Download Economics for Today 2nd edition Irvin B. Tucker

Chapter 28
International Trade
and Finance
• Key Concepts
• Summary
• Practice Quiz
• Internet Exercises
©2002 South-Western College Publishing
1
Why do countries trade?
International trade
allows a country to
consume a
combination of goods
and services that
exceeds its production
possibilities curve
2
U.S. Trading Partners, 2000
Mexico
Canada
Western Europe
Australia
Eastern Europe
Japan
Asia
Africa
Latin America
3
U.S. Production and Consumption
80
70
60
40
20
0
Grain (tons per year)
100 A
B´ (with trade)
B (without trade)
PPC
U.S.
Steel (tons per day)
C
10
20
30
40
50
4
80
60
Grain (tons per year)
100
D
40
30
20
0
Japanese Production
and Consumption
E (without trade)
E´ (with trade)
PP
Japan
C
Steel (tons per day)
10
20
30
F
40
50
5
Why should countries
specialize and trade?
Total world output
increases, and therefore,
the potential for greater
total world consumption
also increases
6
If countries should
specialize, in what
should they specialize?
They should produce
those goods and services
in which they have a
comparative advantage
7
What is
comparative advantage?
The ability of a country
to produce a good at a
lower opportunity cost
than another country
8
What is
absolute advantage?
The ability of a country
to produce a good
using fewer resources
than another country
9
What is free trade?
The flow of goods between
countries without
restrictions or special taxes
10
What is protectionism?
The government’s use of
embargoes, tariffs,
quotas, and other
restrictions to protect
domestic producers from
foreign competition
11
What is an embargo?
A law that bars trade
with another country
12
What is a tariff?
A tax on an import
13
What is a quota?
A limit on the quantity
of a good that may be
imported in a given
time period
14
What are the arguments
for protectionism?
• Infant industry argument
• National security argument
• Employment argument
• Cheap foreign labor argument
• Free trade agreements
15
What is a recent free
trade agreement?
North America Free Trade
Agreement (NAFTA)
16
What is NAFTA?
A 1993 free trade agreement
between the U.S., Canada,
and Mexico
17
What is the
balance of payments?
A bookkeeping record of all
the international
transactions between a
country and other
countries during a given
period of time
18
What is the
current account?
The first section of the
balance of payments,
which includes trade in
currently produced
goods and services
19
What is the
balance of trade?
The most widely reported
and largest part of the
current account defined
as the value of a
nation’s merchandise
imports subtracted from
its merchandise exports
20
How is a current
account deficit
financed?
By a capital account surplus
21
What is the
capital account?
The second section of
the balance of
payments, which
records payment flows
for financial capital
22
50
U. S. Balance of Trade, 1979-2000
-50
-100
-150
-200
Balance of Trade
(billions of dollars)
0
-250
Year
79
81
83
85
87
89
91
93
95
97
99 01
23
What does the
balance of payments
always equal?
Zero; the current account
deficit should equal the
capital account surplus
24
How could the US
have a balance of
payments problem?
The problem is with the
composition of the
balance of payments
25
What is an
exchange rate?
The number of one
nation’s currency that
equals one unit of
another nation’s currency
26
If 1.81 dollars is
exchangeable for 1
British pound, what is
the exchange rate?
1 / 1.81 = .552
pounds per dollar
27
How is the exchange
rate determined?
Supply and demand for
foreign exchange
28
Price (yen per dollar)
Supply and Demand for Dollars
200
150
S of $ (U.S. citizens)
E
100
50
D for $ (Japanese citizens)
0
100 200 300 400 500
Quantity of dollars (millions per day)
29
What happens when a
currency depreciates?
The price of the currency
falls in relation to
another currency
30
What happens when a
currency appreciates?
The price of the currency
rises in relation to
another currency
31
What can cause a
currency to
change value?
The demand and/or
supply of the currency
can change
32
What can cause a
change in demand of
a currency?
There can be a change in • tastes and preferences
• relative price levels
• relative interest rates
33
Decrease in Demand
200
150
100
50
Price (yen per dollar
250
S
E1
E2
D1
D2
Quantity of Dollars (millions per day
100 200 300 400 500
34
U.S.
exports
less
popular
Decrease
in the
demand
for
dollars
Value of the
dollar falls
(dollar
depreciates)
35
What can cause a
change in supply of
a currency?
