Transcript Lecture15 - UCSB Economics

Introduction to Economics
International Trade and Finance
The US Economy
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Last Time: Monopoly Power
Rips off Consumers
 Rips off Society
 Rips off Democracy

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Trade and California
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Los Angeles Times
Thursday, November 15, 2001
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Los Angeles Times
Monday, November 19, 2001
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Los Angeles Times
Monday, November 19, 2001
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Los Angeles Times Monday, November 19, 2001
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Outline: Lecture Fifteen-Trade
News: the Price of Oil
 The Western Movement: Manifest Destiny

 Autarchy
 self-sufficiency
 The Advantages
of Exchange
 specialization

The Political Economy of Trade
 Arguments
for Free Trade
 Arguments Against Free Trade
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Price of Oil: Before and After 9-11
Demand Before 9-11
Price per Barrel
Supply
Barrels of Oil
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Los Angeles Times Monday, November 19, 2001
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OPEC Cartel Policy: Control Supply
Demand Before 9-11
Price per Barrel
OPEC
Supply
Barrels of Oil
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How to Fight a Foreign Cartel
Do Nothing: Hope the Cartel Breaks Down
 Impose an Excise Tax

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Paying at the Gas Pump
Country
Britain
France
Germany
Netherlands
Belgium
Italy
USA
Price
$4.35
$3.50
$3.37
$3.82
$3.43
$3.58
$1.71
%Tax
76.3
68.3
67.5
65.1
65.0
63.4
22.4
The New York Times, Thursday Oct 19, 2001
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Demand and Supply
Price
Supply
a
Demand
Quantity
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Excise Tax
Supply: Price Includes Tax
Tax Per Gallon
Price
Supply: Price Net of Tax
a
Demand
Quantity
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Excise Tax
Tax Per Gallon
Price
b
Supply
a
Demand
Quantity
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Excise Tax
Restricts Quantity Demanded
 Raises price

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Profits Before Excise Tax:
Revenue Equals Price*Quantity
Price
Supply
a
P
Revenue
Demand
Q
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Quantity
18
Cost Equals Area Under Supply Curve
Price
Supply
a
Cost
Demand
Quantity
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Profit Equals Revenue Minus Cost
Price
Supply
a
Profit
Demand
Quantity
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Profit Equals Revenue Minus Cost
Price
Supply
a
P
Profit
Demand
Cost
Q
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Quantity
21
Excise Tax Equals Tax/Gallon*Quantity
Tax Per Gallon
Price
b
Supply
a
Tax
Demand
Q
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Quantity
22
Excise Tax
Tax Per Gallon
Price
b
Supply
a
Tax
Profit
Demand
Q
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Quantity
23
Excise Tax Redistributes Profits from
Foreign Suppliers to Home Country
Tax Per Gallon
Price
b
Supply
a
Tax
Profit
Demand
Q
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Quantity
24
Tax Policy As A Weapon
Excise Tax Can Restrict Quantity
Demanded
 Excise Tax Can Shift Profits from Foreign
Suppliers to Home Country
 Excise Tax Can Be A Foreign Policy
Weapon

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Autarchy

Self-Sufficient Economy
 only
trade within a region
 Sioux, Pawnees etc. were self-sufficient
 hunted
and gathered their food
 roamed the land and moved their homes
 made their clothes
 early
settlers were self-sufficient: home
production
 grew
their food
 cleared the land and built their homes
 made their clothes
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Trade Concepts

Trade allows countries (and individuals) to
specialize at what they do best rather than
being jacks-of-all-trades. By specializing
and becoming expert countries (and
individuals) increase productivity and
output.
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Autarchy-continued

West of the Alleghanies
 opened
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up to trade by Erie canal
28
Erie Canal
Completed
in 1825
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Production Functions, Labor Constraints and the Production
Possibility Frontier: Land is a Fixed Factor; Diminishing Returns
Agriculture
Production
Function with
diminishing
returns
Production Possibility Frontier
relative price of agricultural
goods to manufactured goods
depends on demand as well
as supply
Labor for
Agriculture
Manufactures
Labor
Constraint
450
Production Function
with diminishing returns
Labor for Manufactures
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Source: Lecture Thirteen
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Isolated West
Production Possibility Frontier, PPF
Agriculture
Regional Tastes:
manufactures are
scarce and hard to
make, i.e. valuable
Manufactures
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The Slope of the Production
Possibility Frontier
 Recall:
the slope of the production
possibility frontier reveals relative
values
rate
of exchange: 2 beaver pelts for every
mink pelt
 if
beaver pelts sell for 1 dollar, then mink
pelts are worth 2 dollars
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Production Functions, Labor Constraints and
the Production Possibility Frontier: No Fixed Factor
Beavers
Production
Function
Production Possibility Frontier
One mink is worth, or trades
for, two beavers: prices are
determined by labor inputs
2
1
Beaver Days
6
3
Labor
Constraint
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Minks
1
450
2
3
6
Mink Days
source: Lecture Thirteen
Production Function
35
Beavers
2
slope: B/ M = 2 = PM/PB = MCM/MCB
1
1
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Minks
36
Isolated West
Production Possibility Frontier, PPF
Agriculture
Regional Tastes:
manufactures are
scarce and hard to
make, i.e. valuable
QAg
QMf
Manufactures
steep slope, Ag/ Mf = PMf/PAg , so manufactures are dear
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Trade for a Small Region

