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Welcome to Welcome to EC 382: International EC 382: International EconomicsEconomicsBy:By: Dr. Jacqueline KhorassaniDr. Jacqueline Khorassani

Week FiveWeek Five

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Week Five: Class OneWeek Five: Class One

Tuesday, October 2Tuesday, October 214:10-15:0014:10-15:00AC 202AC 202

Return ICAReturn ICA Expect ICA tomorrowExpect ICA tomorrow

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Thanks for your Thanks for your feedbackfeedback I just wanted to mention that in I just wanted to mention that in

Ireland we spell 'Labour'Ireland we spell 'Labour'with a 'u', as shown. I felt a lot of with a 'u', as shown. I felt a lot of the Irish students might be the Irish students might be gettinggettingconfused by this. Thank you for confused by this. Thank you for your time. your time. – Evan Coady Evan Coady

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A requestA request

Could you please outline the format Could you please outline the format of our exam on the 10th of October of our exam on the 10th of October in class on Tuesday?in class on Tuesday?

Sure, the exam will have two partsSure, the exam will have two parts– Part One: Multiple Choice QuestionsPart One: Multiple Choice Questions

You choose the best answerYou choose the best answer There are no negative marksThere are no negative marks

– Part Two: Short essay questions and or Part Two: Short essay questions and or problemsproblems

55

Who are Who are Immigrants?Immigrants?

Individuals that permanently Individuals that permanently change their country of change their country of residence to a foreign country.residence to a foreign country.

In 1965, 75 million people lived in a In 1965, 75 million people lived in a country outside their country of birth.country outside their country of birth.

In 2000, immigrants residing in a new In 2000, immigrants residing in a new country was greater than 150 million.country was greater than 150 million.

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What are the reasons for international What are the reasons for international movements of labor? movements of labor? (you asked questions)(you asked questions)

Fact: most immigration comes Fact: most immigration comes from developing countries.from developing countries.

– Push factors-Push factors- push labor out of push labor out of these countriesthese countries

low standard of living in low standard of living in developing countries developing countries

high rates of unemployment.high rates of unemployment. PovertyPoverty

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What are the reasons for international What are the reasons for international movements of labor? movements of labor? (you asked questions)(you asked questions)

Pull factors-Pull factors- pull workers pull workers into developed nationsinto developed nations

– Higher incomesHigher incomes– Higher standard of living Higher standard of living

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Is Conor Lawlor here Is Conor Lawlor here today?today?

Evan Coady and the rest of us wish you Evan Coady and the rest of us wish you a very a very Happy 21 Birthday Conor.

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What are the effects of What are the effects of international international movements of labor?movements of labor?

Assume that India is labor Assume that India is labor abundant and the U.S. is abundant and the U.S. is capital abundant.capital abundant.

– Wages in the U.S. are higher Wages in the U.S. are higher than India.than India.

– Indian labor would migrate to the Indian labor would migrate to the U.S.U.S.

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What are the effects of What are the effects of international international movements of labor on Indians?movements of labor on Indians?

Workers in India will benefit from Workers in India will benefit from ______ wages with the reduction in ______ wages with the reduction in supply.supply.

India’s capital-to-labor ratio ________.India’s capital-to-labor ratio ________.– Increase in India’s labor productivity.Increase in India’s labor productivity.– Indian wages will rise.Indian wages will rise.

India’s total output will fall.India’s total output will fall.– Returns to owners of capital in India fall Returns to owners of capital in India fall

because of because of Higher wages paidHigher wages paid Reduced productionReduced production

higher

rises

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What are the effects of international What are the effects of international

movements of labor on Americans?movements of labor on Americans?

Increase in labor force lowers the Increase in labor force lowers the amount of capital each worker amount of capital each worker has available to work with.has available to work with.

– Capital to labor ratio falls in the U.S. Capital to labor ratio falls in the U.S. which decreases labor productivity.which decreases labor productivity.

– Wages in U.S. fall.Wages in U.S. fall. Total output rises.Total output rises.

