Download 7: INTERNATIONAL TRADE VOCABULARY (with some additional

7: INTERNATIONAL TRADE
VOCABULARY (with some additional terms)
Comparative Advantage – When a product can be produced at a lower domestic opportunity cost than
that of a trading partner
Terms of Trade – Rate at which units of one product can be exchanged for units of another product
Foreign Exchange Market – A market in which various national currencies are exchanged for one
another
Exchange Rates – Equilibrium prices within a foreign exchange market
Appreciation – International value of a currency increases
Depreciation – International value of a currency declines
Protective Tariff – Excise taxes or duties placed on imported goods
Import Quota – Limits on quantities or total value of specific items that may be imported
Nontariff Barrier – Licensing requirements, unreasonable standards pertaining to product quality, and
“red tape” in customs procedures
Export Subsidies – Government payments to domestic producers of export goods
Balance on Goods and Services – Difference between exports value and imports value
Trade Surplus – Value of exports exceed value of imports
Trade Deficit –Value of imports exceed value of exports
Flexible/Floating Exchange Rate System – Demand and supply determine exchange rates and no
government intervention occurs
Fixed Exchange Rate System – Governments determine exchange rates and make necessary adjustments
to maintain rates
Purchasing Power Parity Theory – Exchange rates equate purchasing power of various currencies. Ex: A
basket costs $5 in the U.S. and £2.50 in the U.K. Therefore $1.00 = £0.50
CHAPTER 6
4 LINKS/FLOWS BETWEEN THE UNITED STATES AND GLOBAL ECONOMY
- Trade Flow – Exports and imports of goods and services to other nations
- Resource Flow – Production facilities are established within U.S. and foreign countries;
labor moves between nations
- Technology Flow – Technological advancements diffuses between nations
- Financial Flow – Money is transferred between U.S. and world as we pay for imports, buy
foreign assets, and pay interest on debt
U.S. Exports = 12% GDP
U.S. Imports = 17% GDP, but still largest trading nation in terms of volume of goods/services
U.S. has trade deficit in goods with the world, but a trade surplus in services. The most significant of
these services is airline transportation
In order of important trading partners; Canada, Mexico, China, Japan, Germany, United Kingdom,
Korea, Taiwan, Netherlands France
REASONS FOR GROWTH IN INTERNATIONAL TRADE
- Transport Tech – Improvements in transportation have shrunk globe, facilitated efficient
global travel
- Communication Improvements – Links traders instantaneously
- Decline in Tariffs – 37% to 4% now
If Americans buy from the U.K., dollars go to the U.K. and eventually return to the U.S. to purchase
our goods and services, making us wealthier
FALSE SPECULATION
- Protecting American jobs increases price of products and less competition acts as a result –
Trade fosters competition, which rewards productivity and restrain cost.
- U.S. to compete with low foreign wages? – Low wages and low productivity is high unit
cost. U.S. has high productivity
2 TYPES OF ADVANTAGES A COUNTRY CAN HAVE
- Absolute Advantage – Quantity made; a country can make more and be better at something than
someone else. A country can also have an absolute advantage in everything
- Comparative Advantage – Lowest opportunity cost; producing at lower domestic opportunity cost
than a trading partner. No country can have comparative advantage in everything
Nations cannot trade if they do not have a comparative advantage over their neighbors.
Coffee (tons)
30
25
20
15
A
10
05
0
05
10
15
20
25
30
Wheat (tons)
The U.S. can produce 30 tons of coffee, or 30 tons of wheat, or any mix of the two. The U.S. cost-ratio
for the two products is 1 ton of coffee for 1 ton of wheat.
1C = 1W
The optimal mix in the U.S. economy is a combination of 18 tons of wheat and 12 tons of coffee.
Coffee (tons)
30
25
20
15
10
B
05
0
05
10
15
20
25
30
Wheat (tons)
Brazil can produce 20 tons of coffee or 10 tons of wheat, or any mix of the two. Brazilian cost ratio for
the two products is 2 ton of coffee for 1 ton of wheat.
2C = 1W
The optimal mix in Brazil is 8 tons of wheat and 4 tons of coffee.
Wheat Production:
U.S. = 18 tons 26 tons
Brazil = 8 tons
Coffee
Coffee
Coffee Production:
U.S. = 12 tons 16 tons
Brazil = 4 tons
12
o
18
Wheat
4
0
8
Wheat
Both economies can meet their needs without trading. With no trade the world supply of wheat would
be 26 tons and the world supply of coffee would be 16 tons.
