Unit 5 International Trade and Finance 1

Why do people trade? More access to trade means more choices, cheaper prices and a higher standard of living. Video clip: trading up 2

Topic 1: Trade and opportunity cost  2 types of problems: ◦ Output problems - look at total items being produced ◦ Input problems - look at resources that go into making a product

Input or Output Question? Number caught per day DeerAntelope Henry46 John2412 5

Input or Output Question? Months to produce one CarPlane Canada8 months10 months Japan15 months12 months 6

2 Types of Advantages: absolute and comparative 1. Absolute advantage  Output problem: person/country can make more of the item than other country  Input problem: person/country can make item using less resources (time, land etc) than other country

Absolute Advantage? Number caught per day DeerAntelope Henry46 John2412 8

Absolute Advantage? Months to produce one CarPlane Canada8 months10 months Japan15 months12 months 9

◦ a country is able to produce a good at a lower opportunity cost than another country

Comparative advantage ** Comparative advantage Is gained through specialization To figure comparative advantage….Must calculate the PER UNIT opportunity cost * This will be different for INPUT and OUTPUT problems Output problem = COST/GAIN Input Problem = GAIN/COST The country that can produce the item at a lower opportunity cost should specialize in that item

To figure opportunity cost - Cost/Gain The following chart illustrates the number of CDs and pounds of beef that Japan and Canada can produce in a day Japan Canada 1 CD = ____ B 1 CD = _____ B 1 B = ______ CD 1 B = ______CD Japan should produce __________ Canada should produce _________ CD ‘sBeef Japan42 Canada46

Japan, 1 CD = 1/2 B, 1 B = 2 CD Canada 1CD = 3/2 B, 1 B = 2/3 CD Japan should produce CDs Canada should produce Beef

The following chart illustrates the number of hours it takes the U.S. and France to make one loaf of bred and one bushel of corn U.S. 1 B = _________ C, 1C = __________ B France 1 B = ________C, 1 C = __________B The U.S. should produce ________________ France should produce __________________ BreadCorn U.S.4 hours2 hours France4 hours6 hours

In the U.S. 1 B = 2 C, 1C = 1/2 B In France 1 B = 2/3 C 1 C = 3/2 B The U.S. should produce Corn France should produce Bread

Practice: Who has the Comparative Advantage? Number caught per day DeerAntelope Henry46 John Henry 1 D = _____ A 1A = ______D John 1D = ______A 1A = ______D

Comparative Advantage? Number caught per day DeerAntelope Henry46 John Henry 1D = 3/2 A 1 A = 2/3 D John 1 D = ½ A 1A = 2 D

Comparative Advantage? Number caught per day DeerAntelope Henry46 John Henry 1D = 3/2 A 1 A = 2/3 D John 1 D = ½ A 1A = 2 D

Practice: Who has the Comparative Advantage? Months to produce one CarPlane Canada8 months10 months Japan15 months12 moths 19 Canada 1C = _____ P 1 P = _____C Japan 1C = ______P 1P = _____C

Comparative Advantage? Months to produce one CarPlane Canada810 Japan Canada 1 C = 4/5 P 1 P = 5/4 C Japan 1 C = 5/4 P 1P = 4/5 C

Comparative Advantage? Months to produce one CarPlane Canada810 Japan Canada 1 C = 4/5 P 1 P = 5/4 C Japan 1 C = 5/4 P 1P = 4/5 C

1. The following table gives the number of hours it takes in the United States and Scotland, using the same amount of resource, to produce a ton of oats or one bagpipe.  a. Output or input problem?? b. Who has the absolute advantage in oats? Bagpipes? c. Who has the comparative advantage in Oats? Bagpipes? OatsBagpipes U.S.2 hours3 hours Scotland5 hours4 hours

Input problem; looks at TIME making Absolute advantage: Oats = U.S. (takes less time to make) Bagpipes = U.S. (takes less time to make) Comparative Advantage: U.S. Scotland 1 O = 2/3 BP 1 O = 5/4 BP 1 BP = 3/2 O 1BP = 4/5 O U.S = OATS Scotland = BAGPIPES

The table below gives the total number of pens and paper that country X and country Y can produce. Country X Country Y A B C D E F A B C D E F Pens Pens Paper paper PENS 4 PAPER 8 PENS 3 PAPER 12 a. Output or input problem? b. Who has the absolute advantage in producing pens? paper ? c. Who has the comparative advantage in producing pens? paper?

Output problem Absolute advantage:  Pens = X  Paper = Y Comparative Advantage: Country X Country Y 1 Pen = 2 paper 1 pen =4 paper 1 paper = 1/2 pen 1 paper = ¼ pen

 Free Trade = trade without restrictions  Protectionism = trade with restrictions (ex. Tariffs and quotas)

 Supply decreases, causing prices to increase

G’s revenue from tariff? Q demanded at Pw + t? Q supplied at Pw + t ?

