ECON 201 Macroeconomics

1. ECON 201Macroeconomics Chapter 12 International Trade & Exchange Rates

2. Ch 12 Objectives Key facts about U.S. international trade. About comparative advantage, specialization, & international trade. How exchange rates are determined  in currency markets. Rebuttals to common arguments for protectionism. The role played by free-trade zones & the World Trade Organization (WTO) in promoting international trade.

3. What is international trade? Exchange of goods and services across national borders.

4. International Trade & Finance link economies together. Is often at the center of U.S. economic policy. Economic change in one part of the world has repercussions for countries around the globe.

5. Economic Basis for Trade International Trade allows Nations to specialize their productions. nations can specialize, increase the productivity of their resources, and realize a larger total output.

6. Why do nations trade? • Uneven economic resources among nations. • Efficient production of various goods requires different technologies & resources. • Quality & non-price attributes. • Some people like imported goods.

7. Japan • large, well‑educated labor force and can specialize in labor‑intensive commodities. • Australia • abundance of land • can cheaply produce land‑intensive agricultural products. • Industrially advanced nations (including Japan) are in a position to produce capital‑intensive goods.

8. In Their Element Japan – digital cameras, video games players, DVD players Australia – wheat, wool, meat Brazil – coffee Countries with Lg. amts. of capital – cars, ag equipment, chemicals

9. U.S. Trade Facts: 2007 • U.S. has a trade deficit in goods: • In 2007, U.S. trade deficit in goods was $816 billion. • U.S. has a trade surplus in services: • In 2007, U.S. trade surplus in services was $107 billion. • Principal U.S. exports: chemicals, agricultural products, consumer durables, semiconductors, and aircraft. • Principal U.S. imports: petroleum, automobiles, metals, household appliances, and computers. • Largest trading partner: Canada (current #’s U.S. census Bureau) A Trade deficit occurs when imports exceed exports. A Trade surplus occurs when exports exceed imports. LO: 12-1

10. U.S. Trade Balances on Goods and Services, 2007 -250 -70 -60 -50 -40 -30 -20 -10 20 10 Surplus Deficit +10.0 Australia Belgium +9.8 The U.S. trade deficit with China was $257 billion in 2007. Canada -67.0 China -256.6 Germany -45.3 Japan -85.0 -77.3 Mexico +14.3 Netherlands Source: BEA LO: 12-1

11. U.S. Total Exports are Second Only to Germany Percentage Share of World Exports, Selected Nations 2007 0 2 4 6 8 10 12 Germany United States China Japan France Netherlands United Kingdom Italy 9.20 8.59 8.02 5.38 4.06 3.83 3.71 3.40 Source: World Trade Organization LO: 12-1

12. More Facts U.S. dependence on foreign oil is reflected in its $94 billion trade deficit (imports exceed exports)with OPEC nations in 2005. 2008 – trade deficit was 175,613 million dollars. As of January, 09’ - over 4 million. U.S. leads the world in the volume of exports and imports. Germany is the world’s top exporter; U.S. exports of goods make up about 9% of the world’s exports.

13. Specialization and Comparative Advantage • Specialization and trade increase the productivity of a country’s resources and allow for greater total output and income. • Specialization results in more efficient production. • Comparative advantage allows us to determine who should produce what. • The terms of trade, or the rate at which units of one product can be exchanged for units of another product, can make both countries better off. Comparative advantage is a lower relative or comparative opportunity cost than that of another person, producer, or country. LO: 12-2

14. Principle of Comparative Advantage • Review • refers to the ability of a person or a country to produce a particular good at a lower opportunity cost than another country. • explains how trade can create value for both parties even when one can produce all goods with less resources than the other. • The net benefits of such an outcome are called gains from trade.

15. Principle of Comparative Advantage • Lower Opportunity cost – • total output will be greatest when each good is produced by the nation that has the lower opportunity cost.

16. Trade and Specialization Increase Total Output LO: 12-2

17. Specialization and Gains from Trade LO: 12-2

18. Absolute and Comparative Advantage • In the above example, the U.S. has an absolute advantage in producing both goods: • The U.S. can produce 30 tons of soybeans while Mexico can produce 15 tons. • Also, the U.S. can produce 90 tons of avocados compared to Mexico’s 60 tons. • The U.S. has a comparative advantage in soybeans. • For the U.S., 1S ≡ 3A; for Mexico, 1S ≡ 4A • Soybeans are relatively cheaper in the U.S. • Mexico has a comparative advantage in avocados. • 1 ton of avocados costs 1/4 ton of soybeans in Mexico, which is less than the cost in the U.S. (1A ≡ 1/3S). LO: 12-2

19. Gains from Specialization and Terms of Trade • If the U.S. specializes in soybean production while Mexico specializes in avocado production and both agree on the terms of trade, both countries will gain from specialization and trade. • The United States can shift production between soybeans and avocados at the rate of 1S for 3A. • Mexico can shift production at the rate of 4A for 1S. • Suppose that, through negotiation, the two nations agree on terms of trade of 1 ton of soybeans for 3.5 tons of avocados. • These terms of tradeare mutually beneficial to both countries, since each can “do better” through such trade than through domestic production alone. The terms of trade is the rate at which units of one product can be exchanged for units of another product. LO: 12-2

