e.P*
where:
P = domestic price level
P* = foreign price level
For PPP to hold the assumptions are even stronger, especially the assumption that all goods are traded. While shoes are traded goods haircuts are not. This form of PPP is called ‘absolute PPP’. A weaker form of PPP is ‘relative PPP’.
%Δe = %ΔP - %ΔQP*
Relative PPP says that differences in inflation rates are reflected in the exchange rate.
Absolute PPP requires that both the levels and rates of change in P, P* must be matched.
Relative PPP does not require that levels of P, P* must follow the formula.
The elasticities approach uses two concepts:
- the law of one price
- elasticity
The elasticities approach to the balance of trade provides an analysis of how devaluations will affect the balance of trade depending on elasticities of supply and demand for goods and for foreign exchange.
There is a condition for a devaluation to improve the balance of payments: The Marshall-Lerner Condition.
Marshall-Lerner Condition
A devaluation will improve a country’s trade balance and provide a stable foreign exchange market if the domestic elasticity of demand for imports plus the foreign elasticity of demand for imports is more than 1.
This is an application of the fact that high elasticities are ‘good’.
The J Curve
The J curve is a phenomenon whereby a devaluation will temporarily worsen the balance of payments even if the Marshall-Lerner Condition is satisfied.
It arises from having trade contracts which cannot be rewritten immediately.
If U.S. export prices are fixed in $ and imports are fixed in ¥ and the dollar devalues then (temporarily) the U.S. receives the same $ revenue from exporting but has to pay more (in $) for the same quantity of imports. So there is a trade deficit.
The Pass-Through Period
The currency contract period is the period after a devaluation when contracts reflect pre-negotiation prices.
Pass-through analysis considers the ability of international prices to adjust in the short-run.
‘Pricing to market’ behavior occurs when exporters deliberately adjust profit margins to limit the pass-through of higher prices to importers. In the previous example this would occur if the Japanese exporters chose to lower their ¥ prices to allow for the fact that the $ has fallen in value.
Tuesday, November 4, 2008
topic 5.1
TESTS OF TRADE MODELS
topic 5.1
Tests of the Classical Model
MacDougall tested the classical model in 1937
Leontieff tested the HO model
topic 5.1
Tests of the Classical Model
MacDougall tested the classical model in 1937
- compared the U.S. and The U.K.
- obtained measures of labor productivity for each industry in each country
- U.S. wages were double those in the U.K.
- this implies that the U.S. should be exporting more (relative to the U.K.) of the goods from industries with double or greater the productivity of their counterparts in the U.K.
- the classical model only uses labor inputs - so capital does not enter the story
- the data semmed consistent with this
- a problem is that the classical model does not deal with two countries exporting to a third country with unknown productivities
- other models can explain the export pattern he found
Leontieff tested the HO model
- he invented the input-output table, originally used during WW II to plan the economy
- he used data from the 1950s
- he carried out the following calculation - if the U.S. decreased exports and decreased imports by $1 million each, and the free capital and labor was moved from the export sector to the import sector, would there be enough caspital and labor to replace the missing imports?
- he found that extra capital would be needed and tehre would be surplus labor available after replacing the imports
- this means that the U.S. exported more labor intensive products and imported more capital intensive goods
- since the U.S. was assumed to be capital abundant (an exporter of capital intensive goods)
- this contradicts the HO model - hence the "Leontieff Paradox."
- Vanek explained the paradox as the result of missing a third factor - natural resources
- the HOV model is an HO model that adds a third factor of production - natural resources
- Travis claimed that tariffs distorted the results
- Other suggested explanations were that tastes should be included, or that technologies are not really identical across countries
- a more recnt test by leamer concluded that many other factors should be considered in adddition to labor and capital
- other economists looking at these emprical issues include Maskus, Bowen, Trefler, and Harrigan
Monday, November 3, 2008
topic 6.1
TARIFFS
topic 6.1
Commercial policy is actions taken by government to influence the volume and composition of trade flows:
Gains from trade:
Static gains from trade:
Dynamic gains from trade:
TARIFFS
Revenue effect
Protective effect
Figure 6.4 depicts the gain from trade (on the import side) for a small country:
Figure 6.6 depicts the welfare loss due to a tariff (ie loss on import side):
Complications to tariffs:
Estimating the protectiveness of tariffs is difficult - there are so many different rates.
Tariffs on inputs contribute to protection.
The ERP is an attempt to get at the effective rate of protection.
Countries negotiate;
Tariffs can be ad valorem, specific, or compound.
MFN: most favored nation status
GSP: generalised system of preferences
Trade agreements include NAFTA, the EU, free trade agreements
Multilateral is the most globally efficient but also the most politically difficult.
topic 6.1
Commercial policy is actions taken by government to influence the volume and composition of trade flows:
- tariffs
- quotas
- subsidies
- nontariff barriers
Gains from trade:
- static gains
- dynamic gains
Static gains from trade:
- figure 6.1 depicts the static gains
- there are two parts to the gain - consumption and production
- consumption gains arise because even if production doesn't change imported goods are cheaper
- production gains arise from specialization
Dynamic gains from trade:
- importing capital
- technology diffusion
- competitive pressures
- economies of scale from expanded market
- immigration (not in text!)
TARIFFS
Revenue effect
Protective effect
Figure 6.4 depicts the gain from trade (on the import side) for a small country:
- consumer surplus increases by a+b+c
- producer surplus increases by a
- so total welfare gain is b+c
Figure 6.6 depicts the welfare loss due to a tariff (ie loss on import side):
- the tariff effectively raises the price of imports from pw to pw+t
- before the tariff the welfare gain from trade was (b+c+d+e) (e is not in the text)
- after the tariff consumers lose b+c+d
- government gains revenue c
- deadweight loss is b+d
- why isn't the whole area (b+c+d+e) lost? Becasue the world is not actually charging a higher price for the imported good. A tariff is a tax that causes losss only to the extent it distorts behavior (quantities consumed and produced).
Complications to tariffs:
- deadweight loss depends on elasticities
- a large country theoretically could benefit - "optimal tariff"
Estimating the protectiveness of tariffs is difficult - there are so many different rates.
Tariffs on inputs contribute to protection.
The ERP is an attempt to get at the effective rate of protection.
Countries negotiate;
- multilaterally
- bilaterally
Tariffs can be ad valorem, specific, or compound.
MFN: most favored nation status
GSP: generalised system of preferences
Trade agreements include NAFTA, the EU, free trade agreements
Multilateral is the most globally efficient but also the most politically difficult.
topic 5.2
ALTERNATIVE THEORIES OF COMPARATIVE ADVANTAGE
topic 5.2
HUMAN SKILLS THEORY
PRODUCT LIFE CYCLE THEORY
INCREASING RETURNS AND IMPERFECT COMPETITION
topic 5.2
HUMAN SKILLS THEORY
- Focuses on skilled vs. unskilled workers.
- US is skilled labor abundant. So the Leontieff paradox is no longer a paradox - the captial/labor distinction no longer exists.
PRODUCT LIFE CYCLE THEORY
- Initially new products are developed and exported from developed countries.
- Later production is standardized and produced abroad, which may be a capital-intensive process. This explains the Leontieff Paradox.
- A problem with this model is that it seems more plausible with sophisticated products.
- Comparative advantage arises from the demand side.
- Trade will occur between countries with similar tastes - so developed countries will trade with other developed countries for reasons of consumer preference.
- This model applies best to differentiated consumer products.
- Could also help to explain intraindustry trade.
- Is intraindustry trade a statistical artifact?
INCREASING RETURNS AND IMPERFECT COMPETITION
- Increasing returns: a proportionate increase in inputs results in a greater than proportionate increase in outputs.
- Increasing returns can be internal to a firm or external to an individual firm (but internal to an industry - i.e. as an industry grows everyone's costs go down).
- A convex (to origin) PPF can represent increasing returns. As more resources are shifted to one industry output increases more than proportionately.
- When a country opens to trade even if the relative price of goods do not change the country still has an incentive to specialize. this can be shown with the curved PPF where complete specialization with trade allows the country to reach a higher CIC even though the value Ps/Pf has not changed.
- There is no simple rule for optimal specialization. History can establish an industry in a location and it remains there for hundreds of years.
- It is no longer true that perfect competition prevails because the choices of one firm affect market prices. We have monopoly, oligopoly, or monopolistic competition.
- With imperfect competition it becomes more difficult to predict the welfare effects of trade.
Wednesday, October 22, 2008
topic 4.4
THE STOLPER-SAMUELSON THEOREM
topic 4.4
The factor that is used intensively in the product whose price has risen gains from this price rise, while the other factor loses.
Consider figure 4.4.
There are two isoquants that overlap when the level of output is set the same for both goods, at $1 for T and $1 for S.
We are looking at country B here, the country which is abundant in labor. We know that B exports,T, and so when trade is opened it must be the price of T that increases.
If the value of Pt should increase while we keep Ps the same, the new isoquant for T is closer to the axis since it requires a lower quantity of T to constitute $1 of value.
