International Economics

Unit 5 Pretest

As we learn about International Economics, let’s see

what you already know.

Remember – do the best you can, but don’t stress –

this assessment doesn’t count toward your grade

On your Zipgrade answer sheet, bubble in the best

answer for questions #1 – 10.

Ignore the rest of the answer sheet

SSEIN1 The student will explain why individuals, businesses, and governments trade goods and services.

SSEIN2 The student will explain why countries sometimes erect trade barriers and sometimes advocate free trade.

SSEIN3 The student will explain how changes in exchange rates can have an impact on the purchasing power of individuals in the United States and in other countries.

• Exports

• Imports

• Absolute Advantage

• Comparative Advantage

• Tariff

• Protective

• Revenue

• Quota

• Protectionists

• Free Traders

• Foreign Exchange

• Foreign Exchange Rate

• Fixed Exchange Rate

• International

Monetary Fund

• World Bank

• Trade Bloc

• European Union (EU)

• North Atlantic Free

Trade Agreement

(NAFTA)

• Association of South-

East Asian Nation

(ASEAN)

• Balance of Payments

• Balance of Trade

• Embargo

• Purchasing Power

• Subsidy

• Trade Standards

• Trade

• Trade Barrier

• Trade Surplus

• Trade Deficit

• World Trade

Organization

(WTO)

The student will explain why individuals,

businesses, and governments trade goods

and services.

Define and distinguish between absolute

advantage and comparative advantage

Explain that most trade takes place because of

comparative advantage in the production of a

good or service

Explain the difference between balance of

trade and balance of payments

You previously learned that specialization and

voluntary exchange allow all parties to benefit

in an economy

Well, the same works for regions and nations!

When countries specialize in certain goods, they are

able to make more of that good and then benefit

from trading with others

What a country produces depends on its resources –

its natural resources such as land, water, metals and

climate and its skilled and educated workers

Each nation sells some of its products to other nations and then buys things from other nations that it can’t easily produce This activity is called trade Goods and services that are sold to other nations are called exports

Goods and services that are bought from other nations are called imports

Specialization and trade increase the amount and variety of goods available to all nations!

The benefit that comes from specialization depends on the concepts of comparative advantage and absolute advantage

If a country can make a larger quantity of a good than another country, then it is said to have an absolute advantage in that good

However, absolute advantage does not mean that a country should produce that certain product They may produce it at the expense of producing

other useful goods

In this case, the opportunity cost of not producing the other good may be too much for the country to give up!

This is why comparative advantage is important!

Sometimes we import things that we could make ourselves – why would we do that?

The reason is that sometimes its cheaper in opportunity costs to import a good rather than produce it! That is the concept of comparative advantage in a

nutshell!

If one country can make a product relatively more efficiently (lower opportunity cost) than another country, then it is said to have a comparative advantage in that good

The US can produce more sugar than the small nation of Nicaragua. The US can also produce more fertilizers than Nicaragua. So, the US has an absolute advantage in both areas. However, the opportunity cost of producing sugar is higher in the US than it is in Nicaragua: to grow and refine enough sugar to supply our nation’s demand, we would need to take land, capital, and workers away from producing other things, such as fertilizer, that we produce more efficiently and profitably. Nicaragua, on the other hand, can produce sugar very cheaply, while the opportunity cost of trying to produce their own fertilizer would be too high. The US has a comparative advantage over Nicaragua in producing fertilizer, so we export it to Nicaragua. Nicaragua, conversely, has a comparative advantage over the US in producing sugar, so Nicaragua exports it to the US

Get it?

Remember this formula (write this down!)

We Give Up = Your Opportunity Cost

If We Make

But, how do we know who has a comparative advantage in what? That’s where the statistics come in!

Ex: Statistics from our initial example…

This shows the US’s absolute advantage in both

products – it makes more than Nicaragua

Within the US, production is higher in fertilizer, so we now know that the US has a comparative advantage in that (and vice versa for Nicaragua!)

Sugar Fertilizer

U.S. 80 100

Nicaragua 70 50

Total 150 150

Remember We Give Up = Opportunity Cost (OC)

Our Formula>> If We Make

Making Sugar

US 100/80 = 5/4 = 1-1/4 OC

NC 50/70 = 5/7 OC

So Nicaragua has the lower

Opportunity Cost for making

sugar

Making Fertilizer

US 80/100 – 4/5 OC

NC 70/50 – 7/5 OC

So the U.S. has the lower

Opportunity Cost for

making fertilizer

Sugar Fertilizer

U.S. 0 200

Nicaragua 200 0

Total 200 200

If the two countries decide to specialize in their

comparative advantage, the new production

statistics may look like this:

As you can see, the production levels of both

products increase and everyone benefits

through trade!

