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It is comparative
advantage that
matters, not
absolute advantage.
United States
Japan
“S&D” determine currency strengths.
Ricardo
“Loonie”
Exports equal 28% of global economic output, but
only 12% of U.S. output. [U.S. supplies 1/8 of world’s exports]
In 2005, American imports & exports totaled around $2.3 tril.
[$1.3 trillion in exports & $2.0 trillion in imports][Deficit $716 B]
Globalization: Merchandise Exports
as a Share of World GDP (28%)
05
Globalization increases U.S. income by $1 trillion a year,
or $10,000 per household. Or, without globalization,
Americans would be poorer by $1 trillion a year.
Principal U.S. Exports & Imports, 2002
Exports
Amount
Semiconductors
$42.3
Computers
38.6
Chemicals
49.8
Automobiles
20.5
Telecommunications
22.2
Consumer Durables
40.1
Generating Equipment 27.6
Aircraft
26.7
Grains
14.4
Nonferrous Metals
12.2
Imports
Amount
Semiconductors
37.6
Computers
75.3
Chemicals
33.1
Automobiles
114.1
Telecommunications 23.2
Clothing
64.3
Household Appliances 66.4
Consumer Electronics 32.2
Iron and Steel
17.7
Petroleum
103.6
The U.S. and World Trade
U.S. Exports & Imports of Goods, 2002
Value (Billions of Dollars)
Exports to:
Industrial Countries
Developing Countries
Total
.
Imports from:
$381
302
$683
Value (Billions of Dollars)
Industrial Countries
Developing Countries
Total
$594
573
$1,167
Most of our trade is with other industrial countries like ourselves.
244
287
[in 05]
200 211
180
180
170
160
160
140
140
120
120
100
120
[05]
85
80
100
IMPORTS
138
60
80
60
40
20
42
[in 05]
20
0
54
40
Canada Mexico China
0
Canada
55
Germany
Mexico
[05]
34
Japan Germany
China
39
UK
Japan
28
Korea
22
Taiwan
UK
44
Korea
35
Taiwan
34
France
EXPORTS
17
Singapore
17
Netherlands
22
France
Export Goods & Services make
up about 12% of American GDP
Exports have more than doubled
as a percent of GDP since 1975
$726 billion trade deficit in 2005
1. Revenue Tariffs – applied to products not produced domestically
[bananas, coffee]. These are normally low & their purpose is to provide
income for the government.
2. Protective Tariffs – tax on imports designed to protect domestic
producers from foreign competition [autos, shoes, textiles].
*We have tariffs on 8,753 products (70% of our imports). They add about
3% to prices. They cost consumers an extra $70 billion. [$1,000 per family]
Hong Kong
2.6%
2nd
1st
3rd
2.6%
Smoot-Hawley Tariff of 1930-so high it decreased imports
60% and hurt all international trade. International trade plummeted
62% from $60 billion in 1928 to $25 billion in 1938.
The next day the
stock market tanked
and the economy was
dead for 10 years.
Reed Smoot
Willis Hawley
Tariffs on over 12,000 products went up. Agricultural tariffs
went from 20% to 34%, clocks from 45% to 55%, woolen
products from 50% to 60%, wines, spirits, & beverages from
36% to 47%, corn and butter tariffs were doubled, over 800
production items were taxed. Domestic prices fell by over
25% while overseas prices rose 60%. By 1933, world trade
was about 1/3 of the 1929 level. All nations were losers. This
policy put the
“Great”
in the
Depression.
1. Reciprocal Trade Act – 1934-Roosevelt said to other countries,
“If you’ll lower your tariffs, we’ll reciprocate and lower
ours by the same percent.” [up to 50% of existing rates]
2. GATT[General Agreement on Tariffs & Trade] 1947–1995
- started with 23 nations and ended with 128 nations –
set the rules for world trade. GATT had no mechanism to
enforce their rules. Tariffs fell from 40% to 4%.
