EC239- Midterm Exam Guide - Comprehensive Notes for the exam ( 123 pages long!)
WLU
EC239
MIDTERM EXAM
STUDY GUIDE
EC239 Lesson 1
1.1 Brief History of International Trade Theory
• 15th-18th cen. A group of writers in Europe knows as the mercantilists advocated the need for
restricting imports
o According to them, achieving a favourable trade balance was a key to promote a
atio’s ecooic stregth - a trade surplus would result in a net inflow of gold & silver
which in turn would ^ domestic spending & employment
• 18th cen. David Hume’s price-specific-flow doctrine argued against the mercantilist view of
restrictive trade policy
o The doctrine states that under a gold-standard, a + trade balance is not sustainable in
the LT. A + trade balance implies a net inflow of gold which in turn ^ domestic $ supply.
The > $ supply => ^ price in the LR, decreasing the demand for domestic goods (exports)
and ^ the demand for cheaper foreign goods (imports)
▪ This eventually eliminates the trade surplus
• Mercantilist view of the world economy. They believed that the wealth of the world was fixed &
that one nation could gain only at the expense of its trading partners
• Adam Smith challenged the mercantilist view (^) by explaining how international trade allows
countries to take advantage of specialization and division of labour and has the potential to
benefit both trading partners.
• Smith believed that for mutual gain through trade each nation must have absolute advantage or
be more productive than the other country in at least one good
• David Ricardo (1772-1823) later developed a theory of competitive advantage to show that
mutually beneficial trade is possible even if a country does not have any absolute advantage
• Early 19th cen.: 2 Swedish economists, Eli Heckscher & Bertil Ohlin developed a trade theory
(Heckscher-Ohlin Model) showing that a country will produce and export goods that uses its
relatively abundant factor ore intensively
• International trade theory took a new turn in the 1980s with the development of new trade
theory.
o Relaxes some of the assumptions of previous models by allowing ^ returns to scale &
imperfect completion
1.2 Rising Importance of International Trade
1.3 Topics Covered in the Study of International Trade
• International trade refers to the movement of g & s across borders
• We study why countries trade with each other, how countries gain from trade, factors that
determine the pattern of trade across countries and also the causes and consequences of
restrictive trade policies
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EC239 Lesson 2: World Trade: An Overview
Introduction
• Reliance on trade has not ^ uniformly across countries and the amount of trade also differs
between pairs of countries
• The Gravity Model of Trade is ased o Isaa Neto’s la of graitatio that desries ho
the gravitational force between any two objects depends on their masses and the distance
between them
o This model considers that (a) the size of bilateral trading partners, as measured by their
GDP, along with (b) the distance between trading partners, as crucial in determining the
volume of trade between the two countries
Who Trades With Whom?
• The US is a major trading partner for most major countries
o Given it is the largest economy in the world, we can say that the size of an economy
plays a crucial role in determining bilateral trade
• There is a tendency for countries to trade more with countries that are geographically closer
The Gravity Model and the logic behind it
• International trade economists have conducted a number of empirical tests to confirm the trade
pattern that we have observed
• To predict the volume of trade between any two countries use the formula: Tij=(A*Yi*Yj)/Dij
where Tij is the value of trade between country i and country j, A is a constant, Yi is the GDP of
country i, Yj is the GDP of country j, and Dij is the distance between country i and country j
• This equation implies that the volume of trade between any two countries is proportional; all
other things =, to the product of the to outries’ GDPs, ad diiish ith the distae
between them
• In a slightly more general form, the gravity model that is commonly estimated is:
Tij=(A*Yia*Yjb)/Dijc where a, b, and c are allowed to differ from 1 and chosen to fit the actual data
as closely as possible
• The logic of the gravity model:
o The size of an economy (as given by its GDP) is an important factor in determining
bilateral trade
o The larger the economy, the larger its income and the more it can spend on imports
o A larger economy produces a wide range of products attracting larger shares of other
outries’ spedig
o Distance also matters as it determines the transportation cost of trade
o The smaller the distance between any two countries, the lower the transportation cost
and the > the trade volume
2.3 Using the Gravity Model: Looking for Anomalies
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Document Summary
1. 1 brief history of international trade theory: 15th-18th cen. The > $ supply => ^ price in the lr, decreasing the demand for domestic goods (exports) and ^ the demand for cheaper foreign goods (imports: this eventually eliminates the trade surplus, mercantilist view of the world economy. : 2 swedish economists, eli heckscher & bertil ohlin developed a trade theory (heckscher-ohlin model) showing that a country will produce and export goods that uses its relatively abundant factor ore intensively. International trade theory took a new turn in the 1980s with the development of new trade theory: relaxes some of the assumptions of previous models by allowing ^ returns to scale & imperfect completion. 1. 3 topics covered in the study of international trade. Gdp, along with (b) the distance between trading partners, as crucial in determining the volume of trade between the two countries. The gravity model and the logic behind it.
