International economics is a macroeconomic discipline studying general principles, conditions and

participants of exchange of goods, services, labour, capital, technology and information in the world
market.
International economics deals with the trade and financial interdependence among nations.
Main aspects:
-theory
-policy
-practice
Main areas:
-international trade
-international finance
International trade deals with:
-international trade theory (analysis of the basis for trade, trade patterns, and gains from trade)
-international trade policy
(examination of reasons for and effects of different trade instruments, economic integration,
international trade institutions and organizations, international trade strategy ...)
International finance deals with open-economy macroeconomics:
- theory of international finance (balance-of-payments, exchange rates regimes, adjustment...)
- international monetary policy (monetary integration, international capital movement, financial
markets, international financial institutions...)
Trade theory is the product of an evolution of ideas in economic thought.
Mercantilism the first complete view on international trade.
Stages of reproduction process:
Phase I: production
Phase II: allocation/distribution
Phase III: exchange (trade)
Phase IV: consumption
Magic triangle of economic goals:
-economic growth
-internal equilibrium
-external equilibrium
Theoretical directions in international trade (in chronological order):
-mercantilism (XVI, XVII, beginning of XVIII)
-liberalism (end of XVIII, XIX)
-protectionism (end of XIX)
-government interventionism (after 1930)
-neoliberalism (end of XX and beginning of XXI)
MERCHANTILISM:
-colonialization period
-gold standard
-wealth of nations was measured by the stock of precious metals

Main goal of economic policy: To increase wealth!

Marcantilists preached economic nationalism national interests were basically in conflict; one
nation could gain only at the expenses of other nations.
Zero-sum game if one wins, the another one must lose.
Trade theories that belong to the same group have some common characteristics
Theory of Absolute Advantages (Smith):
Assumptions:
-model 2x2x1;
-labour theory of value;
-constant costs;
-perfect competition;
-full employment;
-free trade;
-zero transportation costs;
-perfect mobility of productions factors (labour) within and between countries;
A country has an absolute advantage if it is the most efficient country in production of certain good.
We calculate the absolute advantage comparing production costs for a unit of the certain product
within two countries.
Gains from trade:
-World resources will be utilized most efficiently and the world output and welfare will maximize, if
countries specialise according to their absolute advantages.
-All countries benefit from mutual trade international trade is a positive-sum game.
Absolute Advantage means you can produce a good using less resources.
Comparative Advantage means you can produce a good at smaller opportunity cost.
Theory of Comparative Advantages (Ricardo):
Assumptions:
model 2x2x1;
labour theory of value;
constant costs;
perfect competition;
full employment;
free trade;
zero transport costs;
perfect mobility of labour between industries within a country and no international mobility;
fixed but different technology between countries;
fixed resources, technology, tastes etc.
Pattern of trade:
A country will specialise in production of products in which it has comparative advantages and
exchange those products for products in which it has comparative disadvantages.
Gain from trade:
-Equal distribution of gains international trade is positive-sum game.
Basis for trade (Ricardos trading principle):

Basis for trade arises from differences in relative productivity (comparative costs differences)
between countries.
Comparative advantages are calculated by comparing relative unit costs of production (comparing
ratios of unit costs).
aLx/aLy : aLxf/aLyf
aLx time/labour costs for production of an unit of the product x in domestic country;
aLy time/labour costs for production of an unit of the product Y in domestic country;
aLxf time/labour costs for production of an unit of the product x in foreign country;
aLyf time/labour costs for production of an unit of the product Y in foreign country;
Theory of Reciprocal Demand (John Stuart Mill):
Export price will be determinated by reciprocal demand intensity. Reciprocal demand is demand of
each of two countries for export product of the other one.
Similarities between classical and neoclassical trade theories:
-several assumptions: full employment, perfect competition, free trade;
-thesis on reason for trade based on comparative advantages principle;
The main thesis of classical trade theories on reason for trade based on comparative advantages
principle strongly stands in neoclassical theories as well.
Neoclassical offer an explanation of the causes of comparative cost differences
Differences: What is different in neoclassical theories?
-two- or multi-factors models;
-abandonment of labour theory of value;
-costs expressed in money terms instead in physical product units;
-both constant and variable (changeable) costs;
-both complet and incomplet specialisation;
-transportation costs;
Opportunity cost theory - Haberler:
Basic assumptions:
-model 2x2x3 (two countries - two commodities -three production factors);
-perfect competition;
-free trade;
-full employment;
-increasing costs.
G. Haberler introduced a new element in his analysis the principle of marginal costs.
The main thesis:
A country has a comparative advantage in some product, if it can produce an additional unit of that
product at lower opportunity costs expressed in terms of other product, than another country can do
it.
Opportunity costs can be illustrated by production possibilities schedule (PPF); the slope of PPF is
equal to opportunity costs;
PPF indicates the maximum amount of any two products an economy can produce, assuming that all
resources are used in their most efficient manner (full employment).

