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

2 Week Five: Class One Tuesday, October 2 14:10-15:00 AC 202 Tuesday, October 2 14:10-15:00 AC 202 Return ICA Return ICA Expect ICA tomorrow Expect ICA tomorrow

3 Thanks for your feedback I just wanted to mention that in Ireland we spell 'Labour' with a 'u', as shown. I felt a lot of the Irish students might be getting confused by this. Thank you for your time. I just wanted to mention that in Ireland we spell 'Labour' with a 'u', as shown. I felt a lot of the Irish students might be getting confused by this. Thank you for your time. –Evan Coady

4 A request Could you please outline the format of our exam on the 10th of October in class on Tuesday? Could you please outline the format of our exam on the 10th of October in class on Tuesday? Sure, the exam will have two parts Sure, the exam will have two parts –Part One: Multiple Choice Questions You choose the best answer You choose the best answer There are no negative marks There are no negative marks –Part Two: Short essay questions and or problems

5 Who are Immigrants? Individuals that permanently change their country of residence to a foreign country. Individuals that permanently change their country of residence to a foreign country. In 1965, 75 million people lived in a country outside their country of birth. In 1965, 75 million people lived in a country outside their country of birth. In 2000, immigrants residing in a new country was greater than 150 million. In 2000, immigrants residing in a new country was greater than 150 million.

6 What are the reasons for international movements of labor? (you asked questions) Fact: most immigration comes from developing countries. Fact: most immigration comes from developing countries. –Push factors- push labor out of these countries low standard of living in developing countries low standard of living in developing countries high rates of unemployment. high rates of unemployment. Poverty Poverty

7 What are the reasons for international movements of labor? (you asked questions) Pull factors- pull workers into developed nations Pull factors- pull workers into developed nations –Higher incomes –Higher standard of living

8 Is Conor Lawlor here today? Evan Coady and the rest of us wish you a very Evan Coady and the rest of us wish you a very Happy 21 Birthday Conor.

9 What are the effects of international movements of labor? Assume that India is labor abundant and the U.S. is capital abundant. Assume that India is labor abundant and the U.S. is capital abundant. –Wages in the U.S. are higher than India. –Indian labor would migrate to the U.S.

10 What are the effects of international movements of labor on Indians? Workers in India will benefit from ______ wages with the reduction in supply. Workers in India will benefit from ______ wages with the reduction in supply. India’s capital-to-labor ratio ________. India’s capital-to-labor ratio ________. –Increase in India’s labor productivity. –Indian wages will rise. India’s total output will fall. India’s total output will fall. –Returns to owners of capital in India fall because of Higher wages paid Higher wages paid Reduced production Reduced production higher rises

11 What are the effects of international movements of labor on Americans? Increase in labor force lowers the amount of capital each worker has available to work with. Increase in labor force lowers the amount of capital each worker has available to work with. –Capital to labor ratio falls in the U.S. which decreases labor productivity. –Wages in U.S. fall. Total output rises. Total output rises.

12 What are the effects of international movements of labor on Americans? Owners of capital in the U.S. gain Owners of capital in the U.S. gain –Lower wages paid –Produce more output (U.S. labor will oppose open immigration.) (U.S. labor will oppose open immigration.) (Owners of capital favor open immigration.) (Owners of capital favor open immigration.) The output of the world economy rises since workers can move to countries where they are more productive. The output of the world economy rises since workers can move to countries where they are more productive. Note: I will not go over Figure 5-2 Note: I will not go over Figure 5-2 –You are responsible to know it.

13 Immigration and Public Policy To maximize the world’s total output, policy should be completely open immigration. To maximize the world’s total output, policy should be completely open immigration. Wages drop in the host country Wages drop in the host country Few countries have open immigration but few have a ban on immigration. Few countries have open immigration but few have a ban on immigration. Policies to prevent the brain drain Policies to prevent the brain drain The movement of skilled or professional workers from one country to another. The movement of skilled or professional workers from one country to another.

14 Immigration and Public Policy The guest worker programs of Europe allow workers from developing countries to work there temporarily rather than to immigrate permanently. The guest worker programs of Europe allow workers from developing countries to work there temporarily rather than to immigrate permanently. Other issues Other issues Unemployment insurance Unemployment insurance Education Education Housing Housing Healthcare Healthcare

15 Immigration and Public Policy Offshore assembly provisions Offshore assembly provisions Allow firms to export materials and parts of a good to foreign countries for final assembly; Allow firms to export materials and parts of a good to foreign countries for final assembly; When the assembled goods are returned to the home country, duties are assessed only on the value added in the foreign country. When the assembled goods are returned to the home country, duties are assessed only on the value added in the foreign country.

16 Immigration and Public Policy Firms have used foreign labor to process paperwork as well as subcontract design and engineering work. Firms have used foreign labor to process paperwork as well as subcontract design and engineering work.

17 What is a Multinational Corporation? A firm that conducts part of its business across national boundaries (MNC) A firm that conducts part of its business across national boundaries (MNC) Why? Why? –Labor shortages in home country. –Increase efficiencies by internalizing certain activities instead of contracting them out. –Control

18 Slides Will not be discussed in class unless there are questions Will not be discussed in class unless there are questions You are responsible for the material covered in these slides You are responsible for the material covered in these slides

19 The OLI approach A framework that explains why MNCs engage in foreign direct investment. A framework that explains why MNCs engage in foreign direct investment. O is ownership – commonly ownership of an intangible asset O is ownership – commonly ownership of an intangible asset –A good or process a firm has developed that other firms find difficult to replicate. –It is a source of comparative advantage.

