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

2 Week Four: Class One Tuesday, September 18 14:10-15:00 AC 202 Tuesday, September 18 14:10-15:00 AC 202 Your ICA1s are graded but I forgot to bring them to class today. Your ICA1s are graded but I forgot to bring them to class today. –You will receive them tomorrow Expect an ICA tomorrow Expect an ICA tomorrow

3 What are the causes of international factor movements? Assume factors of production are mobile between India and the U.S. Assume factors of production are mobile between India and the U.S. Assume the U.S. is capital abundant and India is labor abundant. Assume the U.S. is capital abundant and India is labor abundant. Labor earns a higher wage in the U.S. than in India. Labor earns a higher wage in the U.S. than in India. Inequality of wages would cause workers from India to migrate to the U.S. Inequality of wages would cause workers from India to migrate to the U.S.

4 What are the effects of international factor movements? Wages would begin to _____ in the U.S. as supply increases. Wages would begin to _____ in the U.S. as supply increases. Wages would begin to ______ in India as supply decreases. Wages would begin to ______ in India as supply decreases. Migration of labor would stop when wages are equal between countries Migration of labor would stop when wages are equal between countries – no more gains from migration. – no more gains from migration. fall rise

5 What about capital? Capital will migrate from the U.S. to India to earn a higher rate of return. Capital will migrate from the U.S. to India to earn a higher rate of return. Capital will migrate until the rate of return is the same between the two countries. Capital will migrate until the rate of return is the same between the two countries.

6 Fact In general, capital is more mobile than labor; why? In general, capital is more mobile than labor; why? –Immigration restrictions –Language/cultural barriers

7 How does the international factor movement compare to international trade? International trade is sometimes International trade is sometimes –a substitute for factor movements between countries. –a complement for factor movements between countries

8 Example of substitute Ireland is capital abundant and has comparative advantage in production of capital intensive goods and return to capital is low. Ireland is capital abundant and has comparative advantage in production of capital intensive goods and return to capital is low. Two alternatives: Two alternatives: 1.Export capital intensive good (machines) & import labor intensive good (shoes), or 2.Capital leaves the nation and labor enters the nation until there is no more comparative advantage or disadvantage; produce machines and shoes domestically. – If factor movements are blocked, trade is pursued.

9 Example of complements Shoes and machines can be traded, but some goods and services can not be traded. Like what? Shoes and machines can be traded, but some goods and services can not be traded. Like what? –Haircuts Someone who lives in Ireland will not go to Turkey to get a hair cut Someone who lives in Ireland will not go to Turkey to get a hair cut But the Turkish hairdresser (labor) can migrate to Ireland But the Turkish hairdresser (labor) can migrate to Ireland

10 Which one is economically preferred? And why? The literature has shown that The literature has shown that When possible, factor movements are preferred to trade. When possible, factor movements are preferred to trade. –World output will be maximized –Blocking factors from earning the highest rate of return is less efficient.

11 What is foreign direct investment (FDI)? It implies directly investing in the firm’s plant and equipment. (Physical investment as opposed to just sending money.) It implies directly investing in the firm’s plant and equipment. (Physical investment as opposed to just sending money.) It takes the form of a domestic corporation opening a foreign subsidiary or buying control of existing foreign firm represents real investments in land, nonresidential investment, and equipment and software. It takes the form of a domestic corporation opening a foreign subsidiary or buying control of existing foreign firm represents real investments in land, nonresidential investment, and equipment and software.

12 FDI: Facts More than 92% of FDI originated in developed countries. More than 92% of FDI originated in developed countries. World’s developed countries received nearly 76% of the world’s FDI. World’s developed countries received nearly 76% of the world’s FDI.

