International Economics

International Economics

Unit 5 Pretest As we learn about International Economics, let s see what you already know. Remember do the best you can, but don t stress this assessment doesn t count toward your grade On your Zipgrade answer sheet, bubble in the best answer for questions #1 10. Ignore the rest of the answer sheet

SSEIN1 The student will explain why individuals, businesses, and governments trade goods and services. SSEIN2 The student will explain why countries sometimes erect trade barriers and sometimes advocate free trade. SSEIN3 The student will explain how changes in exchange rates can have an impact on the purchasing power of individuals in the United States and in other countries.

Exports Imports Absolute Advantage Comparative Advantage Tariff Protective Revenue Quota Protectionists Free Traders Foreign Exchange Foreign Exchange Rate Fixed Exchange Rate International Monetary Fund World Bank Trade Bloc European Union (EU) North Atlantic Free Trade Agreement (NAFTA) Association of South- East Asian Nation (ASEAN) Balance of Payments Balance of Trade Embargo Purchasing Power Subsidy Trade Standards Trade Trade Barrier Trade Surplus Trade Deficit World Trade Organization (WTO)

The student will explain why individuals, businesses, and governments trade goods and services. Define and distinguish between absolute advantage and comparative advantage Explain that most trade takes place because of comparative advantage in the production of a good or service Explain the difference between balance of trade and balance of payments

You previously learned that specialization and voluntary exchange allow all parties to benefit in an economy Well, the same works for regions and nations! When countries specialize in certain goods, they are able to make more of that good and then benefit from trading with others What a country produces depends on its resources its natural resources such as land, water, metals and climate and its skilled and educated workers

Each nation sells some of its products to other nations and then buys things from other nations that it can t easily produce This activity is called trade Goods and services that are sold to other nations are called exports Goods and services that are bought from other nations are called imports Specialization and trade increase the amount and variety of goods available to all nations! The benefit that comes from specialization depends on the concepts of comparative advantage and absolute advantage

If a country can make a larger quantity of a good than another country, then it is said to have an absolute advantage in that good However, absolute advantage does not mean that a country should produce that certain product They may produce it at the expense of producing other useful goods In this case, the opportunity cost of not producing the other good may be too much for the country to give up! This is why comparative advantage is important!

Sometimes we import things that we could make ourselves why would we do that? The reason is that sometimes its cheaper in opportunity costs to import a good rather than produce it! That is the concept of comparative advantage in a nutshell! If one country can make a product relatively more efficiently (lower opportunity cost) than another country, then it is said to have a comparative advantage in that good

The US can produce more sugar than the small nation of Nicaragua. The US can also produce more fertilizers than Nicaragua. So, the US has an absolute advantage in both areas. However, the opportunity cost of producing sugar is higher in the US than it is in Nicaragua: to grow and refine enough sugar to supply our nation s demand, we would need to take land, capital, and workers away from producing other things, such as fertilizer, that we produce more efficiently and profitably. Nicaragua, on the other hand, can produce sugar very cheaply, while the opportunity cost of trying to produce their own fertilizer would be too high. The US has a comparative advantage over Nicaragua in producing fertilizer, so we export it to Nicaragua. Nicaragua, conversely, has a comparative advantage over the US in producing sugar, so Nicaragua exports it to the US Get it?

Remember this formula (write this down!) We Give Up = Your Opportunity Cost If We Make

But, how do we know who has a comparative advantage in what? That s where the statistics come in! Ex: Statistics from our initial example Sugar Fertilizer U.S. 80 100 Nicaragua 70 50 Total 150 150 This shows the US s absolute advantage in both products it makes more than Nicaragua Within the US, production is higher in fertilizer, so we now know that the US has a comparative advantage in that (and vice versa for Nicaragua!)

Remember Our Formula>> We Give Up = Opportunity Cost (OC) If We Make Making Sugar US 100/80 = 5/4 = 1-1/4 OC NC 50/70 = 5/7 OC So Nicaragua has the lower Opportunity Cost for making sugar Making Fertilizer US 80/100 4/5 OC NC 70/50 7/5 OC So the U.S. has the lower Opportunity Cost for making fertilizer

If the two countries decide to specialize in their comparative advantage, the new production statistics may look like this: Sugar Fertilizer U.S. 0 200 Nicaragua 200 0 Total 200 200 As you can see, the production levels of both products increase and everyone benefits through trade!

