Transcript Economics for Today by Irvin B. Tucker 2003

Chapter 21
International Trade
and Finance
• Key Concepts
• Summary
• Practice Quiz
©2004 Thomson/South-Western
1
Why do countries trade?
International trade
allows a country to
consume a
combination of goods
and services that
exceeds its production
possibilities curve
2
U.S. Trading Partners, 2001
Mexico
Canada
Western Europe
Australia
Eastern Europe
Japan
Asia
Africa
Latin America
China
3
U.S. Production and Consumption
80
70
60
40
20
0
Grain (tons per year)
100 A
B´ (with trade)
B (without trade)
PPC
U.S.
Steel (tons per day)
C
10
20
30
40
50
4
80
60
40
30
20
Grain (tons per year)
100
Japanese Production
and Consumption
D
E (without trade)
E´ (with trade)
PPC
Japan
Steel (tons per day)
0
10
20
30
F
40
50
5
Why should countries
specialize and trade?
Total world output
increases, and therefore,
the potential for greater
total world consumption
also increases
6
If countries should
specialize, in what
should they specialize?
They should produce
those goods and services
in which they have a
comparative advantage
7
What is
comparative advantage?
The ability of a country
to produce a good at a
lower opportunity cost
than another country
8
What is
absolute advantage?
The ability of a country
to produce a good
using fewer resources
than another country
9
What is free trade?
The flow of goods between
countries without
restrictions or special taxes
10
What is protectionism?
The government’s use of
embargoes, tariffs,
quotas, and other
restrictions to protect
domestic producers from
foreign competition
11
What is an embargo?
A law that bars trade
with another country
12
What is a tariff?
A tax on an import
13
What is a quota?
A limit on the quantity
of a good that may be
imported in a given
time period
14
What are the arguments
for protectionism?
• Infant industry argument
• National security argument
• Employment argument
• Cheap foreign labor argument
• Free trade agreements
15
What is the General
Agreement on Tariffs
and Trade?
Formed in 1947 by most of
the worlds industrialized
nations, GATT agreed to
end tariff wars
16
What is the World
Trade Organization?
Formed in 1995 from
GATT, the WTO enforces
rulings in global trade
disputes
17
What is a recent free
trade agreement?
North America Free Trade
Agreement (NAFTA)
18
What is NAFTA?
A 1993 free trade agreement
between the U.S., Canada,
and Mexico
19
What is the
balance of payments?
A bookkeeping record of all
the international
transactions between a
country and other
countries during a given
period of time
20
What is the
current account?
The first section of the
balance of payments,
which includes trade in
currently produced
goods and services
21
What is the
balance of trade?
The most widely reported
and largest part of the
current account defined
as the value of a
nation’s merchandise
imports subtracted from
its merchandise exports
22
How is a current
account deficit
financed?
By a capital account surplus
23
What is the
capital account?
The second section of
the balance of
payments, which
records payment flows
for financial capital
24
U. S. Balance of Trade, 1979-2001
50
-150
-250
-350
-450
Balance of Trade
(billions of dollars)
-50
Year
79
81
83
85
87
89
91
93
95
97
99 01
25
What does the
balance of payments
always equal?
Zero; the current account
deficit should equal the
capital account surplus
26
How could the US
have a balance of
payments problem?
The problem is with the
composition of the
balance of payments
27
What is an
exchange rate?
The number of one
nation’s currency that
equals one unit of
another nation’s currency
28
If 1.81 dollars is
exchangeable for 1
British pound, what is
the exchange rate?
1 / 1.81 = .552
pounds per dollar
29
How is the exchange
rate determined?
Supply and demand for
foreign exchange
30
Price (yen per dollar)
Supply and Demand for Dollars
200
150
S of $ (U.S. citizens)
E
100
50
D for $ (Japanese citizens)
0
100 200 300 400 500
Quantity of dollars (millions per day)
31
What happens when a
currency depreciates?
The price of the currency
falls in relation to
another currency
32
What happens when a
currency appreciates?
The price of the currency
rises in relation to
another currency
33
What can cause a
currency to
change value?
The demand and/or
supply of the currency
can change
34
What can cause a
change in demand of
a currency?
There can be a change in • tastes and preferences
• relative price levels
• relative interest rates
35
Decrease in Demand
200
150
100
50
Price (yen per dollar
250
S
E1
E2
D1
D2
Quantity of Dollars (millions per day
100 200 300 400 500
36
U.S.
exports
less
popular
Decrease
in the
demand
for
dollars
Value of the
dollar falls
(dollar
depreciates)
37
What can cause a
change in supply of
a currency?
