1.What Is International Economics About?

Goods and services flow across international borders. So do people. The effects of trade and migration
are part of international economics.

Residents of one country may borrow money from and lend money to residents of other countries. The
effects of this is also part of international economics.

Government policies of one country may affect other countries. This too is international economics.

2. What are the gains from trade?

That there are gains from trade is probably the most important insight in international economics.

Countries selling goods and services to each other almost always generates mutual benefits.

Trade benefits countries by allowing them to export goods made with relatively abundant resources and
import goods made with relatively scarce resources.

➢ When countries specialize, they may be more efficient due to the larger scale of production.

➢ Countries may also gain by trading current resources for future resources (international borrowing
and lending) and from international migration.

Trade is predicted to benefit countries as a whole in several ways, but trade may harm particular groups
within a country.

– International trade can harm the owners of resources that are used relatively intensively in industries
that compete with imports.

– Trade may therefore affect the distribution of income within a country.

a. When a buyer and a seller engage in a voluntary transaction, they are both usually better off.

Norwegian consumers import oranges that they would have a hard time producing in Norway.

b. How could a country that is the most (least) efficient producer of everything gain from trade?

Countries use finite resources to produce what they are most productive at (compared to their other
production choices), and then trade those products for what they want to consume.

Countries can specialize in production, while consuming a great diversity of goods and services through
trade.

3. What is the structure/pattern of trade? In other words, which goods/services are exported, and

which are imported? What are the fundamental laws that govern international allocation of

resources and the flow of trade?

The pattern of trade describes who sells what to whom. Differences in climate and resources explain
why Brazil exports coffee and Saudi Arabia exports oil. But why does Japan export automobiles, while
the U.S. exports aircraft? Why some countries export certain products can stem from differences in:

– Labor productivity

– Relative supplies of capital, labor and land and their use in the production of different goods and
services

4. Trade patterns for Vietnam

Strong outward-oriented (export-dependent) economy with trade in goods and services accounting for
more than 170% of GDP. Main exports: labour-intensive manufactures (clothing, shoes, electronics),
seafood, crude oil, rice, coffee, wooden products, machiner Main imports: Machinery and equipment,
petroleum products, steel, raw materials for clothing/shoe industry, electronics, plastic, automotives
Services remain the strongest sector, accounting for about 43% of GDP (but only 30% of employment)
Major services sectors: trade, finance, real estate, tourism

Firstly, Vietnam relies heavily on import and export activities to increase economic chief. It is forecasted
that in 2022, Vietnam can achieve import and export turnover about 780-800 billion US dollars, double
GDP, among the highest in the world gender. Such an open economy will be well-affected when the
global economy increases rapid growth, but will be negatively affected when the global economy
declines such as forecast for the next few years. Similar to China, Vietnam needs to reduce the rate
imports/exports/GDP by developing the share of the domestic economy, including including increasing
the localization rate of exports – so that growth is more stable.

Second, Vietnam's exports are highly dependent on the US market; accounts for about 30% of total
exports and is very disproportionate – US trade deficit with Vietnam has reached US$100 billion in 10
first month of 2022 compared to $90.8 billion for the whole of 2021. This increases the risk that the US
side will seek to increase tariffs or other measures other to reduce the large trade deficit for Vietnam. So
Vietnam It is necessary to take active measures to make trade relations with the US balanced as well as
developing other export markets, especially Asia Europe.

Third, Vietnam depends on China for imports (up to 110 billion VND). USD in 2021 or 33% of total
imports) – especially raw materials, equipment and spare parts needed for export processing. Vietnam
has The accumulated trade deficit is very large for China. If the input supply from China is interrupted for
whatever reason, industry and exports of Vietnam was greatly affected. Therefore, Vietnam also needs
to diversify its sources import.

