Chapter 15: International Economics (Trade & Finance)

Today, all economies are closely linked with the global economy. This chapter deals with international trade and the flow of money.

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1. International Trade Theory

(1) Comparative Advantage

• Even if a country is more productive in all areas (Absolute Advantage), both countries benefit if they specialize in products they are relatively better at (lower opportunity cost) and trade them.

(2) Heckscher-Ohlin Theory

• A theory stating that labor-abundant countries export labor-intensive products, while capital-abundant countries export capital-intensive products. (Difference in factor endowments)

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2. Trade Policy and Protectionism

• Tariff: A tax levied on imported goods to raise their price and reduce imports.
• Import Quota: A policy that limits the actual volume of goods that can be imported.
• Outcome: Domestic consumers lose while domestic producers gain, resulting in an overall loss of efficiency (deadweight loss) for society.

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3. Exchange Rate and International Finance

(1) Exchange Rate

• The exchange ratio between domestic and foreign currency.
• Exchange Rate Rise (Domestic currency depreciation): Enhanced price competitiveness of exports (exports increase), rise in import prices (imports decrease).

(2) Purchasing Power Parity (PPP)

• A theory stating that the exchange rate is determined at a level where the real purchasing power of the currencies of both countries is equal. (e.g., Big Mac Index)

(3) Balance of Payments (BOP)

• Current Account: Trade in goods and services, flow of income, etc.
• Capital and Financial Account: Flows of assets like stocks, bonds, and direct investment.

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4. Policy in an Open Economy (Mundell-Fleming Model)

• Flexible Exchange Rate System: Monetary policy is more effective than fiscal policy.
• Fixed Exchange Rate System: Fiscal policy is more effective than monetary policy.

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Key Checklist

• What do we call the principle of specializing in a product with a relatively lower opportunity cost? (Answer: Comparative Advantage)
• Generally, is an exchange rate rise (won depreciation) favorable or unfavorable for exports? (Answer: Favorable)
• Which item represents the difference in a country’s exports and imports of goods and services? (Answer: Current Account)
• Which theory explains exchange rates based on the logic that the price of a Big Mac should be the same everywhere in the world? (Answer: Purchasing Power Parity)