Why Do Nations Trade . . .?

1. Why Do Nations Trade . . .?

2. Economics is based on. . . • Supply and Demand And • Incentives

3. Market-Oriented Economic System

5. Market-Oriented Economic System includes . . . Basic Competitive Model: • Consumers making rational choices • Profit Maximizing Firms • Highly competitive markets

6. Market-Oriented Economic System also needs • Incentives • Price System • Property Rights – to use it and sell it • Inequality i.e., acceptance of. . . . • (almost) free markets . . • Belief in the benefits of efficiency • An understanding of cost benefit analysis

7. Market-Oriented Economic (Price) System vs . . . • Rationing system • Pure free market/libertarianism • Strong government regulatory system

8. Market-Oriented Economic (Price) System vs . . . • Command economy • State owned enterprises • Communist • Socialism • national socialism • Mixed market economies

9. Market-Oriented Economic (Price) System vs . . . - The International economy (trade and finance, etc.) is based on a mix of economic systems, but primarily a market-based, free trade system - Every economic system must deal with it on those terms - The global economy – international trade, finance, investment – is more free-market than most domestic economies

10. Capitalism vs Everything Else - What are the alternatives? - Is capitalism the worst possible system? . . . . except for all the rest? • Should economic results be even, with little opportunities for change? • Should foreign trade be • Free? • Fair?

11. Bilateral vs Multilateral Trade • Virtually all trade is multilateral • No country can just have bilateral trade • Too much emphasis on bilateral balances • Need not be a zero sum game, but gains are not equal • Exposes trading nations to external factors and makes them interdependent • Cannot survive without trade

12. Current Issues • China has slowly allowed its currency to appreciate • Japan has struggled to depreciate its currency's position • Germany has resisted EU bailouts • Perimeter of EU barely hanging on to Euro Risks include: • Debt crisis worsening in EU and in US • Lack of consumer and business confidence

13. Chinese YuanSource: St Louis Fed

14. Japanese YenSource: St Louis Fed

15. EuroSource: St Louis Fed

16. Trade Weighted Value of US$Source: St Louis Fed

17. Daily Foreign Exchange TradingSource: BIS via WSJ

18. Opportunity Costs Everything has an opportunity cost Resources (time, capital, labor) are finite • Going to the movies • Going to college • Public infrastructure investments • Private financial investments

19. Sunk Costs • An Economic Cost – that can be discounted. • Should take them into account before deciding, but .... • Example: Mortgage Loan Application Fees

20. Marginal Costs vs Marginal Benefits To do something or not to do something – trade offs are critical to most decisions • Related to opportunity costs Examples • Reducing carbon emissions - Tire pressure rules in California??? • Auto safety standards

21. Opportunity Set • Group of available options • Involve Trade-offs, i.e. what is possible • Involve Budget Constraints • Time Constraints • Consumption Curve

22. Opportunity Set A group of available options Budget constraints for individuals CDs 12 Borrowing? $120 available savings? 6 DVDS

23. Production Possibility Curve and Diminishing Returns . . . for societies Guns Note: Curved line vs. straight line Butter

24. Efficiency and productivity decline the more inputs are used Diminishing Returns

25. Trade Between Countries • Countries trade to increase economic well-being. Trade will affect three main internal markets: • Product • Labor • Capital

26. Comparative vs Absolute Advantage

27. PROBLEM #9 Resources Needed

28. PROBLEM #9 Resources Needed Different Production Costs

29. Assumption: Single Product Production with 72,000 workers in each country

30. OPPORTUNITY SETS Wool 800 Portugal Production Possibilities 720 England Production Possibilities 900 600 Wine

31. Assumption: Single Product Production with 72,000 workers in each country

32. Production/consumption with 36,000 workers in each sector; no trading Why would Portugal Trade?

33. PROBLEM #9, cont. After trade: consumption outcome

34. Comparative Advantage vs. Absolute Advantage (see Stiglitz pp 42-43)

36. PRODUCTION POSSIBILITIES(Stiglitz, p. 42-43) Garments China’s Production Possibilities Marginal Rate of Transformation E’ 20,000 E 10,000 E’’ 9,000 US Production Possibilities. Airplanes Produced 100 300 200

37. PROBLEM #11 Initial Situation with Total 240,000 worker hours, no trade and labor equally divided among industries within countries

38. OPPORTUNITY SETS Trucks 600 U.S. Production Possibilities 400 EU Production Possibilities. 3000 Cars 2,400

39. PROBLEM #11 Problem: Increase car production by 10 units, leave Truck production unchanged

40. PROBLEM #11 Problem: Increase car production by 10 units, leave Truck production unchanged 1. US produces 50 fewer cars and adds ten additional Trucks 2. EU drops 10 Trucks, increases car production by 60 units 3. US exchanges 10 Trucks with Europe for 55 cars