International Trade

The U.S. and International Trade The sheer volume of exports and imports indicates that international trade is beneficial. Nations trade because they believe the products they receive (imports) are worth more than the products they sell (exports). Without international trade, many products would not be available on the world market. Many imports to the United States are necessities that would be unavailable without trade.

Absolute and Comparative Advantage A country has an absolute advantage when it can produce a product more efficiently than another country can. Even when one country enjoys an absolute advantage, trade between it and another country is still beneficial because of comparative advantage. A country has a comparative advantage when it produces a product relatively more efficiently. Relative efficiency is determined by the opportunity cost of producing one product over another.

The Gains from Trade Each country must produce more of the good in which it has a comparative advantage and then exchange the extra output for the extra output of its trading partners. Comparative advantage is based on the assumption that a country should produce a product that has a low opportunity cost.

Absolute and Comparative Advantage

Review A country has an absolute advantage when it can produce a product more efficiently than another country can. A country has a comparative advantage when it produces a product relatively more efficiently. Relative efficiency is determined by the opportunity cost of producing one product over another.

Absolute Advantage Example: If one unit of labor in Scotland can produce 80 units of wool or 20 units of wine; while in Spain one unit of labor makes 50 units of wool or 75 units of wine, then Scotland has an absolute advantage in producing wool and Spain has an absolute advantage in producing wine.

Comparative Advantage Example: The United States can produce 50 Units of Coal or 100 Units of Iron. For every 1 Unit of Coal the U.S. produces, they must give up producing 2 Units of Iron.

Comparative Advantage (cont.) Example: Germany can produce 20 Units of Coal or 30 Units of Iron. For every 1 Unit of Coal Germany produces, they must give up producing 1.5 Units of Iron.

Comparative Advantage Example: The United States has a higher opportunity cost for producing Coal (2 Units of Iron v. 1.5 Units of Iron), therefore Germany has a comparative advantage in coal production.

Using Production Possibility Curves Who has an absolute advantage? Who has a comparative advantage?

Trade Balance and Trade Barriers

The Two Balances Balance of Trade– the value of exports minus the value of imports (measured in terms of goods). Balance of Payments – the money a nation owes on imports minus the amount of money a nation is owed by other nations for exports (measured in terms of money).

Barriers to Trade Sometimes governments feel that they need to limit the amount of trade they have with a particular country. Types of Trade Barriers include: 1. tariffs 2. quotas 3. embargoes 4. safety/health standards 5. subsidies

Tariffs Tax on Imports. Increases the price of other nation’s goods. Domestic companies will have an advantage. Helps protect emerging domestic businesses

Quotas - Specific limit to the amount of a product a foreign nation can import. - Lessens the number of products that compete with domestic companies.

Embargoes the refusal to trade with a nation. Can cause shortages and high prices for affected products.

Standards or Subsidies Safety/ Health Standards – product requirements that make foreign products more expensive. Subsidies - type of financial government assistance, such as a grant, tax break, or trade barrier, in order to encourage the production or purchase of a good.

Embargoes the refusal to trade with a nation. Can cause shortages and high prices for affected products.

Trading Blocks and Free Trade

Trading Blocks Trade blocks are intergovernmental associations that manage and promote trade activities for specific regions of the world.

Examples EU – European Union NAFTA – North American Free Trade Agreement ASEAN - Association of Southeast Asian Nations *Each Trading Block promotes free trade between its member nations.

Arguments Against Free Trade 1. A country could become so specialized that it would end up being so dependent on other countries that it would affect national defense. 2. Could hurts new industries - new industries should be protected from foreign competition.

Arguments Against Free Trade 3. Tariffs and quotas protect domestic jobs from cheap foreign labor. 4. Keeping the money at home will limit imports and will keep American money in the United States.

Introduction to Foreign Exchange Rates

Financing International Trade Foreign exchange is the buying and selling of the currencies of different nations. The foreign exchange rate is the price of one country’s currency in terms of another country’s currency.

Exchange Rates Exchange rates can tell you the value of one nation’s goods in terms of another nations money. For instance: If the exchange rate between the U.S. and Mexico is $1=10 pesos and in Mexico they sell shirts for 30 pesos, then that shirt would cost $3 in U.S. currency.

Exchange Rate Table If a shirt cost $5 in the U.S., then what would it cost in terms of the Euro? If a DVD cost 7£ (British Pounds), then what would it cost in terms of the U.S. dollar?