1 international trade and finance ©2006 south-western college publishing
TRANSCRIPT
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International Trade and Finance
©2006 South-Western College Publishing
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Interdependence and Trade
Consider your typical day:You wake up to an alarm clock made in Korea.You pour yourself some orange juice made from oranges grown in Florida.
You put on some clothes made of cotton grown in Georgia and sewn in factories in Thailand.
You watch the morning news broadcast from New York on your TV made in Japan.
You drive to class in a car made of parts manufactured in a half-dozen different countries.
…and you haven’t been up for more than two hours yet!
How do we satisfy our wants and needs in a global economy?
We can be economically self-sufficient.
We can specialize and trade with others,
leading to economic interdependence.
Why is interdependence the norm?
Interdependence occurs because people are better off when they specialize and trade with others.
What determines the pattern of production and trade?
Patterns of production and trade are based upon
differences in opportunity costs.
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Why do countries trade?International trade allows a country to consume a combination of goods and services that exceeds its production possibilities curve
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U.S. Trading Partners, 2004
Mexico
Canada
Western Europe
Australia
Eastern Europe
Japan
Asia
Africa
Except Mexico
China
Imagine . . .only two goods: potatoes and meatonly two people: a potato farmer and a
cattle rancher What should each produce? Why should they trade?
A Parable for the Modern Economy
Self-Sufficiency
By ignoring each other: Each consumes what they each produce. The production possibilities frontier is also
the consumption possibilities frontier.
Without trade, economic gains are diminished.
The Farmer and the Rancher Specialize and Trade
Each would be better off if they specialized in producing the product they are more suited to produce, and then trade with each other.
The farmer should produce potatoes. The rancher should produce meat.
Trade Expands the Set of Consumption Possibilities
Potatoes (pounds)
Meat (pounds)
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1
(a) How Trade Increases the Farmer’s Consumption
0
A
3
3
A*
Farmer’s consumption without trade
Farmer’s consumption with trade
Trade Expands the Set of Consumption Possibilities
Potatoes (pounds)
Meat (pounds)
52.5
40
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(b) How Trade Increases The Rancher’s Consumption
0
B
21
3
B*
Rancher’s consumption without trade
Rancher’s consumption with trade
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Why should countries specialize and trade?
Total world output increases, and therefore, the potential for greater total world consumption also increases
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What conclusion can we draw from this?
International trade allows a country to consume a combination of goods that exceeds its production possibilities curve
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If countries specialize, in what should they
specialize?They should produce those goods and services in which they have a comparative advantage
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What iscomparative advantage?
The ability of a country to produce a good at a lower opportunity cost than another country
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What advantage comparative advantage?
World output and consumption are maximized when each country specializes in producing and trading goods for which it has a comparative advantage
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What isabsolute advantage?The ability of a country to produce a good using fewer resources than another country
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Should Tiger Woods Mow His Own Lawn?
?? ?
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What is free trade?The flow of goods between countries without restrictions or special taxes
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What is protectionism?The government’s use of embargoes, tariffs, quotas, and other restrictions to protect domestic producers from foreign competition
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What is an embargo?A law that bars trade with another country
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What is a tariff?A tax on an import
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What is a quota?A limit on the quantity of a good that may be imported in a given time period
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What are the arguments for protectionism?
• Infant industry argument• National security argument• Employment argument• Cheap foreign labor argument• Free trade agreements
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What is a recent free trade agreement?
North America Free Trade Agreement (NAFTA)
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What is NAFTA? A 1993 free trade agreement between the U.S., Canada, and Mexico
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What is thebalance of payments?
A bookkeeping record of all the international transactions between a country and other countries during a given period of time
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What is the current account?
The first section of the balance of payments, which includes trade in currently produced goods and services
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What is the balance of trade?
The most widely reported and largest part of the current account defined as the value of a nation’s merchandise imports subtracted from its merchandise exports
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How is a current account deficit
financed?By a capital account surplus
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What is thecapital account?
The second section of the balance of payments, which records payment flows for financial capital
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83 8785 89 91 93 95 97 99 01 03
-500
-450
-400
-450
-400
-350
-550
Bal
ance
of
Tra
de
(bil
lio
ns
of
do
llar
s)U. S. Balance of Trade, 1983-2004
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TaiwanJapan Canada ItalyGermanyMexico FranceChina
123456789
Ireland
10111213
-124
-66
-52
-41-39
-18 -14 -14 -12
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What does the balance of payments
always equal?Zero; the current account deficit should equal the capital account surplus
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How could the US have a balance of
payments problem? The problem is with the composition of the balance of payments
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What is an exchange rate?
The number of one nation’s currency that equals one unit of another nation’s currency
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If 1.81 dollars is exchangeable for 1
British pound, what is the exchange rate?
1 / 1.81 = .552 pounds per dollar
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How is the exchange rate determined?
Supply and demand for foreign exchange
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What happens when a currency depreciates?The price of the currency falls in relation to another currency
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What happens when a currency appreciates?
The price of the currency rises in relation to another currency
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What can cause a currency to
change value?The demand and/or supply of the currency can change
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What can cause a change in demand of
a currency?There can be a change in -• tastes and preferences• relative price levels• relative interest rates
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U.S. exports
less popular
Decrease in the
demand for
dollars
Value of the dollar falls
(dollar depreciates)
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What can cause a change in supply of
a currency?There can be a change in -• relative incomes• relative price levels• relative interest rates