3. GATT was based on these three principles.
A. Equal, nondiscriminatory treatment for all member nations
B. The reduction of tariffs [Uruguay round will end in 2005]
C. The elimination of import quotas [Based on cooperation and
negotiation, or “I’ll lower mine if you will lower yours.”]
WTO
GATT protected intellectual property (patents,
trademarks, and copyrights). GATT in 1995 was
replaced by the World Trade Organization [WTO].
These agreements have already boosted the world’s
GDP by $6 trillion [8%]. [148 nations]
U.S. consumers will gain $30 billion annually.
WTO
We have trade restrictions on oranges from S. America, machine tools from Switzerland, TVs
from S. Korea, computer screens from Japan, and steel from nearly everywhere on earth. There
are also restrictions on watches, tobacco, ships, ice cream, cheese, clothing, sugar, & hundreds
of other products. Sugar quotas for 12,000 sugar growers cost consumers $3 billion per year
[cost twice the world price -22 cents per pound v. 10 cents per pound for the world price].
The annual cost of retaining just 1 job through trade restraints is $1 million in specialty
steel, $550,000 in nuts and screws, $240,000 in orange juice, and $200,000 in glassware.
In 1980, U.S. auto companies sold 1 million fewer cars than in 1979. The “Big 3” lost over
$4 billion. The “Big 3” demanded protection so they could retool for smaller cars. Japan agreed to
voluntarily freeze auto exports to 1.65 million from 1981-1983 & 1.85 million in 1984. With fewer
choices, domestic car prices rose $2,000 and Japanese car prices rose $2,500. We had a
smaller selection, had to wait longer and paid $15.7 billion extra.
148
WTO
WTO Objectives: [They have settled 200 disputes]
1. Accord national treatment to imported goods
[regulate “M” the same as domestic goods]
2. Accord “most favored nation status” to member
nations [charge all same tariffs & quotas]
3. Eliminate tariffs & non tariff barriers.
4. A government must find the best goods internationally.
Reductions in Tariffs Worldwide
WTO
New Rules to Promote Trade in Services
Reduction in Agricultural Subsidies
Intellectual Property Protections
Phasing Out Textile Quotas & Tariffs
Tariffs will be totally eliminated by 2008
WTO settled more disputes in 10 years than
GATT did in 50 years.
• This would include South, Central and North
America, from Anchorage to Patagonia, a
population of 800 million. This would be the
largest free-trade zone on the planet.
President Bush favors this. It includes 34
nations with a combined output of $13
trillion.
FTAA
Import Quotas – sets a maximum amount for
an import. They may be a more effective protective
device than tariffs which do not limit the amount
of goods entering a country.
The vote for CAFTA
was 217-215.
• CAFTA is a comprehensive trade agreement between the U.S.,
Costa Rica, the Dominican Republic, El Salvador,
Guatemala, Honduras, and Nicaragua.
• It will eliminate the tariffs on $33 billion worth of currently traded
goods to 44 million customers. CAFTA is considered to be a
stepping stone to the FTAA which would include 34 countries.
Non-tariff Barriers –licensing requirements, re-inspections,
unreasonable standards pertaining
unnecessary bureaucratic red tape
The Japanese conduct stringent
that cost the Japanese consumer
33%
22%
to quality
and safety, or
in customs procedures.
re-inspections of our autos
an extra $500.00.
31%
86%
23%
25%
Started with
these 15
15 initial mbrs
Joined by
these 10
in 2004
[U.S.,
GDP
Canada,
U.S.
Canada
$12 tril.
$1 Trillion
& Mexico
Mexico
]
$1 Trillion
[40% live on less than $2 day]
Population 297 mil.
30 million
106 million [50% in poverty]
[Only 28% grad. high school]
Per Capita $40,000
$30,000
$9,000 [ave. ed. Level is 6
Ave. Hourly $16.00
$17.00
$2.00
th
grade]
[.60 min. wage]
NAFTA is a $14 trillion market [1,000 page docu]
gamble for 421 million consumers.