So the new isocost line is obtained by rotating an isocost line clockwise. The new isocost line is tangent to the original S isoquant and the new T isoquant.
Looking at the intercepts, W must have increased while R must have decreased.
Looking at the intercepts and then comparing to the change in prices:
For capital units, their 'reward' R has decreased while the price of T has increased and the price of S is the same. So capital is definitely worse off.
For labor it is less clear why labor gains. W has increased to be sure, but then the price of good T has increased. We need to know whether the percentage increase in W is enough to offset the price increase.
It is. We need to look at the geometry of the diagram. Comparing the proportional shift inward of the T isoquant (which gives us the percentage price increase) and the proportional movement along the W axis, we see that W must increase proportionally more than Pt increases. So it is true that labor gains.
This illustrates the theorem.
Why is it that 'in the context of the H-O model this theorem translates into the simple statement that the abundant factor gains from trade while the scarce factor loses'?
According to HO the labor abundant country will export the labor intensive good, which is the good which must experience a price rise when trade is opened up (otherwise there is no incentive to export). The SS theorem says that if opening up to trade increases the price of T, then it will increase W becasue L is the factor used intensively in producing it.
So opening to trade benefits the abundant factor. Notice that to make this statement we have to link up both the HO and SS theorems. So it is not really a 'simple statement' after all!
A footnote about country A and B. If we start out with one country producing the same value of both goods (like in the case above) it cannot be the case that the other country is doing the same thing. In our model one country (A) is always more capital abundant than the other. Using the price definition of abundance, this means that the isocost lines in the two countries do not have the same slope. The labor abundant country, for example, has flatter slopes for the isocost lines, by the definition of labor abundance. If you look at the diagram, if one country is starting out with overlapping isocost lines, forcing the other country's isocost lines to have a different slope means that they cannot be overlapping. The bottom line is that it is impossible for A and B to be both simultaneously starting at a point with overlapping isocost lines.
topic 4.4
The factor that is used intensively in the product whose price has risen gains from this price rise, while the other factor loses.
Consider figure 4.4.
There are two isoquants that overlap when the level of output is set the same for both goods, at $1 for T and $1 for S.
We are looking at country B here, the country which is abundant in labor. We know that B exports,T, and so when trade is opened it must be the price of T that increases.
If the value of Pt should increase while we keep Ps the same, the new isoquant for T is closer to the axis since it requires a lower quantity of T to constitute $1 of value.
So the new isocost line is obtained by rotating an isocost line clockwise. The new isocost line is tangent to the original S isoquant and the new T isoquant.
Looking at the intercepts, W must have increased while R must have decreased.
Looking at the intercepts and then comparing to the change in prices:
For capital units, their 'reward' R has decreased while the price of T has increased and the price of S is the same. So capital is definitely worse off.
For labor it is less clear why labor gains. W has increased to be sure, but then the price of good T has increased. We need to know whether the percentage increase in W is enough to offset the price increase.
It is. We need to look at the geometry of the diagram. Comparing the proportional shift inward of the T isoquant (which gives us the percentage price increase) and the proportional movement along the W axis, we see that W must increase proportionally more than Pt increases. So it is true that labor gains.
This illustrates the theorem.
Why is it that 'in the context of the H-O model this theorem translates into the simple statement that the abundant factor gains from trade while the scarce factor loses'?
According to HO the labor abundant country will export the labor intensive good, which is the good which must experience a price rise when trade is opened up (otherwise there is no incentive to export). The SS theorem says that if opening up to trade increases the price of T, then it will increase W becasue L is the factor used intensively in producing it.
So opening to trade benefits the abundant factor. Notice that to make this statement we have to link up both the HO and SS theorems. So it is not really a 'simple statement' after all!
A footnote about country A and B. If we start out with one country producing the same value of both goods (like in the case above) it cannot be the case that the other country is doing the same thing. In our model one country (A) is always more capital abundant than the other. Using the price definition of abundance, this means that the isocost lines in the two countries do not have the same slope. The labor abundant country, for example, has flatter slopes for the isocost lines, by the definition of labor abundance. If you look at the diagram, if one country is starting out with overlapping isocost lines, forcing the other country's isocost lines to have a different slope means that they cannot be overlapping. The bottom line is that it is impossible for A and B to be both simultaneously starting at a point with overlapping isocost lines.
Wednesday, October 15, 2008
topic 4.3
THE RYBCZYNSKI THEOREM
topic 4.3
The theorem is:
If a country experiences an increase in its endowment of any one factor holding all other things constant (including prices of products and factors) then the output of the good that uses the factor intensively will rise and the output of the other good will fall.
Consider figure 4.3 (p. 115).
To orient ourselves consider two isoquants: S output valued at $1 and T output valued at $1. (This is an arbitrary starting point -the theorem does not depend on it.)
The relative goods price is Ps/Pt = 1.
Ps/Pt = 1 implies that both S and T isoquants 'use' the same isocost line. So in the figure the isocost line is really two overlapping isocost lines.
Cost equals price of production so the isocost line represents an expenditure on hiring factors of production of $1 total.
For the isocost line the intercepts are 1/R (all the value of output goes to capital) or 1/W (all the value of output goes to labor).
The Rybczynski theorem keeps Ps/Pt constant by definition so wherever production occurs the isocost slope is the same which means that:
All the labor and capital has to be absorbed into production. That can only occur at E if GE is the ray for T production and EH is the ray for S production.
Now suppose we increase the labor endowment so E' is the new combination of L and K that must be absorbed.
Then (keeping Ps/Pt and K constant) we can only move from E to E' if the new rays are G'E' and H'E'.
So production of T increases and S decreases.
This proves the theorem.
The intuition is: to absorb all the factors (no unemployment), if we increase the total labor available we have to increase production of the labor intensive good relative to the other good.
We get this strong result because we are not allowing 'prices' (W/R) to change. All the adjustment to the 'shock' (endogenous increase in L) has to occur on the quantity side.
topic 4.3
The theorem is:
If a country experiences an increase in its endowment of any one factor holding all other things constant (including prices of products and factors) then the output of the good that uses the factor intensively will rise and the output of the other good will fall.
Consider figure 4.3 (p. 115).
To orient ourselves consider two isoquants: S output valued at $1 and T output valued at $1. (This is an arbitrary starting point -the theorem does not depend on it.)
The relative goods price is Ps/Pt = 1.
Ps/Pt = 1 implies that both S and T isoquants 'use' the same isocost line. So in the figure the isocost line is really two overlapping isocost lines.
Cost equals price of production so the isocost line represents an expenditure on hiring factors of production of $1 total.
For the isocost line the intercepts are 1/R (all the value of output goes to capital) or 1/W (all the value of output goes to labor).
The Rybczynski theorem keeps Ps/Pt constant by definition so wherever production occurs the isocost slope is the same which means that:
- S production will occur along the Ks/Ls ray.
- T production will occur along the Kt/Lt ray.
All the labor and capital has to be absorbed into production. That can only occur at E if GE is the ray for T production and EH is the ray for S production.
Now suppose we increase the labor endowment so E' is the new combination of L and K that must be absorbed.
Then (keeping Ps/Pt and K constant) we can only move from E to E' if the new rays are G'E' and H'E'.
So production of T increases and S decreases.
This proves the theorem.
The intuition is: to absorb all the factors (no unemployment), if we increase the total labor available we have to increase production of the labor intensive good relative to the other good.
We get this strong result because we are not allowing 'prices' (W/R) to change. All the adjustment to the 'shock' (endogenous increase in L) has to occur on the quantity side.
Monday, October 6, 2008
topic 4.2
PROOF OF THE H-O THEOREM
topic 4.2
Assume:
Industry S is capital intensive, both countries have the same set of isoquants that expand along the same rays and look the same in every way. So figure 4.2 works for both countries. But because factor endowments are different each country will choose to produce on a different specific pair of (unit) isoquants, the isocost curve will be different and (at least in autarky) the slope -W/R will be different.
If capital and labor are perfectly mobile with a country then in equilibrium the wage rate and rental will be the same in both industries (why would labor accept a lower wage in one industry when they can move to the other industry?)
To summarize figure 4.2. Both countries have the same set of isoquants. S is relatively capital intensive and so the S isoquants expand along a ray to the left of the ray for industry T. Now let's discuss choosing actual production levels.
First we have to make a change in our definition of relative factor abundence. We shall adopt the 'price definition' of relative factor abundance:
A country is relatively capital abundant if the wage/rental payment in its country is higher than the wage rental in the other country.
This definition uses the measure of the relative price of the factor inputs instaed of quantities. This definition may not always match what we would get with the 'quantity' definition.
Restating the H-O theorem using the price definition of factor abundance:
When the autarky wage/rental ratio is higher in A than B (A is capital intensive)the autarky relative price of S is lower in A than in B (A will export S).
If the autarky price of S is lower in A than B we know that when trade is opened up A will export S and import T. So what this defintion is saying is that the capital abundant country will export the capital intensive good.
