International Economics

PROF.RAGHUNANDAN HELWADE
International economics
• International economics deals with the economic
activities of various countries and their
consequences.
• In other words, international economics is a field
concerned with economic interactions of
countries and effect of international issues on the
world economic activity.
• It studies economic and political issues related to
international trade and finance.
 International economics
• International Economics is an exciting and dynamic subject that equips students with
the tools with which to tackle important real-world issues in this age of globalisation
and financial integration .

• International economics is concerned with the effects upon economic activity from
international differences in productive resources and consumer preferences and the
international institutions that affect them. It seeks to explain the patterns and
consequences of transactions and interactions between the inhabitants of different
countries, including trade, investment and transaction.
• International trade
• International finance
• International monetary economics and international macroeconomics
• International political economy, a sub-category of international relations, studies
issues and impacts from
• for example international conflicts, international negotiations, and
international sanctions; national security and economic nationalism; and international
agreements and observance
 International economics
• 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.
 Concept
• International economics refers to a study of international
forces that influence the domestic conditions of an economy
and shape the economic relationship between countries.
• In other words, it studies the economic interdependence
between countries and its effects on economy.
• The scope of international economics is wide as it 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.
• International economics has emerged as one of the most
essential concepts for countries. Over the years, the field of
international economics has developed drastically with
various theoretical, empirical, and descriptive contributions.
• 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.
• International economics is divided into two
parts, namely, theoretical and descriptive.
• These two parts are discussed as follows:
• (a) Theoretical International Economics:
• Deals with the explanation of international
economic transactions as they take place in
the institutional environment.
 Theoretical international economics is
further grouped into two categories
• (i) Pure Theory of International Economics:
• Involves microeconomic part of international economics. The pure
theory of international economics deals with trade patterns,
impact of trade on production, rate of consumption, and income
distribution. Apart from this, it also involves the study of effects of
trade on prices of goods and services and rate of economic growth.
• (ii) Monetary Theory of International Economics:
• Involves macroeconomic part of international economics. The
monetary theory of international economics is concerned with
issues related to balance of payments and international monetary
system. It studies causes of disequilibrium between payments and
international monetary system and international liquidity.
• (b) Descriptive International Economics:
• Deals with institutional environment in which
international transactions take place between
countries. Descriptive international economics also
studies issues related to international flow of goods
and services and financial and other resources. In
addition, it covers the study of various international
economic institutions, such as IMF, WTO, World Bank,
and UNCTAD.
• Among aforementioned concepts, such as
globalization, gains from trade, pattern of trade,
balance of payments, and FDI, globalization forms the
major part to be learned in international economics.
Why trade?
• All trade is voluntary
• People trade because they believe that they
will be better off by trading
International trade
• International trade is the exchange of goods and
services among countries.
• Total trade equals exports plus imports.
• In 2020, the total international trade was just under $19
More than 25% of the goods traded are machinery and
electronics, like computers, boilers, and scientific
instruments.
• Almost 12% are automobiles and other forms of
transportation.
• Next comes oil and other fuels contributing 11%.
Chemicals, including pharmaceuticals, add another 10%.
Key Takeaways

• International trade opens new markets and

exposes countries to goods and services
unavailable in their domestic economies. 
• Countries that export often develop companies
that know how to achieve a competitive
advantage in the world market.
• Trade agreements may boost exports and
economic growth, but the competition they bring
is often damaging to small, domestic industries.
Advantages of International Trade

• Exports create jobs and boost economic growth, as

well as give domestic companies more experience
in producing for foreign markets.
• Over time, companies gain a competitive
advantage in global trade.
• Research shows that exporters are more
productive than companies that focus on domestic
trade.
• Imports allow foreign competition to reduce prices
and expand the selection, like tropical fruits, for
consumers.
Disadvantages of International Trade

