International Trade

Why do nations trade?

• Distribution of resources are uneven among nations (natural, human, and capital resources)

• Efficient production of various goods required different technologies or combinations of resources

• Products are differentiated as to quality and other nonprice attributes (imported goods vs. domestic goods)

Examples…• Land-intensive goods– Examples: Australia (vast amounts of land for wheat,

wool, meat) and Brazil (soil and climate for coffee production)

• Capital-intensive goods– Industrially advanced countries with large amounts

capital• Labor-intensive goods– Countries heavy in skilled labor– Example: Japan

• Can produce some goods at lower cost such as digital cameras, video games, etc.

Comparative Advantage (review)

• Principle says that total output will be greatest when each good is produced by the nation that has the lowest domestic opportunity cost for that good

• Review workbook activities outside of class for test!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

Terms of Trade

• Exchange ratio that a country will trade with another country

• REVIEW WORKBOOK ACTIVITY 50 OUTSIDE OF CLASS!!!!!!!!!!

Case for Free Trade

• Argument: through free trade based on the principle of comparative advantage, the world economy can achieve a more efficient allocation of resources and a higher level of material well-being than it can without free trade– Promotes competition and deters monopoly– Competition lowers prices (forces domestic firms to

produce more efficiently/lower cost)– Links national interests and breaks down national

animosities (tend to negotiate rather than make war)

Supply and Demand Analysis of Exports and Imports

• Determines how equilibrium prices/quantities of exports and imports are determined

• Amount of a good or service a nation will export or import depends on differences between the equilibrium world price and the equilibrium domestic price

• In absence of trade, the domestic prices in a closed economy may or may not equal the world equilibrium prices

• When economies are opened for international trade, differences between world and domestic prices encourage exports/imports

Trade Barriers

• WORKBOOK ACTIVITY 51!!!!!!!

Balance of Payments System

Financing International Trade

Balance of Payments

• A country’s balance of payments is commonly defined as the record of transactions between its residents and foreign residents over a specified period.

• Each transaction is recorded in accordance with the principles of double-entry bookkeeping, meaning that the amount involved is entered on each of the two sides of the balance-of-payments accounts

• Compiled by Bureau of Economic Analysis – Shows all payments a nation receives from foreign

countries and all the payments it makes to them– Shows “flows” of inpayments and outpayments

• Any transaction that causes money to flow into a country is a credit to it BOP account, and any transaction that causes money to flow out is a debit– If someone in England buys a South Koreans stereo, the

purchase is a debit to the British account and a credit to the South Korean account

– If a Brazilian company sends an interest payment on a loan to a bank in the U.S., the transaction represents a debit to the Brazilian BOP account and a credit to the U.S. BOP account

• BOP includes:– CURRENT ACCOUNT – deals with international trade in

goods/services and with earning on investments; measures the flows of goods/services

– CAPITAL ACCOUNT – consists of capital transfers and the acquisition and disposal of non-produced, non-financial assets

– FINANCIAL ACCOUNT – records investment flows; records transfers of financial capital and non-financial capital

– Capital/Financial account may be combined by some resources….

Current Account

• Shows current import and export payments of both goods and services

• The difference between a nation's total exports of goods, services and transfers, and its total imports of them. Current account balance calculations exclude transactions in financial assets and liabilities.

• The account is divided into four sections: goods, services, income (such as salaries and investment income) and unilateral transfers (for example, worker's remittances).

• Trade Deficit –sub category of current account

Current Account• Sum of balances in the merchandise, services, income, and

unilateral transfers accounts– Merchandise: exports of goods (credits) and imports of goods

(debits)• Consists of all raw materials and manufactured goods bought/sold• When exports exceeds imports (credits exceeds debits), account shows

a surplus• When imports exceeds exports, account shows a deficit• Balance of merchandise is referred to a balance of trade!!!!