There can be a change in • relative incomes
• relative price levels
• relative interest rates
36
Decrease in Supply
200
150
100
50
Price (yen per dollar
250
S
E2
2
S
1
E2
D
Quantity of Dollars (millions per day)
100 200 300 400 500
37
Japanese
imports
less
popular
Decrease
in the
supply of
dollars
Value of the
dollar rises
(dollar
appreciates)
38
What happens when
demand and/or
supply changes?
The currency seeks a
new equilibrium; the
value changes
39
Japanese
Increase the
buy more
demand for
U.S.
dollars
exports
Japanese Impact on relative Value of the
price
price changes on dollar rises
level
Exchange Rates (dollar
rises
appreciates
U.S.
Decrease
citizens
in the
buy fewer
supply of
Japanese
dollars
imports
40
The Effects of Shift in Supply on
Market Equilibrium
300
250
S2
E2
1
200
150
100
50
S
E1
D2
D1
Quantity of dollars
100 200 300 400 500 600 700
41
Key Concepts
42
Key Concepts
• Why do countries trade?
• Why should countries specialize and trade?
• If countries should specialize, in what should
they specialize?
• What is comparative advantage?
• What is absolute advantage?
• What is free trade?
• What is protectionism?
43
Key Concepts cont.
•
•
•
•
•
•
•
•
•
What is an embargo?
What is a tariff?
What is a quota?
What is Nafta?
What is the balance of payments?
What is the balance of trade?
What is an exchange rate?
What can cause a currency to change value?
What if demand - supply changes?
44
Summary
45
Comparative advantage is a
principle that allows nations to
gain from trade. Comparative
advantage means that each
nation specializes in a product
for which its opportunity cost is
lower in terms of the production
of another product and then
nations trade.
46
When nations follow the principle
of comparative advantage, they
gain. The reason is that world
output increases and each nation
ends up with a higher standard of
living by consuming more goods
and services than possible
without specialization and trade.
47
U.S. Production and Consumption
80
70
60
40
20
0
Grain (tons per year)
100 A
B´ (with trade)
B (without trade)
PPC
U.S.
Steel (tons per day)
C
10
20
30
40
50
48
Free trade benefits a nation as a
whole, but individuals may lose
jobs and incomes from the
competition from foreign goods
and services.
49
Protectionism is a government’s
use of embargoes, tariffs,
quotas, and other methods t
impose barriers intended to both
reduce imports and protect
particular domestic industries.
50
Embargoes prohibit the import of
export of particular goods. Tariffs
discourage imports by making
them more expensive. Quotas limit
the quantity of imports or exports of
certain goods. These trade barriers
often result primarily from domestic
groups that exert political pressure
to gain from these barriers.
51
The balance of payments is a
summary bookkeeping record of all
the international transactions a
country makes during a year. It is
divided into different accounts,
including the current account, the
capital account and the statistical
discrepancy.
52
The current account summarizes
all transactions in currently
produced goods and services.
The overall balance of payments
is always zero after an
adjustment for the statistical
discrepancy.
53
The balance of trade measures only
goods (not services) that a nation
exports and imports. A balance of
trade can be in deficit or in surplus.
The balance of trade is the most
widely reported and largest part of
the current account. Since 1975, the
U.S. has experienced balance of
trade deficits.
54
50
U. S. Balance of Trade, 1979-2000
-50
-100
-150
-200
Balance of Trade
(billions of dollars)
0
-250
Year
79
81
83
85
87
89
91
93
95
97
99 01
55
An exchange rate is the price of
one nation’s currency in terms of
another nation’s currency.
Foreigners who wish to purchase
U.S. goods, services, and financial
assets demand dollars. The supply
of dollars reflects the desire of U.S.
citizens to purchase foreign goods,
services and financial assets.
56
The intersection of the supply and
demand curves for dollars
determines the number of units of
a foreign currency per dollar.
57
Price (yen per dollar)
Supply and Demand for Dollars
200
150
S of $ (U.S. citizens)
E
100
50
D for $ (Japanese citizens)
0
100 200 300 400 500
Quantity of dollars (millions per day)
58
Shifts in supply and demand for
foreign exchange result from changes
in such factors as tastes, relative
price levels, relative real interest
rates, and relative income levels.
