1. Chapter 19
Section 1

2. Section 1: The Benefits of World Trade
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In this section, you will learn why it is important for nations to trade with one another.

3. Benefits of Trade
Countries benefit from trade with each other when each concentrates on the goods and services that it can produce most efficiently.
Many goods we consume in the United States are imports.
Goods bought from other countries for domestic use
More than 60% of our consumer electronics were imported from overseas.
Exports, on the other hand, are the goods the United States sells to other countries.
More than 40% of our nation’s engineering and scientific instruments are sold to consumers overseas.
Many goods we consume in the United States are imports.
Goods bought from other countries for domestic use
Some top US imports are coal, food oils, fertilizers and pesticides, coffee and chocolate
More than 60% of our consumer electronics (tvs, radios) were imported from overseas.
Additionally, many raw materials come from foreign sources.
Exports, on the other hand, are the goods the United States sells to other countries. Top US exports are fuel, aircrafts and cars.
More than 40% of our nation’s engineering and scientific instruments are sold to consumers overseas.

4. Nations benefit through world trade because each nation differs in type and amount of the factors of production it has available to them.
Nations benefit through world trade because each nation differs in type and amount of the factors of production it has available to them. This is especially true for natural resources. The type and amount of labor and capital available to a nation are equally important.

6. Absolute and Comparative Advantage
A nation does not need to have an absolute advantage over another country in producing a certain good or service to benefit from trade with that country.
All nations must make choices in how they use their scarce resources.
The amount of importing and exporting a nation does is affected by the specific combination of all its resources.
Depending on this combination, a nation has either an absolute or a comparative advantage in production.
The amount of importing and exporting a nation does is affected by the specific combination of all its resources. Depending on this combination, a nation has either an absolute or a comparative advantage in production.

7. ABSOLUTE ADVANTAGE Banana Production Brazil vs. France
Absolute advantage is the ability of one country, using the same amount of resources as another country, to produce a particular product at less cost.
Example:
Banana Production
Brazil
vs.
France
Absolute advantage is the ability of one country, using the same amount of resources as another country, to produce a particular product at less cost.
The amount of resources in a nation often gives that nation an absolute advantage over another nation in the production of one or more goods.
For example: Brazil’s tropical climate and inexpensive labor make it ideally suited for growing bananas. Even using the same amount of land, labor, capital and entrepreneurship, a country with a moderate climate, such as France, would produce fewer bananas. Therefore Brazil has an absolute advantage in banana production over France.

8. SPECIALIZATION
A nation often finds it profitable to produce and export a limited assortment of goods for which it is particularly suited.
This concept is known as specialization.
Specialization helps determine the goods the US imports and exports.
EXAMPLE: Japan’s specialization in consumer electronics has led many nations to import these types of products from Japan.

9. COMPARATIVE ADVANTAGE
Comparative advantage is the ability of a country to produce a product at a lower opportunity cost than another country.
Countries benefit with each other when each concentrates on that production for which it is relatively most efficient.
A nation doesn’t need to have an absolute advantage in the production of a good to find it profitable to specialize and then to trade with other countries.
Comparative advantage plays an important role in the import/export process. Comparative advantage is the ability of a country to produce a product at a lower opportunity cost than another country.
Countries benefit with each other when each concentrates on that production for which it is relatively most efficient.

10. COMPARATIVE ADVANTAGE EXAMPLE
Country X
&
Country Y

11. Pounds of Corn
Pounds of Beans 50 10 25 8
Country X
Country Y
According to this example, who has an absolute advantage in corn production?
Country X
According to this example, who has an absolute advantage in bean production?
According to this example, Country X has an absolute advantage in the production of both corn and beans. That is, with the same amount of inputs, Country X can produce more of either crop than Country Y.
Does this mean that Country X will produce both crops and have no reason to trade with Country Y? NO! Country X can produce slightly more beans than Country Y. However, it can produce a great deal more corn than Country Y. It would make little sense for Country X to take land, labor, and capital resources away from the efficient production of corn and use them for the less efficient production of beans. Country X’s opportunity cost—what it gives up to get something else—would be less if it invested all its resources in the production of corn. It could export its surplus corn and use the money to buy beans.

