2. Motive for Trading People expect to gain by trading with other people. They hope to receive a good or service that is more valuable than whatever they trade away.

3. Interdependence Every day you rely on many people from around the world, most of whom you do not know, to provide you with the goods and services you enjoy. coffee from Kenya dress shirt from China cell phone from Taiwan hair gel from Cleveland, OH

4. Interdependence Trade can make everyone better off. We will now learn why people – and nations – choose to be interdependent, and how they gain from trade.

5. Our Example Two countries: the U.S. and Japan Two goods: computers and wheat One resource: labor, measured in hours We will look at how much of both goods each country produces and consumes –if the country chooses to be self-sufficient –if it trades with the other country

6. Trade Makes Both Countries Better Off U.S. consumption without trade consumption with trade gains from trade computers wheat Japan consumption without trade consumption with trade gains from trade computers wheat

7. Production Possibilities in the U.S. The U.S. has 50,000 hours of labor available for production, per month. Producing one computer requires 100 hours of labor. Producing one ton of wheat requires 10 hours of labor.

8. 4,000 100 5,000 2,000 1,000 3,000 500200 300400 0 Computers Wheat (tons) The U.S. PPF The U.S. has enough labor to produce 500 computers, or 5000 tons of wheat, or any combination along the PPF.

9. 4,000 100 5,000 2,000 1,000 3,000 500200 300400 0 Computers Wheat (tons) The U.S. Without Trade Suppose the U.S. uses half its labor to produce each of the two goods. Then it will produce and consume 250 computers and 2500 tons of wheat.

10. Japan has 30,000 hours of labor available for production, per month. Producing one computer requires 125 hours of labor. Producing one ton of wheat requires 25 hours of labor. 9 Production Possibilities in Japan

11. Computers Wheat (tons) 2,000 1,000 200 0 100 300 Japan’s PPF Japan has enough labor to produce 240 computers, or 1200 tons of wheat, or any combination along the PPF.

12. Japan Without Trade Computers Wheat (tons) 2,000 1,000 200 0 100 300 Suppose Japan uses half its labor to produce each of the two goods. Then it will produce and consume 120 computers and 600 tons of wheat.

13. Consumption With and Without Trade Without trade, –U.S. consumers get 250 computers and 2500 tons wheat. –Japanese consumers get 120 computers and 600 tons wheat. We will compare consumption without trade to consumption with trade. First, we need to see how much of each good is produced and traded by the two countries.

14. 4,000 100 5,000 2,000 1,000 3,000 500200 300400 0 Computers Wheat (tons) U.S. Production With Trade Producing 3400 tons of wheat requires 34,000 labor hours. The remaining 16,000 labor hours are used to produce 160 computers. Let’s say the U.S. wants to produce 3,400 tons of wheat.

15. Japan’s Production With Trade Producing 240 computers requires all of Japan’s 30,000 labor hours. Computers Wheat (tons) 2,000 1,000 200 0 100 300 So, Japan would produce 0 tons of wheat. Let’s say that Japan wants to produce 240 Computers.

16. International Trade Exports: goods produced domestically and sold abroad Imports: goods produced abroad and sold domestically

17. Consumption under trade How much of each good is consumed in the U.S.? How much of each good is consumed in Japan? 16 Suppose the U.S. exports 700 tons of wheat to Japan, and imports 110 computers from Japan. (So, Japan imports 700 tons wheat and exports 110 computers.)

18. 4,000 100 5,000 2,000 1,000 3,000 500200 300400 0 Computers Wheat (tons) U.S. Consumption With Trade computerswheat produced1603400 + imported 1100 – exported 0700 = amount consumed 2702700

19. Japan’s Consumption With Trade Computers Wheat (tons) 2,000 1,000 200 0 100 300 computerswheat produced2400 + imported0700 – exported1100 = amount consumed 130700

20. Trade Makes Both Countries Better Off U.S. consumption without trade consumption with trade gains from trade computers25027020 wheat2,5002,700200 Japan consumption without trade consumption with trade gains from trade computers12013010 wheat600700100

21. Two Measures of the Cost of a Good Two countries can gain from trade when each specializes in the good it produces at lowest cost. Recall: Another measure of cost is opportunity cost. In our example, the opportunity cost of a computer is the amount of wheat that could be produced using the labor needed to produce one computer.

22. Opportunity Cost and Comparative Advantage Comparative advantage: the ability to produce a good at a lower opportunity cost than another producer Which country has the comparative advantage in computers? To answer this, must determine the opp. cost of a computer in each country.

