Introduction
Dr. Anwesha Aditya
IIT Kharagpur
What Is International Economics About?
• International economics is about how nations interact
through:
– trade of goods and services, flows of money, and investment.
• International economics is an old subject, but continues to
grow in importance as countries become tied more to the
international economy.
• Nations are now more closely linked than ever before.
International Trade Versus Finance
• International trade focuses on transactions involving movement of goods
and services across nations.
- Gains from trade, explaining patterns of trade, effects of government
policies on trade
• International finance focuses on financial or monetary transactions across
nations.
-Balance of payments, exchange rate determination, international
policy coordination and capital markets
I s su e s :
Three Basic
u s e s ,
Ca Tr a de
r n a n d at i o n al
Patte e s o f I nte r n
e q u en c
Con s
Basis of Trade
• First, when do countries engage in international trade in
goods and services? What are the factors that drive goods
and factors to flow from one country to the other?
• Inter versus intra industry explanation
Patterns of Trade
• Why do some countries export manufactured goods and others export
agricultural goods?
• Differences in climate and resources can explain why Brazil exports coffee
and Australia exports iron ore.
• But why does Japan export automobiles, while the U.S. exports aircraft?
• Why some countries export certain products can stem from differences in:
– Labor productivity
– Relative supplies of capital, labor and land and their use in the
production of different goods and services
Gains from Trade
• Normative issue: whether international exchange
and trade are always gainful for countries.
• Under certain market and technological conditions,
international exchange of goods and services by
atomistic agents raises national welfare of all
trading nations if such exchanges follow the
principles of comparative advantage.
Free Trade versus Protection
• Despite gains from trade, countries had often been observed to restrict
trade through import tariffs and non-tariff barriers.
• Policy makers affect the amount of trade through
– tariffs: a tax on imports or exports,
– quotas: a quantity restriction on imports or exports,
– export subsidies: a payment to producers that export,
– or through other regulations (ex., product specifications)
that exclude foreign products from the market, but still allow
domestic products.
• What are the costs and benefits of these policies?
Size Matters: The Gravity Model
• 3 of the top 10 trading partners with the U.S.
in 2008 were also the 3 largest European economies: Germany, U.K., and
France, the countries having the largest gross domestic product (GDP) in
Europe.
• Why does the U.S. trade most with these European countries and not
other European countries?
The Gravity Model (cont.)
• In fact, the size of an economy is directly related to the
volume of imports and exports.
– Larger economies produce more goods and services, so they have
more to sell in the export market.
– Larger economies generate more income from
the goods and services sold, so they are able to buy more imports.
The Gravity Model (cont.)
• In its basic form, the gravity model assumes that only size
and distance are important for trade in the following way:
Tij = A x Yi x Yj /Dij
where
T ij is the value of trade between country i and country j
A is a constant
Y i the GDP of country i
Y j is the GDP of country j
Dij is the distance between country i and country j
Distance and Borders (cont.)
• Besides distance, borders increase the cost and time needed to trade.
• Trade agreements between countries are intended to reduce the
formalities and tariffs needed to cross borders, and therefore to increase
trade.
• The gravity model can assess the effect of trade agreements on trade:
does a trade agreement lead to significantly more trade among its
partners than one would otherwise predict given their GDPs and
distances from one another?
Has the World Become “Smaller”?
• The negative effect of distance on trade according to the
gravity models is significant, but has grown smaller over time
due to modern transportation and communication.
• Technologies that have increased trade:
– Wheels, sails, compasses, railroads, telegraph, steam
power, automobiles, telephones, airplanes, computers, fax machines,
Internet, fiber optics, personal digital assistants, GPS satellites…
Has the World Become “Smaller”?
(cont.)
• Political factors, such as wars, can change trade patterns
much more than innovations in transportation and
communication.
• World trade grew rapidly from 1870 to 1913.
– Then it suffered a sharp decline due to the two world wars and the
Great Depression.
– It started to recover around 1945 but did not recover fully until
around 1970.
• Since 1970, world trade as a fraction of world GDP has
achieved unprecedented heights.
Virtual Trade
• Breakthrough in information and communication technology
has enabled many previously non-traded services tradable.
• Virtual trade arising due to time zone difference has very
recently emerged as the fourth dimension of determining
trade patterns among countries (Marjit, Mandal and
Nakanishi, 2020).