Our example is extremely simplified In reality, nations may trade in similar products instead of just specializing in entire industries For example, both the US and Japan make and trade cars why doesn t one of them just specialize? Well, both countries can make cars relatively efficiently and the imports give American and Japanese consumers a wider variety of goods!

A nation s balance of trade is the difference between the value of its imports and the value of its exports in a given year For example, if a nation imports $1 million worth of goods and exports $3 million worth, then it is said to have a positive balance of trade A positive balance of trade is also known as a trade surplus If, on the other hand, they imported $3 million and exported $1 million, the nation has a negative balance of trade, or a trade deficit

Trade isn t the only thing that a nation pays for in a year it also covers other transactions between households, firms, and the government of one nation to another This could include transfer payments, tourism, military spending, interest payments on loans, corporate dividends, the buying and selling of land and businesses, bank deposits, or the buying and selling of currency! Any transaction that brings money into a nation is a credit and any transaction that takes money out is a debit The difference between the total amount of money coming into a nation and the total amount leaving is called its balance of payments

Just as in a family budget, the amount of money going out should not be greater than the amount of money coming in Otherwise, the nation will incur a debt So, ideally, a nation s balance of payments should be zero or a positive number In recent decades, the US has suffered from a negative balance of payments because of our trade deficit (which includes the cost of imported oil, foreign aid, and military investment abroad)

Suppose that two of your friends, Karl and Kate want to make some extra money. They decide to print designs on T-shirts and make birdhouses. Kate can print six T-shirts OR make two birdhouses per hour. Karl can print one T-shirt OR make one birdhouse per hour.

Who has absolute advantage with: T-Shirts? Birdhouses? Who has comparative advantage with: T-Shirts? Birdhouses? Based on the Law of Comparative Advantage, who should produce: T-Shirts? Birdhouses? How will total productivity improve if Karl and Kate specialize and trade?

In the year 2000, nation A sold exports worth $5 million and bought imports worth $8 million. Which of the following statements is definitely true about nation A in the year 2000? a. It had a positive balance of payments b. It had a negative balance of payments c. It had a trade surplus d. It had a trade deficit Corn US 75 100 Russia 60 40 Soybeans Based on the table, which is true? a. The US has an absolute advantage in corn; Russia has an absolute advantage in soybeans b. The US has an absolute advantage in soybeans; Russia has an absolute advantage in corn c. The US has an absolute advantage in both crops d. Russia has an absolute advantage in both crops

We still need to have the following students activate their student account on USA Test Prep. On your phone, go to: USATestPrepCreateAccount Logon: wheeler Password: newton74

When countries interact with other countries, each country gains a higher standard of living. A high degree of economic interdependence exists in the world No country is able to get everything it needs within its own borders. We live in a time in which most countries are moving toward open economies: High degrees of free trade with few trade barriers such as quotas and tariffs.

Absolute Advantage: one country can produce a product at lower cost or with higher labor productivity Comparative Advantage: One country can produce at a lower opportunity cost than another country

Comparative Advantage Uneven distribution of resources

Shoes Wheat China 400.25 wheat 100 4 shoes U.S.A 1000.5 wheat 500 2 shoes Opportunity Cost in red

The student will explain why countries sometimes erect trade barriers and sometimes advocate free trade. Define trade barriers as tariffs, quotas, embargoes, standards, and subsidies Identify costs and benefits of trade barriers over time List specific examples of trade barriers List specific examples of trading blocs such as the EU, NAFTA, and ASEAN Evaluate arguments for and against free trade

International trade today increases the amount and variety of goods available to all nations It also makes nations interdependent! This requires American businesses to compete with companies around the world including those in nations where workers are paid far less than what American workers earn So, to improve balance of payments and to protect businesses in certain domestic industries, nations may impose trade barriers to limit imports from other nations!

