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Welcome to
EC 382: International
Economics
By: Dr. Jacqueline Khorassani
Week Four
1
Week Four: Class One


Tuesday, September 18
14:10-15:00
AC 202
Your ICA1s are graded but I forgot to
bring them to class today.
– You will receive them tomorrow

Expect an ICA tomorrow
2
What are the causes of
international factor
movements?




Assume factors of production are mobile
between India and the U.S.
Assume the U.S. is capital abundant and
India is labor abundant.
Labor earns a higher wage in the U.S. than
in India.
Inequality of wages would cause workers
from India to migrate to the U.S.
3
What are the effects of
international factor movements?




Wages would begin to _____
in
fall
the U.S. as supply increases.
rise
Wages would begin to ______
in
India as supply decreases.
Migration of labor would stop
when wages are equal between
countries
– no more gains from migration.
4
What about capital?


Capital will migrate from the
U.S. to India to earn a higher
rate of return.
Capital will migrate until the rate
of return is the same between
the two countries.
5
Fact

In general, capital is more
mobile than labor; why?
– Immigration restrictions
– Language/cultural barriers
6
How does the international factor
movement compare to international
trade?

International trade is
sometimes
– a substitute for factor
movements between countries.
– a complement for factor
movements between countries
7
Example of substitute


Ireland is capital abundant and has
comparative advantage in production of
capital intensive goods and return to capital
is low.
Two alternatives:
1.Export capital intensive good (machines) &
import labor intensive good (shoes), or
2.Capital leaves the nation and labor enters the
nation until there is no more comparative
advantage or disadvantage; produce machines
and shoes domestically.
–
If factor movements are blocked, trade is
pursued.
8
Example of complements

Shoes and machines can be traded,
but some goods and services can
not be traded. Like what?
– Haircuts
 Someone
who lives in Ireland will not go
to Turkey to get a hair cut
 But the Turkish hairdresser (labor) can
migrate to Ireland
9
Which one is economically
preferred? And why?


The literature has shown that
When possible, factor movements
are preferred to trade.
– World output will be maximized
– Blocking factors from earning the
highest rate of return is less efficient.
10
What is foreign direct
investment (FDI)?


It implies directly investing in the firm’s
plant and equipment. (Physical
investment as opposed to just sending
money.)
It takes the form of a domestic
corporation opening a foreign subsidiary
or buying control of existing foreign firm
represents real investments in land,
nonresidential investment, and
equipment and software.
11
FDI: Facts


More than 92% of FDI
originated in developed
countries.
World’s developed countries
received nearly 76% of the
world’s FDI.
12
FDI in the world
Table 5.2
13
International Economics

Week 4- Class 2
– Wednesday, September 19
– 11:10-12:00 PM
– Tyndall

Please pick up your ICA1
14
ICA2





In teams of 2
Half a page
Print both names
3 Multiple Choice Questions
Write down the answers
15
Question 1

A relatively large amount of intraindustry
trade would be associated with:
–
–
–
–
A) an index of intraindustry trade close to 1.0.
B) an index of intraindustry trade close to zero.
C) an index of intraindustry trade of 0.20.
D) a large amount of imports in a product
category with few exports in the same product
category.
16
Question 2

According the product cycle model,
comparative advantage:
– A) may move from one country to
another country as the product matures.
– B) is based on the income level of the
domestic country.
– C) will remain in the country where the
product is introduced.
– D) is based on economies of scale.
17
Question 3

Why is international trade viewed as a
"second best" alternative when compared to
the movement of the factors of production?
– A) Being able to move the factors of production
would increase world output.
– B) International trade has too many problems
associated with it.
– C) Factors of production are cheaper and easier
to acquire.
– D) Resources are best used with international
trade.
18
Yesterday, I showed
Table 5-2
19
Question: what does Africa’s
negative outflow of FDI mean?
 Africa
has a negative outflow
of FDI which means that Africa
has withdrawn its FDI outflow.
20
What are the reasons for FDI?

Higher rate of return on investment
because
– the receiving nation is capital scarce
and labor abundant

Low cost of labor
21
What are the reasons for
FDI?






Low cost of transportation of output
Low cost of transportation of inputs
Low cost of paper work (licensing,
permits ,..etc.)
Low taxes
High trade barriers in the receiving
nation
Low cost of natural resources
22
What are the effects of FDI?

In the source country

The country that sends the capital to another
country.
– When capital moves out of the source
decreases
country, the supply of capital ________
which causes an increase in the rate of
return to capital.


Owners of capital in source country benefit
Owners of transferred capital benefit from higher
rate of return in foreign country.
23
What are the effects of FDI on
the labor in the source country?

Reduction in supply of capital
means less capital for labor to use.
– Capital-to-labor ratio declines
– Productivity of labor declines

Wages decline
– Note: in a competitive market wage =
marginal product of labor
24
I received a question
(just in time)


Why when there is less capital the
productivity of labor declines?
Think of me as a labor, in which scenario
will I be more productive in class?
1. Give me a chuck and a blackboard
2. Give me a laptop and projector
–
Note: by “less capital” we mean lower
valued (less technologically advanced)
capital
25
What are the effects of
FDI on the host country?

