3 Why Trade? There is uneven distribution of natural resources. Efficient production of goods requires different technologies and combinations of resourcesProduce items that differ in qualityResults of the trade:Specialization which increases productivity and are able to purchase more goods and services – comparative advantage v. absolute advantageSupplement your domestic PPC with a new trading possibilities line
4 PPC for two countries Country Output before specialization USA 18 wheat12 coffeeBrazil8 wheat4 coffee
5 SpecializationIf the United States and Brazil specialize in the good in which they hold the comparative advantage:CountryOutputs before specializationOutputs after specializationUSA18 Wheat30 wheat12 coffee0 coffeeBrazil8 wheat0 wheat4 coffee20 coffee
6 World trade analysis Who Benefits? Who is hurt? Consumers can buy more and different products at a lower priceDomestic IndustriesExport industriesWho is hurt?Import competing firmsDomestic consumers of export industriesMobility of capital and workers
7 International Flows of Goods & Capital 2Closed economy - does not interact with other economies in the worldOpen economy - interacts freely with othereconomies around the world
8 Flow of goods: exports, imports,& net exports 3Exports – domestically produced goods and services that are sold abroadImports - goods and services produced abroad solddomestically
9 Trade BarriersRevenue TariffsTaxes placed on imported goods not produced domesticallyProtective TariffsTaxes placed on goods to shield domestic producers from foreign competitionImport QuotasQuantity restrictions on imported goodsVoluntary Trade RestrictionsQuotas that an exporting country places on its own productsGovernment subsidyPayments to domestic companies which allows for production at a lower costNON TARIFF BARRIERSProduct Standards and RegulationsHealth and safety rules to guarantee minimum standard of quality which are often disguising an import quotaRed TapeBureaucracy involved in exporting products to a particular country – licensingDumpingCharging a price for an exported good that is below the actual cost of production to undercut the competition
10 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.
11 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.
12 Economic Impact of Tariffs Direct effects:Decline in consumption since the price is higher with less competitionIncreased domestic production spurred by the higher price in the marketDecline in imports caused by lower consumption of the foreign goodGovernment gains portion of what consumers lose by paying more for the goodIndirect Effects1. 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
14 Flow of goods: exports, imports,& net exports 4Net exports - value of a nation’s exports minus the value of its importsTrade balance (balance of payments) - value of a nation’s exports minus the value of its importsCurrent Account - the difference between a nation's total exports ofgoods, services and its total imports of them.Current account balance calculations exclude transactions in financial assets and liabilities.
15 Flow of goods: exports, imports,& net exports 5Trade surplus - excess of exports over importsExports > ImportsTrade deficit - excess of imports over exportsExports < ImportsBalanced trade - exports equal importsExports = Imports
16 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) bya foreign nation Domestic financial investment in foreign assets, such as bonds, stocks or other financial instruments
17 Flow of financial resources: net capital outflow 7Financial Capital - can refer to money used by entrepreneurs and businesses tobuy what they need to make their products or provide their servicesCapital Account - reflects net change in national ownership of assets
18 Flow of financial resources: net capital outflow 8Net capital outflow – refers to the difference between the purchase of foreign assets by domestic residents and the purchase of domestic assets by foreignersCan 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
19 International Flows of Goods & Capital 9Factors - 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 andabroad Cost of transporting goods from country to country Government policies towardinternational trade
20 Foreign Exchange Market 10FOREX (Foreign Exchange Market) - is a form of exchange for the global decentralized trading of international currencies (video)
21 International Flows of Goods & Capital 11Variables that influence demand for foreign moneyInterest RatesTravel abroadTrade
22 Prices for International Transactions 12Exchange rate - rate at which a person can trade currency of onecountry for currency of anotherFixed (Pegged), FloatingAppreciation (strengthen) - increase in the value of a currency; amountof foreign currency it can buyDepreciation (weaken) - decrease in the value of a currency; amount of foreign currency it can buy
23 Determinants of exchange rates ExampleDepreciatesAppreciatesChanges in tastesJapanese autos decline in popularity in the United StatesJapanese yenDollarChange in tastesGerman tourists come to the United StatesGerman MarkChanges in relative incomesEngland is in a recession; its imports decline while the US is growing increasing US importsBritish poundChange in relative pricesGermany experiences a 3% inflation rate compared to the US 10% inflation rateGerman markChanges in relative interest ratesFED raises interest rates while Bank of England does notSpeculationCurrency traders believe France will have more rapid inflation that USFrench FrancCurrency traders think that German interest rates will plummet relative to US rates
24 Appreciation Depreciation 1. Decrease in Taste 1. Increase in Taste 2. Decrease Interest Rates3. Decrease in Tr. Partner’s Income4. Increase in Price Level1. Increase in Taste2. Increase Interest Rates3. Increase in Trading Partner’s Income4. Decrease in Price LevelTherefore, it takes fewerpennies, so the dollar isstronger [$ price decreases]Therefore, it takes morepennies, so the dollar isweaker. [$ price increases]
25 The Foreign Exchange Market Currency Appreciation and DepreciationInternationalvalue of dollarfalls (dollardepreciates)Exports increaseImports decreaseDollar priceof anothercurrency[yen]increases[$1 to $2]D2EqualsDS$2$1.50DAD3Dollar priceof anotherCurrency[yen]decreases[$1 to .50]# of YenEqualsInternationalvalue of dollarrises (dollarappreciates)Imports increaseExports decrease
26 “Strong Dollar” 81 82 83 84 85 81 82 83 84 85 81 82 83 84 85 Exports Strong and Weak DollarAs 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.
27 Measuring TradeExchange Rate – the value of one foreign nation’s currency in relation to another nation’s currencyDetermining the Rate of Exchange1 Dollar = 12 Mexican Pesos 1/12 = .083Hotel room costs 500 Pesos per night x 500 = $41.66 500/12 = $41.66
28 Foreign Exchange Market Graph Exchange RateSupply of currencyEquilibriumexchange rateDemand for currencyEquilibrium quantityQuantity of Dollars Exchanged into Foreign CurrencyAn increase in the demand for U.S. dollars appreciates the value of the currency to other currenciesA decrease in demand for U.S. dollars depreciates the value of the currency to other currenciesAn increase supply of U.S. dollars depreciates the value of the U.S. currencyA decrease in supply of U.S. dollars appreciates the value of the U.S. currency
29 Foreign Exchange Market Graph US citizens travel to the England for the 2012 OlympicsMarket for US Dollars$/GBPMarket British PoundsGBP/$S1S2Se1 e2e2e1D2D1D1Qe1 Qe2Qe1 Qe2 Q of PoundsQ 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
30 Foreign Exchange Market Graph French citizens travel to the United States to shopMarket for DollarsMarket for Eurose/$$/eS1S2Se1 e2e2 e1D2D1D1Qe1 Qe2 Q of DollarsQe1 Qe2Q of Euros•Increased supply of Euros caused a depreciation of the Euro to the dollar•An increase demand of the U.S. dollar caused an appreciation of the U.S. dollar
31 Japan suffers a recession after the tsunami Foreign Exchange Market GraphJapan suffers a recession after the tsunami$ MarketYen MarketYen/$$/YenS2SS1e2 eee2D1DD2Q of DollarsQe2 Qe1Qe2 Qe1Q 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