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International Economics
International Trade and Exchange
Arguments for free trade
Countries benefit from trading for goods and
services they don’t have
Countries benefit by producing what they are
most efficient in producing (comparative
advantage)
US producers benefit from exporting items to
foreign countries
US consumers benefit from lower prices of
foreign products
Arguments for Trade
Restrictions
Increased imports hurts domestic industries
leading to domestic unemployment (e.g.
textiles)
Tariffs or quotas may be instituted to protect
workers in the home country
Tariffs or quotas may be used to protect
infant industries
Nations also want to maintain productive
diversity (eg. Steel for defense industries)
Some nations dump products or restrict US
imports
Trade Terms
Import quota - a limit on the amount
of a product that can be imported
Import tariff - a tax on a specified
product
Infant industries - those industries
just getting started
Open economy- an economy with
foreign trade
Balance of Trade Terms
A Nation’s balance of trade is its exports
minus its imports
A nation that exports more than it imports
has a trade surplus
A nation that imports more than it exports
runs a trade deficit
The US in 2010 had a trade deficit of
approximately 498 billion dollars
Possible Reasons for a
nation’s trade deficit
Exports may be of inferior quality
Country may not have many products to
export
A nation’s currency may be
overpriced,making imports cheap
A nation may have higher incomes than its
trading partners
Poorer nations can’t afford richer nation’s
products
More Balance of Payments
Terms
Balance of Payments an accounting of
funds that flow into and out of a country
comprised of capital account and current
account.
Current account - a portion payments
comprised of the trade balance of goods and
services
Capital account - a portion of the balance
payments comprised of foreign purchases of
US assets minus US purchases of foreign
assets, plus the change in official reserves
Current and Capital Account
Balances
The capital and current account must equal 0
. There is an identity between the current and
capital accounts. If we run a trade deficit, we
have a deficit in the current account, but a
corresponding surplus in the capital account.
Investments are part of capital accounts, but
income from investments are part of current
accounts
Exchange Rates
 Exchange rate the value of one nation’s currency in
terms of another’s
 Most countries have a floating exchange rate that
changes with the supply and demand of currency
 For example, if Europeans want more US products
they demand more dollars, leading to a rise in the
value of the dollar vis a vis the Euro. The dollar
appreciates
 Conversly, if the US demands more Yen to buy
Japanese products, the dollar falls in relation to the
Yen. The dollar depreciates.
Determinants in Exchange
Rates
Demand for a nation’s products
Relative prices of a nation
Relative incomes, wealth or poverty of a
nation
Speculation by currency brokers
Relative interest rates
Weak Dollar
Dollar is worth less relative to other
currencies
Benefits: expands US exports, helps
trade deficit, leads to growth in GDP
through NX
Problems: imports are more expensive,
inputs in production bought abroad are
more expensive, tough on US tourists
Strong dollar
US dollar worth more relative to other
currencies
Benefits: imports are cheaper, foreign
inputs in production are cheaper, good
for US tourists
Problems: hurts exports, makes trade
deficit worse, lowers GDP
Price Levels and Interest
Rates in NX
Higher price levels discourage foreigners from
buying US products --> NX falls
Lower price levels encourage foreigners to
buy US products --> NX rises
Higher interest rates encourage foreign
investors in US --> capital account increases -> NX falls
Lower interest rates discourage foreign
investors in the US --> captial account
decreases --> NX rises
First View Expansionary
Policy- interest rate focus
Expansionary Fiscal Policy
 Gov borrowing to increase AD --> crowding out -->
interest rate increases -->capital flows into US -->
dollar appreciates --> imports go up --> NX down
Expansionary Monetary Policy
 Fed increases Money Supply --> interest rates fall -->
Capital flows out of US -->dollar depreciates -->
exports go up --> NX up
Contractionary policies would be opposite for each. E.g.
Contractionary fiscal policy would raise NX
Contractionary monetary policy would lower NX
Second View
Price Level Focus
Expansionary policies lead to higher price
levels --> inflation means our products are
more expensive --> exports fall --> NX falls
Contractionary policies lead to lower price
levels --> falling prices --> exports increase -> NX rises
(suggestion: look to see if the question
focuses on interest rates or price levels to
determine which view to use on AP)
Which of the following is most likely to cause
an increase in the international value of the US
dollar?
1.
2.
3.
4.
5.
Higher US real interest rates
Lower US government expenditures
Higher real interest rates abroad
Expansionary monetary policy
Reduced inflation abroad
An increase in which of the following
would reduce the US balance of trade
deficit?
1. US rate of inflation compared to other
countries
2. The value of foreign currency relative
to the US dollar
3. US demand for foreign goods
4. The federal budget deficit
5. US interest rates compared to other
countries
Assume Canadian consumers increase their
demand for Mexican financial assets
 Supply of Canadian Dollars





1.
2..
3..
4..
5..
Increase
Increase
Decrease
Decrease
Not Change
Value of Peso Canadian Net Exports
Increase
Increase
Increase
Decrease
Increase
Increase
Decrease
Decrease
Increase
Decrease
Suppose the real interest rate in Canada
increases relative to that of Mexico
 Will this rise in interest rate initially affect Canada’s
current account or capital account?
 Design a correctly labeled graph of the foreign
exchange market for the Canadian dollar, show the
effect of the change in the real interest rate in
Canada on the international value of the Canadian
dollar (expressed as Mexican pesos per Canadian
dollar.
 How will the change in the international value of the
Canadian dollar that you identified affect Canadian
exports to Mexico?
 Will the Canadian GDP rise or fall? Explain.