1. Chapter 12 International Trade & Exchange Rates
ECON 201 Macroeconomics
Chapter 12
International Trade & Exchange Rates

2. Ch 12 Objectives Key facts about U.S. international trade.
About comparative advantage, specialization, & international trade.
How exchange rates are determined  in currency markets.
Rebuttals to common arguments for protectionism.
The role played by free-trade zones & the World Trade Organization (WTO) in promoting international trade.

3. What is international trade?
Exchange of goods and services across national borders.

4. International Trade & Finance
link economies together.
Is often at the center of U.S. economic policy.
Economic change in one part of the world has repercussions for countries around the globe.

5. Economic Basis for Trade
International Trade allows Nations to specialize their productions.
nations can specialize, increase the productivity of their resources, and realize a larger total output.

6. Why do nations trade? Uneven economic resources among nations.
Efficient production of various goods requires different technologies & resources.
Quality & non-price attributes.
Some people like imported goods.

7. Japan
large, well‑educated labor force and can specialize in labor‑intensive commodities.
Australia
abundance of land
can cheaply produce land‑intensive agricultural products.
Industrially advanced nations (including Japan) are in a position to produce capital‑intensive goods.

8. In Their Element
Japan – digital cameras, video games players, DVD players
Australia – wheat, wool, meat
Brazil – coffee
Countries with Lg. amts. of capital – cars, ag equipment, chemicals

9. U.S. Trade Facts: 2007 U.S. has a trade deficit in goods:
In 2007, U.S. trade deficit in goods was $816 billion.
U.S. has a trade surplus in services:
In 2007, U.S. trade surplus in services was $107 billion.
Principal U.S. exports: chemicals, agricultural products, consumer durables, semiconductors, and aircraft.
Principal U.S. imports: petroleum, automobiles, metals, household appliances, and computers.
Largest trading partner: Canada (current #’s U.S. census Bureau)
These are the main facts about U.S. Trade in The U.S. has a trade deficit in goods. A trade deficit occurs when imports exceed exports. In 2007, the U.S. trade deficit in goods was $816 billion. The U.S. has a trade surplus in services. A trade surplus occurs when exports exceed imports. In 2007, the U.S. trade surplus in services was $107 billion. Principal U.S. exports are chemicals, agricultural products, consumer durables, semiconductors, and aircraft. Principal U.S. imports are petroleum, automobiles, metals, household appliances, and computers. The largest U.S. trading partner is Canada.
A Trade deficit occurs when imports exceed exports.
A Trade surplus occurs when exports exceed imports.
LO: 12-1

10. U.S. Trade Balances on Goods and Services, 2007
Deficit
Surplus
Australia
+10.0
Belgium
+9.8
The U.S. trade deficit with China was $257 billion in 2007.
Canada
-67.0
China
-256.6
Germany
-45.3
In 2007, the U.S. had a trade surplus vis-à-vis such countries as Australia, Belgium, and Netherlands. The U.S. had a trade deficit against most countries, such as Canada, Germany, Japan, Mexico. The largest trade deficit U.S. has vis-à-vis China, $257 billion dollars in 2007.
Japan
-85.0
Mexico
-77.3
Netherlands
+14.3
-10
-20
-30
-40
-50
-60
-70
-250 10 20
Source: BEA
LO: 12-1

11. U.S. Total Exports are Second Only to Germany
Percentage Share of World Exports, Selected Nations 2007
Germany
United States
China
Japan
France
Netherlands
United Kingdom
Italy
9.20
8.59
8.02
5.38
4.06
Despite U.S. trade deficit, it is the second largest exporter in the world. Eight and a half percent of the world exports in 2007 were provided by the U.S. Germany was in the first place with 9.2 percent of the world exports.
3.83
3.71
3.40
Source: World Trade Organization
LO: 12-1

12. More Facts
U.S. dependence on foreign oil is reflected in its $94 billion trade deficit (imports exceed exports)with OPEC nations in 2005.
2008 – trade deficit was 175,613 million dollars. As of January, 09’ - over 4 million.
U.S. leads the world in the volume of exports and imports.
Germany is the world’s top exporter; U.S. exports of goods make up about 9% of the world’s exports.