Marginal rate of transformation: MRT = MCs/MCt

The slope of PPF provides a measure of the MRT, which indicates the amount of one product that
must be sacrificed in order an additional unit of another product to be produced.
Terms-of-trade betwen two products are equal to the relation of their marginal costs.
terms-of-trade are equal to the relation of the substitution costs:
Ps/Pt = MCs/MCt = t/s
Under constant-costs conditions:
P = MC = AC
Amount of some product to be sacrificed in order to produce a new unit of another product is
always the same.
PPF a straight line equal to price line
Terms-of-trade between two products are equal to the relation of their marginal costs and to the
relation of their average costs.

Under changeable-costs conditions:

P = MC AC
Terms-of-trade are determinated by marginal not average costs.
PPF is a concave line to the diagrams origin and it is not identical to the price line the price line is a
tangent to PPF.
-under increasing-costs conditions sacrificed amount of some product increases for each new
unit of another product;
-under decreasing-costs contidions - sacrificed amount of some product decreases for each new
unit of another product;
constant costs the complete specialisation;
changeable costs the incomplete specialisation;
Incomplete (partial) specialisation a country meets its needs in some product partly from domestic
production, partly from imports.
Heckscher-Ohlin Theory (H-O Theory), known also as general-equilibrium theory, factorendowment theory and theory of factor proportions:

RICARDOS MODEL

H-O MODEL

Similarities
- model two countries two commodities
- perfect competition both in commodity market and factor market
- free trade
- homogenous products
- identical tastes and preferences (identical demand conditions)
- constant average costs
- perfect mobility of labour within countries and perfect immobility
between countries
- given and fixed technology
- zero transportation costs
Differencies
one-factor model
two-factor model and different factor
(labour theory of value)
intensivity of products
different production functions for the same identical production functions for the same
product in different countries
product in different countries
different technology between countries
identical technology in different countries
Relative factor endowment can be defined in two ways:
-by physical units of factors the quantitative definition;
-by factor prices the price definition.
A country is considered to be relatively capital abundant not if its total amount of capital is bigger
than total amount of capital in the other country, than if its ratio of total amount of capital to total
amount of labour is higher than that ratio in another country.
TK1/TL1 > TK2/TL2
Price definition:
A country is relatively capital abundant if its ratio of interest rate (price of capital) to wage (price of
labour) is lower than that ratio in another country.
PK1/PL1 < PK2/PL2
r1/w1 < r2/w2
Relative factor intensity:
A product is capital-intensive, if the ratio of capital to labour in its production (K/L) is bigger than that
ratio in production of another product.
(K/L)x > (K/L)y
A capital-abundant country exports capital-intensive products and a labour-abundant country
exports labour-intensive products.

