Net Exports, Exchange Rates, and International Finance Notes

Introduction to International Trade

  • International trade is significant for both goods/services provision and as a market for a country's products.

Importance of International Trade

  • Clothing labels indicate global sourcing.
  • Parking lots showcase cars from various countries (Japan, Korea, Sweden, etc.).
  • Grocery stores offer produce from Latin America and Asia.

Learning Outcomes

  • Arguments for free trade.
  • Determinants of net exports and their effects on aggregate demand.

International Transactions

  • Exports: Goods and services sold to foreign countries.
  • Imports: Goods and services purchased from foreign countries.
  • Foreign Investment: Investment flows between countries.

Arguments for free trade

  • International trade increases the variety of goods and services available.
  • Comparative Advantage: Trade enables countries to consume beyond their production possibilities.

International Trade Terminology

  • Trade Surplus: Exports exceed imports.
  • Trade Deficit: Imports exceed exports.
  • Exchange Rates: The value of one currency in terms of another.
  • Trade Barriers: Tariffs and quotas.
  • Export Subsidies: Government support for exports.
  • Dumping: Selling goods below cost in a foreign market.
  • Balance of Payments: A record of all international transactions.
  • Current and Capital Account: Components of the balance of payments.
  • Exchange Rates and Determinants: Factors influencing exchange rates.

Rising Importance of International Trade

  • International trade is growing in importance.
  • World Output vs. Export Growth: From 1990-2010, world output grew by 3% annually, while exports grew by 6% annually.

Factors Contributing to Trade Increase

  • Transportation and Communication Advances: Reduced costs of moving goods globally.
  • Shipping Containerization: Reduced shipping costs by up to 90% since 1956.
  • Trade Barrier Reduction: Lowered barriers between countries.

Trade Barriers

  • Tariff: A tax on imported goods.
  • Impact: Raises the cost of imported goods, shifting the supply curve left, increasing prices, and reducing quantity.

Justifications for Trade Restriction

  • Infant Industries: Protecting new industries to achieve economies of scale.
  • National Security: Protecting industries vital for national defense.
  • Job Protection: Shielding domestic jobs from foreign competition.

Types of Trade Barriers

  • Tariffs: Taxes on imports.
    • Revenue Tariff: Designed to raise government revenue.
    • Protective Tariff: Designed to protect domestic industries.
  • Import Quota: Limits on the quantity of imports.
  • Nontariff Barrier (NTB): Regulations that impede trade.
  • Voluntary Export Restriction (VER): Self-imposed limits on exports.

Quota Impact

  • Example: A quota reducing shoe imports by half.
  • Effect: Shifts the supply curve left, increasing the price of shoes and reducing the equilibrium quantity.

Determinants of Net Exports

  • Net Exports = Exports - Imports
  • Factors affecting both exports and imports:
    • Income: Higher foreign incomes increase exports, and higher domestic income increases imports.
    • Relative Prices: Changes in domestic price levels affect exports and imports.
    • Interest Rates
    • Exchange Rates: Strong currency hurts exports, helps imports; weak currency helps exports, hurts imports.
    • Trade Policies: Tariffs, quotas, etc.
    • Preferences and Technology

Income

  • Impact of foreign income: Increases exports.
  • Impact of domestic income: Increases imports.
  • GDP Impact: Increase in real GDP boosts imports; reduction reduces imports.

Relative Prices

  • Price Level Changes: A higher domestic price level reduces exports and increases imports.
  • International Trade Effect: The negative relationship between net exports and the price level contributes to the downward slope of the aggregate demand curve.

The Exchange Rate

  • Currency Purchases: Foreign buyers need domestic currency to buy domestic goods.
  • Flexible or Floating Exchange Rate System: Exchange rates determined by market forces.
  • Fixed Exchange Rate System: Exchange rates set by the government.
  • Depreciation: A decrease in the value of a currency.
  • Appreciation: An increase in the value of a currency.
  • Devaluation: A government decrease in the value of a currency (fixed rate).
  • Revaluation: A government increase in the value of a currency (fixed rate).

Exchange Rate Impact

  • Increase in Exchange Rate: Reduces exports and increases imports, thus reducing net exports.
  • Decrease in Exchange Rate: Increases exports and reduces imports, thus increasing net exports.

Net Exports and Aggregate Demand

  • Price Level Change: Causes movement along the aggregate demand curve (international trade effect).
  • Other Determinants Change: Shifts the aggregate demand curve (magnitude equals the change in net exports times the multiplier).

Changes in Net Exports and Aggregate Demand

  • Increase in Net Exports: Shifts the aggregate demand curve to the right.
  • Decrease in Net Exports: Shifts the aggregate demand curve to the left.

Class Exercise

  • Analysis of Aggregate Demand and Supply Shifts in Various Countries:
    1. Mexico: Expansion in the United States increases Mexican exports, shifting its aggregate demand to the right, raising both real GDP and price level.
    2. Japan: A sharp fall in Japan’s exchange rate increases net exports, shifting aggregate demand to the right, raising both real GDP and price level.
    3. Germany: Increased French purchases of German goods increase German net exports, shifting aggregate demand to the right, raising both real GDP and price level.
    4. United States: Recession in Canada decreases U.S. exports, shifting aggregate demand to the left, reducing both price level and real GDP.