–

–
–

Host country
The country that receives the factor of production from
another country.
decreases
Supply of capital increases which ________ the
rate of return.
Increase because there is more
Labor productivity _________
capital per worker.
Return to labor increases.
Opening of trade increases wages and
decreases returns to capital in the laborabundant country.
26
You had a question on
Figure 5.1


Before we get to the figure let’s
prepare ourselves
What is a demand curve for oranges?
– A curve that shows the highest price we
are wiling and able to pay at each level of
quantity of oranges

The highest price represents the value of
oranges to us
27
International Economics

Week Four- Class 3
– Wednesday, September 26
– 15:10-16:00
– AC 201

I still have leftover ICA1s
– Pick them up please
28
ICA2-Question 1

A relatively large amount of intraindustry
trade would be associated with:
–
–
–
–

A) an index of intraindustry trade close to 1.0.
B) an index of intraindustry trade close to zero.
C) an index of intraindustry trade of 0.20.
D) a large amount of imports in a product
category with few exports in the same product
category.
Answer: A
29
ICA2- Question 2

According to the product cycle model,
comparative advantage:
– A) may move from one country to another
country as the product matures.
– B) is based on the income level of the domestic
country.
– C) will remain in the country where the product
is introduced.
– D) is based on economies of scale.

Answer: A
30
ICA 2- Question 3

Why is international trade viewed as a "second
best" alternative when compared to the movement
of the factors of production?
– A) Being able to move the factors of production would
increase world output.
– B) International trade has too many problems associated
with it.
– C) Factors of production are cheaper and easier to acquire.
– D) Resources are best used with international trade.

Answer: A
31
Demand Curve for
oranges
The value of 2nd pound of
oranges to us is €10
This is called marginal
value of the 2nd pound
P
10
The value of 5th pound of
oranges to us is €7
7
This is called marginal
value of the 5th pound
D
2
5
Q
32
The same is true for
demand curve for capital
The value of 2nd unit of
capital is €10
But what determines this
value?
P
10
It depends on how
productive capital is
7
We are willing to pay the
2nd capital €10, because
it can produce €10 of
output for us.
D
2
5
Q
€10 is the value of
marginal product of
capital
33
The same is true for
demand curve for capital
If we end up hiring 5
capital, each unit
produces up to the
height of the demand
curve
P
If we could hire capital
continually, the area
under the demand
curve up to 5 unit of
capital = total output
D
5
Q
34
Figure 5.1: Output and Welfare Effects of
International Capital Mobility
US is capital abundant
Total output in the
US = a + b
India is capital scarce
Return to Capital, U.S.
Return to Capital, India
Sk
Sk
R
a
a’
Total
output in
India =
a’+ b’
E’
I
RU
E
S
DUS
b’
b
DINDI
A
Capital Stock, U.S.
Assumption: Supply of capital is fixed (vertical)
Capital Stock, India
35
Figure 5.1: Output and Welfare Effects of
International Capital Mobility
Out put in US drops
b+ c
by ____________
Capital moves from US to India
Return to Capital, U.S.
Return to Capital, India
Sk’
Sk
Sk
R
e
RUS’
RU
F
d
I
c
RI
’
E
DUS
S
a
b
e’
d’
a’
Sk’
F’
c’
E’
b’
Output in
India goes up
c’+b’
by ________
World out
put
up
goes_____
DINDI
A
Capital Stock, U.S.
Capital Stock, India
36
Figure 5.1: Output and Welfare Effects of
International Capital Mobility
US capital’s share of
Indian output is
b’
_____.
Total return to capital (capital’s share of total
output) in the US changes from a + b to
a+d
___________
Return to Capital, U.S.
Return to Capital, India
Sk’
Sk
Sk
R
e
RUS’
RU
F
d
I
c
RI
’
E
DUS
S
a
b
e’
d’
a’
Sk’
F’
c’
India’s
capital’s share
of out put
declined from
a’+d’ to
_____.
a’
E’
b’
DINDI
A
Capital Stock, U.S.
Capital Stock, India
37
Figure 5.1: Output and Welfare Effects of
International Capital Mobility
India’s labor’s share
of out put used to be
e’
_________
Now it is
Us labor’s share of output used to be
e
e+d+c. Now it is ________.
Return to Capital, U.S.
Return to Capital, India
Sk’
Sk
Sk
R
e
RUS’
RU
F
d
I
c
RI
’
E
DUS
S
a
e’+d’+c’
_______.
b
e’
d’
a’
Sk’
F’
a’
c’
E’
b’
DINDI
A
Capital Stock, U.S.
Capital Stock, India
38
Recap
1.
2.
3.
4.
5.
World output went up
US capital’s share of the world output
went up
India’s capital share of the world
output went down
US labor share of out put went down
India’s labor share of output went up
39
The role of Government
Governments restrict the free flow of
foreign direct investment in several ways.

–
Industrial Policy

A government policy designed to stimulate the
development and growth of an industry.
–
It tends to favor local firms at the expense of foreign
firms.
40