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Chapter 16

Chapter 16. International Trade. OBJECTIVES. Formulate a hypothesis on why countries trade. Explain the significance of absolute advantage and comparative advantage. Identify barriers to international trade. Analyze the functions of the WTO, IMF, and World Bank.

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Chapter 16

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  1. Chapter 16 International Trade

  2. OBJECTIVES Formulate a hypothesis on why countries trade. Explain the significance of absolute advantage and comparative advantage. Identify barriers to international trade. Analyze the functions of the WTO, IMF, and World Bank. Critique the NAFTA Agreement. Assess foreign exchange rates. Evaluate trade deficits and surpluses. Economics-Biba S. Kavass 2010

  3. THOUGHT PROVOKING? Why do governments encourage businesses in their country to trade with other nations? Economics-Biba S. Kavass 2010

  4. WHERE DOES IT COME FROM? Bananas from Ecuador Clothes from China Coffee from Colombia Oil from the Middle East Economics-Biba S. Kavass 2010

  5. Why Nations Trade Countries lack goods at home Specialization – produce the things they do best and exchange those products for those things that others do best. Economics-Biba S. Kavass 2010

  6. American Dependence on Trade Economics-Biba S. Kavass 2010

  7. THOUGHT PROVOKING? Why can’t the U.S. produce these raw materials themselves? Economics-Biba S. Kavass 2010

  8. THE BASIS FOR TRADE Trade works best when countries focus on those products they can produce the best. Economics-Biba S. Kavass 2010

  9. ABSOLUTE ADVANTAGE • Exists when a country can produce more of a product than another country at a lower cost or with more productivity. • Example: US has an absolute advantage in producing automobiles and computers. We can produce at a lower cost and higher production level. Economics-Biba S. Kavass 2010

  10. COMPARATIVE ADVANTAGE • Exists when a country has the ability to produce a product relatively more efficiently, or at a lower opportunity cost. • Assumption is that everyone will be better off specializing in the products they produce best (or more profitably). • Example: Wheat industry in US Textile Industry in China Economics-Biba S. Kavass 2010 10/23/2014

  11. THOUGHT PROVOKING? • Tobacco over Virginia and North Carolina • Soybeans over Alabama • Country music over California Do you know of a product for which your state has a comparative advantage? Economics-Biba S. Kavass 2010

  12. OPPORTUNITY COST • Value of the next best choice or the next highest valued alternative use of that resource. • Example: Choosing between seeing a movie or staying at home and reading a book. If you choose the movie, you can not spend that time at home reading a book and you can not spend the money spent on the movie on something else. Your opportunity cost is 1) money spent on movie, 2) time spent at the movies, and 3) knowledge and pleasure you forgo by not reading the book. Economics-Biba S. Kavass 2010

  13. PRODUCTION POSSIBILITY FRONTIER (PPF) • Diagram showing the point at which an economy is most efficiently producing its goods and services and, therefore, allocating its resources in the best way possible. • If the economy is not producing the quantities indicated by the PPF, resources are being managed inefficiently. • Shows there are limits to production, so an economy, to achieve efficiency, must decide what combination of goods and services can be produced. Economics-Biba S. Kavass 2010

  14. PPF Economics-Biba S. Kavass 2010

  15. PPF Con’t • Write the following on whiteboard while PPF slide is still up: • Points A, B, and C represent most efficient use of resources • Point X represents an inefficient use of resources • Point Y represents an unobtainable use of resources • To produce more wine, must give up some of the resources used to produce cotton. • From Point B to A, we are producing more wine but not as much cotton. Economics-Biba S. Kavass 2010

  16. PPF Growth/Decline • If PPF shifts outward, there is growth in economy. • If PPF shifts inward, economy is shrinking (usually a decrease in supplies). Economics-Biba S. Kavass 2010

  17. COMPLETE HANDOUT ON PRODUCTION POSSIBILITIES FRONTIER Economics-Biba S. Kavass 2010

  18. Review Question Why is it beneficial for a country to trade with another when it has a comparative advantage? Write down your answer and turn in for a grade. Economics-Biba S. Kavass 2010

  19. BARRIERS TO INTERNATIONAL TRADE Economics-Biba S. Kavass 2010

  20. THOUGHT PROVOKING? • Displace selected industries and jobs • Health Inspections • Political, Social, Religious Objections • War What might be some barriers to international trade? Economics-Biba S. Kavass 2010

  21. Restricting International Trade Tariffs Quotas Economics-Biba S. Kavass 2010

  22. TARIFFS • Tax placed on imports to increase their price in the domestic market. • Protective Tariff – high enough to protect less-efficient domestic industries – domestic industry protected from being undersold by a foreign one. • Revenue Tariff – high enough to generate revenue for the government without actually prohibiting imports. Economics-Biba S. Kavass 2010

  23. QUOTAS A limit placed on the quantities of a product that can be imported. Foreign goods sometimes cost so little that a tariff is not enough – government can use a quota to keep goods out of the country. Economics-Biba S. Kavass 2010

  24. Tariff-Rate Quota • Provides for a low tariff on a certain quantity (the quota amount), and a higher tariff on any quantity above the level of the quota. • Example – US has a tariff-rate quota on sugar and sugar-containing products imports Economics-Biba S. Kavass 2010

  25. Quota Weekly Commodity Status ReportU.S. Customs and Border ProtectionAs of November 21, 201 Economics-Biba S. Kavass 2010