PROOF
We will prove H-O by using figure 4.2.
However, we will do it differently from the text. The text starts with country A and then does a comparison with country B. We will do the opposite, going from B to A.
Suppose that the two isoquants shown are the isoquants for producing one unit of each good.
Then by comparing isocost lines which would apply to producing one unit of each good we know which good has the higher cost per unit.
Because these countries have perfectly competitive markets:
price (per unit) = marginal cost = average cost
So, knowing about relative costs of production tells us something about the relative prices of goods.
To begin, suppose we ask what is the relative cost of producing one unit of S and one unit of T in country B.
Suppose Wb/Rb are as shown in figure 4.2 and so production (of one unit each) will occur at X and Y. Since the isocost line for producing one unit of S goes through X, and the isocost line for producing one unit of T goes through Y, we can see that the cost of producing (one unit of)S is greater than the cost of producing (one unit of) T [the S isocost line is further out]. This means that Ps>Pt.
Now move over to country A. By the definition of factor abundance Wa/Ra > Wb/Rb. If we rotate the two isocosts lines to make Wa/Wb higher the distance between the two isocost curves decreases. In fact, there comes a point where the two isocost lines will merge into one (this is shown on figure 4.2). At this point Ps + Pt. So Ps has fallen below its value in B.
[There is nothing really special about the case where Ps = Pt. This happens to be the case where the dollar price of both goods is the same. It is only used because it makes the fall in the price of S as we increase W/R especially clear.]
Since autarky Ps/Pt is lower in the country which is more capital abundant we have proved the H-O theorem. Capital abundant S will export the capital intensive good.
topic 4.2
Assume:
- isoquants manifest constant returns to scale
- both countries have identical isoquants (same technology)
- both countries have identical consumption preferences
- A is capital abundant
- S is capital intensive
- both countries start on the two unit isoquants
- the price of the two goods is equal in A (this is arbitrary and only to make the demonstration easier)
- there is perfect competitionm and so prices exactly equal the cost of production
Industry S is capital intensive, both countries have the same set of isoquants that expand along the same rays and look the same in every way. So figure 4.2 works for both countries. But because factor endowments are different each country will choose to produce on a different specific pair of (unit) isoquants, the isocost curve will be different and (at least in autarky) the slope -W/R will be different.
If capital and labor are perfectly mobile with a country then in equilibrium the wage rate and rental will be the same in both industries (why would labor accept a lower wage in one industry when they can move to the other industry?)
To summarize figure 4.2. Both countries have the same set of isoquants. S is relatively capital intensive and so the S isoquants expand along a ray to the left of the ray for industry T. Now let's discuss choosing actual production levels.
First we have to make a change in our definition of relative factor abundence. We shall adopt the 'price definition' of relative factor abundance:
A country is relatively capital abundant if the wage/rental payment in its country is higher than the wage rental in the other country.
This definition uses the measure of the relative price of the factor inputs instaed of quantities. This definition may not always match what we would get with the 'quantity' definition.
Restating the H-O theorem using the price definition of factor abundance:
When the autarky wage/rental ratio is higher in A than B (A is capital intensive)the autarky relative price of S is lower in A than in B (A will export S).
If the autarky price of S is lower in A than B we know that when trade is opened up A will export S and import T. So what this defintion is saying is that the capital abundant country will export the capital intensive good.
PROOF
We will prove H-O by using figure 4.2.
However, we will do it differently from the text. The text starts with country A and then does a comparison with country B. We will do the opposite, going from B to A.
Suppose that the two isoquants shown are the isoquants for producing one unit of each good.
Then by comparing isocost lines which would apply to producing one unit of each good we know which good has the higher cost per unit.
Because these countries have perfectly competitive markets:
price (per unit) = marginal cost = average cost
So, knowing about relative costs of production tells us something about the relative prices of goods.
To begin, suppose we ask what is the relative cost of producing one unit of S and one unit of T in country B.
Suppose Wb/Rb are as shown in figure 4.2 and so production (of one unit each) will occur at X and Y. Since the isocost line for producing one unit of S goes through X, and the isocost line for producing one unit of T goes through Y, we can see that the cost of producing (one unit of)S is greater than the cost of producing (one unit of) T [the S isocost line is further out]. This means that Ps>Pt.
Now move over to country A. By the definition of factor abundance Wa/Ra > Wb/Rb. If we rotate the two isocosts lines to make Wa/Wb higher the distance between the two isocost curves decreases. In fact, there comes a point where the two isocost lines will merge into one (this is shown on figure 4.2). At this point Ps + Pt. So Ps has fallen below its value in B.
[There is nothing really special about the case where Ps = Pt. This happens to be the case where the dollar price of both goods is the same. It is only used because it makes the fall in the price of S as we increase W/R especially clear.]
Since autarky Ps/Pt is lower in the country which is more capital abundant we have proved the H-O theorem. Capital abundant S will export the capital intensive good.
Friday, October 3, 2008
topic 4.1
THE HECHSHER-OHLIN MODEL
Topic 4.1
The H-O model differs from the classical model because the explanation for international differences in PPFs is different.
In the classical model there is effectively only one factor of production - labor. The different PPFs reflect different production technologies (using labor) for each country.
In the H-O model technology is the same for all countries but factor endowments are different. This causes the PPFs to be different between countries.
Differing factor endowments are attractive as an explanation for trade because (at least some) factors of production are immobile between countries whereas technology is a public good which flows freely across borders. If there is a superior technology for making a product a country can always license it from abroad.
Assumptions:
Let's consider the capital intensity assumption a little futher. What this means is that no matter what the W/R ratio is, industry S always uses a higher K/L than industry T. And this is true for both countries whether they are in autarky or trading with each other.
There are different types of production structure that can insure ('ensure' in British english) that this is true. The simplest is to set K/L at a fixed ratio for every level of production in each industry. This 'fixed coefficients' technology generates right-angle isoquants that expand al0ng a ray from the origin. Whatever the W/R ratio the same K/L will be chosen. Diagrammatically the isocost lines are always tangent at the corner points of the isoquants.
This diagram shows right-angled isoquants (there are actually an infinite number of them) with the K/L ratio fixed for every level of production. Whatever the value for W or R the isocost line will always touch an isoquant at a corner. So production will always use K/L in a fixed ratio.
Capital intensity of A (in this fixed coefficients case) means that the ray for industry S is to the left of the ray for industry T.
Topic 4.1
The H-O model differs from the classical model because the explanation for international differences in PPFs is different.
In the classical model there is effectively only one factor of production - labor. The different PPFs reflect different production technologies (using labor) for each country.
In the H-O model technology is the same for all countries but factor endowments are different. This causes the PPFs to be different between countries.
Differing factor endowments are attractive as an explanation for trade because (at least some) factors of production are immobile between countries whereas technology is a public good which flows freely across borders. If there is a superior technology for making a product a country can always license it from abroad.
Assumptions:
- There are two factors of production: labor (L) and capital (K) which are paid wages (W) and rental (R).
- Countries have identical production technology.
- In both countries the S industry is more capital intensive than the T industry (notice we use the word 'intensive' when speaking of indutries).
- Countries differ in their endowments of factors of production. Country A is relatively capital abundant (we use 'abundant' with reference to countries).
Let's consider the capital intensity assumption a little futher. What this means is that no matter what the W/R ratio is, industry S always uses a higher K/L than industry T. And this is true for both countries whether they are in autarky or trading with each other.
There are different types of production structure that can insure ('ensure' in British english) that this is true. The simplest is to set K/L at a fixed ratio for every level of production in each industry. This 'fixed coefficients' technology generates right-angle isoquants that expand al0ng a ray from the origin. Whatever the W/R ratio the same K/L will be chosen. Diagrammatically the isocost lines are always tangent at the corner points of the isoquants.
This diagram shows right-angled isoquants (there are actually an infinite number of them) with the K/L ratio fixed for every level of production. Whatever the value for W or R the isocost line will always touch an isoquant at a corner. So production will always use K/L in a fixed ratio.
Capital intensity of A (in this fixed coefficients case) means that the ray for industry S is to the left of the ray for industry T.
Friday, September 26, 2008
appendix 3.2
OFFER CURVES AND THE TERMS OF TRADE
Appendix 3.2
Offer curves are an alternative way to represent the reciprocal demand that determines the terms of trade.
Figure A 3.2 shows A's desired trade for three different values of the terms of trade. As the TOT line gets steeper we see A's desired imports rise from T0 to T3, while desired exports rise from S0 to S3. As the TOT rises A is able to achieve a higher standard of living.
This change in the TOT is 'favorable' to A because it favors the good that A exports.
Figure 3.3 plots A's desired exports against A's desired imports.
If we think of the TOT as a price then as it rises A 'offers' a specific exchange of S for T.
The offer curve combines supply and demand behavior in one curve. It takes money prices out of the picture. Instead of offering to pay a certain number of dollars for a good, countries are going straight to making a barter offer.
In this approach money is a distraction and models that dispense with it get to the 'real' economics of trade.
