Chapter 17 International Trade

Why Do Nations Trade? There is an unequal distribution of resources There is an unequal distribution of resources High school terms – other countries have stuff that we don’t 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 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 Natural Resources – Farm land, mineral deposits, oil, natural gas, water, woodlands U.S. Strengths – farm land U.S. Strengths – farm land U.S. Weaknesses – none (though oil consumption far exceeds supply) U.S. Weaknesses – none (though oil consumption far exceeds supply)

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

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

How Do Nations Decide What to Produce and Trade? David Ricardo’s Law of Comparative Advantage David Ricardo’s Law of Comparative Advantage Absolute Advantage – you can produce it at a lower cost than other countries (effectively meaningless) Absolute Advantage – you can produce it at a lower cost than other countries (effectively meaningless) Comparative Advantage – your opportunity cost is lower than other countries for producing that good Comparative Advantage – your opportunity cost is lower than other countries for producing that good The best results come from trading based on comparative advantage The best results come from trading based on comparative advantage

Huh? U.S. can make 2 barrels of oil, or 6 bales of wheat U.S. can make 2 barrels of oil, or 6 bales of wheat Mexico can make 1 barrel of oil, or 1 bale of wheat Mexico can make 1 barrel of oil, or 1 bale of wheat Who has the absolute advantage for oil? Who has the absolute advantage for oil? For wheat? For wheat?

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

Benefit of Trading Based on Comparative Advantage Each side will bargain to make the best deal possible Each side will bargain to make the best deal possible The U.S. can produce its own oil, or send wheat to Mexico in exchange for oil The U.S. can produce its own oil, or send wheat to Mexico in exchange for oil If Mexico accepts 2 wheat for 1 oil, both side profit If Mexico accepts 2 wheat for 1 oil, both side profit

Trade and Employment Trading based on comparative advantage creates specialization – countries only produce what they can produce at lower opportunity costs than others Trading based on comparative advantage creates specialization – countries only produce what they can produce at lower opportunity costs than others Specialization can cause unemployment in an individual sector, but it also makes goods cheaper, overall Specialization can cause unemployment in an individual sector, but it also makes goods cheaper, overall

U.S. Exports and Imports U.S. is the world’s largest exporter and importer U.S. is the world’s largest exporter and importer Imports: Imports: 1. Industrial supplies and materials 1. Industrial supplies and materials 2. Consumer goods 2. Consumer goods 3. Capital goods 3. Capital goods Exports: Exports: 1. Capital goods 1. Capital goods 2. Industrial supplies and materials 2. Industrial supplies and materials 3. Consumer goods 3. Consumer goods

U.S. Exports and Imports Trade Surplus – when a country exports more than it imports (more money coming in to the country than going out) Trade Surplus – when a country exports more than it imports (more money coming in to the country than going out) Trade Deficit – when a country imports more than it exports (more money going out than coming in) Trade Deficit – when a country imports more than it exports (more money going out than coming in) U.S. Balance of Trade for $708.5 Billion Trade Deficit ($1.6 trill. in exports - $2.3 trill. in imports) U.S. Balance of Trade for $708.5 Billion Trade Deficit ($1.6 trill. in exports - $2.3 trill. in imports)

Trade Barriers Definition – restriction on trade of goods to or from foreign countries Definition – restriction on trade of goods to or from foreign countries

Trade Barriers Import Quota – limit on number of goods that can be imported Import Quota – limit on number of goods that can be imported Voluntary Export Restraint (VER) – reduction in exports, done to encourage another country to reduce trade barriers Voluntary Export Restraint (VER) – reduction in exports, done to encourage another country to reduce trade barriers Often NOT really voluntary… done at another country’s request Often NOT really voluntary… done at another country’s request

Trade Barriers Tariff – tax on imported goods, discourages consumers from buying those goods Tariff – tax on imported goods, discourages consumers from buying those goods Embargo – total ban on trade Embargo – total ban on trade U.S. currently has 4 embargos – Cuba, North Korea, Iran, Syria U.S. currently has 4 embargos – Cuba, North Korea, Iran, Syria

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

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

What is the Goal of Trade Barriers? Reasons for protectionism: Reasons for protectionism: Protect an infant industry that needs time to develop Protect an infant industry that needs time to develop

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

Current Free Trade Agreements World Trade Organization (WTO) World Trade Organization (WTO) Acts as a referee in trade to reduce tariffs and restrictions 150 Members

Current Free Trade Agreements European Union (EU) European Union (EU) Unified economy of 27 European countries Same currency, free trade

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

Current Free Trade Agreements Asian Pacific Economic Cooperation Asian Pacific Economic Cooperation Countries along the Pacific (U.S. China, Russia etc.) agree to reduce barriers

Multinational Corporations and Trade Integrate a variety of countries into production of a good Integrate a variety of countries into production of a good Reduce distinction between foreign and domestic goods Reduce distinction between foreign and domestic goods

Multinational Corporations and Trade Some fears that corporations take advantage of under- developed countries, and destroy local cultures Some fears that corporations take advantage of under- developed countries, and destroy local cultures This is often referred to as cultural imperialism This is often referred to as cultural imperialism

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

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

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