Finally, Vietnam depends on a fleet of foreign merchant ships. About 90% of Vietnam's import and
export volume is transported by By sea – up to 24 million tons in 2021. Vietnam's merchant fleet The
South accounts for only 7% of the market share, and most of it depends on the leading companies
foreign sea. Therefore, Vietnam will be greatly affected if international freight rates increase high or not
have enough and timely ships due to the strong increase in world demand. Vietnamese Nam needs to
have a plan to build his fleet of ocean merchant ships, to meet at least 50% of the demand for
transportation of import and export goods.

5. What are the terms of trade?In other words, at what prices are the exported and

imported goods exchanged?

• ToT indicate changes in relative buying power of a country’s exports;

• Refer to a export basket compared to import basket;

• If export prices rises relative to import prices the ToT have improved; i.e. more import can be acquired
for each export unit

Definition: the price of export goods relative to import goods – relative prices

The terms of trade of a given country are a proxy for the benefits from trade to that country

Once a country is engaged in trade, any change in world market prices affects its terms of trade, its real
income and wealth.

Income Terms of Trade

The income terms of trade reflect the capacity to import goods – paid for with exports

An increase in the income terms of trade maysimply reflect an increased integration into theworld
economy

This measure does not capture the total capacity to import: capital transfer can also finance

Imports

In the long run, there will be a tendency for exports and imports to equalize – for exports to pay in full

for imports

7. Effects of Government Policies

If a government restricts trade, what are the costs if foreign governments respond likewise?

Trade policies are often chosen to cater to special interest groups, rather than to maximize national
welfare. Governments tend to adopt tariffs, then negotiate them down in exchange for reduction in
trade barriers of other countries.

8. What are the Consequences (Benefits and Costs) of International Trade?

a.Benefits of International Trade

Individuals
▪ Consumption of better quality products with lower prices

▪ Consumption of diverse products

Firms

▪ Greater business opportunities

▪ Greater profit

Nation

▪ Fast economic growth

▪ Job creation

b.Costs of International Trade

Individuals

▪ Loss of jobs employed in the less competitive industries

Firms

▪ Face stronger competition and may lose competitive edge

Nation

▪ Greater income disparity

▪ Possibility of environmental degradation in developing countries

▪Greater vulnerability to foreign shocks

9. Reasons countries trade goods with each other include:

❑Differences in the technology used in each country (i.e., differences in each country’s ability to

manufacture products)

❑Differences in the total amount of resources (including labor, capital, and land) found in each

country

❑The proximity of countries to each other (i.e., how close they are to one another)

10. Other sources of Gain from Trade

• Productivity (most productive firms expand and export)

• Returns to scale (small countries can support larger firms)

• Competition (monopolies in small countries lose market power)

• Variety (buyers can access more choices)

• Supply chains (firms source parts from cheapest sources)

• Technology (producers access foreign technologies)

11. Reasons for trade

a.Comparative Advantage

Absolute advantage is not a good explanation for trade patterns. Instead, comparative advantage is the
primary explanation for trade among countries.A country has comparative advantage in producing those
goods that it produces best compared with how well it produces other goods.

b.Absolute Advantage

When a country has the best technology for producing a good, it has an absolute advantage in the
production of that good.

12. Mercantilism

Economic philosophy in 17th and 18th centuries, in England, Spain, France, Portugal and the
Netherlands.

– Belief that nation could become rich and powerful only by exporting more than it imported.

The Mercantilists’ Views on Trade

– Export surpluses brought inflow of gold and silver.

– Trade policy was to encourage exports and restrict imports.

– One nation gained only at the expense of another.

– Economic philosophy in 17th and 18th centuries, in England, Spain, France, Portugal and the
Netherlands.

Mercantilism is not an organized body of thought. Schemes, plans, suggestions for policies to increase

national wealth Especially prominent from the 16th to the 18th century in Europe

The Montaigne fallacy: in trade, the gain of one person or country can only come at the loss of another
person or country

“No profit can possibly be made but at the expense of another.”

