ECO 121 MACROECONOMICS Lecture Three Aisha Khan Section L & M Spring 2010

US in the Global Economy  M&B Chapter 5  Global Economy

International Linkages  Goods and Services flow (trade flows)  Capital and labor flows (resource flows)  Information and Technology flows  Financial flows  What is a trade balance?

US and World Trade  Volume  Trend in volume for the US and the World  Dependence  Trade Patterns  Trade deficit in goods  Trade surplus in services  Financial linkages

But WHY Trade?  Economically?  Specialization  Concentrating your productive efforts on a limited range of tasks for effective and efficient performance  Division of Labor

Absolute Advantage  One country is said to have an absolute advantage over another in the production of a particular good if it can produce a given quantity with less total resources

Comparative Advantage  A country has a comparative advantage in producing a good if the opportunity cost of producing that good in terms of other goods is lower in that country than it is in other countries.

Example CottonPotatoes US60100 Pakistan105 Trade between two nations: The amount of output produced with one unit of resources

 US needs to give up 0.6 cotton bundles to produce 1 bag of potatoes  Pakistan needs to give up 2 cotton bundles to produce 1 bag of potatoes  Comparative Advantage: US (potatoes)  US needs to give up 1.6 bags of potatoes to get 1 cotton bundle  Pakistan needs to give up 0.5 bags of potatoes to get 1 cotton bundle  Comparative Advantage: Pak (cotton) CottonPotatoes US60100 Pakistan105

Trade Advantages Standard of Living DevelopmentOutput Efficiency and Productivity

Trade and its impact

Foreign Exchange Market  Exchange of goods and services requires the exchange in currency  The foreign exchange market helps determine the exchange rate / price at which currency will be exchanged  Competitive  Links all domestic prices to foreign prices

 Exchange rates also fluctuate  Appreciation  Gain in value of currency  Impacts: cheaper imports, expensive exports  Depreciation  Loss in value of currency  Impacts: cheaper exports, expensive imports

Why intervene in trade?  Domestic industry protection (protectionism)  Costs to society (higher than world prices)  Political considerations  Religious, cultural norms

Intervention  Protective Tariffs  Import quotas  Non-tariff barriers  Export subsidies

Rapid Trade Growth  Regardless of intervention  Transportation technology  Communications technology  General decline in Tariffs and restrictions

Trade Agreements  Objective:  To avoid the backfiring of intervention in trade  To facilitate mutually concerned countries

History in Trade Institutions  Reciprocal Trade Agreement Act 1934  Started downward trend in tariffs  Only between two countries  Negotiating authority  Generalized reductions  General Agreement on Tariffs and Trade  Rounds of agreement to reduce trade barriers  Uruguay Round 1995

World Trade Organization  Uruguay Round succeeded as WTO  Critical of WTO  Created to expand international trade and allow investment to move around laws that protect resources  Labor and environment laws

Trade Blocs  European Union  North American Free Trade Agreement

EU, NAFTA, etc  longer-term advantages  internal economies of scale  external economies of scale  better terms of trade  increased competition between members  longer-term disadvantages  certain regions of the union may suffer  possibility of oligopolistic collusion  administrative costs