Topic 3: Foreign Exchange (aka. FOREX)

US sells cars to Mexico Mexico buys tractors from Canada Canada sells syrup to the U.S. Japan buys Fireworks from Mexico For all these transactions, there are different national currencies - each country must be paid in their own currency The buyer (importer) must exchange their currency for that of the sellers (exporter).

 Looks at relationship between exports and imports  Trade surplus = Exports > imports ◦ Causes AD to increase  Trade Deficit = Imports > exports ◦ Causes AD to decrease

Foreign Exchange Market: FOREX Examines the price of one currency in terms of the other currency.

FOREX simplified Imagine a shack in the middle of the pacific ocean - on the shelves in the stock room is every country’s currency “Fred” is the operator of this shack If a person wants (demands) one currency, they have to pay for it using their currency

People will bring their Pesos to Fred who will go into the stock room and place the pesos on the shelf. The SUPPLY of pesos in the “shack” just increased Fred then goes and gets the dollars off the shelf to give to the customer. The SUPPLY of dollars in the stock room just decreased

More Canadians are traveling to the United States: Demand for dollars increases Demand for Canadian dollars decrease Supply of Dollars decreases Supply of Canadian dollars increases

Things that impact the Supply and demand of a currency

Example: More Japanese teenagers want American clothing In order for Japanese teenagers to buy American clothing, they will need to convert Japanese currency to American currency

2. Changes in Relative Price Level If prices are lower in one country, more people will want to buy products from this country Example: Prices in the United States rise relative to prices in Germany. People in the U.S. will want to buy the cheaper German made products and will need German currency to do so

If interest rates are higher in one country relative to those in another country, countries will want to put their $ into the banks with the higher interest rates Example: Interest rates in the U.S. rise relative to those in Canada. Canadians will want to save their money in U.S. banks but they will need to convert their currency to dollars to do so

If income goes up in a country, they will buy more foreign products; if income goes down in a country, they will buy less foreign products Example: Income for Americans has decreased; Americans will buy less products from all foreign countries

 Expansionary = causes value of currency to go down  Contractionary = causes the value of currency to go up

Foreign Exchange Q Demand Supply Equilibrium: $1 = £1 Quantity of ____________ Price of ____

 Numbers 1 and 2 on practice WS

Appreciation: currency is more valuable than the other country’s currency Depreciation: currency is less valuable than the other country’s currency

 What happens to the Demand for the dollar?  What happens to the demand for the euro?  What happens to the supply of the euro?  What happens to the supply of the dollar? Draw a graph that shows the Change in the demand for Dollars.

The U.S. dollar _____________________________  As a result of the changing value of the dollar,  Exports from the U.S. will _______  Imports from the U.S. will _________  U.S. will have a trade ____________

The demand for yen will______ The demand for the dollar will ______ The supply of the yen will _______ The supply of the dollar will _______ Show on a graph the change in the supply of dollars. The dollar will _____________ in comparison to the yen. As a result of the change in value, U.S. exports will _______ U.S. imports will ____ U.S will have a trade _______.

 Numbers 3 and 4 practice WS

Balance of Payments (BOP) Database that records monetary transactions between countries The balance of payments is made up of two accounts. 1. current account 2. financial account. * Balance of trade : relationship between exports and imports only

Current Account Includes: 1. Merchandise and service Trade 2. Income receipts – income received from stocks and dividends 3. Transfers of money (includes foreign aid)

 Surplus = more $ comes into country Than is leaving  Deficit = more $ leaving country than what is coming in

Financial Account Includes: Transactions between foreign countries of physical and financial assets FINANCIAL ACCOUNT = THINK ASSETS!!!! Physical Asset: EX: a U.S. company buys a hotel in Russia Financial Asset : purchase of other country’s stocks, bonds, treasury bills EX: A German student buys stock in an American company Credit vs debit – think about who OWNS the assets

 Capital account surplus: if a nation's investments abroad are greater than foreign investments at home. $ is flowing into a country (capital inflow)  Capital account deficit: foreign investments at home are greater than investments abroad; $ flowing out of the (capital outflow) Example:  U.S is buying up more assets in Mexico, Brazil, and Hungry, than Japanese, Germany, and Canada investors are buying up of U. S. assets, then we have a surplus. A deficit is the reverse.

Transaction Current or FINANCIAL account Debit or credit for U.S. Harley Davidson USA purchases $25 million in production machinery from a Japanese company CURRECTDEBIT Bank of America pays $5 million in interest to French depositors CURRENTDEBIT A London record store spends $10,000 on CD ’s by an American singing group CURRENTCREDIT Senor Ramos from Spain buys a shopping center in Florida FINANCIALDEBIT