Unit Six: International Trade and Monetary Exchange Key Topics: absolute and comparative advantage, arguments for

free trade, balance of trade, balance of payments, interest rates, exchange rates, currency appreciation and depreciation Readings: Baumol & Blinder, Chapters 33, 34, 35 Test: one long answer question, 30 40 multiple choice questions
Barriers to trade: 1) Tariffs: Tax on imported/exported goods a. Economists hate it b. Effect: higher prices c. Political weapon d. Pros: Protects domestic industry 2) Quota: Limit on imports a. Keeps prices up 3) Export subsidies: Incentive for US to export goods Tariffs and Subsidies: Tariff and Quota are essentially the same thing (have the same economic effect) o Difference tariffs make money An export subsidy is an incentive for a domestic manufacturer to export their goods o Common example reduction in production costs Non-Tariff Barriers: - Onerous licensing requirements, unreasonable product quality requirements, or just plain old red tape (bureaucracy)! Voluntary export restrictions - Countries agree to limit their exports for military/political reasons Economic Impact of Tariffs (Look at world market graph) DIRECT EFFECTS OF TARIFFS: 1) HIGHER PRICES 2) Decline in consumption 3) Increase domestic production 4) Decline in imports 5) Tariff revenues INDIRECT EFFECTS OF TARIFFS: 1) Exporting nation cuts production, earns less $ to buy imports 2) Trade partner will then cut production and export less Economic Impact of Quotas: 1) Generally same as tariffs a. BUT nation that imposes quota instead of tariffs loses tariff revenue 2) Instead: that $ goes to exporting nation in form of higher prices for material it is allowed to export Net Costs of Tariffs and Quotas

1) Price of imported product goes up 2) Higher price of imports causes some consumers to shift purchases to higher priced domestic goods 3) Prices of domestically produced goods rise because of decreased competition The Case for Trade barriers 1) Military self-sufficiency argument 2) Diversification for stability argument 3) Infant industry argument 4) Protection against dumping argument a. Dumping: selling for less $ than what it takes to make b. Illegal in foreign trade c. Undercuts competitors to increase market share d. Essentially, a way to become a monopoly 5) Increased domestic employer argument 6) Cheap foreign labor argument Trade Agreements - GATT (1947-1992) - World Trade Organization (WTO) (1992-pres.) - European Union *Note: 1) convert currency and 2) people trade, NOT nations Balance of payments: 1) Capital account a. sale/purchase of any real/financial asset 2) CAPITAL = CURRENT 3) Current account a. imports/exports of goods/services (trade balance) b. transfers CURRENCY EXCHANGE GRAPHS DEMAND SHIFTS FOR CURRENCY: 1) Change in tastes and preferences for an imported product 2) Relative income changes a. Income of nation A increases relative to nation B i. Nation B appreciates ii. Nation A depreciates 3) Inflation! a. Higher prices in nation A i. Nation A depreciates ii. Nation B appreciations 4) Relative interest rates 5) Changes in relative investment opportunities 6) Speculation Demand increase (appreciation) creates temporary Balance of payments deficit

BOP deficit: An imbalance in a nations balance of payments in which payments made by the country exceed payments received by the country. This is unfavorable because more currency is flowing out of the country than is flowing in, resulting in a reduction in the supply of money in the nation and an increase in the exchange rate relative to foreign currencies.

Risk & Uncertainty - Trade Fixed Exchange Rates 1) Trade policy a. Discourage imports b. Encourage exports c. (Tariffs increase supply curve) 2) Stabilization (M&F policy) a. Increases interest rates 3) Currency Reserves