There can be a change in • relative incomes
• relative price levels
• relative interest rates
38
Decrease in Supply
200
150
100
50
Price (yen per dollar
250
S
E2
2
S
1
E2
D
Quantity of Dollars (millions per day)
100 200 300 400 500
39
Japanese
imports
less
popular
Decrease
in the
supply of
dollars
Value of the
dollar rises
(dollar
appreciates)
40
What happens when
demand and/or
supply changes?
The currency seeks a
new equilibrium; the
value changes
41
Japanese
Increase the
buy more
demand for
U.S.
dollars
exports
Japanese Impact on relative Value of the
price
price changes on dollar rises
level
Exchange Rates (dollar
rises
appreciates
U.S.
Decrease
citizens
in the
buy fewer
supply of
Japanese
dollars
imports
42
The Effects of Shift in Supply on
Market Equilibrium
300
250
S2
E2
1
200
150
100
50
S
E1
D2
D1
Quantity of dollars
100 200 300 400 500 600 700
43
Key Concepts
44
Key Concepts
• Why do countries trade?
• Why should countries specialize and trade?
• If countries should specialize, in what should
they specialize?
• What is comparative advantage?
• What is absolute advantage?
• What is free trade?
• What is protectionism?
45
Key Concepts cont.
•
•
•
•
•
•
•
•
•
What is an embargo?
What is a tariff?
What is a quota?
What is Nafta?
What is the balance of payments?
What is the balance of trade?
What is an exchange rate?
What can cause a currency to change value?
What if demand - supply changes?
46
Summary
47
Comparative advantage is a
principle that allows nations to
gain from trade. Comparative
advantage means that each
nation specializes in a product
for which its opportunity cost is
lower in terms of the production
of another product and then
nations trade.
48
When nations follow the principle
of comparative advantage, they
gain. The reason is that world
output increases and each nation
ends up with a higher standard of
living by consuming more goods
and services than possible
without specialization and trade.
49
U.S. Production and Consumption
80
70
60
40
20
0
Grain (tons per year)
100 A
B´ (with trade)
B (without trade)
PPC
U.S.
Steel (tons per day)
C
10
20
30
40
50
50
Free trade benefits a nation as a
whole, but individuals may lose
jobs and incomes from the
competition from foreign goods
and services.
51
Protectionism is a government’s
use of embargoes, tariffs,
quotas, and other methods t
impose barriers intended to both
reduce imports and protect
particular domestic industries.
52
Embargoes prohibit the import of
export of particular goods. Tariffs
discourage imports by making
them more expensive. Quotas limit
the quantity of imports or exports of
certain goods. These trade barriers
often result primarily from domestic
groups that exert political pressure
to gain from these barriers.
53
The balance of payments is a
summary bookkeeping record of all
the international transactions a
country makes during a year. It is
divided into different accounts,
including the current account, the
capital account and the statistical
discrepancy.
54
The current account summarizes
all transactions in currently
produced goods and services.
The overall balance of payments
is always zero after an
adjustment for the statistical
discrepancy.
55
The balance of trade measures only
goods (not services) that a nation
exports and imports. A balance of
trade can be in deficit or in surplus.
The balance of trade is the most
widely reported and largest part of
the current account. Since 1975, the
U.S. has experienced balance of
trade deficits.
56
U. S. Balance of Trade, 1979-2001
50
-150
-250
-350
-450
Balance of Trade
(billions of dollars)
-50
Year
79
81
83
85
87
89
91
93
95
97
99 01
57
An exchange rate is the price of
one nation’s currency in terms of
another nation’s currency.
Foreigners who wish to purchase
U.S. goods, services, and financial
assets demand dollars. The supply
of dollars reflects the desire of U.S.
citizens to purchase foreign goods,
services and financial assets.
58
The intersection of the supply and
demand curves for dollars
determines the number of units of
a foreign currency per dollar.
59
Price (yen per dollar)
Supply and Demand for Dollars
200
150
S of $ (U.S. citizens)
E
100
50
D for $ (Japanese citizens)
0
100 200 300 400 500
Quantity of dollars (millions per day)
60
Shifts in supply and demand for
foreign exchange result from changes
in such factors as tastes, relative
price levels, relative real interest
rates, and relative income levels.
61
Depreciation of currency occurs
when one currency becomes worth
fewer units of another currency. If a
currency depreciates, it becomes
weaker. Depreciation of a nation’s
currency increases its exports and
decreases its imports.
62
Appreciation of currency occurs
when one currency becomes worth
more units of another currency. If a
currency appreciates, it becomes
stronger. Appreciation of a nation’s
currency decreases its exports and
increases its imports.
63
END
64