INTERNATIONAL ECONOMICS XU SONG PROFESSOR OF ECONOMICS ANHUI UNIVERSITY OF FINANCE & ECONOMICS

1. INTERNATIONAL ECONOMICS XU SONG PROFESSOR OF ECONOMICS ANHUI UNIVERSITY OF FINANCE & ECONOMICS

2. ANHUI UNIVERSITY OF FINANCE & ECONOMIC Dept. of Int’l Trade and Economics & Business School XU SONG Prof. of Economics Office: 2nd Floor (West wing), Building 4 Office Hour: Every Afternoon 2:00－5:00 Tel: 3128117(O)

3. 1.1A Books on International Economics Dominick Salvatore: International Economics 7th Ed. 2001 Prentice-Hall, Inc. & Tsinghua University Press Paul R. Krugman & Maurice Obstfeld International Economics Theory and Policy 5th Ed. 2000 Addison Wesley Longman & Tsinghua Uni. Press Dennis R. Appleyard & Alfred J. Field. Jr.. International Economics 4th ed. 1998 The McGraw-Hill, Inc. & China Machine Press Robert J. Carbaugh:International Economics 6th ed. 1998 The McGraw-Hill, Inc. & Dongbei Uni. of Finance and Economics Press

4. Dr. Dominick Salvatore Professor at Fordham University of New York City

5. 1.1B Contents of the Book 21 Chapters Part One:International Trade Theory Part Two: International Trade Policies Part Three: Balance of Payments and Exchange Rates Part Four: Open-Economy Macroeconomics and the International Monetary System

6. 1.1C Contents of Each Chapter Six Sections in the text Summary ----- 6 paragraphs A Look Ahead--- What is to be discussed in the next chapter. Key Terms Questions for Review----13 Questions Problems---- 13 Problems. Appendix----- More advanced knowledge.

7. 1.2A What Is International Economics? It deals with the economic interdependence among nations. It analyzes the flow of goods and services, payments between nations, policies regulating the flow and their effects on national welfare. International trade International trade theory International trade policy International Finance Foreign exchange markets Balance of payments Open economy macroeconomics

8. 1.2B International Trade and Policy International trade theory ------- analyzes the basis for and gains from trade (The forces that give rise to trade between nations. List some.) (Increase in consumption from specialization.) International trade policy --------examines the reasons for and the effects of trade restrictions and new protectionism. (Tariff, quotas, license, advanced deposits on imports, government procurement, restrictions, technical barrier, environmental barrier, social accountability, ISO …...)

9. 1.2C International Finance Foreign exchange markets ----- describes the frameworks for the exchange of one national currency for another. We exchange RMB for dollars. Balance of payments ----- measures nation's total receipts from and total payments to the rest of the world. For example, we try to achieve trade balance. Open economy macroeconomics ------ deals with the mechanisms for adjustment in balance of payments disequilibria (国际收支失衡调整机制)as well as the effects of the macroeconomics interdependence (宏观经济互相依存性)among nations under different international monetary system, and their effects on a nation's welfare.

10. 1.2D Purpose to Study International Economics To predict and explain the economic events in the world. To examine the basis for and gains from international trade. To examine the reasons for and the effects of trade restrictions. To understand what is gong in the world and their effects on the world economy. To have a better job!!! Why ? ( Because this knowledge is needed in MNCs, banking and government organizations. )

11. Why ? 1.3A Assumptions in International Trade • 2×2×2 model • No trade restrictions • Perfect mobility of factors within nations and not • internationally • Perfect competition • No transportation costs Answer: It is easier to study international economics. What would happen if we relax these assumptions? Most of our conclusions can still hold. For example, more than 2 nations and more than 2 production factors.

12. What is foreign trade dependency? What is the purpose? How to measure it? 1.3BForeign Trade Dependency ---------The ratio of imports and exports of goods and services of a nation to its GDP. What nations have the higher degree of foreign trade dependency? What is the trade dependency in China? Why is it like this? Why is international trade very important to a nation? A nation can not survive without foreign trade, such as Japan, Germany, Belgium and others.A nation can not produce all the products it needs, for example that US can not produce coffee, cocoa, tea, scotch and other products, they don't have the materials. The economies of all nations are closely related to each other. To improve the standard of living.

14. 1.4A China GDP and Foreign Trade Dependency Data source:China Customs

15. 1.4B Reasons for the High Dependency GDP is smaller than it should be. Many values created are not included in the GDP. For example, the pigs, cattle and some others in the countryside are not included. The real GDP is much higher, three times higher than it is. Processed products take up too much percentage in the exports. In the last several years, the value of processed goods is more than 50% in the exports. RMB was depreciating all the years before 1994. In 1984, the exchange rate was US$1.00 for ￥2.32. In 1990, it was USD1.00 for ￥4.72. In 1994, USD1.00 for ￥8.62. What will happen in the future to China trade dependency ?

