6/3/ The U.S. in the Global Economy Chapter 5

In this chapter, you will learn: 1. Some key facts about U.S. international trade 2. About comparative advantage, specialization, and international trade 3. How exchange rates are determined in currency markets 4. How & why government sometimes interferes with free international trade 5. About trade-related topics such as the World Trade Organization (WTO), trade adjustment assistance, offshoring of jobs, and fair-trade products 6/3/2016 2

3 International Linkages (5.1) Goods & services flow (trade flow) Goods & services flow (trade flow) Capital & labor (resource) flow Capital & labor (resource) flow Information & technology flows Information & technology flows Financial flows Financial flows

6/3/ The U.S. & World Trade Volume & pattern Volume & pattern Volume of international trade has been increasing Volume of international trade has been increasing The U.S. is almost entirely depending on other countries for products like bananas, cocoa, coffee, etc. The U.S. is almost entirely depending on other countries for products like bananas, cocoa, coffee, etc.

Trade patterns Trade Deficit Trade Deficit Imports exceed exports Imports exceed exports Trade Surplus Trade Surplus Exports exceed imports Exports exceed imports Most important trading partner is Canada. Most important trading partner is Canada. 6/3/2016 5

Financial Linkages U.S. is world’s largest borrower of foreign funds U.S. is world’s largest borrower of foreign funds Can be used to purchase foreign goods Can be used to purchase foreign goods 6/3/2016 6

7 Rapid Trade Growth Transportation technology Transportation technology High transportation costs are a barrier to any type of trade High transportation costs are a barrier to any type of trade Improvements in transportation have shrunk the globe & fostered world trade Improvements in transportation have shrunk the globe & fostered world trade Communications technology Communications technology Dramatic improvements in communications technology have also advanced world trade Dramatic improvements in communications technology have also advanced world trade Exporters can access overseas markets & carry out trade deals Exporters can access overseas markets & carry out trade deals General decline in tariffs General decline in tariffs U.S. tariffs as a percentage of imports are now 5%, down from 37% in 1940 U.S. tariffs as a percentage of imports are now 5%, down from 37% in 1940

6/3/ Specialization & Comparative Advantage (5.2) U.S. labor & other resources are shifted toward export industries & away from import industries U.S. labor & other resources are shifted toward export industries & away from import industries Specialization & international trade increase the productivity of a nation’s resources & allow for greater total output Specialization & international trade increase the productivity of a nation’s resources & allow for greater total output

Production Possibilities Analysis Absolute advantage- When a country can produce more output than other country Absolute advantage- When a country can produce more output than other country Comparative advantage- when a nation can produce a product at a lower opportunity cost Comparative advantage- when a nation can produce a product at a lower opportunity cost Table 5.4 & 5.5 Table 5.4 & 5.5 6/3/2016 9

Production Possibilities Tables (Mexico & U.S.) Mexico Production Alternatives ProductABCDE Avocados Soybeans U.S.ProductionAlternatives Product ABCDE Avocados Soybeans /3/ Soybeans U.S. must give up 3 tons of avocados to get 1 ton of soybeans Mexico must give up 4 tons of avocados to get 1 ton of soybeans C.A. U.S. for soybeans Avocados Mexico must give up ¼ ton of soybeans to get 1 ton of avocados U.S. must give up 1/3 ton of soybeans to get 1 ton of avocados C.A. Mexico for avocados

Terms of Trade Through negotiation, the two nations can agree on an “exchange rate” that’s mutually beneficial to both countries Through negotiation, the two nations can agree on an “exchange rate” that’s mutually beneficial to both countries Each country can “do better” through such trade than through domestic production of both products Each country can “do better” through such trade than through domestic production of both products 6/3/

