Chapter 1: Introduction

Learning Objectives
1 Distinguish between international and domestic
economic issues.
2 Explain why seven themes recur in international
economics and discuss their significance.
3 Distinguish between the trade and monetary aspects of
international economics.
Preview
• What is international economics about?
• International trade topics: (1) Gains from trade, (2)
explaining patterns and volume of trade, (3) effects of
government policies on trade
• International finance topics: (4) Balance of payments,
(5) exchange rate determination, (6) international policy
coordination, (7) international capital markets
• International trade versus finance
What Is International Economics
About?
• International economics is about how nations interact
through trade of goods and services, flows of money,
and investment.
• International economics is an old subject, but continues
to grow in importance.
• Nations are now more closely linked than ever before.

David Hume Adam Smith

(1711-1776) (1723-1790)
What Is International Economics
About?
• Underlying theories used in international economics
same as for domestic economies you learned in
previous courses
• E.g. supply and demand, investment, monetary and
fiscal policy
• What are the major differences?
– Countries have their own laws and policies (e.g.
tariffs)
– Countries use different currencies
What Is International Economics
About?
• U.S. exports and imports as shares of gross domestic
product have been on an upward trend.
– International trade has roughly tripled in importance
compared to the economy as a whole in the past 50
years.
– Both imports and exports fell substantially in 2009
due to the recession.
Exports and Imports as a Percentage of
U.S. National Income

(Shaded areas indicate U.S. recessions.) Both imports and exports have
risen as a share of the U.S. economy, but imports have risen more.
Source: U.S. Bureau of Economic Analysis
Effect of COVID-19 on U.S. Trade Volume
Effect of COVID-19 on U.S. Trade Volume
Effect of COVID-19 on Vietnam Net
Exports
What Is International Economics
About?
• Compared to the United States, other countries are
even more tied to international trade.
– Their imports and exports as a share of GDP are
substantially higher.
– The United States, due to its size and diversity of
resources, relies less on international trade than
almost any other country.
Average of Exports and Imports as
Percentages of National Income in 2015

Vietnam

International trade is even more important to most other countries than

it is to the United States.
Source: World Bank
Theme 1: Gains from Trade
• That there are gains from trade is probably the most
important insight in international economics.
• Countries selling goods and services to each other
almost always generates mutual benefits.
1. When a buyer and a seller engage in a voluntary
transaction, both can be made better off.
 Norwegian consumers import oranges that they
would have a hard time producing.
Gains from Trade
2. How could a country that is the most (least)
efficient producer of everything gain from trade?
 Countries use finite resources to produce what
most productive at (compared to their other
production choices), then trade those products
for what they want to consume.
 Countries can specialize in production, while
consuming many goods and services through
trade.
Gains from Trade
3. Trade benefits countries by allowing them to export
goods made with relatively abundant resources and
imports goods made with relatively scarce resources.
4. When countries specialize, they may be more efficient
due to larger-scale production.
5. Countries may also gain by trading current resources
for future resources (international borrowing and
lending) and due to international migration.
Gains from Trade
• Trade is predicted to benefit countries as a whole in
several ways, but trade may harm particular groups
within a country.
– International trade can harm the owners of resources
that are used relatively intensively in industries that
compete with imports.
– Trade may therefore affect the distribution of income
within a country.
Theme 2: Patterns of Trade
• The pattern of trade describes who sells what to whom.
• Differences in climate and resources explain why Brazil
exports coffee and Saudi Arabia exports oil.
• But why does Japan export automobiles, while the U.S.
exports aircraft?
• Why some countries export certain products can stem from
differences in:
– Labor productivity
– Relative supplies of capital, labor and land and their
use in the production of different goods and services
Theme 3: Effects of Government
Policies on Trade
• Free trade grew in the 1990s led by the US
– NAFTA - 1993
– World Trade Organization (WTO) - 1994
• Policy makers affect the amount of trade through
– Tariffs: a tax on imports or exports,
– Quotas: a quantity restriction on imports or exports,
– Export subsidies: a payment to producers that export, or
– Through other regulations (ex., product specifications)
that exclude foreign products from the market, but still allow
domestic products.
• What are the costs and benefits of these policies?
Effects of Government Policies on
Trade
• If a government restricts trade, what are the costs if foreign
governments respond likewise?
• Trade policies are often chosen to cater to special interest
groups, rather than to maximize national welfare.
– More about internal conflict than external
– Big impact on income distribution within a nation
• Governments tend to adopt tariffs, then negotiate them
down in exchange for reduction in trade barriers of other
countries.
International Finance Topics
• Exchanging risky assets such as stocks and bonds can
benefit all countries by diversification that reduces the
variability of income – another source of gains from trade.
• Most international trade involves monetary transactions.
• Many monetary events have important consequences for
international trade.
Theme 4: Balance of Payments
• Governments measure the value of exports and imports,
as well as the value of financial assets that flow into and
out of their countries.
– Trade deficits, where countries import more than they
export in value, may be offset by flows of financial
assets.
• All three values are measured in the government’s
national income accounts.
• The official settlements balance, or the balance of
payments, measures the balance of funds that central
banks use for official international payments.
Theme 5: Exchange Rate
Determination
• Exchange rates are an important financial issue for
most governments.
• Exchange rates measure how much domestic currency
can be exchanged for foreign currency and thus affect
how much:
– Goods denominated in foreign currency (imports)
cost in the domestic country.
– Goods denominated in domestic currency (exports)
cost in foreign markets.
• Some exchange rates change continually (float) while
others are fixed for periods of time.
Theme 6: International Policy
Coordination
• In an integrated economy, one country’s economic policies
usually affect other countries as well, leading to the need
for some degree of policy coordination.
– General Agreement on Tariffs and Trade (GATT) - 1947
– Enforced by WTO
Theme 7: The International Capital
Market
• Capital markets are arrangements by which individuals
and firms exchange money now for promises to pay in
the future.
• Capital markets have special concerns in an international
setting
– Currency fluctuations can alter the value paid.
– Countries might default on debt.
• Often special regulations that countries impose on
foreign investments.
– Sometimes offer opportunities to evade regulations
placed on domestic markets.
International Trade Versus Finance
• International trade focuses on transactions involving
movement of goods and services across nations.
– E.g. should Europe subsidize agricultural exports?
• International finance focuses on financial or monetary
transactions across nations.
– E.g. should China allow their currency to float freely?
– International monetary theory (Chapters 2-7) and
policy (Chapters 8-11).
Why do we care?
• Causes and consequence of large trade deficits in the US
• Dramatic appreciation of USD in early 1980s and subsequent
depreciation in late 1980s
• Debt crisis – e.g. Mexico (1994), Argentina (2001)
• Financial crisis – e.g. east Asia (1997)
• Why the Eurozone?
• Increased pressure for protection from foreign competition in 1980s
and 90s
• Housing market bubble burst in US spread to the rest of the world
through linkages in international capital markets
• Current rise in opposition to globalization – e.g. Brexit and US politics
• Rise of cryptocurrency – Bitcoin, Facebook Libra