The West takes Eastern trade prices as given
 after
canals open up transportation and goods
are exchanged

In the East, manufactures are more plentiful
and agricultural goods are scarcer

Ag/ Mf = PMf/PAg , is less steep, i.e in the East,
manufactures are less expensive relative to
agricultural goods
 the
East has a comparative advantage in
manufactures and the West has a comparative
advantage in agriculture
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West Trades with the East
Production Possibility Frontier, PPF
Agriculture
Eastern Prices: Ag/ Mf = PMf/PAg
Regional Tastes:
Manufactures
steep slope, Ag/ Mf = PMf/PAg , so manufactures are dear
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Trade Allows the West to Specialize in Agriculture
Production Possibility Frontier, PPF
Eastern Prices: Ag/ Mf = PMf/PAg
Agriculture
Specialize
in Ag at B
Regional Tastes:
B
A
Manufactures
steep slope, ∆Ag/∆Mf = PMf/PAg , so manufactures are dear
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Trade Permits the Decoupling of
Consumption from Production
In the self-sufficient West, people had to
produce what they consumed.
 When trade opened up with the East, the
West could specialize in producing
agricultural goods and import, i.e. trade for
manufactures

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Trade Allows the West to Decouple Production & Consumption
Production Possibility Frontier, PPF
Eastern Prices: Ag/ Mf = PMf/PAg
Agriculture
QAg
Exports
Regional Tastes:
B
C
CAg
A
Imports
QMf
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CMf
Manufactures
42
The Political Economy of Trade
Arguments for Free Trade
 Arguments Against Free Trade

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International Trade: Pro & Con
Pro
Con






Can’t compete with
low wages abroad
jobs are lost abroad
need to protect infant
industries
need to protect
strategic industries
excessive
specialization
unfair competition
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

Consumers gain from
more goods
competition keeps
industry progressive
44
Summary-Vocabulary-Concepts







autarchy/self-sufficiency
production possibility
frontier
exchange of goods
comparative advantage
specialization
export
import
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
Comparative sdvantage
45
Outline: Lecture Fifteen
Trade, domestic and foreign
 Balance of Payments Accounting
 Purchasing Power Parity
 Central Bank Reserves & Foreign Exchange
Intervention

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Balance of Payments Concepts

Balance of Merchandise Trade
 Value
of what we sell minus what we buy
Balance of Trade (Goods & Services)
 Balance on Current Account

 net
of transfer payments
 net of income on investments
If we buy more than we sell on current
account, then we pay for it with the capital
account
 On capital account we sell IOU’s, I.e bonds

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Balance of Payment Accounts
We are called a debtor nation if we are
selling IOU’s to pay for goods and services
 As a debtor nation, we are vulnerable to
foreigners selling their US assets and
repatriating their money, called capital flight

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Exports of Goods and Services as Fraction of GDP, 1929-1995 .
0.12
Exports as % of GNP
0.1
Linear (Exports as % of
GNP)
0.06
0.04
0.02
1993
1989
1985
1981
1977
1973
1969
1965
1961
1957
1953
1949
1945
1941
1937
1933
0
1929
Fraction
0.08
Year
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Growth in World Trade
Source: Economic Report of the President, 1997
http://www.gpo.ucop.edu/catalog/erp97.html
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Http://www.yardeni.com
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Measuring the Balance of Trade
Merchandise Balance of Trade: goods
 Balance of Trade ( Net Exports) : add
services
 Balance on Current Account:

 first:
add net transfer payments
 second: add income from US assets abroad
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Balance of Payments
 Merchandise
Exports
Trade Balance
of Goods
 capital
goods, except automotive: 41%
 industrial supplies and materials: 24%
 consumer goods, except automotive: 11%
 automotive vehicles, engines & parts: 11%
 foods, feeds, beverages: 9%
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Balance of Payments (Cont.)
Imports
of Goods
 capital
goods, except automotive: 29%
 industrial supplies and materials: 25%
 consumer goods, except automotive: 21%
 automotive vehicles, engines & parts: 16%
 foods, feeds, beverages: 4%
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Source:CIA
CIA
Source:
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Balance on Goods: Merchandise Trade Balance, US 1996 .
900000
800000
700000
Millions $
600000
500000
400000
300000
200000
100000
0
Exports
Source:
Llad
PhillipsUS
Imports
Dept. of Commerce, Survey of Current Business
56
Balance on Merchandise, US , 1946-1996, Millions $ .
900000
800000
700000
Exports, $M
Imports
Merchandise Net
600000
400000
300000
200000
100000
94
91
88
85
82
79
76
73
70
67
64
61
58
55
52
-100000
49
0
46
Millions $
500000
-200000
Year
Source:
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Economic Report of the President, 1997
57
Balance of Payments
Merchandise Trade Balance
 Balance of Trade: Net Exports(component
of GNP)