Our example is extremely simplified

In reality, nations may trade in similar products

instead of just specializing in entire industries

For example, both the US and Japan make and trade

cars – why doesn’t one of them just specialize?

Well, both countries can make cars relatively

efficiently and the imports give American and

Japanese consumers a wider variety of goods!

A nation’s balance of trade is the difference

between the value of its imports and the value

of its exports in a given year

For example, if a nation imports $1 million worth

of goods and exports $3 million worth, then it is

said to have a positive balance of trade

A positive balance of trade is also known as a trade

surplus

If, on the other hand, they imported $3 million and

exported $1 million, the nation has a negative

balance of trade, or a trade deficit

Trade isn’t the only thing that a nation pays for in a year – it also covers other transactions between households, firms, and the government of one nation to another This could include transfer payments, tourism,

military spending, interest payments on loans, corporate dividends, the buying and selling of land and businesses, bank deposits, or the buying and selling of currency!

Any transaction that brings money into a nation is a credit and any transaction that takes money out is a debit

The difference between the total amount of money coming into a nation and the total amount leaving is called its balance of payments

Just as in a family budget, the amount of money going out should not be greater than the amount of money coming in Otherwise, the nation will incur a debt

So, ideally, a nation’s balance of payments should be zero or a positive number

In recent decades, the US has suffered from a negative balance of payments because of our trade deficit (which includes the cost of imported oil, foreign aid,

and military investment abroad)

Suppose that two of your friends, Karl and Kate

want to make some extra money.

They decide to print designs on T-shirts and

make birdhouses.

Kate can print six T-shirts OR make two birdhouses

per hour.

Karl can print one T-shirt OR make one birdhouse

per hour.

Who has absolute advantage with:

T-Shirts?

Birdhouses?

Who has comparative advantage with:

T-Shirts?

Birdhouses?

Based on the Law of Comparative Advantage,

who should produce:

T-Shirts?

Birdhouses?

How will total productivity improve if Karl and

Kate specialize and trade?

Based on the table, which is

true?

a. The US has an absolute

advantage in corn; Russia

has an absolute advantage

in soybeans

b. The US has an absolute

advantage in soybeans;

Russia has an absolute

advantage in corn

c. The US has an absolute

advantage in both crops

d. Russia has an absolute

advantage in both crops

In the year 2000, nation A sold

exports worth $5 million and

bought imports worth $8

million. Which of the following

statements is definitely true

about nation A in the year 2000?

a. It had a positive balance of

payments

b. It had a negative balance of

payments

c. It had a trade surplus

d. It had a trade deficit

Corn Soybeans

US 75 100

Russia 60 40

We still need to have the following students activate their student account on USA Test Prep.

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When countries interact with other countries,

each country gains a higher standard of living.

A high degree of economic interdependence

exists in the world

No country is able to get everything it needs within

its own borders.

We live in a time in which most countries are

moving toward open economies:

High degrees of free trade with few trade barriers

such as quotas and tariffs.

Absolute Advantage: one country can

produce a product at lower cost or with

higher labor productivity

Comparative Advantage: One country can

produce at a lower opportunity cost than

another country

Comparative Advantage

Uneven distribution of resources

Shoes Wheat

China 400 .25 wheat 100 4 shoes

U.S.A 1000 .5 wheat 500 2 shoes

Opportunity Cost in red

The student will explain why countries sometimes erect trade barriers and sometimes advocate free trade. Define trade barriers as tariffs, quotas,

embargoes, standards, and subsidies

Identify costs and benefits of trade barriers over time

List specific examples of trade barriers

List specific examples of trading blocs such as the EU, NAFTA, and ASEAN

Evaluate arguments for and against free trade

International trade today increases the amount

and variety of goods available to all nations

It also makes nations interdependent!

This requires American businesses to compete with

companies around the world – including those in

nations where workers are paid far less than what

American workers earn

So, to improve balance of payments and to

protect businesses in certain domestic industries,

nations may impose trade barriers to limit

imports from other nations!

When a government enacts a policy that attempts to limit imports, it is practicing protectionism Protectionism aims to “protect” domestic (i.e. home

country) industries by limiting competition with foreign producers

It lessens the variety of goods for consumers, but may keep domestic workers employed!