When a government enacts a policy that attempts to limit imports, it is practicing protectionism Protectionism aims to protect domestic (i.e. home country) industries by limiting competition with foreign producers It lessens the variety of goods for consumers, but may keep domestic workers employed! The opposite of protectionism is free trade, or open trade between nations without barriers to imports

Tariff: a tax imposed on certain imports These make imports more expensive to buy and earn revenue for the government Quota: a limit on the number of certain products that can be imported Standards: rules about the quality of imports If the product doesn t meet the standards, then it isn t imported Subsidies: direct financial aid to certain domestic industries These lower the production costs for businesses

Trade barriers do protect jobs in some industries that face foreign competition, but they lead to: Fewer choices for consumers Higher prices for all goods (imports or domestic) Hard times for workers in other industries For example, other export industries that may now have fewer sales abroad in response to barriers on imports from those nations Other nations imposing their own trade barriers against the US, hurting American exports

The most severe trade barrier is an embargo, or a total ban on one or more products from a particular nation Embargos are often motivated by political rather than economic factors because they put pressure on governments to change their actions The most famous embargo is the 1970s oil embargo imposed by OPEC against the US and other western nations The US also had an embargo against Cuba that was recently lifted.

Most economists argue that free trade: Improves economic efficiency Offers consumers of all nations a wide variety of goods Offers consumers the lowest possible prices However, those who favor trade barriers argue that: It protects national security It protects infant industries in the nation It protects domestic jobs

Trade Surplus the value of a nation s exports exceeds the value of what they import Trade Deficit the value of a nation s exports are less than the value of what they import

Trade blocs are groups of nations that work together through trade agreements

Trade Agreements are documents that outline the conditions under which trade will take place between nations. General Agreement on Tariffs and Trade (GATT) NAFTA: The North American Free Trade Agreement. CAFTA: The Central American Free Trade Agreement. ASEAN: Association of Southeast Asian Nations EU: European Union US is member of World Trade Organization (WTO) Organization that seeks to reduce protectionism around the world.

Signed in 1992 and went into affect in 1994 It called for the gradual elimination of trade barriers (tariffs and others) between the US, Canada, and Mexico over a 15-year period By 2004, agencies such as the World Bank concluded that, overall, NAFTA had a small positive effect on the economic growth and productivity of both the US and Mexico

The European Economic Community (EEC) was established in 1957 to create a common market in Europe In 1993, this association was strengthened with the creation of the European Union 27 nations with a shared currency, the Euro Today, the EU is the largest free association of trading nations in the world

Another successful trade bloc is the Association of Southeast Asian Nations It began in 1992 and now includes 10 nations of Southeast Asia It has worked towards economic growth and stability by creating a free trade region in this part of the world

Currently, there are discussions on a new trading bloc the Trans-Pacific Partnership.

Advocates argue that it benefits us in the following ways: Greater variety of goods available Lower prices Encourages cooperation between partners Critics argue that it hurts us in the following ways: Lose domestic jobs to other countries with lower costs It helps the other countries more than the U.S. Potential security risks What do YOU think? Should we move forward with the TPP agreement?

A person who favors a protectionist trade policy would MOST likely: a. Call for an end to quotas b. Support a reduction in tariffs c. Call for supporting national security and American jobs d. Claim that trade restrictions result in fewer choices and higher prices What is the most important purpose of NAFTA? a. To increase trade barriers between the US, Canada, and Mexico b. To reduce trade barriers between the US, Canada, and Mexico c. To help the Mexican economy with American and Canadian subsidies d. To compete with the nations of the European Union

On a clean sheet of paper, write your name, date, block # and title: Opener Wednesday, 2/24 Trade Barriers Then write at least 3-5 sentences about what you think this cartoon really means.

