1. International Economics
Topic 10
International Economics

2. International Economics
International trade
Microeconomic perspective
Comparative advantage
Trade barriers vs. free trade
International finance
Macroeconomic perspective
Exchange rate determination

3. US Trade US trade deficit in goods and surplus in services
US exports about 13% of its output
Chemicals
Agricultural products
Consumer durables
Semiconductors
Aircraft
U.S. provides about 8.5% of world’s exports

4. US Trade Principal U.S. imports include: Petroleum Automobiles Metals
Household appliances
Computers

5. Why do countries trade? Nations have different resource endowments
Labor intensive
Land intensive
Capital intensive
Comparative advantage
A nation has a comparative advantage in good A when it has a lower opportunity cost of producing A,compared with another nation.

6. Comparative Advantage
Vegetables (Tons) 30 25 20 15 10 5 35 40 45
Beef (Tons)
(b) Mexico 12 18 8 4 A Z
(a) United States

7. Comparative Advantage

8. Trade Barriers and Export Subsidies
Tariffs, import quota, nontariff barrier (NTB), voluntary export restriction (VER), and export subsidies
Effects of trade barriers on prices, consumption, production, etc.
Arguments for trade protection

9. Multilateral Trade Agreements
General Agreement on Tariffs and Trade (GATT, )
World Trade Organization (WTO, 1995)
European Union (EU)
North American Free Trade Agreement (NAFTA)

10. International Finance
Lending and borrowing among countries
International asset transactions
Currency exchange – daily global currency transaction volume is several trillion $.

11. Exchange Rates The price of a currency in terms of another currency
€1=$1.252
Demand vs. supply
Appreciation vs. depreciation
Revaluation vs. devaluation

12. Exchange Rate Determination
Determinants of exchange rates
Factors that change demand/supply
Changes in tastes
Relative income changes
Relative price-level changes
Purchasing-power-parity theory
Relative interest rates
Relative expected returns on assets
Speculation

13. The Demand for British Pounds
To analyze demand for pounds, start with a very basic question
Who is demanding them?
Anyone who has dollars and wants to exchange them for pounds
In our model of market for pounds, we assume that American households and businesses are the only buyers
Why do Americans want to buy pounds?
To buy goods and services from British firms
To buy British assets

14. The Demand For British Pounds

15. The Demand For Pounds Curve
Curve tells us quantity of pounds Americans will want to buy in any given period, at each different exchange rate
Curve slopes downward
The lower the exchange rate, the greater the quantity of pounds demanded
Why does a lower exchange rate—a lower price for the pound—make Americans want to buy more of them?
Because the lower the price of the pound, the less expansive British goods are to American buyers
As we move rightward along demand for demand for pounds curve, as in the move from point A to point E

16. Shifts in the Demand for Pounds Curve
If any of these variables changes, entire curve will shift
Keep in mind that we are assuming that only one of them changes at a time; we suppose the rest to remain constant
U.S. real GDP
Relative price levels
Americans’ tastes for British goods
Relative interest rates
Expected changes in the exchange rate

17. The Supply of British Pounds
Demand for pounds is one side of market for pounds
Other side is supply of pounds
In real world, pounds are supplied from many sources
In our model of market for pounds, we assume that British households and firms are the only sellers
British supply pounds in the dollar—pound market for only one reason
They want dollars
Thus, to ask why the British supply pounds is to ask why they want dollars
To buy goods and services from American firms
To buy American assets

18. The Supply of Pounds Curve
Supply curve for foreign currency
Curve tells us quantity of pounds British will want to sell in any given period, at each different exchange rate
Curve slopes upward
The higher the exchange rate, the greater is the quantity of pounds supplied
Why does a higher exchange rate—a higher price for the pound—make the British want to sell more of them?
Because the higher the price for the pound, the more dollars someone gets for each pound sold
As we move rightward along the supply of pounds curve, such as the move from point E to point F

19. The Supply of British Pounds

20. Shifts in the Supply of Pounds Curve
When exchange rate changes, we move along supply curve for pounds
But other variables can affect supply of pounds besides exchange rate
Real GDP in British
Relative price levels
British tastes for U.S. goods
Relative interest rates
Expected change in the exchange rate

21. The Equilibrium Exchange Rate
Important—and in most cases, realistic—assumption
Exchange rate between dollar and pound floats
Is freely determined by forces of supply and demand
Without government intervention to change it or keep it from changing
In come cases, however, governments do not allow exchange rate to float freely
Instead manipulate its value by intervening in market, or even fix it at a particular value
When exchange rate floats, price will settle at level where quantity supplied and quantity demanded are equal
Intersection of demand curve and supply curve

22. The Equilibrium Exchange Rate

23. What Happens When Things Change?
What would cause price of pound to rise or fall?
Simple answer—anything that shifts demand for pounds curve, or supply of pounds curve, or both curves together
Appreciation
An increase in price of a currency in a floating-rate system
Depreciation
A decrease in price of a currency in a floating-rate system
When a floating exchange rates changes, one country’s currency will appreciate (rise in price) and other country’s currency will depreciate (fall in price)