2. Llad Phillips1 Introduction to Economics International Trade and Finance The US Economy

3. Llad Phillips2 Last Time: Monopoly Power Rips off Consumers Rips off Consumers Rips off Society Rips off Society Rips off Democracy Rips off Democracy

4. Llad Phillips3 Trade and California

5. Llad Phillips4 Los Angeles Times Thursday, November 15, 2001

6. Llad Phillips5 Los Angeles Times Monday, November 19, 2001

7. Llad Phillips6 Los Angeles Times Monday, November 19, 2001

8. Llad Phillips7 Los Angeles Times Monday, November 19, 2001

9. Llad Phillips8 Outline: Lecture Fifteen-Trade News: the Price of Oil News: the Price of Oil The Western Movement: Manifest Destiny The Western Movement: Manifest Destiny  Autarchy  self-sufficiency  The Advantages of Exchange  specialization The Political Economy of Trade The Political Economy of Trade  Arguments for Free Trade  Arguments Against Free Trade

10. Llad Phillips9 Barrels of Oil Price per Barrel Demand Before 9-11 Supply Price of Oil: Before and After 9-11

11. Llad Phillips10 Los Angeles Times Monday, November 19, 2001

12. Llad Phillips11 Barrels of Oil Price per Barrel Demand Before 9-11 Supply OPEC Cartel Policy: Control Supply OPEC

13. Llad Phillips12 How to Fight a Foreign Cartel Do Nothing: Hope the Cartel Breaks Down Do Nothing: Hope the Cartel Breaks Down Impose an Excise Tax Impose an Excise Tax

14. Llad Phillips13 Paying at the Gas Pump The New York Times, Thursday Oct 19, 2001

15. Llad Phillips14 Demand and Supply Quantity Price Demand Supply a

16. Llad Phillips15 Excise Tax Quantity Price Demand Supply: Price Net of Tax Tax Per Gallon a Supply: Price Includes Tax

17. Llad Phillips16 Excise Tax Quantity Price Demand Supply Tax Per Gallon a b

18. Llad Phillips17 Excise Tax Restricts Quantity Demanded Restricts Quantity Demanded Raises price Raises price

19. Llad Phillips18 Revenue Profits Before Excise Tax: Revenue Equals Price*Quantity Quantity Price Demand Supply a P Q

20. Llad Phillips19 Cost Equals Area Under Supply Curve Quantity Price Demand Supply a Cost

21. Llad Phillips20 Profit Equals Revenue Minus Cost Quantity Price Demand Supply a Profit

22. Llad Phillips21 Profit Equals Revenue Minus Cost Quantity Price Demand Supply a Cost Profit Q P

23. Llad Phillips22 Excise Tax Equals Tax/Gallon*Quantity Quantity Price Demand Supply Tax Per Gallon a b Tax Q

24. Llad Phillips23 Excise Tax Quantity Price Demand Supply Tax Per Gallon a b Tax Q Profit

25. Llad Phillips24 Excise Tax Redistributes Profits from Foreign Suppliers to Home Country Quantity Price Demand Supply Tax Per Gallon a b Tax Q Profit

26. Llad Phillips25 Tax Policy As A Weapon Excise Tax Can Restrict Quantity Demanded Excise Tax Can Restrict Quantity Demanded Excise Tax Can Shift Profits from Foreign Suppliers to Home Country Excise Tax Can Shift Profits from Foreign Suppliers to Home Country Excise Tax Can Be A Foreign Policy Weapon Excise Tax Can Be A Foreign Policy Weapon

27. Llad Phillips26 Autarchy Self-Sufficient Economy Self-Sufficient Economy  only trade within a region  Sioux, Pawnees etc. were self-sufficient  hunted and gathered their food  roamed the land and moved their homes  made their clothes  early settlers were self-sufficient: home production  grew their food  cleared the land and built their homes  made their clothes

28. Llad Phillips27 Trade Concepts Trade allows countries (and individuals) to specialize at what they do best rather than being jacks-of-all-trades. By specializing and becoming expert countries (and individuals) increase productivity and output. Trade allows countries (and individuals) to specialize at what they do best rather than being jacks-of-all-trades. By specializing and becoming expert countries (and individuals) increase productivity and output.

