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Chapter 12: International Trade and Exchange Rates U.S. Trade Facts: 2007 U.S. has a trade deficit in goods: In 2007, U.S. trade deficit in goods was $816 billion. U.S. has a trade surplus in services: In 2007, U.S. trade surplus in services was $107 billion. Principal U.S. exports: chemicals, agricultural products, consumer durables, semiconductors, and aircraft. Principal U.S. imports: petroleum, automobiles, metals, household appliances, and computers. Largest trading partner: Canada A Trade deficit occurs when imports exceed exports. A Trade surplus occurs when exports exceed imports. LO: 12-1 12-2 U.S. Trade Balances on Goods and Services, 2007 Surplus Deficit Australia Belgium Canada China Germany Mexico Netherlands +10.0 -67.0 -45.3 +9.8 -256.6 -77.3 +14.3 Source: BEA -10 -20 -30 -40 -50 -60 -70 -250 10 20 J apan -85.0 The U.S. trade deficit with China was $257 billion in 2007. LO: 12-1 12-3 U.S. Total Exports are Second Only to Germany Germany United States China Japan France Netherlands United Kingdom Italy 0 2 4 6 8 10 12 9.20 8.59 8.02 5.38 4.06 3.83 3.71 3.40 Source: World Trade Organization Percentage Share of World Exports, Selected Nations 2007 LO: 12-1 12-4 Specialization and Comparative Advantage Specialization and trade increase the productivity of a countrys resources and allow for greater total output and income. Specialization results in more efficient production. Comparative advantage allows us to determine who should produce what. The terms of trade, or the rate at which units of one product can be exchanged for units of another product, can make both countries better off.
Comparative advantage is a lower relative or comparative opportunity cost than that of another person, producer, or country. LO: 12-2 12-5 Trade and Specialization Increase Total Output Production alternatives: Mexico Product A B C D E Avocado 0 20 24 40 60 Soybeans 15 10 9 5 0 Production alternatives: U.S. Product A B C D E Avocado 0 30 33 60 90 Soybeans 30 20 19 10 0 LO: 12-2 12-6 Absolute and Comparative Advantage In the above example, the U.S. has an absolute advantage in producing both goods: The U.S. can produce 30 tons of soybeans while Mexico can produce 15 tons. Also, the U.S. can produce 90 tons of avocados compared to Mexicos 60 tons. The U.S. has a comparative advantage in soybeans. For the U.S., 1S 3A; for Mexico, 1S 4A Soybeans are relatively cheaper in the U.S. Mexico has a comparative advantage in avocados. 1 ton of avocados costs 1/4 ton of soybeans in Mexico, which is less than the cost in the U.S. (1A 1/3S).
LO: 12-2 12-7 Gains from Specialization and Terms of Trade If the U.S. specializes in soybean production while Mexico specializes in avocado production and both agree on the terms of trade, both countries will gain from specialization and trade. The United States can shift production between soybeans and avocados at the rate of 1S for 3A. Mexico can shift production at the rate of 4A for 1S. Suppose that, through negotiation, the two nations agree on terms of trade of 1 ton of soybeans for 3.5 tons of avocados. These terms of trade are mutually beneficial to both countries, since each can do better through such trade than through domestic production alone.
The terms of trade is the rate at which units of one product can be exchanged for units of another product. LO: 12-2 12-8 Specialization and Gains from Trade LO: 12-2 12-9 Trade with Increasing Costs If resources are no longer perfectly substitutable between alternative uses, resources less and less suitable to the production of one good must be allocated to the production of the other good in expanding the other goods output. The primary effect of increasing opportunity costs is less-than-complete specialization.
LO: 12-2 12-10 Foreign Exchange Market A foreign exchange market is a market in which foreign currencies are exchanged and relative currency prices are established. An exchange rate is the rate at which one currency trades for another. Buyers and sellers interacting in international markets will exchange currencies through the foreign exchange market. In the market for foreign currency, the intersection of the demand for foreign currency and the supply of foreign currency determine the exchange rate.
LO: 12-3 12-11 Q 0 D o l l a r
P r i c e
o f
1
P o u n d
Quantity of Pounds P Market for Foreign Currency (Pounds) D l S l Dollar Depreciates (Pound Appreciates) Dollar Appreciates (Pound Depreciates) Exchange Rate: $2 = 1 $2 $3 $1 Q l Depreciation is a decrease in the value of a currency relative to another currency. Appreciation is an increase in the value of a currency relative to another currency. LO: 12-3 12-12 Determinants of Exchange Rates Factors that cause a countrys currency to appreciate or depreciate are: Tastes Relative Income Relative Price Levels Relative Interest Rates Speculation LO: 12-3 12-13 Protectionism or Free Trade? Argument for protectionism Save U.S. jobs restrict imports Cheap foreign labor pulls down wages in the U.S. Tariffs are needed to protect against dumping. Rebuttal Import restrictions alter the composition of employment but dont affect total employment; they also lead to less effective resource allocation. Gains from trade are based on comparative advantage. Specialization through trade increases labor productivity and wages. Dumping is prohibited by most countries that impose anti-dumping duties. Cases of dumping are rare.
Dumping is the sale of products in a foreign country at prices either below cost or below the prices charged at home. LO: 12-4 12-14 Multilateral Trade Agreements and Trade Blocks General Agreement on Tariffs and Trade (GATT) 1947, 23 nations Nations agreed to give equal treatment to one another, to reduce tariffs through multinational negotiations, and to eliminate import quotas. World Trade Organization (WTO) 1993, 152 nations (as of 2008) Oversees the provisions of the current world trade agreement, resolves disputes stemming from it, and holds rounds of trade negotiations. European Union (EU) a trade block of 27 European nations Nations that have eliminated tariffs and quotas among them established common tariffs for imported goods from outside the member nations, reduced barriers to the free movement of capital, etc. North American Free Trade Agreement (NAFTA) 1993, free-trade zone of US, Canada, and Mexico. LO: 12-5 12-15