International Trade

Key Questions Why do countries trade with each other? How does international trade help the economy? What are the effects of tariffs and quotas? Why do exchange rates matter? Key Questions

Should a nation never trade for goods and services it can produce itself?

"What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage. The general industry of the country, being always in proportion to the capital which employs it, will not therby be diminished... but only left to find out the way in which it can be employed with the greatest advantage." Adam Smith, 1776

“Under a system of perfectly free commerce, each country naturally devotes its capital and labour to such employments as are most beneficial to each. This pursuit of individual advantage is admirably connected with the universal good of the whole. By stimulating industry, by regarding ingenuity, and by using most efficaciously the peculiar powers bestowed by nature, it distributes labour most effectively and most economically… It is this principle which determines that wine shall be made in France and Portugal, that corn shall be grown in America and Poland, and that hardware and other goods shall be manufactured in England.” David Ricardo, 1817

Benefits of trade: nationally Maintains and improves relations between countries Allows countries to acquire goods and services they may not be able to produce on their own Natural Resources Raw Materials Allows countries to obtain products that other countries may produce more efficiently (less costly) Foreign competition diminishes domestic monopoly power

Example: clothing & food United States Mexico Skilled workforce, capital, land Comparative advantage in food production Less-skilled workforce Comparative advantage in labor-intensive goods

Gains from trade Mexico and the U.S. prefer some of both goods. Choice to make: Each country could produce both outputs on own, or They could specialize and trade Where do gains from trade come from? Nations produce goods in which they have a low opportunity cost of production, and trade in exchange of goods in which they have a high opportunity cost Lower costs of production lead to maximized combined output Solution: Mexico makes clothes, U.S. grows food

Benefits of trade: Consumer People can acquire a product or service through trade more cheaply Economies of scale result in lower prices Promotes competition Wider variety of goods Lower prices

Over the past 70 years, nations all over the world have increased imports and exports Lower costs Reduced trade barriers Increased specialization Since 1980, while world GDP has grown at just under 3.5% annually, trade has been growing at about 5.7% annually. The growth in trade is interesting because it largely reflects the effects of specialisation and trade in intermediate goods

Barriers to Trade Barriers create inefficiencies in protected industries Tariffs Taxes levied on imported goods and services Subsidies A benefit (usually cash) given y a country to support an industry Quotas Limits on the quantity of products that can be imported into a country

Why prevent trade? National Security Infant Industries Anti-Dumping Argument: Without ability to produce own missiles, firearms, aircraft, etc. a nation could be reliant on its enemies Infant Industries Argument: New industries need protection until they are established and able to compete internationally Anti-Dumping Argument: Foreign suppliers sell a good below the price it charges in its home country (usually subsidized) Special Interests Argument: Groups that lobby their government for consideration (tariffs, subsidies, etc.) to protect their domestic products

Arguments for and against Protectionism Free Trade Protects domestic jobs Allows new industries to grow until competitive Protects national security Lower prices Allows for a greater variety of goods Improves economic welfare Access to new markets

Terminology Trade balance Trade surplus Trade deficit Free trade Total exports minus total imports Trade surplus Positive trade balance, when exports > imports Trade deficit Negative trade balance, when imports > exports The U.S. has had a trade deficit since 1975 Free trade The absence of barriers such as tariffs or quotas Protectionism Use of barriers such as tariffs, quotas, or embargoes

Even More Terminology Absolute Advantage Comparative Advantage Ability to produce a good or service at a lower cost per unit than anyone else Comparative Advantage Ability to produce a good or service at a lower opportunity cost than other countries (or businesses)

Containership information Largest 18,000 TEU, or 9,000 40’ semi trailers Average Number of pairs of shoes per container in a 40’ container 10,000+ pairs of shoes Number of pairs per avg ship if all shoes 90 million Nike cost to ship $1.00 per pair

Major Trading partners of the U.S.

Exchange rates Def: The price of foreign currency The amount of dollars required to buy units of another currency Exchange rates are prices Prices are determined in world currency markets AKA foreign exchange markets How are these prices determined? Like other markets, supply and demand determine prices (exchange rates) How to use Number of euros you can buy with one dollar (€ per $) Number of dollars required to buy one euro ($ per €)

Exchange rates Currency Appreciation Currency Depreciation Bottom line Occurs when a currency increases in value relative to other currencies Dollar appreciation means that You can buy more euros with a dollar It becomes more valuable in world markets Currency Depreciation Occurs when a currency decreases in value relative to other currencies Bottom line If exchange rates rise, foreign currency becomes more expensive Imports become more expensive Exports cheaper for other countries