Trading With Other Trading With Other NationsNations

EconomicsEconomics

Chapter 18Chapter 18

ImportsImports

Imports are goods bought from other Imports are goods bought from other countries for domestic use.countries for domestic use. Roughly 13% of GDP in the US.Roughly 13% of GDP in the US.

ExportsExports

Exports are goods sold to other Exports are goods sold to other countries.countries.

Differences Among NationsDifferences Among Nations

Nations benefit from world trade Nations benefit from world trade because each differs in the type and because each differs in the type and amount of the factors of production it amount of the factors of production it has available for use.has available for use.

Absolute AdvantageAbsolute Advantage

Absolute advantage is the ability of Absolute advantage is the ability of one country, using the same quantity one country, using the same quantity of resources as another, to produce a of resources as another, to produce a particular product at a lower absolute particular product at a lower absolute cost.cost. SpecializationSpecialization is a concept that a nation is a concept that a nation

should produce and export a limited should produce and export a limited assortment of goods for which it is assortment of goods for which it is particularly suited in order to remain particularly suited in order to remain profitable.profitable.

Comparative AdvantageComparative Advantage

Comparative advantageComparative advantage is is the ability of a country to the ability of a country to produce a product at a produce a product at a lower opportunity cost lower opportunity cost than another country.than another country.

Comparative AdvantageComparative Advantage Two men live alone in an isolated island. Two men live alone in an isolated island.

To survive they must undertake a few To survive they must undertake a few basic economic activities like water basic economic activities like water carrying, fishing, cooking and shelter carrying, fishing, cooking and shelter construction and maintenance. The first construction and maintenance. The first man is young, strong, and educated and man is young, strong, and educated and is faster, better, more productive at is faster, better, more productive at everything. He has an absolute everything. He has an absolute advantage in all activities. The second advantage in all activities. The second man is old, weak, and uneducated. He man is old, weak, and uneducated. He has an absolute disadvantage in all has an absolute disadvantage in all economic activities. In some activities the economic activities. In some activities the difference between the two is great; in difference between the two is great; in others it is small.others it is small.

Is it in the interest of either of them to Is it in the interest of either of them to work in isolation? No, specialization and work in isolation? No, specialization and exchange (trade) can benefit both of exchange (trade) can benefit both of them.them.

How should they divide the work? How should they divide the work? According to comparative, not absolute According to comparative, not absolute advantage: the young man must spend advantage: the young man must spend more time on the tasks in which he is more time on the tasks in which he is much better and the old man must much better and the old man must concentrate on the tasks in which he is concentrate on the tasks in which he is only a little worse. Such an arrangement only a little worse. Such an arrangement will increase total production and/or will increase total production and/or reduce total labor. It will make both of reduce total labor. It will make both of them richer.them richer.

Let's break this down into a simple Let's break this down into a simple example. You have two firms that both example. You have two firms that both produce two main products: ice cream produce two main products: ice cream and bicycles. The first firm, The Danish and bicycles. The first firm, The Danish Ice Cream and Bicycle Co., is located in Ice Cream and Bicycle Co., is located in Denmark, where dairy milk is abundant; Denmark, where dairy milk is abundant; the second firm, The Gobi Ice Cream the second firm, The Gobi Ice Cream and Bicycle Co., is smack in the middle and Bicycle Co., is smack in the middle of the Gobi Desert. of the Gobi Desert.

The Gobi Ice Cream and Bicycle Co. The Gobi Ice Cream and Bicycle Co. must expend a lot of money to make ice must expend a lot of money to make ice cream, whereas The Danish Ice Cream cream, whereas The Danish Ice Cream and Bicycle Co. spends way less to and Bicycle Co. spends way less to produce the same amount. The two produce the same amount. The two firms are dead even in their production firms are dead even in their production costs for bicycles. costs for bicycles.

Since The Danish Ice Cream and Bicycle Since The Danish Ice Cream and Bicycle Co. has a comparative advantage with Co. has a comparative advantage with ice-cream production, it should probably ice-cream production, it should probably consider turning exclusively to ice consider turning exclusively to ice cream. Along the same vein, The Gobi cream. Along the same vein, The Gobi Ice Cream and Bicycle Co. should Ice Cream and Bicycle Co. should probably give up the ice cream and probably give up the ice cream and focus on the product in which it is the focus on the product in which it is the least disadvantaged (bicycles). least disadvantaged (bicycles).

Financing World TradeFinancing World Trade

Medium of ExchangeMedium of Exchange USUS

DollarDollar MexicoMexico

PesoPeso IndiaIndia

RupeeRupee Japan Japan

YenYen

Exchange RateExchange Rate

Exchange RateExchange Rate What the price of their country’s What the price of their country’s

currency is in terms of another nation’s currency is in terms of another nation’s currency.currency.

