International Economics: Introduction to International Economics and the Gravity Model
Summary
TLDRThis video introduces the field of international economics, tracing its origins to David Hume's essay and Adam Smith's 'The Wealth of Nations.' It highlights the growth of international trade from 4% to 20% of US GDP and emphasizes its significance in global economies. The video discusses the unique challenges of international trade, such as sovereign nations' restrictions and currency exchange rates. It also previews themes like gains from trade, the pattern of trade, and the gravity model, which correlates trade volume with economic size and distance between countries.
Takeaways
- 📚 International economics began with David Hume's essay in the mid-1700s, which focused on British international trade policy.
- 🌐 International trade has grown significantly from accounting for 4% of US real GDP in the 1960s to around 20% today.
- 🔄 The field of international economics is distinct from domestic economics due to the involvement of two sovereign nations with potential trade restrictions.
- 💵 Currency exchange is a key aspect of international trade, with exchange rates determining the price of one currency in terms of another.
- 🌟 The concept of gains from trade is central to international economics, indicating that trade can be a positive-sum game where all parties benefit.
- 🏭 Comparative advantage is a driving force behind why countries specialize in certain goods and services for trade.
- 🌍 The gravity model is an empirical relationship used to understand the amount of trade between countries, based on GDP and distance.
- 📈 The size of economies (GDP) and the distance between countries are significant determinants of trade volumes.
- 💼 Trade patterns are not always straightforward and can involve complex models with multiple goods, unlike the simplified two-good models.
- 📊 Exchange rate determination is a topic that will be covered, focusing on how demand and supply dynamics affect currency values.
Q & A
What is the significance of David Hume's essay in the field of international economics?
-David Hume's essay, published in the mid-1700s, was significant because it was one of the first to discuss British international trade policy in a formal, model-based way, which laid the groundwork for the field of economics as we know it today.
How has the importance of international trade evolved over time in the US economy?
-In the 1960s, international trade accounted for about 4% of the US real GDP, but it has grown significantly and now represents roughly 20% of the real GDP, indicating that international trade has become a substantial part of the US economy.
What are the main differences between domestic and international trade?
-International trade involves two sovereign nations, which can impose restrictions on what and how much can be bought. Additionally, international trade involves different currencies and exchange rates, which can affect the price of goods.
Why is the exchange rate considered the price of currency?
-The exchange rate is considered the price of currency because it determines how many units of one currency are required to purchase a unit of another currency, similar to how prices determine the cost of goods.
What is the concept of gains from trade?
-Gains from trade refer to the mutual benefits that arise when parties engage in trade, allowing both parties to be better off compared to not trading. This concept is based on the idea of specialization and comparative advantage.
How does the gravity model explain the amount of trade between two countries?
-The gravity model suggests that the amount of trade between two countries is positively related to the size of their economies (GDP) and inversely related to the distance between them. It is an empirical relationship that helps estimate trade volumes based on these factors.
What are the implications of a change in exchange rates for international trade?
-A change in exchange rates can affect the price of goods from a foreign country, potentially making them more or less expensive. This can influence the volume of trade and the balance of trade between countries.
What does the script suggest about the distribution of gains from trade?
-While trade can make all parties involved better off, it does not necessarily imply that everyone is made better off. There can be cases where one group benefits while another does not or even becomes worse off.
Why is it important to understand the pattern of trade?
-Understanding the pattern of trade helps to determine which goods a country exports and imports, which is crucial for economic planning and policy-making. It also provides insights into a country's comparative advantage.
What role does the size of economies play in international trade according to the gravity model?
-According to the gravity model, larger economies tend to have more trade between them. The model suggests that the product of the GDPs of two countries is a significant factor in the amount of trade that occurs.
How does the distance between two countries affect trade according to the gravity model?
-The gravity model posits that the distance between two countries has an inverse relationship with the amount of trade. The farther apart the countries are, the less trade tends to occur between them.