6/3/ Foreign Exchange Market Market where various national currencies are exchanged for one another Market where various national currencies are exchanged for one another Exchange rates Exchange rates Rate at which the currency of one nation can be exchanged for the currency of another nation Rate at which the currency of one nation can be exchanged for the currency of another nation Changing Rates: Changing Rates: Depreciation – Dollar loses value against another currency Depreciation – Dollar loses value against another currency Exports rise & imports become more expensive Exports rise & imports become more expensive Appreciation – Dollar gains value against another currency Appreciation – Dollar gains value against another currency Imports rise & exports fall because the dollar is now stronger than other currencies Imports rise & exports fall because the dollar is now stronger than other currencies

6/3/ Trade impediments & subsidies (5.3) Protective tariffs Protective tariffs Taxes placed on imported goods Taxes placed on imported goods Protects domestic producers from foreign competition Protects domestic producers from foreign competition Import quotas Import quotas Limit on the amount that can be imported Limit on the amount that can be imported Nontariff barriers Nontariff barriers I.E. licensing requirements, unreasonable standards on quality, or red tape I.E. licensing requirements, unreasonable standards on quality, or red tape Export subsidies Export subsidies Government payments to domestic producers who export Government payments to domestic producers who export

6/3/ Why Government Trade Interventions? Misunderstanding the gains from trade Misunderstanding the gains from trade Not just higher employment…more output=lower prices Not just higher employment…more output=lower prices Political considerations Political considerations Businesses that don’t have a comparative advantage use political activity to achieve their goals Businesses that don’t have a comparative advantage use political activity to achieve their goals Costs to society Costs to society Benefits business but hurts consumers through higher prices Benefits business but hurts consumers through higher prices

6/3/ Multilateral Trade Agreements & Free-Trade Zones General Agreement on Tariffs & Trade (GATT) 1947 General Agreement on Tariffs & Trade (GATT) 1947 Negotiated reduced trade barriers among nations Negotiated reduced trade barriers among nations World Trade Organization (WTO) World Trade Organization (WTO) GATT’s successor GATT’s successor Oversees trade agreements & rules on trade disputes among member nations Oversees trade agreements & rules on trade disputes among member nations

European Union (EU) Abolished tariffs & import quotas on nearly all products traded among the participating nations Abolished tariffs & import quotas on nearly all products traded among the participating nations Free movement of capital & labor throughout the zone Free movement of capital & labor throughout the zone Common identity Common identity Economic interests Economic interests Trade rules Trade rules 6/3/

Euro Common currency for European Union (EU) Common currency for European Union (EU) Ends inconvenience & expense of exchanging currencies Ends inconvenience & expense of exchanging currencies Enhanced free flow of goods, services, & resources through EU Enhanced free flow of goods, services, & resources through EU 6/3/

North American Free Trade Agreement (NAFTA) Started a free trade zone in 1993 with Canada, Mexico, & United States Started a free trade zone in 1993 with Canada, Mexico, & United States Some combined output as the EU but encompasses a much larger geographic area Some combined output as the EU but encompasses a much larger geographic area Eliminated tariffs & other trade barriers Eliminated tariffs & other trade barriers Critics of NAFTA – loss of U.S. jobs Critics of NAFTA – loss of U.S. jobs Lower wages & weaker regulations on pollution & worker safety in Mexico Lower wages & weaker regulations on pollution & worker safety in Mexico Employment has increased in the U.S. since NAFTA…some sectors have been negatively affected though Employment has increased in the U.S. since NAFTA…some sectors have been negatively affected though 6/3/

Trade Adjustment Assistance Act (2002) Provides cash assistance for up to 78 weeks for workers displaced by imports or plant relocations abroad Provides cash assistance for up to 78 weeks for workers displaced by imports or plant relocations abroad Workers must participate in job searches, training programs, or remedial education Workers must participate in job searches, training programs, or remedial education 6/3/

Offshoring of Jobs Shifting work previously done by American workers to workers located in other locations. Shifting work previously done by American workers to workers located in other locations. Recent advances in technology have enabled U.S. firms to offshore service jobs Recent advances in technology have enabled U.S. firms to offshore service jobs 6/3/