Chapter 6: The United States in the Global Economy AP Macroeconomics Chapter 6: The United States in the Global Economy

International Linkages

Trade Flows Goods and services flow Capital and labor flow Information and tech flow

Dependence Products we must import Bananas, coffee, cocoa, tea…

GDP Gross Domestic Product Market value of all goods and services produced in one country in a year

Trade Patterns US currently in a trade deficit Current trade surplus in services

Trade Patterns Canada;US largest partner Largest deficit with China US major dependence on foreign oil

Specialization and Comparative Advantage

Specialization US produces more exports and fewer imports Example: More resources for aircraft, and wheat. Less for automobiles and clothes “Do shifts in resources like these make economic sense? Do they enhance US total output and thus the US standard of living?”

YES! Specialization and exchange result in greater output “It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy . . . . If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.” -Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776

Comparative Advantage (CA) A nation has a CA when it can produce a product at a lower domestic opportunity cost than a potential trading partner

Absolute Advantage Ability to produce more of a good or service than competitors, using the same amount of resources

Comparative Cost A nation must give up an amount of one product to secure another

Comparative Cost Example Question: What are the comparative costs of avocados and soybeans in Mexico? Answer: By comparing production alternatives A and B, we see that 5 tons of soybeans (=15-10) must be sacrificed to produce 20 tons of avocados (=20-0). 1S=4A

Comparative Cost Example Meanwhile the US production alternatives R and S reveals it costs 10 tons of soybeans (=30-20) to obtain 30 tons of avocados (=30-0) 1S=3A Which nation has a comparative advantage in soybeans?

Comparative Cost Example The US has advantage over Mexico in soybeans US forgoes 3 tons of avocados while Mex forgoes 4 tons Who has the Comparative advantage in avocados?

Comparative Cost Example 1 ton of avocados costs 1/3 ton of soybeans in US, it is only ¼ ton of soybeans in Mexico Soybeans Avocados Mexico: Must give up 4 tons of avocados to get 1 ton of soybeans. United States: Must give up 3 tons of avocados to get 1 ton of soybeans Comparative Advantage: United States Mexico: Must give up ¼ ton of soybeans to get 1 ton of avocados. United States: Must give up 1/3 ton of soybeans to get 1 ton of avocados. Comparative Advantage: Mexico

Input Method Deals with amount of resources needed to produce one unit of output Time required to produce one radio Time required to produce one bushel of wheat Ted 20 minutes 5 minutes Nancy 30 minutes 15 minutes Who has an absolute advantage in production of radios? Wheat? Ted

Input Method ORIGINAL Time required to produce one radio Time required to produce one bushel of wheat Ted 20 minutes 5 minutes Nancy 30 minutes 15 minutes EQUATION Time required to produce one radio Time required to produce one bushel of wheat Ted 20 mins . 1 radio = 5 mins = 4 bushels 5 mins . 1 wheat = 20 mins = ¼ radio Nancy 30 mins . 1 radio = 15 mins = 2 bushels 15 mins . 1 wheat = 30 mins = ½ radio

Input Method Who has the comparative advantage in radios? Who has the comparative advantage in wheat? What should be the next stop for Ted and Nancy? Nancy Ted EQUATION Time required to produce one radio Time required to produce one bushel of wheat Ted 20 mins . 1 radio = 5 mins = 4 bushels 5 mins . 1 wheat = 20 mins = ¼ radio Nancy 30 mins . 1 radio = 15 mins = 2 bushels 15 mins . 1 wheat = 30 mins = ½ radio

Output Method Amount of output that can be produced with a given amount of input (time) Radios produced per hour Wheat produced per hour Ted 60 mins . 20 mins = 3 radios 60 minutes 5 minutes = 12 bushels Nancy 60 minutes . = 2 radios 30 minutes 60 minutes . = 4 bushels 15 minutes Who has the absolute advantage? What about the OC to produce each item? Ted

Opportunity Cost of Production ORIGINAL Radios produced per hour Wheat produced per hour Ted 60 mins . 20 mins = 3 radios 60 minutes 5 minutes = 12 bushels Nancy 60 minutes . = 2 radios 30 minutes 60 minutes . = 4 bushels 15 minutes OC of Production OC of producing one radio OC of producing one bushel of wheat Ted 3 radios = 1 hour = 12 bushels 1 radio = 12/3 = 4 bushels 12 bushels = 1 hour = 3 radios 1 bushel= 3/12 = ¼ radio Nancy 2 radios = 1 hour = 4 bushels 1 radio = 4/2 = 2 bushels 4 bushels = 1 hour = 2 radios 1 bushel = 2/4 = ½ radio

Opportunity Cost of Production Who has the CA in radios? Who has the CA in wheat? Nancy Ted OC of Production OC of producing one radio OC of producing one bushel of wheat Ted 3 radios = 1 hour = 12 bushels 1 radio = 12/3 = 4 bushels 12 bushels = 1 hour = 3 radios 1 bushel= 3/12 = ¼ radio Nancy 2 radios = 1 hour = 4 bushels 1 radio = 4/2 = 2 bushels 4 bushels = 1 hour = 2 radios 1 bushel = 2/4 = ½ radio

Please make a Production Possibilities Frontier from the data listed GRAPH TIME! Please make a Production Possibilities Frontier from the data listed ORIGINAL Radios produced per hour Wheat produced per hour Ted 60 mins . 20 mins = 3 radios 60 minutes 5 minutes = 12 bushels Nancy 60 minutes . = 2 radios 30 minutes 60 minutes . = 4 bushels 15 minutes

Terms of Trade Allows nations to grow beyond their own means Improves global resource allocation

The Foreign Exchange Market The Multiple Currency Issue

Foreign Exchange Market Various currencies are exchanged for one another Exchange rate: rate one currency is exchanged for another

Linkages to Domestic and Foreign Prices Multiply the product price by the exchange rate Example: Dollar to yen rate is $.01 per yen, therefore ¥20,000 costs $200

Changing Rates Depreciation: Dollar loses value to other currency Appreciation: Dollar gains value

Government and Trade

Trade Impediments and Subsidies (1/4) Protective Tariffs Designed to shield domestic producers from foreign competition

Trade Impediments and Subsidies (2/4) Import Quotas (more effective than tariffs) Limits quantities of specific products

Trade Impediments and Subsidies (3/4) Nontariff Barriers Custom limitations by bureaucratic red tape through licenses and standards

Trade Impediments and Subsidies (4/4) Export Subsidies Government payments to domestic producers of export goods Reduces production costs, enables more product to sell

Why Interventions? Misunderstandings Political considerations Cost to society

Multilateral Trade Agreements And Free Trade Zones

Trade Wars When one nation intervenes others may reciprocate Example: Smoot-Hawley Act of 1930 placed high tariffs which other nations raised theirs, one cause of Great Depression

Reciprocal Trade Agreements Act (1934) Lowered US tariffs by Negotiating authority: Authorized President to negotiate agreements Generalized reductions: “most-favored-nation clause” favored trade with close allies

World Trade Organization (WTO) 145 nations Rules on trade disputes Advises on environmental and wage issues

The European Union (EU) Created Euro trade bloc (free-trade zone) Brings together common identity, economic interests, trade rules

The Euro Common currency used in participating nations Helps consumers and businesses to conduct trade

North American Free Trade Agreement (NAFTA) Free-trade zone between Canada, Mexico, and US Elimination of tariffs Critics fear loss of US jobs

Global Competition Globalization Trend to integrate industry, commerce, communication, travel and culture throughout the world Critics worry about impact on environment, workers, poor, competition