Country B also has an offer curve.
Figure 3.4 puts the two offer curves on the same diagram.
There is only one TOT where the desired exports and imports all match. This is the equilibrium TOT.
At this equilibrium the two country's CICs must be tangent to each other.
Production choices, consumption choices, the terms of trade, goods prices and the exchange rate are all consistent with each other in general equilibrium. Unless there is some shock to the system the world will remain in this equilibrium state.
Appendix 3.2
Offer curves are an alternative way to represent the reciprocal demand that determines the terms of trade.
Figure A 3.2 shows A's desired trade for three different values of the terms of trade. As the TOT line gets steeper we see A's desired imports rise from T0 to T3, while desired exports rise from S0 to S3. As the TOT rises A is able to achieve a higher standard of living.
This change in the TOT is 'favorable' to A because it favors the good that A exports.
Figure 3.3 plots A's desired exports against A's desired imports.
If we think of the TOT as a price then as it rises A 'offers' a specific exchange of S for T.
The offer curve combines supply and demand behavior in one curve. It takes money prices out of the picture. Instead of offering to pay a certain number of dollars for a good, countries are going straight to making a barter offer.
In this approach money is a distraction and models that dispense with it get to the 'real' economics of trade.
Country B also has an offer curve.
Figure 3.4 puts the two offer curves on the same diagram.
There is only one TOT where the desired exports and imports all match. This is the equilibrium TOT.
At this equilibrium the two country's CICs must be tangent to each other.
Production choices, consumption choices, the terms of trade, goods prices and the exchange rate are all consistent with each other in general equilibrium. Unless there is some shock to the system the world will remain in this equilibrium state.
appendix 3.1
THE CLASSICAL MODEL WITH MANY GOODS
Appendix 3.1
Suppose:
In Table 3.1 are the labor/output ratios.
Country A's comparative advantage is in good Y.
We guess that B will export T and A will export Y, but what about the other 3 goods?
We know that goods T and Y determine the range for relative wages.
1/3 < Wa/(E.Wb) < 1
Table 3.2 ranks the value of (labor hours per unit B produced/labor hours per unit A produced) for each good.
B's greatest comparative advantage good (its most competitive export) is on the left. To produce one unit of T, country B only requires one-third as much labor as country A does.
This ordering is called 'the chain of comparative advantage'.
Suppose the relative wage rate was 2/3. Then B would produce all the goods except Y.
Where do the wages rates actually get detemined? In theory the wage rates in each country should adjust so that trade is balanced. If the wage rate in one country is 'too high' then the price of its least competitive export will be too high to compete in the market. So the country will tend to do some combination of lowering the wage rate and cutting back production of its least advantageous good until trade is balanced.
Appendix 3.1
Suppose:
- there are 5 goods
- all other classical assumptions hold especially fixed labor/output ratios
In Table 3.1 are the labor/output ratios.
Country A's comparative advantage is in good Y.
We guess that B will export T and A will export Y, but what about the other 3 goods?
We know that goods T and Y determine the range for relative wages.
1/3 < Wa/(E.Wb) < 1
Table 3.2 ranks the value of (labor hours per unit B produced/labor hours per unit A produced) for each good.
B's greatest comparative advantage good (its most competitive export) is on the left. To produce one unit of T, country B only requires one-third as much labor as country A does.
This ordering is called 'the chain of comparative advantage'.
Suppose the relative wage rate was 2/3. Then B would produce all the goods except Y.
Where do the wages rates actually get detemined? In theory the wage rates in each country should adjust so that trade is balanced. If the wage rate in one country is 'too high' then the price of its least competitive export will be too high to compete in the market. So the country will tend to do some combination of lowering the wage rate and cutting back production of its least advantageous good until trade is balanced.
Monday, September 22, 2008
topic 3.4
THE CLASSICAL MODEL OF INTERNATIONAL TRADE
Topic 3.4
Trade and wages
If labor is the only factor of production then in pretrade equilibrium the price of a good is simply the number of hours to produce it.
Psa = Wa x 3
Pta = Wa x 6
Psb = Wb x 12
Ptb = Wb x 8
Suppose both countries use the same currency.
Then for trade to occur the pretrade price of S must be lower in country A than in country B. And the opposite must be true for T.
Psa < E x Psb
Pta > E x Ptb
Where the exchange rate E converts country B currency into country A currency.
Then
Wa/(E x Wb) < 4
Wa/(E x Wb) > 4/3
that is 4/3 < Wa/(E x Wb) < 4
The middle term is the relative wage ratio.
Workers in A must earn more than in country B as measured in country A currency.
Differences in labor productivity explain the wage differences. Labor in A is 4/3 times as productive as labor in B (in textiles) and 4 times as productive in S production. These numbers set the limits for wage differences.
If the wage rate for labor in country A is more than four times the wage rate in country B then that would erase the advantage of buying goods from A. The extra high wage in A would erase any price advantage for S goods imported from A.
For good T, if wages in country B are more than ¾ the wages in A, it wipes out the productivity advantage of country B in the production of T.
To summarize, the wage rate in a country cannot be so high that it wipes out the natural comparative advantage that country has in its export good.
Another way of thinking about it: we know that productivity determines the standard of living in a country. It makes sense that relative productivity determines the relative wage rate between two countries. So the relative advantage A has in its export good sets the upper bound on its wage premium.
But, and this is truly surprising – it is not absolute advantage that sets the (limits for) the wage premium. It is comparative advantage. Being the lowest cost producer of a good in terms of labor costs does not raise your relative wage. It is the structure of comparative advantage (lowest opportunity cost) that matters.
Another remarkable result: it is the trade sector that drives relative wages. Because trade in this model drives both countries to specialize completely (by assumption), the whole production pattern of an economy is determined by comparative advantage.
Topic 3.4
Trade and wages
If labor is the only factor of production then in pretrade equilibrium the price of a good is simply the number of hours to produce it.
Psa = Wa x 3
Pta = Wa x 6
Psb = Wb x 12
Ptb = Wb x 8
Suppose both countries use the same currency.
Then for trade to occur the pretrade price of S must be lower in country A than in country B. And the opposite must be true for T.
Psa < E x Psb
Pta > E x Ptb
Where the exchange rate E converts country B currency into country A currency.
Then
Wa/(E x Wb) < 4
Wa/(E x Wb) > 4/3
that is 4/3 < Wa/(E x Wb) < 4
The middle term is the relative wage ratio.
Workers in A must earn more than in country B as measured in country A currency.
Differences in labor productivity explain the wage differences. Labor in A is 4/3 times as productive as labor in B (in textiles) and 4 times as productive in S production. These numbers set the limits for wage differences.
If the wage rate for labor in country A is more than four times the wage rate in country B then that would erase the advantage of buying goods from A. The extra high wage in A would erase any price advantage for S goods imported from A.
For good T, if wages in country B are more than ¾ the wages in A, it wipes out the productivity advantage of country B in the production of T.
To summarize, the wage rate in a country cannot be so high that it wipes out the natural comparative advantage that country has in its export good.
Another way of thinking about it: we know that productivity determines the standard of living in a country. It makes sense that relative productivity determines the relative wage rate between two countries. So the relative advantage A has in its export good sets the upper bound on its wage premium.
But, and this is truly surprising – it is not absolute advantage that sets the (limits for) the wage premium. It is comparative advantage. Being the lowest cost producer of a good in terms of labor costs does not raise your relative wage. It is the structure of comparative advantage (lowest opportunity cost) that matters.
Another remarkable result: it is the trade sector that drives relative wages. Because trade in this model drives both countries to specialize completely (by assumption), the whole production pattern of an economy is determined by comparative advantage.
topic 3.3
THE CLASSICAL MODEL OF INTERNATIONAL TRADE
Topic 3.3
The Gains from International Trade
Consider Figure 3.4
The way we calculate the gains from trade is to compare the equilibrium CIC in autarky with the trade equilibrium CIC.
So moving from K to I is a gain from trade. Since I is above to the right of K it represents a welfare gain.
(But if consumption preferences were extreme (e.g. A residents only consumed S) then there would be no gain from trade.)
Another test of gains is: is the vertical intercept higher (GDP1/ PTO).
The further the TOT is from the PPF of country A, the greater are the gains to that country.
This model does not explicitly solve for the exact equilibrium TOT.
A small country could actually have greater relative trade gains than a larger country if the TOT was equidistant between the two PPFs because equal trade gains are being divided by a smaller base.
Topic 3.3
The Gains from International Trade
Consider Figure 3.4
The way we calculate the gains from trade is to compare the equilibrium CIC in autarky with the trade equilibrium CIC.
So moving from K to I is a gain from trade. Since I is above to the right of K it represents a welfare gain.
(But if consumption preferences were extreme (e.g. A residents only consumed S) then there would be no gain from trade.)
Another test of gains is: is the vertical intercept higher (GDP1/ PTO).
The further the TOT is from the PPF of country A, the greater are the gains to that country.
This model does not explicitly solve for the exact equilibrium TOT.