However, total output will be greatest when each good is produced by the nation that has the lowest
domestic opportunity cost.
Wheat Production:
U.S. cost ratio: 1W = 1C
The opportunity cost of producing one ton of wheat is losing the chance to produce one ton of coffee. It
cost the U.S. the price of one ton of coffee to produce one ton of wheat.
Brazil’s cost ratio: 1W = 2C
The opportunity cost of producing one ton of wheat is losing the chance to produce two tons of coffee.
It cost Brazil the price of two tons of coffee to produce one ton of wheat.
The U.S. has a comparative advantage in wheat.
Coffee Production:
U.S. cost ratio: 1C = 1W
The opportunity cost of producing one ton of Coffee is losing the chance to produce one ton of wheat.
It cost the U.S. the price of one ton of wheat to produce one ton of coffee.
Brazil’s cost ratio: 2C = 1W (1C = ½ W)
The opportunity cost of producing one ton of coffee is losing the chance to produce ½ ton of wheat. It
cost Brazil the price of ½ ton of wheat to produce one ton of coffee.
Brazil has a comparative advantage in coffee.
CHAPTER 38
When a business buys from a foreign company, they must first convert domestic money into
currency of the other country in the foreign exchange market
TYPES OF FOREIGN EXCHANGE MARKETS
- Banks
- Airports
- Shops
Foreign Exchange Market – a market in which various national currencies are exchanged for each
other
Foreign exchange markets:
- Are competitive (fluctuate due to S/D)
- Enable consumers to understand the value of their items
SCENARIO
U.S. has economic boom. Because AD increases, people are wealthier. Wealthier people consume
more foreign goods. Demand for foreign currency increases. Dollar price for foreign currency
increases, causing foreign currency to appreciate in value as dollar value decreases
In the long run, since value of foreign currency increased, PL of foreign goods is more expensive to
the Americas
TYPES OF EXCHANGE RATES:
- Flexible (floating) ER – Supply and demand determine exchange rates with no government
intervention
- Fixed ER System – Government determines rate of exchange by making many economic
adjustments
- Managed Floating ER – ER floats freely until a problem in which government would intervene
FACTORS THAT APPRICIATE THE DOLLAR
T – Taste for U.S. goods – an increase in the foreign demand for U.S. products, increases foreign
demand for dollar.
R – Rate of interest – Higher IR in U.S. leads to more foreign investments, increasing foreign demand
for dollar.
I – Increase in foreign national incomes will increase demand for U.S. G/S, and increase the demand for
the dollar.
P – Price levels – Lower price levels in the U.S. increase exports to foreign nations, which will increase
demand for dollar.
S – Speculation – Predictions of U.S. dollar appreciation will cause currency speculators to demand
more dollars causing the foreign price of the dollar to rise.
The Foreign Exchange Market:
Dollar Price of Yen
The Yen’s equilibrium in the FEM is where the quantity demanded by foreigners equals the quantity
supplied in foreign markets.
Sy
$1
Dy
100
Quantity of yen
Suppose incomes rise in the U.S. due to an economic boom. Consumers will be willing and able to buy
more U.S. and Japanese goods.
An increase in U.S. demand for Japanese goods will increase the demand for yen and raise the dollar
price for yen (how much each yen cost).
If the equilibrium exchange rate changes so that it takes more dollars to buy a Japanese Yen, then the
dollar has depreciated in value (the international value of the dollar has declined).
S
$2
$1
D$
D2
D1
The U.S. supply of Yen is up-sloping because a higher dollar price of Yen means U.S. goods are cheaper
to the Japanese.
The U.S. demand for Yen is down-sloping because, at lower dollar prices for Yen, Americans will want to
buy more Japanese goods and services.
$ price of
Yen
FEM
S2
S1
$1.50
$D
$1.00
Q2
Q1
Q
yen
U.S. imports of Japanese goods create a supply of dollars in Japanese banks.
U.S. import transactions create a U.S. demand for foreign monies and the satisfaction of this demand
decreases the supplies of foreign monies held by U.S. banks. The decrease in supply of foreign currency
increases its value to U.S. dollars.
Under a system of freely flexible (floating) exchange rates a U.S. trade deficit with Japan will tend to
cause an increase in the dollar price of yen. Also, under a system of freely floating exchange rates, an
increase in the international value of a nation's currency will cause its imports to rise.