NAFTA will roll back 20,000 separate tariffs over 15 yrs.
Before NAFTA, those barriers averaged 11% in Mexico,
5% in Canada, & 4% in the U.S.
American consumers will save $20 billion per year
when all trade barriers are removed.
Mexico buys 70% of its imports from Texas.
Texas’ exports to Mexico have increased from
$19 billion in 1994 to over $52 billion in 2005.
Mexico’s imports of U.S. goods have gone from
$51 billion to $120 billion, supporting over
1 million jobs in the U.S. Imports from Mexico
have more than tripled to $170 billion..
NAFTA encourages more world-wide investment
in Mexico. This is enhancing their productivity and
income. Some of this increased income is being used
used to buy U.S. exports. A higher standard of
living in Mexico will help stem the flow of illegal
immigrants to the U.S.
1. Most of our merchandise trade is with other industrially
advanced (capitalist/communist) nations.
2. Quantitatively, our most important trade partner is
(Japan/Mexico/Canada/Germany/Djibouti).
3. American exports of goods/services average about (30%/25%/12%/4%) of GDP.
4. According to the theory of comparative advantage, a good should
be produced in that nation where its cost is (most/least) in terms
of alternative goods which might otherwise be produced.
5. The ratio at which nations will exchange two goods is the
(domestic comparative [opportunity] cost/terms of trade).
6. A (quota/tariff) is an excise tax on imported goods.
7. If the U.S. eliminates tariffs on Cuban rollerblades, we would expect the price
of Cuban rollerblades to (increase/decrease) in the U.S. Also employment
would (increase/decrease) in the Cuban rollerblade industry.
8. The Smoot-Hawley Tariff of 1930 established very (low/high)
tariffs on goods imported to the U.S.
9. GATT included over 100 nations and emphasized tariff (reductions/increases)
for members, and (increasing/decreasing) import quotas.
10. The Reciprocal Trade Agreements Act of 1934 brought about
considerable (increases/reductions) in American trade barriers.
11. The European Union (abolished/increased) tariffs among one another
and established a system of common tariffs with non-member nations.
12. NAFTA included the U.S., Mexico, and (Japan/Canada/Djibouti).
13. Proponents of NAFTA contend it will (incr/decr) the flow of illegal immigrants
(incr/decr) U.S. exports by raising productivity & income in Mexico, and enable
the U.S. to obtain (more/less) total output from its scarce resources.
[“S&D” determine currency strengths]
[What if the U.S. wants more Japanese cars?]
United States
Japan
[“S&D” determine currency strengths]
[What if the Germans want more American cars?]
United States
Germany
Foreign Currency per U.S. Dollar
$1 will buy
EXCHANGE RATES:
47.68 Indian rupee
.63 British pounds
1.48 Canadian dollars
10.91 Mexican pesos
1.36 Swiss francs
.93 European euros
119 Japanese yen
1,237 South Korean won
8.54 Swedish krona
Or
DEPRECIATION
Euro Price of $
APPRECIATION
[Euros looking for $’s]
150
Dollar Price of Euro
D
A
100
50
Let’s say that Europeans decide to
buy more American cars. [Taste]
D1
s
D1
[Dollars looking for Euros]
E1
D2
Europeans decide to buy
fewer American cars.
E3
D3
D # of Dollars A
[Dollars looking for Euros]
S
[Euros looking for Dollars]
$1.50
$1.00
$ .50
D # of Euros A
Increase in U.S. Growth Rate (Y)
[We buy more from Japan appreciating
the yen and depreciating the dollar]
D1
Price of
$1.50
$1.00
D2
S
D
“Booming” Economy
AS
AD2
AD1
YR
Y*
Quantity of
A
“We want more
Japanese cars,
computers, DVD
Players, digital
cameras, and
camcorders.”
Decrease in U.S. Growth Rate (Y)
Recessionary Economy
AS [We buy less from Japan
AD1
AD2
depreciating the yen and
PL
appreciating the dollar]
YR Y*
Price of
$1.00
$.50
D1
A
D2
D
Quantity of
S
“Five million of us
have lost our jobs.
