1 Welcome to EC 382: International Economics By: Dr. Jacqueline Khorassani Week Three

2 Week Three: Class One Tuesday, September 18 14:10-15:00 AC 202 Tuesday, September 18 14:10-15:00 AC 202 I ordered 5 copies of the textbook for the library I ordered 5 copies of the textbook for the library I did not receive any questions from you on Study Guide 3 I did not receive any questions from you on Study Guide 3 –If you don’t ask, I assume you know Expect an in class assignment tomorrow Expect an in class assignment tomorrow

3 Definitions Brazil is more Capital abundant than China if Brazil is more Capital abundant than China if K/L in Brazil>K/L in China

4 Definition Production of computers is more capital intensive than production of shoes if Production of computers is more capital intensive than production of shoes if –Production of computers requires a higher K/L than production of shoes.

5 Factor-Proportions Theorem Given a set of assumptions (outlined on page 62 of your book, ask me if you don’t understand the assumptions) Given a set of assumptions (outlined on page 62 of your book, ask me if you don’t understand the assumptions) Brazil has comparative advantage over China in production of computers if Brazil has comparative advantage over China in production of computers if 1.Production of computers is relatively capital intensive and 2.Brazil is a relatively capital abundant nation

6 Now let’s work through an example K/L in US =1/2 K/L in US =1/2 K/L in Germany = 1/1 K/L in Germany = 1/1 Which nation is labor abundant? Which nation is labor abundant? –US, because it has a higher L/K ratio According to Factor-Proportions Theorem, US has comparative advantage in production of goods and service that are ______ intensive. According to Factor-Proportions Theorem, US has comparative advantage in production of goods and service that are ______ intensive. Labor

7 Now let’ continue with the example Pre-trade, which nation has a higher (Wage/price of capital) ratio? Pre-trade, which nation has a higher (Wage/price of capital) ratio? –Germany –Because labor is relatively more scarce in Germany –Suppose (W/price of capital) ratio in Germany = 5/5=1 –Suppose (W/price of capital) ratio in US = 2/4 = 0.5

8 After trade US will specialize in production of ______ intensive goods and services. US will specialize in production of ______ intensive goods and services. Production of labor intensive goods in US will _______ while production of capital intensive in goods in Germany will______. Production of labor intensive goods in US will _______ while production of capital intensive in goods in Germany will______. Labor increase

9 What does this do to demand for labor? For capital in US? Wages? Price of capital? What does this do to demand for labor? For capital in US? Wages? Price of capital? –Demand for labor in the US will go _____. Wage will go __________ Wage will go __________ –from 2 to 2.5. –Demand for capital in the US will go __________. Price of capital will go __________ Price of capital will go __________ –from 4 to 3.5. up Down

10 The opposite happens in Germany The opposite happens in Germany –Wage will go down from 5 to 4.2 and the price of capital will go up from 5 to 5.9 Eventually, W/price of capital in both nations will be the same. Eventually, W/price of capital in both nations will be the same. –0.71 This is referred to as factor-price equalization This is referred to as factor-price equalization

11 Summary of ratios USGermany Pre-trade: W/price of capital 2/4= 0.5 5/5 =1 Post-trade: W/price of capital 2.5/3.5 = /5.9 = 0.71

12 Suppose Germany is labor scarce and capital abundant Suppose Germany is labor scarce and capital abundant According to Factor Proportions Theory, Germany is likely to have comparative advantage in ________ intensive goods According to Factor Proportions Theory, Germany is likely to have comparative advantage in ________ intensive goods Germany will specialize in production of ______ intensive goods. Germany will specialize in production of ______ intensive goods. Capital

13 Production of labor intensive goods in Germany will go _______ while production of capital intensive in goods in Germany will go ______. Production of labor intensive goods in Germany will go _______ while production of capital intensive in goods in Germany will go ______. down up

14 What does this do to demand for labor? For capital in Germany? What does this do to demand for labor? For capital in Germany? –Demand for labor will go down, – Income of labor will go down. –Demand for capital will go up, –Income of the owners of the capital will go up This is the Stopler-Samuelson Theorem This is the Stopler-Samuelson Theorem

15 Is US capital or labor abundant? Is US capital or labor abundant? –Capital abundant According to Factor-Proportions Theorem, US must be exporting ________ intensive goods and importing _________intensive goods. According to Factor-Proportions Theorem, US must be exporting ________ intensive goods and importing _________intensive goods. Leontief fund that US industries with trade surplus were more labor intensive than US industries with trade deficits  Paradox Leontief fund that US industries with trade surplus were more labor intensive than US industries with trade deficits  Paradox Capital Labor

16 How do you explain the paradox? Some goods are land (natural resource) intensive (not the same of capital intensive) Some goods are land (natural resource) intensive (not the same of capital intensive) Protectionism Protectionism Physical/human capital Physical/human capital Technology intensive goods Technology intensive goods How about when we import and export the same goods? How about when we import and export the same goods?

