CHAPTER 1

INTRODUCTION TO
INTERNATIONAL ECONOMICS
Prepared by:
Dr. Siti Badariah Saiful Nathan

Chapter 1 1
 LEARNING GOALS
After reading this chapter, students should be able to:
 Understand the meaning and importance of
globalization
 Understand the relationship between international
trade and the nation’s standard of living
 Describe the subject matter (trade and monetary
aspects) of international economics
 Identify the major international economic problems
and challenges facing the world today

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 Definition of International Economics

 Deals with the economic & financial interdependence

among nations.
 Analyzes the flow of goods & services, payments &
receipts of monies between a country & the rest of the
world.
 This is also influenced and affected by the political,
social, cultural & military relations among countries.

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Chapter 1 4
 What is Globalization?

 Integration of World Markets

 Free Access
 Removal of Tariffs
 Removal of Non-Tariff Barriers
 Unrestricted Employment
 Free Trade

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 Globalization : Definition

The increasing integration of economies around

the world, particularly through trade & financial

flows, but also through the movement of ideas &

people, facilitated by the revolution in
telecommunication & transportation.

Chapter 1 6
 The Globalization Challenge

The world has experienced 3 periods of rapid

globalization:

 1870 – 1914

 1945 – 1980

 1980 – present

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Globalization
Cause
period
European industrial revolution &
1870 – 1914 opening-up of new, resource-rich but
sparsely populated areas.
End of WWII; rapid ↑ int’l trade due to
1945 – 1980 dismantling of trade protection put in
place during the Great Depression

Rapid ↑ int’l trade but much faster due

to the improvements in
1980 – present
telecommunication & transportation,
massive int’l capital flows

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Chapter 1 9
 The Globalization Challenge
Globalization has been blamed for :
 World poverty & child labor in poor countries.
 Job losses & lower wages in rich countries.
 Environmental pollution & climatic changes throughout the
world.

anti-globalization movement
(A loose coalition of groups opposed to globalization)
Concerns:
 Environmental damage
 Loss of domestic labor protections
 Erosion of domestic sovereignty
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Differences between domestic & international trade

 Usage of different currencies

 Greater specialization of workers
 Advantages - bigger market size, variety of goods
& services, large volume and greater interaction
 higher cost & imposition of trade barriers

Chapter 1 11
 International Trade &
the Nation’s Standard of Living

 The international economy generates interdependence (the

economic events & policies in a nation can significantly
affect other nations).
Economic growth in country A  ↑ demand for imports 
↑ econ. growth in other countries

 Measure of interdependence :
Ratio of imports and exports of goods & services to GDP

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Dec 2013

How do we measure the importance of

international trade in a nation's economy?

(2 marks)

Chapter 1 13
 Answer

 The importance of international trade in an economy can be

measured by the sum of exports and imports divided by
GDP.
 The ratio or percent will indicate the degree of
interdependence among nations in terms of it's exports and
imports as a percentage of GDP.
 The higher the ratio or % the greater the degree of
interdependence, vice versa.
 Numerical example.
(2 marks)

Chapter 1 14
International trade & the nation’s standard of living

Other ways in which nations are interdependent:

 ↑ interest rates in Malaysia  ↑ funds into Malaysia
 ↑ demand for RM  ↑ value of RM  exports >
expensive & imports cheaper  ↓ economic activity
in Malaysia.
 ↓ trade barriers  ↑ export of high-tech goods  ↑
employment & wages in these sectors but not in non-
high-tech sectors.

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The Gravity Model

Chapter 1 16
 The Gravity Model

 Postulates that (cet. par.) the bilateral trade between

2 countries is proportional or at least positively
related to the product of the 2 countries’ GDP & to
be smaller the greater the distance between the 2
countries.
OR
 The larger (& the more equal in size) & the closer
the 2 countries are, the larger the volume of trade
between them is expected to be.

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 The theoretical foundations of gravity models:
Newton’s Law

The gravity model is named and modeled after Newton’s

Universal Law of Gravitation from physics:

Chapter 1 18
 Purpose of International Economic
Theories & Policies
 Purpose of economic theory  to predict & explain.
 Assumptions:
 2 nations
 2 commodities
 2 factor-world
 No trade restrictions
 Perfect mobility of factors within the nations but no
international mobility
 Perfect competition in all commodity & factor
markets
 No transportation costs
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International economic theory examines:
1) The basis for & gains from trade.

2) The reasons for & the effects of trade restrictions.

3) Policies directed at regulating the flows of international

payments & receipt; & the effects of policies on a nation’s
welfare & the welfare of other nations.

4) The effectiveness of macro policies under different

monetary systems.

