International Economics Flashcards
(112 cards)
1
Q
Why do firms trade?
A
CiRRES
- Cost factors: cheaper/better inputs, internal economics of scale so lower cost by concentrating production on few production sites
- increase revenues through new customers
- risk diversification
- ethical considerations (e.g. pharma offering medecines to developing countries)
- specialising in core competencies (so outsource less profitable steps in the value chain)
2
Q
What did the Mercantilists argue?
A
Wealth = stock of precious metals possessed by a country.
Value of exports must exceed imports for a country to become wealthy.
Counter example: Dutch disease (they found gas)
3
Q
What is the Dutch disease?
A
Dutch disease (the Dutch found gas) = detrimental effect of a resource-led export boom on other sectors of that exporting country:
- Appreciation effect: Export (oil) revenues materialise in dollars. When you convert these back into your currency, demand for your currency increases and your domestic currency appreciates. This deteriorates the international competitiveness of other exporting sectors.
- Inflation effect: Higher income from oil revenue raises income and wages, including in the non-exporting industries (mainly services). This lead to higher prices (inflation), which even more impairs the non-oil exporting sectors.
4
Q
What did Adam Smith argue?
A
- Trade is based on absolute cost-advantages
- Free trade increases the wealth of nations; both exports and imports are important
5
Q
What does the theory of absolute advantages say?
A
A country has an absolute advantage when its labour productivity in producing one item is higher than another country’s.
Each country should specialize in the good that it can produce more efficiently to increase worldwide wealth
Labour productivity = output/input (work hours)
Output calculation: 1000 hours, 1 car per 10 hours work
Output = 1000h x 1car/10h = 100 cars
6
Q
What did David Ricardo argue?
A
Comparative advantage:
Trade is even positive for a country which has a lower labor productivity (absolute disadvantages) wrt every good if these absolute advantages differ between goods, thereby creating comparative advantages
7
Q
What are the assumptions in the Ricardian Model (comparative advantages)?
A
- 2 countries (domestic (D) and foreign (F))
- 2 goods (cars and toys)
- Labour is the only resource used for production
- Labour supply in each country is the same and constant
- Labour productivity varies between countries (usually due to differences in technology), but is constant over time
- Perfect competition, so hourly wages of employees in toy production = market value of toys produced in an hour. Same goes for the car industry.
- As workers will work in the industry paying a higher wage, competition leads to equal wages in both industries within a country (people are mobile between different industries)
- Constant economies of scale (no higher marginal proft if you produce more)
8
Q
How to calculate a comparative advantage?
A
A country has a comparative advantage in producing a good if the opportunity cost of producing that good is lower in that country than in other countries:
aX/aY < aX/aY –> domestic comparative advantage
–> Produce the good for which your opportunity cost is lower (and so have comparative advantage)
Labour input coefficients
= hours needed to make the product
= input (hours) / output = 1/productivity
= a (domestic) or a* (foreign country)
Domestic opportunity cost of good X = aX/aY
= hours to produce X/hours to produce Y
= quantity of good Y that is given up to produce one more X
Foreign opportunity cost of good X = aX/aY
9
Q
What is the production possibility frontier (PPF) of an economy?
A
The production possibility frontier (PPF) of an economy shows the maximum amount of each good that can be produced for a fixed amount of resources:
L = aX x QX + aY x QY
aX = hours of labour needed to produce product X
aY = hours of labourneeded to produce produc Y
QX = quantity of good X
QY = quantity of good Y
L = total amount of labour resources
10
Q
How do you graph the production possibility frontier (PPF) of an economy? What it tell us?
A
x-axis: quantity of good X (QX)
y axis: quantity of good Y (QY)
L = aX x QX + aY x QY
Draw for domestic (PPF) and foreign country (PPF*)
CN = consumption possibilities (non-trade)
Ctrade = consumption possibilities with trade
Outer curve has absolute advantage
Steeper slope means higher opportunity cost for Good X (so no competitive advantage for producing Good X)
When the economy uses all its resources: opportunity cost of good X = absolute value (positive) of the slope of the PPF L = aX x QX + aY x QY aY x QY = L - aX x QX QY = L/aY - (aX/aY) x QX absolute value of the slope = aX/aY = opportunity cost of producing good X
11
Q
What are the terms of trade?
A
Terms of trade = the relation between the price of country’s exports and the price of a country’s imports.
Domestic terms of trade
= Price of exported good X / Price of imported good Y
= PX/PY
Foreign terms of trade = Price of exported good Y / Price of imported good X
12
Q
What is the relative price?
A
Relative price
= the relation between the world price for good X and the world price for good Y
= PX/PY
There is only one single relative world price WITH trade.
13
Q
What does the Ricardian model (theory of comparative advantage) tell us about the terms of trade?
A
Trade occurs when:
- equilibrium relative price of good X (=PX/PY) is higher than one country’s opportunity costs (=aX/aY) –> country has incentive to sell
- equilibrium relative price of good X (= PX/PY) is lower than the other country’s opportunity costs (=aX/aY) –> other country has incentive to buy
Therefore:
- production (opportunity) costs determine the limits of the relative price range
- reciprocal demand determines what the actual exchange ratio will be within these limits.