Source: World Trade Organization
Distribution of GDP across the
economic sector, India
Source: World Bank
Share of GDP in different industries:
BRICS
Source: BRICS Joint Statistical Publication, 2021
Share of employed persons to total
employed person by industry, 2021: BRICS
Source: BRICS Joint Statistical Publication, 2021
World Trade and Recovery after
Covid-19
Source: UNCTAD secretariat calculations based on COMTRADE data.
Trade Trends Over the Years
Source: UNCTAD secretariat calculations based on COMTRADE data.
Trade in goods and services, by sector: Global Scenario
Source: UNCTAD secretariat calculations based on COMTRADE data.
Table: India’s trade trend over the
years
Source: Ministry of Commerce and Industry
Fig: Merchandise Trade during
FY 2022-23 (April-March)
Source: RBI
Fig: Services Trade during
March 2023*
Source: RBI
Notes: The estimated value of services export for March 2023* is USD 27.75 Billion, as compared to USD 26.95 Billion in March 2022.
https://pib.gov.in/PressReleasePage.aspx?PRID=1916220
Table: Trade during FY 2022-23 (April-March)* (in USD Billion)
2022-23 (USD 2021-22 (USD
Particulars Flow
Billion) Billion)
Exports 447.46 422
Merchandise
Imports 714.24 613.05
Exports 322.72 254.53
Services*
Imports 177.94 147.01
Exports 770.18 676.53
Overall Trade
Imports 892.18 760.06
(Merchandise+Services) *
Trade Balance -122 -83.53
Source: RBI
Note: The latest data for services sector released by RBI is for February 2023. The data for March 2023 is an estimation
https://pib.gov.in/PressReleasePage.aspx?PRID=1916220
Top 6 exporting commodity groups (Values
Rank in US $ Million)
Top 6 Export Commodities 2017-2018 % Share
Natural Or Cultured Pearls,Precious Or Semiprecious Stones,Pre.Metals,Clad With Pre.
1 41,743.47 13.7528
Metal And Artcls Thereof;Imit.Jewlry;Coin.
Mineral Fuels, Mineral Oils And Products Of Their Distillation; Bituminous Substances;
2 38,469.36 12.6741
Mineral Waxes.
3 Nuclear Reactors, Boilers, Machinery And Mechanical Appliances; Parts Thereof. 17,867.84 5.8868
Vehicles Other Than Railway Or Tramway Rolling Stock, And Parts And Accessories
4 17,255.38 5.685
Thereof.
5 Organic Chemicals 14,796.74 4.8749
6 Pharmaceutical Products 13,255.62 4.3672
India's Total Export (2017-18) 3,03,526.16 100
Rank Top 6 Export Commodities 2022-2023 % Share
Mineral Fuels, Mineral Oils And Products Of Their Distillation; Bituminous Substances;
1 1,01,241.86 22.4448
Mineral Waxes.
Natural Or Cultured Pearls,Precious Or Semiprecious Stones,Pre.Metals,Clad With Pre.
2 38,112.48 8.4493
Metal And Artcls Thereof;Imit.Jewlry;Coin.
Electrical Machinery And Equipment And Parts Thereof; Sound Recorders And
3 28,608.54 6.3424
Reproducers, Television Image And Sound Recorders And Reproducers,And Parts.
4 Nuclear Reactors, Boilers, Machinery And Mechanical Appliances; Parts Thereof. 27,476.71 6.0915
5 Organic Chemicals 21,377.32 4.7392
Vehicles Other Than Railway Or Tramway Rolling Stock, And Parts And Accessories
6 21,219.86 4.7043
Thereof.
India's Total Export (2022-23)
Source: Ministry of Commerce and Industry 4,51,070.00 100
Top 6 importing commodity groups (Values in
US $ Million)
Rank Top 6 Import Commodities 2017-2018 % Share 2022-23 % Share
Mineral Fuels, Mineral Oils And Products Of Their Distillation;
1 1,32,294.61 28.41 2,60,921.01 36.44
Bituminous Substances; Mineral Waxes.
Natural Or Cultured Pearls,Precious Or Semiprecious Stones,Pre.
