Welcome to EC 382: International Economics By: Dr. Jacqueline Khorassani

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

2. Week Four: Class One • Tuesday, September 1814:10-15:00AC 202 • Your ICA1s are graded but I forgot to bring them to class today. • You will receive them tomorrow • Expect an ICA tomorrow

3. What are the causes of international factor movements? • Assume factors of production are mobile between India and the U.S. • Assume the U.S. is capital abundant and India is labor abundant. • Labor earns a higher wage in the U.S. than in India. • Inequality of wages would cause workers from India to migrate to the U.S.

4. What are the effects of international factor movements? • Wages would begin to _____ in the U.S. as supply increases. • Wages would begin to ______ in India as supply decreases. • Migration of labor would stop when wages are equal between countries • – no more gains from migration. fall rise

5. What about capital? • Capital will migrate from the U.S. to India to earn a higher rate of return. • Capital will migrate until the rate of return is the same between the two countries.

6. Fact • In general, capital is more mobile than labor; why? • Immigration restrictions • Language/cultural barriers

7. How does the international factor movement compare to international trade? • International trade is sometimes • a substitute for factor movements between countries. • a complement for factor movements between countries

8. Example of substitute • Ireland is capital abundant and has comparative advantage in production of capital intensive goods and return to capital is low. • Two alternatives: • Export capital intensive good (machines) & import labor intensive good (shoes), or • Capital leaves the nation and labor enters the nation until there is no more comparative advantage or disadvantage; produce machines and shoes domestically. • If factor movements are blocked, trade is pursued.

9. Example of complements • Shoes and machines can be traded, but some goods and services can not be traded. Like what? • Haircuts • Someone who lives in Ireland will not go to Turkey to get a hair cut • But the Turkish hairdresser (labor) can migrate to Ireland

10. Which one is economically preferred? And why? • The literature has shown that • When possible, factor movements are preferred to trade. • World output will be maximized • Blocking factors from earning the highest rate of return is less efficient.

11. What is foreign direct investment (FDI)? • It implies directly investing in the firm’s plant and equipment. (Physical investment as opposed to just sending money.) • It takes the form of a domestic corporation opening a foreign subsidiary or buying control of existing foreign firm represents real investments in land, nonresidential investment, and equipment and software.

12. FDI: Facts • More than 92% of FDI originated in developed countries. • World’s developed countries received nearly 76% of the world’s FDI.

13. FDI in the world Table 5.2

14. International Economics • Week 4- Class 2 • Wednesday, September 19 • 11:10-12:00 PM • Tyndall • Please pick up your ICA1

15. ICA2 • In teams of 2 • Half a page • Print both names • 3 Multiple Choice Questions • Write down the answers

16. Question 1 • A relatively large amount of intraindustry trade would be associated with: • A) an index of intraindustry trade close to 1.0. • B) an index of intraindustry trade close to zero. • C) an index of intraindustry trade of 0.20. • D) a large amount of imports in a product category with few exports in the same product category.

17. Question 2 • According the product cycle model, comparative advantage: • A) may move from one country to another country as the product matures. • B) is based on the income level of the domestic country. • C) will remain in the country where the product is introduced. • D) is based on economies of scale.

18. Question 3 • Why is international trade viewed as a "second best" alternative when compared to the movement of the factors of production? • A) Being able to move the factors of production would increase world output. • B) International trade has too many problems associated with it. • C) Factors of production are cheaper and easier to acquire. • D) Resources are best used with international trade.

19. Yesterday, I showed Table 5-2

20. Question: what does Africa’s negative outflow of FDI mean? • Africa has a negative outflow of FDI which means that Africa has withdrawn its FDI outflow.

21. What are the reasons for FDI? • Higher rate of return on investment because • the receiving nation is capital scarce and labor abundant • Low cost of labor

22. What are the reasons for FDI? • Low cost of transportation of output • Low cost of transportation of inputs • Low cost of paper work (licensing, permits ,..etc.) • Low taxes • High trade barriers in the receiving nation • Low cost of natural resources

23. What are the effects of FDI? • In the source country • The country that sends the capital to another country. • When capital moves out of the source country, the supply of capital ________ which causes an increase in the rate of return to capital. • Owners of capital in source country benefit • Owners of transferred capital benefit from higher rate of return in foreign country. decreases

24. What are the effects of FDI on the labor in the source country? • Reduction in supply of capital means less capital for labor to use. • Capital-to-labor ratio declines • Productivity of labor declines • Wages decline • Note: in a competitive market wage = marginal product of labor