There is a fixed amount of trade, one country can only expand its share at the expense of other
countries’

Therefore, exports should be encouraged and imports discouraged

Population growth and a rich treasury could only come from prosperous industry and trade.

– This prosperity could be brought about if the economy’s stock of money (i.e., gold and silver coins) is
large.

– Assuming a state does not have gold and silver mines, the onlyway it would increase its stock of those
metals is if it exports more than it imports.

– As a result, ensuring a trade surplus for oneself and a trade deficit for one’s rivals is the primary
objective of economic policy.

– Tariffs and other import restrictions can be effective in reducing imports.

– Subsidies and regulation can be effective in increasing exports. Mercantilism suggests that it is in a
country’s best interest to maintain a trade surplus – to export more than it imports

Mercantilism advocates government intervention to achieve a surplus in the balance of trade

It views trade as a zero-sum game - one in which a gain by one country results in a loss by

another. Mercantilists measured wealth of a nation by stock of precious metals it possessed.

Government intervenes to achieve a surplus in exports

– King, exporters, domestic producers: happy

– Subjects, others people: unhappy because domestic goods stay expensive and of limited variety

The Economic doctrine: in which government intervention of foreign trade is of paramount importance
for ensuring the prosperity and security of the state.

13. What are the methods to achieve the surplus in Exports?

To encourage exports:

• Export subsidies, encourage manufacturing, subsidize national shipping (navigation acts)

To discourage imports:

High tariffs on manufactured goods

Colonies for raw materials (and later: captive markets)

Bullion regulations:
– Prohibition of export of bullion, central government monopoly

– Sophisticated mercantilists realized such regulations self- Defeating

14. Consequences of Mercantilism

- Gain to privileged merchants

- Greater government control and direction of the economy Colonialism

- Corruption: merchants used bribes and similar means to gain subsidies, protection for their specific
interests

- Inefficient factor allocation leading to overall reduction in prosperity

- Many policies self-defeating: you cannot permanently increase your exports without eventually having
greater imports

- Bullionism self-defeating (price-specie flow mechanism)

15. Drawbacks of mercantilism theory or Neo-Mercantilism theory

- Mercantilism weakens a country

- Restrictions on free trade decreases country’s wealth

- Overlooks other factors such as natural resources, manpower and its skill level, capital

- Restrictive Policies promoting exports and restrict import creating trade barriers

-Comonial Exploitation.

16. Criticism of Mercantilism Theory

• Mercantilism is a philosophy of a zero sum game - where people benefit at the expense of others. It is
not a philosophy for increasing global growth and reducing global problems.

Also, increasing other peoples wealth can lead to selfish benefits, e.g. growth of other countries,
increases markets for our exports. Trying to impoverish other countries will harm our own growth and
prosperity.

Mercantilism which stresses government regulation and monopoly tends to lead to inefficiency and
corruption.

• Mercantilism justified Empire buildig and the poverty of colonies to enrich the Empire country.

17. Wealth of Nations

The causes of economic progress and the creation of wealth was Adam Smith’s main topic
of interest

– David Ricardo, by contrast, focused on how wealth is shared among different groups in society

According to Smith, the wealth of a nation derives from the level of the technology in use.

The level of technology and its rate of improvement depend on the division of labor.

18. Definition “absolute advantage”:

The advantage in the production of a productenjoyed by one country over another when ituses fewer
resources to produce thatproduct than the other country does

➢ A country

– Should specialize in production of and export products for which it has absolute advantage; import
other products

– Has absolute advantage when it is more productive than another country in producing a particular
product

Example:

Suppose country A and country B produce wheat, but that A's climate is more suited to wheat and its
labor is more productive.

Country A will therefore produce more wheat per acre than country B and use less labor in growing it
and bringing it to the market.

Country A thus enjoys an absolute advantage over country B in the production of wheat.