The opposite of protectionism is free trade, or open trade between nations without barriers to imports

Tariff: a tax imposed on certain imports These make imports more expensive to buy and earn

revenue for the government

Quota: a limit on the number of certain products that can be imported

Standards: rules about the quality of imports If the product doesn’t meet the standards, then it

isn’t imported

Subsidies: direct financial aid to certain domestic industries These lower the production costs for businesses

Trade barriers do protect jobs in some industries

that face foreign competition, but they lead to:

Fewer choices for consumers

Higher prices for all goods (imports or domestic)

Hard times for workers in other industries

For example, other export industries that may now have

fewer sales abroad in response to barriers on imports from

those nations

Other nations imposing their own trade barriers

against the US, hurting American exports

The most severe trade barrier is an embargo, or

a total ban on one or more products from a

particular nation

Embargos are often motivated by political rather

than economic factors because they put pressure on

governments to change their actions

The most famous embargo is the 1970s oil

embargo imposed by OPEC against the US and

other western nations

The US also had an embargo against Cuba that was

recently lifted.

Most economists argue that free trade:

Improves economic efficiency

Offers consumers of all nations a wide variety of

goods

Offers consumers the lowest possible prices

However, those who favor trade barriers argue

that:

It protects national security

It protects “infant industries” in the nation

It protects domestic jobs

Trade Surplus – the value of a nation’s

exports exceeds the value of what they

import

Trade Deficit – the value of a nation’s exports

are less than the value of what they import

Trade blocs are groups of nations that work

together through trade agreements

Trade Agreements are documents that outline the

conditions under which trade will take place

between nations.

General Agreement on Tariffs and Trade (GATT)

NAFTA: The North American Free Trade Agreement.

CAFTA: The Central American Free Trade Agreement.

ASEAN: Association of Southeast Asian Nations

EU: European Union

US is member of World Trade Organization (WTO)

Organization that seeks to reduce protectionism

around the world.

Signed in 1992 and went into affect in 1994

It called for the gradual elimination of trade

barriers (tariffs and others) between the US,

Canada, and Mexico over a 15-year period

By 2004, agencies such as the World Bank

concluded that, overall, NAFTA had a small

positive effect on the economic growth and

productivity of both the US and Mexico

The European Economic Community (EEC) was

established in 1957 to create a “common

market” in Europe

In 1993, this association was strengthened with

the creation of the European Union – 27 nations

with a shared currency, the Euro

Today, the EU is the largest free association of

trading nations in the world

Another successful trade bloc is the Association

of Southeast Asian Nations

It began in 1992 and now includes 10 nations of

Southeast Asia

It has worked towards economic growth and

stability by creating a free trade region in this

part of the world

Currently, there are discussions on a new

trading bloc – the Trans-Pacific Partnership.

Advocates argue

that it benefits us in

the following ways:

Greater variety of

goods available

Lower prices

Encourages

cooperation between

partners

Critics argue that it

hurts us in the

following ways:

Lose domestic jobs to

other countries with

lower costs

It helps the other

countries more than the

U.S.

Potential security risks

What do YOU think? Should we move forward

with the TPP agreement?

What is the most important

purpose of NAFTA?

a. To increase trade barriers

between the US, Canada,

and Mexico

b. To reduce trade barriers

between the US, Canada,

and Mexico

c. To help the Mexican

economy with American

and Canadian subsidies

d. To compete with the

nations of the European

Union

A person who favors a

protectionist trade policy

would MOST likely:

a. Call for an end to quotas

b. Support a reduction in

tariffs

c. Call for supporting

national security and

American jobs

d. Claim that trade

restrictions result in

fewer choices and higher

prices

On a clean sheet

of paper, write

your name, date,

block # and title:

Opener –

Wednesday, 2/24

Trade Barriers

Then write at

least 3-5

sentences about

what you think

this cartoon really

means.

The student will explain how changes in

exchange rates can have an impact on the

purchasing power of individuals in the United

States and in other countries.

Define exchange rate as the price of one nation’s

currency in terms of another nation’s currency

Locate information on exchange rates

Interpret exchange rate tables

Explain why, when exchange rates change, some

groups benefit and others lose

When international trade occurs, one nation must exchange money, or currency, for another nation’s goods

The problem is: not every nation uses the same currency! So, before a transaction takes place, the purchasing

nation must exchange their currency for the currency of the producing nation!