20 The OLI approach L is for locational advantages L is for locational advantages –It may be in the firm’s global interests to locate outside home country. –For example, location of natural resources –Take advantage of cheaper imports – vertical integration –Natural and legal barriers to trade

21 The OLI approach I is for internalization I is for internalization –A firms’ propensity to perform functions internally that outside firms could do –Firm derives benefit from internalizing process

22 Host country’s policy toward MNC Host country could ban activities of MNCs Host country could ban activities of MNCs Host country could treat MNCs as a domestic firm – national treatment Host country could treat MNCs as a domestic firm – national treatment Most likely regulation falls between the two extremes Most likely regulation falls between the two extremes Generally MNCs must pay taxes on profits of local subsidiaries. Generally MNCs must pay taxes on profits of local subsidiaries.

23 Home country’s policy toward MNC Home country gives tax credit against local tax liability for taxes paid abroad. Home country gives tax credit against local tax liability for taxes paid abroad.

24 Transfer pricing over or under pricing of goods in intra- firm trade of MNC. over or under pricing of goods in intra- firm trade of MNC. –Allows firms to use intra-firm pricing to maximize after-tax profits –Was used to transfer profits out of countries with exchange controls Some transfer pricing will occur until income taxes are uniform across countries. Some transfer pricing will occur until income taxes are uniform across countries.

25 International Economics Week Five- Class 2 Week Five- Class 2 –Wednesday, October 3 –11:10-12:00 PM –Tyndall

26 ICA3: True or False 1. FDI tends to raise the welfare of the owners of capital in the host country. 2. Immigration may lower domestic wages, but it also augments the total output of the country. 3. The return to capital in the host country will tend to increase as the domestic supply of capital is augmented with foreign capital.

27 Tax on imported goods Tax on imported goods Why? Why? –Revenue for Government –Protect domestic suppliers of similar goods from foreign completion Protect jobs Protect jobs What is a tariff?

28 What are the types of tariff? 1. Specific tariffs Tax per unit Tax per unit specific tariff is regressive. Why? specific tariff is regressive. Why? –A specific tariff of $1,000 on each imported auto a high percentage of the value of less expensive cars a high percentage of the value of less expensive cars a low percentage of the value of high- priced cars a low percentage of the value of high- priced cars

29 Under specific tariff, what type of cars will be imported less? Expensive cars? Cheap cars? Cheap cars Cheap cars –A specific tariff encourages domestic producers to produce less expensive goods.

30 2. Ad valorem tariffs –Taxes = fraction of the value of the imported goods A 5% tariff on an international price of $10,000 means that customs officials collect the fixed sum of _________. A 5% tariff on an international price of $10,000 means that customs officials collect the fixed sum of _________. –Importers have an incentive to under-voice the price of the imported good. –Ad valorem tariffs are more difficult for a country to administer than specific tariffs. What are the types of tariff? $500

31 3. Compound tariffs – a combination of an ad valorem and a specific tariff –Common on agricultural products whose prices tend to fluctuate. What are the types of tariff?

32 1. Free alongside (FAS) price The price of the imported good in the exporting nation before loading the good for shipment to the importing country The price of the imported good in the exporting nation before loading the good for shipment to the importing country 2. Free on Board (FOB) price FAS + the cost of loading the good in the means of transportation FAS + the cost of loading the good in the means of transportation What are different methods of valuing imports?

33 3. Cost, Insurance, and Freight (CIF) price FOB + all inter-country transportation costs up to the importing country’s port of entry. FOB + all inter-country transportation costs up to the importing country’s port of entry. What are different methods of valuing imports?

34 What is consumer surplus (CS)? D P1P1 P Q Consumer Surplus Price Quantity The difference between the highest price consumers would be willing to pay (Price on demand curve) and the market price. Graphically, it is equal to the area under the demand curve and above the price The higher the CS the ___________ the consumers Better off

35 What is producer surplus (PS)? E P2P2 Producer Surplus S Quantity of Cloth Price of Cloth Q P The difference between the market price and lowest price producers will sell a good (price on the supply curve). Graphically, it is equal to the area under the price and above the supply curve The higher the PS the ___________ the producers Better off

36 International Economics Week Five- Class 3 Week Five- Class 3 –Wednesday, October 3 –15:10-16:00 –AC 201

37 ICA3: True or False 1. FDI tends to raise the welfare of the owners of capital in the host country. False, capital become more abundant, its return goes down. False, capital become more abundant, its return goes down.

38 ICA3: True or False 2. Immigration (into a country) may lower domestic wages, but it also augments the total output of the country. True, supply of labor goes up True, supply of labor goes up Wage rate drops Wage rate drops Production goes up Production goes up

39 ICA3: True or False 3. The return to capital in the host country will tend to increase as the domestic supply of capital is augmented with foreign capital. False, the same as question 1 False, the same as question 1

40 CS/PS S D E Price Quantity P1P1 Q P P2P2 Consumer Surplus Producer Surplus

41 How does a free trade affect consumer surplus and producer surplus? Price Quantity Price Quantity D Exports Imports D E US India a b c d S S 10 4 a’ b’ c’ d’ 8 E’ 8 CS ↑ by b+ d, PS ↓ by b CS ↓ by b’, PS ↑ by b’ + d’

42 What are the economic effects of tariffs? 1. Case of small importing nation Note: A small nation can import as much as it likes at the same international price. Note: A small nation can import as much as it likes at the same international price. –World Price = €8. –Domestic government imposes a specific tariff on imported good in the amount of €2/unit –Domestic Price = = €10

43 What are the economic effects of tariffs in a small importing nation? S D E Price Quantity a b c d Tariff = 2 -a+b+c+d: loss in CS = €75 - a: added to PS= €25 - b: cost of resources transferred from their best use to the production of 5 more units of the good= €5 - c: government revenue = €40 -d: loss to consumers = €5 - a + c: redistribution effect - b+d: dead-weight loss