23. Opportunity Cost and Comparative Advantage The opp. cost of a computer is –10 tons of wheat in the U.S., because producing one computer requires 100 labor hours, which instead could produce 10 tons of wheat. –5 tons of wheat in Japan, because producing one computer requires 125 labor hours, which instead could produce 5 tons of wheat. So, Japan has a comparative advantage in computers.

24. Comparative Advantage and Trade Differences in opportunity cost and comparative advantage create the gains from trade. When each country specializes in the good(s) in which it has a comparative advantage, total production in all countries goes up, the world’s “economic pie” is bigger, and all countries can gain from trade. The same applies to individual producers (like the farmer and the rancher specializing in different goods and trading with each other).

25. Unanswered Questions…. We made a lot of assumptions about the quantities of each good that each country produces, trades, and consumes, and the price at which the countries trade wheat for computers. In the real world, these quantities and prices would be determined by the preferences of consumers and the technology and resources in both countries. For now, though, our goal was only to see that trade, indeed, can make everyone better off.

26. Other Benefits of International Trade Consumers enjoy increased variety of goods. Producers sell to a larger market and may achieve lower costs through economies of scale. Competition from abroad may reduce market power of some firms and lead to lower prices. Trade enhances the flow of ideas, facilitates the spread of technology around the world.

27. Why Do People Trade? Trade Is the Voluntary Exchange of Goods and Services among individuals and businesses. International Trade & Globalization

28. Globalization is a process of interaction and integration among people, companies, and governments of different nations.

29. Then Why All the Opposition to Trade? Recall “Trade can make everyone better off”. The losses are often highly concentrated among very few people, who feel them acutely. The gains are often spread thinly over many people, who may not see how trade benefits them. Hence, the losers have more incentive to organize and lobby for trade restrictions/barriers. Individuals and actions taken to restrict free trade between countries are called protectionists or protectionism.

30. Trade Restrictions or Barriers 1. Tariff: a tax on imports Example: Cotton shirts World Price = $20 Tariff: T = $10/shirt Consumers must pay $30 for an imported shirt. So, domestic producers can charge $30 per shirt. In general, the price facing domestic buyers & sellers equals (WP + T ). A tariff creates revenue for the govt.

31. 2. An import quota is a limit on the # of imports. Mostly, has the same effects as a tariff: –raises price, reduces quantity of imports –Increases cost to consumers –Increases profits to sellers A quota creates profits for the foreign producers of the imported goods, who can sell them at higher price.

32. Other trade restrictions/barriers 3. Embargo – a quota set at zero; govt. prohibits import of item. (political) 4. Standards – Govt. imposed to ensure safety of imports 5. Subsidies – Govt. makes payments to local suppliers to reduce the production costs of the supplier. Lower production costs should allow suppliers to charge less….make more competitive with foreign suppliers

33. Arguments for Restricting Trade 1. The jobs argument Trade destroys jobs in industries that compete with imports. Economists’ response: Look at the data to see whether rising imports cause rising unemployment…

34. U.S. Imports & Unemployment, decade averages, 1956-2005 0% 2% 4% 6% 8% 10% 12% 14% 16% 1956 -65 1966 -75 1976 -85 1986 -95 1996 -2005 imports (% of GDP) unemployment (% of labor force)

35. Arguments for Restricting Trade cont’d 1. The jobs argument cont’d Trade destroys jobs in the industries that compete against imports. Economists’ response: Total unemployment does not rise as imports rise, because job losses from imports are offset by job gains in export industries. Even if all goods could be produced more cheaply abroad, the country need only have a comparative advantage to have a viable export industry and to gain from trade.

36. Arguments for Restricting Trade cont’d. 2. The national security argument An industry vital to national security should be protected from foreign competition, to prevent dependence on imports that could be disrupted during wartime. Economists’ response: Producers may exaggerate their own importance to national security to obtain protection from foreign competition.

37. Arguments for Restricting Trade cont’d. 3. The infant-industry argument A new industry argues for temporary protection until it is mature and can compete with foreign firms. Economists’ response: Difficult for govt to determine which industries will eventually be able to compete, and whether benefits of establishing these industries exceed cost to consumers of restricting imports. Besides, if a firm will be profitable in the long run, it should be willing to incur temporary losses.