Example: If US uses 15 hours of labor to produce one unit of tomatoes and Mexico uses 10 hours to
produce the same amount of tomatoes, Mexico has absolute advantage in the production of tomatoes.

Example: Source of Advantage

– Canada is efficient in growing wheat, inefficient in growing bananas.

– Nicaragua is efficient in growing bananas, inefficient in growing wheat.

– Canada has absolute advantage in wheat, Nicaragua has absolute advantage in bananas.

– Mutually beneficial trade can take place if both countries specialize in their absolute advantage.

19. Role of Government

As one might expect from Smith’s conviction that markets were extremely efficient, he was in favor of a
government that did not hamper the working of the market.

However, Smith emphasized the fact that the government should

– maintain law and order,

– ensure the defense of the nation from foreign enemies,

– erect and maintain public works that private citizens would not build,

– Subsidize education for those who could not afford it, and

– Regulate international trade when free trade endangers ‘infant industries’ or compromises national
security

20. Absolute Advantage: Numerical

Example

After opening up to trade, both countries completely focus on their absolute advantages

The foreign country ́s (home country ́s) labor completely shifts towards producing food (clothing), which
has a higher value when exported abroad. The foreign country (home country) imports clothing (food)
which is cheaper abroad

Assuming that both countries completely specialize in their absolute advantage the international prices
must be somewhere in the range: - 0.5 ≤ international price of 1 unit of food ≤ 2.5 and - 2 ≥ international
price of 1 unit of clothing ≥ 0.4. Both countries gain by trade and specialize according to their absolute
advantages. The other commodity can be imported at a lower price than before trade Both countries
gain by reaching a higher utility than in autarky

16. Principle of comparative advantage

– Even if a nation has an absolute cost disadvantage in the production of both goods

The less efficient nation

– Specialize in and export the good in which it is relatively less inefficient

Where its absolute disadvantage is least

The more efficient nation

– Specialize in and export that good in which it is relatively more efficient

Where its absolute advantage is greatest

Definition “comparative advantage”: The advantage in the production of a product enjoyed by one
country over another when that product can be produced at lower cost in terms of other products
(Opportunity Cost) than it could be in the other country.
Country should specialize in the production of those goods in which it is relatively more productive...
even if it has absolute advantage in all goods it produces

20. Sources of Comparative Advantage

– Countries’ comparative advantage comes from:

Accumulated Physical and Human Capital Difference in cultures & social institutions

Dynamic comparative advantage – “learning by doing” which develops industry specific expertise

– “Infant Industry” argument for tariffs & subsidies Difference in natural resources, topography, climate
may play an initial role – but acquired advantages dominate differences in initial conditions

Technological change and governmental policies

China – workforce/technology

Canada – resources

Alberta – oil

India – technology/skilled people

Mexico – greenhouse/climate

New Zealand – sheep

Vietnam ? ? (Rice, Coffee)

21. The Gains from Trade

Each country is able to consume at a point that lies beyond its ppc, reflecting the greater productivity
under international division of labour

The gains from trade for each country depends on its terms of trade: the relative price of its exports in
terms of its imports

International trade affects production, as each country specializes

And it affects consumption, as the price of imported goods decline, resulting in higher consumption of
these (substitution effect)

It also increases real incomes, so consumers tend to buy more of each product (income effect)

22. Historical Development of Modern

Trade Theory

Principle of comparative advantage

– Even if a nation has an absolute cost disadvantage in the production of both goods

The less efficient nation

– Specialize in and export the good in which it is relatively less inefficient

Where its absolute disadvantage is least

The more efficient nation

– Specialize in and export that good in which it is relatively more efficient

Where its absolute advantage is greatest

23. Implications of comparative advantage

Policy of Laissez-faire (law of free market) still holds

Gains need not be equal

Hours of work traded need not be equal but the advantage still exists

Trade is based on the existence of relative – not absolute – production advantages

24. Ricardian Model Theory

Countries have comparative advantage in producing different goods and hence they can get

mutual benefits from trade

–This is because countries differ from each other. The more different they are, the larger the (potential)
benefits from trade

Trade makes both countries better off.

