Transcript International Trade

AAEC 2305
Fundamentals of Ag Economics
Chapter 8
International Trade
Objectives
This chapter will help you learn:
How international trade affects the
determination of domestic prices, production,
and consumption.
How resource endowments and production
technology determine a nation’s comparative
advantage and thereby its exports and imports.
How international trade policies can be used to
alter domestic market equilibrium.
(continued)
About the history of U.S. agricultural trade
and the role of agriculture in the GATT and
WTO negotiations.
International Trade
International trade is the sale and purchase
of goods across national boundaries.
Unrestricted International Trade – If
international trade is not restricted, buyers
& sellers in one country may purchase
goods (& services) from any other country.
Hence – each buyer and seller has the option to
make a transaction either in the domestic
market or abroad.
The choice depends on where you can get the
higher (lower) price if you are selling (buying)
Exchange Rates
Comparing prices at home and abroad is
complicated by the fact that prices in other
countries are denominated in their home
currency.
To compare foreign prices with the
domestic price, the foreign-currency-based
price is converted into its domestic currency
equivalence using the exchange rate.
(continued)
Exchange rates represent the price of one
country’s currency in terms of the currency
of another country.
These exchange rates are a direct reflection
of the supply and demand conditions in
currency markets.
With higher interest rates, the value of the
dollar strengthens and makes US products
more expensive in foreign currencies.
(continued)
With lower interest rates, the value of the
dollar weakens and makes U.S. products
more price competitive.
Example – assume it costs 600 German
Marks to purchase a ton of American wheat
valued at $200 (an exchange rate of 3:1)
Suppose monetary policy drives the value
of the dollar down to a 2:1 exchange rate
(now it only takes two German marks to
buy one dollar)
(continued)
The ton of American wheat now costs the
German buyer only 400 marks.
With the lower price and other factors held
constant, we would expect the Germans to
import more American wheat.
This is why American Farmers &
Agribusinesses tend to benefit from a weak
dollar.
1980’s
When the Fed pursued a tight money policy
in 1979 and drove the discount rate to 14%,
the value of the dollar rose sharply.
Why? – With high interest rates in America,
foreign investors wanted to buy dollardenominated investments, like bonds, to get
those higher interest earnings.
(continued)
While the American consumer benefited from the
strong dollar (i.e., foreign products were cheaper),
U.S. agricultural exports became uncompetitive in
world markets.
The results were dramatic. Total agricultural
exports plunged from $44 billion in 1981 to only
$26 billion in 1986.
This was the depth of the economic depression in
agriculture – primarily a result of changing
monetary policies.
World Price
Instead of examining prices from all pontential
foreign buyers or sellers, we assume that there is a
world price (Pw) made up of the combined
markets of all countries in the world.
We will also assume that all prices are expressed
in dollars (which is often the case in international
transactions)
Furthermore, we will ignore transportation costs to
& from the world market so that we can examine
the essential features of international trade.
Small-Country Assumption
For almost all commodities, the volume in
the world market (total world production) is
much larger than the production or
consumption of any one country.
Therefore, the trade of any single country
has little effect on the world price.
A country that cannot change world prices
by altering its exports or imports is called a
small country.
(continued)
For commodities where the small country holds,
the world market can buy (sell) as much as the
economy can produce (purchase) at a given
world price.
Hence, if the government does not intervene in
international trade, the equilibrium domestic
price is equal to the world price.
Since the value of American trade, including
agricultural trade, is by far the largest of any
nation, it may appear that the U.S. can dominate
the world market.
(continued)
However, if we compare U.S. production and
trade with the ROW for several important
agricultural commodities we find this is not the
case.
Since the U.S. is a small country for most
agricultural commodities, for the remainder of this
discussion we will make the small-country
assumption (unless otherwise stated), which is that
shifts in domestic demand or supply and trade
policy changes do not change world price.
Equilibrium Price with Trade
With no international market, and gov’t
policy preventing imports and exports, the
equilibrium price (and quantity) is found at
the intersection of domestic supply and
demand. (sometimes called the closedeconomy case)
(continued)
ExportsSupposed the economy is opened up to
international trade, with the world price above
the intersection of the domestic supply and
demand curves.
Producers can now sell all they can produce on
the world market at the higher world price
(Pw). Producers will sell to domestic
consumers only at this higher price.
(continued)
Since the Pw is higher than in the closed
economy – producers expand production
and consumers reduce consumption.
Additionally, this quantity differential that
would be a surplus in a closed economy is
exported.
Although domestic demand does not equal
domestic supply – the market is in
equilibrium.
(continued)
ImportsSuppose the Pw is below the intersection of
domestic supply and demand.
Consumers can now purchase as much of the
commodity as they want at the lower world
price.
Domestic producers must lower their prices to
compete.
(continued)
Since Pw is lower than the domestic price
would be if trade was prohibited, consumers
will expand consumption and producers
reduce production.
The would-be shortage in a closed-economy
is imported.
(continued)
Under the import and export cases, the
market is in equilibrium. Producers can sell
as much as they want, and consumers can
purchase as much as they want, at the
market equilibrium price.
With international trade, the market
equilibrium price is the world price (Pw).
Shift in the Demand Curve
in an Open Economy
The shift in demand and supply curves have
different effects in an open economy
compared to an economy closed to
international trade.
In an open economy, the domestic price and
the world price are the same at Pw.
Changes in domestic demand do not change
the price because the country’s exports are
not large enough to alter the world price
(small country assumption)
(continued)
Suppose there has been an outward shift in
domestic demand. What are the effects to
quantity supplied (Qs), quantity demanded
domestically (Qd), and quantity exported or
imported.
**Refer to in-class examples**
Why Nations Trade:
For nations, differences in productive
capacities determine who or which nation
specializes in producing various goods and
thus international trade flows.
To understand how these differences affect
trade flows, we must first examine the
benefits from international trade.
(continued)
Exporting is beneficial in that jobs are
created and profits are generated. The
income produced can be used to buy foreign
or domestic goods.
Why would consumers want to consume
foreign goods?
1) It might not be possible to produce the
foreign good at home.
2) It might be cheaper to purchase goods from
another country.
Absolute vs. Comparative
Advantage
Absolute Advantage – a country has an
absolute advantage in the production of a
good if it can produce more of that good
with a given set of resources than another
country.
If one country has an absolute advantage in the
production of rice and another country has an
absolute advantage in the production of beans,
then the trade flows are obvious.
(continued)
Comparative Advantage – a country has a
comparative advantage in those goods for
which it has the lowest opportunity cost
compared to its trading partners.
What is meant by “lowest opportunity cost”?
If countries export those goods and services for
which that have a comparative advantage and
import goods for which they have a
comparative disadvantage – Trade is mutually
beneficial to all nations.
(continued)
If all nations were the same, there would be
no reason to trade.
However, there are 3 important differences
that explain why countries trade.
1) Resource endowments
2) Production technologies
3) Tastes and Preferences