A small country could actually have greater relative trade gains than a larger country if the TOT was equidistant between the two PPFs because equal trade gains are being divided by a smaller base.
Sunday, September 21, 2008
topic 3.3
THE CLASSICAL MODEL OF INTERNATIONAL TRADE
Topic 3.3
The Gains from International Trade
Consider Figure 3.4
The way we calculate the gains from trade is to compare the equilibrium CIC in autarky with the trade equilibrium CIC.
So move from K to I is a gain from trade. Since I is above to the right of K it represents a welfare gain.
If consumption preferences were extreme (eg A residents only consumed S) then there would be no gain from trade.
Another test of gains is the vertical intercept higher (GDP,/ PTO).
The further the TOT is from the PPF of country A, the greater are the gains to that country.
This model does not explicitly solve for the exact equilibrium TOT.
A small country could have greater relative trade gains than a larger country if the TOT was equidistant between the two PPFs.
Topic 3.3
The Gains from International Trade
Consider Figure 3.4
The way we calculate the gains from trade is to compare the equilibrium CIC in autarky with the trade equilibrium CIC.
So move from K to I is a gain from trade. Since I is above to the right of K it represents a welfare gain.
If consumption preferences were extreme (eg A residents only consumed S) then there would be no gain from trade.
Another test of gains is the vertical intercept higher (GDP,/ PTO).
The further the TOT is from the PPF of country A, the greater are the gains to that country.
This model does not explicitly solve for the exact equilibrium TOT.
A small country could have greater relative trade gains than a larger country if the TOT was equidistant between the two PPFs.
topic 3.2
THE CLASSICAL MODEL OF INTERNATIONAL TRADE
Topic 3.2
The GE solution to the classical model.
Suppose we have the PPFs from figure 3.1.
In the test the two PPFs are not drawn to the same scale.
Figure 3.2 adds the CICs that are at a tangency with the PPFs.
If we allow trade to occur what will happen?
There will be only one would price. This price will be between the two autarky prices.
How much specialization will occur?
If we know what the new equilibrium will be we can say.
Comparative advantage determines specialization and trade.
Figure 3.3 illustrates an equilibrium.
The new world price is in between the autarky prices.
Suppose the new price is 3/4. This represents the ‘terms of trade’.
A will produce more S
B will produce more T
A will produce only S because this allows A to reach the highest CCI.
Similarly B will only produce T and reach its highest CCI.
How do we know that the new price is feasible? I.e. why should supply and demand be matched perfectly at that price? Because the price adjusts until it is at the equilibrium value (choosing ¾ is just a guess for illustration only).
This price is called the terms of trade: ‘TOT’
HIJ in Figure 3.3 is the ‘trade triangle’.
The trade triangle tells us how much S country A will export (J – H) and how much T it will import (all of its T consumption).
The trade triangles for the two countries must be congruent since the horizontal sections are equal and the hypotenuse has the same slope.
Walras Law
If there are n markets in a GE economy and (n-1) are in equilibrium then the last market must be in equilibrium.
Topic 3.2
The GE solution to the classical model.
Suppose we have the PPFs from figure 3.1.
In the test the two PPFs are not drawn to the same scale.
Figure 3.2 adds the CICs that are at a tangency with the PPFs.
If we allow trade to occur what will happen?
There will be only one would price. This price will be between the two autarky prices.
How much specialization will occur?
If we know what the new equilibrium will be we can say.
Comparative advantage determines specialization and trade.
Figure 3.3 illustrates an equilibrium.
The new world price is in between the autarky prices.
Suppose the new price is 3/4. This represents the ‘terms of trade’.
A will produce more S
B will produce more T
A will produce only S because this allows A to reach the highest CCI.
Similarly B will only produce T and reach its highest CCI.
How do we know that the new price is feasible? I.e. why should supply and demand be matched perfectly at that price? Because the price adjusts until it is at the equilibrium value (choosing ¾ is just a guess for illustration only).
This price is called the terms of trade: ‘TOT’
HIJ in Figure 3.3 is the ‘trade triangle’.
The trade triangle tells us how much S country A will export (J – H) and how much T it will import (all of its T consumption).
The trade triangles for the two countries must be congruent since the horizontal sections are equal and the hypotenuse has the same slope.
Walras Law
If there are n markets in a GE economy and (n-1) are in equilibrium then the last market must be in equilibrium.
topic 3.1
THE CLASSICAL MODEL OF INTERNATIONAL TRADE
Topic 3.1
Mercantilism aimed to limit imports and promote exports.
Adam Smith developed his ideas to refute mercantilism.
We shall continue to develop a model of international trade.
Factors of production cannot move between countries.
This keeps the PPF fixed (with static technology) and it also prevents wage equalization
There are no barriers to trade in goods.
So there are no tariffs or quotas.
Exports pay for imports.
This is balanced trade.
There are no flows of money or bonds (there are no ‘capital flows’).
Labor is the only factor of production
This is the ‘labor theory of value’.
Production exhibits constant returns to scale between labor and output.
Proportional changes in imports lead to proportional changes in outputs when labor is the only factor of production this means that there is a fixed ratio of output to input.
The constant returns assumption allows us to derive formulas that are independent of the absolute level of output.
Absolute advantage can be illustrated by tables.
There are two variations of these tables. One version assumes that each country has the same amount of labor and then presents the maximum output of each good that is possible for each country. The other version holds the production levels the same for each country the same and then presents the different amounts of labor required within each country.
Both variations are equivalent – they are different approaches to presenting the same information. Tables are only useful for presenting linear PPFs.
Table 3.1 is the second type of table.
From table 3.1 we see than country A has an absolute advantage in producing S and country B has the absolute advantage in producing T.
Diagram 3.1
If each country had 12 hours of labor A has the absolute advantage in T (it can produce more units of T) and B has the absolute advantage of S (if can product more units of S).
In order to know where each country would be in autarky and where they would change production if trade was allowed we need information about consumption preferences (not in diagram 3.1).
Under reasonable consumption preferences (the best we can do without being given the ‘true’ CICs) and assuming that both countries consume both goods it is likely that A will specialize in T and B will specialize in S.
Table 3.3 represents a situation where A has the absolute advantage in both good.
Diagram 3.2
A has the absolute advantage in both goods, but its comparative advantage is S.
There is potential for A to specialize in production of S while B specializes in production of T.
Topic 3.1
Mercantilism aimed to limit imports and promote exports.
Adam Smith developed his ideas to refute mercantilism.
We shall continue to develop a model of international trade.
Factors of production cannot move between countries.
This keeps the PPF fixed (with static technology) and it also prevents wage equalization
There are no barriers to trade in goods.
So there are no tariffs or quotas.
Exports pay for imports.
This is balanced trade.
There are no flows of money or bonds (there are no ‘capital flows’).
Labor is the only factor of production
This is the ‘labor theory of value’.
Production exhibits constant returns to scale between labor and output.
Proportional changes in imports lead to proportional changes in outputs when labor is the only factor of production this means that there is a fixed ratio of output to input.
The constant returns assumption allows us to derive formulas that are independent of the absolute level of output.
Absolute advantage can be illustrated by tables.
There are two variations of these tables. One version assumes that each country has the same amount of labor and then presents the maximum output of each good that is possible for each country. The other version holds the production levels the same for each country the same and then presents the different amounts of labor required within each country.
Both variations are equivalent – they are different approaches to presenting the same information. Tables are only useful for presenting linear PPFs.
Table 3.1 is the second type of table.
From table 3.1 we see than country A has an absolute advantage in producing S and country B has the absolute advantage in producing T.
Diagram 3.1
If each country had 12 hours of labor A has the absolute advantage in T (it can produce more units of T) and B has the absolute advantage of S (if can product more units of S).
In order to know where each country would be in autarky and where they would change production if trade was allowed we need information about consumption preferences (not in diagram 3.1).
Under reasonable consumption preferences (the best we can do without being given the ‘true’ CICs) and assuming that both countries consume both goods it is likely that A will specialize in T and B will specialize in S.
Table 3.3 represents a situation where A has the absolute advantage in both good.
Diagram 3.2
A has the absolute advantage in both goods, but its comparative advantage is S.
There is potential for A to specialize in production of S while B specializes in production of T.
Wednesday, September 10, 2008
topic 2.4
TOOLS OF ANALYSIS FOR INTERNATIONAL TRADE MODELS
topic 2.4
Can we devise a better measure of national welfare than community indifference curves? Ideally we would like to create a GDP measure. Then we can answer question like ‘does trade make a country better off?’
formula for GDP
GDP = Ps S + Pt T
GDP/Pt = (Ps / Pt) . S + T
converts our GDP measure into units of T
Figure 2.7 shows how this equation allows us to convert a production point into a measure of real GDP.
We are going to convert everything into ‘T’ units.
What about tastes? Don’t they matter?
They do matter, and they enter in via the market prices Ps, Pt.
