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International Finance. Trade and Foreign Exchange Week 10, Class 1B Fall 2006 Professor Diamond SCU School of Law. International Finance. Conflict over currencies occurs in larger context Important to understand dynamics of trade Currencies are, in part, the pricing mechanism for trade
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International Finance Trade and Foreign Exchange Week 10, Class 1B Fall 2006 Professor Diamond SCU School of Law
International Finance • Conflict over currencies occurs in larger context • Important to understand dynamics of trade • Currencies are, in part, the pricing mechanism for trade • Though in modern era, they take on a life of their own (hedging and derivatives)
International Finance • Key areas: • Theory of Comparative Advantage • National Income Product Accounting • Trade law and regime • Exchange rate regimes
International Finance • Theory of Comparative Advantage • An argument about a rational division of labor • Overall, society gains if individuals concentrate on what they do best • This means doing what they do best not necessarily what they do better than others • That would be “absolute” not comparative advantage • Economist apply the same approach to companies and countries • If an entity produces more than they need they can then trade with others
International Finance • This leads to specialization as markets emerge • Consider some simple examples: • Woodrow Wilson • M&A lawyers • Not making a value judgment • These are absolute advantage examples
International Finance • Let’s shift to the comparative advantage • We reach back to Ricardo - 1815 • Part of the assault on “mercantilism • Portugal and Britain • We assume: two countries, two goods, and only one input or resource (labor) required to produce the goods. • One bale of Wool in Portugal requires 3 units of Labor But 10 Units of Labor to produce in Britain. • Meanwhile, one barrel of wine requires 1 unit of labor in P but 5 in GB.
International Finance • A model, not reality • A null hypothesis with lots of assumptions • For example, we assume Zero Transaction Costs • What are transaction costs? • Policy implications • Transition costs • First mover advantage
International Finance • Let’s add some assumptions to show the impact of other factors: • Wages • Exchange Rates • Let’s take an example comparing Mexico and the United States • And we will use two familiar products: beer and chips
