AP Macroeconomics

Unit 5

I. Trade Basics

Balance of trade: X - M Negative=trade deficit Positive=trade surplus

Balance of payments: $ entering - $ leaving includes investment, foreign aid, etc.

II. Absolute Advantage

8 4

Old

Guy

10 10

Young

Guy

FishCoco-nuts

Max they can produce of each

When 1 country is better at making something.

Young guy has absolute adv. in coconuts Young guy has absolute adv. in coconuts && fish. fish.

II. Absolute Advantage

8 4

Old

Guy

(B)

10 10

Young

Guy

(A)

FishCoco-nuts

Max they can produce of each good

III. Comparative Advantage

4 2

Old

Guy

4 6

Young

Guy

FishCoco-nuts

Amounts they consume before trade

What is young guy’s opportunity cost of coconuts?

Fish? What is old guy’s

opportunity cost of coconuts?

Fish?

III. Comparative Advantage

0.5 2

Old

Guy

1 1

Young

Guy

FishCoco-nuts

Opportunity Cost

III. Comparative Advantage Lower opportunity cost in a good = comparative

advantage in that good Countries benefit by making the things they

have a comparative advantage in, and trading.

III. Comparative Advantage

0.5 c-nut

2 fish

Old

Guy

1 c-nut

1 fish

Young

Guy

FishCoco-nuts

Opportunity Cost

III. Comparative Advantage The Big Trick

“Steeper” PPF’s have the comparative advantage in the good on the vertical axis!

III. Comparative Advantage

4 2

Old

Guy

4 6

Young

Guy

FishCoco-nuts

Amounts they consume before trade

III. Comparative Advantage

8 0

Old

Guy

0 10

Young

Guy

FishCoco-nuts

Amounts they produce with

trade

III. Comparative Advantage

4 2

Old

Guy

4 6

Young

Guy

FishCoco-nuts

Amounts they produce without trade

8 0

Old

Guy

0 10

Young

Guy

FishCoco-nuts

Amounts they produce with

trade

Totals: 8 8 10 8

III. Comparative Advantage

4 2

Old

Guy

4 6

Young

Guy

FishCoco-nuts

Amounts they consume before trade

4 3

Old

Guy

4 7

Young

Guy

FishCoco-nuts

Amounts they consume after trade

III. Comparative Advantage

4 3

Old

Guy

4 7

Young

Guy

FishCoco-nuts

Amounts they consume after trade

Terms of trade: Old man trades 4 fish

for 3 coconuts.

III. Comparative Advantage

4 3

Old

Guy

4 7

Young

Guy

FishCoco-nuts

Amounts they consume after trade

III. Comparative Advantage

III. Comparative AdvantageCoconuts

Fish

B

A

10

10

6

6

III. Comparative Advantage

Product per hour Corn Wheat Mike 8 6 John 2 4

Corn Wheat

Mike’s O.C.: 6/8 8/6

John’s O.C.: 4/2 2/4

Who should make what?

III. Comparative Advantage

Input Method Apples needed to make

one: Pie Juice Jeff 5 3 Judy 6 3

Convert to outputs Units per apple: Pie Juice Jeff 1/5 1/3 Judy 1/6 1/3

Jeff’s OC 5/3 3/5 Judy’s OC 6/3 3/6

Who should make what?

III. Comparative Advantage Terms of Trade: the rate by which one unit of

one good will be traded for another good. Determine each country’s O.C. of each good.

Nebraska

III. Comparative Advantage Nebraska-Wheat; Florida-Pears Now, Nebraska is willing to give up up to 4 wheat

per pear, & Florida wants at least 3 wheat per pear. Terms of Trade: 1 Pear will be traded for between 3

& 4 Wheat

Nebraska

III. Comparative Advantage

Other benefits of specialization: More efficient use of resources. Increased production without increase in

resources. Effects of specialization on PPC?

Comparative Advantage

What is O.C. of each good for each country? Who has comparative advantage in what? What are the terms of trade?

IV. Trade Barriers

tariff: tax on imports revenue protective

IV. Trade Barriers

quota: limit on # of imports link

IV. Trade Barriers

embargo: all trade with a certain country made illegal

link

IV. Trade Barriers

Trade embargo with Iran Airplanes- 17 Iranian passenger jets have

crashed in 25 years, killing 1,500 people Oil- free trade with Iran would reduce the world

price of oil by 10%.

