The Global Economy “Is the world really flat?”

Global Trade Issues Outsourcing jobs Illegal immigration – jobs taken Migration for jobs Balance of trade (trade deficit) Environment vs. economic growth Poverty in third world nations – does trade help or hurt?

Outsourcing vs. Insourcing

Trade Flows Nations are linked by the exchange of: Trade flows = Goods and services [exports (X) and imports (M)] Resource flows = capital (production facilities) and labor move from nation to nation Information and technology flows = info on prices, products, interest rates & investment opportunities; new technology Financial flows = Money for imports, assets, interest on debts & foreign aid

Why Trade? For resources we don’t produce ourselves Climate and natural resource limitations Lack of skilled labor Lack of low cost labor Lack of capital resources (factories, equipment, technology, etc.)

Why Trade? For political reasons To help allies – strengthen relations EX: U.S. and Taiwan in 1950’s To show disapproval or force a change in political policies through embargo or boycott EX: Boycott of S. Africa due to apartheid No trade with China ( ) and Cuba (1950-present)

Why Trade? For economic reasons ABSOLUTE ADVANTAGE – when a nation can produce MORE of a good or service with the same or fewer resources EX: Diamonds from S. Africa COMPARATIVE ADVANTAGE – when a nation can produce a good or service at the lowest opportunity cost EX: wheat from U.S.

Comparative Advantage Specialization – allows nations with the lowest opportunity cost to do what they do best, then trade Arbitrage – buy low and sell high All participants in a voluntary exchange will benefit Allows total output to increase Illustrated with PPC

Avocados Avocados Soybeans MEXICOU.S.

Comparative Advantage Graph indicates that when self sufficient…… Mexico produces 24 avocados & 9 soybeans when most efficient U.S. produces 33 avocados & 19 soybeans when most efficient To Find Opportunity cost = take max production #, put in fraction & reduce to show ratio

Comparative Advantage To Find Opportunity cost for Mexico = take max production #, put in fraction & reduce 60 avocados/15 soybeans is an opportunity cost of 4 tons of avocados for each additional 1 ton of soybeans (1s=4a) AND 15 soybeans/60 avocados =¼ ton soybeans for each additional 1 ton of avocados (1 a = ¼ s)

Comparative Advantage To Find Opportunity cost for U.S. = take max production #, put in fraction & reduce 90 avocados/30 soybeans is an opportunity cost of 3 tons of avocados for each additional 1 ton of soybeans (1s=3 a) AND 30 soybeans/90 avocados = 1/3 ton soybeans for each additional 1 ton of avocados (1 a = 1/3 s)

Comparative Advantage After determining opportunity cost for each nation – compare them to find the “lowest op cost” – that shows what they should specialize in & trade Mexico has the advantage in avocados (1/4 is less “cost” than 1/3 tons of soybeans) U.S. has the advantage in soybeans (3 is less “cost” than 4 tons of avocados)

Gains from trade When Mexico specializes in avocados, they produce 60 tons When the U.S. specializes in soybeans, they produce 30 tons Without trade, the maximum production (by both nations combined) would be: = 57 tons of avocados (gain of 3 tons) = 28 tons of soybeans (gain of 2 tons)

Trade Barriers Tariff – tax on imports (revenue & protective) Quota – limit on number of imports Informal barriers – licenses, fees, health inspections, & regulations on transportation Cultural and language differences

Protectionism vs. Free Trade Pro Protectionism – National defense (keep tech safe) Avoid dependency on other nations (ex:oil) Protect jobs (keep $$ & jobs at home) Infant industries need time to develop Keep balance of trade (exports = imports)

Protectionism vs. Free Trade Pro Free Trade Competition forces producers to lower prices & provide higher quality Trade raises the standard of living for all parties More efficiency when businesses specialize & trade = higher profits for owners Lost jobs are replaced with others Barriers lead to retaliation

Balance of Trade Difference between exports and imports (ideal is to have equal amounts; more exports = trade surplus; more imports = trade deficit) Surplus sounds good; deficit sounds bad; but this is not always true U.S. has had a negative trade balance since 1981 – economists do not agree on how serious this is!

U.S. Trade Deficit for over 20 yrs

Balance of Trade Balance of payments is based on: Credits (value of things sold abroad): Goods & services U.S. securities (Treasury bonds or stocks) Factories or businesses in the U.S. Interest owed to U.S. citizens for investments abroad

Balance of Trade Debits (value of things bought from firms abroad) Goods and services Foreign securities (stocks in foreign businesses) Factories or businesses abroad Interest paid to foreign citizens on their investments here

Balance of Payments Account There are two main accounts – Current Accounts (CA) & Financial Accounts (FA) previous“Capital Account” If an account is positive it is said to have a surplus; if negative = a deficit The overall account must be balanced (or total zero) CA + FA = zero

Balance of Payments Account Current Account (CA) trade in goods & services: Exports of goods & services + (plus) Imports of goods & services - (minus) Financial Account (FA) summarizes trade in assets U.S. assets owned by foreigners + (plus) Foreign assets owned by U.S. - (minus)

1999 Changes to BOT Categories Old Current Account became 2 accounts: the “New Current Account” –G & S; Income pmts & receipts and the “New Capital Account” – account to record capital transfers (ex: assets a migrant brings when moving here or debt forgiveness); It is a small account for U.S., but more impt for other nations

1999 Changes to BOT Categories Old Capital Account is now the “New Financial account” – trade in assets 2008 Macro AP Exam had question using the terms: “Capital & Current Accounts” which was confusing to students (because they had not learned BOT or learned the new terms & didn’t know the old ones!)

Foreign Exchange Rates Exchange rate – price of one currency in terms of another (multiply foreign price by exchange rate to get U.S. price) Fixed rate – rate of exchange stays the same; in past basis was gold Flexible rate (floating) – based on supply and demand for each currency

Foreign Exchange Rates Flexible rates – began in 1971 when U.S. went off the gold standard U.S. imports increased and foreigners were gaining U.S. dollars & exchanging them for U.S. gold Foreign exchange market - wherever one currency is exchanged for another

Foreign Exchange Appreciation (strong dollar) – dollar buys more of another currency & results in less expensive imports and more expensive exports (SID) Depreciation (weak dollar) – dollar buys less of another currency & results in more expensive imports and less expensive exports (WES)

Foreign Exchange $ price for yen $/Y Yen price for $ Y/$ Qty of yen Qty of $ S D S D Supply of yen from Japanese importers who must exchange them for $$ to buy U.S. goods Demand for yen by U.S. importers who need them to buy Japanese goods

Foreign Exchange Causes of S & D change - shifts (leads to exchange rate change): Incomes go up or down (can buy more or less of foreign goods) Tastes Relative price level (inflation in one nation makes foreign goods cheaper) Real Interest Rates (want to earn on financial assets abroad if rates are higher)

Foreign Exchange Must practice the supply and demand graphs for exchange rates PRACTICE – PRACTICE – PRACTICE!!!

AP Problem Areas – Increasing Questions on the Exam Comparative Advantage problems in FRQ’s FOREX graphs & resulting changes in currency values, export/imports BOT questions