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 The Scope of International Economics

1) International trade theory

 Analyzes the basis of & the gains from international
trade.
 Focuses on microeconomic aspects of the
international economy.
2) International trade policy
 Examines the reasons for & the effects of restrictions
on international trade.
 Analyzes the implications for international trade theory
of such restrictions.

Chapter 1 21
 The Scope of International Economics
3) Balance of payment & foreign exchange markets
 BOP = a summary statement of all int’l transactions
of the residents of a nation with the rest of the world.
 Provides a statistical summary of the size of int’l
trade & asset ownership for a country.
 Forex mkt = the institutional framework for the
exchange of one national currency into another.
4) Open-economy macroeconomics
 Examines how disequilibria lead to macroeconomic
adjustment under different international monetary
system.

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 The Benefits of International Trade

 Specialization as the basis of trade

 International trade allows countries to specialize
because of the wider mkt. Large-scale production
will ↑ efficiency.

 Decrease costs
 as countries specialize, production ↑ & cost can be ↓.

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 Differences in demand
 trading with other countries allows differences in
consumer’s demand and taste to be met.
 consumers can enjoy varieties of imported products
that are not able to be locally produced.

 Increased competition
 international trade ↑ competition because domestic
firms have to compete with foreign products. This
will ↑ efficiency and promote R&D.

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 Act as an “engine of growth”
 when countries export their goods to other countries,
it would generate exports earnings. This will ↑
national output & income i.e. international trade can
act as an engine of growth.
 when a country achieves economic growth, it
indicates an ↑ in the standard of living.
 Political, social & cultural advantage
 countries can gain political, social and cultural
advantage from international trade. These non-
economic advantage could be gained by promoting trade
– e.g. ASEAN, NAFTA etc.

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 International Economic Problems & Challenges

1) Deep Financial and Economic Crisis

 In 2008 & 2009 the world faced the most serious
financial and economic crisis which started from the U.S.
& to the rest of the world.
 Although much efforts have been made such as rescuing
financial institutions, reducing interest rate, introducing
economic stimulus etc, it only succeeded in preventing
the crisis from becoming deeper.
 Advanced nations faced deep recession & economic
growth of the emerging markets reduced.
 Challenge - How to overcome slow growth & high
unemployment by ↓ over-borrowing, unsustainable
budget deficit, & loss of international competitiveness
among advanced nations.
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2) Trade Protectionism in Advanced Countries

 Free trade is the best policy for the world but most
nations impose restrictions on free trade. Trade
restrictions usually benefit small number of producers
while harm majority of the consumers.
 The problem is worsened by the ↑ competition from
emerging market economies (e.g. China & India).
Fears of job losses  calls for protectionism from
foreign competition in advanced countries.
 Challenge - how advanced countries can remain
competitive, avoid job losses, share the benefits of
globalization & avoid increased protectionism.

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3) Exchange Rates Fluctuations & Financial Crisis
 Financial crisis  financial & economic instability & ↓
growth in advanced & emerging markets.
 E.g. financial crises in Southeast Asia (1997-98) & US
(2007) - caused instability in the financial markets &
economic crisis in the region.
 Effect of crisis:
 Disrupt the pattern of international trade,
specialization & lead to unstable international
financial conditions throughout the world.
 Challenge: reforms in monetary systems & more
international coordination of economic policies.

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4) Structural Imbalances in Advanced countries &
Insufficient Restructuring in Transition Economies
 U.S. – living beyond its means by excessive borrowing from
abroad  resulted in huge capital inflows, overvalued dollar,
huge & unsustainable trade deficits & unstable financial
conditions.
 Europe – faces inflexible labor markets & Japan faces
inefficiencies in distribution system that slows their growth.
 Transition economies needs additional economic restructuring to
establish a full market economy & achieve rapid growth.
Inadequate growth in these areas dampens the growth of the
whole world economy  calls for protectionism.

 Challenge: How to avoid national and regional challenges

quickly from becoming global economic problems in this
interdependent world.
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5) Deep Poverty in Many Developing Countries
 Even though developing countries such as China
and India have grown rapidly, some of the poorest
developing countries (Sub-Saharan Africa) face
deep poverty and high foreign debt, economic
stagnation and widening international inequalities
in living standards.
 Challenge: How to stimulate growth to ↓
inequalities.

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6) Resource Scarcity, Environmental Degradation, Climate
Change and Unsustainable Development

 Economic growth in rich countries & development in

poor countries are now causing scarcity in resources,
environmental degradation, & climate change.
 Growing demand & supply rigidities  ↑ petroleum, raw
materials & food prices.
 Environmental pollution, destruction of the Amazon
forest & dangerous climatic changes  serious effect on
life.
 Challenge: Need joint efforts from sciences, world
cooperative effort & change in world governance to
solve the problems.
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Chapter 1 32