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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).