Chapter 17 International Trade

Why Do Nations Trade? There is an unequal distribution of resources High school terms – other countries have stuff that we don’t All nations need goods and services, but may not have the factors of production required

Resource Distribution Natural Resources – Farm land, mineral deposits, oil, natural gas, water, woodlands U.S. Strengths – farm land U.S. Weaknesses – none (though oil consumption far exceeds supply)

Resource Distribution Human Capital – knowledge and skills of workers, overall education level U.S. Strengths – very high literacy rate 97%, largest network of universities U.S. Weaknesses – none

Resource Distribution Physical Capital – manmade objects used to produce other goods and services U.S. Strengths – extensive communications network, roads and transportation U.S. Weaknesses – none

Resource Distribution

How Do Nations Decide What to Produce and Trade? Determine your country’s absolute and comparative advantages Absolute Advantage – you can produce it at a lower cost than other countries Comparative Advantage – your opportunity cost is lower than other countries for producing that good The best option is to trade based on comparative advantage

Huh? U.S. can make 4 barrels of oil, or 12 bales of wheat Mexico can make 2 barrel of oil, or 2 bale of wheat Who has the absolute advantage for oil? For wheat?

Huh? What is the U.S. opportunity cost for each barrel of oil? What is Mexico’s opportunity cost for each barrel of oil? Who has the comparative advantage for oil? For wheat?

Comparative/Absolute Review Jim can produce 6 IPOD’s or 18 pairs of shoes in 1 hour John can produce 3 IPOD or 3 pair of shoes in an hour Who has the absolute advantage for IPOD’s ? For Shoes?

Comparative/Absolute Review What is the Jim’s opportunity cost for each IPOD? What is John’s opportunity cost for each IPOD? Who has the comparative advantage for IPOD’s? For shoes?

Benefit of Trading Based on Comparative Advantage Each side will bargain to make the best deal possible John can produce his own IPOD, or send shoes to Jim in exchange for IPOD By trading both sides can profit

Trade and Employment Trading based on comparative advantage creates specialization – produce only some goods/services rather than everything they need and want Specialization can cause unemployment, but it also makes goods cheaper, overall

Trade Barriers U.S. is the world’s largest exporter and importer Trade Barrier – restriction on trade of goods to or from foreign countries Trade Barriers can take many forms

Trade Barriers Tariff – tax on imported goods, discourages consumers from buying those goods Embargo – total ban on trading

What is the Goal of Trade Barriers? Protectionism - Preserve jobs and industries in your country

What is the Goal of Trade Barriers? Reasons for protectionism: Save jobs that would go to countries with cheap labor

What is the Goal of Trade Barriers? Reasons for protectionism: Protect national security for critical industries needed in a war

Trade Organizations

Current Free Trade Agreements Reciprocal Trade Agreement Act Passed by Congress to allow the President to reduce tariffs U.S. grants “normal trade relations” status to trade partners

Current Free Trade Agreements World Trade Organization (WTO) Acts as a referee in trade to reduce tariffs and restrictions 149 Members

Current Free Trade Agreements European Union (EU) Unified economy of 12 European countries Same currency, free trade

Current Free Trade Agreements North American Free Trade Agreement (NAFTA) Eliminates all trade barriers between Canada, the U.S., and Mexico by 2009

Exchange Rates Exchange Rate – amount of another currency you can trade your currency for Ex. Trading a dollar for 10 pesos Exchange Rates change daily, based on supply and demand

Exchange Rates Strong Currency vs. Weak Currency A strong currency is appreciating – growing in value compared to other currencies A weak currency is depreciating – decreasing in value

Exchange Rates Effects of strong and weak currencies A strong dollar discourages other countries from buying American goods (decreases exports) A weak dollar makes American goods cheaper for other countries (increases exports)