Conventional Theories

Assumptions

New
Theories

Given and fixed

On technology

Changeable and different between

countries

Identical and fixed

On tastes

Identical or different, changeable

Perfect competition

On market structure

Imperfect competition

Constant

On costs

Changeable (increasing)

Homogeneous

On products

Homogenous and Differentiated

Technological Theories:
-Theory on economic growth and international trade (Rybczynski theorem, Theory on technical progress);
-Technological gap theory;
-Product life cycle theory.
Assumptions on technology
In conventional theories:
-production possibilities of countries are given and fixed;
-Ricardos model no technological change, given but different technology between countries;
-H-O model no technological change, the same technology available to all countries.
Assumptions on technology
In new theories:
-continuous moving of PPF due to:
increase in factor supply, or
more efficient use of factors (because of technological change);
-different technology between countries;
-technological change as a new reason for trade;
New theories consider technology as very important for explanation of basis for trade
Economic growth is growth in potential output; PPF shifts outward.

Economic growth causes changes in production and consumption that have important implications
on international trade.
Balanced growth growth in supply of all factors at the same rate
Unbalanced growth growth in supply of only one factor or faster growth in supply of one factor
compared to growth of the other one
Rybczynski theorem:
At constant product prices, an increase in the endowment of one factor will increase the output of
the product intensive in that factor and will reduce the output of the other product intensive in the
other factor
Technical progress changes a way of use of factors in production enabling the same output to be
produced with less inputs.
Three types of technical progress neutral, labour-saving and capital-saving
Effect of economic growth on trade depends of neto-results of growth on production and
consumption
-neutral growth (trade and output grew at the same rate);
-protrade growth (faster growth of trade);
-antitrade growth (faster growth of output).
Technological Gap Theory (M. V. Posner)
Technological gap theory proposes that changes in international trade are dictated by the relative
technological sophistication of countries.
Basic assumption:
-International trade can be based on differences in technological changes over time among countries
because of a time lag in transfer of technology.
-Innovation creates a technological gap which provides for a temporary monopoly in the world
market.
Main thesis:
-Technological innovations create dynamic comparative advantages comparative advantages can
be changed or created due to technological change and diffusion of technology.
-A large portion of trade among industrialised countries is based on tehnological innovations.
Types of lags:
-imitation lag
-demand lag
-net-lag (export monopoly)
Product Life Cycle Theory (Vernon)
-Vernons theory is a modification of H-O theory rather than an alternative;
-This theory focuses on the role of technological innovation as a key determinant of trade patterns in
manufactured products.

Differences compared with conventional theories:

-different technology between countries;
-technology changes over time;
-capital moves among countries;
-focus on a product and not on a country;
-limited usability only for technology-intensive products;
-analysis of both supply-side factors (costs) and deman-side factors (income);
-dynamic comparative advantages.
I phase new-product phase (highly skilled labour and R&D)
II phase product-growth phase (scale economy)
III phase product-maturity phase (cheaper labour)
Main thesis:
The more standardised a product becomes, the more his production moves to lower income
countries with low labour costs that in this phase are more important than R&D expenses.
Later phases are characterised by lack of innovation and emphasis on factor endowments
Linder's theory:
Assumptions (implicitly):
-imperfect competition;
-increasing returns (scale economies);
-product differentiation.
Structure of international trade is different than it has been presented in conventional models:
developed countries trade much more mutually that with developing countries, and they trade in
similar products, not in products of different industries.
Basis for trade:
Basis for trade in primary and secondary products is not identical explanation of trade in primary
products is supply-side based (relative factor endowment), and explanation of trade in industrial
products is demand-side based (similarity in demand structure)
Main thesis:
International trade in industrial products depends much more on similarities of consumers
preferences, than on costs differences.
The more similar demand structure among countries is, the bigger their mutual trade in industrial
products will be.
Demand structure is determinated by consumers preferences and income p/c
Domestic demand determines both exports and imports commodity structure, providing they are
similar
Linders theory concludes that the same products can be traded in both directions
Linders theory emphasizes relation between: income preferences technical progress trade
Linders theory indicates types of countries that will trade, but not directions or pattern of trade.