14
Q
Is an increase in a country’s terms of trade good or bad? Why?
A
An increase in a country’s terms of trade is typically good…because it indicates that fewer export goods are needed to purchase the same number of import goods.
Terms of trade = the relation between the price of country’s exports and the price of a country’s imports.
15
Q
What does the Ricardian model tell us about the scope and distribution of the benefits of trade?
A
The further apart the domestic opportunity cost ratios (aX/aY) are:
- the more room for mutually advantageous trade
- the larger the benefits that can be derived from global trade
The distribution of the benefits between the two countries depends on where the Terms of Trade (ToT) settle:
- If near the foreign country’s opportunity cost ratio, the home country derives most of the gains from trade.
- If neasr the home country’s opportunity cost ratio, the foreign country reapsmost of the benefits.
16
Q
What are relative wages? What determines them?
A
Wages of domestic country/wages of foreign country.
NB: although the Ricardian model predicts that relative prices equalise across countries after trade, it will not predict that relative wages will do the same.
Productivity (technological) differences and relative prices determine wage differences in the Ricardian model
17
Q
Work out the hourly wages in the home and foreign country where:
- 1 (domestic) car sells for $30,000 (takes 100 hours to produce)
- 1 (foreign) toy sells for $1,000 (takes 5 hours to produce)
What is the relative wage for the domestic country?
A
Hourly wage = product price / hours to produce product
Home country wages:
$30,000/100 = $300 per hour to produce cars (x)
Foreign country wages:
$1,000/5 = $200 per hour to produce toys (Y)
Relative wage = 300/200 = 3/2
= Px/ax / PY/aY = Px/PY times aY/ax
1/ax = productivity
Relative wage = relative price x a*Y/ax
18
Q
What determines the wage and the wage differences between both countries? Who enjoys the higher wage? What impact does trade have on wages? When will a good be produced with cost advantages?
A
- Terms of trade (relative prices) and labour productivity (output/input = 1/aX) determine wages
- Terms of trade and absolute productivity advantage (aX/a*X) determines the wage differences across both countries
Relative wage = wx/wY = Px/PY x a*Y/ax
If the relative productivity of a country is higher than the relative wages, the good will be produced with cost advantages
ax/ax > w/w domestic country exports
NB: A country with absolute advantage in producing a good (so more productive) will enjoy a higher wage in that industry after trade, as the relative price of the good exported increases and the relative price of the imported good decreases.
19
Q
What is the absolute cost of production for one good X?
A
a (hours to produce good X) x w
NB: highest wage in a country is the one to use!
20
Q
What are the prerequesites for a good to be exported according to absolute cost advantage?
A
a/a > w/w –> export
hours to produce X abroad/hours to produce X domestically > domestic wages/foreign wages
OR a* x w* > a x w –> export
If a/a < w/w –> import
- The cost of high wages at home can be offset by high productivity. The cost of low productivity in the foreign country can be offset by low wages.
–> if the relative productivity of the home country in producting a good (1/a / 1/a* = a/a) is higher than the relative wage (w/w), then the good will be produced with cost advantages in that country. If it is lower it will be imported.
21
Q
What is the impact of trade on wages according to the Ricardian model?
A
Workers earn a higher wage after trade liberlization, because the relative price of exported goods increases and the relative price of imported goods decreases.
22
Q
Why might countries oppose specialisation as suggested by the Ricardian model of comparative advantage?
A
- Sectoral change: It results in job losses in some sectors (so need to assist them), but job gains in others; which sectors depends on the nation’s comparative advantage
- Recent years points to comparative advantage of industrialised nations residing in services, so you expect a move from manufacturing to the service sector.
23
Q
What empirical evidence supports the Ricardian model?
A
- Empirical evidence shows low wages are associated with low productivity (cf wage and productivity of US Japan and Germany with China and India)
- Other evidence show wages rise as productivity rises.
- Ratio of US to British exports in 1951 cf ratio of labour productivity in 26 manufcturing industries suggests relationship between comparative advantage and exports; US had absolute advantage in all, but the ratio of exports was low in the least productive sectors of the US
24
Q
What are the limitations of the Ricardian model (comparative advantage)?
A
- Complete specialisation in production does not occur because:
- labour is not the only production factor
- protectionism
- transportation costs reduce or prevent trade in some goods - Limiting the analysis to “labour”:
- assumes away important effects of international trade on the distribution of income within countries
- allows no role for differences among resources between countries as a reason for trade - It neglects the possible role of economies of scale as a cause of trade, whch is important to explain intraindustry trade.
- Trade due to comparative advantages explains why countries export and import dissimilar goods (“interindustry trade”) but not “intraindustry trade” of similar (but not identical) goods that can even arise if both technology and factor endowments are identical between countries.
25
What conclusions does the Ricardian model provide?
1. Comparative advantage if opportunity cost is lower than in other countries
2. After specialisation, the relative price of the produced good rises, income for those workers rise and imported goods are less expensive for consumers.