3 ways to conceptualize it:

• indirect production

• expanded consumption

• conservation of resources ??

25. Gain from Trade in General

Sources of Gain From Trade:

– Most sources of gain are analogous to how individuals gain from trade

– Comparative advantage focuses on

- Differences in ability to produce goods

– Other sources of gain, not in this model

+ Differences in tastes

+ Economies of scale

27. What trade does not do :

– Trade does not help everybody

There are losers from trade

– (We’ll see later in the course who they are)

– Trade does not reduce inequality

At least not necessarily; it could, in some cases

But there are also good reasons why it may increase inequality

– Trade may not cause countries to grow faster (There is debate on that)

– Trade certainly does not fix all problems

Weak or corrupt government

Failure to save

Poor technology

(Look at some developing. It gains from trade, but it is still very

poor.)

28. What are the ultimate determinants of comparative advantage?

Ricardo did not bother to answer this question.

• He just assumed that the differences in comparative advantage depended on

comparative difference in labor productivity (that is, differences in technology), but he did not explain
the basis for these differences. Implicit reason in his example was climate...
• It remained to Heckscher and Ohlin to offer an explanation for comparative advantage.

29. Heckscher-Ohlin Model

In addition to differences in labor productivity, trade occurs due to differences in resources across
countries.

The Heckscher-Ohlin theory argues that trade occurs due to differences in labor, labor skills,physical
capital, capital, or other factors ofproduction across countries.

– Countries have different relative abundance offactors of production.

– Production processes use factors of production with different relative intensity.

This is a modern development of the Ricardian theory

Introduced by two Swedish economists: Eli Heckscher and Bertil Ohlin, in the first part of the 20th
century Heckscher was a famous economic historian, Ohlin economist and politician and later Nobel
laureate Ohlin’s formulation:

“Commodities requiring for their production much of [abundant factors of production] and little of
[scarce factors] are exported in exchange for goods that call for factors in the opposite proportions. Thus
indirectly, factors in abundant supply are exported and factors in scanty supply are imported.”

A country exports the product that uses its relative abundant factor(s) intensively and imports the
product that uses its relatively scarce factor(s) intensively

A country is relatively labour-abundant if it has a higher ratio of labour to other factors than does the
rest of the world

A product is relatively labour-intensive if labour costs are a greater share of its value than they are of the
value of other products

30. Heckscher-Ohlin Model Basic Model Assumptions :

1. Two countries, two (homogeneous) goods and two (homogeneous) factors of production

2. Identical technology, different factor endowments

3. Constant returns to scale

4. Different factor intensities in production

5. Factors perfectly mobile inside each country and

immobile between the countries

6. (Identical preferences among everyone)

7. Perfect competition in all markets:

→ (price of labour) w = MPPL*P, (price of capital) r = MPPK*P

8. (No transportations costs)

31. What are the ultimate determinants of comparative advantage?

A country has comparative advantage in those commodities that use its abundant factors intensively.
This is why labor-abundant countries, such as India and China export footwear, rugs, textiles, and other
labor intensive commodities; and land-abundant countries, such as Argentina, Australia, and Canada,
export meat, wheat, wool, and other land- intensive commodities.