2 Metals,Clad With Pre.Metal And Artcls Thereof;Imit.Jewlry;Coin. 74,710.42 16.05 73,930.32 10.33
Electrical Machinery And Equipment And Parts Thereof; Sound
3 Recorders And Reproducers, Television Image And Sound 48,269.18 10.37 67,637.27 9.45
Recorders And Reproducers,And Parts.
Nuclear Reactors, Boilers, Machinery And Mechanical
4 37,824.21 8.12 54,376.99 7.59
Appliances; Parts Thereof.
5 Organic Chemicals 19,201.28 4.12 28,975.72 4.05
6 Plastic And Articles Thereof. 13,926.43 2.99 23,122.88 3.23
India's Total Import 4,65,580.99 100 7,15,968.90 100.00
Source: Ministry of Commerce and Industry
Syllabus
1. Introduction:
What is international economics about? An overview of world trade,
how it has evolved and its growing complexity; Distinction between
international trade and international finance.
2. Basis of Trade:
Arbitrage and inter-industry trade; Absolute and comparative
advantages; Different sources of comparative advantage; Regulation
of externalities; Perverse comparative advantage; Basis of intra-
industry trade.
3. Gains from Trade:
Trade as a positive-sum game - Gains from Trade theorem,
illustration and its meaning; Equilibrium in an open economy and
gains from trade (in terms of production possibility curve and
community indifference curve): GFT theorem and Pareto optimality;
Decomposition of GFT; substitution possibilities in production and
consumption and magnitudes of GFT; Necessary and sufficient
conditions of GFT: Tangency and convexity conditions (market
structure & technology).
4. International Equilibrium:
Offer curves: derivation; properties, related elasticities; Offer curve
under increasing opportunity costs: Derivation and Elasticity;
International Equilibrium and determination of terms of trade; Offer
curve under constant opportunity cost and distribution of GFT
between large and small countries; International Equilibrium and
determination of terms of trade; Welfare property in terms of trade-
indifference curves; distribution of GFT between large and small
countries; Walrasian static stability and Marshall-Lerner condition.
5. Neoclassical Trade Models:
(a) Technology & Trade: Ricardian model in 2x2x1 framework The
doctrine of Comparative Cost Advantage and GFT; One-factor
economy: Assumptions, Production Possibility Frontier, Relative
demand and supply, Autarkic terms of trade; Trade in the Ricardian
model: Technology as the basis of trade; complete specialization;
Large and small countries revisited; Role of demand; double-factoral
ToT.
(b) Factor endowment & trade:
Heckscher-Ohlin Samuelson model in 2x2x2 framework (12L)
Factor Abundance, Trade and Income Distribution - Two-factor
economy, Heckscher-Ohlin theorem: Factor abundance as the
basis for international trade; Relation between factor
endowment and output (Rybsczynski Effect or the supply
shift); Rybczynski theorem, Effect of trade on income
distribution: Stolper-Samuelson theorem (price magnification
effect); Relation between Commodity Price and Factor-Price
(One-to-one correspondence); Factor Price Equalization
theorem and its sources of disruption: factor intensity reversal.
Condition for incomplete specialization
(c) Empirical validity of Heckscher-Ohlin Samuelson model (2L)
Leontief paradox and Explanations
6. Trade Policy
(a) Price interventions (tariff and export subsidies):
Partial equilibrium analysis of tariff; dead-weight losses of the tariff; General
equilibrium analysis of tariff: TOT effect and VOT effect; tariff in a small and
large country, welfare effect and optimum tariff; tariff retaliation; tariff and
protection (infant industry argument for protection; effective rate of
protection, Metzler Paradox); TOT deterioration and welfare loss under
export subsidy; Lerner’s Symmetry.
(b) Quantitative Restrictions (Import quota and VER):
Scarcity rent and dead-weight losses, TOT effect and welfare under import
quota; price equivalence between tariff and import-quota. VER: its effect in
the exporting country; equivalence of economic effects under import quota
and VER for the importing country. tariff-quota equivalence (under perfect
competition and monopoly); environmental regulations as nontariff barriers
References
• Acharyya, R., International Economics: An
Introduction to Theory and Policy, Oxford University
Press.
• Caves, R. E., J. Frankel and R.W. Jones, 1995, World
Trade and Payments, Harper and Collins.
• Krugman, P. R. and M. Obstfeld, International
Economics: Theory and Policy, Pearson Education.
