Why and How Nations Trade

1. Chapter 24, Lesson 1 Why and How Nations Trade

2. Trade Between Nations • Individual nations do not always have the necessary resources to make the products their people need and want. • To solve this problem of scarcity, nations trade with one another. • Nations import, or bring into the country, goods produced in other nations. • They export, or sell to other nations, goods they produce. • Some less advanced economies, known as single-resource economies, specialize in a single export. • This makes them very vulnerable to price changes in the marketplace.

3. Comparable Advantage • The main reason countries trade is because of comparable advantage, the ability to produce something at a lower opportunity cost than another country can. • For instance, if a country can make 1 product in less time or for less money than another product, their time is better spent making more of the first product. • A country’s factors of production – natural resources, labor, capital, and entrepreneurs – often determine its comparable advantage. • For example, China has a large labor force, so they are better at manufacturing goods that require a large pool of labor. • The United States has abundant farmland, so we produce much of the world’s food.

4. Managing Trade • Because many consumers want low prices, many of the nation’s stores line their shelves with products from nations with low labor costs, such as China. • China can produce many goods more cheaply than the United States can. • However, when consumers buy these products, they are hurting American companies who are then forced to cut production and lay off workers.

5. Trade Barriers • Protectionism is the use of tactics that make imported goods more expensive than domestic goods. • A tariff is a tax on imports. • It raises the cost of foreign goods to make domestic ones more attractive. • An import quota limits the amount of a particular good that enters a country. • This allows domestic producers of the product to be able to compete. • A subsidy is a payment or other benefit given by government to help a domestic producer. • The problem with these methods is that they raise the prices on goods.

6. Free Trade Agreements • Most countries now try to reduce trade barriers, a policy known as free trade. • To increase trade, countries often join together with a few key trading partners to set up areas of free trade. • In 1994 the United States, Canada, and Mexico joined together in the North American Free Trade Agreement (NAFTA), creating the largest free trade zone in the world. • Since then, trade among the 3 nations has more than tripled.

7. Other Free Trade Organizations • The European Union (EU) includes 27 countries and is currently the largest economy in the world. • Most EU nations even share a common currency called the euro, making trade easier. • The African Union (AU) promotes unity among nations and economic development in Africa. • The Asia-Pacific Economic Cooperation (APEC) promotes free trade among members in that part of the world. • The World Trade Organization (WTO), formed in 1995, includes 153 member nations, oversees trade agreements, and tries to settle trade disputes among member nations.

8. Balance of Trade • The difference between the value of a nation’s imports and the value of its exports is the balance of trade. • When the value of a nation’s exports is greater than the value of its imports, it has a positive balance of trade, also known as a trade surplus. • This is good because when a country has a trade surplus for a long period of time, the value of its currency increases. • When a nation imports more than it exports, it has a negative balance of trade, also known as a trade deficit. • For period of long deficits, the demand for domestic goods decreases, so workers lose their jobs and the value of currency decreases.

9. Role of Currency and Exchange Rates • The value of one nation’s currency in relation to another is its exchange rate. • Nations like to carry out trade using their own currency. • For instance, if the United States has to pay for imports from Japan in yen, then they have to sell U.S. dollars to get it. • The higher supply of dollars in the market drives down the value of the dollar, so the United States much prefers to pay in U.S. dollars.