25. I received a question (just in time) • Why when there is less capital the productivity of labor declines? • Think of me as a labor, in which scenario will I be more productive in class? • Give me a chuck and a blackboard • Give me a laptop and projector • Note: by “less capital” we mean lower valued (less technologically advanced) capital

26. What are the effects of FDI on the host country? • Host country • The country that receives the factor of production from another country. • Supply of capital increases which ________ the rate of return. • Labor productivity _________ because there is more capital per worker. • Return to labor increases. • Opening of trade increases wages and decreases returns to capital in the labor-abundant country. decreases Increase

27. You had a question on Figure 5.1 • Before we get to the figure let’s prepare ourselves • What is a demand curve for oranges? • A curve that shows the highest price we are wiling and able to pay at each level of quantity of oranges • The highest price represents the value of oranges to us

28. International Economics • Week Four- Class 3 • Wednesday, September 26 • 15:10-16:00 • AC 201 • I still have leftover ICA1s • Pick them up please

29. ICA2-Question 1 • A relatively large amount of intraindustry trade would be associated with: • A) an index of intraindustry trade close to 1.0. • B) an index of intraindustry trade close to zero. • C) an index of intraindustry trade of 0.20. • D) a large amount of imports in a product category with few exports in the same product category. • Answer: A

30. ICA2- Question 2 • According to the product cycle model, comparative advantage: • A) may move from one country to another country as the product matures. • B) is based on the income level of the domestic country. • C) will remain in the country where the product is introduced. • D) is based on economies of scale. • Answer: A

31. ICA 2- Question 3 • Why is international trade viewed as a "second best" alternative when compared to the movement of the factors of production? • A) Being able to move the factors of production would increase world output. • B) International trade has too many problems associated with it. • C) Factors of production are cheaper and easier to acquire. • D) Resources are best used with international trade. • Answer: A

32. Demand Curve for oranges • The value of 2nd pound of oranges to us is €10 • This is called marginal value of the 2nd pound • The value of 5th pound of oranges to us is €7 • This is called marginal value of the 5th pound P 10 7 D 5 2 Q

33. The same is true for demand curve for capital The value of 2nd unit of capital is €10 But what determines this value? It depends on how productive capital is We are willing to pay the 2nd capital €10, because it can produce €10 of output for us. €10 is the value of marginal product of capital P 10 7 D 5 2 Q

34. The same is true for demand curve for capital If we end up hiring 5 capital, each unit produces up to the height of the demand curve If we could hire capital continually, the area under the demand curve up to 5 unit of capital = total output P D 5 Q

35. Return to Capital, U.S. Return to Capital, India Sk Sk RI RUS DUS DINDIA Capital Stock, U.S. Capital Stock, India Figure 5.1: Output and Welfare Effects of International Capital Mobility US is capital abundant India is capital scarce Total output in the US = a + b Total output in India = a’+ b’ a’ E’ a E b’ b Assumption: Supply of capital is fixed (vertical)

36. Return to Capital, U.S. Return to Capital, India Sk’ Sk Sk Sk’ e’ RI e d’ c’ RUS’ RI’ d c RUS DUS a’ b’ DINDIA a b Capital Stock, U.S. Capital Stock, India Figure 5.1: Output and Welfare Effects of International Capital Mobility Out put in US drops by ____________ b+ c Capital moves from US to India Output in India goes up by ________ c’+b’ F’ World out put goes_____ F E’ up E

37. Return to Capital, U.S. Return to Capital, India Sk’ Sk Sk Sk’ e’ RI e d’ c’ RUS’ RI’ d c RUS DUS a’ b’ DINDIA a b Capital Stock, U.S. Capital Stock, India Figure 5.1: Output and Welfare Effects of International Capital Mobility US capital’s share of Indian output is _____. Total return to capital (capital’s share of total output) in the US changes from a + b to ___________ b’ a + d India’s capital’s share of out put declined from a’+d’ to _____. F’ a’ F E’ E

38. Return to Capital, U.S. Return to Capital, India Sk’ Sk Sk Sk’ e’ RI e d’ c’ RUS’ RI’ d c RUS DUS a’ b’ DINDIA a b Capital Stock, U.S. Capital Stock, India Figure 5.1: Output and Welfare Effects of International Capital Mobility India’s labor’s share of out put used to be _________ Now it is _______. Us labor’s share of output used to be e+d+c. Now it is ________. e e’ e’+d’+c’ F’ a’ F E’ E

39. Recap • World output went up • US capital’s share of the world output went up • India’s capital share of the world output went down • US labor share of out put went down • India’s labor share of output went up

40. The role of Government • Governments restrict the free flow of foreign direct investment in several ways. • Industrial Policy • A government policy designed to stimulate the development and growth of an industry. • It tends to favor local firms at the expense of foreign firms.