• The only way to boost exports is to make trade easier

overall. Governments do this by reducing tariffs and other
blocks to imports. That reduces jobs in domestic industries
that can't compete on a global scale.
• That also leads to job outsourcing, which is when
companies relocate call centers, technology offices, and
manufacturing to countries with a lower cost of living.
• Countries with traditional economies could lose their local
farming base as developed economies subsidize their
agribusiness.
• Both the United States and European Union do this, which
undercuts the prices of the local farmers in other countries
Difference-regional trade and
international trade
• 1. Factor Immobility:
• The classical economists advocated a separate theory of international
trade on the ground that factors of production are freely mobile
within each region as between places and occupations and immobile
between countries entering into international trade. Thus, labour and
capital are regarded as immobile between countries while they are
perfectly mobile within a country.
• The international mobility of capital is restricted not by transport costs
but by the difficulties of legal redress, political uncertainty, ignorance
of the prospects of investment in a foreign country, imperfections of
the banking system, instability of foreign currencies, mistrust of the
foreigners, etc. Thus, widespread legal and other restrictions exist in
the movement of labour and capital between countries. But such
problems do not arise in the case of inter-regional trade
2. Differences in Natural Resources:
• Different countries are endowed with different types of
natural resources. Hence they tend to specialise in
production of those commodities in which they are richly
endowed and trade them with others where such resources
are scarce. In Australia, land is in abundance but labour and
capital are relatively scarce. On the contrary, capital is
relatively abundant and cheap in England while land is scarce
and dear there.
• Thus, commodities requiring more capital, such as
manufactures, can be produced in England; while such
commodities as wool, mutton, wheat, etc. requiring more
land can be produced in Australia. Thus both countries can
trade each other’s commodities on the basis of comparative
cost differences in the production of different commodities.
3. Geographical and Climatic Differences:

• Every country cannot produce all the commodities

due to geographical and climatic conditions, except
at possibly prohibitive costs. For instance, Brazil has
favourable climate geographical conditions for the
production of coffee; Bangladesh for jute; Cuba for
beet sugar; etc. So countries having climatic and
geographical advantages specialise in the
production of particular commodities and trade
them with others.
4. Different Markets:

• International markets are separated by difference in

languages, usages, habits, tastes, fashions etc. Even the
systems of weights and measures and pattern and styles in
machinery and equipment differ from country to country. For
instance, British railway engines and freight cars are basically
different from those in France or in the United States.
• Thus goods which may be traded within regions may not be
sold in other countries. That is why, in great many cases,
products to be sold in foreign countries are especially designed
to confirm to the national characteristics of that country.
Similarly, in India right-hand driven cars are used whereas in
Europe and America left-hand driven cars are used.
5. Mobility of Goods:

• There is also the difference in the mobility of goods

between inter-regional and international markets.
The mobility of goods within a country is restricted by
only geographical distances and transportation costs.
But there are many tariff and non-tariff barriers on
the movement of goods between countries. Besides
export and import duties, there are quotas, VES,
exchange controls, export subsidies, dumping, etc.
which restrict the mobility of goods at international
plane.
6. Different Currencies:

• The principal difference between inter-regional and international trade

lids in use of different currencies in foreign trade, but the same
currency in domestic trade. Rupee is accepted throughout India from
the North to the South and from the East to the West, but if we cross
over to Nepal or Pakistan, we must convert our rupee into their rupee
to buy goods and services there.
• It is not the differences in currencies alone that are important in
international trade, but changes in their relative values. Every time a
change occurs in the value of one currency in terms of another, a
number of economic problems arise. “Calculation and execution of
monetary exchange transactions incidental to international trading
constitute costs and risks of a kind that are not ordinarily involved in
domestic trade.
Problem of Balance of Payments:

• Another important point which distinguishes international trade

from inter-regional trade is the problem of balance of payments.
The problem of balance of payments is perpetual in international
trade while regions within a country have no such problem. This
is because there is greater mobility of capital within regions than
between countries.
• Further, the policies which a country chooses to correct its
disequilibrium in the balance of payments may give rise to a
number of other problems. If it adopts deflation or devaluation or
restrictions on imports or the movement of currency, they create
further problems. But such problems do not arise in the case of
inter-regional trade.
Different Transport Costs:

• Trade between countries involves high

transport costs as against inter- regionally
within a country because of geographical
distances between different countries.
• Different Economic Environment

