Chapter 1: The Global Economy
Cultural globalization, to what extend there is a global culture, or a set of universal cultural
Economic globalization, referring to the decline of national markets and the rise of global
markets as the firms focal point; rise of global markets. Due to the rapid increase in cross-
border flows of goods, services, capital, technology. Businesses play an important role: FDI
and cross-border acquisitions.
Geographical globalization; compressed time and space, reduced travel times and rapid
exchange of information (e.g. technological).
Institutional globalization; spread of ‘universal’ institutional arrangements across the globe;
universal institutional arrangements (IMF, WTO and WB).
Political globalization; relationship between the power of markets and firms versus the
nation-state; growing international cooperation.
Globalization: the increased interdependence of national economics and greater integration of
goods, labour and capital markets. The disruptive effects of globalization are mainly:
Giant MNEs that control the world economy;
Widening income gap between rich and poor (between countries as well as within
Low wages and bad working conditions in developing countries;
Destruction of local market.
Box 1.2. Logarithmic graphs
Advantage: it can simultaneously depict developments in the level of a variable and in the
growth rate of a variable (the slope of the line reflects the growth rate of the variable).
Disadvantage: they can be deceptive concerning the difference in levels for variables at the
same point in time and for the same variable at different point in time.
Globalization and economy efficiency
If no tariffs, transport costs or other barriers to trade exist, the equilibrium on world markets is
characterized by the same price in both countries, and the volume of trade is such that exports
In this equilibrium both countries’ welfare is maximized. That means “world welfare” is maximized,
too. This is shown by the triangles representing the net surplus gain in each country.
There may be a number of reasons for a deviation between Home’s and Foreign’s price, which is
called a price wedge, firms have to overcome transport costs, tariffs, cultural differences before they
can export to Home’s market (price wedge = pH – pF > 0). As the price wedge rises, the country prices
diverge more and more. The volume of trade falls, and logically: the welfare in both countries (and so
also the world) falls. If the price wedge diminishes, the trade flows will increase, which will be
beneficial for the globalization process. Fragmentation
A second illustration, of the fact that rising relative trade flows may under-estimate the degree of
globalization, is fragmentation: the fact that the production process is now subdivided into various
phases which are physically separated. This enables a finer and more complex division of labour. It is
clear that these complex production processes lead to increased interdependence of national
economies and more intricate international connections. Chapter 3: Trade, comparative advantage, and competition
The comparative advantage
There are a number of simplifying assumptions:
There is only one factor of production: labour. This factor of production is perfectly mobile
within countries, but cannot migrate across borders. As a consequence the factor wage is
therefore the same in different sectors within a country, but may different between
Markets are characterized by perfect competition. The action of one firm will not trigger a
reaction by other firms, due to the fact that individual firms are too small relative to the
whole market to affect the behaviour of others. There are constant returns to scale, no
matter if firms are small or large, unit costs are the same.
An absolute advantage is a country's ability to produce a certain good more efficiently than another
country. David Ricardo argued that a country does not need to have an absolute advantage in the
production of any commodity for international trade between it and another country to be mutually
beneficial. By focusing on the production of those goods in which a country is relatively more
efficient both countries can gain from international trade, even if goods are imported from a less
productive trade partner. The countries then have to focus on the product which they can produce at
the lowest opportunity cost / most efficient relative to the other products; their comparative
advantage. The fact that the comparative advantage works in practice can be explained due to the price. Under
perfect conditions, with constant returns to scale and only one factor of production (labour) it
𝑤𝑎𝑔𝑒 𝑟𝑎𝑡𝑒 (𝑝𝑒𝑟 ℎ𝑜𝑢𝑟)
𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑐𝑜𝑚𝑚𝑜𝑛𝑑𝑖𝑡𝑦 =
𝑙𝑎𝑏𝑜𝑢𝑟 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑣𝑖𝑡𝑦 (𝑝𝑒𝑟 ℎ𝑜𝑢𝑟)
Due to the fact that customer compare prices, to ensure that the production takes place according to
the comparative advantage, the price of this commodity with the comparative advantage should be
lower than the other commodity.
𝑃𝑐𝑜𝑢𝑛𝑡𝑟𝑦 𝐴 𝑤𝑖𝑡ℎ 𝑐𝑜𝑚𝑝𝑎𝑟𝑎𝑡𝑖𝑣𝑒 𝑎𝑑𝑣𝑎𝑛𝑡𝑎𝑎𝑔𝑒 < 𝑃𝑐𝑜𝑢𝑛𝑡𝑟𝑦 𝐵 𝑤𝑖𝑡ℎ 𝑐𝑜𝑚𝑝𝑎𝑟𝑎𝑡𝑖𝑣𝑒 𝑑𝑖𝑠𝑎𝑑𝑣𝑎𝑛𝑡𝑎𝑔𝑒
Merging the equations for both products will give:
If the wages are within the indicated range, consumers can simply enforce specialization according to
comparative advantages by comparing prices and buying from the cheapest source. Furthermore, if
the commodity prices are not in range with the equation, this will automatically adapt itself through
the labour market (demand and wages in country B ↑, demand and wages in country A ↓). Thus, all countries can always compete in world markets, even if they are less productive than their
trading partners, if the compensate lower productivity by lower wages. Furthermore, a smarter re-
allocation of factors of production based on the comparative advantage will be beneficial for both
countries. However, the link between labour productivity and trade flows in the model is too strict to be
observed. Other elements determining comparative advantages and productivity differences are also
important (location, climate, available land, institutions). Still, the theory holds in empirical research. It is important to understand that the theory of comparative advantage demonstrates that even if a
firm is more productive than a foreign counterpart, it might still lose market share because other
domestic firms might have a higher productivity advantage relative to foreign firms than the firm that
loses market share. The fact that firms within a sector go bankrupt can be a sign that comparative
Many multinational firms in OECD countries move their low-skilled assembly activities,
resulting in job-loss and lower wages. However, what often happens is that the low-skilled country is
specializing in the assembly sector in which it has a comparative advantage, while another country is
losing a sector in which it has a comparative disadvantage.