1. AP ECON – March 17th 1. Read and take notes until slide 24. 2. STOP and complete the classwork. Turn it in 3. Continue on with ppt. I will check notes tomorrow. 1

2. Unit 5: International Trade 2

3. International Trade 3

4. Where does your stuff come from? (Check the tags on your clothes, shoes, watch, calculator, etc.) Why have your clothes and personal items traveled all around the world?

5. Why do people trade? 1.Assume people didn’t trade. What things would you have to go without? Everything you don’t produce yourself! (Clothes, car, cell phone, bananas, heath care, etc) The Point: Everyone specializes in the production of goods and services and trades it to others 2. What would life be like if cities couldn’t trade with cities or states couldn’t trade with states? Limiting trade would reduce people’s choices and makes the worse off. The Point: More access to trade means more choices and a higher standard of living. 5

6. Absolute and Comparative Advantage 6

7. Per Unit Opportunity Cost Review Assume it costs you $50 to produce 5 t-shirts. What is your PER UNIT cost for each shirt? $10 per shirt Now, take money our of the equation. Instead of producing 5 shirts you could have made 10 hats. 1.What is your PER UNIT OPPORTUNITY COST for each shirt in terms of hats given up? 1 shirt costs 2 hats 2.What is your PER UNIT OPPORTUNITY COST for each hat in terms of shirts given up? 1 hat costs a half of a shirt 7 = Opportunity Cost Units Gained Per Unit Opportunity Cost

8. Per Unit Opportunity Cost Review Ronald McDonald can produce 20 pizzas or 200 burgers Papa John can produce 100 pizzas or 200 burgers 1. What is Ronald’s opportunity cost for one pizza in terms of burgers given up? 2.What is Ronald’s opportunity cost for one burger in terms of pizza given up? 3.What is Papa John’s opportunity cost for one pizza in terms of burgers given up? 4. What is Papa John’s opportunity cost for one burger in terms of pizza given up? 8 Ronald has a COMPARATIVE ADVANTGE in the production of burgers Papa John has a COMPARATIVE ADVANTAGE in the production of pizza 1 pizza cost 10 burgers 1 burger costs 1/10 pizza 1 pizza costs 2 burgers 1 burger costs 1/2 pizza

9. Absolute and Comparative Advantage Absolute Advantage The producer that can produce the most output OR requires the least amount of inputs (resources) Ex: Papa John has an absolute advantage in pizzas because he can produce 100 and Ronald can only make 20. Comparative Advantage The producer with the lowest opportunity cost. Ex: Ronald has a comparative advantage in burgers because he has a lowest PER UNIT opportunity cost. 9 Countries should trade if they have a relatively lower opportunity cost. They should specialize in the good that is “cheaper” for them to produce.

10. Benefits of Specialize and Trade 10

11. International Trade Sugar (tons) 45 40 35 30 25 20 15 10 5 0 30 25 20 15 10 5 0 5 10 15 20 25 30 5 10 15 20 Wheat (tons) SW 030 1.529 328 4.527 626 7.525 924 10.523 1222 13.521 1520 16.519 18 19.517 SW 200 18.51 172 15.53 144 12.55 116 9.57 88 6.59 510 3.511 The US Specializes and makes ONLY Wheat Brazil Makes ONLY Sugar 11 USABrazil Trade: 1 Wheat for 1.5 Sugar

12. TRADE SHIFTS THE PPC! Sugar (tons) 45 40 35 30 25 20 15 10 5 0 30 25 20 15 10 5 0 5 10 15 20 25 30 5 10 15 20 AFTER TRADE Wheat (tons) International Trade 12 USABrazil

13. Sugar (tons) 45 40 35 30 25 20 15 30 25 20 15 10 5 10 15 20 25 30 5 10 15 20 Wheat (tons) USA Brazil WheatSugar 30 1020 (1W costs 1S)(1S costs 1W) (1W costs 2S)(1S costs 1/2W) Which country has a comparative advantage in wheat? 1.Which country should EXPORT Sugar? 2.Which country should EXPORT Wheat? 3.Which country should IMPORT Wheat? 13

14. Output Questions: OOO= Output: Other goes Over 14

15. Input Questions: IOU= Input: Other goes Under 15

16. Practice FRQ

17. A.Which country has an absolute advantage in the production of tractors? Explain how you determined your answer. B.Which country has an absolute advantage in the production of cars? Explain how you determined your answer. C.Which country has a comparative advantage in the production of cars? Use the concept of opportunity cost to explain how you determined your answer. D.For Xanadu, what is the opportunity cost of producing one car? E.If the two countries specialize and trade with each other, which country will import cars? Explain why?

