UNIT 6- International Trade

Reasons We Trade With Other Countries

1. To improve our standard of living

2. Every country lacks some vital resources it can only get through trade

3. Each country’s climate, labor force, natural resources make it efficient in some production and inefficient in others

4. Specialization allows for mass production and greater efficiency

Determining What to Trade

• Absolute Advantage → occurs when one nation produces a product more efficiently than another nation

• Comparative Advantage → occurs when one nation can produce a product at a lower opportunity cost than another nation

• How to determine absolute/comparative advantage:

  1. Input or output problem:

     • input = resources (time, land, etc.) to produce a constant output

     • output = production given a constant resource (input)

  2. Absolute advantage: input → less resources, output → more production

  3. Comparative advantage: input = into/under, output = over

     • **Comparative Advantage is always based on the lower OPPORTUNITY COST**

     • whichever you have comparative advantage in is what you will export

Exchange Rates

• Exchange rate states the price in terms of one currency at which another currency can be bought

  • Dollar vs. Euro, vs. Peso, etc.

• Fixed Exchange Rates:

  • government sets exchange rate

  • Devaluation → decrease the value of the currency

    • used to boost tourism, increase exports, improve trade balance

    • makes goods cheaper

    • used to fight recession because it increases aggregate demand

  • Revaluation → increase the value of the currency

    • used to fight inflation because it decreases aggregate demand

• Floating Exchange Rates:

  • exchange rate is determined by the market forces of supply and demand for that currency

  • Currency Depreciation → value of currency decreases; a weak dollar

    • caused by a decrease in interest rates, increase in domestic inflation, less demand for US goods

    • weak dollar causes increase in exports and decrease in imports (trade balance)

  • Currency Appreciation → the value of the currency increases; a strong dollar

    • caused by an increase in interest rates, a decrease in domestic inflation, increased demand for U.S. goods

    • strong dollar causes decrease in exports and increase in imports

• Effects of Fiscal Policy:

  • expansionary fiscal policy increases interest rates → dollar appreciates

  • contractionary fiscal policy decreases interest rates → dollar depreciates

• Effects of Monetary Policy:

  • expansionary monetary policy decreases interest rates → dollar depreciates

  • contractionary monetary policy increases interest rates → dollar appreciates

Foreign Exchange Market Graph:

Free Trade vs. Protectionism

• Free trade → no tariffs, no quotas, no barriers to trade

• Protectionism → workers in import competing firms

• Arguments for protectionism:

  • self-sufficient military → the industries that produce for the military don’t want to have to import in the time of war

  • preserve domestic goods → protect your job

  • cheap foreign labor argument → how can Americans compete

  • protection against dumping → where a foreign government gives an export subsidy to a foreign company so they can sell goods below market price in the home market

  • infant industry argument → protect new industries long enough until they have a chance to compete

• Tariff = a tax on imported goods

• Quotas = a limit on a good that is imported

  

Balance of Payments

• The balance of spending flowing into the country from other countries and spending flowing out of the country into other countries

• Credit (+) → money flowing into country

• Debit (-) → money flowing out of country

• Tracks all money coming into the country and all money that leaves the country

• Current Account:

  • Balance of Trade = exports - imports

  • Net Investment Income = interest/dividends

  • Net Transfer Payments → government aid to another country

  • Net Services → a foreign company providing services for a U.S. company and vice versa