Unit 4: International Economics The Basics of International Trade

Think and Write Given that the U.S. (like all nations) has limited productive resources, where do you think our country ought to focus in its production decisions (meaning…what are we best suited to produce)? Answer and support your reasoning… (there is no “right or wrong”)

Production and Trade Decisions It makes the most economic sense to produce where we are most efficient Must consider production possibilities & related opportunity costs Allows us to specialize

Absolute Advantage Occurs when one nation is able to produce a product “more” efficiently than another or produce a greater ouput. Two ways to look at it… Input Method: When a nation is able to produce the same output as another with less inputs Output Method: When a nation is able to produce more output than another with the same input

Absolute Advantage (cont.) Example based on inputs… Country A produces 5 computers with 2 workers while Country B produces 5 computers with 4 workers. Example based on outputs… Country A is able to produce 10 computers with 6 workers while it takes Country B 6 workers to produce 12 computers. Large nations will almost always have an absolute advantage. Why?

Example of Absolute Advantage Nations # of iPods produced per hour # of Tablet Computers produced per hour Warriorland 40 20 Mustangland 90 30 Which nation has the Absolute Advantage producing iPods? Tablets?

Comparative Advantage Occurs when one country has the lowest opportunity cost for producing that good. It’s the ratio of “What is being produced” vs. “What is given up” Nations specialize if they can produce with lower opportunity costs than another. It’s why we trade!!!!

Example of Comparative Advantage Nations # of iPods produced per hour # of Tablet Computers produced per hour Warriorland 40 20 Mustangland 50 30 Which nation has the Comparative Advantage producing iPods? Tablets?

Managing Our Trade We do so through by “balancing out” the flow of goods and/or money between the nations we trade with… Do we export or import more goods from a trading partner?

Balance of Trade Exports – Imports (X-M) Greater exports = TRADE SURPLUS Greater imports = TRADE DEFICIT Exports = Imports = BALANCED TRADE Measures the $ value of exports vs. imports

Balance of Payments Records all international monetary ($) transactions $ flowing out and $ flowing in $ flowing in are “credits” $ flowing out are “debits” Balance of Payment Deficit: occurs when DEBITS > CREDITS Balance of payment Surplus: occurs when CREDITS > DEBITS

Balance of Payments (cont.) Balance of Payment is ideally zero… Calculated by transactions in three types of accounts… Current Account (Balance of Trade) – lets us know whether we have a trade deficit or trade surplus Financial Account measures the value of stocks/bonds one country buys from another. Capital Account measures the value of capital goods (buildings, etc. )one country buys from another.

Balance of Payments Balance of Payments = Current Account ($) + Financial Account ($) + Capital Account ($)

Trade Barriers Laws passed to restrict flow of goods between its country and another Goal is typically to promote its industries

Types of Trade Barriers Tariffs – tax place on imports Quotas – limit in quantity of goods from another nation Embargo – a complete ban due for political reasons Standards – requirements on quality of goods before it comes in – protects consumers Subsidies – a transfer payment from the government to exporting companies – goal is to allow its exports compete with other nations on the international market.

Trading Blocs A group of countries that band together and limit trade barriers in order to promote trade between members Designed to improve efficiency Designed to raise standard of living and establish new trading partners Opponents say it gives some partners an unfair advantage due to labor costs and lack of restrictions on environment

Examples of Trading Blocs European Union (EU) – 28 nations France, Italy, Belgium, UK, Poland, Sweden, etc. North American Free Trade Agreement (NAFTA) – US, Mexico, Canada Association of South East Asian Nations (ASEAN) – 10 nations Philippines, Singapore, Thailand, and Vietnam, etc.

Accomplishments of the EU Common currency Peace in Europe Environmental protection Safer/cheaper transportation

Accomplishments of NAFTA Trade and investment between members has increased (not as much as hoped for) Industries have specialized more Foreign investment has increased Has not… Solved labor problems - illegal immigration/migration Solved environmental issues Set common rules for subsidies

Accomplishments of ASEAN Rate of GDP growth of the region is the fastest in the world Wages are increasing & poverty decreasing Over 70% of goods traded between nations have no tariffs!

Exchange Rates The price of one nation’s currency vs. another… http://www.x-rates.com/table/?from=USD

Calculating Exchange Rates U.S. Dollar : Japenese Yen $1.00 ¥114.04  If you went to Japan, you’d get ¥114.04 for each dollar! How about the other way around?

Calculating an Exchange Rate Japenese Yen : U.S. Dollar ¥1 $ ? How many $US could a visitor from Japan get for each Yen he brings? The math is simple…just divide $1/114.04 and you get ¥1 = $.0088 US If a person from Japan came to America and wanted to buy a Big Mac Meal ($5.99), how many Yen would they need to exchange? $5.99/.0088 = ¥680.68!!!!!!!

When the Dollar Appreciates It increases in value compared to other currencies – it is a STRONG $m Imports increase and are cheaper for consumers to buy U.S. exports decline The U.S. trade deficit increases

When the Dollar Depreciates Its value decreases compared to other currencies – it is a WEAK $ U.S. exports increase and prices of exports go up U.S. imports decline and prices of imports increase U.S. trade deficit decreases Foreign investment in the U.S. grows