We can’t buy as many
American or
Japanese products.”
1. Increase in taste
[more demand for a country’s products or assets]
2. Increase in interest rates
[Overseas investors increase their investments there.]
3. Decrease in price level
[overseas buyers want to buy our cheaper goods.]
4. Decrease in growth rate
[A country’s declining economy results
in them buying less from other countries;
decreasing demand for their currency
and thus appreciating the declining
economy’s currency]
5. Decrease in the price of a currency
relative to the other
Higher I. R.’s or Lower PL Appreciate the
S2 S1
D1 D2
200
Price of the
Yen depreciates as
it takes more Yen
to buy a dollar.
Yen depreciates even
more as it takes even
more to buy a dollar.
150
100
D
D
50
0
Quantity of Dollars
U.S
Price level
Decreases
or U.S.
Interest rates
Increase
Japanese buy
more U.S. X
U.S. citizens buy
fewer Japanese
M
A
Increase in the
demand for ’s
Decrease in the
supply of
’s for
Appreciates
Double Shifts: Although there are double shifts in some situations,
it doesn’t change the appreciation/depreciation answers. So – let’s just
concentrate on the demand curve for each situation.
Therefore, it takes fewer
pennies, so the dollar is
stronger [$ price decreases]
Therefore, it takes more
pennies, so the dollar is
weaker. [$ price increases]
A few notes re: answering FX FRQs:
• When answering an FX FRQ, students can choose to graph and
show either FX changes in either demand or supply, and do not need
to draw both a simultaneous change in demand and supply. Often
the FRQ will require the student to show the impact specifically to
either demand or supply, so they would change the graph
accordingly.
• Let's take an example: Let's say the FRQ states that inflation is rising
faster in the U.S. relative to Europe, and the FRQ requires one to
draw an FX graph showing the FX effect on the Euro. The student
should show the Euro graph as affecting only demand or supply, but
not both, to keep it simple. For example, the student could show an
increase in demand for the Euro (appreciation of Euro as Americans
are drawn to less expensive European goods) OR a decrease in
supply of the Euro (appreciation of Euro as Europeans import less of
higher priced (inflated) American goods).
• Bottom line: any time one currency's demand shifts, the other
currency's supply graph shifts IN THE SAME DIRECTION.
Teaching them this will help control a successful outcome by
ensuring they understand the logic of how currency's relate to one
another.
A few notes re: answering FX FRQs
cont’d:
****Note: imported resource costs, used
extensively in domestic production (using the
example of an appreciating dollar), would
become relatively less expensive due to a
stronger dollar, thus lowering U.S. production
costs and increasing U.S. supplier
profitability.......giving U.S. producers
(suppliers) an economic incentive to produce
more (ie, AS shifts right).
– The exact opposite would occur if the dollar
depreciates....AS shifts left reducing AS and
increasing product prices.
Appreciation/Depreciation
Prax Q’s
14. If the dollar depreciates relative to the peso, the
peso will (appreciate/depreciate) relative to the dollar.
15. Appreciation of the dollar will tend to (increase/decrease)
American imports & (increase/decrease) American exports.
16. The yen price of the dollar has decreased from
150=$1 to
100=$1, which means the dollar
(apprec/deprec), which (incr/decr) our imports from Japan.
17. Depreciation of the euro will (increase/decrease)
European exports & (increase/decrease) their imports.
18. If Mexico decides to increase their investments
in the U.S., the peso will (appreciate/depreciate) which
would (increase/decrease) [Mexico’s imports]
U.S. exports to Mexico.
19. If the exchange rate changes so that more Japanese
yen are required to buy a dollar then the yen will
(appreciate/depreciate) and Americans will
purchase (more/less) Japanese goods.
20. If Americans increase their investments in Europe, then the supply of
dollars in European banks will (incr/decr) & the dollar will (apprec/deprec).