This exchange is governed by foreign exchange rates – or the value of one nation’s currency in terms of another nation’s currency

Current Dollar Exchange Rates

Relative value of the American dollar in exchange for foreign currencies.

Exchange rates are “floating”, e.g., they change based on the relative Supply and Demand for a currency.

The value of the dollar compared to the value of other currencies is determined by supply and demand.

Demand for U.S. dollars is synonymous with demand for U.S. products.

Foreigners importing U.S. products must pay U.S. companies in dollars and therefore must purchase dollars to purchase American made products.

High demand for American products will drive the value of the dollar up compared to other currencies.

Current exchange rate values are shown in

exchange rate tables like this one:

You convert the currencies by multiplying by

the current exchange rate for the transaction

Value of $1 US

(in foreign curr.)

Value of foreign

currency (in US $)

Canadian $ 0.97 1.03

Euro 0.70 1.42

Japanese Yen 113.94 0.008

Mexican Peso 10.84 0.09

Let’s imagine that you import a Japanese

computer that costs $1,000

The American company must exchange $1,000

for Yen – but, how many?

Figure it out by looking at the table:

Then, set up the multiplication:

$1 US = 113.94 yen

$1000 = (113.94) X 1000 yen

So, $1000 = 113,940 yen

Value of $1 US (in

foreign curr.)

Value of foreign

currency (in US $)

Canadian $ 0.97 1.03

Euro 0.70 1.42

Japanese Yen 113.94 0.008

Mexican Peso 10.84 0.09

Exchange rates change over time

When a currency is strong in terms of another,

that means it is worth more

So, if the US $ is strong, American tourists can buy

more abroad and US businesses can import more

foreign goods for lower cost

When currencies lose their value, they have

depreciated in terms of another currency

If the currency gains value, it has appreciated

When the dollar is strong,

or appreciates:

Imports increase and are

cheaper for consumers to

buy

Travel abroad is cheaper

for American tourists

US exports decline

The US trade deficit

increases

When the dollar is weak, or

depreciates:

US exports increase and

the prices of exports go

up

Travel abroad is more

expensive for American

tourists

The US trade balance

improves

Foreign investment in US

businesses increases

So, there are pros and cons of both conditions!

What is a ‘weak’ dollar? The value of the dollar falls compared to other currencies

More U.S. dollars are needed to purchase foreign currencies

The value of the dollar is depreciating

Who is helped by a weak dollar? U.S. Producers – because they’re competing with higher priced

imported goods & services

Foreign Consumers – because they can buy U.S. goods & services at a

lower price

U.S. Exporters – because American goods & services become less

expensive for foreign consumers

Who is hurt by a weak dollar? U.S. consumers – because the cost of foreign goods & services is more

expensive

U.S. investors in foreign companies because it costs more

Foreign exporters – because their goods & services are more expensive

What is a strong dollar? The value of the dollar rises compared to other currencies

More foreign currency is needed to purchase a U.S. dollar

The value of the dollar is appreciating.

Who is helped by a strong dollar? U.S. consumers because the prices of foreign goods & services are less

expensive

U.S. investors in foreign companies because the prices of foreign

securities are lower

U.S. importers because they can sell foreign goods & services at a

lower price

Who is hurt by a strong dollar? U.S. producers because they are competing against lower priced

foreign goods & services

Foreign consumers because U.S. goods & services are more expensive

U.S. exporters because U.S. goods & services are more expensive

1. If the exchange rate between the US dollar

and Australian dollar changes from 1USD =

1.8 AUD to 1USD = 1.5 AUD then . . . .

2. 1 USD = .90 EUR

French soup = 1.80 euros. I want to buy 5 cups of

French soup. How much would this cost in USD?

Foreign Trade is extremely important –

nations work together to produce and

consume all types of goods and services

And, exchange rates are very important to

people involved in international trade,

tourism, or investment industries

So, changes in exchange rates are posted

daily and experts are hired to predict and

interpret these changes for the future!

Stacy traveled to Mexico and

took out $100 in US currency.

When she exchanged this for

pesos, she received about:

a. 10.3 pesos

b. 103 pesos

c. 1,034 pesos

d. 900 pesos

What might cause the value

of the US dollar to appreciate

in relationship to the Euro?

a. Increased demand for

European products in the

US

b. Increased demand for US

products in Europe

c. Increases in the US money

supply

d. High rates of inflation in

the US

Value of $1

US in pesos

Value of 1 peso

in US dollars

10.34 .09

Across the world, there are _______ different types of

monetary systems or currencies.