For example, it consumers hade a low preference (on the margin) for good S, then Ps would be low relative to Pt, and the line in figure 2.7 would be flat. Then GDP would increase little in response to greater S production, but it would increase a great deal is T production increased.
We are using T as the ‘numeraire’ good.
The concept of standard of living uses the measure per capita GDP.
An alternative but equivalent approach to national welfare is to use national demand and supply curves.
We will derive these curves from PPFs and CICs.
Figure 2.8 shows how to derive the curves.
Recall that a demand curve is a representation of a function.
‘call out’ a => quantity
market price demanded
Likewise, for supply
‘call out’ a => quantity
market price supplied
So be rotating the line representing different relative prices we can generate demand and supply quantities.
Ps / Pt = ($ /units of S) / ($ /units of T)
Cancel out the $
Ps / Pt = units of T / units of S
The vertical axis is the ‘price’ of S in terms of the numeraire T
Rotating the price line about the PPF generates the supply curve.
As we rotate Ps / Pt about the PPF we find the point of tangency with a CIC. This generates a demand curve.
The position of the PPF ‘anchors’ the consumers so they are only allowed to consume quantities consistent with what they can produce this period. There is no borrowing from the future in this model.
Nwo introduce a second country, country ‘B.’
Figure 2.10 shows the two demand and supply curve diagrams, each one representing the situation in autarky.
If we allow trade between the countries we expect that the new global market price Ps / Pt will be intermediate between the autarky prices.
Because country A has the lower autarky price of S it has the comparative advantage in S. Trade will start out with consumers in country B importing S, and country B producers will export T. Trade will begin by following the pattern of comparative advantage.
Comparative advantage can only be assessed by looking at the countries’ relative autarky positions. But in the real would we don’t observe the autarky state. This is a great challenge for testing trade theories based on comparative advantage.
topic 2.4
Can we devise a better measure of national welfare than community indifference curves? Ideally we would like to create a GDP measure. Then we can answer question like ‘does trade make a country better off?’
formula for GDP
GDP = Ps S + Pt T
GDP/Pt = (Ps / Pt) . S + T
converts our GDP measure into units of T
Figure 2.7 shows how this equation allows us to convert a production point into a measure of real GDP.
We are going to convert everything into ‘T’ units.
What about tastes? Don’t they matter?
They do matter, and they enter in via the market prices Ps, Pt.
For example, it consumers hade a low preference (on the margin) for good S, then Ps would be low relative to Pt, and the line in figure 2.7 would be flat. Then GDP would increase little in response to greater S production, but it would increase a great deal is T production increased.
We are using T as the ‘numeraire’ good.
The concept of standard of living uses the measure per capita GDP.
An alternative but equivalent approach to national welfare is to use national demand and supply curves.
We will derive these curves from PPFs and CICs.
Figure 2.8 shows how to derive the curves.
Recall that a demand curve is a representation of a function.
‘call out’ a => quantity
market price demanded
Likewise, for supply
‘call out’ a => quantity
market price supplied
So be rotating the line representing different relative prices we can generate demand and supply quantities.
Ps / Pt = ($ /units of S) / ($ /units of T)
Cancel out the $
Ps / Pt = units of T / units of S
The vertical axis is the ‘price’ of S in terms of the numeraire T
Rotating the price line about the PPF generates the supply curve.
As we rotate Ps / Pt about the PPF we find the point of tangency with a CIC. This generates a demand curve.
The position of the PPF ‘anchors’ the consumers so they are only allowed to consume quantities consistent with what they can produce this period. There is no borrowing from the future in this model.
Nwo introduce a second country, country ‘B.’
Figure 2.10 shows the two demand and supply curve diagrams, each one representing the situation in autarky.
If we allow trade between the countries we expect that the new global market price Ps / Pt will be intermediate between the autarky prices.
Because country A has the lower autarky price of S it has the comparative advantage in S. Trade will start out with consumers in country B importing S, and country B producers will export T. Trade will begin by following the pattern of comparative advantage.
Comparative advantage can only be assessed by looking at the countries’ relative autarky positions. But in the real would we don’t observe the autarky state. This is a great challenge for testing trade theories based on comparative advantage.
topic 2.3
TOOLS OF ANALYSIS FOR INTERNATIONAL TRADE MODELS
Topic 2.3
Let’s try applying a little calculus
Π = Pt T + Ps S
where Π = profit
Pt, Ps = prices of T, S
T, S = outputs of T, S
this is an endowment model so costs are zero, the firm is simply trying to maximize revenue
dΠ = Pt ∆T + Ps ∆S
at the profit maximization point dΠ = O
so Pt ∆T + Ps ∆S = O
so Ps/Pt = - ∆T/ ∆S (1)
(by the way firms act competitively and so they treat prices as parameters, not variables)
(1) says that production will be chosen so that the point on the PPF will have the same slope as the ratio of prices.
another way of describing this:
· Ps/Pt is outside the control of the firm because it is determined by consumers
· the firm wants (1) to be true
· the firm will increase T and decrease S or the opposite (moving along the PPF) until (1) is true
· once (1) is true the firm will stop and remain at that point on the PPF forever until there is a change in Ps/Pt
· the firm is reacting to price changes, not attempting to influence them
what if we are at a point like ‘U’ on the PPF where
-Ps/Pt < ∆T/ ∆S (assuming CIC0 determines prices via tangency)
(when we are looking at negative slopes the steeper slope has a lower numerical value)
to rephrase, the CIC curve has a steeper slope than the PPF at U
so 0 < ∆T/∆S + Ps/Pt (2)
given that we are at U, let us consider what would happen if we increased S production
so ∆ S > 0
Multiply both sides of (2) by Pt ∆S
then Ps ∆S + Pt ∆T > 0
so we will increase Π if we increase S
If we were starting on the PPF to the right of X (at a point like Y) similar reasoning would show that we could increase Π by decreasing S production.
Intuitively, the ‘U’ point is a situation where the price of S is relatively high compared to the price of T and the opportunity cost of increasing S production (T sacrificed) is low. So the firm figures that it will make more profit by ↑ S and selling it at the ‘high’ price of S, even after factoring in the loss of revenue from decreasing production of T.
At this point it’s worth pointing out that the model does not really have a mechanism for determining what prices will actually be at ‘U’ We are just assuming that somehow the prevailing market price will be close to the slope of CIC0 at ‘U’ because of ‘consumer demand’
Topic 2.3
Let’s try applying a little calculus
Π = Pt T + Ps S
where Π = profit
Pt, Ps = prices of T, S
T, S = outputs of T, S
this is an endowment model so costs are zero, the firm is simply trying to maximize revenue
dΠ = Pt ∆T + Ps ∆S
at the profit maximization point dΠ = O
so Pt ∆T + Ps ∆S = O
so Ps/Pt = - ∆T/ ∆S (1)
(by the way firms act competitively and so they treat prices as parameters, not variables)
(1) says that production will be chosen so that the point on the PPF will have the same slope as the ratio of prices.
another way of describing this:
· Ps/Pt is outside the control of the firm because it is determined by consumers
· the firm wants (1) to be true
· the firm will increase T and decrease S or the opposite (moving along the PPF) until (1) is true
· once (1) is true the firm will stop and remain at that point on the PPF forever until there is a change in Ps/Pt
· the firm is reacting to price changes, not attempting to influence them
what if we are at a point like ‘U’ on the PPF where
-Ps/Pt < ∆T/ ∆S (assuming CIC0 determines prices via tangency)
(when we are looking at negative slopes the steeper slope has a lower numerical value)
to rephrase, the CIC curve has a steeper slope than the PPF at U
so 0 < ∆T/∆S + Ps/Pt (2)
given that we are at U, let us consider what would happen if we increased S production
so ∆ S > 0
Multiply both sides of (2) by Pt ∆S
then Ps ∆S + Pt ∆T > 0
so we will increase Π if we increase S
If we were starting on the PPF to the right of X (at a point like Y) similar reasoning would show that we could increase Π by decreasing S production.
Intuitively, the ‘U’ point is a situation where the price of S is relatively high compared to the price of T and the opportunity cost of increasing S production (T sacrificed) is low. So the firm figures that it will make more profit by ↑ S and selling it at the ‘high’ price of S, even after factoring in the loss of revenue from decreasing production of T.
At this point it’s worth pointing out that the model does not really have a mechanism for determining what prices will actually be at ‘U’ We are just assuming that somehow the prevailing market price will be close to the slope of CIC0 at ‘U’ because of ‘consumer demand’
Monday, September 8, 2008
topic 2.2
TOOLS OF ANALYSIS FOR INTERNATIONAL TRADE MODELS
Topic 2.2
The basic model
When measuring welfare gains the reference point is autarky.
Consider Figure 2.5
It represents a closed economy.
There are two goods:
· Soybeans (S)
· Textiles (T)
EF is the PPF
CIC0 ,CIC1 ,CIC2 are I.C.s
Producing at ‘Z’ allows the country to reach the highest I.C.
The point (Sz, Tz) is determined by the production opportunities and tastes.
Note that this model has no mechanism to explain how the economy gets to Z. There is no explicit market, no dynamics.