Outlines
📚 Introduction to International Economics
This paragraph introduces the field of international economics, tracing its roots back to the mid-1700s with David Hume's essay on British international trade policy. It highlights the evolution of economics from an informal discussion-based field to a model-based one, emphasizing the importance of international trade. The speaker notes the significant growth of international trade as a portion of GDP, from about 4% in the 1960s to roughly 20% today. The differences between domestic and international trade are also discussed, including the involvement of sovereign nations, potential restrictions on trade, and the use of different currencies with exchange rates affecting the price of goods.
🌐 Understanding International Trade Dynamics
The second paragraph delves into the nuances of international trade, focusing on the gains from trade and the concept of comparative advantage. It challenges the zero-sum game misconception, explaining that trade can be a positive-sum game where both parties can benefit. The paragraph also touches on the distribution of trade benefits and the potential for some groups to be worse off despite overall gains. The discussion sets the stage for exploring models that explain trade patterns, including the gravity model, which is introduced as an empirical relationship to understand the determinants of trade amounts. The model considers GDP and distance between countries as key factors influencing trade volumes.
🔍 The Gravity Model of Trade
In this paragraph, the gravity model of trade is explained in detail. The model suggests that the amount of trade between two countries is influenced by the size of their economies (GDP) and the distance between them. The model is likened to Newton's law of universal gravitation, where the 'gravitational pull' between two economic bodies is stronger when their economies are larger and weaker when they are farther apart. The speaker clarifies that while the class will not estimate the model parameters, understanding the gravity model helps to grasp empirically how trade is determined. The paragraph concludes by setting the stage for future discussions on behavioral models of trade.
Mindmap
Keywords
💡International Economics
💡David Hume
💡The Wealth of Nations
💡Model-Based Field
💡International Trade
💡Sovereign Nations
💡Currency Exchange
💡Gains from Trade
💡Comparative Advantage
💡Gravity Model
💡Econometrics
Highlights
International economics began with David Hume's essay in the mid-1700s, focusing on British international trade policy.
Hume's work transitioned economics from an informal discussion-based field to a model-based one.
Adam Smith's 'The Wealth of Nations' also focused significantly on British international trade policy.
International trade as a percentage of real GDP has grown from about 4% in the 1960s to roughly 20% today.
Some countries have more than half of their economic activity accounted for by international trade.
International trade involves two sovereign nations with potential restrictions on what and how much can be bought.
Different rules in different countries can affect international trade.
International trade involves different currencies and exchange rates, affecting the price of goods.
The exchange rate is the price of one currency in terms of another and is determined by demand and supply.
Gains from trade come from countries specializing in what they have a comparative advantage in.
Trade can be a positive-sum game, where both parties can be made better off.
The benefits of trade are not always evenly spread across different groups of people.
The pattern of trade is determined by a model with multiple goods, not just two as in the basic model.
The amount of trade is determined by factors such as GDP and distance between countries.
The gravity model is an empirical relationship that helps understand the amount of trade between countries.
The gravity model is based on the idea of gravitational pull between two bodies, relating to the size of economies and distance between countries.
The gravity model suggests that the amount of trade increases with the size of economies and decreases with distance.
Countries that are geographically close tend to have a larger volume of trade.
The gravity model is not used for estimating in this class but helps understand empirically how trade is determined.
Upcoming videos will discuss models that explain why countries trade with each other.
