International Economics Overview

Introduction

• International Economics covers the exchange of goods, services, factors of production, and capital across national boundaries
• It focuses on flows such as goods, services, labor, and direct foreign investment between countries

Globalization of the World Economy

• The first period of globalization occurred between 1870 and 1914, driven by the Industrial Revolution and opening up of new lands in North America, South America, Australia, New Zealand, and South Africa
• The second period starting with the end of World War II in 1945 and lasting till around 1980 witnessed rapid growth in international trade due to the dismantling of trade protectionist policies

International Trade and the Nation's Standard of Living

• The ratio of exports and imports of goods and services to the Gross Domestic Product (GDP) of a country is a measure of its economic relationship with other nations
• It implies the levels of interdependence among nations, which has been increasing over the years

South Africa in World Trade

• South Africa has a relatively open economy with an openness index exceeding 20%
• The openness index, defined as exports as a percentage of the GDP, declined between 1985 and 1994 due to international sanctions imposed on the country
• Despite sanctions, South Africa remained a major supplier of minerals, but financial sanctions led to capital flight and low growth

Why Nations Trade: The Classical Theory

• This theory explores the reasons behind international trade using classical economic principles

Mercantilists' Views on Trade

• Mercantilists believed in accumulating wealth through trade surpluses
• It emphasized maximizing exports and minimizing imports to maintain a positive balance of trade

Classical Theorists

• Adam Smith introduced the concept of absolute advantage. It states that a country should specialize and export goods it produces more efficiently than others
• David Ricardo refined this idea with the theory of comparative advantage. This theory suggests that countries should specialize and export goods in which they have a lower opportunity cost of production, even if they don't have absolute advantage in any particular good

Gain from Trade

• Specialization and trade based on comparative advantage allow countries to consume beyond their individual production possibilities frontier, leading to gains from trade.

Ricardian Theory

• This theory rests on the assumption that labor is the only factor of production and is fully employed.
• The theory assumes identical characteristics of goods consumed in both countries, perfect competition, and constant returns to scale
• In this model, labor is mobile between different industries within a country but not between countries

Illustration of Absolute Advantage

• The example highlights two countries, X and Y, with different productivities in goods A and B.
• Country X is more efficient in producing good B, while Country Y is more efficient in producing good A (absolute advantage)

Autarky prices

• Autarky prices are the domestic ratios at which goods exchange in the absence of trade; they represent the opportunity cost of one good in terms of the other.
• In the example, Country X's autarky prices are 2A:1B, and Country Y's are 6A:1B.
• Whether trade occurs depends on the final terms of trade, which is determined by the relative demand and supply of both countries' products.