Chapter 18:International Trade

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2004 Trade Facts

Principal U.S. trade exports include chemicals, semiconductors, consumer durables, computers and generating equipment.

Principal imports include automobiles, petroleum, computers, household appliances, and clothing.

Canada is the U.S.’s most important trading partner.

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2004 Trade Facts

The U.S. has a sizable trade deficit with China.

The U.S. dependence on foreign oil is reflected in its trade with members of OPEC.

The U.S. leads the world in the combined volume of exports and imports.

Exports of goods and services make up about 10% of total U.S. output.

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Comparative Advantageand Specialization

Specialization and trade increase the productivity of a country’s resources and allow for greater total output and income. Comparative advantage allows us to determine

who should produce what. Specialization results in more efficient

production. 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.

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Production Possibilities Analysis Example

Consider two goods, avocados and soybeans, produced by two countries, Mexico and the U.S.

Suppose that each country must give up a constant amount of one product to secure a certain increment of the other product. This is called constant costs.

Furthermore, assume that both countries’ labor forces are of equal size.

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Production Possibilities Analysis Example

Table 18.1

Table 18.2

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Production Possibilities Analysis Example

A country has an absolute advantage if can produce more of a product than another country given its fixed resources in a specified time period.

A country has a comparative advantage if it has a lower relative or comparative cost than that of another country.

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Production Possibilities Analysis Example

The U.S. has an absolute advantage in producing both products since it can produce more of both goods than Mexico, assuming that the labor forces are of equal size. 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.

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Production Possibilities Analysis Example

The U.S. has a comparative advantage over Mexico 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 over the U.S. 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).

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Production Possibilities Analysis Example

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.

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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.

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The Foreign Exchange Market

A foreign exchange market is a market in which foreign currencies ware 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.

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Exchange Rates

In the market for foreign currency, the intersection of the demand for foreign currency and the supply of foreign currency determine the exchange rate.

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Exchange Rates

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Depreciation ad Appreciation

Depreciation (of a currency) means a decrease in the value of a currency relative to another currency

Appreciation (of a currency) means an increase in the value of a currency relative to another currency

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Determinants ofExchange Rates

Factors that cause a country’s currency to appreciate or depreciate are: Tastes Relative Income Relative Price Levels Relative Interest Rates Speculation

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Government and Trade

Governments sometimes try to restrict the free flow of imports or encourage exports in order to protect domestic industries.

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Government and Trade

Trade protections and subsidies are designed to shield domestic producers from foreign competition. These include: tariffs import quotas nontariff barriers (NTBs) voluntary export restriction (VER) export subsidies

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Economic Impact of Tariffs

Direct Effects Higher prices reduce quantity demanded but

increase quantity supplied. Foreign producers are hurt by tariffs. Government gains revenue from tariffs.

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Economic Impact of Tariffs

Indirect Effects Domestic firms using the protected good as

inputs are hurt. Competition is reduced in protected industries. Foreigners sell fewer imports; thus, they buy

fewer exports. As a result, U.S. export industries earn less.

Tariffs reduce efficiency and the world’s real output.

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Net Costs of Tariffs

The gains that U.S trade barriers produce for protected industries and their workers come at the expense of much greater losses for the entire economy.

The result is economic inefficiency.

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Three Argumentsfor Protection

Three arguments for trade protection have persisted for decades in the U.S. They are: Increased Domestic Employment Argument Cheap Foreign Labor Argument Protection-against-Dumping Argument

Dumping: the sale of products in a foreign country at prices either below costs or below the price charged at home.

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Trade Adjustment Assistance

In 2002, the U.S. passed the Trade Adjustment Assistance Act, which aids workers affect by international trade. Workers displaced by imports or plant

relocations abroad may qualify. Assistance comes in the form of cash,

education and training benefits, health care subsidies, and wage subsidies for those age 50 and older.

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Multilateral Trade Agreementsand Free-Trade Zones

One of the benefits of free trade is lower tariffs.

Countries have come together to create multilateral trade agreements and free-trade zones (or trading blocs) to help reduce or eliminate barriers to trade.

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Multilateral Trade Agreementsand Free-Trade Zones

General Agreement on Tariffs and Trade (GATT) 1947-1993

World Trade Organization, (WTO) 1993 GATT’s successor

European Union Trade bloc, or free-trade zone

North American Free Trade Agreement (NAFTA) 1993

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U.S. Trade Deficits

The U.S. has experienced large and persistent trade deficits since 1994.

In 2004, the trade deficit on goods was $665 billion and the trade deficit on goods and services was $617 billion.

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Causes of the Trade Deficits

There are several reasons for these large trade deficits: Strong growth in U.S. income that

accompanies economic growth resulting in increased spending on imported goods

Large trade deficits with China have emerged A declining U.S. saving rate

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Implication of U.S. Trade Deficits

Increased Current Consumption The U.S. receives more goods and services

from abroad, thus augmenting the standard of living.

Increased U.S. Indebtedness Trade deficits must be financed by borrowing

from the rest of the world, selling off assets, or dipping into foreign currency reserves.

Downward Pressure on the Dollar The dollar depreciates as dollars flood the

currency market.