32. Model based on two concepts:

1. Factor endowments—the quantities of productive resources possessed by a country

2. Factor intensity—the amount of labor per unit of capital used in production of a product

33. Relative Factor Availability

Relative factor availability is key

If wheat is land-intensive and the U.S. has a relatively greater supply of land than the rest of the world,
then it will tend to export wheat

U.S. land supply/U.S. labour supply > rest of the world’s land supply/rest of the world’s labour supply

That is, there are more hectares of usable land per worker in the U.S. than elsewhere. This is what gives
U.S. wheat production a comparative advantage

34. Factor Endowments:

Countries differ in their relative factor endowments

Notation: K=capital, L=labour, r = price of capital, w = price of labour

Physical definition: (K/L)1 > (K/L)2  country 1 is capital-

abundant (labour-scarce), country 2 is labour-abundant (capital-scarce)

Price definition: (r/w)1 < (r/w)2  country 1 is capital-abundant, country 2 is labour-abundant

Given assumptions of perfect competition + identical technology and preferences, the physical and price
definitions are identical

Factor abundance versus factor scarcity: When a country enjoys a relative abundance of a factor, the
factor’s relative cost is less than in countries where the factor is relatively scarce
❑ A country’s comparative advantage lies in the production of goods that use relatively abundant
factors

❑ Relative price levels differ among nations because:

❑ Nations have different relative endowments of factor inputs {labor (skilled or unskilled)}, land,
capital.

35. Factor intensity

The nations differ in that one is relatively labor abundant while the other is relatively capital abundant.

Further, the commodities produced differ in factor intensity.

– Factor intensity is determined by the ratio of capital (K) to labor (L) required for the production of the
commodity.

▪ Different commodities require factor inputs with differing intensities of production.

▪ Wheat is land intensive

▪ Textiles are labor intensive

▪ Aircraft are capital intensive

Example US vs Mexico

For example, the U.S. has more of both labor and capital than Mexico, but the quantity of capital
advantage in the U.S. over Mexico is greater than the quantity of labor advantage in the U.S. over
Mexico. The U.S., therefore, is capital abundant and Mexico is labor abundant.

35. Heckscher-Ohlin Theorem with a Single Technique:

• The structure of trade, in general, can be traced back to differences in factor endowments, technology,
and tastes.

• Since Heckscher-Ohlin theory assumes that technology and tastes are similar between countries, it
attributes the comparative advantage to differences in factor endowments.

In summary, the capital-abundant country exports the capital-intensive commodity, and the labor-
abundant country exports the labor- intensive commodity.

36. Country will export the commodity that uses relatively intensively its relatively abundant factor of
production

example: China is labour-abundant and Finland is capital-abundant i.e. (K/L)H < (K/L)F and (r/w)H >
(r/w)F
→ China exports labour-intensive products (e.g. clothes) to Finland and imports capital- intensive
products (e.g. paper) from Finland

In summary, France, the capital-abundant country exports Airplane the capital-intensive

Product (i.e import coffee, labor-intensive commodity) , and Vietnam the labor-abundant country
exports Coffee ,the labor-intensive commodity.

37. Factor endowments:

The EU is richly endowed with a wide variety of factors: natural resources, skilled labor, and physical
capital

– Expectation: The EU will export agricultural products (particularly those requiring skilled labor and
physical capital) and machinery and industrial goods (requiring physical capital and scientific and
engineering skills)

– Result: Major EU exports include grain products made with small labor and large capital inputs; and

commercial aircraft made with physical capital and skilled labor

38. Free Trade Equilibrium Pattern of Trade

Home exports computers, the good that uses intensively the factor of production (capital) found in
abundance at Home.

• Foreign exports shoes, the good that uses intensively the factor of production (labor) found in
abundance there.

• This important result is called the Heckscher-Ohlin theorem.

39. Why is the H.O. model called the factor-proportions theory?

The H-O theory is also known as the factor- proportions theory or factor-endowment theory.

A nation will export the product that uses its most abundant factor intensively.

The H-O model explains comparative advantage in terms of the factor abundance of nations and the
factor intensity of commodities.

Heckscher-ohlin theorem

In H-O model, 2 countries (A, B) share the same technology and preferences (iso-utility curve)

The only difference is factor abundance Assume A is relatively capital abundant and B is relatively labour
abundant Country A is capable of producing more capital intensive good (good 1) and country B is
capable of producing more labor intensive good (good 2) ➔ Different PPF shape