Currency CalculatorsCurrency Calculators

Exchange RatesExchange Rates

Exchange Rate FormulaExchange Rate Formula

Exchange Rate FormulaExchange Rate Formula Y to X Exchange rate = 1 / X to Y Y to X Exchange rate = 1 / X to Y

exchange rate.exchange rate. Japan to U.S. exchange rate = 1 / U.S. to Japan to U.S. exchange rate = 1 / U.S. to

Japan exchange rateJapan exchange rate $1 = 117Y (this is the U.S. to Japan rate)$1 = 117Y (this is the U.S. to Japan rate) Japan to U.S. = 1 / 117 = .00854Japan to U.S. = 1 / 117 = .00854

A TV that costs 20,000Y costs $170.80 A TV that costs 20,000Y costs $170.80 (20,000 x .00854)(20,000 x .00854)

Exchange Rate ExampleExchange Rate Example

RememberRemember Y to X exchange rate = 1 / X to Y exchange rate.Y to X exchange rate = 1 / X to Y exchange rate.

The Canadian dollar is worth .67 U.S. The Canadian dollar is worth .67 U.S. dollars. Canada to U.S. exchange rate is .67dollars. Canada to U.S. exchange rate is .67

How many Canadian dollars can we buy How many Canadian dollars can we buy with one U.S. dollar?with one U.S. dollar? U.S to Canada exchange rate = 1 / Canada to U.S to Canada exchange rate = 1 / Canada to

U.S. exchange rate.U.S. exchange rate. U.S. to Canada = 1 / .67 = 1.4925 = $1.49U.S. to Canada = 1 / .67 = 1.4925 = $1.49

So one U.S. dollar can get $1.49 in Canadian Funds.So one U.S. dollar can get $1.49 in Canadian Funds.

Rate Exchange ExampleRate Exchange Example Let's take the Japanese Yen for example. 1 American Dollar Let's take the Japanese Yen for example. 1 American Dollar

equals 106.82 Yen. That means that converted to Yen, equals 106.82 Yen. That means that converted to Yen, $1.00 can buy 106.82Y worth of Japanese goods. $1.00 can buy 106.82Y worth of Japanese goods.

Now, let's learn to calculate. First, we know that 106.82Y Now, let's learn to calculate. First, we know that 106.82Y equals $1.00, but what would be the U.S. dollar-Yen equals $1.00, but what would be the U.S. dollar-Yen exchange rate?? 106.82 is not right! You divide 1.00 into exchange rate?? 106.82 is not right! You divide 1.00 into 106.82 which equals 0.009 cents per 1 Yen. That is not 106.82 which equals 0.009 cents per 1 Yen. That is not even 1 penny's worth per Yen in Japan. even 1 penny's worth per Yen in Japan.

Okay, now that I have confused some of you. Let's take a Okay, now that I have confused some of you. Let's take a TV bought in Japan. We have bought a Sanyo TV which TV bought in Japan. We have bought a Sanyo TV which costs $20,000Y in Japan. How much is that in American costs $20,000Y in Japan. How much is that in American dollars you ask? dollars you ask?

Let's calculate. Remember that 0.009 cents equals 1 Yen. Let's calculate. Remember that 0.009 cents equals 1 Yen. So, we just take 0.009 multiplied by 20,000 which equals So, we just take 0.009 multiplied by 20,000 which equals $180.00 U.S. dollars. That wasn't so bad now was it?? This $180.00 U.S. dollars. That wasn't so bad now was it?? This conversion goes for ALL exchange rates whether it is Euros, conversion goes for ALL exchange rates whether it is Euros, Pounds, Francs, etc. Pounds, Francs, etc.

Fixed Exchange RateFixed Exchange Rate

From 1944-early 1970s foreign exchange From 1944-early 1970s foreign exchange markets used a fixed exchange rate.markets used a fixed exchange rate. A system under which a national government A system under which a national government

set the value of its currency in relation to a set the value of its currency in relation to a single standard---usually gold held in reserve.single standard---usually gold held in reserve.

This system eventually proved impracticalThis system eventually proved impractical Devaluation often played a part in why it Devaluation often played a part in why it

didn’t work.didn’t work. Why keep things fixed when economies are Why keep things fixed when economies are

constantly changing.constantly changing.

