Unit 4 – International Economics

Standard SSEIN1 The student will explain why individuals, businesses, and governments trade goods and services. a. Define and distinguish between absolute advantage and comparative advantage. b. Explain that most trade takes place because of comparative advantage in the production of a good or service. c. Explain the difference between balance of trade and balance of payments.

What is Trade? The voluntary exchange of goods/services Also known as commerce

Why Trade? Resources are not distributed equally around the globe Land – agriculture vs. oil Labor – high literacy rate = skilled workforce Capital – factories, infrastructure (Entrepreneurship)

Trade Because countries differ in resources, they differ in the production of g/s Leads to specialization Specialization – producing certain g/s rather than what you need Do what you are good at…trade for what you’re not!

Trade Countries then rely on each other for the production of g/s. This is known as interdependence.

Absolute vs. Comparative Advantage Absolute Advantage – when a nation/person can produce more of a g/s with given resources Who has the absolute advantage? Pizza Salads 9 36 6 12 Nino Tony

Comparative Advantage – the ability to produce most efficiently given all the other products that could be produced Specialization in what you do best given the resources available

(Opportunity Cost of a) (Opportunity Cost of a) Salad Opportunity cost determines comparative advantage. Lower opportunity cost is where you have comparative advantage. Who has the comparative advantage in Pizza? Salads? (Opportunity Cost of a) Pizza (Opportunity Cost of a) Salad 4 salads ¼ pizza 2 salads ½ pizza Nino Tony

International Trade and Comparative Advantage Cheese Wheat United States 3 12 France 2 4 Which country has the absolute advantage in cheese? Wheat? Which country has the comparative advantage in cheese? Wheat? Would these countries benefit from trade?

US has absolute advantage in both cheese and wheat US has absolute advantage in both cheese and wheat. (They produce more than France.)

France has the comparative advantage in cheese France has the comparative advantage in cheese. (They produce cheese more efficiently. They have a lower opportunity cost…don’t have to sacrifice as much wheat as the US.) (Opportunity Cost of) Cheese (Opportunity Cost of) Wheat United States 4 units of wheat ¼ unit of cheese France 2 units of wheat ½ unit of cheese

The United States has a comparative advantage in the production of wheat.( They produce it more efficiently. The opportunity cost of producing wheat is lower…give up less cheese than France.) (Opportunity Cost of) Cheese (Opportunity Cost of) Wheat United States 4 units of wheat ¼ unit of cheese France 2 units of wheat ½ unit of cheese

Barriers to Trade Most countries have some sort of trade restrictions which prevents foreign goods from moving freely into the country Most common types: tariffs, quotas The idea is to “protect” domestic industries

Protectionism The use of trade barriers to protect industries from foreign competition Ex. US Steel (tariff)

Tariff: Tax on imported goods US Steel Quota: a limit on the amount that can be imported

Embargo Boycotting trade with another country Typically for political reasons Ex. Trade embargo with Cuba

Other Barriers to Trade Standards – certain requirements set by governments that must be met in order to import a good (sometimes too strict)

Subsidies – payments by a government to a business that helps keep it going (thus preventing trade at fair market prices) Canada and softwood timber

Free Trade Agreements Trading Blocks – countries who have agreed to limit or restrict trade barriers NAFTA – North American Free Trade Agreement Goal is to eliminate all tariffs/trade barriers between Canada, United States, and Mexico by 2009

EU – European Union Group of (Western) European countries that abolished trade restrictions among member countries Replaced individual currencies with the Euro Very competitive with the US dollar

ASEAN – Association of Southeast Asian Nations Promotes economic and social growth 10 member countries including Philippines, Thailand, Vietnam Goal is to complete free trade agreements with Japan, China, India, South Korea, Australia, and New Zealand by 2013

Exchange Rates The value of a foreign nation’s currency in terms of the home nation’s currency Exchange rates fluctuate on a daily basis

Tuesday, October 02, 2007 1 USD in USD Australian Dollar 1.13045 0.884603 British Pound 0.489788 2.0417 Canadian Dollar 1.0002 0.9998 Chinese Yuan 7.5093 0.133168 Euro 0.706065 1.4163 Hong Kong Dollar 7.7625 0.128824 Indian Rupee 39.65 0.0252207 Japanese Yen 115.83 0.00863334 Mexican Peso 10.9101 0.0916582 South African Rand 6.9091 0.144737 South Korean Won 915.7 0.00109206 Swiss Franc 1.175 0.851064 Downloaded from http://www.x-rates.com

Appreciation – an increase in value of a currency “Strong” Ex. Strong US dollar… Increase imports Decrease exports

Depreciation – a decrease in the value of a currency “Weakening” Ex. Weak US dollar… Decrease imports Increase exports

Calculating Exchange Rates If converting to US dollars… Foreign Currency Foreign Currency per dollar

Practice A new sweater in England costs £50. What is the cost in US dollars? A dinner in France costs €25. What is the cost in US dollars? A hotel room in Japan costs ¥20,000. What is the cost in US dollars?

Balance of Trade vs. Balance of Payments Balance of Trade: the relationship between a nation’s imports and exports Balance of Payments: the financial record of all financial payments between countries Tracks the flow of money in or out of a country