13. Specialization and Comparative Advantage
Specialization and trade increase the productivity of a country’s resources and allow for greater total output and income.
Specialization results in more efficient production.
Comparative advantage allows us to determine who should produce what.
The terms of trade, or the rate at which units of one product can be exchanged for units of another product, can make both countries better off.
Specialization and trade increase the productivity of a country’s resources and allow for greater total output and income. Specialization results in more efficient production. Comparative advantage allows us to determine who should produce what. Comparative advantage is a lower relative or comparative opportunity cost than that of another person, producer, or country. The terms of trade, or the rate at which units of one product can be exchanged for units of another product, can make both countries better off.
Comparative advantage is a lower relative or comparative opportunity cost than that of another person, producer, or country.
LO: 12-2

14. Principle of Comparative Advantage
Review
refers to the ability of a person or a country to produce a particular good at a lower opportunity cost than another country.
explains how trade can create value for both parties even when one can produce all goods with less resources than the other.
The net benefits of such an outcome are called gains from trade.

15. Principle of Comparative Advantage
Lower Opportunity cost –
total output will be greatest when each good is produced by the nation that has the lower opportunity cost.

16. Trade and Specialization Increase Total Output
Production alternatives: Mexico
Product A B C D E
Avocado 20 24 40 60
Soybeans 15 10 9 5
Production alternatives: U.S.
Product A B C D E
Avocado 30 33 60 90
Soybeans 20 19 10
Consider an example of the U.S. and Mexico producing avocado and soybeans. Suppose Mexico can produce 15 tons of soybeans if it does not produce any avocado, 10 tons of soybeans and 20 tons of avocado, etc. If Mexico produces only avocado, it can produce 60 tons. The U.S. is bigger, thus it can produce more of both goods: 30 tons of soybeans and no avocado, 20 tons of soybeans and 30 tons of avocado, etc. 90 tons of avocado and no soybeans. If each country produces both goods, say in alternative C, then they can produce a total of 57 tons of avocado and 28 tons of soybeans. However, if they specialize (Mexico producing only avocado and U.S. producing only soybeans), the total output will be 60 tons of avocado and 30 tons of soybeans.
LO: 12-2

17. Specialization and Gains from Trade
Before specialization, Mexico produced 24 tons of avocados and 9 tons of soybeans, while the U.S. produced 33 tons of avocados and 19 tons of soybeans. With specialization, Mexico produced 60 tons of avocados and the U.S. produced 30 tons of soybeans. Mexico sold 35 tons of avocados to the U.S. in exchange for 10 tons of soybeans. After trade, Mexico had 25 tons of avocados and 10 tons of soybeans, 1 ton of each more than before trade. The U.S. had 35 tons of avocados, 2 more tons than before trade, and 20 tons of soybeans, 1 more than before trade. Thus, both countries gained from specialization and trade.
LO: 12-2

18. Absolute and Comparative Advantage
In the above example, the U.S. has an absolute advantage in producing both goods:
The U.S. can produce 30 tons of soybeans while Mexico can produce 15 tons.
Also, the U.S. can produce 90 tons of avocados compared to Mexico’s 60 tons.
The U.S. has a comparative advantage in soybeans.
For the U.S., 1S ≡ 3A; for Mexico, 1S ≡ 4A
Soybeans are relatively cheaper in the U.S.
Mexico has a comparative advantage in avocados.
1 ton of avocados costs 1/4 ton of soybeans in Mexico, which is less than the cost in the U.S. (1A ≡ 1/3S).
In the above example, the U.S. has an absolute advantage in producing both goods: The U.S. can produce 30 tons of soybeans while Mexico can produce 15 tons. Also, the U.S. can produce 90 tons of avocados compared to Mexico’s 60 tons. The U.S. has a comparative advantage in soybeans. For the U.S., producing 1 ton of soybeans costs 3 tons of avocado, for Mexico, one ton of soybeans costs 4 tons of avocado. Soybeans are relatively cheaper in the U.S. Mexico has a comparative advantage in avocados. 1 ton of avocados costs 1/4 ton of soybeans in Mexico, which is less than the cost in the U.S. (1 ton of avocado costs 1/3 of a ton of soybeans).
LO: 12-2