12. Pounds of Corn
Pounds of Beans 50 10 25 8
Country X
Country Y
According to this example, who has a comparative advantage in corn production?
Country X
According to this example, who has a comparative advantage in bean production?
Country Y
Country X has a comparative advantage in corn production. Comparative advantage, remember, is the ability of a country to produce a product at a lower opportunity cost than another country. Country Y has a comparative advantage in bean production. Country Y can produce about the same amount of beans as Country X, but only half as much corn. By using its resources to grow only beans, Country Y is giving up the relatively inefficient production of corn. Country Y, then, has a lower opportunity cost for bean production than does Country X. Country Y should produce the maximum amount of beans, export beans to Country X, and import corn. Both countries benefit when each country concentrates on the production for which it is relatively more efficient.

13. End Here

14. Section 2: Financing World Trade
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In this section, you will learn how nations convert their different currencies in order to trade more easily with one another.

15. Fixed Exchange Rates
Under a system of fixed exchange rates, national governments set the value of their currencies relative to other currencies.
Countries must find a common way to pay one another for the goods they import and export. The exchange rate becomes a key factor.
Foreign exchange markets allow for individuals and businesses to easily and quickly convert one currency to another.
From 1945 to 1970s, they operated with a fixed rate of exchange.
Countries have different currencies. Countries must find a common way to pay one another for the goods they import and export. The exchange rate becomes a key factor.
Foreign exchange markets allow for individuals and businesses to easily and quickly convert one currency to another.
From 1945 to 1970s, they operated with a fixed rate of exchange. Under this system a national government sets the value of its currency and that of other currencies.

16. Foreign Exchange Rate Listing

17. A fixed rate of exchange had some advantages:
The International Monetary Fund (IMF) supported a fixed rate of exchange.
A fixed rate of exchange had some advantages:
Importers and exporters knew exactly how much of a foreign currency they could purchase with their own nation’s money.
The system allowed central banks to affect the level of exports and imports in their country by devaluing the currency.
The International Monetary Fund (IMF) supported a fixed rate of exchange and monitored the system.
A fixed rate of exchange had some advantages:
Importers and exporters knew exactly how much of a foreign currency they could purchase with their own nation’s money.
The system allowed central banks to affect the level of exports and imports in their country by devaluing the currency.

18. However, this system of a fixed rate of exchange proved impractical.
Devaluation is the lowering a currency’s value in relation to other currencies by government order.
However, this system of a fixed rate of exchange proved impractical.
Devaluation is the lowering a currency’s value in relation to other currencies by government order.
However, this system of a fixed rate of exchange proved impractical. The basic problem was the difficulty of fixing exchange rates in an international economic climate that was constantly changing.

19. Flexible Exchange Rates
Under a system of flexible exchange rates, supply and demand determine currency values.
In August 1971 most of the world’s nations turned to a flexible exchange rate.
The forces actually determining exchange rates are the supply and demand of goods and services that can be bought with a particular currency.
In addition, political or economic instability within a country may encourage people to exchange their currency for a more stable currency.
In August 1971 most of the world’s nations turned to a flexible exchange rate.
The forces actually determining exchange rates are the supply and demand of goods and services that can be bought with a particular currency.
In addition, political or economic instability within a country may encourage people to exchange their currency for a more stable currency.

20. When the price of a currency falls through the action of supply and demand, it is termed depreciation.
As with devaluation, depreciation of a country’s currency improves its competitive edge in foreign trade.
When the price of a currency falls through the action of supply and demand, it is termed depreciation.
As with devaluation, depreciation of a country’s currency improves its competitive edge in foreign trade.

21. Balance of Trade
The United States has had a negative balance of trade since the 1970s.
A currency’s exchange rate has an important effect on a nation’s balance of trade.
Balance of trade is the difference between the value of a nation’s exports and its imports.
There is a positive balance of trade when the value of goods leaving a nation exceeds the value of those coming in.
When the value of goods coming into a country is greater than the value of those going out, there is a trade deficit.
A currency’s exchange rate has an important effect on a nation’s balance of trade.
Balance of trade is the difference between the value of a nation’s exports and its imports.
There is a positive balance of trade when the value of goods leaving a nation exceeds the value of those coming in. In this case, the nation is bringing in more money as payments for goods than it is paying out.
When the value of goods coming into a country is greater than the value of those going out, there is a trade deficit.

22. United States Merchandise Trade by Area (in billions of dollars)
Area of World
US Imports
US Exports
Western Europe
$246
$151
Canada
$ 311
$231
Japan
$ 147
$58
United Kingdom
$ 53
$45
OPEC Members (Saudi Arabia, Kuwait, Iran and others)
$ 150
$39

23. This chart shows that the US has had a negative trade balance since 1980.

24. A nation has a positive balance of trade if the value of its exports is greater than the value of its imports. It has a negative balance of trade if the value of its imports is greater than the value of its exports.