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Introduction to Economics International Trade and Finance The US Economy Llad Phillips 1 Last Time: Monopoly Power Rips off Consumers Rips off Society Rips off Democracy Llad Phillips 2 Trade and California Llad Phillips 3 Los Angeles Times Thursday, November 15, 2001 Llad Phillips 4 Los Angeles Times Monday, November 19, 2001 Llad Phillips 5 Los Angeles Times Monday, November 19, 2001 Llad Phillips 6 Los Angeles Times Monday, November 19, 2001 Llad Phillips 7 Outline: Lecture Fifteen-Trade News: the Price of Oil The Western Movement: Manifest Destiny Autarchy self-sufficiency The Advantages of Exchange specialization The Political Economy of Trade Arguments for Free Trade Arguments Against Free Trade Llad Phillips 8 Price of Oil: Before and After 9-11 Demand Before 9-11 Price per Barrel Supply Barrels of Oil Llad Phillips 9 Los Angeles Times Monday, November 19, 2001 Llad Phillips 10 OPEC Cartel Policy: Control Supply Demand Before 9-11 Price per Barrel OPEC Supply Barrels of Oil Llad Phillips 11 How to Fight a Foreign Cartel Do Nothing: Hope the Cartel Breaks Down Impose an Excise Tax Llad Phillips 12 Paying at the Gas Pump Country Britain France Germany Netherlands Belgium Italy USA Price $4.35 $3.50 $3.37 $3.82 $3.43 $3.58 $1.71 %Tax 76.3 68.3 67.5 65.1 65.0 63.4 22.4 The New York Times, Thursday Oct 19, 2001 Llad Phillips 13 Demand and Supply Price Supply a Demand Quantity Llad Phillips 14 Excise Tax Supply: Price Includes Tax Tax Per Gallon Price Supply: Price Net of Tax a Demand Quantity Llad Phillips 15 Excise Tax Tax Per Gallon Price b Supply a Demand Quantity Llad Phillips 16 Excise Tax Restricts Quantity Demanded Raises price Llad Phillips 17 Profits Before Excise Tax: Revenue Equals Price*Quantity Price Supply a P Revenue Demand Q Llad Phillips Quantity 18 Cost Equals Area Under Supply Curve Price Supply a Cost Demand Quantity Llad Phillips 19 Profit Equals Revenue Minus Cost Price Supply a Profit Demand Quantity Llad Phillips 20 Profit Equals Revenue Minus Cost Price Supply a P Profit Demand Cost Q Llad Phillips Quantity 21 Excise Tax Equals Tax/Gallon*Quantity Tax Per Gallon Price b Supply a Tax Demand Q Llad Phillips Quantity 22 Excise Tax Tax Per Gallon Price b Supply a Tax Profit Demand Q Llad Phillips Quantity 23 Excise Tax Redistributes Profits from Foreign Suppliers to Home Country Tax Per Gallon Price b Supply a Tax Profit Demand Q Llad Phillips Quantity 24 Tax Policy As A Weapon Excise Tax Can Restrict Quantity Demanded Excise Tax Can Shift Profits from Foreign Suppliers to Home Country Excise Tax Can Be A Foreign Policy Weapon Llad Phillips 25 Autarchy Self-Sufficient Economy only trade within a region Sioux, Pawnees etc. were self-sufficient hunted and gathered their food roamed the land and moved their homes made their clothes early settlers were self-sufficient: home production grew their food cleared the land and built their homes made their clothes Llad Phillips 26 Trade Concepts Trade allows countries (and individuals) to specialize at what they do best rather than being jacks-of-all-trades. By specializing and becoming expert countries (and individuals) increase productivity and output. Llad Phillips 27 Autarchy-continued West of the Alleghanies opened Llad Phillips up to trade by Erie canal 28 Erie Canal Completed in 1825 Llad Phillips 29 Llad Phillips 30 Llad Phillips 31 Production Functions, Labor Constraints and the Production Possibility Frontier: Land is a Fixed Factor; Diminishing Returns Agriculture Production Function with diminishing returns Production Possibility Frontier relative price of agricultural goods to manufactured goods depends on demand as well as supply Labor for Agriculture Manufactures Labor Constraint 450 Production Function with diminishing returns Labor for Manufactures Llad Phillips Source: Lecture Thirteen 32 Isolated West Production Possibility Frontier, PPF Agriculture Regional Tastes: manufactures are scarce and hard to make, i.e. valuable Manufactures Llad Phillips 33 The Slope of the Production Possibility Frontier Recall: the slope of the production possibility frontier reveals relative values rate of exchange: 2 beaver pelts for every mink pelt if beaver pelts sell for 1 dollar, then mink pelts are worth 2 dollars Llad Phillips 34 Production Functions, Labor Constraints and the Production Possibility Frontier: No Fixed Factor Beavers Production Function Production Possibility Frontier