Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Download Topic 8: International Trade
Document related concepts
Transcript
Topic 8: International Trade Comparative Advantage Exchange Rates Absolute Advantage Someone has an absolute advantage in producing something when they can do so more efficiently (using fewer factors of production, e.g., less labor) than someone else. The person or group that is “better” at producing a good has the absolute advantage in doing so. Comparative Advantage Someone has comparative advantage in producing something when their opportunity costs of doing so are lower than someone else. Compared to someone else, everyone has a comparative advantage in the production of something. Comparative advantage does not imply absolute advantage. Things I could do: Writing Papers and Teaching Farm Where is my absolute advantage? Where is my comparative advantage compared to others? Things I could do: Writing Papers and Teaching Landscaping and yard maintenance Remodel my kitchen Clean my bathroom Where is my absolute advantage? Where is my comparative advantage compared to others? Examples The French and Irish can make both wine and beer Beer Wine France 500 1000 Ireland 1000 100 Who has the absolute advantage in each product? Who has the comparative advantage in wine? Ireland must give up 10 Beer for each wine France must give up 1/2 beer for each wine France has lower opportunity cost, thus it has comparative advantage. Examples The French and Irish can make both wine and beer Beer Wine France 500 1000 Ireland 1000 100 Who has the comparative advantage in beer? Ireland must give up 1/10 Wine for each Beer France must give up 2 Wine for each Beer Ireland has lower opportunity cost, thus it has comparative advantage. Examples The Scottish and Irish can make both sweaters and beer Sweaters Beer Scotland 1000 900 Ireland 1300 1000 Who has the absolute advantage in each product? Who has the comparative advantage in sweaters? Ireland must give up 10/13 Beer for each sweater Scotland must give up 9/10 Beer for each sweater 10/13<9/10, so Ireland has lower opportunity cost, thus it has comparative advantage. Examples The Scottish and Irish can make both sweaters and beer Sweaters Beer Scotland 1000 900 Ireland 1300 1000 Who has the comparative advantage in Beer? Ireland must give up 13/10 Sweater for each Beer Scotland must give up 10/9 Sweater for each Beer 10/9<13/10, so Scotland has lower opportunity cost, thus it has comparative advantage. Examples In Class Exercise Examples Abby, Bruce and Carlos can make cheese and bread Cheese Bread Abby 500 600 Bruce 200 700 Carlos 600 300 As always with comparative advantage problems in this class, assume linear PPFs for each producer. Who has the absolute advantage in each product Carlos has it in Cheese Bruce has it in Bread Examples Abby, Bruce and Carlos can make cheese and bread Cheese Bread Abby 500 600 Bruce 200 700 Carlos 600 300 Who has the comparative advantage in Cheese? Abby v. Bruce? Abby Abby v. Carlos? Bruce Bruce v. Carlos? Carlos Carlos > Abby > Bruce Examples Abby, Bruce and Carlos can make cheese and bread Cheese Bread Abby 500 600 Bruce 200 700 Carlos 600 300 Who has the comparative advantage in Bread? Graph the PPF for the economy with trade. Comparative Advantage Summary Use the concept of comparative advantage to argue in favor of companies moving production from US to China or India. Who gains? On average, US citizens are better off. Are all US citizens better off? Consider the exchange of “goods” and “services”. Which does the US have comparative advantage in compared to most other countries? Effects of Foreign Trade on Fiscal Policy Benefits of expansionary policy are no longer concentrated in domestic boarders. Might need more aggressive policy to see same effects at home. That is, the effective multiplier might be smaller. If the MPC is 0.8, an increase in G of 1000 might increase domestic Y by less than 1000 / (1- 0.8) = 5000. This is because some of the Y increase takes place in other countries. Effects of Foreign Trade on Monetary Policy For this, we need to consider the foreign exchange market. Consider a world with only two countries: USA and UK Alternatively, think of UK as “rest of the world” Demand for Pounds (£) by holders of $ 1. 2. 3. 4. 5. Import UK produced goods and services Travel to UK Buy UK financial assets (e.g., stocks, bonds, currency) Buy UK “direct” investments (e.g., property, capital goods, firms) Speculation in currency markets (i.e., expect price of £/$ to increase) Supply of Pounds (£) in exchange for $ 1. 