59
Depreciation of currency occurs
when one currency becomes worth
fewer units of another currency. If a
currency depreciates, it becomes
weaker. Depreciation of a nation’s
currency increases its exports and
decreases its imports.
60
Appreciation of currency occurs
when one currency becomes worth
more units of another currency. If a
currency appreciates, it becomes
stronger. Appreciation of a nation’s
currency decreases its exports and
increases its imports.
61
Chapter 28 Quiz
©2002 South-Western College Publishing
62
1. With trade, the production possibilities for
two nations lie
a. outside their consumption possibilities.
b. inside their consumption possibilities.
c. at a point equal to the world production
possibilities curve.
d. none of the above.
B. When countries specialize and trade,
total world output increases and
potential total total world consumption
also increases.
63
2. Free trade theory suggests that when
trade takes place
a. both nations will be worse off.
b. one nation must gain at the other
nation’s expense.
c. both nations are better off.
d. one nation will gain and the other
nation will be neither better nor worse
off.
C. Free trade allows a country to consume
a combination of goods that exceeds its
production possibilities curve.
64
3. Which of the following is true when two
countries specialize according to their
comparative advantage?
a. It is possible to increase their total
output of all goods.
b. It is possible to increase their total
output of some goods only if both
countries are industrialized.
c. One country is likely to gain from trade
while the other loses.
d. None of the above.
A. Comparative advantage is the ability
of a country to produce a good at a
lower opportunity cost than another 65
country.
4. According to the theory of comparative
advantage, a country should produce and
a. import goods in which it has an
absolute advantage.
b. export goods in which it has an
absolute advantage.
c. import goods in which it has a
comparative advantage.
d. export goods in which it has a
comparative advantage.
D. Don’t confuse comparative advantage
and absolute advantage. Absolute
advantage is the ability of a country to
produce a good using fewer resources
66
than another country.
Exhibit 11 Potatoes and Wheat
Output (tons per hour)
COUNTRY
POTATOES
WHEAT
U.S.
1
3
Ireland
1
2
67
5. In Exhibit 11, which country has the
comparative advantage in the production
of potatoes?
a. The United States because it requires
fewer resources to produce potatoes.
b. The United States because it has the
lower opportunity cost of potatoes.
c. Ireland because it requires fewer
resources to produce potatoes.
d. Ireland because it has the lower
opportunity cost of potatoes.
D. To produce 1 ton of potatoes, the
opportunity cost for the U.S. is 3 tons of
wheat. To produce 1 ton of potatoes, the
opportunity cost for Ireland is 2 tons of68
wheat.
6. In Exhibit 11, the opportunity cost of
wheat is
a. 1/3 ton of potatoes in the United States
and 1/2 ton of potatoes in Ireland.
b. 2 tons of potatoes in the United States
and 1 1/2 tons of potatoes in Ireland.
c. 8 tons of potatoes in the United States
and 4 tons of potatoes in Ireland.
d. none of the above.
A. U.S. 1 ton potatoes = 3 tons of wheat
1/3 ton of potatoes = 1 ton of wheat
Ireland 1 ton potatoes = 2 tons of wheat
1/2 ton potatoes = 1 ton of wheat
69
7. In Exhibit 11, the opportunity cost of
potatoes is
a. 1/2 ton of wheat in the United States
and 2/3 ton of wheat in Ireland.
b. 2 tons of wheat in the United States and
1 1/2 tons of wheat in Ireland.
c. 16 tons of wheat in the United States
and 6 tons of wheat in Ireland.
d. none of the above.
D. U.S. 1 ton potatoes = 3 tons of wheat
Ireland 1 ton potatoes = 2 tons of wheat
70
8. If the countries In Exhibit 11 follow the
principle of comparative advantage, the
United States should
a. buy all of its potatoes from Ireland.
b. buy all of its wheat from Ireland.
c. buy all of its potatoes and wheat from
Ireland.
d. produce both potatoes and wheat and
not trade with Ireland.
A. The U.S. should specialize in the
production of wheat when it has a
comparative advantage (see question
6 for opportunity cost calculations).
71
9. A tariff increases the
a. quantity of imports.
b. ability of foreign goods to compete
with domestic goods.
c. prices of imports to domestic
buyers.
d. all of the above.
C. A tariff is a tax, also called
customs duties, on an import.