Theory of Economies of Scale (Kruggman)

Assumptions:
-imperfect competition;
-increasing returns scale economies;
-product differentiation
Krugmans theory is international trade theory based on scale economies.
Internal economy of scale:
-Average costs depend on the size of an individual company but not necessarily on that of the
industry.
-A company specialises in only one or a few product varieties.
-A company with internal economy of scale is large and can monopolise an industry.
-Internal economy of scale creates imperfect competition in the industry.
External economy of scale:
-Average costs depend on the size of the industry but not necessarily on the size of any one
company.
-Single companies might not be large, but they cooperate within an industry.
-The market consists of many small companies and it is perfectly competitive.
-A country can dominate at the world market.
Krugmans theory gives one of the most popular explanations of intra-industry trade (IIT): IIT is based
on scale economies and product differentiation
Theory on Competitive Advantages (Porter)
-emphasis on productivity as the key determinant of international competitiveness (as in Ricardos
theory)
-synthesis of former ideas and thesis in international trade theory
Porters theory successfully combines some thesis and characteristics from conventional and new
theories:
-It combines macro- and micro view - competitiveness and international trade is analysed both from
the point of view of a company as the main subject and from the point of view of a national economy
as the creator of business environment.
-It combines elements of supply-side of the market (factor endowment) and demand-side (demand
conditions) etc.
According to Porter, primary economic goal of a country is high and increasing level of living
standard. Countrys apability to reach the main goal depends on productivity in using its resources
Porter creater a Diamond of national advantages which illustrates four basic interconnected groups
of determinants of competitive advantages and two additional variables as well.
Diamond of national advantages:
factor conditions
demand conditions
related and supporting industries
firm strategy, structure, rivalry
chance
government

THEORY OF INTERNATIONAL TRADE

Theories
Theory
of comparative advantages
of competitive
advantages
Conventional theories
New theories
New paradigma
Main characteristics:
- before 1945
- universal theories
(but of limited
usefulness)
- macroeconomic
theories (main
actors - countries;
focus of analysis
on countries;
developed by
theoreticians)
- static theories
(static assumptions)
- based on analysis of
supply-side
elements (costs)
- explained interindustry trade and
special cases of
intra-industry trade
(seasonal and
border trade)
- theories of static
comparative advantag

Main characteristics:
- after 1945
- partial theories
- microeconomic
theories
(main actors companies; focus of
analysis on
characteristics of
industry/product;
developed by business
economists)
- dynamic theories
(dynamic assumptions)
- based on analysis of
both supply-side
elements (costs) and
demand-side elements
(income, tastes)
- explained both interand intra-industry
trade
- theories of dynamic
comparative advantages

Main characteristics:
- universal theory
- macro- and
microeconomic
theory
- dynamic theory
(dynamic assumptions)
- based on analysis both
of supply-side and
demand-side elements
- explained both interand intra-industry trade
- theory of competitive
advantages

-absolute (pure) free trade (neither natural nor artificial barriers),

-completely open and completely closed economy only theoretical categories;
-open economy (a modern view) an economy with high level of trade liberalisation;
-closed economy an economy with numerous and very high trade barriers;
Foreign trade policy (a narrow definition): system of instruments used by government in order to
regulate exchange of goods;
Types of foreign trade policy:
-Passive foreign trade policy
-Active foreign trade policy (direct and indirect subsidies)
Passive foreign trade policy includes restrictions on import and export flows.
Active foreign trade policy includes instruments of export promotion.

Main goals of passive trade policy:

-protection of domestic producers;

