The Nation and the World Economy

Question 1

Globalisation

Answer 1

A process by which the economies of the world become more integrated by the freer flow across national boundaries of goods and services, investment, finance and labour.

Question 2

How do we measure globalisation?

Answer 2

• International trade of goods and services (trade).
• International integration of capital markets (flows of savings and investment).
• International labour markets (migration).

Question 3

International Trade

Answer 3

• Trade between two countries is an extension of trade within a country.
• International trade affects both firms and countries.
• Due to trade, countries such as the UK can import coffee
  and bananas, and export Rolls-Royce.
• Countries can become richer as a result of an open trading environment e.g China and the Middle East countries.

Question 4

What is merchandise trade?

Answer 4

• Trade in tangible products that are physically shipped across borders.
• Trade in services is a more recent phenomenon: tourism, financial and legal services, education.

Question 5

Common measures of globalisation

Answer 5

• Imports or exports or total trade as a share of
  GDP.
• Reduction in trade costs (price gaps) between countries.

Question 6

What caused world trade to increase after WWII?

Answer 6

• Reduction in trade costs (price gaps) e.g freight costs (transportation costs) of goods and services between countries.
• Decline in man-made barriers to trade e.g. tariffs and quotas. Instead replaced by multilateral agreements e.g. WTO.
• Information and communication technologies (ICT) revolution.

Question 7

Deglbalisation

Answer 7

Increasing trade costs during the Depression
* Partly due to tariffs and quotas on imports.

Question 8

Offshoring

Answer 8

• Previously, trade of merchandise goods was standardised.
• Today, raw materials shipped back and forth between countries during the manufacturing process.
• This new trend or feature of world trade and production is referred to as offshoring or outsourcing.
• Think of the Trump Tax Reform Plan passed by the US Senate in December 2017. What is its effect on offshoring?

Question 9

Trade Balance

Answer 9

• Although trade has increased among countries, there is a widening gap between imports and exports.
• Trade balance or net exports is the difference between total value of exports and total value of imports (includes both goods & services)
• Trade surplus: exports > imports.
• Trade deficit: exports < imports.
• Balanced trade: exports = imports.
• The world is closed and trade must balance.

Question 10

Integration of capital markets

Answer 10

• Countries lend to and borrow from each other to finance
  investment.
• The sources and uses of foreign exchange are recorded
  in the balance of payments (BOP), which include:
• Foreign portfolio investment: buying foreign stocks
  or bonds.
• Foreign direct investment (FDI): ownership of foreign physical assets
• BOP = current account + capital and financial account.
• Current account (CA) consists of:
  CA = exports − imports + net earnings from assets abroad
• CA deficit: country is borrowing (receiving net capital
  flows).
• CA surplus: country is lending (net capital outflow).

Question 11

International labour markets

Answer 11

• Fewer advances in labour market integration than goods or financial market integration due to immigration barriers.
• Wages still differ across countries due to migration costs.
• International trade in goods and services acts as a substitute for migration
• It allows workers to improve their standard of living through working in export industries even when they cannot migrate to earn higher incomes.

Question 12

Why does trade occur?

Answer 12

• Differences across countries.
• Differences in the productivity of labour (due to differences in technology) used in each country - the Ricardian model.
• Differences in the total amount of resources (labour, labour skills, physical capital, land or other factors of production) between countries - the Heckscher-Ohlin model.
• Differences in the costs of offshoring.
• Economies of scale (larger scale of production is more efficient).
• Economies of agglomeration – cost reductions from locating close to other firms in similar industries.
• Low communication or coordination costs.
• Proximity of countries to one another.

Question 13

Why does the U.S. trade more heavily with the 3 largest European economies than with the others?

Answer 13

• The size of an economy is directly related to the volume of imports and exports.
  Ø Larger economies produce more goods and services
  Ø attract large shares of other countries spending in the export market.
  Ø generate more income so they buy more imports.

Question 14

Absolute advantage

Answer 14

• A country has absolute advantage over another in the production of a good if it can produce it with fewer resources than the other country.
• When a country has the best technology for a producing a good.

Question 15

Comparative advantage

Answer 15

• A country has a comparative advantage in producing a good if the opportunity cost of producing the good in that country is lower than it is in other countries.

Question 16

Comparative advantage Ricardo example

Answer 16

• Introduced by David Ricardo in 18th century.
• Two countries: Portugal and England.
• Two goods: wine and cloth.
• Technology: Portugal better in production of both goods.
• Portugal has comparative advantage in production of wine.
• England has comparative advantage in production of cloth.
• Technology: Portugal better in production of both goods.
• Trade can occur due to the comparative advantages in both countries.
• Countries gain from trade by exporting the goods in which they have a comparative advantage.
• Ricardo shows that countries can benefit from balanced international trade without having tariffs.

Question 17

Steps in developing comparative advantage model

Answer 17

Ø Derive the production possibilities frontier.
Ø Establish the autarky (no trade) equilibrium. Ø Determine the export patterns.
Ø Explain how wages are determined.
Ø Determine the international prices for
all countries.
Ø Establish the equilibrium with international trade
Ø Explain the gains from trade in our model.

Question 18

Assumptions of comparative advantage model

Answer 18

• Assumptions of our model:
• Two countries: Wheatland (home country) and Clothland
  (foreign country).
• Two goods: wheat (WT) and cloth (C).
• Labour is the only factor of production used in the production of each good.
• Labour productivity varies across countries due to differences in technology, but labour productivity in each country is constant.
• The supply of labour in each country is constant.
• Perfect competition.
• Perfect labour markets - but immobile across countries (no migration).

Question 19

No trade

Answer 19

• Imagine both countries can produce both goods which is subject to constant returns to scale.
• What will production and consumption in each country be if there is no trade?
• To answer the above question we need to provide some numbers.
• calculations for Wheatland first and those of Clothland second.
• Suppose in Wheatland, 1 worker can produce 4 bushels of wheat or 2 yards of cloth.
• Production is expressed in terms of marginal products of labour (MPL). Thus
  𝑀𝑃𝐿wt = 4 𝑀𝑃𝐿c = 2
• Suppose there are 25 workers in Wheatland, thus 𝐿bar = 25 (see assumption: supply of L is constant).
• Let’s derive Wheatland’s production possibilities frontier (PPF) in autarky.
• The textbook uses feasible production frontier while we are using PPF. The two terms refer to the same thing.

Question 20

LOOK AT SLIDES 40 ONWARDS

Answer 20

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