13-1COPYRIGHT © 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

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Trade Terminology• Exports

– Value of goods and services sold to foreigners• Imports

– Value of goods and services purchased from foreigners

• Trade balance– Value of nation’s exports minus imports

• Trade deficit– Amount by which nation’s trade balance is in deficit

• Imports exceed exports

• Trade surplus– Amount by which nation’s trade balance is in surplus

• Exports exceed imports

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Country Export and Import Data

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Absolute Advantage• Country can produce a good at lower resource

cost than another country– Example: Growing coffee in Brazil and growing barley

in United States• Brazil can produce coffee at lower resource cost than can

United States because it has better climate to do so

• United States is better suited for growing barley at lower resource cost than is Brazil due to better weather, proper land, machinery, and technology

– With United States specializing in barley and Brazil specializing in coffee, both countries would produce more total output than if each country tried to produce both goods

» Larger total output means larger total consumption: each country could benefit from specialization and trade

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Comparative Advantage• Country can produce a good at lower opportunity cost than another country

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Comparative Advantage (cont.)• From Table 9-2:

– Opportunity cost of producing two floppy disks in U.S. is one pair of shoes (2:1 ratio)

– Opportunity cost of producing two floppy disks in Greenland is two pairs of shoes that will not be produced (1:1 ratio)

• Because U.S. gives up fewer shoes when producing floppy disks, has comparative advantage in floppy disk production

– Opportunity cost of producing two pairs of shoes in U.S. is four floppy disks (1:2 ratio)

– Opportunity cost of producing two pairs of shoes in Greenland is only two floppy disks (1:1 ratio)

• Greenland has comparative advantage in shoe production– If U.S. specializes in floppy disk production, and Greenland specializes

in shoe production, two countries will be able to come up with rate of exchange in trade that will be mutually beneficial

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Production Possibilities Curve

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Consumption Possibilities Curve• Shows alternative combinations of maximum amounts of two products that

can be consumed within country during particular time period

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The Basis for Advantage• Factors that may determine why one country is

better at producing a good than another country:– Weather and climate

– Labor productivity• While skills and education are important determinants of

labor productivity, even more important are capital and technology used in conjunction with labor

– As a result, U.S. workers are generally higher productive

– Quality and availability of land

– Capital equipment

– Technology

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No Trade vs. Free Trade

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The Effects of Free Trade

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Restrictions to Free Trade• Two common types of trade restrictions

are quotas and tariffs– Quota

• Restriction on quantity of imported good

– Tariff• Tax on imported good

• Purpose of most U.S. trade restrictions is to force or encourage American consumers to buy more American-made products and fewer foreign counterparts

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The Effects of Trade Restrictions

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Less-Developed Countries (LDCs)

• Problems that people of less-developed countries (LDCs) experience with trade:

1. Lack of diversity in exports

2. Reliance of many LDCs on primary commodities (unprocessed raw material and agricultural products) for export

3. Overreliance on important imports from other countries

4. Globalization has created opportunities for local and foreign companies to exploit local workers, including children, in production of goods for export

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Problems with Primary Commodities

• Have experienced a problem known as declining terms of trade– Price of country’s exports declines relative to

price of imports

• Prices for these types of products are often very unstable– Inelastic demand characterizes markets for

many primary commodities

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Problems with Primary Commodities (cont.)

• Supply for primary commodities tends to fluctuate a lot

– Combination of fluctuating supply and inelastic demand results in large fluctuation in price

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Politics and Trade• United States has restricted trade (in past

and present) with several countries to bring about political goals– Cuba– Iran– Sudan– Libya– North Korea– China– Vietnam

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International Trade Agreements• North American Free Trade Agreement (NAFTA)

– Agreement between United States, Canada, and Mexico allowing more equal access to one another’s markets

• European Union (EU)

• Mercosur

• Andean Community

• ASEAN

• General Agreement on Tariffs and Trade (GATT)– International trade agreement, first negotiated in 1947, that has

included efforts to reduce tariff barriers among countries of world– Replaced by World Trade Organization (WTO)

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The Economic Left and the Economic Right

• THE ECONOMIC RIGHT (Conservative)– Generally favor free trade– Feel free trade results in

efficiencies that arise in general from free markets

– Concerned about inefficiencies with trade restrictions

– Promote freer markets for international trade

• THE ECONOMIC LEFT (Liberal)– Concerned about effects

of free trade on U.S. workers and businesses

– Argue that government intervention in form of quotas and tariffs is necessary to protect U.S. citizens from “unfair” trade practices in foreign countries

– Concerned about effects of globalization on less developed countries

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Appendix: Exchange Rate Determination

• Exchange rate is price of one country’s currency in terms of another country’s currency– Always a relative value

• Most of industrialized world uses flexible (floating) exchange rate system– Exchange rates are determined on basis of

demand and supply

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Appendix: The Dollar and the Peso

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Appendix: Appreciation and Depreciation

• Appreciate: Value of one country’s currency increases relative to another country’s currency

• Depreciate: Value of one country’s currency decreases relative to another country’s currency

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Appendix: Economic Policy• Economic policy in United States (or any other

country) can have impact on exchange rates– Trade restrictions on imports

• If U.S. purchases of imported good decline, so does demand for foreign currency with which to pay for good

– As demand for foreign currency falls, value of that currency decreases (and relative value of dollar increases)

» Rising value of dollar makes exports more expensive to foreign consumers, who will likely purchase fewer of them

– Interest rates• If U.S. interest rates rise relative to interest rates in other

countries, U.S. financial markets now become more attractive to foreign investors

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Appendix: International Managementof Exchange Rates

• Group of Eight (G-8)– Eight countries (United States, Canada, Britain,

France, Italy, Germany, Japan, Russia) that coordinate policies in effort to influence exchange rates

• Major goal of G-8 is to stabilize exchange rates of major world currencies within acceptable range of one another

• Six Markets Group (Asian G-6)– Six (original) countries (United States, Japan, China,

Singapore, Australia, Hong Kong) that coordinate financial policies

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