Chapter 1: Introduction
Learning Objectives
1 Distinguish between international and domestic
economic issues.
2 Explain why seven themes recur in international
economics and discuss their significance.
3 Distinguish between the trade and monetary aspects of
international economics.
Preview
• What is international economics about?
• International trade topics: (1) Gains from trade, (2)
explaining patterns and volume of trade, (3) effects of
government policies on trade
• International finance topics: (4) Balance of payments,
(5) exchange rate determination, (6) international policy
coordination, (7) international capital markets
• International trade versus finance
What Is International Economics
About?
• International economics is about how nations interact
through trade of goods and services, flows of money,
and investment.
• International economics is an old subject, but continues
to grow in importance.
• Nations are now more closely linked than ever before.
David Hume Adam Smith
(1711-1776) (1723-1790)
International vs Domestic Theories
• Underlying theories used in international economics
same as for domestic economies you learned in
previous courses
– e.g., supply and demand, investment, monetary and
fiscal policy
• What are the major differences?
– Countries have their own laws and policies
e.g., tariffs
– Countries use different currencies
U.S. Exports and Imports (% of GDP)
• Trade share has increased in U.S., especially imports
• Some notable slowdown in past 15 years
• Trade has tended to fall during recessions
U.S. Net Exports
• The U.S. has been running trade deficits for decades
• Why did net exports increase with the financial crisis (2009) but
decrease following Covid-19 (2020)?
Vietnam Current Account Balance
• Vietnams net exports have been drifting upwards
• U.S. is biggest buyer of exports
• China is biggest seller of imports
Trade (% of GDP)
• The United States, due to its size and diversity of resources, relies less
on international trade than most other countries.
Theme 1: Gains from Trade
• That there are gains from trade is probably the most
important insight in international economics.
• Countries selling goods and services to each other
almost always generates mutual benefits.
– Norwegian consumers import oranges that they
would have a hard time producing.
Theme 1: Gains from Trade
• How could a country that is the most (least) efficient
producer of everything gain from trade?
– Countries can specialize in production, while
consuming many goods and services through trade.
Theme 1: Gains from Trade
• Countries may also gain by trading current resources for
future resources: international borrowing and lending.
• Trade is predicted to benefit countries as a whole in
several ways, but trade may harm particular groups
within a country.
– E.g., owners of resources that are used in industries
that compete with imports.
– Trade may affect the distribution of income within a
country.
Theme 2: Patterns of Trade
• The pattern of trade describes who sells what to whom.
• Differences in climate and resources explain why Brazil
exports coffee and Saudi Arabia exports oil.
• But why does Japan export automobiles, while the U.S.
exports aircraft?
• Why some countries export certain products can stem from
differences in:
– Labor productivity
– Relative supplies of capital, labor and land and their
use in the production of different goods and services
• We will mostly take trade patterns as given in this course
Vietnam Patterns of Trade in 2024
Theme 3: Effects of Government
Policies on Trade
• Policy makers affect the amount of trade through
– Tariffs: a tax on imports or exports,
– Quotas: a quantity restriction on imports or exports,
– Export subsidies: a payment to producers that export
– Other regulations
• Free trade grew in the 1990s led by the US
– NAFTA - 1993
– World Trade Organization (WTO) - 1994
• What are the costs and benefits of these policies?
Theme 3: Effects of Government
Policies on Trade
• If a government restricts trade, what are the costs if foreign
governments respond likewise?
• Trade policies are often chosen to cater to special interest
groups, rather than to maximize national welfare.
– More about internal conflict than external
– Big impact on income distribution within a nation
• Governments tend to adopt tariffs, then negotiate them
down in exchange for reduction in trade barriers of other
countries.
International Finance Topics
• International finance studies exchange rates, international
borrowing and lending, capital flows, and financial crises.
• Most international trade involves monetary transactions.
• Many monetary events have important consequences for
international trade.
– E.g., government debt defaults or exchange rate pegs
Theme 4: Balance of Payments
• Balance of payments records a country’s transactions
with the rest of the world.
– Trade in goods and services
– Income flows
– Financial flows
– Official reserve transactions
• The official settlements balance measures the balance
of funds that central banks use for official international
payments.
Theme 5: Exchange Rate
Determination
• Exchange rates are an important financial issue for
most governments.
• Exchange rates measure how much domestic currency
can be exchanged for foreign currency and thus affect
how much:
– Goods denominated in foreign currency (imports)
cost in the domestic country.
– Goods denominated in domestic currency (exports)
cost in foreign markets.
• Some exchange rates change continually (float) while
others are fixed for periods of time.
Theme 6: International Policy
Coordination
• In an integrated world, one country’s policies affect others.
– Trade policy, monetary policy, exchange-rate policies,
debt/default issues
• Leads to the need for some degree of policy coordination.
– General Agreement on Tariffs and Trade (GATT) - 1947
– WTO – 1994
– Various regional trade agreements
– Bretton Woods system of exchange rates
Theme 7: The International Capital
Market
• Capital markets are arrangements by which individuals
and firms exchange money now for promises to pay in
the future.
• Capital markets have special concerns in an international
setting
– Currency fluctuations can alter the value paid.
– Countries might default on debt.
• Often special regulations that countries impose on
foreign investments.
– Sometimes offer opportunities to evade regulations
placed on domestic markets.
International Trade Versus Finance
• International trade
– Movement of goods and services across nations
– E.g., should Europe subsidize agricultural exports?
• International finance
– Financial or monetary transactions across nations
– E.g., should China allow their currency to float freely?
– International monetary theory (Chapters 2-7) and
policy (Chapters 8-11).
Why do we care?
• Trade imbalances
– U.S. large trade deficit – causes and consequences
• Exchange rate swings
– Dramatic appreciation of USD in early 1980s and subsequent
depreciation in late 1980s
• Crisis and default
– Debt crisis – e.g. Mexico (1994), Argentina (2001)
– Financial crisis – e.g. east Asia (1997)
• Globalization and policy conflict
– Why the Eurozone?
– Pressure for protection from foreign competition in 1980s and 90s
– Rise in opposition to globalization – e.g., Brexit, European and US politics
– Housing market bubble burst in US spread to the rest of the world through
linkages in international capital markets
– Rise of cryptocurrency – Bitcoin