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Open-Economy Macroeconomics: Basic Concepts
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Could we build A Jet Liner Without World Trade?
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Why Trade? There is uneven distribution of natural resources.
Efficient production of goods requires different technologies and combinations of resources Produce items that differ in quality Results of the trade: Specialization which increases productivity and are able to purchase more goods and services – comparative advantage v. absolute advantage Supplement your domestic PPC with a new trading possibilities line
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PPC for two countries Country Output before specialization USA
18 wheat 12 coffee Brazil 8 wheat 4 coffee
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Specialization If the United States and Brazil specialize in the good in which they hold the comparative advantage: Country Outputs before specialization Outputs after specialization USA 18 Wheat 30 wheat 12 coffee 0 coffee Brazil 8 wheat 0 wheat 4 coffee 20 coffee
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World trade analysis Who Benefits? Who is hurt?
Consumers can buy more and different products at a lower price Domestic Industries Export industries Who is hurt? Import competing firms Domestic consumers of export industries Mobility of capital and workers
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International Flows of Goods & Capital
2 Closed economy - does not interact with other economies in the world Open economy - interacts freely with other economies around the world
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Flow of goods: exports, imports,& net exports
3 Exports – domestically produced goods and services that are sold abroad Imports - goods and services produced abroad sold domestically
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Trade Barriers Revenue Tariffs Taxes placed on imported goods not produced domestically Protective Tariffs Taxes placed on goods to shield domestic producers from foreign competition Import Quotas Quantity restrictions on imported goods Voluntary Trade Restrictions Quotas that an exporting country places on its own products Government subsidy Payments to domestic companies which allows for production at a lower cost NON TARIFF BARRIERS Product Standards and Regulations Health and safety rules to guarantee minimum standard of quality which are often disguising an import quota Red Tape Bureaucracy involved in exporting products to a particular country – licensing Dumping Charging a price for an exported good that is below the actual cost of production to undercut the competition
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Free Trade v. Protectionism
*1. National Defense Argument: certain industries should remain based in our country, especially if they manufacture items vital to our defense. Items this argument have been used for include: pens, pottery, peanuts, papers, candles, thumbtacks, tuna fishing, and pencils. *2. Infant Industry Argument: new industries must be protected from older, established foreign competitors until they are mature enough to compete. However, removing protection is almost impossible. 3. Dumping Argument: domestic industries need to be protected from foreign dumping. Dumping is the sale of goods abroad at a price below their cost and therefore undersell domestic competitors to put them out of business; obtain monopoly power and raise their prices.
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Protectionism and Free Trade
4. Foreign–Export–Subsidies Argument: Some governments subsidize the firms that export goods. Firms say that this forces them to compete with both the firm and the government in question. 5. Low Foreign Wages Argument: A country’s low wage advantage may be offset by its productivity disadvantage. High wages means high productivity. Low wages mean low productivity.
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Economic Impact of Tariffs
Direct effects: Decline in consumption since the price is higher with less competition Increased domestic production spurred by the higher price in the market Decline in imports caused by lower consumption of the foreign good Government gains portion of what consumers lose by paying more for the good Indirect Effects 1. Promote the expansion of inefficient industries which do not have the comparative advantage and cause the contraction of those industries which do have the comparative advantage
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Flow of goods: exports, imports,& net exports
4 Net exports - value of a nation’s exports minus the value of its imports Trade balance (balance of payments) - value of a nation’s exports minus the value of its imports Current Account - the difference between a nation's total exports of goods, services and its total imports of them. Current account balance calculations exclude transactions in financial assets and liabilities.
