International Economics

2017
 INTROUCTION

 The world’s economies has become

increasingly integrated
 The degree of a country’s
involvement in international trade
and finance is referred to as the
openness of its economy
 Background
• International trade enables nations to
specialise their production.
• Enhance their resource productivity and
acquire more goods & Services.
• Sovereign nations, like individuals and regions
of a nation can gain by specialising in the
product they can produce efficiently, and
• By trading for goods they cannot produce
efficiently.
 But why do countries trade
• Three facts:
1. Distribution of natural, human, and capital resources
is uneven- A country may not have certain commodities
in sufficient supply – need to import them.
2. Efficient production of various goods require
different technologies or combination of resources.
3. Cost differences caused by uneven distribution of
resources throughout the world (relative scarcity)
 Important Terms to Know
• Specialization: Division of labor into specific tasks and
roles intended to increase the productivity of
workers.
• Globalization: Name for the process of increasing
the connectivity and interdependence of the world's
markets and businesses.
• Imports: Goods and services purchased from other
countries
• Exports: Goods and services sold to other countries
 Absolute Advantage

• Individual – exists when a person can produce

more of a certain good/service than someone
else in the same amount of time (or can
produce a good using the least amount of
resources.)
• National – exists when a country can produce
more of a good/service than another country
can in the same time period.
• Some countries have absolute advantage in
the production of certain goods.
• E.g, SA has an absolute advantage in the
mining of gold over most countries in the
world.
• The oil-rich countries in the middle-east have
an absolute advantage in exporting of oil.
 Absolute advantage
Country Shirts Cellphones

Zim 100 5

SA 50 10
Is Absolute Advantage the only basis
for trading?

What if a person or a nation has an

absolute advantage in producing
everything….would there still be a
reason to specialize and trade?
 Comparative Advantage
 A person or a nation has a comparative
advantage in the production of a product
when it can produce the product at a lower
domestic opportunity cost than can a trading
partner.
 one country can produce certain goods or
services more economically relative to other
countries
Comparative advantage as the basis
for trade is one of the most
important ideas in economics.
 Comparative Advantage
• Comparative advantage is the basis for all
trade between individuals, regions, and
nations.
• A person or nation will specialize in the
production of a product for which it has a
lower opportunity cost and trade to obtain
those products for which its opportunity cost
is higher.
 Specialization and Trade
• Gains from trade are based on comparative
advantage, not absolute advantage
 Bake Make
Cakes Pizza
Ms. 2 cakes/hr. 6 pizzas/hr.
Gray
Mr. 4 cakes/hr. 8 pizzas/hr.
Pinson

Who has the absolute advantage in producing cakes? Mr. Pinson

Who has the absolute advantage in producing pizza? Mr. Pinson
Would Mr. Pinson be better off if he specializes and trades?
 Mr. Pinson should specialize and trade if he has a
comparative advantage (lower opportunity cost)
in the production of one of the products.
Bake Make
Cakes Pizza

Ms. 2 cakes/hr. 6 pizzas/hr.

Gray

Mr. 4 cakes/hr. 8 pizzas/hr.

Pinson

Mr. Pinson has a lower opportunity cost in producing cakes; therefore, he should
specialize in the production of cakes. Ms. Gray has a lower opportunity cost in
producing pizza; therefore, she should specialize in the production of pizza.
 Terms of trade
Bake Make
Cakes Pizza
Pinson will specialize in cakes. Gray will specialize in pizzas.

Ms. Gray 1c = 3p 1p = 1/3c

For one cake, Gray would be For one pizza, Gray will want
willing to pay anything up to 3 more than 1/3 cakes.
pizzas.