• Different Political Environment

• Cultural differences
International trade growth can be a
Engine for economic growth
• International trade growth can be a foundation for economic
growth and poverty reduction, but it must be inclusive and
consistent with sustainable development.
• Integration of micro, small, and medium enterprises, the
backbone of developing economies, into value chains is vital for
achieving inclusive trade growth.
• Trade growth increases economic development but is also
correlated with an increase in carbon emissions and can place
pressure on the environment and natural resources.
• Policymakers need to take proactive actions to channel trade
and investment into activities and sectors that can help mitigate
the environmental and social impacts while capturing the
economic benefits.
 The Lewis
versus Riedel Controversy Revisited
• Trade as an Engine of Growth: Is there a stable quantitative relationship between the
exports of developing countries and prosperity in developed countries ? The
controversy between Lewis and Riedel on this question is taken up anew in this paper
and examined in the light of ten years of added data and by estimating additional
relationships. In his 1979 Nobel lecture, W. Arthur Lewis1put forward the proposition
thatthere is astable quantitative relationship between exports of less developed
countries (LDCs) and prosperity in developed countries (DCs). Trade is seen as
an engine of growth, but since the DCs at the time were undergoing a severe recession
following, inter alia, oil price shocks, Lewis was pessimistic as to the continued
operation of trade as an engine of growth for LDCs. Instead, he suggested increased
reliance on South-South trade to take up the slack left by the developed countries. In
1984, Lewis' contention of a stable and mechanical
relationship was severely attacked by James Riedel. Riedel argues that Lewis'
presumption is based on unrealistic theoretical assumptions. He presents
statistical evidence showing that the quantitative relationship which Lewis believesto
have been stable for a period of over 100 years is in fact very unstable and can be
expected to remain so.
Trade Flows