29. Llad Phillips28 Autarchy-continued West of the Alleghanies West of the Alleghanies  opened up to trade by Erie canal

30. Llad Phillips29 Erie Canal Completed in 1825

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33. Llad Phillips32 Labor for Manufactures Labor for Agriculture 45 0 Agriculture Manufactures Labor Constraint Production Function with diminishing returns Production Function with diminishing returns Production Functions, Labor Constraints and the Production Possibility Frontier: Land is a Fixed Factor; Diminishing Returns Production Possibility Frontier relative price of agricultural goods to manufactured goods depends on demand as well as supply Source: Lecture Thirteen

34. Llad Phillips33 Agriculture Manufactures Isolated West Production Possibility Frontier, PPF Regional Tastes: manufactures are scarce and hard to make, i.e. valuable

35. Llad Phillips34 The Slope of the Production Possibility Frontier Recall: the slope of the production possibility frontier reveals relative values Recall: the slope of the production possibility frontier reveals relative values  rate of exchange: 2 beaver pelts for every mink pelt  if beaver pelts sell for 1 dollar, then mink pelts are worth 2 dollars

36. Llad Phillips35 Mink Days 3 6 Beaver Days 36 45 0 1 2 12 Beavers Minks Labor Constraint Production Function Production Function Production Functions, Labor Constraints and the Production Possibility Frontier: No Fixed Factor Production Possibility Frontier One mink is worth, or trades for, two beavers: prices are determined by labor inputs source: Lecture Thirteen

37. Llad Phillips36 Beavers Minks 1 2 1 slope: B/ M = 2 = P M /P B = MC M /MC B

38. Llad Phillips37 Agriculture Manufactures Isolated West Production Possibility Frontier, PPF Regional Tastes: manufactures are scarce and hard to make, i.e. valuable steep slope, Ag/ Mf = P Mf /P Ag, so manufactures are dear Q Mf Q Ag

39. Llad Phillips38 Trade for a Small Region The West takes Eastern trade prices as given The West takes Eastern trade prices as given  after canals open up transportation and goods are exchanged In the East, manufactures are more plentiful and agricultural goods are scarcer In the East, manufactures are more plentiful and agricultural goods are scarcer  Ag/ Mf = P Mf /P Ag, is less steep, i.e in the East, manufactures are less expensive relative to agricultural goods  the East has a comparative advantage in manufactures and the West has a comparative advantage in agriculture

40. Llad Phillips39 Agriculture Manufactures West Trades with the East Production Possibility Frontier, PPF Regional Tastes: steep slope, Ag/ Mf = P Mf /P Ag, so manufactures are dear Eastern Prices: Ag/ Mf = P Mf /P Ag

41. Llad Phillips40 Agriculture Manufactures Trade Allows the West to Specialize in Agriculture Production Possibility Frontier, PPF Regional Tastes: steep slope, ∆Ag/∆Mf = P Mf /P Ag, so manufactures are dear Eastern Prices: Ag/ Mf = P Mf /P Ag A B Specialize in Ag at B

42. Llad Phillips41 Trade Permits the Decoupling of Consumption from Production In the self-sufficient West, people had to produce what they consumed. In the self-sufficient West, people had to produce what they consumed. When trade opened up with the East, the West could specialize in producing agricultural goods and import, i.e. trade for manufactures When trade opened up with the East, the West could specialize in producing agricultural goods and import, i.e. trade for manufactures

43. Llad Phillips42 Agriculture Manufactures Trade Allows the West to Decouple Production & Consumption Production Possibility Frontier, PPF Regional Tastes: Eastern Prices: Ag/ Mf = P Mf /P Ag A B C Q Mf Q Ag C Mf C Ag Exports Imports

44. Llad Phillips43 The Political Economy of Trade Arguments for Free Trade Arguments for Free Trade Arguments Against Free Trade Arguments Against Free Trade

45. Llad Phillips44 International Trade: Pro & Con Can’t compete with low wages abroad Can’t compete with low wages abroad jobs are lost abroad jobs are lost abroad need to protect infant industries need to protect infant industries need to protect strategic industries need to protect strategic industries excessive specialization excessive specialization unfair competition unfair competition Consumers gain from more goods Consumers gain from more goods competition keeps industry progressive competition keeps industry progressive Con Pro

46. Llad Phillips45 Summary-Vocabulary-Concepts autarchy/self-sufficiency autarchy/self-sufficiency production possibility frontier production possibility frontier exchange of goods exchange of goods comparative advantage comparative advantage specialization specialization export export import import Comparative sdvantage Comparative sdvantage

47. Llad Phillips46 Outline: Lecture Fifteen Trade, domestic and foreign Trade, domestic and foreign Balance of Payments Accounting Balance of Payments Accounting Purchasing Power Parity Purchasing Power Parity Central Bank Reserves & Foreign Exchange Intervention Central Bank Reserves & Foreign Exchange Intervention

48. Llad Phillips47 Balance of Payments Concepts Balance of Merchandise Trade Balance of Merchandise Trade  Value of what we sell minus what we buy Balance of Trade (Goods & Services) Balance of Trade (Goods & Services) Balance on Current Account Balance on Current Account  net of transfer payments  net of income on investments If we buy more than we sell on current account, then we pay for it with the capital account If we buy more than we sell on current account, then we pay for it with the capital account On capital account we sell IOU’s, I.e bonds On capital account we sell IOU’s, I.e bonds

