Embrace International Economics: Understanding Definitions, Theorems, and Theories

1. Welcome to EC 382: International EconomicsBy:Dr. Jacqueline Khorassani Week Three

2. Week Three: Class One • Tuesday, September 1814:10-15:00AC 202 • I ordered 5 copies of the textbook for the library • I did not receive any questions from you on Study Guide 3 • If you don’t ask, I assume you know • Expect an in class assignment tomorrow

3. Definitions • Brazil is more Capital abundant than China if K/L in Brazil>K/L in China

4. Definition • Production of computers is more capital intensive than production of shoes if • Production of computers requires a higher K/L than production of shoes.

5. Factor-Proportions Theorem • Given a set of assumptions (outlined on page 62 of your book, ask me if you don’t understand the assumptions) • Brazil has comparative advantage over China in production of computers if • Production of computers is relatively capital intensive and • Brazil is a relatively capital abundant nation

6. Now let’s work through an example • K/L in US =1/2 • K/L in Germany = 1/1 • Which nation is labor abundant? • US, because it has a higher L/K ratio • According to Factor-Proportions Theorem, US has comparative advantage in production of goods and service that are ______ intensive. Labor

7. Now let’ continue with the example • Pre-trade, which nation has a higher (Wage/price of capital) ratio? • Germany • Because labor is relatively more scarce in Germany • Suppose (W/price of capital) ratio in Germany = 5/5=1 • Suppose (W/price of capital) ratio in US = 2/4 = 0.5

8. After trade • US will specialize in production of ______ intensive goods and services. • Production of labor intensive goods in US will _______ while production of capital intensive in goods in Germany will______. Labor increase increase

9. What does this do to demand for labor? For capital in US? Wages? Price of capital? • Demand for labor in the US will go _____. • Wage will go __________ • from 2 to 2.5. • Demand for capital in the US will go __________. • Price of capital will go __________ • from 4 to 3.5. up up Down Down

10. The opposite happens in Germany • Wage will go down from 5 to 4.2 and the price of capital will go up from 5 to 5.9 • Eventually, W/price of capital in both nations will be the same. • 0.71 • This is referred to as factor-price equalization

11. Summary of ratios

12. Suppose Germany is labor scarce and capital abundant • According to Factor Proportions Theory, Germany is likely to have comparative advantage in ________ intensive goods • Germany will specialize in production of ______ intensive goods. Capital Capital

13. down • Production of labor intensive goods in Germany will go _______ while production of capital intensive in goods in Germany will go ______. up

14. What does this do to demand for labor? For capital in Germany? • Demand for labor will go down, • Income of labor will go down. • Demand for capital will go up, • Income of the owners of the capital will go up • This is the Stopler-Samuelson Theorem

15. Is US capital or labor abundant? • Capital abundant • According to Factor-Proportions Theorem, US must be exporting ________ intensive goods and importing _________intensive goods. • Leontief fund that US industries with trade surplus were more labor intensive than US industries with trade deficits  Paradox Capital Labor

16. How do you explain the paradox? • Some goods are land (natural resource) intensive (not the same of capital intensive) • Protectionism • Physical/human capital • Technology intensive goods • How about when we import and export the same goods?

17. Definitions • Specific factors of production can’t move between production of cars and bread • Examples? • Mobile factors of production can move between production of cars and bread • Examples?

18. The Specific-Factors Model • If the U.S. is well endowed with the specific factor used to produce cars, it will have comparative advantage in production of cars.

19. International Economics • Week Three- Class 2 • Wednesday, September 19 • 11:10-12:00 PM • Tyndall

20. I received questions • Is it ok to use capital abundant in place of capital intensive? • No, they mean different things • Would you penalize one for using rent as price of capital. • No but I did not use the term rent because • In economics price of capital is interest rate • Rent is price of land (natural resources)

21. I received a question on Table 3.4, Page 69 • Over the years, • Per capita GDP has grown more sharply in South Korea than in India • The ratio of capital to worker has gone up more sharply in South Korea than in India • Degree of openness (measured by (imports + exports)/GDP) has grown more sharply in South Korea than in India.

22. I received a request • To not give you an In Class Assignment today • Sorry, can’t do, because • If you don’t keep up with class, after a while you will not benefit from the class • It is better to learn a little at the time. • Most of this material builds upon the previous stuff • At the end of semester, I will drop the bottom one or two assignment from the course grade.

23. In Class Assignment • I will show you 3 multiple choice questions • On 1/2 sheet of a paper • Print your name • And put your answers down

24. Question 1 • If Dutch labor can produce 3 soda pops in a day or 5 yogurt cones in a day, while British labor can produce 2 soda pops and 4 yogurt cones, then __________ has a comparative advantage in yogurt cones. • A) England • B) both England and the Netherlands • C) the Netherlands • D) There is not enough information to answer this question.

