# CHAPTER 3 AND 9 INTERDEPENDENCE AND APPLICATIONS OF TRADE.

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CHAPTER 3 AND 9 INTERDEPENDENCE AND APPLICATIONS OF TRADE

COMPARATIVE ADVANTAGE Benefits o f Specialization Absolute advantage  Produce a good using fewer inputs than another producer  Can have absolute advantage in both goods Comparative Advantage  Opportunity cost revisited  The ability to produce a good at a lower opportunity cost than another producer  Cannot have comparative advantage in both goods

COMPARATIVE ADVANTAGE Output Method (Other Goes Over) Canada and the United States can each produce 4 tons of wheat a year. The United States can produce 10 tons of flour a year, while Canada can produce 5 tons of flour a year. Calculate the opportunity cost. Determine which country has absolute & comparative advantage. Input Method (Other Goes Under) Joe and Sally produce two products: hamburgers and french fries. It takes Joe 4 hours to make 100 hamburgers and 2 hours to make 50 french fries. It take s Sally 6 hours to make 100 hamburgers and 4 hours to make 50 french fries. Calculate the opportunity cost. Determine which country has absolute & comparative advantage.

CHAPTER 9: INTERNATIONAL TRADE The world price The price of a good that prevails in the world market for that good. Determining trade: Compare domestic price with world price  Determine who has comparative advantage  If domestic price < world price  Export the good  Country – has comparative advantage  If domestic price > world price  Import the good  World – has comparative advantage

INTERNATIONAL TRADE IN AN EXPORTING COUNTRY 5 Price of textiles Quantity of textiles 0 Once trade is allowed, the domestic price rises to equal the world price. The supply curve shows the quantity of textiles produced domestically, and the demand curve shows the quantity consumed domestically. Exports from Isoland equal the difference between the domestic quantity supplied and the domestic quantity demanded at the world price. Sellers are better off (producer surplus rises from C to B + C + D), and buyers are worse off (consumer surplus falls from A + B to A). Total surplus rises by an amount equal to area D, indicating that trade raises the economic well-being of the country as a whole. D Domestic Quantity Demanded Before tradeAfter tradeChange Consumer Surplus Producer Surplus Total Surplus A+B C A+B+C A B+C+D A+B+C+D -B +(B+D) +D The area D shows the increase in total surplus and represents the gains from trade Domestic Quantity Supplied C A B Domestic Supply Domestic Demand Price before trade Price after trade World Price Exports

INTERNATIONAL TRADE IN AN IMPORTING COUNTRY 6 Price of textiles Quantity of textiles 0 Once trade is allowed, the domestic price falls to equal the world price. The supply curve shows the amount produced domestically, and the demand curve shows the amount consumed domestically. Imports equal the difference between the domestic quantity demanded and the domestic quantity supplied at the world price. Buyers are better off (consumer surplus rises from A to A + B + D), and sellers are worse off (producer surplus falls from B + C to C). Total surplus rises by an amount equal to area D, indicating that trade raises the economic well- being of the country as a whole D Domestic Quantity Supplied Before tradeAfter tradeChange Consumer Surplus Producer Surplus Total Surplus A B+C A+B+C A+B+D C A+B+C+D +(B+D) -B +D The area D shows the increase in total surplus and represents the gains from trade Domestic Quantity Demanded C A B Domestic Supply Domestic Demand Price before trade Price after trade World Price Imports

THE EFFECTS OF A TARIFF 7 Price of textiles Quantity of textiles 0 A tariff reduces the quantity of imports and moves a market closer to the equilibrium that would exist without trade. Total surplus falls by an amount equal to area D + F. These two triangles represent the deadweight loss from the tariff. B Before tariffAfter tariffChange Consumer Surplus Producer Surplus Government Revenue Total Surplus A+B+C+D+E+F G None A+B+C+D+E+F+G A+B C+G E A+B+C+E+G -(C+D+E+F) +C +E -(D+F) The area D + F shows the fall in total surplus and represents the deadweight loss of the tariff G Imports without tariff A C Imports with tariff D F E Domestic Demand Domestic Supply Price without tariff World Price Price with tariff Q1SQ1S Q2SQ2S Q2DQ2D Q1DQ1D Tariff

TRADE CAN MAKE EVERYONE BETTER OFF BENEFITS  Increased consumer/producer surplus  Increased variety of goods  Lower costs through economies of scale  Increased competition  Enhanced flow of ideas COSTS  Loss of domestic jobs  Damage to national security  Hurts infant industries  Promotes unfair- competition Promoting Free Trade: NAFTA/GATT (WT0)

CHAPTER 31 OPEN ECONOMY MACROECONOMICS FLOW OF GOODS AND SERVICES Net exports: imports, exports Balance of trade: surplus, deficit, balanced trade (page 693- factors) FLOW OF CAPITAL: INVESTMENT ASSETS Net capital outflow = Domestic residents’ purchases of foreign assets - foreigners’ purchases of domestic assets NCO is also called net foreign investment. Foreign Direct Investment Foreign Portfolio Investment NCO = NX FA-DA = E- I

OPEN-ECONOMY MACROECONOMICS: BASIC CONCEPTS 10 THE FLOW OF CAPITAL NCO measures the imbalance in a country’s trade in assets:  When NCO > 0, “capital outflow” Domestic purchases of foreign assets exceed foreign purchases of domestic assets.  When NCO < 0, “capital inflow” Foreign purchases of domestic assets exceed domestic purchases of foreign assets.

OPEN-ECONOMY MACROECONOMICS: BASIC CONCEPTS 11 VARIABLES THAT INFLUENCE NCO 1.Real interest rates paid on foreign assets 2.Real interest rates paid on domestic assets 3.Perceived risks of holding foreign assets 4.Government policies affecting foreign ownership of domestic assets

OPEN-ECONOMY MACROECONOMICS: BASIC CONCEPTS 12 NOMINAL AND REAL EXCHANGE RATE Nominal exchange rate: the rate at which one country’s currency trades for another We express all exchange rates as foreign currency per unit of domestic currency. Appreciation and Deprecation Real exchange rate: the rate at which the goods and services of one country trade for the goods and services of another Real exchange rate = where P = domestic price P*=foreign price (in foreign currency) e = nominal exchange rate, i.e., foreign currency per unit of domestic currency e x P P*

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