3. Trade benefits both high and low productivity countries, although it may change the distribution of income within countries.
4. Cost advantage can result from high productivity OR low wages
26
What model explains intraindustry trade? How?
Helpman and Krugman model, using economies of scale.
Assumes:
- Firms are homogenous (same size, productivity, each captures same share of total exports) (same assumptation as Ricardo)
- Goods are heterogenous (differentiated), not homogeneous as assumed by Ricardo (e.g. VW v Peugeot)
- Increasing economies of scale make it advantageous to specialize in production of a limited range of goods and services, explaining some intraindustry trade.
- increasing economies of scale leads to monopolies or oligopolies. Therefore, excess profits are captured by large firms (unlike Ricardian perfect competition with workers receiving all profit)
27
What types of economies of scale are there? What are these industries characterised by?
1. Internal economies of scale: where average cost per unit of output decreases with the increase of the size of the firm (characterised by monopolies, oligopolies, monopolistic competition)
2. External economies of scale: where average cost per unit of output decreases with the increases of the size of the industry (characterised by many small firms)
28
Is either internal or exteral economies of scale consistent with perfect competition?
Internal economies of scale - NO
| External economies of scale - YES
29
Why might external economies of scale exist?
If a larger industry is organised in industrial clusters, this can allow for :
- more efficient provision of services/equipment to firms in the industry, due to nearness of supplies and availability of consultancies
- higher availability of workers, transparency of a local labour market and labour pooling
- higher availability of implicit information and accumulation of knowledge (driven by learning curve effects = dynamic increasing returns)
- cluster effects: collaboration, joint R and D, exchange of info, infrastructure
30
What happens if the number of firms in a market with monopolistic competition increases?
- Smaller market shares, so:
- Higher average cost (each firm sells less)
- Lower prices due to competition
- Equilibrium price and number of firms where price = average cost
31
How does international trade affect markets with monopolistic competition?
- Bigger market size
- More production, lower average costs
- More firms than in purely national market
- Higher competition so consumers benefit from lower prices and increased product variety
32
What does the presence of monpolistic competition predict wrt trade and income distribution?
- More intraindustry trade
| - No change in income distribution within a country
33
Represent the effects of trade on an industry with internal economies of scale on a graph. Explain what it is saying.
x-axis: number of firms, n
y-axis: Cost, C and Price, P
Downwards sloping price function: prices decrease with increasing number of firms (does not depend on market size)
Upwards sloping cust curve (CC): costs increase with increasing number of firms in a given market due to internal economies of scale
Shift CC down (slightly flatter) due to trade liberalisation: Trade liberalisation increases market size, increases market share, decreases unit costs due to internal economies of scale (some firms that can't compete at new, lower equilibrium price drop out)
New equilibrium: Consumers get more variety for a lower price.
Trade therefore offers an opportunity for mutual gains from trade, even if countries do not differ in their reources or technology. NB: total output and employment can be maintained in all countries, given that the country can respecialise and export more intermediary or other products.
34
What is the Grubel-Lloyd Index?
The Grubel-Lloyd Index measures the extent of intra-industry trade.
100 = pure intra-industry trade
0 = pure inter-industry trade
35
What determines the relative importance of intraindustry trade?
How similar the countries are:
- Similar comparative advantages --> intraindustry trade
- Different comparative advantages --> interindustry trade
e.g. General Electric refrigerators
- US consumers prefer refrigeraters with 2 doors --> produced in USA
- Mexican consumers prefer 1 door --> produced in Mexico
Trade to satisfy preferences in both goods
36
What might determine the pattern of trade if external economies of scale exist?
Historical accidents, often caused by political action in line with economic policy (industrial policy)
--> countries may remain large producers in certain industries, even if another country could potentially produce the goods more cheaply
e.g. car industry in Stuttgart, industrial banana, semiconductor industry in the Silicon Valley stayed in the USA and didn't move to India
37
Do external economies of scale justify an infant industry argument?
Debatable.
Otherwise, countries with a head start with substantial learning effects may prevent other more efficient countries from entering the market.
38
What do the different models explain? What don't they explain?
- Ricardian (inter-industrial trade and specialisation): comparative advantages drive specialization processes, raises relative price of produced goods, lowers relative prices of imported goods, raises wages, benefits both high and low productivity countries. Ignores role of resources, impact on distribution of income, doesn't explain intraindustrial trade.
- Krugman (intra-industrial trade and product differentiation): Increasing returns and product differentiation drive intra-industry trade.
- Gravity Model: helps describe the main characteristics of the structure of today's world's aggregated trade flows
- Melitz and Helpman model (Domestic firms, exporting firms, and FDI firms: Only the most productive firms trade, the even more productive firms do FDI
39
What are the steps of international economic activities?
1. Domestic firms deliver only the regional or national market - many firms!
2. Exporters serve foreign markets too - few firms!
3. Multinational firms produce in the target market - ver few firms
40
Describe the Melitz model
- Recognises firms are heterogeneous (diff size, productivity) - unlike Ricardian and Krugman models. E.g. in the 1980s only 18% French manufacturing firms were exporters
- Builds on monpolistic competition from Helpman-Krugman and extends it by a dynamic component
41
Describe the Melitz model assumptions as it pertains to domestic production.