Transcripts
so in this video we're going to think
about kind of an introduction to what
international economics
is the field of Economics as as it
exists today really began with
International economics um it started
when David Hume published a a essay in
the mid 1700s about 20 years before Adam
Smith published The Wealth of Nations
and in hume's essay really what he was
discussing was uh British International
Trade policy and if you read The Wealth
of Nations um you'll see that a good
portion of that most of it is is devoted
to um British International Trade policy
and it was Hume that kind of turned the
field of Economics from a a an informal
discussion-based
field into a a a modelbased field which
is is how you've been taught the
economics that you know we we think
about models like the demand and supply
model or the model of uh comparative
advantage um and so it was really Hume
that that started
that in terms of how important
international trade is um if you go back
to say the 1960s at least with the us
about 4% of real GDP um was accounted
for by International Trade um and that's
continued to grow if you uh look now
it's roughly 20% of of uh real GDP so
international trade is a good sized
portion of of our economy it's even
bigger for other countries so if you
there are several countries
where more than half of their um
economic activity is accounted for by
international trade
let's talk for a second about how the
field of international econ is different
from other subdisciplines of Economics
so if you're thinking about say buying a
good um from somebody in another state
let's say you drive to Kansas and uh you
stop at a store and you buy something
well we've studied how that transaction
works we know that price is going to be
determined by demand and supply fly and
um you can take the money that you've
got in your pocket or the money that's
represented by your um debit card and
you can buy that product and you can
drive home and that's really kind of the
extent of it if you buy something from
somebody in a foreign
country these days the transaction still
kind of feels that way it's you're going
to a lot of times get on on uh the
internet and buy something maybe maybe
through Amazon or um some
other online store and it'll be shipped
to you and the transaction feels very
similar to that transaction of buying
something from somebody in Kansas but
there are some important differences and
the first one is
that there are two Sovereign Nations
that are involved there and so there can
be restrictions in terms of what you buy
or how much you buy that are imposed by
the United States they might limit how
much you can purchase from somebody in
another country or those restrictions
could be imposed by the other country it
could be maybe not just a limit on how
much you buy but our country May impose
a tax on you when you buy it or or the
foreign country May impose a tax on you
when you buy it um so that's the first
difference is that depending on the
country there can be different rules
about what you can buy or how much you
buy the other interesting thing is
that you're going to be paying for the
product with a different currency than
what they use in the foreign country if
you buy something from somebody in
Kansas that's not even a consideration
because we're using the dollar they're
using the dollar and and you don't even
think about it but if you buy something
from somebody in another country there's
going to be two currencies involved
there's going to be an exchange rate and
what we'll see in this class is that the
exchange rate is really the price of
currency so if we think about the dollar
and the Euro the exchange rate between
the two tells us how many dollars it
takes you to buy a
Euro and that can change and what we'll
see is that that's determined by the
demand and supply for euros versus
dollars and so um that's an interesting
um characteristic of it you could if the
exchange rate changes the price that you
pay for that good from the foreign
country could be different um in a week
than what it is today and so we have to
think about how the exchange rate and
the fact that we're using different
currencies affects um economic
activity there are going to be some
themes that we're going to cover in this
class and the first one is one that
you've already talked about and that is
gains from trade so if you think back to
um your principles of macro class or
possibly even at the beginning of
principles of micr class you probably
studied a model of why people
trade um we'll begin um in our next
video talking about that model of why
people trade and the reason that people
trade is that there are gains from
Trading the world is not a zero sum game
we're used to thinking about a lot of
people think about the world as if it's
a zero SU game and what that means is
that um if I'm made better off by some
transaction then that must mean that the
other person's made worse off by that
transaction and it turns out that that's
not really how it works there are some
times when a particular situation might
be a zero sum game but in terms of of
trade between two people or trade
between two countries it's actually a
positive sum game and what that means is
that both the parties involved in the
trade can be B made better off and
that's counterintuitive to a lot of
people so we'll talk about where the
gains from trade come
from you probably hopefully remember
that it comes from people or countries
specializing in what they have the
comparative advantage in we'll review
that um we'll also talk about the fact
that everybody can be made better off by
trade but that's not necessarily that
doesn't necessarily imply that everybody
is made better off by trade so in some
of the simple models that we'll talk
about at the beginning um we'll see that
that everybody involved will become
better off but we'll have a little bit
more complicated models that that are
more representative of the real world
and we'll see that in those cases it
could be the case that that one group