Mr. Pinson 1c = 2p 1p = 1/2c

For one cake, Pinson will want For one pizza, Pinson would be
more than 2 pizzas. willing to pay anything up to ½
cake.
 Terms of trade
Maximum output per worker per day
CARS BARRELS OF WINE

GER 2 (1c=4w) 8(1w=2/8)

SA 1( 1c= 6w) 6 (1w= 1/6)

 Figure 16-1 Production Why countries
trade

possibilities in Germany
(Textbook page 303)
and
South Africa

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 Benefits from
Specialization and Trade

• Specialization and trade increase productivity and

the standard of living within a nation.
• Because of specialization and trade, there will be a
larger global output of goods and services.
• Everyone can benefit when people trade with one
another. Not only can people enjoy a greater
quantity of goods and services, but they can also
enjoy a greater variety of goods.
 Trade policy
• Trade leads to greater production of traded
goods, by implication leads to an increase in
economic welfare.
• Steps are taken to open up economies to
international trade and reap the benefits of
such trade.
• However, every government still takes steps to
protect domestic firms against foreign
competition.
 Measures/Steps used to protect domestic
firms
• Import tarriffs
- Are duties or taxes imposed on products
imported into a country.
- used to protect domestic industries from
foreign competition.
• Import quota
-Seek to control physical quantity of imports and
takes a direct form of intervention in the market
mechanism.
• Subsidies
- Granted to home producers

• Exchange controls
- restrict imports by limiting the amount of
foreign currency available for their purchase.
• Exchange rate policy
- Movements in exchange rate may have a
significant effect on exports and imports.
- Exchange rate policy may have much more
influence in international trade than traditional
instruments of trade policy such as tariffs,
quotas, and subsidies.
 Exchange rate
• Foreign trade Involves payment in foreign
currency such as euros, pound, dollars, and yen.
• SA importers have to pay in these currencies
when they buy and are obliged to exchange
rands for these currencies.
• Thus, there is demand on the SA importers for
foreign currency.
• On the other hand, importers in other countries,
have to pay in rand for SA exports.
• The rate at which currencies are exchanged is known
as the rate of exchange or exchange rate.
• The price of one currency when expressed to the
other eg ZAR/USD
• A value of a currency can either appreciate or
depreciate.
• Appreciation means that the value of one currency
has increased in terms of another.
• Depreciation means the value of one currency has
decreased in terms of another.
 EXCHANGE RATES

• A rise in the exchange rate means the domestic

currency has depreciated
• If the exchange rate falls the domestic currency
has appreciated
 THE DEMAND FOR
FOREIGN EXCHANGE
• The demand for foreign exchange is a result of
domestic residents demanding foreign goods and
services
• The exchange rate is price of foreign exchange
• As the exchange rate changes, the quantity
demanded of foreign goods and services will
change
 THE DEMAND FOR
FOREIGN EXCHANGE
• Shifts in the Demand for Foreign Exchange
– Changes in the demand for foreign exchange are
related to the income level, the relative price
levels, and tastes and preferences
– The most important factors are changes in
income and prices relative to the foreign country
 THE DEMAND FOR
FOREIGN EXCHANGE
• Changes in Domestic Income
– As SA income increases, demand for all goods
including imports increases
– This leads to an increase in the demand for
foreign currency and a shift in the demand
curve to the right
– If income declines, the effect will be the
opposite and the demand curve will shift to the
left
 THE DEMAND FOR
FOREIGN EXCHANGE
The Change in Demand for Foreign Exchange

R/Dollar

D’

D” D

Dollar
 Foreign exchange market
• A foreign market is a global decentralized
market for the trading of currencies.
• In terms of volume of trading, it is by far the
largest market in the world.
• The main participants in this market are the
larger international banks.
 Exchange
rates
• The foreign exchange
market
– The demand for
dollars

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 The demand for dollars
• Those who demand dollars are rand holders
• They are seeking to exchange rand for dollars
• Demand for dollars is the same as supply for
rands
• Demand for dollars is as a result of SA residents
demanding foreign goods & services, assets,
and speculators who anticipates a decline in
the value of a rand against the dollar.
 Demand for dollars (cont)
• The idea is that the more expensive the dollars
are in terms of the rand, the lower the
quantity demanded for dollars, ceteris
paribus.
End of lesson!!!
 Supply of Dollars
• Suppliers of dollars are the holders of dollars
and are seeking to exchange them for Rands.
• Supply for dollars is as a result of exports by
South Africans.
• The foreign buyers of SA exports whose prices
are quoted in dollars supply and which are
then exchanged for Rands.
 The Equilibrium exchange rate
• The rate at which quantity of dollars
demanded equals the quantity of dollars
supplied.
• At lower cost there will be an excess demand
for dollars.
 Changes in Supply and Demand:
Depreciation and appreciation
• Anything that causes a change in the supply or
demand of foreign exchange will result in a
change in the exchange rate, ceteris paribus.
• A rand can either appreciate or depreciate
against the dollar.
 Exchange
rates
The foreign exchange market
s
xchange rate
d and supply: Currency
depreciation