Self-selection into domestic production:
1. Potential entrants (sink irreversible investment) - to enter (e.g. market research, business plan...). Nb no knowledge of their productivity until they enter the market.
2. Entrants (randomly draw productivities) - through lottery, where different random distributions can be assumed
3aa. High productivity entrants (positive profits) - so πD(Θ) > 0
- -> 3ab. Survivors
3ba. Low productivity entrants (negative profits) - so πD(Θ) < 0)
- -> 3bb. Exiters.
- Demand side: demand function
- Supply side: asymmetric firms with different productivity levels
- Productivity is denoted by Θ and Θ(j) for firm j.
- Fixed costs cfD of production, e.g. costs for getting market access, establishing sales channels, initial market research, establishing and supporting service activities
- Variable costs of production c/Θ(j) (per unit of output) where c is the same for all firms
- Firm j selects profit maximising price, leading to firm-specific profit πD(Θ), which depends on productivity level of the firm in a linear profit function
42
Represent the Melitz model on a graph, as it applies to the domestic market. Interpret it.
x-axis: Θ for productivity
y-axis: π for profits
πD (profits from domestic activity) straight line:
- intersecting y-axis below 0 at -cfD (fixed costs from domestic activity)
- intersecting x-axis at ΘD (where you start to be profitable)
Interpretation:
Firms between 0 and y-intercept ΘD are exiters. To the right of ΘD are the survivors who will stay (with profit)
43
What are the assumptions of the Melitz model for exporting?
- To serve a foreign market, a firm incurs greater fixed costs than for the domestic market cfx > cfD
- The fixed costs are specific to each country the exports go to, and arise for each new destination country --> fixed costs increase with the number of destination countries
- Further, variable costs of exporting are incurred, modeled as melting iceberg costs (T-1 units will melt during the journey)
Consequences:
- Each firm may achieve an aditional profit from taking part in international trade
- Additional profit follows the linear profit function πx(Θ), which again depends on the firm's productivity
44
Represent the Melitz model on a graph, as it applies to the exporting. Interpret it.
x-axis: Θ for productivity
y-axis: π for profits
πD (profits from domestic activity) intersects y-axis at -cfD and x-axis at ΘD.
πx (additional profits from exporting):
- intersects y-axis at -cfx (below -cfD)
- intersects x-axis at Θx: the bigger the foreign market, the smaller is the cut-off point for Θx
- flatter slope than for πD, as marginal profits of exports are smaller due to the additional melting iceberg costs
Interpretation:
- Below ΘD: firm quits
- Between ΘD and Θx: firm produces for domestic market only
- Above Θx: firm realises additional profits from exporting
45
From the Melitz model, how do we find how many firms with quit, be purely domestic or export?
Theoretically:
Answer depends on distribution assumed for the random variables in the lottery from the beginning.
Draw the density function of the productivities in the lottery on the graph (highest point close to ΘD). The areas below the function show the relative frequences of firm types.
3 categories:
- A (below ΘD) = quit
- B (between ΘD and Θx) = domestic
- C (above Θx) = export
46
According to the Meliz model, how does trade liberalization impact on domestic and exporting markets?
1. Multilateral trade liberalisation reduces tariffs and non-tariff trade barriers, reducing "shipping costs" and raising variable profits from exporting (seen in the slope of the profit function):
- -> slope of πx rotates upwards (represented by π'x), reducing the cut-off point Θ'x, so more firms will self-select into exporting
2. Trade liberalisation allows the entering of new foreign frms, raising competition in the domestic market, lowering prices and profits for domestic firms.
- -> slope of πD rotates down to the right (represented by π'D for post-trade liberalisation), increasing cut-off point Θ'D. So due to the higher competition, there is a higher minimum productivity level. This will drive the least productive firms out of the market, leading to higher average productivity in the domestic economy. The unaltered total demand will be served by more productive firms.
Empirically: Trefler shows this productivity effect after the USA-Canada free trade agreement
47
What are the costs and benefits of trade liberalisation?
Costs: Some firms had to exit the market --> costs of adjustment, re-employing/retraining staff from these firms
Benefits: Average level of productivity in the economy increases.
48
What is horizontal FDI?
Market-seeking FDI, where firms produce offshore to directly serve the foreign market. Exports to the country may become unnecessary.
49
What are the assumptions of the Melitz and Helpman model with respect to FDI?
- Fixed costs cfi (for FDI) are higher than for exports cfx
- Variable costs of production abroad equal variable costs of production at home (no exporting costs - e.g. 2 similar high-income countries) --> same slope as for domestic profit function
- Cut-off level will be higher than for exporting firms
- Intersection between additional profits from exporting or FDI.
50
Represent the Melitz model on a graph, as it applies to FDI. Interpret it.
x-axis: Θ for productivity
y-axis: π for profits
- πD (profits from domestic activity) intersects y-axis at -cfD and x-axis at ΘD.