20. Trade with Increasing Costs • If resources are no longer perfectly substitutable between alternative uses, resources less and less suitable to the production of one good must be allocated to the production of the other good in expanding the other good’s output. • The primary effect of increasing opportunity costs is less-than-complete specialization. LO: 12-2

21. Foreign Exchange Market • A foreign exchange market is a market in which foreign currencies are exchanged and relative currency prices are established. • An exchange rate is the rate at which one currency trades for another. • Buyers and sellers interacting in international markets will exchange currencies through the foreign exchange market. • In the market for foreign currency, the intersection of the demand for foreign currency and the supply of foreign currency determine the exchange rate. LO: 12-3

22. Market for Foreign Currency (Pounds) P $3 Dollar Price of 1 Pound $2 $1 0 Q Quantity of Pounds Sl Depreciation is a decrease in the value of a currency relative to another currency. Exchange Rate: $2 = £1 Dollar Depreciates (Pound Appreciates) Appreciation is an increase in the value of a currency relative to another currency. Dollar Appreciates (Pound Depreciates) Dl Ql LO: 12-3

23. Exchange Rates Enable customers in one country to translate prices of foreign goods into units of their own currency. Simply Multiply the foreign product price by the exchange rate.

24. Determinants of Exchange Rates • Factors that cause a country’s currency to appreciate or depreciate are: • Tastes • Relative Income • Relative Price Levels • Relative Interest Rates • Speculation LO: 12-3

25. Argument for protectionism Save U.S. jobs – restrict imports Cheap foreign labor pulls down wages in the U.S. Tariffs are needed to protect against dumping. Rebuttal Import restrictions alter the composition of employment but don’t affect total employment; they also lead to less effective resource allocation. Gains from trade are based on comparative advantage. Specialization through trade increases labor productivity and wages. Dumping is prohibited by most countries that impose anti-dumping duties. Cases of dumping are rare. Protectionism or Free Trade? Dumping is the sale of products in a foreign country at prices either below cost or below the prices charged at home. LO: 12-4

26. Multilateral Trade Agreements and Trade Blocks • General Agreement on Tariffs and Trade (GATT) • 1947, 23 nations • Nations agreed to give equal treatment to one another, to reduce tariffs through multinational negotiations, and to eliminate import quotas. • World Trade Organization (WTO) • 1993, 152 nations (as of 2008) • Oversees the provisions of the current world trade agreement, resolves disputes stemming from it, and holds rounds of trade negotiations. • European Union (EU) – a trade block of 27 European nations • Nations that have eliminated tariffs and quotas among them established common tariffs for imported goods from outside the member nations, reduced barriers to the free movement of capital, etc. • North American Free Trade Agreement (NAFTA) • 1993, free-trade zone of US, Canada, and Mexico. LO: 12-5

27. Limits to Terms of Trade • At what exchange ratio will they trade? • Must get a better price than domestically or why trade? • U.S. will not give up more than 1 wheat for each coffee. • Brazil will not trade more than 2 coffee for 1 wheat. • Actual Terms of trade – determined by negotiation.

28. Actual Exchange Ratio Depends on world supply and demand for the product.

29. Benefits of free trade Promotes competition Deters monopoly Forces firms to use low-cost production techniques. Be more innovative More consumer choices Links Natl. interest & breaks down Ntl. Animosities.

30. Government Barriers • Eliminate gains from specialization. • Must shift resources if they can’t trade freely. • Tariffs • Revenue Tariff • Protective Tariff • Import Quota • Non-tariff barrier (NTB) • Voluntary Export Restriction(VER)

31. Tariffs • Excise taxes on imports, used for revenue purposes, or protect domestic producers from foreign competition by raising import prices. • Revenue Tariff • Protective Tariff • Import Quota - specify the maximum amounts of imports allowed in a certain period of time. Low import quotas may be a more effective protective device than tariffs, which do not limit the amount of goods entering a country.

32. Voluntary Export Restriction(VER) - agreements by foreign firms to “voluntarily” limit their exports to a particular country. Japan has voluntary limits on its auto exports to the United States. Non-tariff barrier (NTB)- licensing requirements, unreasonable standards, or bureaucratic red tape in customs procedures.

33. Dumping • act of a manufacturer in one country exporting a product to another country at a price which is either below the price it charges in its home market or is below its costs of production. • Fallacy of composition • arises when one infers that something is true of the whole from the fact that it is true of some part of the whole.

34. Smoot Hawley Tariff Act of 1930 • Raised U.S. tariffs on over 20,000 imported goods. • 1,028 economists signed a petition against it. • Help to create great depression? • Representative W.C. Hawley (left) and Senator Reed Smoot (right) shake hands in agreement on new tariff bill.

35. Acts and Adjustments • Trade Adjustment Assistance Act- 2002- • WTO – 1993 • Successor to the General Agreement on Tariffs & Trade (GATT) 1947. • Designed to supervise and liberalize international trade. • Oversees trade agreements. • Headquartered in Geneva, Switzerland.

36. Cheap Labor • Offshoring • Relocation by a company from one country to another. • Loss of U.S. jobs • Increases demand for complementary jobs • Cheap imports will flood U.S. markets • Domestic living standards go down • Economic logic – reduce costs

37. Free Trade World economy can achieve a more efficient allocation of resources and a higher level of material well‑being.

38. End chapter 12