DevaluationDevaluation DevaluationDevaluation

Lowering a currency’s value in relation to other currencies by Lowering a currency’s value in relation to other currencies by government order.government order.

if the United States is losing money in its trade with France, a if the United States is losing money in its trade with France, a decision may be made to devalue the U.S. dollar by 10%. decision may be made to devalue the U.S. dollar by 10%. Whereas previously one dollar may have been worth about 5.5 Whereas previously one dollar may have been worth about 5.5 francs, a 10% devaluation causes it to be worth only about 5 francs, a 10% devaluation causes it to be worth only about 5 francs. Such a move causes French products to become more francs. Such a move causes French products to become more expensive for Americans and U.S. products to become cheaper expensive for Americans and U.S. products to become cheaper for Frenchmen. An ounce of French cologne that previously for Frenchmen. An ounce of French cologne that previously cost 55 francs in France and 10 dollars in the United States cost 55 francs in France and 10 dollars in the United States may still sell for 55 francs in France but will now cost 11 dollars may still sell for 55 francs in France but will now cost 11 dollars in the United States. The net result of such a devaluation is in the United States. The net result of such a devaluation is that U.S. exports tend to increase and imports tend to that U.S. exports tend to increase and imports tend to decrease, thus helping to reverse the balance of payments decrease, thus helping to reverse the balance of payments deficit. deficit.

55/5.5= $1055/5.5= $10 55/5=$1155/5=$11

IMFIMF

International Monetary Fund (IMF)International Monetary Fund (IMF) An agency whose member governments An agency whose member governments

once were obligated to keep their once were obligated to keep their exchange rates more or less fixed; today exchange rates more or less fixed; today it offers monetary advice and provides it offers monetary advice and provides loans to developing nations.loans to developing nations.

Flexible Exchange RatesFlexible Exchange Rates

In 1971 most nations turned to a In 1971 most nations turned to a flexible exchange rate.flexible exchange rate. An arrangement in which the forces of An arrangement in which the forces of

supply and demand are allowed to set supply and demand are allowed to set the price of various currencies.the price of various currencies.

Currencies float up and down a little each Currencies float up and down a little each day.day.

Balance of TradeBalance of Trade

A currency’s exchange rate can have an A currency’s exchange rate can have an important effect on a nation’s balance of important effect on a nation’s balance of trade—the difference between the value of trade—the difference between the value of a nation’s exports and imports.a nation’s exports and imports. If a nation’s currency depreciates, or becomes If a nation’s currency depreciates, or becomes

weak, the nation will likely export more goods weak, the nation will likely export more goods because its products will become cheaper for because its products will become cheaper for other nations to buy.other nations to buy.

If a nation’s currency increases in value, or If a nation’s currency increases in value, or becomes strong, the amount of exports will becomes strong, the amount of exports will decline.decline.

Balance of TradeBalance of Trade

When the value of goods leaving a When the value of goods leaving a nation (exports) exceeds the value of nation (exports) exceeds the value of those coming in (imports), a positive those coming in (imports), a positive balance of trade is said to exist.balance of trade is said to exist.

A negative balance of trade exists A negative balance of trade exists when the value of goods coming into when the value of goods coming into a nation is greater than the value of a nation is greater than the value of those going out. This is called a those going out. This is called a Trade DeficitTrade Deficit..

Restrictions on World TradeRestrictions on World Trade

Three ways to restrict importsThree ways to restrict imports TariffsTariffs QuotasQuotas EmbargoesEmbargoes

TariffsTariffs

Revenue TariffRevenue Tariff A tax on imports used primarily to raise A tax on imports used primarily to raise

government revenue without restricting government revenue without restricting importsimports

Protective TariffProtective Tariff A tax on imports used to raise the cost A tax on imports used to raise the cost

of imported goods and thereby protect of imported goods and thereby protect domestic producers.domestic producers.

QuotasQuotas

Import QuotasImport Quotas Restrictions imposed on the number of Restrictions imposed on the number of

units of a particular good that can be units of a particular good that can be brought into the country.brought into the country.

EmbargoesEmbargoes

EmbargoEmbargo Complete restriction on the import or Complete restriction on the import or

export of a particular good.export of a particular good.

Trade AgreementsTrade Agreements

General Agreement on Tariffs and General Agreement on Tariffs and Trade (GATT)Trade (GATT) Countries meet to negotiate tariff Countries meet to negotiate tariff

reductions.reductions. World Trade Organization (WTO)World Trade Organization (WTO)

Replaced GATT to form the most far-Replaced GATT to form the most far-reaching global trade agreement in history.reaching global trade agreement in history.

North American Free Trade Agreement North American Free Trade Agreement (NAFTA)(NAFTA)

European Union (EU)European Union (EU)