16. 1.4C Foreign Trade Dependency in Some Nations

17. 1.5A Basic International Trade Data

18. 1.5A Basic International Trade Data(2)

19. 1.5A Basic International Trade Data(3)

20. 1.5A Basic International Trade Data(4)

21. 1.5A Basic International Trade Data(5)

22. 1.6 Some Questions 1. Import/GDP has _______in recent years. (risen, fallen, remained steady) (From 15.7 % in 1997 to 23.9 % in 2002.) 2. Export/GDP has _______in recent years. (risen, fallen, remained steady) (From 20 % in 1997 to 26.4 % in 2002.) 3. Which nation is our largest trading partner? ( Japan:133.57 billion dollars in 2003 ) 4. Which is the second largest trading partner? ( U.S. 126.33 billion dollars in 2003 )

23. 1.6 Some Questions (2) 1.The purpose of trade is to_______. a. improve consume well-being. b. create jobs. 2. Work is a ________. a. cost b.benefit 3. Exports are ________. a. cost b.benefit 4. The objective of international trade is to __________. a. get goods cheaply b.create jobs 5. NAFTA has had a greatest impact on the _____ of U.S. a. inflation rate b.unemployment rate ( All of “a” are correct. They are consistent with standard economic theory. All of “b” are wrong, but they are consistent with old economic theory. ) International economics is not always what you think it is!!! 1. People trade to improve their well-being. Creating jobs is a means to an end. 2. Would you like to work for free? 3. Exports: you make it but don’t consume it. 4. Trade is great at cost-cutting but no net impact on jobs. 5. NAFTA reduces goods prices.

24. THANK YOU !

25. Chapter 2The Law of Comparative Advantage

26. In this chapter, we will examine the development of trade theory from the 17th century to the first half of the 20th century. This historical approach is useful not because we are interested in the history of economic thoughts but because it is a convenient way of introducing the concepts and theories of international trade from the simple to the most complex and realistic. 2.1 Introduction We will use 2X2X1 model and start from absolute advantage, to comparative advantage and to opportunity costs and production possibility frontiers.

27. Mercantilism ---- Some people wrote articles on international trade. Their philosophy was known as mercantilism. 2.2 Mercantilists’ Views on Trade Representative ----- Thomas Munn (1571-1641) Works ---- England’s Treasure by Foreign Trade Wealth: The way for a nation to become rich and powerful was to export more than it imported. The resulting surplus would then be settled by an inflow of bullion. The more gold and silver a nation had, the richer and more powerful it was. What kind of policy should be adopted? The government had to do all in its power to stimulate the nation’s exports and discourage and restrict imports. What is the nature of the trade? One nation could gain only at the expense of other nations. It is called a zero-sum game.

28. 2.2b Different Views on National Wealth Mercantilists attached importance to bullion. But today we pay attention to the stock of human resources, man-made and natural resources available for producing goods and services. The greater this stock of useful resources, the greater is the inflow of goods and services to satisfy human wants and the higher the standard of living in the nation.

29. 2.2c Purposes of Mercantilists’ Trade Theory To maintain larger and better armies with more gold and silver and consolidate their power at home; To acquire more colonies with improved armies and navies; To do more business with more money; To stimulate national output, develop national economy and increase employment.

30. The basis for trade ----------- Absolute advantage 2.3 Adam Smith’s Trade Theory If one nation is more efficient than another nation in the production of one commodity, the nation has absolute advantage in that commodity. The pattern of trade ------- both nations can gain by each specializing in the production of the commodity of its absolute advantage and exporting part of its output with the other nation for the commodity of its absolute disadvantage. Policy: Free trade policy should be adopted to make better use of resources and maximize world welfare.

31. 2.3b Where Do the Gains Come From? By specialization, resources are utilized in the most efficient way and the output of both commodities will rise. The increased output measures the gains from specialization in production available to be divided between the two nations through trade.

32. 2.3d Difference Between Mercantilists & Adam Smith According to mercantilists’ view, one nation could only gain at the expense of another nation and each government should take strict control of all economic activities and trade. They should adopt protectionist measures to stimulate exports and restrict imports. But according to Adam Smith, all nations could gain from free trade and each nation should adopta laissez-faire policy (free trade policy).

33. 2.3e Illustration of Absolute Advantage U.S. has greater efficiency in production of wheat (absolute advantage) and it should specialize in the production of wheat and exchange for cloth , while U.K. has greater efficiency in production of cloth and it should specialize in the production of cloth and exchange for wheat (absolute advantage). What happens if U.S. exchanges 6W for 6C with U.K.?

34. Can we use the theory to carry out foreign trade? 2.3f Comments on the Absolute Advantage It can only explain small part of world trade today, but it can not explain most of the trade between the developed and the developing countries. It can not even explain the trade between advanced countries because their productivities are almost the same.

35. 2.4a The Law of Comparative Advantage Representative ----- David Ricardo (1772-1823) Works ---- Principles of Political Economy and Taxation It explains how mutually beneficial trade can take place even when one nation is less efficient than ( has an absolute disadvantage) the other nation in the production of all commodities. The less efficient nation should specialize in and export the commodity in which its absolute disadvantage is smaller (this is the commodity of its comparative advantage), and should import the other commodity.

36. 2.4b Illustration of Comparative Advantage What should U.S. or U.K. produce? At what rate should they exchange their commodities?

