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Mr. Marinello * Chippewa Valley Theory of Comparative Advantage: ▪ Developed by David Ricardo- He stated that a trading nation should produce a certain product if it can do so at an opportunity cost lower than that of another trading nation. The old view of international trade was absolute advantage: the ability of one trading nation to make a product more efficiently than another trading nation. ▪ If Portugal could make grape juice more efficiently than England, and if England could make cloth more efficiently than Portugal, then trade would be beneficial to both. ▪ Ricardo challenged this view-what if Portugal made both products more efficiently than England? Would trade still be beneficial? He said yes- all based on opportunity cost. Portugal England Grape Juice 2 hours/jug 4 hours/jug Cloth 6 hours/yard 8 hours/yard ▪ For Portugal, every yard of cloth costs 3 jugs of grape juice in lost opportunity. ▪ In England, every yard of cloth costs only 2 jugs of grape juice. ▪ Portugal would be wise to buy cloth from England and to specialize in grape juice. Absolute advantage: the ability of a country to produce more of a good or service than competitors, using the same amount of resources. Comparative advantage: the ability of a country to produce a particular good or service at a lower marginal and opportunity cost over another Since the 1930s, nations have sought to expand trade and reduce or eliminate trade barriers. Organized themselves into groups. European Union ▪ 20% of global trade exports & imports—world’s biggest trader. ▪ Established monetary union- all use the Euro. ▪ Removed barriers to free trade among member nations. ▪ Ultimate goal is to have European borders as free and open as US state borders. NAFTA- North American Free Trade Agreement ▪ 1990- free trade between US, Mexico & Canada ▪ In 1994 it eliminated tariffs in half of the goods exported to Mexico from the US. WTO- World Trade Organization ▪ In 1944 Allied Nations met to make plans after WWII. They produced GATT- General Agreement on Tariffs & Trade- which laid out rules and policies for international trade. Developed into WTO- now has 150 nations ▪ Purposes of WTO: ▪ Negotiating & administering trade agreements ▪ Resolving trade disputes ▪ Monitoring trade policies of member nations ▪ Providing support to developing countries. Any law passed to limit free trade among nations. 5 types: Almost all nations pass some sort of laws that limit trade. ▪ Lead to higher prices on restricted items ▪ Economic retaliation by other nations ▪ Basically political in nature Quotas: limits on the amount of a product that can be imported. ▪ The US has a quota on the amount of textiles that are allowed to be imported. They limit supply and keep textile prices relatively high Tariffs: a fee charged for goods brought into a country from another country. 2 types: ▪ Revenue tariffs: taxes on imports specifically to raise moneyrarely used. ▪ Protective tariff: a tax on imported goods to protect domestic goods. ▪ Raise prices on goods produced more inexpensively elsewhere, which minimizes the price advantage the imports have over domestic goods. Voluntary Export Restraint: ▪ a country’s self-imposed restriction on exports. Embargoes: ▪ a law that cuts off trade with a specific country. Used often for political purposes. US & Cuba. Informal Trade Barriers: ▪ indirect—licenses, environmental regulations and health and safety measures. Impact of Trade Barriers Higher Prices & Trade Wars Arguments for Protectionism Protecting Domestic Jobs Protecting infant or start up industries Protecting national security Foreign Exchange Foreign exchange market: where currencies of different countries are bought and sold. The exchange rate is the price of currency in the currencies of other nations. Flexible rate of exchange: a system in which the exchange rate for currency changes as supply & demand for the currency changes. The Fed keeps track of the international value of the dollar. They determine if the dollar is strong or weak as measured against another currency.