The World Economy: International Trade by Yarbrough & Yarbrough Copyright © 2003 South-Western/Thomson Learning Original PowerPoint Presentation Slides prepared by Kerk Phillips Brigham Young University Modified by Don Ferguson, University of Victoria

Chapter One Introduction to The World Economy Copyright © 2003 South-Western/Thomson Learning

3 Chapter One Outline 1.Introduction 2.Why study international economics? 3.International interdependence 4.Economic significance of political boundaries 5.Studying international economics

4 Introduction International trade –World Trade Organization (WTO) Emerged as an international forum for trade discussions and conflict resolution. –North American Free Trade Agreement (NAFTA) Trade bloc created in 1995 for USA, Canada, and Mexico. –Trade conflicts & upheavals continue U.S./Japan (photo supplies) U.S./Canada (softwood lumber) Asian financial crisis

5 Why Study International Economics? More important than ever before. –The world’s Economies are more closely linked than at any time in history. –The growth and welfare of countries, and of groups within the countries, depend on what is happening in world markets and the policies that countries pursue, both individually and collectively.

6 International Interdependence Difficult today to distinguish a product’s “nationality.” –John Deere tractors built in Japan…Komatsu builds in Illinois. –The Ford Escort is assembled in Germany. –Toyotas are built in Kentucky See Figure 1.1

7 Figure 1.1: Honda Automobiles Produced and Exported by Region, Jan-Sept 2004

8 International Interdependence One of the most important recent trends is the increasing involvement of developing countries in the world economy. –Many nations attempted to isolate themselves for many years (China, Brazil, and India) –This trend produces new patterns of international interdependence. For example, manufacturers produce in countries with lower wages.

9 International Interdependence The dramatic increase in the integration of the world economy has been made possible by large reductions in the costs of transportation and communication. –This has made possible both the rapid expansion of trade and increasing internationalization of production. See Figure 1.2

10 Cost of a 3-minute phone call New York to London Figure 1.2: Transport and Communication Cost, (Index 1930 = 100) Index (1930 = 100) Year Average air-transport cost per passenger mile Average ocean freight and port charges per short ton of cargo

11 International Interdependence Political Implications –Policy makers must now understand that their decisions in antitrust matters, regulations, and taxes have international ramifications. Firms will locate production in low cost countries. They will look for favourable regulations and tax laws.

12 International Interdependence Symptoms of international interdependence. –Rapid expansion of international trade. Since 1950, trade has grown twice as fast as production. Global trade improves individuals’ potential well- being by increasing the quantity of goods and services available to consume. See Figure 1.3 a and b.

Output Trade Figure 1.3a: Growth in World Merchandise Trade & Output, (Percent) 12

14 Figure 1.3b: Growth in World Merchandise Trade & Output, (Percent) World merchandise exports World merchandise output

15 International Interdependence –Countries continue to differ significantly in the extent to which they engage in trade. See Figure 1.4. Large countries like the U.S. tend to engage in less trade (as % of production), than do smaller ones. –Reason? Their domestic markets can efficiently satisfy many needs. –Figure 1.5 shows the marked increase in the U.S.’s global trade in recent years (although it remains relatively small when compared to its GDP).

16 Figure 1.4: Exports and Imports of Goods and Services, 2000 (Percent of GDP)

17 Figure 1.5: U.S. Merchandise Imports and Exports, ($ Billions)

18 International Interdependence Global trade tends to cluster with certain trading partners. –One reason…lower transportation costs. See Figure 1.6

19 Figure 1.6: Regional Flows of Merchandise Trade

20 Economic Significance of Political Boundaries Most economic transactions between individuals or companies from different regions in the same country face a smaller set of barriers than those between those in different countries. National boundaries also help to define each country’s economic policy.

21 Economic Significance of Political Boundaries One major popular misconception about global trade policy is that policy choices pit the interests of one country against those of the other. –In fact, trade policy choices rarely take this form. Trade policy primarily affects the distribution of income within each country. –If U.S. steel producers win protection against Korean producers, then U.S. steel consumers (i.e., auto makers or car buyers) pay higher prices.

22 Studying International Economics International economics usually divided into two parts: –1) Theory of international trade: Expands microeconomic analysis to global questions. –Example: goods and services available to consumers are maximized when each country specializes in producing those goods that it can produce relatively efficiently. Significant political pressure for protectionist policies: Restrict global trade to “protect” domestic producers from foreign competition.

23 Studying International Economics –2) International finance, balance-of-payments theory, or open-economy macroeconomics. Applies macroeconomic analysis to aggregate international problems. Major concerns: –Level of employment and output –Changes in price level, balance of payments, and exchange rates (relative prices of different national currencies). –Interaction of international goals and influences with domestic ones in determining a nation’s macroeconomic performance and policy.

24 Studying International Economics –Open economy One that engages in international transactions. –Closed economy Country that engages in no international transactions.

25 Studying International Economics Positive models (or analysis) describe the way the world economy works in a simplified way. –“If event X happens, then event Y will follow.” –However, there may be disagreement about the way the world works. One individual may think that “if event X happens, then event Z will follow.” Analysts usually resolve such disagreements by conducting further empirical research. Normative analysis depends on our judgements about what is and isn’t desirable.