Economic Growth in International Economics -

Notes by Phillip Mabry

Growth in Economics:
Growth is caused by one of two major sources:
1. Technology
2. Factor Accumulation
Growth changes patterns of production and pattern of consumption in an economy.
An economy can have either BALANCED GROWTH or BIASED GROWTH.
A) Balanced Growth:
Balanced growth is when every industry grows
B) Biased Growth:
When growth is specific to one industry.
Two main types of economies:
A) Small Open Economies (SOE) - Economies which are open to trade but are not large enough
to affect prices across the globe.
B) Large Open Economies (LOE) - Economies which are open to trade and CAN affect prices
across the globe.
Immiserizing Growth:
Growth in which a country is actually worse off than before the growth. For example, if a
SOE sees growth in a sector on their economy which is heavily based on export - the increased
growth may actually lower the terms of trade and make the country worse off.

Conditions of Immiserising Growth:

1. Growth must happen in exportable sector
2. Income elasticity of demand must be low
3. Country must be engaged in trade
4. A country which depends on export of one commodity are more vulnerable to
immiserising growth.

Tariffs are Inflationary:

Tariffs are inflationary because they force the price of import goods artificially higher
than domestic goods which re-directs demand to domestic goods. This increased demand
for domestic goods increases the costs of production of the local goods (and all other
goods who use the same inputs). This increase in the costs of production leads to an
increase in the price of domestic goods nullifying the tariff. Ultimately, the tariff raises
the price of both foreign and domestic goods taking much of the consumer surplus and
disrupting other markets.
Both the increase in domestic production AND the decrease in imports are both net welfare
losses. The added producer surplus and government revenue only help to offset some of the
lost consumer surplus.
Quotas are Inflationary also!

Quotas have the exact same effect on an economy as tariffs with one major exception.
The area of consumer surplus which, under a tariffs, became government revenue now
becomes importer profit. The implementation of a quota lowers the available supply of
goods and raises prices. This increase in prices is a direct result of the increase in the
cost of production (due to the re-directed demand) domestically. However, the cost of
production overseas is unaffected. This increase in price, for the importer, increases
marginal revenue and also increases incentive to exceed the quota by non-traditional
means.

Pushing Exports does not work either!

One tactic of policy makers is to ‘push exports’ through an export subsidy. This means to
offer additional marginal revenue (per unit subsidy) to exporting industries. The idea is to
facilitate greater export and create jobs. This practice increases incentive for produces
to ‘create jobs’ and ‘export more’. This increased supply of our goods overseas leads to an
increase in the demand for our currency. This increased demand for our currency leads to
a DECREASE in the price of import goods.

Also, pushing exports can turn an import competing industry into and export industry.
Meaning, we no longer consumer imports in that industry - but export. This creates major
loss to the country because the amount of the product produced increases greatly and the
price of the product also increases greatly.

More jobs with lower import prices....Win - Win … right?

Not really, the problem is that the subsidy pushes our production past the point of
equilibrium and as a result raises the cost of production - again. This increased cost,
though offset by the subsidy, must be paid. Taxpayers not only pay for the subsidy, but
they pay the increased prices domestically. For example:
If a domestic bike is being sold for $100.00 on both the domestic and world market, and
we decide to subsidize each bicycle with $20 to increase production - the bicycle producer
has a larger incentive to either export all bikes or raise domestic prices. Why would a
seller sell his good for 100$ if he can get 100 overseas PLUS 20 in subsidy? He responds
by increases the price of the bike domestically. Moreover, the increased production by
the company drives up the factors of production for any other industry which uses the
same inputs.

Dumping - The International Price Discriminator:

The process of dumping is used to maximize profits of exporting industry. The exporting
industry, or government, will set different prices to different geographic areas. The difference
in price is not, however, a result of transportation costs. The difference in prices are due to
differences in elasticity of demand.
Conditions of a market for dumping to work:
1. Export industry must have market power. The exporting industry must be able
to affect the price of the good around the world. If the industry could not affect price it cannot set
different prices or discriminate in any way.
2. Export industry must be aware of the elasticity of products in the different
locations. If an industry has enough market power to affect price, this is common knowledge.
3. The industry must be a profit-maximizer
4. P1 > P2 when |Ed1|<|Ed2| The highest price goes to the region with the least
elasticity.

Trade Unions (NAFTA, APEC, and/or EU):

Trade unions have the potential to be beneficial, but are more often harmful to the host nations.
The manner in which we determine if a trade union has ‘helped’ or ‘hurt’ an economy is based
on the comparison of “Trade Diversion” and “Trade Creation.”

1) Before the union.

Before the union goes into effect we have several countries importing goods to
our nation. We’ll say Germany and R.O.W (rest of the world). Due to competition Germany
cannot set prices to a level of their liking. As a result, we import more from ROW than Germany.
After some politicking we decide to create a trade union with Germany. This means we will put
up tariffs on all countries but Germany. This gives Germany an advantage in our market.

2) After the union

After the union is created we see two major types of trade.
A) Trade diversion -- this is the amount of trade we used to buy from
ROW but now buy from Germany. We have not, in effect, changed anything for the host
(importing) nation here.
B) Trade creation -- this is the amount of new trade we create after the
union.
If Trade Creation is greater than Trade Diversion - than the program is
successful. This is, however, rare.
Three conditions that trade creation is greater than trade diversion:
 1) Elasticity of demand must be low. The more inelastic the good, the
greater trade creation after the unions creation.
2) The price after trade union must be lower than before the union
3) Outsider price must be higher, much higher.
- Also, the closer the prices are between Germany and ROW the
greater the trade creation. If ROW has a significant advantage over Germany, the union will not
help Germany to export much more. The difference in prices - before the union - must be small.

Determining Terms of Trade:

Domestic Curves:
D = 100 -20P
S = 20 + 20P
P=2
Q = 60

Foreign Curves:
D = 80 - 20P
S = 40 + 20P
P=1
Q = 60

Excess Domestic Demand = D - S

Excess Demand = 100 - 20P - (20 + 20P)
= 100 - 20P - 20 - 20P
= 80 - 40P
Excess Foreign Supply = S - D
EFS = 40 + 20P - (80 - 20P)
= -40 + 40P

Once you have the excess demand and supply curves of the appropriate import/export country -
set the equations equal to one another.
EDD = EFS
80 - 40P = -40 + 40P
120 - 40P = 40P
120 = 80P
1.5 = P

The equilibrium price in this industry ought to be about 1.5. This can price can be re-
introduced to the original equations to determine quantities demanded and supplied.