A.

Hidhayathulla
Associate Professor of Economics
Jamal Mohamed College
Trichy -2-

Unit I
Lessons 1 to 6
 Lesson 1 - Meaning and Scope of
International Economics
• International economics refers to a study of
international forces that influence the
domestic conditions of an economy and shape
the economic relationship between countries
 Scope
• Economic and political issues related to international trade and
finance
• International trade involves the exchange of goods or services and
other factors of production, such as labor and capital, across
international borders.
• On the other hand, international finance studies the flow of
financial assets or investment across borders. International trade
and finance became possible across nations only due to the
emergence of globalization.
• Globalization can be defined as an integration of economics all over
the world. It involves an exchange of technological, economic, and
political factors across nations due to advancement in
communication, transportation, and infrastructure systems.
• It describes the functioning of different international
economic institutions, such as World Trade
Organization (WTO), International Monetary Fund
(IMF), and United Nations Conference on Trade and
Development (UNCTAD).
• The subject also includes various concepts, such as
globalization, gains from trade, pattern of trade,
balance of payments, and FDI. Apart from this,
international economics describes production, trade,
and investment between countries.
• Generally, the economic activities between
nations differ from activities within nations. For
example, the factors of production are less
mobile between countries due to various
restrictions imposed by governments.
• The impact of various government restrictions on
production, trade, consumption, and distribution
of income are covered in the study of internal
economics. Thus, it is important to study the
international economics as a special field of
economics.
 Lesson 2
Features of International Trade
• (1) Immobility of Factors:
• The degree of immobility of factors like labour and
capital is generally greater between countries than within
a country. Immigration laws, citizenship, qualifications,
etc. often restrict the international mobility of labour.
• International capital flows are prohibited or severely
limited by different governments. Consequently, the
economic significance of such mobility of factors tends to
equality within but not between countries. For instance,
wages may be equal in Mumbai and Pune but not in
Bombay and London.
• (2) Heterogeneous Markets:
• In the international economy, world markets lack
homogeneity on account of differences in climate,
language, preferences, habit, customs, weights
and measures, etc. The behaviour of international
buyers in each case would, therefore, be different.
• (3) Different National Groups:
• International trade takes place between differently
cohered groups. The socio-economic environment
differs greatly among different nations.
• (4) Different Political Units: International trade is a phenomenon
which occurs amongst different political units.
• (5) Different National Policies and Government Intervention:
• Economic and political policies differ from one country to another.
Policies pertaining to trade, commerce, export and import, taxation,
etc., also differ widely among countries though they are more or less
uniform within the country. Tariff policy, import quota system,
subsidies and other controls adopted by governments interfere with
the course of normal trade between one country and another.
• (6) Different Currencies: Another notable feature of international
trade is that it involves the use of different types of currencies. So,
each country has its own policy in regard to exchange rates and
foreign exchange.
 Lesson 3
IMPORTANCE OF INTERNATIONAL TRADE

• Make Use of Abundant Raw Materials

• Some countries are naturally abundant in raw
materials. Without trade, these countries
would not benefit from the natural
endowments of raw materials.
 Comparative Advantage
Countries should specialise in those goods where they
have a relatively lower opportunity cost.
Even if one country can produce two goods at a lower
absolute cost doesn’t mean they should produce
everything.
• Greater Choice
• Specialisation and Economies of Scale
• Service Sector Trade
• Trading Blocks
• Trade is more likely between similar countries of close
geographical proximity. Therefore, this provides added
incentive to create geographical blocks, such as NAFTA
and EU, which enable reduction of non-tariff barriers to
create more free trade
 Lesson 4
Problems arising from Foreign Trade

• Threat to Infant Industry :