2. 3. 4. 5. Import USA produced goods and services to UK Travel to USA Buy USA financial assets (e.g., stocks, bonds, currency) Buy USA “direct” investments (e.g., property, capital goods, firms) Speculation in currency markets (i.e., expect price of £/$ to decrease) Graphing Demand for £ The Price of £ is given in terms of US $, or P=$/£ Graph Demand for £ to Import UK Goods and Services for tourism to UK by currency speculators for investment or financial assets in UK Graphing Demand for £ Demand for £ for investment or financial assets Exchange Rate Investment in $ Investment in £ Return % Return in £ Return converted to $ $5/£1 $100,000 £20,000 10% $2,000 $10,000 $2/£1 $100,000 £50,000 10% $5,000 $10,000 $1/£1 $100,000 £100,000 10% $10,000 $10,000 $0.50/£1 $100,000 £200,000 10% $20,000 $10,000 So, return is the same independent of exchange rate… But, what if we expect the exchange rate to decrease or increase during the course of our investment? Graphing Demand for £ If buy $100,000 investment at $5/£1 exchange rate, and expect to cash in on the investment after exchange rate falls to $2/£1. Investment in $ Investment in £ bought at $5/£1 Return % Return in £ Return converted to $ at $2/£1 $100,000 £20,000 10% $2,000 $4,000 If buy $100,000 investment at $1/£1 exchange rate, and expect to cash in on the investment after exchange rate increases to $2/£1. Investment in $ Investment in £ bought at $1/£1 Return % Return in £ Return converted to $ at $2/£1 $100,000 £100,000 10% $10,000 $20,000 Foreign Exchange Market Graph supply and demand together What is the equilibrium exchange rate? Changes to exchange rate When we consider changes to exchange rates we do so assuming that other things including in-country prices for goods and services do not change. Keeping prices fixed, what happens to exports and imports when the price of the dollar falls? Exports go up, Imports go down. When the price of the dollar rises? Exports go down, Imports go up. Why? A dollar now buys more or less from other countries. Other country currency now buys more or less from US. Changing interest rate What happens if interest rate in USA decreases, but remains unchanged in UK? Buying US financial assets becomes relatively unattractive, so demand for £ increases, and supply of £ decreases. (Graph it) Price of £ increases. US exports increase, UK exports decrease. Therefore: Expansionary monetary policy (to decrease i at home) can be even more effective with trade, since it not only increases domestic investment but it also increases exports. Primary Effects of Monetary Policy with Trade +ΔMS −Δi +ΔI +ΔY dec. Demand Fall in exports go up inc. Supply value of imports down of US $ US $ −Δ MS +Δi −ΔI −ΔY inc. Demand rise in imports go up dec. Supply value of exports down of US $ US $ Example 1 Change in tastes in the USA. Now people like foreign goods more. Supply of $ increases, which decreases the price of $ This decrease in the price of $ will cause some “2nd order” increases to US exports & decreases to US imports, but these will not be as much as the initial changes due to changes in tastes Example 2 Income in US goes up, but not elsewhere. Now US has more $ and will buy more including more imports. Increased income in the US may also increase prices for US goods. Increased demand for imports will cause supply of $ to increase, which decreases the price of $ This decrease in the price of $ will cause some “2nd order” increases to US exports & decreases to US imports. These may or may not be enough to overcome initial price increases at home. Example 3 There is an increase in inflation in the US, relative to rest of world Fewer people want to buy US produced goods. Demand for $ decreases, supply of $ increases. Price of $ falls. The cheaper $ makes buying US produced goods more attractive (a 2nd order effect), but not by enough to offset the initial impact of inflation (a 1st order effect). Circular Flow Draw a circular flow diagram for both the US and UK with trade between the countries. Some questions: Why do investors care about foreign exchange markets? Speculation Changes in currency prices effects the expected return on investment in different locations. How could the Federal Reserve increase the “strength” of the dollar (make the price of dollars go up)? Are you personally made better off when the dollar is stronger? If you are from abroad and must convert currency to $ to pay tuition? If you live in the US and like to travel abroad? If you own a consulting company that typically does 75% of its business in other countries?