17 Definitions Specific factors of production can’t move between production of cars and bread Specific factors of production can’t move between production of cars and bread Examples? Examples? Mobile factors of production can move between production of cars and bread Mobile factors of production can move between production of cars and bread Examples? Examples?

18 The Specific-Factors Model If the U.S. is well endowed with the specific factor used to produce cars, it will have comparative advantage in production of cars. If the U.S. is well endowed with the specific factor used to produce cars, it will have comparative advantage in production of cars.

19 International Economics Week Three- Class 2 Week Three- Class 2 –Wednesday, September 19 –11:10-12:00 PM –Tyndall

20 I received questions Is it ok to use capital abundant in place of capital intensive? Is it ok to use capital abundant in place of capital intensive? –No, they mean different things Would you penalize one for using rent as price of capital. Would you penalize one for using rent as price of capital. –No but I did not use the term rent because –In economics price of capital is interest rate –Rent is price of land (natural resources)

21 I received a question on Table 3.4, Page 69 Over the years, Over the years, –Per capita GDP has grown more sharply in South Korea than in India –The ratio of capital to worker has gone up more sharply in South Korea than in India –Degree of openness (measured by (imports + exports)/GDP) has grown more sharply in South Korea than in India.

22 I received a request To not give you an In Class Assignment today To not give you an In Class Assignment today –Sorry, can’t do, because If you don’t keep up with class, after a while you will not benefit from the class If you don’t keep up with class, after a while you will not benefit from the class It is better to learn a little at the time. It is better to learn a little at the time. Most of this material builds upon the previous stuff Most of this material builds upon the previous stuff –At the end of semester, I will drop the bottom one or two assignment from the course grade.

23 In Class Assignment I will show you 3 multiple choice questions I will show you 3 multiple choice questions On 1/2 sheet of a paper On 1/2 sheet of a paper Print your name Print your name And put your answers down And put your answers down

24 Question 1 If Dutch labor can produce 3 soda pops in a day or 5 yogurt cones in a day, while British labor can produce 2 soda pops and 4 yogurt cones, then __________ has a comparative advantage in yogurt cones. If Dutch labor can produce 3 soda pops in a day or 5 yogurt cones in a day, while British labor can produce 2 soda pops and 4 yogurt cones, then __________ has a comparative advantage in yogurt cones. –A) England –B) both England and the Netherlands –C) the Netherlands –D) There is not enough information to answer this question.

25 Question 2 Which of the following is not a factor of production that the U.S. is abundant in? Which of the following is not a factor of production that the U.S. is abundant in? –A) human capital –B) unskilled labor –C) skilled labor –D) physical capital

26 Question 3 International trade tends to: International trade tends to: –A) have no effect on factor prices. –B) cause the price of the scarce factor to rise and the price of the abundant factor to fall. –C) cause all factor prices to fall. –D) cause the price of the scarce factor to fall and the price of the abundant factor to rise.

27 Definitions (Chapter 4) Intra-industry trade: Export and import within the same industry or product group. Intra-industry trade: Export and import within the same industry or product group. –Example Inter-industry trade: Some industries export and others import. Inter-industry trade: Some industries export and others import. –Example

28 Can factor proportions theory explain the Intra- industry trade? No No –Because that implies that a nation has comparative advantage as well as comparative disadvantage in production of the same product

29 What is the Intra- industry Trade Index? It is used to compare different industries based on their amount of intra-industry trading It is used to compare different industries based on their amount of intra-industry trading X value of exports M value of imports

30 Example Example –US imports $100,000 worth of autos and exports 30,000 worth of autos. What is ITI in the US auto industry? –ITI = 1- (70,000/130,000) = 0.46

31 What if ITI was zero? What if ITI was zero? –Country is either only exporting or only importing –No intra-industry trade How can ITI be 1? How can ITI be 1? –The country’s exports = its imports –100% intra-industry trade

32 Weaknesses of ITI Values of intraindustry trade depend on how a particular industry or product group is defined. Values of intraindustry trade depend on how a particular industry or product group is defined. –More broadly defined groups will show more intraindustry trade. Example: pants Example: pants –More narrowly defined groups will show less intraindustry trade. Example: dress pants and jeans Example: dress pants and jeans

33 Definitions Homogenous goods are those that are identical (consumers can not differentiate between them) Homogenous goods are those that are identical (consumers can not differentiate between them) –Examples Differentiated goods are those that are similar but not identical Differentiated goods are those that are similar but not identical –Examples

34 Why is there intraindustry trade in homogeneous goods? 1. Location Transportation cost Transportation cost It is cheaper for City X to import cement from County A than buy it from City Y It is cheaper for City X to import cement from County A than buy it from City Y City Y will exports cement to Country C City Y will exports cement to Country C B imports and exports cement B imports and exports cement Country A Country B County C City X City Y

35 International Economics Week Three- Day 3 Week Three- Day 3 –Wednesday, September 19 –15:10-16:00 –AC 201 Let’s review this morning’s ICA Let’s review this morning’s ICA

