Chapter 12 - International Trade

Law of comparative advantage

It says that nations can mutually benefit from trade so long as the relative production costs differ at the macroeconomic level

Comparative advantage

When a company can produce a good at a lower opportunity cost than another.

Absolute advantage

When a company has the capability to produce more of the same good than another

what does trade rely on

comparative advantages

Consumption possibility frontier

The line that connects Indiana’s specialization of soybeans to Oregon’s specialization of timber

what does specialization and trade allows

they allow nations to consume beyond the PPC

what does free trade allows based on comparative advantages

it allows for a more efficient allocation of resources and greater prosperity for the trading partners than can be achieved without free trade.

World price

The global equilibrium price of a good when nations engage in trade

Domestic price

The equilibrium price of a good in a nation without trade

world price is above domestic price

the nation becomes an exporter

world price below domestic price

the nation becomes an importer

Balance of payments statement

A summary of the payments received by the United States from foreign countries and the payments sent by the United States to foreign countries

Current account

This account shows current import and export payments of both goods and services and investment income sent to foreign investors of the United States and investment income received by U.S. citizens who invest abroad

what does a deficit balance tells us

that the United States sent more American dollars abroad than foreign currency received in current transactions

Capital (or financial) account

This account shows the flow of investment on real or financial assets between a nation and foreigners

what does a surplus balance tells us

that there was more foreign capital investment in the United States than there was U.S. investment abroad

Official reserves account

The Feds adjustment of a deficit or surplus in the current and capital account by the addition or subtraction of foreign currencies so that the balance of payments is zero

Balance of payments deficit

When the US has sent more dollars out than foreign currency has come in while adding the current and capital account. When this happens, the Fed credits the account to balance it.

Balance of payment surplus

When more foreign currency was coming into the US than American dollars sent abroad. Here, the Fed transfers the surplus currency bank into official reserves.

Exchange rate

The price of one currency in terms of a second currency

Appreciating or stronger currency

When the value of a currency is rising relative to another currency

Depreciating or weaker currency

When the value of a currency is falling relative to another currency

Determinants of exchange rates

External factors that increase the price of one currency relative to another

Consumer tastes

When domestic consumers build a stronger preference for foreign-produced goods and services, the demand for those currencies increases and the dollar depreciates.

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If foreign consumers increase their demand for U.S.-made goods, the dollar appreciates.

Relative incomes

When a nation’s macroeconomy is strong and incomes are rising, they increase their demand for all goods, including those produced abroad

Speculation

Foreign currencies can be traded as assets causing investors to seek to profit from buying currency at a low rate and selling it at a higher rate

what happens when the fed increases the money supply

The interest rates on American financial assets begin to fall, so the demand for the dollar falls and it depreciates relative to other foreign currencies. This increases American net exports shifting AD to the right

what happens when the fed decreases the money supply

American interest rates begin to rise and the dollar appreciates relative to foreign currencies.

This decreases American net exports which shifts AD to the left.

what happens when interest rates rise

capital investments decrease and financial investments increase.

when does the demand for the US dollar increases and the dollar appreciates relative to the euro

When:

* European taste for American-made goods is stronger.
* European relative incomes are rising, increasing demand for U.S. goods.
* The U.S. relative price level is falling, making U.S. goods relatively less expensive.
* Speculators are betting on the dollar to rise in value.
* The U.S. relative interest rate is higher, making the United States a relatively more attractive place for financial investments

Revenue tariff

An excise tax levied on goods not produced in the domestic market

Protective tariff

An excise tax levied on a good that is produced in the domestic market so that it may be protected from foreign competition

economic effects on the tariff

* **Consumers pay higher prices and consume less steel**


* **Consumer surplus has been lost**
* **Domestic producers increase output**


* **Declining imports**


* **Tariff revenue**
* **Inefficiency**
* **Deadweight loss now exists**

Import quota

A limitation on the amount of a good that can be imported into the domestic market

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* With a quota, the government only allows two million tons to be imported. So the impact of the quota, with the exception of the revenue, is the same: higher consumer price and inefficient resource allocation.

Tariffs and quotas economic effects

* Both hurt consumers with artificially high prices and lower consumer surplus.
* Both protect inefficient domestic producers at the expense of efficient foreign firms, creating deadweight loss.
* Both reallocate economic resources toward inefficient producers.

difference between tariffs and quotas

Tariffs collect revenue for the government, while quotas do not.