Introduction to International Economics

Historical Background

• David Hume's Essay (mid-1700s)
  • Discussed British International Trade policy.
  • Shifted economics from informal discussion to a model-based field.
  • Influenced Adam Smith's The Wealth of Nations, which focused on trade policy.

Importance of International Trade

• Growth of International Trade in GDP
  • 1960s: ~4% of US real GDP from international trade.
  • Current: ~20% of US real GDP from international trade.
  • Some countries rely on trade for over 50% of their economic activity.

Differences in Economic Transactions

• Domestic vs. International Transactions
  • Buying goods from another state (e.g., Kansas) involves straightforward demand and supply.
  • International purchases involve two sovereign nations, leading to:
    • Possible restrictions on purchases (limits or taxes).
    • Use of different currencies (e.g., dollars vs. euros).
    • Exchange rates affect prices and can fluctuate.

Key Themes in International Economics

1. Gains from Trade

   • Trade creates a positive-sum game; both parties can benefit.
   • Focus on comparative advantage and specialization.
   • Not everyone might benefit equally from trade; some may be worse off.

2. Pattern of Trade

   • Determines who trades what goods.
   • Need to explore models that consider multiple goods (not just two).

3. Amount of Trade

   • Factors influencing the volume of trade between countries.

4. Exchange Rate Determination

   • Understanding how currency values affect international transactions.
   • Exchange rate movements can change the price of imports/exports.

Gravity Model of Trade

• Concept

  • Trade between two countries (Tij) relates to their GDPs (Yi, Yj) and the distance (Dj) between them.

• Model Formulation

  • General formula: [ T_{ij} = A \cdot \frac{Y_i \cdot Y_j}{D_j} ]
    • Where:
      • Tij = Amount of trade between country I and J.
      • Yi = GDP of country I.
      • Yj = GDP of country J.
      • Dj = Distance between countries I and J.
      • A = Empirical constant (e.g., 5 or 7).

• Interpretation

  • Larger economies (higher GDP) lead to more trade.
  • Greater distance leads to less trade.
  • Concept likened to gravitational pull between celestial bodies (Newton's idea).

• Use of the Model

  • Not estimating specific models in class, but understanding empirical relationships.
  • Future studies may involve econometric estimation of trade relationships.

Conclusion

• Upcoming topics will cover behavioral models explaining why countries trade.
• Focus on understanding economic interactions in international contexts.