One mink is worth, or trades for, two beavers: prices are determined by labor inputs 2 1 Beaver Days 6 3 Labor Constraint Llad Phillips Minks 1 450 2 3 6 Mink Days source: Lecture Thirteen Production Function 35 Beavers 2 slope: B/ M = 2 = PM/PB = MCM/MCB 1 1 Llad Phillips Minks 36 Isolated West Production Possibility Frontier, PPF Agriculture Regional Tastes: manufactures are scarce and hard to make, i.e. valuable QAg QMf Manufactures steep slope, Ag/ Mf = PMf/PAg , so manufactures are dear Llad Phillips 37 Trade for a Small Region The West takes Eastern trade prices as given after canals open up transportation and goods are exchanged In the East, manufactures are more plentiful and agricultural goods are scarcer Ag/ Mf = PMf/PAg , is less steep, i.e in the East, manufactures are less expensive relative to agricultural goods the East has a comparative advantage in manufactures and the West has a comparative advantage in agriculture Llad Phillips 38 West Trades with the East Production Possibility Frontier, PPF Agriculture Eastern Prices: Ag/ Mf = PMf/PAg Regional Tastes: Manufactures steep slope, Ag/ Mf = PMf/PAg , so manufactures are dear Llad Phillips 39 Trade Allows the West to Specialize in Agriculture Production Possibility Frontier, PPF Eastern Prices: Ag/ Mf = PMf/PAg Agriculture Specialize in Ag at B Regional Tastes: B A Manufactures steep slope, ∆Ag/∆Mf = PMf/PAg , so manufactures are dear Llad Phillips 40 Trade Permits the Decoupling of Consumption from Production In the self-sufficient West, people had to produce what they consumed. When trade opened up with the East, the West could specialize in producing agricultural goods and import, i.e. trade for manufactures Llad Phillips 41 Trade Allows the West to Decouple Production & Consumption Production Possibility Frontier, PPF Eastern Prices: Ag/ Mf = PMf/PAg Agriculture QAg Exports Regional Tastes: B C CAg A Imports QMf Llad Phillips CMf Manufactures 42 The Political Economy of Trade Arguments for Free Trade Arguments Against Free Trade Llad Phillips 43 International Trade: Pro & Con Pro Con Can’t compete with low wages abroad jobs are lost abroad need to protect infant industries need to protect strategic industries excessive specialization unfair competition Llad Phillips Consumers gain from more goods competition keeps industry progressive 44 Summary-Vocabulary-Concepts autarchy/self-sufficiency production possibility frontier exchange of goods comparative advantage specialization export import Llad Phillips Comparative sdvantage 45 Outline: Lecture Fifteen Trade, domestic and foreign Balance of Payments Accounting Purchasing Power Parity Central Bank Reserves & Foreign Exchange Intervention Llad Phillips 46 Balance of Payments Concepts Balance of Merchandise Trade Value of what we sell minus what we buy Balance of Trade (Goods & Services) Balance on Current Account net of transfer payments net of income on investments If we buy more than we sell on current account, then we pay for it with the capital account On capital account we sell IOU’s, I.e bonds Llad Phillips 47 Balance of Payment Accounts We are called a debtor nation if we are selling IOU’s to pay for goods and services As a debtor nation, we are vulnerable to foreigners selling their US assets and repatriating their money, called capital flight Llad Phillips 48 Exports of Goods and Services as Fraction of GDP, 1929-1995 . 0.12 Exports as % of GNP 0.1 Linear (Exports as % of GNP) 0.06 0.04 0.02 1993 1989 1985 1981 1977 1973 1969 1965 1961 1957 1953 1949 1945 1941 1937 1933 0 1929 Fraction 0.08 Year Llad Phillips 49 Growth in World Trade Source: Economic Report of the President, 1997 http://www.gpo.ucop.edu/catalog/erp97.html Llad Phillips 50 Http://www.yardeni.com Llad Phillips 51 Measuring the Balance of Trade Merchandise Balance of Trade: goods Balance of Trade ( Net Exports) : add services Balance on Current Account: first: add net transfer payments second: add income from US assets abroad Llad Phillips 52 Balance of Payments Merchandise Exports Trade Balance of Goods capital goods, except automotive: 41% industrial supplies and materials: 24% consumer goods, except automotive: 11% automotive vehicles, engines & parts: 11% foods, feeds, beverages: 9% Llad Phillips 53 Balance of Payments (Cont.) Imports of Goods capital goods, except automotive: 29% industrial supplies and materials: 25% consumer goods, except automotive: 21% automotive vehicles, engines & parts: 16% foods, feeds, beverages: 4% Llad Phillips 54 Source:CIA CIA Source: Llad Phillips 55 Balance on Goods: Merchandise T rade Balance, US 1996 . 