Trading With Other Nations Economics Chapter 18

Imports Imports are goods bought from other countries for domestic use. Roughly 13% of GDP in the US.

Exports Exports are goods sold to other countries.

Differences Among Nations Nations benefit from world trade because each differs in the type and amount of the factors of production it has available for use.

Absolute Advantage Absolute advantage is the ability of one country, using the same quantity of resources as another, to produce a particular product at a lower absolute cost. Specialization is a concept that a nation should produce and export a limited assortment of goods for which it is particularly suited in order to remain profitable.

Comparative Advantage Comparative advantage is the ability of a country to produce a product at a lower opportunity cost than another country.

Comparative Advantage Two men live alone in an isolated island. To survive they must undertake a few basic economic activities like water carrying, fishing, cooking and shelter construction and maintenance. The first man is young, strong, and educated and is faster, better, more productive at everything. He has an absolute advantage in all activities. The second man is old, weak, and uneducated. He has an absolute disadvantage in all economic activities. In some activities the difference between the two is great; in others it is small. Is it in the interest of either of them to work in isolation? No, specialization and exchange (trade) can benefit both of them. How should they divide the work? According to comparative, not absolute advantage: the young man must spend more time on the tasks in which he is much better and the old man must concentrate on the tasks in which he is only a little worse. Such an arrangement will increase total production and/or reduce total labor. It will make both of them richer. Let's break this down into a simple example. You have two firms that both produce two main products: ice cream and bicycles. The first firm, The Danish Ice Cream and Bicycle Co., is located in Denmark, where dairy milk is abundant; the second firm, The Gobi Ice Cream and Bicycle Co., is smack in the middle of the Gobi Desert. The Gobi Ice Cream and Bicycle Co. must expend a lot of money to make ice cream, whereas The Danish Ice Cream and Bicycle Co. spends way less to produce the same amount. The two firms are dead even in their production costs for bicycles. Since The Danish Ice Cream and Bicycle Co. has a comparative advantage with ice-cream production, it should probably consider turning exclusively to ice cream. Along the same vein, The Gobi Ice Cream and Bicycle Co. should probably give up the ice cream and focus on the product in which it is the least disadvantaged (bicycles).

Financing World Trade Medium of Exchange US Mexico India Japan Dollar Peso India Rupee Japan Yen

Exchange Rate Exchange Rate What the price of their country’s currency is in terms of another nation’s currency.

Currency Calculators Exchange Rates

Exchange Rate Formula Exchange Rate Formula Y to X Exchange rate = 1 / X to Y exchange rate. Japan to U.S. exchange rate = 1 / U.S. to Japan exchange rate $1 = 117Y (this is the U.S. to Japan rate) Japan to U.S. = 1 / 117 = .00854 A TV that costs 20,000Y costs $170.80 (20,000 x .00854)

Exchange Rate Example Remember Y to X exchange rate = 1 / X to Y exchange rate. The Canadian dollar is worth .67 U.S. dollars. Canada to U.S. exchange rate is .67 How many Canadian dollars can we buy with one U.S. dollar? U.S to Canada exchange rate = 1 / Canada to U.S. exchange rate. U.S. to Canada = 1 / .67 = 1.4925 = $1.49 So one U.S. dollar can get $1.49 in Canadian Funds.

Rate Exchange Example Let's take the Japanese Yen for example. 1 American Dollar equals 106.82 Yen. That means that converted to Yen, $1.00 can buy 106.82Y worth of Japanese goods. Now, let's learn to calculate. First, we know that 106.82Y equals $1.00, but what would be the U.S. dollar-Yen exchange rate?? 106.82 is not right! You divide 1.00 into 106.82 which equals 0.009 cents per 1 Yen. That is not even 1 penny's worth per Yen in Japan. Okay, now that I have confused some of you. Let's take a TV bought in Japan. We have bought a Sanyo TV which costs $20,000Y in Japan. How much is that in American dollars you ask? Let's calculate. Remember that 0.009 cents equals 1 Yen. So, we just take 0.009 multiplied by 20,000 which equals $180.00 U.S. dollars. That wasn't so bad now was it?? This conversion goes for ALL exchange rates whether it is Euros, Pounds, Francs, etc.

Fixed Exchange Rate From 1944-early 1970s foreign exchange markets used a fixed exchange rate. A system under which a national government set the value of its currency in relation to a single standard---usually gold held in reserve. This system eventually proved impractical Devaluation often played a part in why it didn’t work. Why keep things fixed when economies are constantly changing.

Devaluation Devaluation Lowering a currency’s value in relation to other currencies by government order. if the United States is losing money in its trade with France, a decision may be made to devalue the U.S. dollar by 10%. Whereas previously one dollar may have been worth about 5.5 francs, a 10% devaluation causes it to be worth only about 5 francs. Such a move causes French products to become more expensive for Americans and U.S. products to become cheaper for Frenchmen. An ounce of French cologne that previously cost 55 francs in France and 10 dollars in the United States may still sell for 55 francs in France but will now cost 11 dollars in the United States. The net result of such a devaluation is that U.S. exports tend to increase and imports tend to decrease, thus helping to reverse the balance of payments deficit. 55/5.5= $10 55/5=$11

IMF International Monetary Fund (IMF) An agency whose member governments once were obligated to keep their exchange rates more or less fixed; today it offers monetary advice and provides loans to developing nations.

Flexible Exchange Rates In 1971 most nations turned to a flexible exchange rate. An arrangement in which the forces of supply and demand are allowed to set the price of various currencies. Currencies float up and down a little each day.

Balance of Trade A currency’s exchange rate can have an important effect on a nation’s balance of trade—the difference between the value of a nation’s exports and imports. If a nation’s currency depreciates, or becomes weak, the nation will likely export more goods because its products will become cheaper for other nations to buy. If a nation’s currency increases in value, or becomes strong, the amount of exports will decline.

Balance of Trade When the value of goods leaving a nation (exports) exceeds the value of those coming in (imports), a positive balance of trade is said to exist. A negative balance of trade exists when the value of goods coming into a nation is greater than the value of those going out. This is called a Trade Deficit.

Restrictions on World Trade Three ways to restrict imports Tariffs Quotas Embargoes

Tariffs Revenue Tariff Protective Tariff A tax on imports used primarily to raise government revenue without restricting imports Protective Tariff A tax on imports used to raise the cost of imported goods and thereby protect domestic producers.

Quotas Import Quotas Restrictions imposed on the number of units of a particular good that can be brought into the country.

Embargoes Embargo Complete restriction on the import or export of a particular good.

Trade Agreements General Agreement on Tariffs and Trade (GATT) Countries meet to negotiate tariff reductions. World Trade Organization (WTO) Replaced GATT to form the most far-reaching global trade agreement in history. North American Free Trade Agreement (NAFTA) European Union (EU)