19. Gains from Specialization and Terms of Trade
If the U.S. specializes in soybean production while Mexico specializes in avocado production and both agree on the terms of trade, both countries will gain from specialization and trade.
The United States can shift production between soybeans and avocados at the rate of 1S for 3A.
Mexico can shift production at the rate of 4A for 1S.
Suppose that, through negotiation, the two nations agree on terms of trade of 1 ton of soybeans for 3.5 tons of avocados.
These terms of trade are mutually beneficial to both countries, since each can “do better” through such trade than through domestic production alone.
If the U.S. specializes in soybean production while Mexico specializes in avocado production and both agree on the terms of trade, the rate at which units of one product can be exchanged for units of another product, both countries will gain from specialization and trade. The United States can shift production between soybeans and avocados at the rate of 1 ton of soybeans for 3 tons of avocado. Mexico can shift production at the rate of 4 tons of avocado for 1 ton of soybeans. Suppose that, through negotiation, the two nations agree on terms of trade of 1 ton of soybeans for 3.5 tons of avocados. These terms of trade are mutually beneficial to both countries, since each can “do better” through such trade than through domestic production alone.
The terms of trade is the rate at which units of one product can be exchanged for units of another product.
LO: 12-2

20. Trade with Increasing Costs
If resources are no longer perfectly substitutable between alternative uses, resources less and less suitable to the production of one good must be allocated to the production of the other good in expanding the other good’s output.
The primary effect of increasing opportunity costs is less-than-complete specialization.
If resources are no longer perfectly substitutable between alternative uses, resources less and less suitable to the production of one good must be allocated to the production of the other good in expanding that other good’s output. The primary effect of increasing opportunity costs is less-than-complete specialization.
LO: 12-2

21. Foreign Exchange Market
A foreign exchange market is a market in which foreign currencies are exchanged and relative currency prices are established.
An exchange rate is the rate at which one currency trades for another.
Buyers and sellers interacting in international markets will exchange currencies through the foreign exchange market.
In the market for foreign currency, the intersection of the demand for foreign currency and the supply of foreign currency determine the exchange rate.
A foreign exchange market is a market in which foreign currencies are exchanged and relative currency prices are established. An exchange rate is the rate at which one currency trades for another. Buyers and sellers interacting in international markets will exchange currencies through the foreign exchange market. In the market for foreign currency, the intersection of the demand for foreign currency and the supply of foreign currency determine the exchange rate.
LO: 12-3

22. Market for Foreign Currency (Pounds)Q
Dollar Price of 1 Pound
Quantity of Pounds P Sl
Depreciation is a decrease in the value of a currency relative to another currency.
Exchange
Rate: $2 = £1 $2 $3 $1
Dollar
Depreciates
(Pound
Appreciates)
Appreciation is an increase in the value of a currency relative to another currency.
Dollar
Appreciates
(Pound
Depreciates)
The intersection of the demand-for-pounds curve D1 and the supply-of-pounds curve S1 determines the equilibrium dollar price of pounds, here, $2. That means that the exchange rate is dollars per pound. The upward arrow is a reminder that a higher dollar price of pounds (say, 3 dollars per pound, caused by a shift in either the demand or the supply curve) means that the dollar has depreciated (the pound has appreciated). The downward arrow tells us that a lower dollar price of pounds (say, one dollar per pound, again caused by a shift in either the demand or the supply curve) means that the dollar has appreciated (the pound has depreciated). Depreciation is a decrease in the value of a currency relative to another currency. Appreciation is an increase in the value of a currency relative to another currency. Dl Ql
LO: 12-3

23. Exchange Rates
Enable customers in one country to translate prices of foreign goods into units of their own currency.
Simply Multiply the foreign product price by the exchange rate.

24. Determinants of Exchange Rates
Factors that cause a country’s currency to appreciate or depreciate are:
Tastes
Relative Income
Relative Price Levels
Relative Interest Rates
Speculation
Factors that cause a country’s currency to appreciate or depreciate are tastes, relative income, relative price levels, relative interest rates, and speculation.
LO: 12-3

25. Protectionism or Free Trade?
Argument for protectionism
Save U.S. jobs – restrict imports
Cheap foreign labor pulls down wages in the U.S.
Tariffs are needed to protect against dumping.
Rebuttal
Import restrictions alter the composition of employment but don’t affect total employment; they also lead to less effective resource allocation.
Gains from trade are based on comparative advantage. Specialization through trade increases labor productivity and wages.
Dumping is prohibited by most countries that impose anti-dumping duties. Cases of dumping are rare.
One frequently hears the following three arguments for protectionist policies that restrict trade. Restricting imports, say proponents of protectionism, saves U.S. jobs. The truth is that while import restrictions alter the composition of employment, they don’t affect total employment but lead to less effective resource allocation. Another argument is that cheap foreign labor pulls down wages in the U.S. We learned that gains from trade are based on comparative advantage. Specialization through trade increases labor productivity and wages in both countries involved in trade. Finally, protectionists argue that tariffs are needed to protect against dumping. Dumping is the sale of products in a foreign country at prices either below cost or below the prices charged at home. While it is true that dumping has negative effects, it is prohibited by most countries that impose anti-dumping duties. Cases of dumping are, therefore, rare.
Dumping is the sale of products in a foreign country
at prices either below cost or below the prices charged at home.
LO: 12-4