900000 800000 700000 Millions $ 600000 500000 400000 300000 200000 100000 0 Exports Source: Llad PhillipsUS Imports Dept. of Commerce, Survey of Current Business 56 Balance on Merchandise, US , 1946-1996, Millions $ . 900000 800000 700000 Exports, $M Imports Merchandise Net 600000 400000 300000 200000 100000 94 91 88 85 82 79 76 73 70 67 64 61 58 55 52 -100000 49 0 46 Millions $ 500000 -200000 Year Source: Llad Phillips Economic Report of the President, 1997 57 Balance of Payments Merchandise Trade Balance Balance of Trade: Net Exports(component of GNP) Exports of Goods and Services other private services: 31% travel: 30% royalties and license fees: 13% Imports of Goods and Services travel: 31% other private services: 27% other transportation: 18% Llad Phillips 58 Balance of T rade: Goods and Services, US, 1996 . 1000000 900000 Services Goods 800000 700000 Millions $ 600000 500000 400000 300000 200000 100000 0 Exports Llad Phillips Imports 59 Balance of T rade: Goods and Services, US, Millions $ . 100000 50000 Millions $ -50000 94 91 88 85 82 79 76 73 70 67 64 61 58 55 52 49 46 0 Merchandise Net Services Net Balance of Trade -100000 -150000 -200000 Year Llad Phillips 60 Balance of Payments Merchandise Trade Balance: Goods Balance of Trade: Goods & Services Balance on Current Account Exports of goods & services plus net transfer payments plus US income on assets abroad Imports of goods & services plus net transfer payments plus foreign income on assets in US transfers • US Government grants • US Government pensions & other • private remittances Llad Phillips 61 Balance on Current Account, US, 1996, (Except Asset Income) . 1000000 900000 800000 700000 Millions of $ transfers, net 600000 Services Goods 500000 400000 300000 200000 100000 0 Exports Llad Phillips Imports 62 US Balance of Trade and Net T ransfers . 20000 94 91 88 85 82 79 76 73 70 67 64 61 58 55 52 49 46 0 -20000 Millions $ -40000 -60000 -80000 -100000 Balance of Trade transfers, net -120000 -140000 -160000 Year Llad Phillips 63 Balance of Payments Merchandise Trade Balance: Goods Balance of Trade: Goods & Services Balance on Current Account Exports of goods & services plus net transfer payments plus US income on assets abroad US income on assets abroad • direct investment receipts • other private receipts • US government receipts Imports of goods & services plus net transfer payments plus foreign income on assets in US transfers payments to foreign assets in the US Llad Phillips 64 US Balance on Current Account, 1996, Millions $ . 1400000 1200000 Millions $ 1000000 Investment income transfers, net Services Goods 800000 600000 400000 200000 0 Exports Llad Phillips Imports 65 Receipts and Payments on Assets . 250000 Receipts, US Assets Abroad 200000 Payments on Foreign Assets in US Money income, net 100000 50000 94 91 88 85 82 79 76 73 70 67 64 61 58 55 52 49 0 46 Millions $ 150000 -50000 Year Llad Phillips 66 US Balance on Current Account: Merchandise & T rade . 50000 Debtor Nation Creditor Nation Millions $ -50000 94 91 88 85 82 79 76 73 70 67 64 61 58 55 52 49 46 0 Merchandise Net Balance of Trade -100000 Balance on Current Account -150000 -200000 Year Llad Phillips 67 How Do We Pay Balance on Current Account? We Sell Bonds to Foreign Investors Capital Account, 1996 Foreign Assets in the US, net change (Capital Inflow) foreign official assets in the US, net: $ 122354 M other foreign assets in the US, net: $ 425201 M US Assets Abroad, net change (Capital Outflow) US official reserves, net $ -6668 M other US Government Assets, net $ -690 M US private assets, net: $ 358422 M Llad Phillips 68 Relation Between Capital Account and Current Account Capital Inflow: receipts from sale of US bonds & assets Interest Payments on Foreign Assets Interest Rate Stock of Foreign Assets in US Components of Current Account + Interest Receipts on US Assets Interest Rate StockofofUS Stock US Assets Assets Abroad Abroad capital account component Capital Outflow: payments for foreign bonds & assets 69 Llad Phillips US Balance of Payments, 1996 . 1800000 1600000 1400000 capital account Investment income transfers, net Services Goods Millions $ 1200000 1000000 800000 600000 400000 200000 0 Exports Llad Phillips Imports 70 US: Capital Inflow and Capital Outflow, 1960-1996 . 