38. Arguments for Restricting Trade cont’d. 4. The unfair-competition argument Producers argue their competitors in another country have an unfair advantage, e.g. due to govt subsidies. Economists’ response: Great! Then we can import extra-cheap products subsidized by the other country’s taxpayers. The gains to our consumers will exceed the losses to our producers.

39. Arguments for Restricting Trade cont’d 5. The protection-as-bargaining-chip argument Example: The U.S. can threaten to limit imports of French wine unless France lifts their quotas on American beef. Economists’ response: Suppose France refuses…..then what do we do?

40. Mexican Truck Feud 3/09 MEXICO CITY/WASHINGTON (Reuters) - Mexico slapped tariffs on 90 American agricultural and manufactured exports on Monday in retaliation for Washington's move to block Mexican trucks from using U.S. highways. Mexican Economy Minister Gerardo Ruiz said about $2.4 billion worth of exports from 40 U.S. states would be affected and that his government would soon publish a list of them. Last week, the U.S. Congress canceled funding for a test program begun by the Bush administration that allowed Mexican long-haul trucks to circulate in the United States in compliance with the North American Free Trade Agreement. Among goods affected by the retaliatory move are some fruits and vegetables, wine, juices, sunglasses, toothpaste and coffee, according to a government statement. Most tariffs are 10 percent to 20 percent, with some produce subject to a 45 percent charge.goodsMost

41. Trade Agreements (More Free Trade) A country can liberalize trade with –unilateral reductions in trade restrictions –multilateral agreements with other nations Examples of trade agreements: –North American Free Trade Agreement (NAFTA), 1993 –European Union (EU) – 1993 - 27 countries. 21 use the Euro. World Trade Organization (WTO) est. 1995, enforces trade agreements, resolves disputes

42. Who Do We Trade With?

45. Why do we trade with neighbors? 1. Geographic proximity 2. Lower shipping costs 3. Usually have trade agreements 4. Many have common cultures

47. Balance of Trade When a nation exports more than it imports, it has a trade surplus. When a nation imports more than it exports, it creates a trade deficit. The relationship between a nation’s imports and its exports is called its balance of trade.

49. The United States Trade Deficit The Trade Deficit –The United States has run a trade deficit since the early 1970s Why the Trade Deficit? –Imports of foreign oil as well as Americans’ enjoyment of imported goods account in part for the large American trade deficit Reducing the Trade Deficit –Quotas and other trade barriers can be used to raise prices of foreign-made goods and urge consumers to buy domestic goods.

50. Foreign Exchange

51. Exchange rate is the price of one nation’s currency in terms of another nation’s currency.

52. When foreign products are purchased in a country, it is paid for with the currency of that country. Exchange Rates and International Markets Multinational firms convert currencies on the foreign exchange market, a network of about 2,000 banks and other financial institutions.

53. Exchange rates, like other prices, are determined by the forces of supply and demand.

54. When the exchange rate between two currencies changes, the prices of goods and services traded among countries using those currencies change.

55. Reading an Exchange Rate Table

56. Types of Exchange Rate Systems Fixed Exchange-Rate Systems A currency system in which governments try to keep the values of their currencies constant against one another is called a fixed exchange- rate system. Flexible Exchange-Rate Systems Flexible exchange-rate systems allow the exchange rate to be determined by supply and demand.

57. What is a Strong Dollar? The value of the dollar rises compared to one or more other currencies. More foreign currency is necessary to purchase U.S. dollars The value of the dollar is appreciating

58. Who is helped by a Strong Dollar? U. S. consumers -because the prices of foreign goods and services are lower U. S. investors who invest in companies in other nations – because the price of foreign securities decreases U. S. importers – because they can sell foreign goods and services at lower prices

59. Who is hurt by a Strong dollar? U.S. producers – because they are competing with imports at lower prices Foreign consumers – because U.S. goods and services are more expensive for them to purchase. U. S. Exporters – because U.S. goods and services become more expensive for foreign consumers

60. What is a Weak dollar? The value of the dollar falls compared to one or more other currencies. More U.S. dollars are necessary to purchase foreign currency The value of the dollar is depreciating

61. Who is helped by a weak dollar? U.S. producers – because they are competing with imported g & s at higher- prices Foreign consumers – because they can buy U.S. goods and services at lower prices U.S. Exporters – for foreign consumers, U.S. G & S become less expensive

62. Who is hurt by a weak dollar? U. S. Consumers – Because the prices of foreign goods and services increase. U. S investors who invest in companies in other nations – because the price of foreign securities increase Foreign exporters – because the prices of foreign goods and services are higher