37. 0C 8 C 6W:4C 2.4c Gains from Trade 2C 6 C 6W:6C 6W:8C 4C 4 C 6W:10C 6C 2C 8C 0C 6W:12C Trade range: 4C<6W<12C Rate of Exchange U.S. Gains UK Gains Conclusion: The closer the rate of exchange is to 4C=6W, the smaller is the share of the gain going to the United States and the larger is the share of the gain going to the United Kingdom. On the other hand, the closer the rate of exchange is to 6W=12C, the greater is the gain of the United States relative to that of the United Kingdom.

38. 2.4d Exception to Law of Comparative Advantage Even if one nation has an absolute disadvantage with respect to the other nation in the production of both commodities, there is still a basis for mutually beneficial trade, unless the absolute disadvantage is in the same proportion for the two commodities. This kind of exception is rare.

39. 2.4e How Can They Trade? How can they trade if one nation is in absolute disadvantage in the production of both commodities? They can still trade when the wage is sufficiently lower in one nation than it is in the other nation and when both commodities are expressed in terms of the same currency. Exchange rate: ￡1.00=$2.00 $6 per hour ￡1 per hr in U.S., in U.K.,

40. 2.4f Price of Wheat and Cloth in U.S. & U.K. Exchange rate: ￡1.00=$1.00 U.S.cannot export wheat to U.K. But U.K. can continue to export cloth to U.S. The trade will become unbalanced. The dollar price of pound will have to rise to ￡1.00=$2.00, instead of ￡1.00=$1.00. Exchange rate: ￡1.00=$3.00 U.K.can’t export cloth to U.S. But U.S.can continue to export wheat to U.K. The trade becomes unbalanced. The dollar price of pound has to fall to ￡1.00=$2.00, instead of ￡1.00=$3.00.

41. 2.5 Assumptions for Comparative Advantage 2×2model-----Two nations, two commodities and one factor Free trade. Perfect mobility of labor within each nation but immobility between the two nations. Constant costs of production. No transportation costs No technical change The labor theory of value.

42. It is the amount of a second commodity that must be given up in order to release enough resources to produce one additional unit of the first commodity (comp. cost stresses the opportunity cost). 2.5b The Opportunity Cost Theory The nation with lower opportunity cost in the production of a commodity has a comparative advantage in that commodity and a comparative disadvantage in the second commodity. Opportunity Costs of Wheat in Terms of Cloth 1W 2/3C 1W 2C Opportunity Costs of Cloth in Terms of Wheat 3/2W 1C 1/2W 1C

43. It is a curve showing the various alternative combinations of two commodities that a nation can produce by fully utilizing all of its resources with the best technology available to it. 2.5c Production Possibility Frontier

44. 2.5d Production Possibility Schedules for Wheat and Cloth in U.S. & U.K.

45. 2.5e PPF in U.S & U.K

46. Each point on a frontier represents one combination of wheat and cloth that the nation can produce. 2.5f Features of PPF Points inside the PPF are possible, but are inefficient. It means that the nation has some idle resources or it is not using the best technology available to it. Points outside the PPF are not possible because the nation does not have enough resources to produce at those points. The downward slope of the PPF indicates that when it wants to increase the production of the first commodity, it has to give up the second commodity The straight line reflects the fact that the opportunity cost is constant----constant opportunity costs.

47. 2.5g Constant Opportunity Costs It means that the constant amount of a commodity must be given up to produce each additional unit of another commodity. We have constant opportunity cost when (1) resources or factors are either perfect substitutes for each other or used in fixed proportion in the production of both commodities; (2) all units of the same factor are homogeneous or exactly the same quality. Realistic?

48. It shows the combination of consumption that the nation actually chooses to consume. In the absence of trade, the production possibility frontier is also the consumption frontier. 2.5h Consumption Frontier

49. 2.6 Basis for and Gains from Trade under Constant Costs Before trade: U.S. produces at Point A and consumes at point A( 90W and 60C); U.K. produces at Point A’ and consumes at point A’(40W and 40C). Total output & consumption: Wheat=90W+40W=130W Cloth=60C+40C=100C With trade: U.S. produces at Point B (180W), exchanges 70W for 70C with U.K. and consumes 110W & 70C (gain 20W and 10C) ; U.K. produces at Point B’(120C), exchanges 70C for 70W with U.S. and consumes 70W & 50C (gain 30W and 10C) . Total consumption: Wheat=110W+70W=180W Cloth=70C+50C=120C

50. It is the price of one commodity divided by the price of another commodity. This equals the opportunity cost of the commodity and is given by the absolute slope of the production possibility frontier (sometimes it is called marginal rate of transformation). 2.6b Relative Prices and Comparative Advantage Relative Price of Wheat: PW/ PC =2/3 in U.S. , Pw/ Pc =2/1 in U.K. Relative Price of Cloth: PC/ Pw =1.5 in U.S. , Pc/ Pw =0.5 in U.K. A nation has a comparative advantage if the relative price of a commodity is lower than that in the other nation. Opportunity Cost = Relative Price＝MRT