Introduction to the International Political Economy

Frederick University

2013

The subject of IPE

IPE is concerned with the ways in which political forces (states, institutions, individuals) shape the systems through which economic interactions are expressed, and the effects that economic interactions have upon political structures and outcomes.

The scope of IPE

International trade policies International finance International economic integration The process and problems of

globalization

The main economic problems and the international trade theory

Main economic problems:

Efficiency in allocation

Efficiency in motivation

Efficiency in distribution

How international trade flows contribute to:

efficiency in allocation,

in motivation, and in distribution of scarce resources

domestically and world-wide.

The main economic questions of the international trade theory Efficiency in allocation - what goods are traded

internationally and what are the fundamental laws that govern the international allocation of resources and the flow of trade? - How international trade contributes to rational utilisation of resources world-wide?

Efficiency in motivation - at what prices are the goods and services exchanged, or what are the terms of trade? - How international trade is related to the efficient use of scarce resources?

Efficiency in distribution - what are the gains from trade and where do they come from? How are these gains divided among the trading countries? - What is the impact of international trade in equitable distribution world-wide?

Why do nations trade?

The mercantilist answer: Gold (money) is the immanent form of

wealth The amount of gold is fixed in the short

run More gold can be earned through

exports Protectionist policies contribute to the

growth of the national economy

Why do nations trade?

Adam Smith’s answer: Specialization raises labor

productivity A higher productivity creates an

absolute advantage in production and trade

Free trade makes both parties better-off

Why do nations (people exchange)?

David Ricardo’s answer: Specialization is based not on

absolute but on relative productivity

Exchange is based on comparative advantages

Comparative Advantage – an Example Robinson can catch 12 birds or 5 fish per day. Friday can catch 16 birds or 10 fish per day Robinson’s opportunity costs of catching 5 fish

are 12 birds; the opportunity cost of catching 1 fish is 12/5 = 2,4 birds

Friday’s opportunity costs of catching 10 fish are 16 birds; the opportunity cost of catching 1 fish is 16/10 = 1,6 birds.

Friday has a lower opportunity cost in fishing. Friday has a comparative advantage in

fishing.

Comparative Advantage Robinson’s opportunity costs of catching

12 birds are 5 fish; the opportunity cost of catching 1 bird is 5/12 = 0,42 fish

Friday’s opportunity costs of catching 16 birds are 10 fish; the opportunity cost of catching 1 bird is 10/16 = 0,62 fish.

Robinson has a lower opportunity cost in hunting.

Robinson has a comparative advantage in hunting.

Absolute and Comparative Advantage

Having an absolute advantage – being able to do something with less resources than someone else

Having a comparative advantage – being able to do something at a lower opportunity cost

Why do nations (people exchange)?

David Ricardo’s answer: Specialization is based on relative

productivity Comparative advantages in

production and trade expand production possibilities of both parties and make them better of

Arbitrage tends to equalize prices in the world economy

Gains from trade are enjoyed under the conditions of free trade

Arbitrage and speculation

P

Q

Oz widget market

D

SPOz

QOz

P

Q

Zo widget market

D

S

PZo

QZo

Demand shifts to Zo marketSupply shifts to Oz market

Shifts in Supply and Demand until price differences are eliminated

exports

imports

The Gains from trade

Oz widget market P

Q

D

S

Po= 4

a

b

No trade: Oz price = 4; Q = 30consumer surplus = a

producer surplus = b

Qo = 30

Pw = 2

4a

c

de

Trade: world price = 2; Qo= 16, Q imports = 28, Q = 44Consumer surplus = a+d+eProducer surplus = c

}

Imports = 28

Qo =16 Q = 44

Local consumer's extra gains = d+eLocal producer’sextra gains = -d

The Gains from trade

Zo widget marketP

Q

D

S

Pz = 1.5

Qz = 60

No trade: P = 1.5; Q = 60Consumer surplus = fProducer surplus = g

f

gD

S

P = 2

}

Exports = 28

7850

h

i j

Trade: P = 2; Q = 78Consumer surplus = h = f – iProducer surplus = g + i + j

g

Zo consumer’s extra gain = -iProducer’s extra gains = i + j

1.5

The Gains from tradeOz consumers

Oz producers

Zo consumers

Zo producers

Surplus before trade

a c + d h + i g

Surplus after trade

d + e + a

c h g + i + j

Total: + e + j

Why do nations trade?The factor endowment model – Heckscher-

Ohlin theory Differences in relative factor endowments of

nations Differences in relative price levels Differences in the pattern of factor intensities Product prices equalize in both trading parties

and they both gain from trade Different effects on different groups engaged

in factor abundant and factor intensive industries

International Trade and International Investment

International Good Movementsvs.International Factor MovementsIntraindustry Trade - Stefan Linder

‘s theory – greater trade between the nations with similar levels of income