- πx (additional profits from exporting): intersects y-axis at -cfx (below -cfD), and the x-axis at Θx, flatter slope
- Θi (additional profits from FDI): intersecty y-axis at -cfi, same slope as domestic profit function πD.
- Label intersection of πx and πi as Θi
Interpretation:
- Below ΘD: firm quits
- Between ΘD and Θx: firm produces for domestic market only
- Between Θx and Θi: firm realises additional profits from exporting
- Above Θi: firm does FDI instead of exporting
- -> only the most profitable firms do horizontal (market-seeking) FDI!
51
What is the trade-off for firms considering FDI?
Trade-off in location choice between:
- Proximity to the foreign market (avoid shipping costs, easier access to market, less customisation after production...)
- concentration of production (so economies of scale)
If a firm opts for FDI, it:
- gives up concentration of production at home, but
- has lower variable costs due to higher proximity to the customers in the foreign market and the circumvention of the melting iceberg costs.
52
It what markets does the majority of FDI occur?
Most market-seeking FDI is done in developed countries.
53
What types of tariffs are there?
Absolute/specific tariffs - quantity based tariffs on imported goods, e.g. $1 per kg of cheese
Relative/ad valorem tariff - value-based tariff on imported goods, e.g. 25% tariff on the value of imported cars
54
What are non-tariff barriers?
Rules that pose a barrier to cross-border trade and do not show up as a tariff
55
What are some examples of non-tariff barriers?
DRES-LiQS-LCVER
- documentation requirements
- embargoes/sanctions
- licensing requirements/ import quotas
- quality standards and norms (e.g. Deutsche Industrienormen (DIN) --> International Standards Organisation)
- local content requirements (China)
- voluntary export restraints, e.g. weapons, or to ensure coverage of local market
56
Modeling tariffs and subsidies:
| What are the assumptions?
- 2 countries (domestic and foreign)
- 1 product
- The product can be transferred for free
- The product is being produced and consumed in both countries
- perfect competition (so one price on the world market)
World market:
- Pw = product price on world market
- Qw = trade volume
- MD import demand curve: gives quantity of imports that domestic consumers demand for a given world price: MD = D(P) - S(P)
- XS export supply curve: gives quantity of export that foreign producers would be willing to export for a given price: XS = S*(P*) - D*(P*)
57
How does trade affect the prices in the foreign and domestic countries?
In absence of trade: foreign price (exporter) is lower than domestic price (importer)
With trade: foreign price rises and domestic price sinks until price difference reduces to 0
58
Model the two-country model with the world market on a graph. Interpret it.
All graphs: x-axis quantity (Q), y-axis price (P)
Domestic country: Supply S and demand D curves with high equilibrium
Foreign country: Supply S* and demand D* curves with low equilibrium
World market:
Import demand: MD = D(P) - S(P)
- y-intercept = domestic equilibrium price
- downwards sloping, but flatter than domestic demand curve (higher price elasticity of demand, so reacts quite sensitively to price).
Export demand: XS = S*(P*) - D*(P*)
- y-intercept = foreign equilibrium price
- upwards sloping, but flatter than foreign supply curve
- Pw = price on world market, draw accross to domestic and foreign
- Qw = quantity of trade
Interpretation:
Domestic market: to find import quantity, take the world price, and see the quantity gap between supply and demand.
Foreign market: same thing for exports
59
Use the two-country model with the world market to explain the effects of a tariff in the case of 2 big countries
Big country: trade policy in a big country may effect the price on the world market, and hence the country's Terms of Trade.
Specific tariff: $2 on each imported entity of wheat
- Domestic price rises to PT (price with tariff), but not by the full price of the tariff --> quantity imported decreases (lower quantity demanded, more supplied in domestic market)
- Foreign price falls to PT*, but not by the full price of the tariff --> quantity exported decreases (higher quantity demanded, foreign suppliers supply less)
- Between these prices is t, the price bracket (tariff)
- Quantity of exports falls from Qw to QT
NB: High levels of tariffs sets incentives to elude the tarif and import on the black market (smuggle)
60
Use the two-country model with the world market to explain the effects of a tariff in the case of a small country trading with the world
A small country may not influence its Terms of Trade. It has no effect on the world price of a good, because its demand for the good is an insignificant part of world demand
Domestic market:
- Domestic price rises by the full amount of the tariff --> quantity imported decreases (lower quantity demanded, more supplied in domestic market)
- World price stays unchanged
- The decrease in quantity imported is greater the smaller the country imposing the tariff.
61
What effect does a tariff have for consumers, producers and government in the importing country?
Equilibrium price above the world price
- Consumers: rising prices hurts consumers (lowers consumer surplus, being between Pw and PT and under the demand curve) --> consumers lose 'a', 'b', 'c' and 'd'
- Producers: rising prices benefit producers (increase in producer surplus between Pw and PT over the supply curve --> producers gain 'a'
- Government: gains tariff revenues (box between between S and D at PT prices, and between PT and PT*) --> government gains 'c' (above Pw) and 'e' (below Pw)
Overall: loss of 'b' + 'd' (under PT, above Pw, not between S and D at PT), gain of 'e' (below Pw, above PT*, between S and D at PT)
If e > b + d --> welfare gain, introduce tariff
If e < b + d --> welfare loss, don't introduce tariff.