13 FDI in the world Table 5.2

14 International Economics Week 4- Class 2 Week 4- Class 2 –Wednesday, September 19 –11:10-12:00 PM –Tyndall Please pick up your ICA1 Please pick up your ICA1

15 ICA2 In teams of 2 In teams of 2 Half a page Half a page Print both names Print both names 3 Multiple Choice Questions 3 Multiple Choice Questions Write down the answers Write down the answers

16 Question 1 A relatively large amount of intraindustry trade would be associated with: A relatively large amount of intraindustry trade would be associated with: –A) an index of intraindustry trade close to 1.0. –B) an index of intraindustry trade close to zero. –C) an index of intraindustry trade of –D) a large amount of imports in a product category with few exports in the same product category.

17 Question 2 According the product cycle model, comparative advantage: According the product cycle model, comparative advantage: –A) may move from one country to another country as the product matures. –B) is based on the income level of the domestic country. –C) will remain in the country where the product is introduced. –D) is based on economies of scale.

18 Question 3 Why is international trade viewed as a "second best" alternative when compared to the movement of the factors of production? Why is international trade viewed as a "second best" alternative when compared to the movement of the factors of production? –A) Being able to move the factors of production would increase world output. –B) International trade has too many problems associated with it. –C) Factors of production are cheaper and easier to acquire. –D) Resources are best used with international trade.

19 Yesterday, I showed Table 5-2

20 Question: what does Africa’s negative outflow of FDI mean? Africa has a negative outflow of FDI which means that Africa has withdrawn its FDI outflow. Africa has a negative outflow of FDI which means that Africa has withdrawn its FDI outflow.

21 What are the reasons for FDI? Higher rate of return on investment because Higher rate of return on investment because –the receiving nation is capital scarce and labor abundant Low cost of labor Low cost of labor

22 What are the reasons for FDI? Low cost of transportation of output Low cost of transportation of output Low cost of transportation of inputs Low cost of transportation of inputs Low cost of paper work (licensing, permits,..etc.) Low cost of paper work (licensing, permits,..etc.) Low taxes Low taxes High trade barriers in the receiving nation High trade barriers in the receiving nation Low cost of natural resources Low cost of natural resources

23 What are the effects of FDI? In the source country In the source country The country that sends the capital to another country. The country that sends the capital to another country. –When capital moves out of the source country, the supply of capital ________ which causes an increase in the rate of return to capital. Owners of capital in source country benefit Owners of capital in source country benefit Owners of transferred capital benefit from higher rate of return in foreign country. Owners of transferred capital benefit from higher rate of return in foreign country. decreases

24 What are the effects of FDI on the labor in the source country? Reduction in supply of capital means less capital for labor to use. Reduction in supply of capital means less capital for labor to use. –Capital-to-labor ratio declines –Productivity of labor declines Wages decline Wages decline –Note: in a competitive market wage = marginal product of labor

25 I received a question (just in time) Why when there is less capital the productivity of labor declines? Why when there is less capital the productivity of labor declines? Think of me as a labor, in which scenario will I be more productive in class? Think of me as a labor, in which scenario will I be more productive in class? 1.Give me a chuck and a blackboard 2.Give me a laptop and projector – Note: by “less capital” we mean lower valued (less technologically advanced) capital

26 What are the effects of FDI on the host country? Host country Host country –The country that receives the factor of production from another country. Supply of capital increases which ________ the rate of return. Supply of capital increases which ________ the rate of return. –Labor productivity _________ because there is more capital per worker. –Return to labor increases. Opening of trade increases wages and decreases returns to capital in the labor- abundant country. Opening of trade increases wages and decreases returns to capital in the labor- abundant country. decreases Increase

27 You had a question on Figure 5.1 Before we get to the figure let’s prepare ourselves Before we get to the figure let’s prepare ourselves What is a demand curve for oranges? What is a demand curve for oranges? –A curve that shows the highest price we are wiling and able to pay at each level of quantity of oranges The highest price represents the value of oranges to us The highest price represents the value of oranges to us

28 International Economics Week Four- Class 3 Week Four- Class 3 –Wednesday, September 26 –15:10-16:00 –AC 201 I still have leftover ICA1s I still have leftover ICA1s –Pick them up please