e in supply due US stakeholders

A goods.
e left
e
m US

t improves

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PUBLISHERS
 Exchange
rates
The foreign exchange market

Table 16-1 Changes in supply and demand of dollars: a

summary

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Intervention in the foreign exchange
market
• Exchange rate becomes volatile without
intervention by authorities.
• Therefore, central bank to some extent
manages or manipulate the exchange rate.
• This is done to in order to achieve policy
objectives.
• The managing or manipulation of exchange
rate by the central bank is called managed
floating.
 Exchange
rates
The foreign exchange market

Table 16-2 Impact of changes in rand/dollar exchange rate for

South Africa (Textbook page 308)

Rand depreciate- It becomes more expensive to buy foreign goods, foreign exports decrease.
SA exports increase- SA Current account improves- SA prices increase due to high demand.

Rand appreciate- it becomes less expensive to import foreign goods, foreign imports decrease.
SA exports decrease-SA current account worsen- Domestic prices fall

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 Exchange
rates
• Intervention in the foreign exchange
market

• Exchange rate
policy © VAN SCHAIK
PUBLISHERS
Intervention in the foreign exchange market

• Assume an increase SA imports from US

• Demand curve shift to the right to D1D1
• US dollar appreciates
• In the absence of intervention excess demand for dollars leads to increase
in prices (exchange rate)
• Rand therefore depreciate against the dollar

• SARB intervention
• Assume SARB wants to avoid such depreciation of a rand
•What can it do?
• Supply the necessary reserves to the market
• As a results supply curve shifts to the right
• New equilibrium established @ E2
 Exchange rate policy
• Exchange rate is among the most important
variables in the economy.
• Movements in it have significant impact on
economic growth, employment, inflation, and
the balance of payment as well as the well
being of individuals.
• How can policy makers react in such
circumstances? This will depend on the
exchange rate system that is in force.
• END OF LESSON!!!
 So….if economists all
agree that free trade is
such a great idea, why do
so many people have
problems with the idea?
 Costs of Specialization and Trade
• Domestic jobs are lost.
• Domestic income is lost.
• National security.
• Nations “dumping” goods trying to drive out
domestic competition.
• Other nations don’t treat their workers fairly.
 Barriers to Trade
• Tariffs: a tax on imports
• Quotas: a restriction on the amount of
imports
 Trade Agreements
Trade agreements regulate international trade between two or
more nations. An agreement may cover all imports and exports,
certain categories of goods, or a single category. The United
States is currently engaged in some 320 trade agreements with
various nations.

• General Agreements on Tariffs and Trade

(GATT)
• North American Free Trade Agreement
(NAFTA)
• World Trade Organization
 In order to produce one ton of output, Mexico and the
USA must use the following amount of resources (in acres
of land).

Soybeans Avocados

Mexico 16 8

USA 8 6
 Given a fixed amount of resources, Mexico and the
USA can choose between the following alternatives.

Soybeans Avocados

Mexico 15 60

USA 30 90
Chapter 6 Table
6.5
Mankiw, question 4, page 60
Pat and Kris are roommates. They spend most
of their time studying (of course), but they
leave some time for their favorite activities;
making pizza and brewing root beer. Pat takes
4 hours to brew a gallon of root beer and 2
hours to make a pizza. Kris takes 6 hours to
brew a gallon of root beer and 4 hours to
make a pizza.
What is each roommate’s opportunity cost of
making a pizza? Who has the comparative
advantage in making pizza?
 Root beer Pizza
(hours to make) (hours to make)

Kris 16 8

Pat 4 2