International Economics

1. International Economics International Trade and Exchange

2. Arguments for free trade • Countries benefit from trading for goods and services they don’t have • Countries benefit by producing what they are most efficient in producing (comparative advantage) • US producers benefit from exporting items to foreign countries • US consumers benefit from lower prices of foreign products

3. Arguments for Trade Restrictions • Increased imports hurts domestic industries leading to domestic unemployment (e.g. textiles) • Tariffs or quotas may be instituted to protect workers in the home country • Tariffs or quotas may be used to protect infant industries • Nations also want to maintain productive diversity (eg. Steel for defense industries) • Some nations dump products or restrict US imports

4. Trade Terms • Import quota - a limit on the amount of a product that can be imported • Import tariff - a tax on a specified product • Infant industries - those industries just getting started • Open economy- an economy with foreign trade

5. Balance of Trade Terms • A Nation’s balance of trade is its exports minus its imports • A nation that exports more than it imports has a trade surplus • A nation that imports more than it exports runs a trade deficit • The US in 2010 had a trade deficit of approximately 498 billion dollars

6. Possible Reasons for a nation’s trade deficit • Exports may be of inferior quality • Country may not have many products to export • A nation’s currency may be overpriced,making imports cheap • A nation may have higher incomes than its trading partners • Poorer nations can’t afford richer nation’s products

7. More Balance of Payments Terms • Balance of Payments an accounting of funds that flow into and out of a country comprised of capital account and current account. • Current account - a portion payments comprised of the trade balance of goods and services • Capital account - a portion of the balance payments comprised of foreign purchases of US assets minus US purchases of foreign assets, plus the change in official reserves

8. Current and Capital Account Balances • The capital and current account must equal 0 • . There is an identity between the current and capital accounts. If we run a trade deficit, we have a deficit in the current account, but a corresponding surplus in the capital account. • Investments are part of capital accounts, but income from investments are part of current accounts

9. Exchange Rates • Exchange rate the value of one nation’s currency in terms of another’s • Most countries have a floating exchange rate that changes with the supply and demand of currency • For example, if Europeans want more US products they demand more dollars, leading to a rise in the value of the dollar vis a vis the Euro. The dollar appreciates • Conversly, if the US demands more Yen to buy Japanese products, the dollar falls in relation to the Yen. The dollar depreciates.

10. Determinants in Exchange Rates • Demand for a nation’s products • Relative prices of a nation • Relative incomes, wealth or poverty of a nation • Speculation by currency brokers • Relative interest rates

11. Weak Dollar • Dollar is worth less relative to other currencies • Benefits: expands US exports, helps trade deficit, leads to growth in GDP through NX • Problems: imports are more expensive, inputs in production bought abroad are more expensive, tough on US tourists

12. Strong dollar • US dollar worth more relative to other currencies • Benefits: imports are cheaper, foreign inputs in production are cheaper, good for US tourists • Problems: hurts exports, makes trade deficit worse, lowers GDP

13. Price Levels and Interest Rates in NX • Higher price levels discourage foreigners from buying US products --> NX falls • Lower price levels encourage foreigners to buy US products --> NX rises • Higher interest rates encourage foreign investors in US --> capital account increases --> NX falls • Lower interest rates discourage foreign investors in the US --> captial account decreases --> NX rises

14. First View Expansionary Policy- interest rate focus Expansionary Fiscal Policy • Gov borrowing to increase AD --> crowding out --> interest rate increases -->capital flows into US --> dollar appreciates --> imports go up --> NX down Expansionary Monetary Policy • Fed increases Money Supply --> interest rates fall --> Capital flows out of US -->dollar depreciates --> exports go up --> NX up Contractionary policies would be opposite for each. E.g. Contractionary fiscal policy would raise NX Contractionary monetary policy would lower NX

15. Second ViewPrice Level Focus • Expansionary policies lead to higher price levels --> inflation means our products are more expensive --> exports fall --> NX falls • Contractionary policies lead to lower price levels --> falling prices --> exports increase --> NX rises • (suggestion: look to see if the question focuses on interest rates or price levels to determine which view to use on AP)

16. Which of the following is most likely to cause an increase in the international value of the US dollar? • Higher US real interest rates • Lower US government expenditures • Higher real interest rates abroad • Expansionary monetary policy • Reduced inflation abroad

17. An increase in which of the following would reduce the US balance of trade deficit? • US rate of inflation compared to other countries • The value of foreign currency relative to the US dollar • US demand for foreign goods • The federal budget deficit • US interest rates compared to other countries

18. Assume Canadian consumers increase their demand for Mexican financial assets • Supply of Canadian Dollars Value of Peso Canadian Net Exports • 1. Increase Increase Increase • 2.. Increase Increase Decrease • 3.. Decrease Increase Decrease • 4.. Decrease Decrease Increase • 5.. Not Change Increase Decrease

19. Suppose the real interest rate in Canada increases relative to that of Mexico • Will this rise in interest rate initially affect Canada’s current account or capital account? • Design a correctly labeled graph of the foreign exchange market for the Canadian dollar, show the effect of the change in the real interest rate in Canada on the international value of the Canadian dollar (expressed as Mexican pesos per Canadian dollar. • How will the change in the international value of the Canadian dollar that you identified affect Canadian exports to Mexico? • Will the Canadian GDP rise or fall? Explain.