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Flow of goods: exports, imports,& net exports
5 Trade surplus - excess of exports over imports Exports > Imports Trade deficit - excess of imports over exports Exports < Imports Balanced trade - exports equal imports Exports = Imports
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International Flow of Goods and Capital
6 Foreign direct investment – investment of capital in a foreign nation Domestic physical investment in a foreign economy such as factories, buildings, machinery, firms etc. Disney World in Europe Foreign portfolio investment – investment in an financial asset (bond) by a foreign nation Domestic financial investment in foreign assets, such as bonds, stocks or other financial instruments
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Flow of financial resources: net capital outflow
7 Financial Capital - can refer to money used by entrepreneurs and businesses to buy what they need to make their products or provide their services Capital Account - reflects net change in national ownership of assets
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Flow of financial resources: net capital outflow
8 Net capital outflow – refers to the difference between the purchase of foreign assets by domestic residents and the purchase of domestic assets by foreigners Can be positive or negative Positive – domestic residents are buying more foreign assets than foreigners are buying domestic assets Capital is flowing out of the nation Negative – domestic residents are buying less foreign assets than foreigners are buying domestic assets Capital is flowing into the nation
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International Flows of Goods & Capital
9 Factors - influence a country’s exports, imports, and net exports: Tastes of consumers for domestic & foreign goods Prices of goods at home and abroad Exchange rates People use domestic currency to buy foreign currencies Incomes of consumers at home and abroad Cost of transporting goods from country to country Government policies toward international trade
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Foreign Exchange Market
10 FOREX (Foreign Exchange Market) - is a form of exchange for the global decentralized trading of international currencies (video)
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International Flows of Goods & Capital
11 Variables that influence demand for foreign money Interest Rates Travel abroad Trade
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Prices for International Transactions
12 Exchange rate - rate at which a person can trade currency of one country for currency of another Fixed (Pegged), Floating Appreciation (strengthen) - increase in the value of a currency; amount of foreign currency it can buy Depreciation (weaken) - decrease in the value of a currency; amount of foreign currency it can buy
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Determinants of exchange rates
Example Depreciates Appreciates Changes in tastes Japanese autos decline in popularity in the United States Japanese yen Dollar Change in tastes German tourists come to the United States German Mark Changes in relative incomes England is in a recession; its imports decline while the US is growing increasing US imports British pound Change in relative prices Germany experiences a 3% inflation rate compared to the US 10% inflation rate German mark Changes in relative interest rates FED raises interest rates while Bank of England does not Speculation Currency traders believe France will have more rapid inflation that US French Franc Currency traders think that German interest rates will plummet relative to US rates
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Appreciation Depreciation 1. Decrease in Taste 1. Increase in Taste
2. Decrease Interest Rates 3. Decrease in Tr. Partner’s Income 4. Increase in Price Level 1. Increase in Taste 2. Increase Interest Rates 3. Increase in Trading Partner’s Income 4. Decrease in Price Level Therefore, it takes fewer pennies, so the dollar is stronger [$ price decreases] Therefore, it takes more pennies, so the dollar is weaker. [$ price increases]
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The Foreign Exchange Market
Currency Appreciation and Depreciation International value of dollar falls (dollar depreciates) Exports increase Imports decrease Dollar price of another currency [yen] increases [$1 to $2] D2 Equals D S $2 $1 .50 D A D3 Dollar price of another Currency [yen] decreases [$1 to .50] # of Yen Equals International value of dollar rises (dollar appreciates) Imports increase Exports decrease
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“Strong Dollar” 81 82 83 84 85 81 82 83 84 85 81 82 83 84 85 Exports
Strong and Weak Dollar As Interest Rates Rose . . . [all the way to 13%] “Strong Dollar” The dollar got stronger and stronger “Exports decreased. Agricultural exports dropped from $44 billion to $28 billion as foreign agricultural goods became cheaper.” Exports [Decreased] Imports [Increased] Imports increased as they became cheaper.
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Measuring Trade Exchange Rate – the value of one foreign nation’s currency in relation to another nation’s currency Determining the Rate of Exchange 1 Dollar = 12 Mexican Pesos 1/12 = .083 Hotel room costs 500 Pesos per night x 500 = $41.66 500/12 = $41.66
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Foreign Exchange Market Graph
Exchange Rate Supply of currency Equilibrium exchange rate Demand for currency Equilibrium quantity Quantity of Dollars Exchanged into Foreign Currency An increase in the demand for U.S. dollars appreciates the value of the currency to other currencies A decrease in demand for U.S. dollars depreciates the value of the currency to other currencies An increase supply of U.S. dollars depreciates the value of the U.S. currency A decrease in supply of U.S. dollars appreciates the value of the U.S. currency
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Foreign Exchange Market Graph
US citizens travel to the England for the 2012 Olympics Market for US Dollars $/GBP Market British Pounds GBP/$ S1 S2 S e1 e2 e2 e1 D2 D1 D1 Qe1 Qe2 Qe1 Qe2 Q of Pounds Q of Dollars •An increase demand of the Pound caused an appreciation of the Pound •Increased supply of US Dollars caused a depreciation of the US Dollar
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Foreign Exchange Market Graph
French citizens travel to the United States to shop Market for Dollars Market for Euros e/$ $/e S1 S2 S e1 e2 e2 e1 D2 D1 D1 Qe1 Qe2 Q of Dollars Qe1 Qe2 Q of Euros •Increased supply of Euros caused a depreciation of the Euro to the dollar •An increase demand of the U.S. dollar caused an appreciation of the U.S. dollar
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Japan suffers a recession after the tsunami
Foreign Exchange Market Graph Japan suffers a recession after the tsunami $ Market Yen Market Yen/$ $/Yen S2 S S1 e2 e e e2 D1 D D2 Q of Dollars Qe2 Qe1 Qe2 Qe1 Q of Yen •Decreased supply of Yen caused an appreciation of the Yen to the dollar •An decrease demand of the U.S. dollar caused a depreciation of the U.S. dollar
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