36 ICA1: Question 1 If Dutch labor can produce 3 soda pops in a day or 5 yogurt cones in a day, while British labor can produce 2 soda pops and 4 yogurt cones, then __________ has a comparative advantage in yogurt cones. If Dutch labor can produce 3 soda pops in a day or 5 yogurt cones in a day, while British labor can produce 2 soda pops and 4 yogurt cones, then __________ has a comparative advantage in yogurt cones. –A) England –B) both England and the Netherlands –C) the Netherlands –D) There is not enough information to answer this question. Answer: A Answer: A –Opportunity cost of 1 yogurt in England =2/4= 0.5 sodas –Opportunity cost of 1 yogurt in Netherlands = 3/5 = 0.6 sodas

37 Question 2 Which of the following is not a factor of production that the U.S. is abundant in? Which of the following is not a factor of production that the U.S. is abundant in? –A) human capital –B) unskilled labor –C) skilled labor –D) physical capital Answer: B Answer: B

38 Question 3 International trade tends to: International trade tends to: –A) have no effect on factor prices. –B) cause the price of the scarce factor to rise and the price of the abundant factor to fall. –C) cause all factor prices to fall. –D) cause the price of the scarce factor to fall and the price of the abundant factor to rise. Answer: D Answer: D

39 Why is there intraindustry trade in homogeneous goods? 2. Joint products Country A imports goods + insurance (service) Country A imports goods + insurance (service) Country A exports other goods + insurance (service) Country A exports other goods + insurance (service)

40 Why is there intraindustry trade in homogeneous goods? 3. Entrepot trade –A computer producer in country X has a worldwide distribution center in country Y Country X Country Y Y imports and exports the same computers

41 Why is there intraindustry trade in homogeneous goods? 4. Re-export trade. –Goods are imported into a country, and sometime later the same goods are subjected to a small transformation and exported to another country. Example: Goods are imported, sorted, repackaged and exported to another country to the Far East. Example: Goods are imported, sorted, repackaged and exported to another country to the Far East.

42 Explanations of Intraindustry Trade in Homogeneous Products 5. Seasonal items Country A may only produce strawberries in summer Country A may only produce strawberries in summer Export strawberries in summer Export strawberries in summer Import strawberries in winter Import strawberries in winter

43 Types of differentiated products 1. Horizontally differentiated products have the same price but slightly different characteristics –Examples? Candy bars Candy bars

44 Types of differentiated products 2. Vertically differentiated products have different prices and different characteristics –Examples? autos autos

45 Why would a nation export and import differentiated goods? Price differentials (vertically differentiated products) Price differentials (vertically differentiated products) –Economies of scale What is it? What is it? Average cost goes down as you increase production Average cost goes down as you increase production –Specialization

46 Why would a nation export and import differentiated goods? Example Compact cars are popular in Japan Japan increases its production of compact cars Average cost of producing compact cars declines in Japan Japan gains a comparative advantage in production of compact cars Japan exports compact cars

47 Why would a nation export and import differentiated goods? Big cars are popular in the US US increases its production of big cars Average cost of producing big cars declines in US US gains a comparative advantage in production of big cars US exports big cars

48 The Product Cycle Model Explains why we may turn from exporting a product to importing that product over time. Explains why we may turn from exporting a product to importing that product over time. From the time a new high tech product is developed to the time in becomes widely popular, it goes through 3 stages From the time a new high tech product is developed to the time in becomes widely popular, it goes through 3 stages

49 Example Stage 1 Stage 1 –Computers are just introduced to the market in the US –They are expensive –Need high-income markets –R&D and production improvements require highly skilled workers. –US may export computers to other developed countries

50 Stage 2 Production of computers becomes more standardized. Production of computers becomes more standardized. Production may move to other developed countries instead of exporting to those countries. Production may move to other developed countries instead of exporting to those countries. US may begin to import computers from the new production country. US may begin to import computers from the new production country.

51 Stage 3 Production of computers has become standardized enough that move process to developing countries to utilize unskilled labor to lower costs. Production of computers has become standardized enough that move process to developing countries to utilize unskilled labor to lower costs. US becomes importer. US becomes importer. US moves production focus to new products and cycle starts over. US moves production focus to new products and cycle starts over.

52 The Product Cycle Model

53 The theory of overlapping demands Domestic producers produce goods targeted at tastes and income levels of the domestic market. Domestic producers produce goods targeted at tastes and income levels of the domestic market. Goods are exported to other countries with similar tastes and income levels. Goods are exported to other countries with similar tastes and income levels. Linder states that high-income countries will trade with other high-income countries since income determines general tastes/preferences. Linder states that high-income countries will trade with other high-income countries since income determines general tastes/preferences.

54 The Welfare Implication of Intraindustry Trade Welfare is improved from increased choice and competition. Welfare is improved from increased choice and competition. –Prices tend to be lower with trade in differentiated products. –Quality tends to be higher.

55 The Welfare Implication of Intraindustry Trade Reduces monopoly power of domestic firms Reduces monopoly power of domestic firms Firms can produce at higher levels realizing economies of scale leading to lower prices. Firms can produce at higher levels realizing economies of scale leading to lower prices.