-protection of domestic consumers;
-protection of balance-of-payments (rational spending of foreign currencies);
-increasing budget revenues;
Main goal of active trade policy: promotion of production and export
Neccessary conditions for creating and implementing an adequate protection policy:
-single national economic area;
-political willingness for protection of domestic production;
-instruments for protection and criteria for their use (which industries, how much, by what, how long
to protect)
Main groups of instruments:
-Tariffs
-Non-tariff barriers:
Quantitative restrictions (prohibition, quotas, licenses)
Indirect protectionism
-Export promotion measures
There is no absolute free trade in the world
Tariff is a tax (duty) levied on a product when it crosses national boundaries.
-one of the oldest and the most important trade restrictions;
-at the beginning imposed only for revenue purposes
Tarrifs by main function:
-Protective (protection of domestic producers, domestic consumers or balance of payment;
prohibitive tarrifs reduce import to zero)
-Revenue tarrif (used to increase budget revenue)
Tarrifs by trade flow:
-Import
-Export (rare and prohibited today)
-Transit (do not exist any more)
Tarrifs by trade relation:
-Autonomous (maximum ) tarrifs - no trade aggreements
-Conventional (minimal) - with trade agreement
Tarrifs by way of determination:
-Ad valorem tariffs (% of the price)
-Special tariffs (flat rate)
-Compound tariffs (combination of the two)
Aa valorem:
-advantages: distinguishing among small differentials in product quality, maintaining a constant
degree of protection in the period of changing prices, etc.
-disadvantage: customs valuation;
-used more often than specific tariffs

Special:
-expressed in a fixed amount of money per physical unit of a product;
-method of determination: based on quantity or wheight;
-advantages: easy to apply and administer, particularly to standardised products, easy to determine;
-disadvantages: cannot be applied on all kinds of goods (arts), degree of protection varies inversely
with changes in import prices;
Tarrifs by country of origin:
-Unitary
-Differential (prefferensional,retorsive, etc.)
-Differential tariffs leads to a different treatment of goods originated from different countries; they
have political character.
-Tariff preference/Preferential tariff - a lower (or zero) tariff on a product from one country than is
applied to imports from most countries.
-Retorsive tariff a tariff imposed for a purpose to force other country to release.
Equalization tariffs:
-Anti-dumping tariff a tariff levied on dumped imports.
-Countervailing tariff a tariff levied against imports that are subsidized by the exporting country's
government, designed to countervail the effect of the subsidy
Dumping when export price is "unfairly low," defined as either below the home market price
(normal valute) or below cost
International economic integration represents a process, or an achieved level of institutional
connecting between countries, most often on a regional level through mediation of liberalization of
trade and/or liberalization of moment of factors of production
Elements of the definition:
- process or a level (dynamic category)
- institutional connecting
- regional level (dominant)
- liberalization of trade and other flows
Important concepts for IEI:
-RTA Regional Trading Arrangement
-multilateralism, regionalism, bilateralism
-regionalism / regionalization (the theory or practice of regional rather than central systems of
administration or economic, cultural, or political affiliation.)
IEI according to level of development of member countries:
-IEI between developed countries
-IEI between developing countries
-IEI between developed and developing countries
IEI according to symmetry of obligations member countries
-symmetric
-asymmetric

Aspects of economic integration:

-trade aspect - trade of goods (dominant aspect)
-non-trade aspect - monetary arrangement, fiscal aspect, labor force movement, capital movement,
transfer of technology
Motives for economic integration:
-political motives (underlying (prikriveni je org. rijec))
- lasting peace;
-political stability
-political dominance
economical motives (visible)
-wider market;
-increase in productivity
-economies of scale;
-change of economical structure;
-better negotiating position
IEI is a dynamic category - it grows and develops
multiple levels of economic integration
most widely accepted division - author Bella Balassa;
Levels:
(preferential trade agreement)
free trade area (FTA)
customs union(CU)
common market (CM)
economic union (partial or complete)
FTA
Characteristics:
-free movement of goods (all trade barriers are abolished)
-single customs tariffs are still kept
-rules about the origin of goods
CU
Characteristics:
-free movement of goods (all trade barriers are abolished)
-common customs tariff
-division of tariff income
CM
Characteristics:
-free movement of goods (all trade barriers are abolished)
-free movement of factors of production (labor and capital)
-common customs tariff
Common market - integration with the 4 freedoms: free movement of goods, services, people and
capital
common market unique market
Unique (Jedinstveno) market internal market, market unique to one country.

Partial economic union

Characteristics:
-free movement of goods, services i factors of production
-common currency (monetary union)
-common economic policy
-multinational institutions (nadnacionalne, u nedostatku boljeg prijevoda op. a.)
e.g. European Union