• Trade flows are the buying and selling of goods and services between countries.
• Trade flows measure the balance of trade (exports – imports).  This is the
amount of goods that one country sells to other countries minus the amount of
goods that a country buys from other countries.  This calculation includes all
international goods transactions and represents a country's trade balance.
• Countries that are net exporters export more to international clients than they
import from international producers.
• Net exporters run a trade surplus.  This is due to the fact that they sell more
goods to the international market than they purchase from the international
market.  Demand for that country's currency then increases because
international clients must buy the country’s currency in order to buy these
goods.  This causes the value of the currency to rise.
• Countries that are net importers import more from international producers than
they export to international clients.
 As an example, let us look at Japan
• Japan is an export-driven economy which usually runs a trade surplus. 
Japan exports more goods to international clients than they import from
international producers.
• Japan's trade surplus is the major reason why the JPY has not depreciated
sharply despite severe economic weakness.
• Japan is a net exporter with a current account surplus of about 3% of GDP.
• This creates international demand to buy the JPY in order for international
clients to purchase Japanese products.
• Clearly a change in the balance of payments from one country to another
has a direct effect on currency levels.  Therefore, it is important for traders
to keep abreast of economic data relating to this balance and understand
the implications of changes in the balance of payments.
• JPY has appreciated despite economic weakness.  From 8/2003 – 12/2003
USD/JPY went from 121.00 to 107.00.
 Capital Flows
• Capital flows represent money sent from overseas in order to invest in foreign markets.
• Capital flows measure the net amount of a currency that is purchased or sold for capital
investments.  The key concept behind capital flows is balance. For instance, a country can have
either a positive or negative capital flow.
• A positive capital flow balance implies that investments coming into a country from foreign
sources exceed the investments that are leaving that country for foreign sources.
• As inflows exceed outflows for any given country, there is a natural demand for more of that
country's currency.  This demand causes the value of that currency to increase because a foreign
investor must change his currency into the domestic currency where he is depositing his money.
• A negative capital flow balance indicates that investments leaving a country for foreign sources
exceed investments coming into a country from foreign sources.
• When there is a negative capital flow, there is less demand for that country's currency, which
causes it to lose value.  This is because the investor must sell his local currency to buy the
domestic currency where he is depositing his money.
• Countries that offer the highest return on investment through high interest rates, economic
growth, and growth in domestic financial markets tend to attract the most foreign capital. 
These countries maintain a positive capital flow.  If a country's stock market is doing well, and
they offer a high interest rate, foreign sources are likely to send capital to that country.  This
increases the demand for this currency, and causes its value to appreciate.
As an example, let us take a booming economy in
the United Kingdom and a sluggish economy in the
United States
• .  In the UK, the stock market is performing very well, while in the
United States there is a shortage of investment opportunities.
• In this scenario:
• US residents sell their US dollars and buy British Pounds to take
advantage of a booming British economy.
• Capital flows out of the United States into the United Kingdom.
• Demand for GBP increases and demand for USD decreases.
• The value of USD decreases in relation to the value of the GBP.
• With this overview of Trade Balance, TIC data and Trade
Flows/Capital Flows, you can see how these pieces of information
function in tandem and why a trader of currency would do well to
follow these releases.
 Factors influencing international trade
• Many various factors, such as political, economic, and pr
actical factors can affect the growth of international
trade. .
• Exchange rates,
• competitiveness,
• growing globalization,
• tariffs and trade barriers,
• transportation costs,
languages, cultures,
• various trade agreements affect companies by its decision
to trade internationally.
• Political policies and other government concerns, such as the
relationships between trading nations, are highly important to the
growth of international trade.
• A politically stable nation with few policies restricting international
trade will likely be able to expand its worldwide trade rapidly. Political
instability, however, particularly when it leads to violence, can be a
major barrier to trade growth — many nations place steep tariffs on
exports or imports from certain nations or industries for such reasons.
• While such tariffs can be used to protect fledgling industries or to
place political pressure on some nations, their overall effect on
international trade is often negative.
• One of the biggest stories of the past 20 years has been the successful
integration of many developing countries into the global economy and
their emergence as key players in international trade.
• Developing countries are diverse in the quality of their political and
economic ins titutions but there are strong reasons to believe that
“better” institutions give countries a competitive advantage and
produce better trade outcome
Chap 2 : Absolute Advantage
“The natural advantages which one country has
over another in producing particular
commodities are sometimes so great that it is
acknowledged by all the world to be in vain to
struggle with them.”
Adam Smith in “Wealth of Nations” Book IV, Chapter 2
Comparative Advantage
• David Ricardo extended the ideas of Adam
Smith
• Nations could benefit from trade based on
comparative advantage, not just absolute
advantage
• Comparative advantage refers to a country’s
ability to produce a good at a lower
opportunity cost than another country
Sources of Comparative Advantage
• Differences in technology
• Differences in climate
• Differences in factor endowments
– Factors of production – land, labor and capital
– Factor intensity – the factor that is used
intensively in production
– Heckscher-Ohlin model
Imagine an island with only two trees but lots of boats. The islanders
produce two goods, coconuts and fish.
A nearby island has many trees, but it has very few boats.
Initially, there is no contact between the islands. However, a new
navigational device will soon allow shipments between the islands.
What will happen?
• Only two trees → expensive domestic
coconuts before trade
• Imported foreign coconuts are cheap
• Domestic price of coconuts ↓ with trade

• Lots of boats → cheap domestic fish

before trade
• New export markets for fish increases
demand
• Domestic price of fish ↑ with trade
• Who cares about the price of coconuts?
– People who own trees (land)
– People who climb trees (labor)

• Who cares about the price of fish?

– People who own boats (capital)
– People who sail and fish (labor)
Who could object?

Domestic price is higher than world price.

Country begins to import and domestic price falls.

Domestic consumers benefit.

Domestic producers are harmed.
Who could object?

Domestic price is lower than world price.

Country begins to export and domestic price rises.

Domestic producers benefit.

Domestic consumers are harmed.
The Flow of Currencies:

Whisky sold to Italian hotel

Export earnings for UK

(Credit on Balance
of Payments)

€ changed to £

Map courtesy of http://www.theodora.com

The Flow of Currencies:

Oil from Russia

Oil

£ changed into Roubles Export earnings for Russia

Import expenditure for the UK

(Debit on balance of payments)

Map courtesy of http://www.theodora.com

Specialisation and Trade
• Different factor endowments mean some countries
can produce goods and services more efficiently than
others – specialisation is therefore possible:
• Comparative Advantage:
– Where one country can produce goods at a lower
opportunity cost – it sacrifices less resources in production
Comparative Advantage
Oil (Barrels) Whisky (Litres)

Russia 10 or 5
Scotland 20 or 40
One unit of labour in each country can produce either oil OR
whisky.