18. 10 Points Possible (2 Points For EACH: 1 point answer, 1 point explanation) A. Answer-Xanadu Explanation- Because they can produce more total tractors than Atlantis. B. Answer-Atlantis Explanation- Because they can produce more total cars than Xanadu.

19. (2 Points For EACH: 1 point answer, 1 point explanation) C. Answer- Atlantis Explanation- Because the opportunity cost for Atlantis to make one car is 1/3 a tractor which is less than then the opportunity cost for Xanadu (1 car =2 tractors). D. Answer- Opportunity Costs is 2 Tractors. No explanation required

20. (2 Points For EACH: 1 point answer, 1 point explanation) E. Answer- Xanadu will import cars Explanation- Xanadu should not make cars. They should specialize in making tractors and import cars from Atlantis since they have a lower opportunity cost.

21. Term of Trade 21

22. Kenya India PineapplesRadios 3010 40 (1P costs 1/3R) (1R costs 3 P) (1P costs 1R)(1R costs 1P) Kenya wants Radios If the terms of trade for 1 radio is greater than 3 pineapples then Kenya is worse off and should make radios on their own. India wants Pineapples If the terms of trade for 1 radio is less than 1 pineapple then India is worse off and should make pineapples on their own. What terms of trade benefit both countries?

23. Trading 1 radio for 2 pineapples will benefit both If Kenya produces radios by themselves, they give up 3 Pineapples for each radio. If they can trade 2 pineapples for each radio they are better off. If India produces pineapples by themselves, they give up 1 pineapple for one radio. If they can get 2 pineapples for one radio they are better off. The countries trade at a lower opportunity cost than if they made the products themselves! Kenya India PineapplesRadios 3010 40 (1P costs 1/3R) (1R costs 3 P) (1P costs 1R)(1R costs 1P)

24. Comparative Advantage Practice Create a chart for each of the following problems. First- Identify if it is a output or input question Second-Identify who has the ABSOLUTE ADVANTAGE Third-Identify who has a COMPARATIVE ADVANTAGE Fourth- Identify how they should specialize 1. Sara gives 2 haircuts or 1 perm and hour. Megan gives 3 haircuts or 2 perms per hour. 2. Justin fixes 16 flats or 8 brakes per day. Tim fixes 14 flats or 8 brakes per day. 3. Hannah takes 30 minutes to wash dishes and 1 hour to vacuum the house. Kevin takes 15 minutes to wash dishes and 45 minutes to vacuum. 4. Americans produce 50 computers or 50 TVs per hour. Chinese produce 30 computers or 40 TVs per hour. 24

25. STOP! Come get and complete classwork. Then continue to read and take notes. 25

26. Relationship of Domestic Policies and International Trade

27. Domestic policies affect international trade Fiscal and Monetary Policy, particularly through income/GDP, price level, and the real interest rate, will have effects on international trade and capital flows. –If people increase their income, they will buy more imports. If people have decreased income, they will buy fewer imports. –If local goods are more expensive (high price level/inflation), people will buy more foreign goods. If local goods are cheaper, people will buy fewer foreign goods. –High interest rates cause financial flows into a country (financial account SURPLUS). This will increase the demand for currency, thus causing the currency to appreciate. Imports become cheaper and exports more expensive, which moves the current account towards a DEFICIT.