The bigger the country, the higher the increase in 'e' (for tariff revenue). For a smaller country the net welfare effect is always negative as Pw would stay the same and it would have no 'e'.
In any case, a big part of the rent is shifted from the consumers to the producers!
62
What does the net welfare effect of a tariff for an importing country result from?
1. Efficiency loss due to a distortion of supply and demand (producers produce too much and consumers consume too little compared to the efficient market outcome)
2. Terms of Trade gain because of lower foreign export prices (but not for a small country)
63
What effect does an export subsidy have for consumers, producers and government in the exporting country?
Equilibrium price below the world price
Export subsidies:
- raise the prices for consumers in the exporting country to PS (price = the price exporters would get with subsidy abroad)
- lower the prices in the importing country abroad to PS* (price is subsidised by the exporting country)
...deteriorating the exporting country's terms of trade
Surplus shifting and net welfare loss for exporting country:
- decrease in consumer surplus from raised prices: over Pw, under PS, under D: a + b
- increase in producer surplus (they receive greater prices, here and abroad): over Pw; under PS, over S: a + b + c
- cost to government for subsidy: between PS and PS*, and between D and S at PS: loss of b + c + d + e + f + g
Overall, net welfare loss for exporting country: loss of d + e + f + g
64
What does the negative net welfare effect of an export subsidy for an exporting country result from?
- Efficiency losses (due to distortion of supply and demand)
- Deteriorates its terms of trade (subsidised export price)
NB: export subsidies are illegal under the WTO
65
What are some further instruments of protective policy, and what impact do they have?
1. Import quota:
- lifts prices of imported goods in domestic country, but govt income does not increase
- importing country looses
- Surplus shifting: consumers loose, licence owners (in domestic or foreign country) win.
2. Voluntary export restrictions (VER)
- similar to import quotas (govt gets no additional income); importing country looses
3. Export credits: similar to export subsidies
4. Burocratic barriers
66
What is the gravity equation?
F1 = F2 = G x (m1 x m2)/r^2
F1, F2 = gravitational force of planet 1, planet 2
m1, m2 = mass of planet 1, planet 2 (proxy for market size that increases with GDP)
r = distance from centre of planet 1 to centre of planet 3 (proxy for trade costs that increase with distance)
G = scaling unit of gravity
67
For what empirical analysis is the gravity model used?
For empirical analysis of:
- trade flows, currency and free trade areas, border effects, cultural effects on trade...
- factor flows (FDI/migration)
68
How can you find the world's centres of gravity?
GDP density:
(population density, GDP per capita)
GDP/Labour x Labour/Area
= GDP/Area
69
What is a Latin expression for "all other things being equal"
ceteris paribus
70
What heuristic evidence shows the relationship between market size and trade flows?
Graphing European trade partners of the USA:
x-axis: percent of EU GDP
y-axis: percent of US trade with EU
ceteris paribus approach: holding distance virtually constant
71
What is the stochastic gravity model for a given country?
tradei = γ x Yi^α x di^β x εi
γ = scaling factor (G in gravity equation)
Yi = GDP of destination country i (mass in gravity equation)
α (alpha) = the (positive) elasticity of trade wrt market size
di = distance to destination country i (r in gravity equation)
β = the (negative) elasticity of trade wrt distance
εi = error component
If α is 0.5. If the economy of the trading partner (Yi) increases by 1%, we expect bilateral trade ceteris paribus to increase by 0.5%
If β is -0.5. If a pair of trading partners is 1% further away from each other (di is 1% bigger) than an otherwise comparable pair of trading partners, we expect them to trade 0.5% less
72
Show formally (prove) that α is the elasticity of trade with regard to the market size of the trading partner.
Let α = elasticity of trade with regard to the market size
α = %∆ tradei/%∆ Yi
α = ∂tradei/∂Yi x Yi/tradei (equation 1)
NB: ∂tradei/∂Yi = slope of trade as a function of Y (perfect 1st derivation of trade wrt Y) --> get first derivation.
tradei = γ x Yi^α x di^β x εi
∂tradei/∂Yi = γ x αYi^(α-1) x di^β x εi
∂tradei/∂Yi = α x γ x Yi^α x di^β x εi/Yi (equation 2)
Sub equation 2 in equation 1:
α = (α x γ x Yi^α x di^β x εi/Yi) x Yi/tradei
α = α x tradei/Yi x Yi/tradei
α = α
Therefore, α is the elasticity of trade with regard to the market size of the trading partner.
73
What is the baseline linear gravity regression model?
ln trade i = lnγ + αlnYi + βlndi + εi
α gives country size effect
β gives distance effect
We augment the regression with further variables of special policy interest:
- border: common border effects
- comlang: effects of common language
- regional: regional cluster effect
- cu: effects of a common currency with the trading partner
Coefficient estimates are ceteris paribus, and elasticities
74
How do companies depend on global developments? What about national economies?