But we can say that if agents behave rationally and there is a competitive market we should reach Z eventually.
The key assumption is that if this is a competitive market [That is, agents take prices as given and do not try to strategize.] Then we think that this will be the solution. There is an enormous literature in microeconomics (general equilibrium) theorizing about when an economy will be at the competitive and welfare maximizing equilibrium solution. We are not getting into this theory. But we can do some experiments testing weather these solutions are at least plausible.
In the competitive equilibrium at Z we can say that certain conditions must hold.
One condition is that the relative price of the two goods must equal the ratio of marginal utilities at the tangency point on the indifference curve CIC1.
Equivalently, the MRS (marginal rate of substitution ) (along CIC1) at Z must equal the ratio of prices.
MRS=Ps/Pt
MUs /MUy=Ps /Pt
MUs /Ps= MUy / Pt
Where Ps, Pt =dollar prices of S, T
MU =marginal utility
(By the way we are ignoring all the negatives of these slopes)
The argument for which we expect to reach Z is a sort of proof by contradiction. We look at a point that is not Z and show that agents will move in the correct direction.
Consider point Y.
There is an argument that consumers will move in the ‘correct ‘direction. What is it?
Figure 2.6
Figure 2.6 represents a situation with increasing opportunity costs in production
If the economy is at a point like ‘U’ then producers will move in the correct direction. Why?
Friday, August 22, 2008
topic 2.1
TOOLS OF ANALYSIS FOR INTERNATIONAL TRADE MODELS
Topic 2.1
Questions
· Why does trade occur?
· What goods will a country export/import?
· What will be the volume of trade?
· What will be the prices at which trade occurs?
· What is the effect of trade on factors of production?
Methodology
· Models
· Abstraction from reality
· Positive and normative analysis
· General Equilibrium
· Abstract thinking
· Link real trade and international finance
The basic model
Agents are rational (maximizing)
Note:
Disagree with that text that ‘rationality’ is synonymous with ‘utility maximizing’
‘Predictably irrational ‘
‘Behavioral economics’
The human element matters
There are two countries in the world
This is standard, but a very restrictive assumption. Many elements of trade do not make sense except in a multi-country world.
Ideally, we will get to multi-country models.
In addition, there are only two goods in the world.
Some issues require more than two goods.
There is no money illusion
This is really an assumption about international finance models. In a ‘real trade’ model there isn’t any ‘money’
The essence of the assumption is that only relative prices matter.
The confusion between nominal and real prices is a non-issue in real trade models.
In each country endowments are fixed and the technologies available to each country are constant
This assumption generates a single production possibility frontier for each country
The PPF can have different shapes. A concave PPF represents increasing opportunity costs. A linear PPF represents constant opportunity costs.
Generally, concavity/convexity gives ‘nicer’ solutions to a model.
The concavity/convexity does not have to arise from the production side –it could arise from the consumption side of the model.
There is perfect competition and no externalities exist
These assumptions support an equilibrium solution where there is no divergence between private and social costs. Also there is no scope for strategy by firms in production or pricing.
Factors of production are perfectly mobile between industries within a country
This assumption allows returns to factors to be variable as they move between industries and their marginal product changes.
Reallocating factors of production allows a country to react to changes in demand for its two products.
Community preferences can be represented by a consistent set of community indifference curves
This basically says that we can represent preferences by one huge utility function (or one huge indifference curve) for the whole country. There is no heterogeneity in tastes. In effect, every individual is identical on the consumption.
Topic 2.1
Questions
· Why does trade occur?
· What goods will a country export/import?
· What will be the volume of trade?
· What will be the prices at which trade occurs?
· What is the effect of trade on factors of production?
Methodology
· Models
· Abstraction from reality
· Positive and normative analysis
· General Equilibrium
· Abstract thinking
· Link real trade and international finance
The basic model
Agents are rational (maximizing)
Note:
Disagree with that text that ‘rationality’ is synonymous with ‘utility maximizing’
‘Predictably irrational ‘
‘Behavioral economics’
The human element matters
There are two countries in the world
This is standard, but a very restrictive assumption. Many elements of trade do not make sense except in a multi-country world.
Ideally, we will get to multi-country models.
In addition, there are only two goods in the world.
Some issues require more than two goods.
There is no money illusion
This is really an assumption about international finance models. In a ‘real trade’ model there isn’t any ‘money’
The essence of the assumption is that only relative prices matter.
The confusion between nominal and real prices is a non-issue in real trade models.
In each country endowments are fixed and the technologies available to each country are constant
This assumption generates a single production possibility frontier for each country
The PPF can have different shapes. A concave PPF represents increasing opportunity costs. A linear PPF represents constant opportunity costs.
Generally, concavity/convexity gives ‘nicer’ solutions to a model.
The concavity/convexity does not have to arise from the production side –it could arise from the consumption side of the model.
There is perfect competition and no externalities exist
These assumptions support an equilibrium solution where there is no divergence between private and social costs. Also there is no scope for strategy by firms in production or pricing.
Factors of production are perfectly mobile between industries within a country
This assumption allows returns to factors to be variable as they move between industries and their marginal product changes.
Reallocating factors of production allows a country to react to changes in demand for its two products.
Community preferences can be represented by a consistent set of community indifference curves
This basically says that we can represent preferences by one huge utility function (or one huge indifference curve) for the whole country. There is no heterogeneity in tastes. In effect, every individual is identical on the consumption.
topic 1.2
INTRODUCTION TO INTERNATIONAL ECONOMICS
Topic 1.2
Definitions of trade terms
· GNP (the World bank calls this GNI)
· GDP
· Exports/imports
· Index of openness
· Trade deficit/surplus
· PPP
· Exchange rate
· Terms of Trade
Stylized facts/empirical regularities
· Large economies tend to be more closed
· Most trade is between developed countries
· World trade has grown much faster than GDP since 1950
· Barriers to trade have fallen since 1950
· Asia’s share of world trade has increased
· Gravity models predict trade very well
· Fast growing countries tend to be open
· Most trade is in inputs and intermediate goods (like parts)
· Services are 20 per cent of trade
Topic 1.2
Definitions of trade terms
· GNP (the World bank calls this GNI)
· GDP
· Exports/imports
· Index of openness
· Trade deficit/surplus
· PPP
· Exchange rate
· Terms of Trade
Stylized facts/empirical regularities
· Large economies tend to be more closed
· Most trade is between developed countries
· World trade has grown much faster than GDP since 1950
· Barriers to trade have fallen since 1950
· Asia’s share of world trade has increased
· Gravity models predict trade very well
· Fast growing countries tend to be open
· Most trade is in inputs and intermediate goods (like parts)
· Services are 20 per cent of trade
Wednesday, August 20, 2008
topic 1.1
INTRODUCTION TO INTERNATIONAL ECONOMICS
Topic 1.1
International economics is divided into two areas:
· International trade
· International macroeconomics/finance
International trade (or ‘real’ trade) is the macroeconomics of trade. It studies topics such as:
· Why do countries trade?
· What determines the pattern of trade (who exports and who imports)
· Who produces what products
· How does technology affect trade?
· Who gains from trade?
· How does trade affect income?
· What determines the ‘terms of trade’ and why does it matter?
· What policies should a country adopt for trade?
· What is the relationship between trade and growth?
The classical theory of trade is based on general equilibrium microeconomic theory.
The advantage of general equilibrium theory is that it captures the essential characteristic of international trade—everything affecting everything else.
There are two limitations to general equilibrium theory:
· It is basically a static equilibrium approach.
· It does not handle ‘imperfect competition’ well.
Other theories of trade allow for some degree of market power.
Yet others incorporate geography, or technology, or use the firm as the unit of analysis.
Theories that are more recent incorporate culture, networks, and other ideas from other disciplines.
International macroeconomics/finance is characterized by the addition of money and financial assets to the classical model.
‘Money’ allows/facilitates exchange between different countries.
Assets (like bonds) allow trade over time. Borrowing/lending requires some form of contract and that is what bonds are. Another aspect of allowing assets is that countries can manage risk/uncertainty.
The difference between macroeconomics and finance is that of emphasis. International finance emphasizes assets and risk. International macroeconomics emphasizes currency and generic ‘bonds’ as a way to shift consumption/production over time.
For convenience, we will use the term ‘international finance’
International finance studies:
· Exchange rates
· ‘Capital flows’ and the balance of payments
· Interaction between global monetary policies and global growth and trade
· International finance and growth
International economics has a long intellectual history – going back to Adam Smith and Davis Ricardo.
It is a dynamic area –falling transportation costs, the internet, and technology have made the world ‘flat’.
International economics is difficult to test econometrically—everything affects everything else.
We will do some experiments in international economics. There is some new work that we’ll look at by Vernon Smith and Bart Wilson on the evolution of exchange and specialization.
Topic 1.1
International economics is divided into two areas:
· International trade
· International macroeconomics/finance
International trade (or ‘real’ trade) is the macroeconomics of trade. It studies topics such as:
· Why do countries trade?