49. Llad Phillips48 Balance of Payment Accounts We are called a debtor nation if we are selling IOU’s to pay for goods and services We are called a debtor nation if we are selling IOU’s to pay for goods and services As a debtor nation, we are vulnerable to foreigners selling their US assets and repatriating their money, called capital flight As a debtor nation, we are vulnerable to foreigners selling their US assets and repatriating their money, called capital flight

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51. Llad Phillips50 Growth in World Trade Source: Economic Report of the President, 1997 http://www.gpo.ucop.edu/catalog/erp97.html

52. Llad Phillips51 Http://www.yardeni.com

53. Llad Phillips52 Measuring the Balance of Trade Merchandise Balance of Trade: goods Merchandise Balance of Trade: goods Balance of Trade ( Net Exports) : add services Balance of Trade ( Net Exports) : add services Balance on Current Account: Balance on Current Account:  first: add net transfer payments  second: add income from US assets abroad

54. Llad Phillips53 Balance of Payments Merchandise Trade Balance Merchandise Trade Balance  Exports of Goods  capital goods, except automotive: 41%  industrial supplies and materials: 24%  consumer goods, except automotive: 11%  automotive vehicles, engines & parts: 11%  foods, feeds, beverages: 9%

55. Llad Phillips54 Balance of Payments (Cont.)  Imports of Goods  capital goods, except automotive: 29%  industrial supplies and materials: 25%  consumer goods, except automotive: 21%  automotive vehicles, engines & parts: 16%  foods, feeds, beverages: 4%

56. Llad Phillips55 Source: CIA

57. Llad Phillips56 Source: US Dept. of Commerce, Survey of Current Business

58. Llad Phillips57 Source: Economic Report of the President, 1997

59. Llad Phillips58 Balance of Payments Merchandise Trade Balance Merchandise Trade Balance Balance of Trade: Net Exports(component of GNP) Balance of Trade: Net Exports(component of GNP)  Exports of Goods and Services  other private services: 31%  travel: 30%  royalties and license fees: 13%  Imports of Goods and Services  travel: 31%  other private services: 27%  other transportation: 18%

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62. Llad Phillips61 Balance of Payments Merchandise Trade Balance: Goods Merchandise Trade Balance: Goods Balance of Trade: Goods & Services Balance of Trade: Goods & Services Balance on Current Account Balance on Current Account  Exports of goods & services plus net transfer payments plus US income on assets abroad  Imports of goods & services plus net transfer payments plus foreign income on assets in US  transfers US Government grantsUS Government grants US Government pensions & otherUS Government pensions & other private remittancesprivate remittances

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65. Llad Phillips64 Balance of Payments Merchandise Trade Balance: Goods Merchandise Trade Balance: Goods Balance of Trade: Goods & Services Balance of Trade: Goods & Services Balance on Current Account Balance on Current Account  Exports of goods & services plus net transfer payments plus US income on assets abroad  US income on assets abroad direct investment receiptsdirect investment receipts other private receiptsother private receipts US government receiptsUS government receipts  Imports of goods & services plus net transfer payments plus foreign income on assets in US  transfers  payments to foreign assets in the US

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68. Llad Phillips67 DebtorNation Creditor Nation 

69. Llad Phillips68 How Do We Pay Balance on Current Account? We Sell Bonds to Foreign Investors We Sell Bonds to Foreign Investors Capital Account, 1996 Capital Account, 1996  Foreign Assets in the US, net change (Capital Inflow)  foreign official assets in the US, net: $ 122354 M  other foreign assets in the US, net: $ 425201 M  US Assets Abroad, net change (Capital Outflow)  US official reserves, net $ -6668 M  other US Government Assets, net $ -690 M  US private assets, net: $ 358422 M

70. Llad Phillips69 Capital Inflow: receipts from sale of US bonds & assets Relation Between Capital Account and Current Account + Stock of US Assets Abroad Interest Rate Interest Receipts on US Assets Stock of Foreign Assets in US Interest Rate Interest Payments on Foreign Assets Components of Current Account  Capital Outflow: payments for foreign bonds & assets     Stock of US Assets Abroad capital account component

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72. Llad Phillips71 DebtorNation  CreditorNation

73. Llad Phillips72 Purchasing Power Parity Concept In the long run, the exchange rate should reflect purchasing power as measured by relative prices (relative price indices) in the two countries In the long run, the exchange rate should reflect purchasing power as measured by relative prices (relative price indices) in the two countries