 Exports
of Goods and Services
 other
private services: 31%
 travel: 30%
 royalties and license fees: 13%
 Imports
of Goods and Services
 travel:
31%
 other private services: 27%
 other transportation: 18%
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Balance of T rade: Goods and Services, US, 1996 .
1000000
900000
Services
Goods
800000
700000
Millions $
600000
500000
400000
300000
200000
100000
0
Exports
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Imports
59
Balance of T rade: Goods and Services, US, Millions $
.
100000
50000
Millions $
-50000
94
91
88
85
82
79
76
73
70
67
64
61
58
55
52
49
46
0
Merchandise Net
Services Net
Balance of Trade
-100000
-150000
-200000
Year
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Balance of Payments
Merchandise Trade Balance: Goods
 Balance of Trade: Goods & Services
 Balance on Current Account

 Exports
of goods & services plus net transfer
payments plus US income on assets abroad
 Imports of goods & services plus net transfer
payments plus foreign income on assets in US
 transfers
• US Government grants
• US Government pensions & other
• private remittances
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Balance on Current Account, US, 1996, (Except Asset Income) .
1000000
900000
800000
Millions of $
700000
transfers, net
Services
Goods
600000
500000
400000
300000
200000
100000
0
Exports
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Imports
62
US Balance of T rade and Net Transfers .
20000
94
91
88
85
82
79
76
73
70
67
64
61
58
55
52
49
46
0
-20000
Millions $
-40000
-60000
-80000
-100000
Balance of Trade
transfers, net
-120000
-140000
-160000
Year
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Balance of Payments
Merchandise Trade Balance: Goods
 Balance of Trade: Goods & Services
 Balance on Current Account

 Exports
of goods & services plus net transfer
payments plus US income on assets abroad
 US
income on assets abroad
• direct investment receipts
• other private receipts
• US government receipts
 Imports
of goods & services plus net transfer
payments plus foreign income on assets in US
 transfers
payments to foreign assets in the US

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US Balance on Current Account, 1996, Millions $ .
1400000
1200000
Millions $
1000000
Investment income
transfers, net
Services
Goods
800000
600000
400000
200000
0
Exports
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Imports
65
Receipts and Payments on Assets
.
250000
Receipts, US Assets Abroad
200000
Payments on Foreign Assets in US
Money income, net
100000
50000
94
91
88
85
82
79
76
73
70
67
64
61
58
55
52
49
0
46
Millions $
150000
-50000
Year
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US Balance on Current Account: Merchandise & T rade
.
50000
Debtor
Nation
Creditor Nation
Millions $
-50000
94
91
88
85
82
79
76
73
70
67
64
61
58
55
52
49
46
0
Merchandise Net
Balance of Trade
-100000
Balance on Current Account
-150000
-200000
Year
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
67
How Do We Pay Balance on
Current Account?
We Sell Bonds to Foreign Investors
 Capital Account, 1996

 Foreign Assets
in the US, net change (Capital
Inflow)
 foreign
official assets in the US, net: $ 122354 M
 other foreign assets in the US, net: $ 425201 M
 US Assets Abroad,
net change (Capital Outflow)
 US
official reserves, net $ -6668 M
 other US Government Assets, net $ -690 M
 US private assets, net: $ 358422 M
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Relation Between Capital Account and Current Account
 Capital Inflow: receipts from sale of US bonds & assets

Interest Payments
on Foreign Assets

Interest
Rate
Stock of
Foreign Assets
in US
Components of Current Account
+
Interest Receipts
on US Assets
Interest
Rate
StockofofUS
Stock
US Assets
Assets
Abroad
Abroad
capital account component

 Capital Outflow: payments for foreign bonds & assets
69
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US Balance of Payments, 1996
.
1800000
1600000
1400000
capital account
Investment income
transfers, net
Services
Goods
Millions $
1200000
1000000
800000
600000
400000
200000
0
Exports
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Imports
70
US: Capital Inflow and Capital Outflow, 1960-1996
.