72
10. The infant industry argument for
protectionism is based on the view that
a. foreign buyers will absorb all of the
output of domestic producers in a new
industry.
b. the growth of an industry that is new to
a nation will be too rapid unless trade
restrictions are imposed.
c. firms in a newly developing domestic
industry will have difficulty growing if
they face strong competition from
established foreign firms.
d. none of the above.
C. It is difficult to make this argument because
there is an arbitrary line between an “infant”
and a “grown up” industry.
73
11. The figure that results when
merchandise imports are subtracted
from merchandise exports is
a. the capital account balance.
b. the balance of trade.
c. the current account balance.
d. always less than zero.
B. The capital account records payments
for financial capital, such as stocks and
bonds. The current account includes
trade in currently produced goods and
services.
74
12. Which of the following international
accounts records payments for exports
and imports of goods, military
transactions, foreign travel, investment
income, and foreign gifts?
a. The capital account.
b. The merchandise account.
c. The current account.
d. The official reserve account.
C. The capital account records payments for
financial capital, such as stocks and bonds.
The merchandise account is the value of a
nation’s merchandise imports subtracted
from its merchandise exports. There is no
official reserve account.
75
13. Which of the following international
accounts records the purchase and sale of
financial assets and real estate between
the United States and other nations?
a. The balance of trade account.
b. The current account.
c. The capital account.
d. The balance of payments account.
C. The balance of trade is the value of a nation’s
merchandise imports subtracted from its
merchandise exports. The current account
includes trade in currently produced goods
and services. Balance of payments in a
bookkeeping record of all international
transactions in a given period of time.
76
14. If a Japanese radio priced at 2,000
yen can be purchased for $10, the
exchange rate is
a. 200 yen per dollar.
b. 20 yen per dollar.
c. 20 dollars per yen.
d. none of the above.
A. X yen / dollar = 2,000 yen / 10
dollars = 200 yen / dollar.
77
15. The United States
a. was on a fixed exchange rate system
prior to late 1971, but now is on a
flexible exchange rate system.
b. has been on a fixed exchange rate
system since 1945.
c. has been on a flexible exchange rate
system since 1945.
d. was on a flexible exchange rate system
prior to late 1983, but now is on a fixed
exchange rate system.
A. For most years between World War II
and 1971, were based primarily on
78
gold.
16. Suppose the exchange rate changes so
that fewer Japanese yen are required to
buy a dollar. We would conclude that
a. the Japanese yen has depreciated in
value.
b. U.S. citizens will buy fewer Japanese
imports.
c. Japanese will demand fewer U.S.
exports.
d. none of the above.
B. When the dollar is weak or
depreciates, U.S. goods cost foreign
consumers less and they buy more
U.S. exports.
79
17. Which of the following would cause a
decrease in the demand for French francs
by those holding U.S. dollars?
a. Inflation in France, but not in the United
States.
b. Inflation in the United States, but not in
France.
c. An increase in the real rate of interest
on investments in France .
d. None of the above.
A. A rise in the French Franc relative
price level causes the dollar to
appreciate and demand for French
Francs decreases.
80
18. An increase in the equilibrium price of a
nation’s money could be caused by a (an)
a. decrease in the supply of the money.
b. decrease in the demand for money.
c. increase in the supply of the money.
d. increase in the quantity of the money
demanded.
A.
81
Price (yen per dollar)
Supply and Demand for Dollars
200
150
S of $ (U.S. citizens)
E
100
50
D for $ (Japanese citizens)
0
100 200 300 400 500
Quantity of dollars (millions per day)
82
19. If the dollar appreciates (becomes
stronger), this causes
a. the relative price of U.S. goods to
increase for foreigners.
b. the relative price of foreign goods to
decrease for Americans.
c. U.S. exports to fall and U.S. imports to
rise.
d. a balance of trade deficit for the U.S.
e. all of the above to occur
E.
83
20. Which of the following would cause the
U.S. dollar to depreciate against the
Japanese yen?
a. Greater popularity of U.S. exports in
Japan.
b. A higher price level in Japan.
c. Higher real interest rates in the U.S.
d. Higher incomes in the U.S.
D. As a result of higher income, U.S.
citizens buy more domestic products
and imports. The supply curve for
dollars shifts rightward and the
equilibrium exchange rate decreases.
84
END
85