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What are the effects of What are the effects of international international movements of labor on movements of labor on

Americans?Americans? Owners of capital in the U.S. gainOwners of capital in the U.S. gain

– Lower wages paidLower wages paid– Produce more outputProduce more output

(U.S. labor will oppose open (U.S. labor will oppose open immigration.)immigration.)

(Owners of capital favor open (Owners of capital favor open immigration.)immigration.)

The output of the world economy rises The output of the world economy rises since workers can move to countries since workers can move to countries where they are more productive.where they are more productive.

Note: I will not go over Figure 5-2Note: I will not go over Figure 5-2– You are responsible to know it.You are responsible to know it.

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Immigration and Public Immigration and Public PolicyPolicy

To maximize the world’s total output, To maximize the world’s total output, policy should be completely open policy should be completely open immigration.immigration.

Wages drop in the host countryWages drop in the host country Few countries have open immigration Few countries have open immigration

but few have a ban on immigration.but few have a ban on immigration. Policies to prevent the Policies to prevent the brain drainbrain drain

The movement of skilled or professional The movement of skilled or professional workers from one country to another.workers from one country to another.

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Immigration and Public Immigration and Public PolicyPolicy

The guest worker programs of The guest worker programs of Europe allow workers from Europe allow workers from developing countries to work there developing countries to work there temporarily rather than to immigrate temporarily rather than to immigrate permanently.permanently.

Other issuesOther issues Unemployment insuranceUnemployment insurance EducationEducation HousingHousing HealthcareHealthcare

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Immigration and Public Immigration and Public PolicyPolicy

Offshore assembly provisionsOffshore assembly provisions Allow firms to export materials and Allow firms to export materials and

parts of a good to foreign countries for parts of a good to foreign countries for final assembly;final assembly;

When the assembled goods are When the assembled goods are returned to the home country, duties returned to the home country, duties are assessed only on the value added are assessed only on the value added in the foreign country.in the foreign country.

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Immigration and Public Immigration and Public PolicyPolicy

Firms have used foreign labor to Firms have used foreign labor to process paperwork as well as process paperwork as well as subcontract design and subcontract design and engineering work.engineering work.

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What is What is a Multinational a Multinational Corporation?Corporation?

A firm that conducts part of its A firm that conducts part of its business across national boundaries business across national boundaries (MNC)(MNC)

Why?Why?– Labor shortages in home country.Labor shortages in home country.– Increase efficiencies by internalizing Increase efficiencies by internalizing

certain activities instead of contracting certain activities instead of contracting them out.them out.

– Control Control

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Slides 19-24Slides 19-24

Will not be discussed in class Will not be discussed in class unless there are questionsunless there are questions

You are responsible for the You are responsible for the material covered in these slidesmaterial covered in these slides

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The The OLI approachOLI approach

A framework that explains why MNCs A framework that explains why MNCs engage in foreign direct investment.engage in foreign direct investment.

O is ownershipO is ownership – commonly ownership of an – commonly ownership of an intangible assetintangible asset

– A good or process a firm has developed A good or process a firm has developed that other firms find difficult to that other firms find difficult to replicate.replicate.

– It is a source of comparative advantage.It is a source of comparative advantage.

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The The OLI approachOLI approach

L is for L is for locationallocational advantages advantages– It may be in the firm’s global interests It may be in the firm’s global interests

to locate outside home country.to locate outside home country.– For example, location of natural For example, location of natural

resourcesresources– Take advantage of cheaper imports – Take advantage of cheaper imports –

vertical integrationvertical integration– Natural and legal barriers to tradeNatural and legal barriers to trade

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The The OLI approachOLI approach

I is for I is for internalizationinternalization– A firms’ propensity to perform A firms’ propensity to perform

functions internally that outside functions internally that outside firms could dofirms could do

– Firm derives benefit from Firm derives benefit from internalizing processinternalizing process

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Host country’s policy Host country’s policy toward MNCtoward MNC Host country could ban activities of Host country could ban activities of

MNCsMNCs Host country could treat MNCs as a Host country could treat MNCs as a

domestic firm – domestic firm – national treatmentnational treatment Most likely regulation falls between the Most likely regulation falls between the

two extremestwo extremes Generally MNCs must pay taxes on Generally MNCs must pay taxes on

profits of local subsidiaries. profits of local subsidiaries.

