International Economics and the AP Microeconomics Course

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Usually, material on international economics is introduced at the end of Microeconomics courses and texts, when little time is left for complete and thorough coverage. This tendency may be the source of trouble many students sometimes have with international questions on the AP Exam.

A major strength and appeal of economics is that most of its fundamental concepts—such as elasticity, marginal analysis, opportunity cost, and the supply-and-demand framework—can be applied in both international and domestic contexts. I am not suggesting that more material be included in the course, but that concepts presented early in the course include examples with an international focus, either in class or as part of homework or other out-of-class assignments.

Beginning With Opportunity Cost

A natural point at which to introduce international economic ideas is when the text or syllabus reaches the topic of opportunity cost, which establishes the basis of comparative advantage and exchange. Adding a few relatively simple examples can easily make the point; the same framework for demonstrating comparative advantage by considering the productivity of, say, Bill and Beth, or Farm A and Farm B, can be used for Belgium and France.

The idea of comparative advantage can be easily elaborated by pointing out that the sources of comparative advantage, domestic and international, are natural and/or acquired. For instance: The U.S. has cheap food relative to much of the world in part due to the natural relative abundance of arable land, just as some jockeys have a comparative advantage in horse racing due to their size. These are natural advantages that exist because of the initial endowment of resources. On the other hand, New York has a comparative advantage in financial services, not primarily due to initial endowments (there is nothing natural about the geography of New York that confers a comparative advantage in financial services), but due to productivity acquired through time due to historical circumstances.

Using the Supply-and-Demand Framework

The relationship between the world's supply of and demand for shoes shown in Figure 1 demonstrates comparative advantage. In the graph, the number of exchanges is Qe. For, say, the tenth unit, the price that a buyer is willing to pay is above the price at which a producer is willing to sell. Therefore the producer clearly has a comparative advantage relative to the buyer. If the buyer could produce the goods himself at a cheaper price, then he would have a comparative advantage, and would not be willing to pay more than the seller's asking price. This exchange could occur domestically, or between a foreign buyer and a domestic seller, or between a domestic buyer and a foreign seller.

The supply-and-demand framework can also be used to show imports and exports directly. Figure 2 shows the supply of a good by domestic producers and the demand for that good by domestic buyers. In the absence of any trade, the domestic equilibrium price is Pe and the domestic equilibrium quantity is Qe. If the world price for the good is Pw, then only those domestic producers who can sell at Pw or less will find buyers, so Q1 will be the amount sold by domestic sellers. The quantity demanded at Pw is Q2, which means the distance from Q2 to Q1 (or distance ac) will be the quantity of goods imported. The same analysis can also show the quantity of exports if the world price is above the domestic equilibrium price in the absence of trade.

The supply-and-demand analysis in Figure 2 can also be used to show the benefit of imports, a point often difficult to impress upon students. The social surplus in the absence of trade is the triangle formed above supply and below demand up to Qe. As a result of imports at the world price, consumer surplus is increased and producer surplus is reduced, but the gain to consumers is larger than the loss to producers, resulting in a net gain in social surplus equal to the triangle formed by points a, b, and c. These are the gains from trade. A similar analysis can be used to show the gains from exports when the world price is above the equilibrium domestic price in the absence of trade.

Using Price Elasticity Analysis

In microeconomics, an interesting application of the price elasticity of demand is international price discrimination. For a number of goods, the domestic price charged for a good produced domestically is higher than the price charged in foreign markets. When markets can be separated (if reselling doesn't occur due to such factors as information barriers or transportation costs) and markets are not competitive, firms can charge different prices in different markets for the same good.

In general, when the price elasticity of demand is lower, the price that can be charged will be higher because consumers do not significantly reduce their purchases when the price is increased. For many nations there is a home bias, in that domestic consumers, all else being equal, will prefer goods produced in their own market to those produced internationally. (The "buy American" sentiment is one example, as well as formal rules that require most U.S. states to buy locally even when foreign prices are cheaper.) This home bias means that the price elasticity of demand will be lower for a domestic good sold domestically than for the same domestic good sold in a foreign market. Thus, the price elasticity of demand for Ford trucks will be higher in Japan than in the U.S. The Ford Motor Company, consequently, can sell Ford trucks for a higher price in the U.S. than in Japan because of home bias (apart from transportation costs). The same analysis means that Japanese-produced goods will have a higher price in Japan than in the U.S.

Classroom Activities

The above applications are just a few areas where international ideas can be introduced in a relatively simple manner early in the course. No doubt you can think of many other examples that can serve equally just as well. For example, an analysis of a competitive market can include discussion of the point at which an input imported from nations with a comparative advantage in the production of the input can lower the average cost of production of each firm in the domestic industry. A lower long-run average cost for each firm will in the long run make the domestic industry larger and the price of the good using the input lower, much like technological progress. Another possibility is introducing the effects of immigration on the labor market and the production possibility frontier.

Although the earlier introduction of international economics into the AP Microeconomics course is not a perfect substitute for the in-depth treatment we hope to provide at the end of the course, it can usefully complement that in-depth treatment with little loss of time. For many of us, early exposure might also ease the end-of-semester crunch. Just as important, it can help students understand, and help us remember, that the principles of analysis underlying the distinct and complex field of international economics are the same, familiar concepts we apply in microeconomics.

Authored by

  • Arthur Raymond
    Muhlenberg College
    Allentown, Pennsylvania