600000 Creditor Nation 500000 Debtor Nation Capital Inflow Capital Outflow 300000 200000 100000 Year Llad Phillips 71 96 94 92 90 88 86 84 82 80 78 76 74 72 70 68 66 64 62 0 60 Millions $ 400000 Purchasing Power Parity Concept In the long run, the exchange rate should reflect purchasing power as measured by relative prices (relative price indices) in the two countries Llad Phillips 72 Puchasing Power Parity Exchange Rate Ought to Reflect Puchasing Power a bundle of goods that costs $1000 dollars in the US should be purchasable for $1000 dollars in Japan food, clothing, shelter, etc. Exchange Rate:123.30 yen to the dollar $1000 =123,300 yen so 119,600 yen should buy in Japan what $1000 buys in US Price of the dollar is 123.3 yen Llad Phillips 73 Market for Foreign Exchange in Japan Price of $ Demand for $ Supply of $ 123.3 yen Quantity of $ Llad Phillips 74 Purchasing Power Parity real exchange rate equals nominal exchange rate divided by relative prices for a bundle of goods real x-ch rate = 123.3 yen per $ ÷(CPIJapan/CPIUS) For Example, if there is inflation in Mexico, then the number of pesos to buy a $ should increase real x-ch rate = 9.1575 pesos per $ ÷(CPIMex/CPIUS) Llad Phillips 75 Source: Yardeni Llad Phillips 76 Exchange Rate for Mexico: New Pesos per US $ . 10 96 95 94 93 92 91 90 89 88 87 86 85 84 83 82 81 80 Exchange Rate 1 0.1 0.01 Year Source: International Monetary Fund, International Financial Statistics Yearbook, Llad Phillips 77 1996 Source: OECD Llad Phillips 78 Link Between Government Deficits and Trade Deficits Llad Phillips 79 US Govt. runs a deficit citizens don’t want higher taxes US Treasury finances deficit by selling treasuries US citizens & institutions buy in primary market foreign citizens & institutions buy in primary market Why do foreigners invest in US? politically stable country may be attracted by: low US inflation rate high US interest rate Llad Phillips 80 Central Bank Responsibilities: Domestic and Foreign US Govt Deficit Treasury Issues Bonds Federal Reserve Foreigners Buy Bonds Foreign Concern with US Inflation Foreign Concern with US Interest Rates Llad Phillips 81 Capital Flight 1. foreigners sell their US securities 2. foreigners exchange their US $ proceeds for Yen 3. Supply of dollars shifts and price of the dollar falls demand for $ supply of $ Yen price of US $ quantity of $ 4. Federal Reserve may use its Yen Reserves to buy $, stabilize x-chLladrate Phillips 82 Mexico in 1995 Salinas Government runs a deficit spending domestically to “buy” the election burst of inflation capital flight from peso Mexicans sell pesos and demand $ demand for $ increases, peso price of $ rises forces devaluation Llad Phillips 83 Flight of Pesos from Mexico Peso Price of the $ Supply of S Demand for $ Quantity of $ Llad Phillips 84 Source: Yardeni Llad Phillips 85 Exchange Rate for Mexico: New Pesos per US $ . 10 96 95 94 93 92 91 90 89 88 87 86 85 84 83 82 81 80 Exchange Rate 1 0.1 0.01 Year Source: International Monetary Fund, International Financial Statistics Yearbook, Llad Phillips 86 1996 Thailand in 1997 Production down Toyota source: Business Week 11-17-97 shuts down 2 large factories in Bangkok Banks hold bad loans speculation in golf courses, condos, high rises West worries: potential Intl. financial crisis International Monetary Fund: bailout loans Indonesia: US $10 B Treasury pledges $3B Thailand: $22 B Philippines: $1B South Korea: $40B Llad Phillips 87 Changing Scenario in Asia Four Tigers: Hong Kong, Taiwan, Singapore, South Korea Thailand and Neighbors: China, Malaysia, Indonesia Source: Economic Report of the President , 1997 Llad Phillips 88 Llad Phillips source: Federal Reserve Bank of St. Louis Date 89 1997.09 1996.11 1996.01 1995.03 1994.05 1993.07 1992.09 1991.11 1991.01 1990.03 1989.05 1988.07 1987.09 1986.11 1986.01 1985.03 1984.05 1983.07 1982.09 1981.11 1981.01 Rate T hailand Exchange Rate: Bahts Per Dollar, 1981-1997 . 40 35 30 25 20 15 10 5 0 source: CIA Llad Phillips 90 Source: http://interactive.wsj.com Llad Phillips 91 Source: Yardeni ‘94 Exports: Manufactures: 73% Partners: US 21% Japan 17% Llad Phillips 92 Source: Yardeni Llad Phillips 93 Summary-Vocabulary-Concepts merchandise trade balance balance of trade balance on current account creditor nation debtor nation income on US assets abroad payments on foreign assets in US capital account capital inflow Llad Phillips capital outflow balance of payments purchasing power parity real exchange rate Mexican Peso Japanese Yen Thailand Baht capital flight devaluation 94