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Home country’s policy Home country’s policy toward MNCtoward MNC

Home country gives tax credit Home country gives tax credit against local tax liability for against local tax liability for taxes paid abroad.taxes paid abroad.

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Transfer pricingTransfer pricing

over or under pricing of goods in over or under pricing of goods in intra-firm trade of MNC.intra-firm trade of MNC.– Allows firms to use intra-firm pricing Allows firms to use intra-firm pricing

to maximize after-tax profitsto maximize after-tax profits– Was used to transfer profits out of Was used to transfer profits out of

countries with exchange controlscountries with exchange controls Some transfer pricing will occur Some transfer pricing will occur

until income taxes are uniform until income taxes are uniform across countries.across countries.

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International International EconomicsEconomics Week Five- Class 2Week Five- Class 2

– Wednesday, October 3Wednesday, October 3– 11:10-12:00 PM11:10-12:00 PM– TyndallTyndall

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ICA3: True or FalseICA3: True or False

1.1. FDI tends to raise the welfare of the FDI tends to raise the welfare of the owners of capital in the host country. owners of capital in the host country.

2.2. Immigration may lower domestic Immigration may lower domestic wages, but it also augments the total wages, but it also augments the total output of the country. output of the country.

3.3. The return to capital in the host The return to capital in the host country will tend to increase as the country will tend to increase as the domestic supply of capital is domestic supply of capital is augmented with foreign capital. augmented with foreign capital.

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Tax on imported goodsTax on imported goods Why?Why?

– Revenue for GovernmentRevenue for Government– Protect domestic suppliers of Protect domestic suppliers of

similar goods from foreign similar goods from foreign completioncompletion Protect jobsProtect jobs

What is a tariffWhat is a tariff? ?

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What are the types of What are the types of tariff?tariff?

1.1. Specific tariffsSpecific tariffs Tax per unitTax per unit

specific tariff is regressive. specific tariff is regressive. Why?Why?– A specific tariff of $1,000 on A specific tariff of $1,000 on

each imported autoeach imported auto a high percentage of the value of a high percentage of the value of

less expensive carsless expensive cars a low percentage of the value of a low percentage of the value of

high-priced carshigh-priced cars

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Under specific tariff, what Under specific tariff, what type of cars will be type of cars will be imported less? Expensive imported less? Expensive cars? Cheap cars?cars? Cheap cars? Cheap carsCheap cars

– A specific tariff encourages A specific tariff encourages domestic producers to produce domestic producers to produce less expensive goods.less expensive goods.

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2. Ad valorem tariffs2. Ad valorem tariffs– Taxes = fraction of the value of the Taxes = fraction of the value of the

imported goodsimported goods A 5% tariff on an international price of A 5% tariff on an international price of

$10,000 means that customs officials $10,000 means that customs officials collect the fixed sum of _________.collect the fixed sum of _________.

– Importers have an incentive to Importers have an incentive to under-under-voicevoice the price of the imported good. the price of the imported good.

– Ad valorem tariffs are more difficult for Ad valorem tariffs are more difficult for a country to administer than specific a country to administer than specific tariffs.tariffs.

What are the types of What are the types of tariff? tariff?

$500

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3. Compound tariffs3. Compound tariffs– a combination of an ad valorem a combination of an ad valorem

and a specific tariffand a specific tariff– Common on agricultural products Common on agricultural products

whose prices tend to fluctuate.whose prices tend to fluctuate.

What are the types of What are the types of tariff? tariff?