26. Multilateral Trade Agreements and Trade Blocks
General Agreement on Tariffs and Trade (GATT)
1947, 23 nations
Nations agreed to give equal treatment to one another, to reduce tariffs through multinational negotiations, and to eliminate import quotas.
World Trade Organization (WTO)
1993, 152 nations (as of 2008)
Oversees the provisions of the current world trade agreement, resolves disputes stemming from it, and holds rounds of trade negotiations.
European Union (EU) – a trade block of 27 European nations
Nations that have eliminated tariffs and quotas among them established common tariffs for imported goods from outside the member nations, reduced barriers to the free movement of capital, etc.
North American Free Trade Agreement (NAFTA)
1993, free-trade zone of US, Canada, and Mexico.
Most countries enter into international trade agreements and form trade blocks. The General Agreement on Tariffs and Trade (GATT) was formed in 1947 by 23 nations who agreed to give equal treatment to one another, to reduce tariffs through multinational negotiations, and to eliminate import quotas. The World Trade Organization (WTO) formed in 1993 included 152 nations as of The WTO oversees the provisions of the current world trade agreement, resolves disputes stemming from it, and holds rounds of trade negotiations. The European Union (EU) is a trade block that included 27 European nations as of The EU eliminated tariffs and quotas among members, established common tariffs for imported goods from outside the member nations, reduced barriers to the free movement of capital, and coordinated on other economic policies. The North American Free Trade Agreement (NAFTA) was formed in 1993 and is a free-trade zone of US, Canada, and Mexico.
LO: 12-5

27. Limits to Terms of Trade
At what exchange ratio will they trade?
Must get a better price than domestically or why trade?
U.S. will not give up more than 1 wheat for each coffee.
Brazil will not trade more than 2 coffee for 1 wheat.
Actual Terms of trade – determined by negotiation.

28. Depends on world supply and demand for the product.
Actual Exchange Ratio
Depends on world supply and demand for the product.

29. Benefits of free trade Promotes competition Deters monopoly
Forces firms to use low-cost production techniques.
Be more innovative
More consumer choices
Links Natl. interest & breaks down Ntl. Animosities.

30. Government Barriers Eliminate gains from specialization.
Must shift resources if they can’t trade freely.
Tariffs
Revenue Tariff
Protective Tariff
Import Quota
Non-tariff barrier (NTB)
Voluntary Export Restriction(VER)

31. Tariffs
Excise taxes on imports, used for revenue purposes, or protect domestic producers from foreign competition by raising import prices.
Revenue Tariff
Protective Tariff
Import Quota - specify the maximum amounts of imports allowed in a certain period of time. Low import quotas may be a more effective protective device than tariffs, which do not limit the amount of goods entering a country.

32. Voluntary Export Restriction(VER) - agreements by foreign firms to “voluntarily” limit their exports to a particular country. Japan has voluntary limits on its auto exports to the United States.
Non-tariff barrier (NTB) - licensing requirements, unreasonable standards, or bureaucratic red tape in customs procedures.

33. Fallacy of composition
Dumping
act of a manufacturer in one country exporting a product to another country at a price which is either below the price it charges in its home market or is below its costs of production.
Fallacy of composition
arises when one infers that something is true of the whole from the fact that it is true of some part of the whole.

34. Smoot Hawley Tariff Act of 1930
Raised U.S. tariffs on over 20,000 imported goods.
1,028 economists signed a petition against it.
Help to create great depression?
Representative W.C. Hawley (left) and Senator Reed Smoot (right) shake hands in agreement on new tariff bill.

35. Acts and Adjustments Trade Adjustment Assistance Act- 2002- WTO – 1993
Successor to the General Agreement on Tariffs & Trade (GATT) 1947.
Designed to supervise and liberalize international trade.
Oversees trade agreements.
Headquartered in Geneva, Switzerland.

36. Cheap Labor Offshoring Cheap imports will flood U.S. markets
Relocation by a company from one country to another.
Loss of U.S. jobs
Increases demand for complementary jobs
Cheap imports will flood U.S. markets
Domestic living standards go down
Economic logic – reduce costs

37. Free Trade
World economy can achieve a more efficient allocation of resources and a higher level of material well‑being.

38. End chapter 12