600000
Creditor
Nation
500000
Debtor
Nation
Capital Inflow
Capital Outflow
300000
200000
100000
Year
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71
96
94
92
90
88
86
84
82
80
78
76
74
72
70
68
66
64
62
0
60
Millions $
400000
Purchasing Power Parity Concept

In the long run, the exchange rate should
reflect purchasing power as measured by
relative prices (relative price indices) in the
two countries
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Puchasing Power Parity

Exchange Rate Ought to Reflect Puchasing
Power
a
bundle of goods that costs $1000 dollars in
the US should be purchasable for $1000 dollars
in Japan
 food,

clothing, shelter, etc.
Exchange Rate:123.30 yen to the dollar
 $1000
=123,300 yen
 so 119,600 yen should buy in Japan what $1000
buys in US

Price of the dollar is 123.3 yen
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Market for Foreign Exchange in Japan
Price of $
Demand for $
Supply of $
123.3 yen
Quantity of $
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Purchasing Power Parity

real exchange rate equals nominal exchange rate
divided by relative prices for a bundle of goods
 real

x-ch rate = 123.3 yen per $ ÷(CPIJapan/CPIUS)
For Example, if there is inflation in Mexico, then
the number of pesos to buy a $ should increase
 real
x-ch rate = 9.1575 pesos per $ ÷(CPIMex/CPIUS)
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Source:
Yardeni
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Exchange Rate for Mexico: New Pesos per US $
.
10
96
95
94
93
92
91
90
89
88
87
86
85
84
83
82
81
80
Exchange Rate
1
0.1
0.01
Year
Source:
International Monetary Fund, International Financial Statistics Yearbook,
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77 1996
Source: OECD
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Link Between Government
Deficits and Trade Deficits
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
US Govt. runs a deficit
 citizens

don’t want higher taxes
US Treasury finances deficit by selling treasuries
 US
citizens & institutions buy in primary market
 foreign citizens & institutions buy in primary market

Why do foreigners invest in US?
 politically
stable country
 may be attracted by:
 low
US inflation rate
 high US interest rate
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Central Bank Responsibilities: Domestic and Foreign
US Govt
Deficit
Treasury
Issues Bonds
Federal
Reserve
Foreigners
Buy Bonds
Foreign Concern
with US Inflation
Foreign Concern
with US Interest
Rates
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Capital Flight
1. foreigners sell their US securities
2. foreigners exchange their US $ proceeds for Yen
3. Supply of dollars shifts and price of the dollar falls
demand for $
supply of $
Yen price of US $
quantity of $
4. Federal Reserve may use its Yen Reserves to buy $, stabilize
x-chLladrate
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82
Mexico in 1995

Salinas Government runs a deficit
 spending
domestically to “buy” the election
burst of inflation
 capital flight from peso

 Mexicans
sell pesos and demand $
 demand for $ increases, peso price of $ rises

forces devaluation
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Flight of Pesos from Mexico
Peso Price
of the $
Supply of S
Demand for $
Quantity of $
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Source:
Yardeni
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85
Exchange Rate for Mexico: New Pesos per US $
.
10
96
95
94
93
92
91
90
89
88
87
86
85
84
83
82
81
80
Exchange Rate
1
0.1
0.01
Year
Source:
International Monetary Fund, International Financial Statistics Yearbook,
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86 1996
Thailand in 1997

Production down
 Toyota

source:
Business Week
11-17-97
shuts down 2 large factories in Bangkok
Banks hold bad loans
 speculation
in golf courses, condos, high rises
West worries: potential Intl. financial crisis
 International Monetary Fund: bailout loans

 Indonesia:
 US
$10 B
Treasury pledges $3B
 Thailand:
$22 B
 Philippines: $1B
 South Korea: $40B
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Changing Scenario in Asia
Four Tigers: Hong Kong, Taiwan,
Singapore, South Korea
Thailand and Neighbors: China,
Malaysia, Indonesia
Source: Economic Report of the President ,
1997
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source:
Federal Reserve Bank of St. Louis
Date
89
1997.09
1996.11
1996.01
1995.03
1994.05
1993.07
1992.09
1991.11
1991.01
1990.03
1989.05
1988.07
1987.09
1986.11
1986.01
1985.03
1984.05
1983.07
1982.09
1981.11
1981.01
Rate
T hailand Exchange Rate: Bahts Per Dollar, 1981-1997 .
40
35
30
25
20
15
10
5
0
source: CIA
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Source: http://interactive.wsj.com
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Source: Yardeni
‘94 Exports:
Manufactures: 73%
Partners: US 21%
Japan 17%
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Source: Yardeni
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Summary-Vocabulary-Concepts









merchandise trade balance
balance of trade
balance on current account
creditor nation
debtor nation
income on US assets
abroad
payments on foreign assets
in US
capital account
capital inflow
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








capital outflow
balance of payments
purchasing power
parity
real exchange rate
Mexican Peso
Japanese Yen
Thailand Baht
capital flight
devaluation
94