– Services• Includes travel and tourism, royalties, transportation costs, and

insurance premiums, fees (patents, copyrights, etc.)– Income

• Derived from ownership of assets, such as dividends on holdings of stock and interest on securities

– Unilateral Transfers• When one party gives something but gets nothing in return (examples:

gifts and retirement pensions)• If a farm worker in California sends money to family member in Mexico,

this is an unilateral transfer

Capital Account/Financial Account• Record of a country’s international transactions involving

purchases or sales of financial and real assets…MONEY (money to acquire financial assets, such as stocks, bonds, and bank balances, and money to buy foreign land, housing, factories, and other physical assets)

• When a nation buys a foreign firm or real estate of another nation, it appears in the capital account

• Examples:– Swedish firm buys a manufacturing facility in Idaho – If Mexican citizen buy U.S. Treasury bond, recorded as an

inflow of foreign capital assets into the U.S.– If an American firm buys a ship-building company in Turkey, it

would be an outflow of assets to foreign nations– U.S. residents purchase foreign securities to earn a higher rate

of return and to diversify their portfolios; U.S. capital flows out when Americans buy foreign assets; foreign capital flows in when foreigners buy U.S. assets

• The current and capital accounts should equal zero.• When they do not equal zero, the central bank must

buy or sell currency to resolve the imbalance• BOP transactions impact the foreign current markets

for the participants– When you buy foreign goods, you must have foreign

current to complete exchange (vice versa)• Financial account transfers may impact the loanable

funds markets of participants.– These capital flows include direct investment, purchases

of stocks/bonds, and central bank purchases of assets– Capital inflows will increase the supply loanable funds;

capital outflows will decrease the supply of loanable funds

PRACTICE

• http://www.reffonomics.com/TRB/INPROGRESS/Macroeconomics

Foreign Exchange Rates and Markets

Exchange Rate Systems

• Flexible (floating) exchange rate system – supply and demand determine exchange rates and in which no government intervention occurs

• Fixed exchange rate system – governments determine exchange rates and make necessary adjustments in their economies to maintain those rates (China today)

Flexible Exchange Rate System• Depreciation: value of currency falls in comparison

with other currencies– More needed to buy goods

• Appreciation: value of currency increases in comparison with other currencies– less needed to buy goods

• Three generalizations of exchange rates:– If demand for nation’s currency increases (all else equal),

that currency will appreciate; if the demand declines, that currency will depreciate

– If the supply of a nation’s currency increases, that currency will depreciate (vice versa)

– If a nation’s currency appreciates, some foreign currency depreciates relative to it

KNOW!!!!!!!!!

• If currency appreciates, your goods are now MORE EXPENSIVE, so IMPORTS INCREASE (foreign goods cheaper) and EXPORTS DECREASE.

• If currency depreciates, your goods are now cheaper, so IMPORTS DECREASE (foreign goods more expensive) and EXPORTS INCREASE (thus shifting AD to the right)

Determinates of Exchange Rates• Changes in Tastes

– Change in consumer tastes/preferences for product of foreign country may alter demand for country’s currency

• Relative Income Changes– Nation’s currency likely to depreciate if its growth of national income

is more rapid than that of other countries (country’s imports vary directly with its income level; as income rises in U.S., people buy more domestic and foreign goods, thus causing a demand in foreign currency, depreciating U.S. dollar)

• Relative Price-Level Changes– If price level rises more rapidly in U.S. than in Britain, British goods will

be cheaper than domestic goods thus demanding more British pounds• Relative Interest Rates

– Suppose real interest rates rise in US but stay constant in Britain; British citizens will then find the U.S. attractive place to make financial investments thus supply pounds for U.S. dollars

• Speculation– People who buy and sell currencies with an eye toward reselling or

repurchasing them at a profit

KNOW!!!!• When interest rates rise, there is a decrease in

capital investments (machinery, equipment, etc.) because it becomes more costly to borrow for those projects; HOWEVER…when interest rates rise, we see an increase in financial investments (bonds) because income earned on those bonds is rising (vice versa)

If the Fed increases MS…

Interest rates decrease which…

Decreases demand for $ which…

Depreciates the dollar which…

Increases U.S. Net Exports which…

Increases AD (shift to right...)

If the Fed decreases MS…

Interest rates increase which…

Increases demand for $ which…

Appreciates the dollar which…

Decreases U.S. Net Exports which…

Decreases AD (shift to left…)

GRAPHING TIME….

• Woo hoo…………….