Companies:
- source, produce and sell their products across national borders
- have foreign affiliates or are themselves affiliates of foreign corporations
National economies are not autarkic (self-contained)
75
What is the OECD definition of globalisation?
The term "globalisation" has been widely used to describe the increasing internationalisation of financial markets and of markets for goods and services.
Globalisation refers above all to a dynamic and multidimensional process of economic integration whereby national resources become more and more internationally mobile while national economies become increasingly interdependent.
76
What are some simplistic views and wrong conceptions of globalisation?
"...single market with a single price is created" - NO - maybe for gold, but otherwise not
"The world is flat", ie no barriers - NO - not true; a 'common border' effect is shown in the gravity model
77
What is globalisation a story of?
- diverse regional developments and heterogeneity from several perspectives
- growing number and intensity of different types of cross-border linkages.
78
What is GDP determined by in the long run? What affects these variables?
```
Y = (K,L,A)
Y = real GDP, output of goods and services
K = investment --> FDI (with economic power or majority stake), portfolio investment
L = labour --> migration (over 6 months); mobilty is under 6 months in a country
A = production technology --> technology transfer, knowledge spillover
```
79
Outline the broad history of globalisation.
2 main waves, characterised by technological innovations and political interferences:
- 1840-1914: economies relied on steam power, railroads, telgraph, telephone. Globalisation was interrupted and reversed by wars and depression
- 1945-present: economies rely on telephones, airplanes, computers, internet, fiber optics, social networks
In last 20 yrs, globalisation has gained even more momentum, with new global players, particularly China
But during the worldwide economic crisis, we have seen a swift contriction of worldwide activities.
80
Outline the history of globalisation since 1795 (interpreting the graph)
Big countries that tend to be less open to trade are weighted higher since they comprehend more people and firms.
- Since the end of WWII we see a strong increase of openness to world-wide trade
- Yet already in 1914 (start of WWI) this openness to trade was as high as 0.16, not much lower than in 1995.
- The data suggest the existence of three wages of globalisation:
a) 1815-1880 (industrialisation, steam engine, colonisation);
b) 1900-1914 (economic boom);
c) 1945-1995 (graph ends at 1995) (many new developments: cars, economic growth, economic/international trade agreements, improvement of pohnes, air traffic)
81
What is the formula for trade
Trade = exports + imports
82
Why do big countries tend to have lower trade openness?
There is plenty of opportunity to trade within the country.
83
How is trade openness measured?
(exports + imports) / GDP
| = trade / GDP
84
What is weighted openness?
trade openness weighted by people per country
85
What are the cornerstones of merchandise trade?
Shares in world merchandise (trade in goods, not services) trade:
- The top 10 traders have 41% of total world trade
- Developing economies comprise 50% of total world trade
- Trading triad: USA, EU, China
86
What causes globalisation?
CASA-PPEGP-SCAPES
- Decline of transportation and communication costs
- Globally negotiated reductions in government trade barriers
- 'Slicing up the value chain' and widespread outsourcing of production activities:
a) offshoring and international outsourcing
b) cross-border trade in services and tasks
- Greater awareness of foreign cultures and products, e.g. through migration
- Political changes, e.g. fall of the iron curtain
- Absolute figures of exports, FDI etc can be caused by population growth
- Benefits from specialisation, comparative advantage, effects of economies of scale, productivity differences between countries
- Economic growth and reduction of poverty
87
When does a country have a trade deficit?
Exports < imports
Exports < trade/2
(trade = exports + imports)
88
Which countries are the most important for world trade?
For which countries is world trade the most important?
The biggest countries are the biggest traders in absolute terms --> they are the most important for world trade
World trade is most important for the smaller countries, seen from merchandise trade relative to GDP, or (exports + imports)/GDP
--> The ranking of countries that are most important for world trade (bigger countries) is quite different from the ranking of countries for which world trade is most important (smaller countries)
89
Why might trade = more than a country's GDP?
Part of exports may have a lot of previously imported components.
e. g. import $30k worth of components, value creation of $30k at home, export the product
- -> import = $30k, export = $60k
- -> trade = $90k, GDP = $30k
- -> Trade/GDP = 300%
90
How has the importance of trade developed?
Asymetrically (when looking at exports/GDP)
91
What is intra-regional trade?
Trade between countries that belong to the same geographic region
92
How much of world trade does intra-regional trade of goods (merchandise) constitute?
Intra-regional trade constitutes a little more than 50% of world trade.
Intra-regional trade dominates especially in Europe, but there are more borders there so more opportunity for intra-regional trade
93
Define goods and services
Goods: Things that are tangible, e.g. cars, garments, computers
Services: Activities provided by other people, intangible products. E.g. accounting, banking, cleaning, consultancy, education, insurance, medical treatment
94
What dominates within one economy- goods or services? What is the development?
Germany GDP in 2008:
Services: ≈70% of all domestic value is created by the services sector
Manufacturing: 30%
Agriculture: 1%
- Process of tertiarisation: 1960-2000 - process of the economy becoming more and more services-dominated
- In other wealthy countries, the share of services is higher
95
What is the composition of world trade?