29 ICA2-Question 1 A relatively large amount of intraindustry trade would be associated with: A relatively large amount of intraindustry trade would be associated with: –A) an index of intraindustry trade close to 1.0. –B) an index of intraindustry trade close to zero. –C) an index of intraindustry trade of –D) a large amount of imports in a product category with few exports in the same product category. Answer: A Answer: A

30 ICA2- Question 2 According to the product cycle model, comparative advantage: According to the product cycle model, comparative advantage: –A) may move from one country to another country as the product matures. –B) is based on the income level of the domestic country. –C) will remain in the country where the product is introduced. –D) is based on economies of scale. Answer: A Answer: A

31 ICA 2- Question 3 Why is international trade viewed as a "second best" alternative when compared to the movement of the factors of production? Why is international trade viewed as a "second best" alternative when compared to the movement of the factors of production? –A) Being able to move the factors of production would increase world output. –B) International trade has too many problems associated with it. –C) Factors of production are cheaper and easier to acquire. –D) Resources are best used with international trade. Answer: A Answer: A

32 Demand Curve for oranges D P Q The value of 2 nd pound of oranges to us is €10 This is called marginal value of the 2 nd pound The value of 5th pound of oranges to us is €7 This is called marginal value of the 5th pound

33 The same is true for demand curve for capital D P Q The value of 2 nd unit of capital is €10 But what determines this value? It depends on how productive capital is We are willing to pay the 2 nd capital €10, because it can produce €10 of output for us. €10 is the value of marginal product of capital

34 The same is true for demand curve for capital D P Q 5 If we end up hiring 5 capital, each unit produces up to the height of the demand curve If we could hire capital continually, the area under the demand curve up to 5 unit of capital = total output

35 Figure 5.1: Output and Welfare Effects of International Capital Mobility Return to Capital, U.S. Capital Stock, U.S. Return to Capital, India Capital Stock, India RUSRUS RIRI D US D INDI A Sk E E’ US is capital abundant India is capital scarce a b a’a’ b’ Total output in the US = a + b Total output in India = a’+ b’ Assumption: Supply of capital is fixed (vertical)

36 Figure 5.1: Output and Welfare Effects of International Capital Mobility Return to Capital, U.S. Capital Stock, U.S. Return to Capital, India Capital Stock, India R US ’ RUSRUS RI’RI’ RIRI D US D INDI A Sk’SkSk’Sk E FE’ F’ a d e c b a’ d’ e’ c’ b’ Capital moves from US to India Out put in US drops by ____________ b+ c Output in India goes up by ________ c’+b’ World out put goes_____ up

37 Figure 5.1: Output and Welfare Effects of International Capital Mobility Return to Capital, U.S. Capital Stock, U.S. Return to Capital, India Capital Stock, India R US ’ RUSRUS RI’RI’ RIRI D US D INDI A Sk’SkSk’Sk E FE’ F’ a d e c b a’ d’ e’ c’ b’ Total return to capital (capital’s share of total output) in the US changes from a + b to ___________ US capital’s share of Indian output is _____. b’ India’s capital’s share of out put declined from a’+d’ to _____. a + d a’

38 Figure 5.1: Output and Welfare Effects of International Capital Mobility Return to Capital, U.S. Capital Stock, U.S. Return to Capital, India Capital Stock, India R US ’ RUSRUS RI’RI’ RIRI D US D INDI A Sk’SkSk’Sk E FE’ F’ a d e c b a’ d’ e’ c’ b’ Us labor’s share of output used to be e+d+c. Now it is ________. India’s labor’s share of out put used to be _________ Now it is _______. a’ e e’ e’+d’+c’

39 Recap 1. World output went up 2. US capital’s share of the world output went up 3. India’s capital share of the world output went down 4. US labor share of out put went down 5. India’s labor share of output went up

40 Governments restrict the free flow of foreign direct investment in several ways. Governments restrict the free flow of foreign direct investment in several ways. –Industrial Policy A government policy designed to stimulate the development and growth of an industry. A government policy designed to stimulate the development and growth of an industry. –It tends to favor local firms at the expense of foreign firms. The role of Government