25. Question 2 • Which of the following is not a factor of production that the U.S. is abundant in? • A) human capital • B) unskilled labor • C) skilled labor • D) physical capital

26. Question 3 • International trade tends to: • A) have no effect on factor prices. • B) cause the price of the scarce factor to rise and the price of the abundant factor to fall. • C) cause all factor prices to fall. • D) cause the price of the scarce factor to fall and the price of the abundant factor to rise.

27. Definitions (Chapter 4) • Intra-industry trade: Export and import within the same industry or product group. • Example • Inter-industry trade: Some industries export and others import. • Example

28. Can factor proportions theory explain the Intra-industry trade? • No • Because that implies that a nation has comparative advantage as well as comparative disadvantage in production of the same product

29. What is the Intra-industry Trade Index? • It is used to compare different industries based on their amount of intra-industry trading • X value of exports • M value of imports

30. Example • US imports $100,000 worth of autos and exports 30,000 worth of autos. What is ITI in the US auto industry? • ITI = 1- (70,000/130,000) = 0.46

31. What if ITI was zero? • Country is either only exporting or only importing • No intra-industry trade • How can ITI be 1? • The country’s exports = its imports • 100% intra-industry trade

32. Weaknesses of ITI • Values of intraindustry trade depend on how a particular industry or product group is defined. • More broadly defined groups will show more intraindustry trade. • Example: pants • More narrowly defined groups will show less intraindustry trade. • Example: dress pants and jeans

33. Definitions • Homogenous goods are those that are identical (consumers can not differentiate between them) • Examples • Differentiated goods are those that are similar but not identical • Examples

34. Why is there intraindustry trade in homogeneous goods? 1. Location • Transportation cost • It is cheaper for City X to import cement from County A than buy it from City Y • City Y will exports cement to Country C • B imports and exports cement Country A City Y County C City X Country B

35. International Economics • Week Three- Day 3 • Wednesday, September 19 • 15:10-16:00 • AC 201 • Let’s review this morning’s ICA

36. ICA1: Question 1 • If Dutch labor can produce 3 soda pops in a day or 5 yogurt cones in a day, while British labor can produce 2 soda pops and 4 yogurt cones, then __________ has a comparative advantage in yogurt cones. • A) England • B) both England and the Netherlands • C) the Netherlands • D) There is not enough information to answer this question. • Answer: A • Opportunity cost of 1 yogurt in England =2/4= 0.5 sodas • Opportunity cost of 1 yogurt in Netherlands = 3/5 = 0.6 sodas

37. Question 2 • Which of the following is not a factor of production that the U.S. is abundant in? • A) human capital • B) unskilled labor • C) skilled labor • D) physical capital • Answer: B

38. Question 3 • International trade tends to: • A) have no effect on factor prices. • B) cause the price of the scarce factor to rise and the price of the abundant factor to fall. • C) cause all factor prices to fall. • D) cause the price of the scarce factor to fall and the price of the abundant factor to rise. • Answer: D

39. Why is there intraindustry trade in homogeneous goods? 2. Joint products • Country A imports goods + insurance (service) • Country A exports other goods + insurance (service)

40. Why is there intraindustry trade in homogeneous goods? 3. Entrepot trade • A computer producer in country X has a worldwide distribution center in country Y Y imports and exports the same computers Country X Country Y

41. Why is there intraindustry trade in homogeneous goods? 4. Re-export trade. • Goods are imported into a country, and sometime later the same goods are subjected to a small transformation and exported to another country. • Example: Goods are imported, sorted, repackaged and exported to another country to the Far East.

42. Explanations of Intraindustry Trade in Homogeneous Products 5. Seasonal items • Country A may only produce strawberries in summer • Export strawberries in summer • Import strawberries in winter

43. Types of differentiated products • Horizontallydifferentiated products have the same price but slightly different characteristics • Examples? • Candy bars

44. Types of differentiated products 2. Vertically differentiated products have different prices and different characteristics • Examples? • autos

45. Why would a nation export and import differentiated goods? • Price differentials (vertically differentiated products) • Economies of scale • What is it? • Average cost goes down as you increase production • Specialization

46. Why would a nation export and import differentiated goods? Example Compact cars are popular in Japan Japan increases its production of compact cars Average cost of producing compact cars declines in Japan Japan gains a comparative advantage in production of compact cars Japan exports compact cars

47. Why would a nation export and import differentiated goods? Big cars are popular in the US US increases its production of big cars Average cost of producing big cars declines in US US gains a comparative advantage in production of big cars US exports big cars

48. The Product Cycle Model • Explains why we may turn from exporting a product to importing that product over time. • From the time a new high tech product is developed to the time in becomes widely popular, it goes through 3 stages

49. Example • Stage 1 • Computers are just introduced to the market in the US • They are expensive • Need high-income markets • R&D and production improvements require highly skilled workers. • US may export computers to other developed countries

50. Stage 2 • Production of computers becomes more standardized. • Production may move to other developed countries instead of exporting to those countries. • US may begin to import computers from the new production country.