· What determines the pattern of trade (who exports and who imports)
· Who produces what products
· How does technology affect trade?
· Who gains from trade?
· How does trade affect income?
· What determines the ‘terms of trade’ and why does it matter?
· What policies should a country adopt for trade?
· What is the relationship between trade and growth?
The classical theory of trade is based on general equilibrium microeconomic theory.
The advantage of general equilibrium theory is that it captures the essential characteristic of international trade—everything affecting everything else.
There are two limitations to general equilibrium theory:
· It is basically a static equilibrium approach.
· It does not handle ‘imperfect competition’ well.
Other theories of trade allow for some degree of market power.
Yet others incorporate geography, or technology, or use the firm as the unit of analysis.
Theories that are more recent incorporate culture, networks, and other ideas from other disciplines.
International macroeconomics/finance is characterized by the addition of money and financial assets to the classical model.
‘Money’ allows/facilitates exchange between different countries.
Assets (like bonds) allow trade over time. Borrowing/lending requires some form of contract and that is what bonds are. Another aspect of allowing assets is that countries can manage risk/uncertainty.
The difference between macroeconomics and finance is that of emphasis. International finance emphasizes assets and risk. International macroeconomics emphasizes currency and generic ‘bonds’ as a way to shift consumption/production over time.
For convenience, we will use the term ‘international finance’
International finance studies:
· Exchange rates
· ‘Capital flows’ and the balance of payments
· Interaction between global monetary policies and global growth and trade
· International finance and growth
International economics has a long intellectual history – going back to Adam Smith and Davis Ricardo.
It is a dynamic area –falling transportation costs, the internet, and technology have made the world ‘flat’.
International economics is difficult to test econometrically—everything affects everything else.
We will do some experiments in international economics. There is some new work that we’ll look at by Vernon Smith and Bart Wilson on the evolution of exchange and specialization.
syllabus
Econ 463
International Economics
Fall 2008
Dr. Paul Johnson
Rasmuson Hall 319A
(907) 786-4311
afprj@cbpp.uaa.alaska.edu (please use subject line: ECON 463)
Class information
Prerequisites: ECON 201 and ECON 202
Related classes:
International Finance BA 427
Course aims and outcomes
ECON 463 is an undergraduate course focusing on the study of international markets, institutions and policy.
The primary objective of this course is to help students obtain a better understanding of the international economic environment. This understanding will be aided by introducing students to theoretical tools that illuminate the workings of international markets, institutions and policies.
There will be a special emphasis on recent developments in the study of the simultaneous emergence of specialization and trade and the history of international economic theory.
Student learning outcomes
By the end of this course, you should be able to:
· Explain how international economics contributes to understanding of world events, world economic growth, and the international business environment.
· Apply comparative advantage models to solve analytical problems.
· Apply trade theories to solve analytical trade problems.
· Apply exchange rate theory to solve analytical problems in exchange-rate determination.
· Describe and explain the role of the major international trade organizations.
· Provide an in-depth overview of the major free trade agreements and common currency areas.
· Compare and discuss the major controversies in trade policy.
Approach to learning and teaching
Traditional lecturing will be used where necessary – to explain basic facts and concepts, to give current examples, and to make connections between the different course elements. However, much of the teaching will involve discussions or experiential activities.
Classroom experiments will be an important feature of this course. Current news articles and case studies will be assigned as class discussion readings in order for students to practice applying new knowledge to real world events.
Syllabus
Text Chapter and Topic
1. An Introduction to International Trade
2. Tools of Analysis for International Trade Models
3. The Classical Model of International Trade
4. The Heckscher-Ohlin Model
5. Tests of Trade Models: The Leontief Paradox and Its Aftermath
6. Tariffs
9. Preferential Trade Arrangements
10. International Trade and Economic Growth
Midterm exam (date TBA)
11. An Introduction to International Finance
12. The Balance of Payments
13. The Foreign-Exchange Market
14. Prices and Exchange Rates: Purchasing Power Parity
15. Exchange Rates, Interest Rates, and Interest Parity
17. Basic Theories of the Balance of Payments
18. Exchange Rate Theories
19. Alternative International Monetary Standards
Final Exam (Monday December 8th 1.00-3.45pm.)
Text and readings
The text is Husted and Melvin International Economics 7th Ed. Handouts and readings of current articles will be made available. Handout material is all examinable. (“Handout” may mean posted on the web, or handed out in hard copy).
Grading
Midterm exam 30
Final exam 40
Assignments (including lab report/s) 30
Total 100
Special consideration
Students with disabilities who need extra time/assistance with exams may apply to
Disability Support Services to arrange such assistance.
General conduct and behavior
You are expected to conduct yourself with consideration and respect for the needs of your fellow students and teaching staff. Conduct which disrupts or interferes with a class is not acceptable and students may be asked to leave the class.
Once students are in class they may not leave without specific prior approval. A student who just gets up and leaves a class which is still in session may receive an automatic one letter grade penalty.
Attendance
Your regular and punctual attendance at lectures and seminars is expected in this course.
Students who consistently miss scheduled classes may be subject to an “F” regardless of assignment and exam scores. You should take note of all announcements made in lectures. You will be deemed to have received this information regardless of your absence, except in the case of a written pre-approved absence.
Study commitment
Students will be expected to be current with all assigned readings, and to participate in all class discussion and activities. All assignments must be turned in on the assigned due dates, unless a written exemption has been obtained beforehand, which will be given only in exceptional circumstances.
International Economics
Fall 2008
Dr. Paul Johnson
Rasmuson Hall 319A
(907) 786-4311
afprj@cbpp.uaa.alaska.edu (please use subject line: ECON 463)
Class information
Prerequisites: ECON 201 and ECON 202
Related classes:
International Finance BA 427
Course aims and outcomes
ECON 463 is an undergraduate course focusing on the study of international markets, institutions and policy.
The primary objective of this course is to help students obtain a better understanding of the international economic environment. This understanding will be aided by introducing students to theoretical tools that illuminate the workings of international markets, institutions and policies.
There will be a special emphasis on recent developments in the study of the simultaneous emergence of specialization and trade and the history of international economic theory.
Student learning outcomes
By the end of this course, you should be able to:
· Explain how international economics contributes to understanding of world events, world economic growth, and the international business environment.
· Apply comparative advantage models to solve analytical problems.
· Apply trade theories to solve analytical trade problems.
· Apply exchange rate theory to solve analytical problems in exchange-rate determination.
· Describe and explain the role of the major international trade organizations.
· Provide an in-depth overview of the major free trade agreements and common currency areas.
· Compare and discuss the major controversies in trade policy.
Approach to learning and teaching
Traditional lecturing will be used where necessary – to explain basic facts and concepts, to give current examples, and to make connections between the different course elements. However, much of the teaching will involve discussions or experiential activities.
Classroom experiments will be an important feature of this course. Current news articles and case studies will be assigned as class discussion readings in order for students to practice applying new knowledge to real world events.
Syllabus
Text Chapter and Topic
1. An Introduction to International Trade
2. Tools of Analysis for International Trade Models
3. The Classical Model of International Trade
4. The Heckscher-Ohlin Model
5. Tests of Trade Models: The Leontief Paradox and Its Aftermath
6. Tariffs
9. Preferential Trade Arrangements
10. International Trade and Economic Growth
Midterm exam (date TBA)
11. An Introduction to International Finance
12. The Balance of Payments
13. The Foreign-Exchange Market
14. Prices and Exchange Rates: Purchasing Power Parity
15. Exchange Rates, Interest Rates, and Interest Parity
17. Basic Theories of the Balance of Payments
18. Exchange Rate Theories
19. Alternative International Monetary Standards
Final Exam (Monday December 8th 1.00-3.45pm.)
Text and readings
The text is Husted and Melvin International Economics 7th Ed. Handouts and readings of current articles will be made available. Handout material is all examinable. (“Handout” may mean posted on the web, or handed out in hard copy).
Grading
Midterm exam 30
Final exam 40
Assignments (including lab report/s) 30
Total 100
Special consideration
Students with disabilities who need extra time/assistance with exams may apply to
Disability Support Services to arrange such assistance.
General conduct and behavior
You are expected to conduct yourself with consideration and respect for the needs of your fellow students and teaching staff. Conduct which disrupts or interferes with a class is not acceptable and students may be asked to leave the class.
Once students are in class they may not leave without specific prior approval. A student who just gets up and leaves a class which is still in session may receive an automatic one letter grade penalty.
Attendance
Your regular and punctual attendance at lectures and seminars is expected in this course.
Students who consistently miss scheduled classes may be subject to an “F” regardless of assignment and exam scores. You should take note of all announcements made in lectures. You will be deemed to have received this information regardless of your absence, except in the case of a written pre-approved absence.
Study commitment
Students will be expected to be current with all assigned readings, and to participate in all class discussion and activities. All assignments must be turned in on the assigned due dates, unless a written exemption has been obtained beforehand, which will be given only in exceptional circumstances.
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