28. International trade and foreign exchange rates can change domestic conditions. International trade and capital flows can also affect income, price level, and the real interest rate domestically. –More exports due to increased foreign income = more aggregate demand, meaning higher real GDP and price level. –Money flowing into the country for investment (capital inflow) causes the currency to appreciate. This can reduce exports, which could for example cause unemployment. –Exchange rate. As the value of a currency increases or decreases, imports may become cheaper and exports more expensive, or vice versa. This can, for example, change the cost-of-living, meaning the price level.

29. Which effects are bigger – domestic or international/currency effects? Oftentimes, domestic and international variables move in OPPOSITE directions. For example, a decrease in taxes in the USA will increase disposable income. This will increase consumption of domestic goods AND imports. However, the increase in demand for imports (priced in foreign currency) will cause the dollar to depreciate…which decreases imports. Imports cannot simultaneously increase AND decrease. So how do we know which effect is bigger? The rule of thumb is that “domestic effects are stronger than currency effects.” Thus, in the example above, imports would increase overall. The increase in imports due to increased income will be greater than the decrease in imports that occurs due to a depreciated currency. –This rule may not be true for small economies where imports/exports are a larger percentage of GDP. But for major nations like USA or China or Canada, the rule holds.

30. When thinking of the size of domestic vs. foreign exchange/currency effects, consider relative size. The United States exports $2.34 trillion per year, and imports $2.74 trillion per year, for net exports of -$.4 trillion. Compare this to a GDP of $17.7 trillion, and it’s a relatively small number.

31. Domestic events/policies and their effects on international trade: There are 4 major changes we will discuss in this.ppt 1.Change in real interest rates 2.Change in price level 3.Change in real GDP 4.Change in aggregate demand (due to a tax cut or increase, ie. fiscal policy)

32. Change in Real Interest Rates Real interest rates will affect capital flows. A surplus in the financial account will cause an appreciation of the currency (demand for USD), which causes a deficit on the current account. Thus, it is clear that exports will decrease, while imports will increase. Net exports decrease, meaning aggregate demand decreases, real GDP decreases, and price level decreases. (Some economists have argued that this is one reason why U.S. manufacturing activity has decreased over the past 40 years. As the U.S.A. became the world financial capital, and as U.S. assets remained attractive due to good returns and political/economic stability, people demanded those assets, keeping the dollar strong.)

33. Change in Price Level / Inflation An increase in the price level in the USA will make imports cheaper. It will also make American exports more expensive. We call this a DOMESTIC effect, since the overall price level affects the whole U.S. economy. Increase in demand for foreign currencies will cause the USD to depreciate. There are OPPOSITE effects here. The DOMESTIC effect is that American exports decrease and imports increase. The CURRENCY or FOREIGN EXCHANGE effect is that American exports increase and imports increase. As we’ve discussed, the domestic effect is more powerful. In reality, American exports decrease and imports increase, however this effect is partially offset (negated) by currency depreciation.

34. Change in Real GDP (page 1) Situation: there is a recession in the USA, while German economic activity continues as normal. USA imports fewer German goods. There is less demand for Euro, and also reduced supply of USD. The dollar appreciates, making U.S. products (exports) more expensive and German products (imports) cheaper. Imports into USA increase and USA exports fall. Once again, we have OPPOSITE effects. The fall in real GDP (income) in the USA reduces imports from Germany, but dollar appreciation means that the U.S. imports more. Since we know that the domestic effect (the situation in USA) is more powerful than the FOREX/currency effect, American imports fall.

35. Change in Real GDP (page 1) This example is confusing because the fall in real income will reduce C, or consumption. Again, since this is a domestic effect, it is larger than the effect on net exports. Consumption falls while net exports increase. The total effect on aggregate demand is negative. Price level and real GDP will fall, though the real GDP will decrease by less due to the foreign currency effect. This indicates a “good” side to international trade. Floating exchange rates help to limit economic damage; in this case, the fall in income will be partially offset by an increase in exports, thus limiting unemployment during the recession. Germany now exports less and imports less, however the fall in exports (due to decreased U.S. income) is more severe. Thus, German AD decreases, real GDP decreases, and the price level decreases. This indicates a “problem” with international trade links. The USA has essentially “exported” its recession to its trading partner, Germany.