  26. Review Question Suppose you were in charge of trade policy for the United States. Would you recommend that we increase or decrease trade barriers on athletic shoes? Write down your answer and turn in for a grade. Economics-Biba S. Kavass 2010

  27. Arguments for Trade Protection • Protectionists – people who favor trade barriers to protect domestic industries. • Fear that US jobs may move to other countries • Fear of US money going to other countries • Free Traders – people who prefer fewer or even no trade restrictions. • Argue that competition and profit-loss is part of any economic system and should be allowed to work to balance out economy. Economics-Biba S. Kavass 2010

  28. WORLD TRADE ORGANIZATION (WTO) • International agency that: • Administers trade agreements • Settles trade disputes between governments • Organizes trade negotiations • Provides technical assistance and training for developing countries • Show video from: http://www.wto.org/english/forums_e/students_e/students_e.htm Economics-Biba S. Kavass 2010

  29. International Monetary Fund (IMF) • An specialized agency of the United Nations with a 187 member countries created to foster global growth and economic stability. • Functions: • Promotes international monetary cooperation and exchange rate stability. • Facilitates the balanced growth of international trade. • Provides resources to help members in balance of payments difficulties or to assist with poverty reduction. Economics-Biba S. Kavass 2010

  30. World Bank • Mission is to fight poverty with passion and professionalism for lasting results and to help people help themselves and their environment by providing resources, sharing knowledge, building capacity and forging partnerships in the public and private sectors. • Provide low-interest loans, interest-free credits and grants to developing countries for a wide array of purposes that include investments in education, health, public administration, infrastructure, financial and private sector development, agriculture and environmental and natural resource management. Economics-Biba S. Kavass 2010

  31. NAFTA • North American Free Trade Agreement • Agreement to liberalize free trade by reducing tariffs among Canada, Mexico, and the United States. • Outlined a phase-out of tariffs over 15 year period. • Created in 1993. Economics-Biba S. Kavass 2010

  32. FOREIGN EXCHANGE Economics-Biba S. Kavass 2010

  33. THOUGHT PROVOKING? Imagine that each state had a different type of money. How would you purchase things in other states? Economics-Biba S. Kavass 2010

  34. Foreign Exchange Rate Price of one country’s currency in relation to another country’s currency. Foreign exchange rates are set by the actual flow of money and global macroeconomic conditions. Currencies are traded against one another in an open market that operates 24 hours a day during the week. Economics-Biba S. Kavass 2010

  35. Calculating Foreign Exchange Rates • 1.00 USD = 0.749576 EUR (€) • 1.00 EUR = 1.33495 USD ($) • So for every EUR you purchase you lose 33 cents USD • 1.00 MXN = 0.0808233 USD • 1.00 USD = 12.3727 MXN • For every Mexican Peso you purchase you gain 92 cents USD Economics-Biba S. Kavass 2010

  36. THOUGHT PROVOKING? Based solely on exchange rates, Americans receive more for their dollar in Mexican Pesos than they will in Euros. Based on the currency rates shown in the previous slide, in regards to exchange rates ONLY is it better for Americans to travel to Mexico or Europe right now? Economics-Biba S. Kavass 2010

  37. Comparing Apples to Apples Source: www.walletpop.com Compare Price of 2 liter bottle of Coca-Cola Economics-Biba S. Kavass 2010

  38. Complete Activity 22 from Math Practice “Working with Foreign Exchange Rates” Economics-Biba S. Kavass 2010

  39. FIXED EXCHANGE RATE • A system under which the price of one currency is fixed in terms of another currency so that the rate does not change. • Popular when the world was on a gold standard. • In 1960’s, US bought large quantities of foreign goods with dollars – countries became concerned that US could not honor “dollar is as good as gold.” Countries started redeeming debts for gold which drained US gold reserves. • President Richard Nixon stopped this in 1971. Economics-Biba S. Kavass 2010

  40. FLEXIBLE EXCHANGE RATE Aka Floating Exchange Rates Relies on supply and demand to determine the value of one currency in terms of another. System currently in place today. Economics-Biba S. Kavass 2010

  41. THE BIG MAC INDEX Source: The Economist, July 22, 2010. Economics-Biba S. Kavass 2010

  42. THE BIG MAC INDEX Con’t The Economist uses the price of the ubiquitous McDonald's meal to calculate the "Big Mac Index", a guide showing how far from fair value different world currencies are. The Big Mac theory (a.k.a. purchasing-power parity, or PPP) says that exchange rates should even out the prices of Big Macs sold across the world. In other words, how strong or weak is currency in another country as compared to the U.S. dollar. Source: The Economist, July 22, 2010. Economics-Biba S. Kavass 2010

  43. Trade Deficits and Surpluses • Strength and/or weakness of the USD affects trade. • Balance of Payments – difference between the money a country pays out to, and receives from, other nations when it engages in trade. • Trade Deficits – balance of payments outcome when spending on imports exceeds revenues from exports. • Trade Surplus – balance of payments outcome when revenues received from exports exceeds spending on imports. Economics-Biba S. Kavass 2010

  44. Trade-Weighted Value of the Dollar Index (kept by the Federal Reserve) displaying the strength of the US dollar against a group of major foreign currencies. Economics-Biba S. Kavass 2010

  45. Review Question You are planning to travel to Canada in the next week and you have just learned that the Canadian dollar has weakened. Is this good news or bad news? Good news - US dollar will have increased value in Canada which means purchasing power has increased. Economics-Biba S. Kavass 2010

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