21. If Europeans quadrupled their investments in the U.S. stock market, the
supply of euros in U.S. banks would (incr/decr) & the dollar would (appr/depr).
22. Under a system of freely floating exchange rates, an increase in the international value of a nation’s currency will cause its (exports/imports) to increase.
23. If the exchange rate changes so that fewer dollars are required to buy a yen,
the dollar will (appr/depr) & (fewer/more) U.S. goods will be exported to Japan.
24. If the dollar price of yen increases, then the dollar (appreciates/depreciates)
relative to the yen and our exports to Japan (increase/decrease).
25. If Mexico’s price level is increasing faster than that of the U.S., the peso
will (appr/depr) and their exports to the U.S.[our imports] will (incr/decr).
26. If German’s growth rate[income] is increasing faster than that of Mexico,
the euro will (apprec/deprec) & Germany’s exports to Mexico will (incr/decr).
27. If interest rates are decreasing faster in Italy relative to Mexico, the euro
will (appreciate/depreciate) and Italy’s exports to Mexico will (incr/decr).
28. If the dollar price of the yen decreases, the dollar (appreciates/depreciates)
relative to the yen and American exports to Japan (increase/decrease).
29. If the dollar price of the euro decreases, our imports from Europe (incr/decr).
30. If the exchange rate changes from $1=Y200 to $1=Y100, we can say the
dollar has (apprec/deprec) in value & Japan’s exports to the U.S. (incr/decr).
31. Depreciation of the euro relative to the U.S. dollar would make a trip by
an American to Europe (more/less) expensive.
32. Suppose that yesterday $1 would buy 800 South Korean won, but today
will buy 810 won. We can conclude that the won has (depr/apprec) in value.
2002 AP Essay on Higher Interest Rates in the U.S.
in
2002 Essay
$ Price of Y
The real interest rates in the U.S. and Japan are equal to 7% [say 20-13=7%].
The real interest rate in the U.S. increases to 8% while the real interest rate in
Japan decreases to 6%.
a. How & why will capital flows be affected
by this change in real interest rates?
[financial capital, not real capital]
D1
S
b. Using a correctly labeled graph for the yen
D2
market, show and explain how the value of
$1.35
E1
the yen will change relative to the value of
A
$1.20
the dollar.
E2
c. Explain how the change in the value of the
yen will affect each of the following in the U.S.
(D) # of Yen
(1.) Imports from Japan
(2.) Exports to Japan
Yen Price of Dollar
1. Assume that the U.S. trades with Japan. Draw a correctly labeled graph
of the foreign exchange market for the U.S. dollar. Let’s say that
United States output [GDP] decreases, show and explain how the supply
of the U.S. dollar will be affected in the foreign exchange market.
S2$
D$
S1 $
Y110
Y100
E2
E1
Answer 1: The decrease in
real U.S. output will cause
job losses in the U.S. and
decrease the dollars supplied
for Japanese goods.
Quantity of Dollars
2. Given your answer in 1, indicate what will happen to the
value of the U.S. dollar relative to the Japanese yen.
Answer 2: Due to the decrease in supply of U.S. dollars
[as shown above], it will take more yen to purchase a dollar,
depreciating the yen and therefore appreciating the dollar.
Appreciation/Depreciation Practice
1. If Japan buys 10 million iPod Nanos
the dollar would (appr/depr) and our
imports from Japan would (incr/decr).
2. If U.S. in. rates are increasing faster
than Japan’s, the dollar would (appr/depr)
and our exports would (increase/decrease).
3. If prices are dropping more in Japan
than in the U.S., the yen will (appr/depr)
and Japan’s imports will (increase/decrease).
4. If the U.S. growth rate is faster than that of Japan,
the dollar will (appreciate/depreciate) and U.S.
imports from Japan will (increase/decrease).
5. If the dollar price of the yen decreases, the
dollar has (appreciated/depreciated) and our
imports from Japan will (increase/decrease).