74. Llad Phillips73 Puchasing Power Parity Exchange Rate Ought to Reflect Puchasing Power Exchange Rate Ought to Reflect Puchasing Power  a bundle of goods that costs $1000 dollars in the US should be purchasable for $1000 dollars in Japan  food, clothing, shelter, etc. Exchange Rate:123.30 yen to the dollar Exchange Rate:123.30 yen to the dollar  $1000 =123,300 yen  so 119,600 yen should buy in Japan what $1000 buys in US Price of the dollar is 123.3 yen Price of the dollar is 123.3 yen

75. Llad Phillips74 Price of $ Quantity of $ Market for Foreign Exchange in Japan Demand for $ Supply of $ 123.3 yen

76. Llad Phillips75 Purchasing Power Parity real exchange rate equals nominal exchange rate divided by relative prices for a bundle of goods real exchange rate equals nominal exchange rate divided by relative prices for a bundle of goods  real x-ch rate = 123.3 yen per $ ÷(CPI Japan /CPI US ) For Example, if there is inflation in Mexico, then the number of pesos to buy a $ should increase For Example, if there is inflation in Mexico, then the number of pesos to buy a $ should increase  real x-ch rate = 9.1575 pesos per $ ÷(CPI Mex /CPI US )

77. Llad Phillips76 Source:Yardeni

78. Llad Phillips77 Source: International Monetary Fund, International Financial Statistics Yearbook, 1996

79. Llad Phillips78 Source: OECD

80. Llad Phillips79 Link Between Government Deficits and Trade Deficits

81. Llad Phillips80 US Govt. runs a deficit US Govt. runs a deficit  citizens don’t want higher taxes US Treasury finances deficit by selling treasuries US Treasury finances deficit by selling treasuries  US citizens & institutions buy in primary market  foreign citizens & institutions buy in primary market Why do foreigners invest in US? Why do foreigners invest in US?  politically stable country  may be attracted by:  low US inflation rate  high US interest rate

82. Llad Phillips81 US Govt Deficit Treasury Issues Bonds Foreigners Buy Bonds Foreign Concern with US Inflation Foreign Concern with US Interest Rates FederalReserve Central Bank Responsibilities: Domestic and Foreign

83. Llad Phillips82 Capital Flight 1. foreigners sell their US securities 2. foreigners exchange their US $ proceeds for Yen 3. Supply of dollars shifts and price of the dollar falls Yen price of US $ quantity of $ demand for $ supply of $ 4. Federal Reserve may use its Yen Reserves to buy $, stabilize x-ch rate

84. Llad Phillips83 Mexico in 1995 Salinas Government runs a deficit Salinas Government runs a deficit  spending domestically to “buy” the election burst of inflation burst of inflation capital flight from peso capital flight from peso  Mexicans sell pesos and demand $  demand for $ increases, peso price of $ rises forces devaluation forces devaluation

85. Llad Phillips84 Demand for $ Quantity of $ Peso Price of the $ Supply of S Flight of Pesos from Mexico

86. Llad Phillips85 Source:Yardeni

87. Llad Phillips86 Source: International Monetary Fund, International Financial Statistics Yearbook, 1996

88. Llad Phillips87 Thailand in 1997 Production down Production down  Toyota shuts down 2 large factories in Bangkok Banks hold bad loans Banks hold bad loans  speculation in golf courses, condos, high rises West worries: potential Intl. financial crisis West worries: potential Intl. financial crisis International Monetary Fund: bailout loans International Monetary Fund: bailout loans  Indonesia: $10 B  US Treasury pledges $3B  Thailand: $22 B  Philippines: $1B  South Korea: $40B source: Business Week 11-17-97

89. Llad Phillips88 Changing Scenario in Asia Source: Economic Report of the President, 1997 Four Tigers: Hong Kong, Taiwan, Singapore, South Korea Thailand and Neighbors: China, Malaysia, Indonesia

90. Llad Phillips89 source: Federal Reserve Bank of St. Louis

91. Llad Phillips90 source: CIA

92. Llad Phillips91 Source: http://interactive.wsj.com

93. Llad Phillips92 Source: Yardeni ‘94 Exports: Manufactures: 73% Partners: US 21% Japan 17%

94. Llad Phillips93 Source: Yardeni

95. Llad Phillips94 Summary-Vocabulary-Concepts merchandise trade balance merchandise trade balance balance of trade balance of trade balance on current account balance on current account creditor nation creditor nation debtor nation debtor nation income on US assets abroad income on US assets abroad payments on foreign assets in US payments on foreign assets in US capital account capital account capital inflow capital inflow capital outflow capital outflow balance of payments balance of payments purchasing power parity purchasing power parity real exchange rate real exchange rate Mexican Peso Mexican Peso Japanese Yen Japanese Yen Thailand Baht Thailand Baht capital flight capital flight devaluation devaluation