A unit of labour in Russia can produce either 10 barrels of oil per

period OR 5 litres of whisky.

A unit of labour in Scotland can produce either 20 barrels of oil

OR 40 litres of whisky.
Comparative Advantage

Opportunity Cost = sacrifice/ gain

Russia: if it moved 1 unit of labour from whisky to oil it would sacrifice 5

litres of whisky but gain 10 barrels of oil (OC = 5/10 = ½)
Moving 1 unit of labour from oil to whisky production would lead to a
sacrifice of 10 barrels of oil to gain 5 litres of whisky (OC of whisky is 10/5
= 2)

Scotland: if it moved 1 unit of labour from whisky to oil it would sacrifice

40 litres of whisky but gain 20 barrels of oil (OC = 40/20 = 2)
Moving 1 unit of labour from oil to whisky production would lead to a
sacrifice of 20 barrels of oil to gain 40 litres of whisky (OC of whisky is
20/40 = ½ )

For Scotland the OC of oil is four times higher than that in

Russia
(2 compared to ½)
Comparative Advantage
• In Russia, oil can be produced cheaper than in Scotland
(Russia only sacrifices 1 litre of whisky to produce 2 extra
barrels of oil whereas Scotland would have to sacrifice 2 litres
of whisky to produce 1 barrel of oil.

There can be gains from trade if each country specialises in the

production of the product in which it has the lower opportunity
cost – Russia should produce oil; Scotland, whisky.
Comparative Advantage
Before trade – each country divides its labour between the two products:

Oil (Barrels) Whisky (Litres)

Russia 5 2.5
Scotland 10 20
Total Output 15 22.5

After specialisation – each country devotes its resources to that in which it has
a comparative advantage.

Oil (Barrels) Whisky (Litres)

Russia 10 0
Scotland 0 40
Total Output 10 40
Comparative Advantage
• Total Output has risen and trade can be arranged at a
mutually agreed rate that will leave both countries
better off than without trade. The rate has to be
somewhere between the OC ratios (in this case 2 and
½)
• e.g. If the trade were arranged at 1 barrel of oil for 1
litre of whisky the end result would be:
Who could object?
• The total gains from specialization and trade
are greater than the losses
• But those gains do not necessarily go to the
parties who lost welfare because of the trade
• The challenge becomes the willingness of
“winners” to compensate “losers”
Barriers to Trade
Tariff
• Tax on imported goods or services
• Reasons for tariffs
– Raise tax revenues
– Reduce consumption of the imported good or
service
• Effect – Price of import rises, “cheaper”
domestic goods become more attractive
Quota
• Limits the amount of an imported good
allowed into the country
• Supply is decreased and price increases
• Voluntary Export Restrictions (VER’s) are
similar
Export Subsidy
• Government financial assistance to a firm that
allows a firm to sell its product at a reduced price
• Benefits and harms
– Consumers (both at home and abroad) benefit from
lower prices
– Foreign producers are harmed because of lower world
prices
– Taxpayers in the producing country pay the subsidy
Product Standards
• A type of “hidden” trade barrier
• Types of standards
– Product safety
– Content
– Packaging
Trade Agreements
• General Agreement on Trade and Tariffs
(GATT) and World Trade Organization (WTO)
• Regional trade agreements
GATT
• “Provisional” agreement (1948 – 1994)
• Dramatic tariff reductions were negotiated in
a series of trade rounds
• Grew from 23 to 123 countries
WTO
• WTO created in the Uruguay trade round
• Established in Geneva in 1995
• 153 member countries
• GATT was updated and still forms the legal
framework for WTO negotiations on the goods
trade
What is the WTO?
• A negotiating forum
• A set of rules (international agreements)
– GATT
– GATS (General Agreement on Trade in Services)
– TRIPS (Agreement on Trade-Related Aspects of
Intellectual Property Rights)
• A place to settle trade disputes
Regional Trade Agreements
• Examples include
– North American Free Trade Agreement
– Association of Southeast Asian Nations
– Common Market of the South (MERCOSUR)
– European Union
• Regional agreements have been praised and
criticized
Thank You