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1.1. Free alongside (FAS) priceFree alongside (FAS) price The price of the imported good in the The price of the imported good in the

exporting nation before loading the good exporting nation before loading the good for shipment to the importing countryfor shipment to the importing country

2.2. Free on Board (FOB) priceFree on Board (FOB) price FAS + the cost of loading the good in the FAS + the cost of loading the good in the

means of transportationmeans of transportation

What are different What are different methods of valuing methods of valuing imports? imports?

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3. Cost, Insurance, and Freight 3. Cost, Insurance, and Freight (CIF) price(CIF) priceFOB + all inter-country FOB + all inter-country transportation costs up to the transportation costs up to the importing country’s port of importing country’s port of entry.entry.

What are different What are different methods of valuing methods of valuing imports?imports?

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What is consumer surplus What is consumer surplus (CS)?(CS)?

D

P1

P

Q

Consumer Surplus

Price

Quantity

The difference between the highest price consumers would be willing to pay (Price on demand curve) and the market price.

Graphically, it is equal Graphically, it is equal to the area under the to the area under the demand curve and demand curve and above the priceabove the price

The higher the CS the ___________ the consumers

Better off

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What is producer surplus What is producer surplus (PS)?(PS)?

E

P2

Producer Surplus

S

Quantity of Cloth

Price of Cloth

Q

P

The difference between the market price and lowest price producers will sell a good (price on the supply curve).

Graphically, it is Graphically, it is equal to the area equal to the area under the price and under the price and above the supply above the supply curvecurveThe higher the PS the ___________ the producers

Better off

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International International EconomicsEconomics Week Five- Class 3Week Five- Class 3

– Wednesday, October 3Wednesday, October 3– 15:10-16:0015:10-16:00– AC 201AC 201

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ICA3: True or FalseICA3: True or False

1.1. FDI tends to raise the welfare of FDI tends to raise the welfare of the owners of capital in the host the owners of capital in the host country. country.

False, capital become more False, capital become more abundant, its return goes down. abundant, its return goes down.

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ICA3: True or FalseICA3: True or False

2. Immigration (into a country) may 2. Immigration (into a country) may lower domestic wages, but it lower domestic wages, but it also augments the total output also augments the total output of the country. of the country.

True, supply of labor goes upTrue, supply of labor goes up Wage rate dropsWage rate drops Production goes upProduction goes up

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ICA3: True or FalseICA3: True or False

3. The return to capital in the host 3. The return to capital in the host country will tend to increase as country will tend to increase as the domestic supply of capital is the domestic supply of capital is augmented with foreign capital. augmented with foreign capital.

False, the same as question 1False, the same as question 1

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CS/PSCS/PS

S

D

E

Price

Quantity

P1

Q

P

P2

Consumer Surplus

Producer Surplus

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How does a free trade affect How does a free trade affect consumer surplus and producer consumer surplus and producer surplus?surplus?

Price

Quantity

Price

Quantity

D

Exports

Imports

D

E

US

India

a

b

c

d

SS

10

4

a’

b’

c’

d’

8

E’

8

CS ↑ by b+ d, PS ↓ by b CS↓ by b’, PS ↑ by b’ + d’

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What are the economic What are the economic effects of tariffs?effects of tariffs?

1.1. Case of small importing nationCase of small importing nation Note: A small nation can import as much Note: A small nation can import as much

as it likes at the same international price. as it likes at the same international price.

– World Price = World Price = €8€8..– Domestic government imposes a Domestic government imposes a

specificspecific tariff on imported good in tariff on imported good in the amount of the amount of €2/unit€2/unit

– Domestic Price = 8 + 2 = Domestic Price = 8 + 2 = €10€10

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What are the economic What are the economic effects of tariffs in a effects of tariffs in a

small importing nation?small importing nation?

S

D

E

Price

Quantity

a b c d

35 401510

8

10

Tariff = 2

-a+b+c+d: loss in CS = €75- a: added to PS= €25- b: cost of resources transferred from their best use to the production of 5 more units of the good= €5- c: government revenue = €40-d: loss to consumers = €5- a + c: redistribution effect- b+d: dead-weight loss