The student will explain how changes in exchange rates can have an impact on the purchasing power of individuals in the United States and in other countries. Define exchange rate as the price of one nation s currency in terms of another nation s currency Locate information on exchange rates Interpret exchange rate tables Explain why, when exchange rates change, some groups benefit and others lose

When international trade occurs, one nation must exchange money, or currency, for another nation s goods The problem is: not every nation uses the same currency! So, before a transaction takes place, the purchasing nation must exchange their currency for the currency of the producing nation! This exchange is governed by foreign exchange rates or the value of one nation s currency in terms of another nation s currency

Relative value of the American dollar in exchange for foreign currencies. Exchange rates are floating, e.g., they change based on the relative Supply and Demand for a currency. The value of the dollar compared to the value of other currencies is determined by supply and demand. Demand for U.S. dollars is synonymous with demand for U.S. products. Foreigners importing U.S. products must pay U.S. companies in dollars and therefore must purchase dollars to purchase American made products. High demand for American products will drive the value of the dollar up compared to other currencies. Current Dollar Exchange Rates

Current exchange rate values are shown in exchange rate tables like this one: Value of $1 US (in foreign curr.) Canadian $ 0.97 1.03 Euro 0.70 1.42 Japanese Yen 113.94 0.008 Mexican Peso 10.84 0.09 Value of foreign currency (in US $) You convert the currencies by multiplying by the current exchange rate for the transaction

Let s imagine that you import a Japanese computer that costs $1,000 The American company must exchange $1,000 for Yen but, how many? Figure it out by looking at the table: Then, set up the multiplication: $1 Value US = 113.94 of $1 US yen (in Value of foreign $1000 foreign = (113.94) curr.) X 1000 currency yen (in US $) Canadian $ So, 0.97 $1000 = 113,940 yen 1.03 Euro 0.70 1.42 Japanese Yen 113.94 0.008 Mexican Peso 10.84 0.09

Exchange rates change over time When a currency is strong in terms of another, that means it is worth more So, if the US $ is strong, American tourists can buy more abroad and US businesses can import more foreign goods for lower cost When currencies lose their value, they have depreciated in terms of another currency If the currency gains value, it has appreciated

When the dollar is strong, or appreciates: Imports increase and are cheaper for consumers to buy Travel abroad is cheaper for American tourists US exports decline The US trade deficit increases When the dollar is weak, or depreciates: US exports increase and the prices of exports go up Travel abroad is more expensive for American tourists The US trade balance improves Foreign investment in US businesses increases So, there are pros and cons of both conditions!

What is a weak dollar? The value of the dollar falls compared to other currencies More U.S. dollars are needed to purchase foreign currencies The value of the dollar is depreciating Who is helped by a weak dollar? U.S. Producers because they re competing with higher priced imported goods & services Foreign Consumers because they can buy U.S. goods & services at a lower price U.S. Exporters because American goods & services become less expensive for foreign consumers Who is hurt by a weak dollar? U.S. consumers because the cost of foreign goods & services is more expensive U.S. investors in foreign companies because it costs more Foreign exporters because their goods & services are more expensive

What is a strong dollar? The value of the dollar rises compared to other currencies More foreign currency is needed to purchase a U.S. dollar The value of the dollar is appreciating. Who is helped by a strong dollar? U.S. consumers because the prices of foreign goods & services are less expensive U.S. investors in foreign companies because the prices of foreign securities are lower U.S. importers because they can sell foreign goods & services at a lower price Who is hurt by a strong dollar? U.S. producers because they are competing against lower priced foreign goods & services Foreign consumers because U.S. goods & services are more expensive U.S. exporters because U.S. goods & services are more expensive

1. If the exchange rate between the US dollar and Australian dollar changes from 1USD = 1.8 AUD to 1USD = 1.5 AUD then.... 2. 1 USD =.90 EUR French soup = 1.80 euros. I want to buy 5 cups of French soup. How much would this cost in USD?

Foreign Trade is extremely important nations work together to produce and consume all types of goods and services And, exchange rates are very important to people involved in international trade, tourism, or investment industries So, changes in exchange rates are posted daily and experts are hired to predict and interpret these changes for the future!

What might cause the value of the US dollar to appreciate in relationship to the Euro? Value of $1 US in pesos 10.34.09 Value of 1 peso in US dollars a. Increased demand for European products in the US b. Increased demand for US products in Europe c. Increases in the US money supply d. High rates of inflation in the US Stacy traveled to Mexico and took out $100 in US currency. When she exchanged this for pesos, she received about: a. 10.3 pesos b. 103 pesos c. 1,034 pesos d. 900 pesos

Across the world, there are different types of monetary systems or currencies.