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Chapter 10 - The economics of international investments. After studying this chapter you will be able to: Show how international investment raises the total value of world output and income, and why all countries share in the net gains, explain how international investment permits investors to spread their risk among a greater variety of assets, present evidence and models suggesting that international investment also facilitates the flow of technology between countries. | The Economics of International Investment The foreign-investment fuss ignores facts, economics and history. (The Economist, 1989) The Goals of this Chapter Show how international investment raises the total value of world output and income, and why all countries share in the net gains. Explain how international investment permits investors to spread their risk among a greater variety of assets. Present evidence and models suggesting that international investment also facilitates the flow of technology between countries. Explain why international investment is still small compared to what it could be. A Two-Period International Investment Model The first model presented in this chapter shows how two economies with different time-preferences gain from being able to borrow and lend. The model simplifies by assuming that people live for just two periods, which permits us to use a two-dimensional graphic version of the model. The model also assumes away the problems of risk and default that normally plague intertemporal transactions. This model makes it clear that international trade and international investment are closely related. The Principal Assumptions of the Two-Period Model: Output Y is produced using capital, K, and labor, L, according to the production function Y = F(K,L). Output Y can be used for consumption C or as a productive capital good K. If the labor force, L, remains constant, investment in new capital is subject to diminishing returns. Technology does not change. The economy begins period 1 with a certain endowment of labor and capital. Suppose, finally, that capital goods last just one period, after which point they must be replaced by newly-produced capital inputs. Setting Up the The Supply Side of the Model Output in period 1, Y1, is a function of the amount of capital produced, K1. The two-period intertemporal consumption-possibilities frontier (ICPF) shows that the larger is saving in period 1 (equal to the difference between Y1 and C), the . | The Economics of International Investment The foreign-investment fuss ignores facts, economics and history. (The Economist, 1989) The Goals of this Chapter Show how international investment raises the total value of world output and income, and why all countries share in the net gains. Explain how international investment permits investors to spread their risk among a greater variety of assets. Present evidence and models suggesting that international investment also facilitates the flow of technology between countries. Explain why international investment is still small compared to what it could be. A Two-Period International Investment Model The first model presented in this chapter shows how two economies with different time-preferences gain from being able to borrow and lend. The model simplifies by assuming that people live for just two periods, which permits us to use a two-dimensional graphic version of the model. The model also assumes away the problems of risk and default .