can be made better off while another
group is not made better off they could
be made worse off so we have to think
about that how how are the benefits of
trade spread across different groups of
people we'll spend some time talking
about what determines the pattern of
trade so who trades what um in this
simplest model that you've already
talked about in your principal class you
know that you tend to specialize in the
good for which you have the comparative
advantage but but in that particular
model there's only two goods and so you
specialize in one and you import the
other well typically in a country there
are thousands of goods and so we'll need
to talk about a model where there are
multiple Goods we won't have a thousand
but we'll have more than two and we'll
talk about what determines which of
those goods you export and which of
those goods you
import we'll also spend some time
talking about
the amount of trade what it what
determines how much trade takes place um
we'll talk a little bit at the end of
the semester or at the excuse me at the
end of the class about exchange rate
determination so what determines the
price of a euro in terms of dollars um
you already know I already said it just
a little bit ago that it's going to come
down to demand and Supply but we'll talk
more explicitly about about um how that
works let's start by talking about a
model that that helps us understand
empirically um something about how trade
works and the amount of trade that takes
place and this is a model that is known
as the gravity model um it it's really
nothing more than an empirical
relationship and what that means is it
it's something that helps us understand
the data we can look at the data and we
can um start to get a basic
understanding of of what are the
important determinants
in term that that help us understand the
amount of trade that takes place um so
if we think about how this gravity model
works it's actually very simple so if we
start with ti J we're going to let TI
represent the amount of trade that takes
place between country I and Country J
okay so this is the amount of
trade and empirically what we see is
that the amount of trade that takes
place between two countries is going to
be a function of the GDP of those two
countries the size essentially of their
economies and it's also going to be a
function of the distance between these
two countries now the way this
relationship works is we're going to put
a number a out here we're just going to
let that be a general number for right
now but when we would empirically
estimate this this might turn out to be
a model a number like five or 7 okay so
for now just think about it as some some
number and we're going to multiply that
by y i times y
j these are going to be the gdps of our
two countries so this is the GDP of
country I and the GDP of country J okay
and then we're going to divide that by D
J and this is going to represent the
distance between the two countries so
here's
distance and right here is uh
GDP so what this tells us is that the
amount of trade that takes place between
two countries is related to the the size
of the two economies and notice that if
the size of the two economies goes up or
if one of these goes up that's going to
increase the amount of trade so all
other things equal the bigger the two
countries are the bigger the amount of
trade that takes place between
them we've got the distance between the
two down here in our denominator and so
what that tells us is that the bigger D
is the farther apart these two countries
are the smaller the amount of trade that
takes place and on the other side of the
coin the smaller the distance here the
bigger the amount of trade that we tend
to observe between the two countries and
that makes intuitive sense we tend to
see that countries that are close to
each other Canada and the United States
tend to have a large volume of trade
countries that
are far apart all other things equal
tend to have a smaller amount of trade
that takes place between them and this
is again referred to as the gravity
model and the reason it's referred to as
the gravity model because this is really
based upon Newton's idea of the
gravitational pull between two celestial
bodies so if you think about how that
works we can think about the mass of the
two bodies if you have two celestial
bodies the bigger those two bodies are
the greater the gravitational pull
between them and then the farther apart
those two celestial bodies are the less
gravitational pull between them so this
is very much based upon Newton's idea of
how much how to estimate the
gravitational pull between two bodies
now in terms of of how we take this and
and make it
useful we're not in this class going to
be gathering information on this and
somehow estimating it if you've had an
econometrics class then then you may
have talked about how you would estimate
a uh a function like this it's actually
relatively easy
um but we're not going to be doing that
in this class if if we did want to
estimate it and you might in the future
um typically what we do is we estimate a
little bit more General version of this
so if we take the amount of economic
activity I'm going to kind of rewrite
what we've got
here the way that we tend to actually
estimate this is to estimate parameters
on it alpha beta and
gamma and again if you've had an
econometrics class you know that that
doesn't really make it any more
complicated it just makes it operational
it it it helps us estimate the relative
importance how the data tells us Yi y j
and this distance variable are actually
related to each other so that's the
gravitational or the gravity model um
we're really not going to do anything
more with that it it just helps us
understand
empirically um
how the amount of trade is is determined
we'll get in the next set of videos
we'll start talking about actual models
that help us understand behaviorally why
countries would trade with each other so
we'll do that in our next
video
5.0 / 5 (0 votes)