IV. Trade Barriers

standards: regulations on imports

Example (Listen, Don’t Write): On imported beef, the U.S. requires

farm to fork trace-ability enter U.S. through specified inspection posts country of origin to have adequate food safety system

Reinheitsgebot

Germany’s purity law Lasted from 1516 to 1993. “Beer can only be made using barley, hops,

and water.” Restricted trade because beer-makers in

many other countries used wheat and rye instead of barley.

IV. Trade Barriers

subsidies: gov’t payments to domestic producers

IV. Trade Barriers

Protectionism independent our producers of

protected products are helped

infant industries

Free Trade lower P’s most efficient no retaliation minimal gov’t

involvement foreign relations

IV. Trade Barriers

Arguments for Protectionism The Preserve-Jobs Argument The Infant Industry Argument The Protect Against Dumping Argument The National Defense Argument

AKA The Diversity of Production Argument

Harmful Effects of Protectionism Retaliation Higher Prices

IV. Trade Barriers

Q: Who is hurt by import barriers? A:

foreign producers domestic consumers who must pay higher prices domestic producers that produce complementary

goods to the import goods

IV. Trade Barriers

Q: Who gains and who loses when subsidies are paid to our export industries?

A: export producers gain taxpayers lose by paying more in taxes

IV. Trade Barriers Trade barriers protect domestic industries,

but… keep them from becoming more efficient. Many countries have benefited from trading

blocks: EU-27 countries in Europe (France,

Germany, Italy, UK) NAFTA-U.S., Mexico, Canada ASEAN-10 countries in Asia (Philippines,

Indonesia, Thailand)

V. Balance of Payments

Current Account = Balance of Trade + Net factor & investment income

Capital (or Financial) Account = Net Investment. includes: real estate stock purchases/sales bank accounts

V. Balance of Payments The Balance of Payments = Current Acct Balance + Capital Acct Balance

The Balance of Payments must equal zero!

V. Balance of Payments

If a US citizen buys stock in Toyota how would this be entered into the Balance of Payments?

If this person receives dividends on this stock, how would they be entered?

V. Balance of Payments Balance of Payments in the U.S. For the last three decades, the U.S. has run a current

account deficit. Of the components of the current account, which do you

think contributed the most towards this deficit? What do you think our capital account has looked like

over this period? What are some implications of this?

Persistent trade deficits are often the result of a national savings rate that is too low.

Trade deficits often lead to foreign ownership of domestic capital. If Nx is negative, capital is flowing out of the country, & vice versa.***

VI. Reading Exchange Rate Charts

“Per” means “per 1” Most countries have a flexible exchange rate

system- -supply/demand determine value.

VII. Conversion

If 1 dollar is worth 0.5 pesos… $2 = __ peso $10 = __ pesos $100 = __ pesos

VIII. Rise and Fall If dollar rises, it gains value. If dollar rises against yen,

it takes more yen to buy a dollar. one dollar buys more yen.

VIII. Rise and Fall

Year 1 Yen for sale!

Year 2 Yen for sale!

What appreciated? Depreciated?

VIII. Rise and Fall

Year 1 Dollars for sale!

Year 2 Dollars for sale!

What appreciated? Depreciated?

VIII. Rise and Fall

What happens to value of Pound if: there is an increase in UK interest rates?

Dollars

Pound

VIII. Rise and Fall

What happens to value of Pound if: US interest rates rise?

Dollars

Pound

VIII. Rise and Fall

What happens to value of Pound if: UK speculators predict that the value of gold is

about to fall?

Dollars

Pound

VIII. Rise and Fall

What happens to value of Pound if: UK inflation increases relative to US inflation?

Dollars

Pound

VIII. Rise and Fall

1: large demand for British goods 2: demand for pounds goes up 3: “Price” of Pounds goes up. The Pound

appreciates against the dollar. 4: British goods are no longer so attractive 5: The floating exchange rates have “fixed”

the excessive demand for imported British goods.

VIII. Rise and Fall

losebenefitbenefit lose rise fall

If the Dollar rises in value against the Euro

U.S. producers………….

U.S. consumers………..

European producers….

European consumers..

U.S. exports………………

U.S. imports……………..

IX. Why Exchange Rates Change

Business owners in U.S. want to be paid in ______.

If U.S. goods or investments become more popular, the demand for dollars _______.

This makes the dollar ______ value. Higher inflation in U.S. would make dollar

______ value.

X. Keynesian vs. Classical

AD reflects price levels & employment

There is no natural equilibrium in the economy, except where spending equals income

Fiscal policy can remedy unemployment and inflation

Short-run, sticky wages

Supply creates its own demand

Economies are naturally in equilibrium at FE

Recessions & inflation are temporary

Long run, flexible wages