In 2003:
1. Manufacturing: 61%
2. Services: 20%
3. Mining: 11%
4. Agriculture: 8%
World trade is dominated by the trade of goods
96
What are the four modes of services trade?
CB-CAC-PPaNP
Mode 1. Cross border supply (30%): the service is transferred from the country of the supplier to the country of the consumer, e.g. photoshop task, call centres, x-ray diagnosis
Mode 2. Consumption abroad (10%): the consumer moves/travels to the country of the supplier, e.g. tourism, medical tourism, exchange students
Mode 3. Commercial presence (55%): supply of the service through the commercial presence of the supplier (FDI), e.g. computer services supplied by a foreign affilitate, services from a consulting firm that is a foreign affiliate
Mode 4. Presence of a natural person (5%) - The supplier travels to the country of the consumer, e.g. Spanish teacher in Germany
97
Are appreciations of the domestic currency in general "good" or "bad" for the domestic economy? Refer to the nature of the value chain of a firm.
It depends on the organisation of the value chain.
For firms:
- If you source in other currency areas (e.g. in $USD) and sell in your own currency area, you expect higher profits, eg. Adidas purchases mostly in Asia in $USD (lowering costs), and sells mostly in Euros.
- If you produce "at home" and sell in the dollar area, you would expect lower profits, e.g. BMW
For consumers:
- Their purchasing power for imports (and domestic products) increases (also benefiting firms selling in €)
- They may be employed by importing/exporting companies. The organisation of the company's supply chain may impinge on their wages.
For an export economy like Germany, a 10% appreciation of the € would cost 1% of economic growth.
98
What can firms do to hedge against risks from the volatility of the Euro?
RFOL-RoP
Short term:
1. Risk diversification - source and sell in different currency areas at the same time
2. Buy futures on foreign currency (you fix a price now for a transaction in the future, and are obliged to realise this contract)
3. Buy options for the opportunity to realise a future transaction for a certain price
4. Get loans (foreign capital) in the other currency, and in case of appreciation of your currency, pay back lower interest rates.
Long term:
5. Relocation of production to other currency areas to which you export (horizontal FDI)
99
What issues related to exchange markets does international economics analyse?
- Determinants and consequences of exchange rate fluctuations
- Economic processes with flexible and fixed exchange rates
100
On a graph where the y-axis is "national currency units per US dollar", x-axis is time:
What does it mean if the curve slopes downwards?
Depreciation of the dollar when compared to the other country's currency.
E.g. decrease of €/$ (price of the $ measured in €) means less euros are required to purchase a dollar --> appreciation of the € compared to the dollar.
101
What types of capital linkages between countries are there?
Portfolio investment
| Foreign Direct Investment (FDI)
102
Define Foreign Direct Investment (FDI)
Rather long-term investment ino a company in another country to exercise economic power on that firm (so sway on management decisions):
- ownership of own capital
- at least 10% of the voting rights (as opposed to portfolio investment where you only own a few stocks)
103
What classification schemes are there for FDI?
1. Relation between the investor and the investment object on the value chain
2. Investment motives
3. Type of investment
104
What is the classification scheme for FDI in relation to:
| Relation between the investor and the investment
- Horizontal FDI: investor and affiliate on the same level
| - Vertical FDI: Investor and affiliate on different levels (e.g. cars v rubber production for tyres)
105
What is the classification scheme for FDI in relation to:
| Investment motives
- Market seeking: intended to increase foreign sales
| - Cost reducing: intended to decrease production costs
106
What is the classification scheme for FDI in relation to:
| Type of investment
- Greenfield: establishment of a firm that previously didn't exist
Brownfield:
- Cross-border merger: acquire reciprocal voting rights
- Cross-border acquisition: acquire a majority of shares
107
Classify different types of investment with reference to:
- within or outside the boundaries of the firm
- home country or abroad
At home:
- Within the firm: Domestic in-house production (majority of firms)
- Outside the boundaries of the firm: Domestic outsourcing
Abroad:
- Within the firm: FDI
- Outside the firm: offshore outsourcing
108
The micro perspective: Why would a firm prefer to realise business activities via FDI rather than via foreign outsourcing?
KcLMNePQ
- Keep knowledge within the company, for R+D
- for non-contractual activities (difficult to specify in a contract), e.g. R+D, use of implicit knowledge (motivation, culture)
- in case of very specific products or inputs that would be very expensive in the markets (few available), or if the only supplier were a monopolist
- control over quality
- non-use of child labour
- environmental protection
109
Who is becoming international?
- It's firms, not countries that trade and invest
- Internationalisation is for the few - Superstar Exporters
...hence, aggregate exports are driven by a small number of top exporting firms
110
What does the "Superstar Exporter" phenomenon mean?
1. Very few firms are exporting
2. These firms are very productive (they therefore also pay higher wages and are mostly bigger firms).
10% of the bigget exporting firms accounted for 90% of all French exports in 2008!
111
Who engages in exporting and FDI?
Only the very productive firms export, and only the most productive are engaged in FDI!
112
What does TFP stand for?
Total Factor Productivity (capital, labour, technology)