• The fear is that ‘free trade’ can cause
countries to specialise in primary products –
goods which have volatile prices and low-
income elasticity of demand. To develop,
economies may need to restrict imports and
diversify the economy.
• Trade can lead to cultural homogenization:
Some fear trade gives an advantage to
multinational brands and this can adversely
impact local production and traditions.
• Displacement Effects:
• Foreign trade can cause uncompetitive
domestic industries to close down, leading to
structural unemployment. These losers do not
gain any compensation.
• Trade leads to Dependence:
• Import dependence for essential commodities
leads to vulnerable dependence of the
importing countries on supplying countries.
• Trade as a Tool of Imperialism and
Colonialism:
• Foreign trade is being used as an indirect way
of dominating other countries
 Lesson 5 - International Product Life
Cycle Theory
• Raymond Vernon - 1960s
• It explains the cycle that products go through when
exposed to international market. The cycle describes how a
product matures and declines as a result of
internationalization. The cycle contains five stages.
• Stage I - New Product Introduction
• The cycle begins with the introduction of a new product. In
this stage a firm in a developed country will innovate a new
product. The market for this product will be small and sales
will be low. Vernon says that innovative products are more
likely to be created in a developed nation because the
people have more disposable income to use on new
products.
• To compensate the impact of low sales, the firm
will produce the product locally, so that as
process issues arise or a need to modify the
product in its infancy stage presents itself,
changes can be implemented without too much
risk and without wasting time.
• Stage II – Marketing in other Developed Countries
As sales increase, corporations may start to
export the product out to other developed
nations to increase sales and revenue.
• It’s a straightforward step towards the
internationalization of a product because the appetites
of people within developed nations tends to be quite
similar.
• Stage III - The Maturity Stage
• At this point, when the product has firmly established
demand in developed countries, the manufacturer of
the product will need to consider opening up
production plants locally in each developed country to
meet the demand. As the product is being produced
locally, labor costs and export and costs will decrease
thereby reducing the unit cost and increasing revenue.
• Product development can still occur at this point as
there is still room to adapt and modify the product if
needed. Appetites for the product in developed
nations will continue to increase in this stage.
• Although the unit costs have decreased due to the
decision to produce the product locally, the
manufacture of the product will still require a highly
skilled labor force. Local competition to offer
alternatives start to form. The increased product
exposure begins to reach the countries that have a less
developed economy, and demand from these nations
start to grow.
• Stage IV - Product Standardization and Streamlining of
Manufacturing
• Exports to nations with a less developed economy begin in earnest.
Competitive product offers saturate the market which means that the
original purveyor of the product loses their competitive edge on the
basis of innovation. In response to this, rather than continuing to add
new features to the product, the corporation focuses on driving
down the cost of the process to manufacture the product. They do
this by moving production to nations where the average income is
much lower and standardizing and streamlining the manufacturing
methods needed to make the product.
• Stage V – Market Saturation
• The local workforce in lower income nations are then exposed to
the technology and methods to make the product and competitors
begin to rise as they did in developed nations previously.
Meanwhile, demand in the original nation where the product came
from begins to decline and eventually dwindles as a new product
grabs the attention of the people. The market for the product is
now completely saturated and the multinational corporation leaves
the manufacture of the product in low income countries and
instead, focuses its attention on new product development as it
bows gracefully out of the market.
• What is left of the market share is divvied up between
predominantly foreign competitors and people in the original
country who want the product at this point, will most likely buy an
imported version of the product from a nation where the incomes
are lower. Then the cycle begins again.
 Lesson 6 - Technological Gap Theory

• M.V. Posner in 1961

• The Heckscher-Ohlin theory assumed that the techniques
of production remain unchanged
• Technological change is a continuous process. Even if the
countries have similar factor proportions and tastes, yet
continuous process of inventions and innovations can
give rise to trade.
• As a firm develops a new product, it is first tested in the
home market. After it is proved to be successful in the
home market, it is introduced in the foreign markets.
• The new products confer a temporary
monopoly position upon the producing firm
or exporting country in the world trade. This
monopoly position is often protected by the
patents and copyrights. The exporting country
enjoys comparative advantage over the rest of
the world until the foreign producers imitate
the new varieties of products or learn new
processes of production.
 Assumptions

• (i) There are two countries, A and B.

• (ii) The factor endowments are similar in two
countries.
• (iii) Both the countries have similar demand
conditions.
• (iv) The factor price ratios in the two countries
are similar before trade.
• (v) There are different techniques in the two
countries.
 Technological Gap

• The lag existing between the appearance of new products

and introduction of their substitutes by the foreign
producer manifests the technological gap or imitation gap.
• Posner has decomposed the technological gap into three
components—the foreign reaction lag, domestic reaction
lag and the demand lag.
• The foreign reaction lag is the time taken by the first
foreign firm to produce the new variety of product. The
domestic reaction lag signifies the time required by the
domestic producers to introduce still newer varieties in
order to establish their hold on the domestic market and
sustain it in the foreign market. The demand lag means the
time taken by the domestic consumers to acquire a taste
for the new product.
• Posner referred the integration of innovation
and imitation lag as ‘dynamism’. A dynamic
country in international trade is one which
innovates at a greater rate and which imitates
the foreign innovations at a greater speed. If
one of the two trading countries has a greater
degree of dynamism than the other, the latter
will find the erosion of its markets and
consequent deficit in trade balance.
• If the two countries are otherwise identical,
whether trade between them will be generated
by technological innovation, will depend on the
net effect of the demand and imitation lags. If the
demand lag is longer than the imitation lag, the
producers in the imitating country would adopt
the new technology before the consumers in
their home market had started demanding the
new good. In this case, the technological
innovation would not generate trade.
• On the other hand, if the imitation lag is
longer than the demand lag, the international
trade is likely to be generated by innovation.
So the pattern of trade between the two
countries will depend upon the relative
duration of the two lags.
• In Figure, time is measured along the horizontal scale
and the trade balance of country A, the innovating
country, is measured along the vertical scale. Upto
point t0, no trade takes place between the two
countries. At this point, the innovating country A
introduces the new product. As the consumers in
imitating country B become aware of the product, they
start consuming it.
• Country A, therefore, starts exporting it. In case, the
country B were unable to adopt the new technology,
the exports from country A would continue to rise until
they reached the maximum level in time t3.
• The period, t0t3 can be identified as demand lag. If new technology could
be adopted by country B by the time t1, the imports of the product in their
market could be contained before they reached the maximum level.
Country B then reversed them with trade ceasing at time t2. If the
imitation gap were longer and the producers in country B could not adopt
the new technology until time t4, exports from country A to country B
would have continued at the maximum level until t4.
• As country B started imitating the new technology, there would have been
decline in exports from A to B and these would fall down to zero in time
t6. In this connection, two other possibilities can be discussed. If
producers in country A fail to introduce new innovation in time t6 and
country B makes further innovations, country B will start penetrating the
domestic market of country A indicated by the arrow in the lower part of
the Figure. The second possibility in that producers in country A may
introduce new innovation in time t6 leading to increase in its exports to
country B. That is shown in the Fig by the arrow in the upward direction.