Appreciation/Depreciation Practice
[continued]
6. If Russia sells 10 bil. worth of oil to the
U.S. the ruble would (appr/depr) and their
imports from the U.S. would (incr/decr).
7. If U.S. in. rates are decreasing faster here
than in Canada, the dollar would (appreciate/
depreciate) & U.S. exports would (incr/decr).
8. If prices are increasing more in Japan
than in the U.S., the dollar will (appr/depr)
and our exports will (increase/decrease).
9. If the U.S. growth rate is slower than that of Canada,
the Canadian dollar will (appreciate/depreciate) & Canada’s
exports to the U.S. will (increase/decrease).
10. If the dollar price of the euro increases, the
dollar has (appreciated/depreciated) and our our
imports from France will (increase/decrease).
1. If more Thai bahts are required to buy a dollar,
then the baht has (appreciated/depreciated), &
Thai exports to the U.S. should (increase/decrease).
2. If Latvia’s demand for U.S. Fuzzy Wuzzies decrease,
then Latvia’s Lat will (apprec/deprec) & Latvia’s
imports from the U.S. will (increase/decrease).
3. If interest rates are decreasing faster in S.Korea[4%]
than in Cuba[8%], then the Korean won will (appr/depr)
& Korea’s exports to Cuba will (increase/decrease).
4. If Malaysia’s price level is decreasing faster than that of Brazil,
the Malaysian ringgit will (apprec/deprec) & Malaysia’s exports
to Brazil will (increase/decrease).
5. If growth rate is less rapid in Djibouti than in Swaiziland,
then the Djibouti bouti will (appreciate/depreciate) and
Djibouti’s exports will (increase/decrease).
6. If the Euro price of the S. Korean won decreases, the Euro has
(apprec/deprec) & European exports to Korea will (incr/decr).
7. If interest rates are increasing faster in Zambia than in Spain,
the Zambian Kwachi will (appreciate /depreciate) and Zambia’s
imports from Spain will (increase/decrease).
1. If Korea buys 2 million fewer American autos
the dollar would (appreciate/depreciate) & our
exports to Korea would (increase/decrease).
2. If U.S. interest rates decrease faster than
Haiti’s, the dollar would (appreciate/depreciate) &
our imports would (increase/decrease).
3. If prices are dropping more in Mexico than
in the U.S., the peso will (appreciate/depreciate)
and Mexico’s exports will (increase/decrease).
4. If the U.S. growth rate is faster than that of China,
the dollar will (appreciate/depreciate) and U.S.
exports to China will (increase/decrease).
5. If the dollar price of the renminbi increases, the
dollar has (appreciated/depreciated) and our imports
from China will (increase/decrease).
6. If Zimbabwe wants to buy 3 million American Fuzzy Wuzzys,
the dollar (appreciates/depreciates) and our imports from
Zimbabwe should (increase/decrease).
7. If the bouti price of the dollar increases the bouti will
(appreciate/depreciate) and their exports will (increase/decrease).
1.
If Djibouti buys 4 mil. more U.S. Fuzzy Wuzzies
the dollar would (appreciate/depreciate) & our
exports to Djibouti would (increase/decrease).
2. If U.S. interest rates are increasing faster
than Cuba’s, the dollar would (appr/depr) &
our imports from Cuba would (incr/decr).
3. If prices are increasing more in Canada than
in the U.S., the Canadian loonie will (appr/depr)
and Canada’s exports will (increase/decrease).
4. If the U.S. growth rate is slower than that of China,
the dollar will (appreciate/depreciate) and U.S.
exports to China will (increase/decrease).
5. If the dollar price of the renminbi decreases, the
dollar has (appreciated/depreciated) and our
imports from China will (increase/decrease).
6. If the Congo wants to buy 2 million American Piggy Wiggies,
the dollar (appreciates/depreciates) and our imports from
the Congo should (increase/decrease).
7. If the euro price of the dollar decreases the euro will
(appreciate/depreciate) and their exports will (increase/decrease).