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Published on April 16, 2008

Author: Jeremiah

Source: authorstream.com

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Why Trade?:  Why Trade? Reasons countries benefit from foreign trade They can import resources they lack at home. They can import goods for which they are a relatively inefficient producer. Specialization sometimes permits economies of large-scale production. Why Trade?:  Mutual Gains from Trade When trade is voluntary: Both sides must expect to gain from it Otherwise, they would not trade International and intranational trade are similar in many respects. Some people benefit from trade more then others. Why Trade? *International versus Intranational Trade:  Why international trade is studied separately: Countries are governed by separate governments International trade involves the exchange of national currencies Labor and capital are less mobile internationally than they typically are within a country *International versus Intranational Trade The Law of Comparative Advantage:  The Law of Comparative Advantage One country is said to have an absolute advantage over another in the production of a particular good if it can produce that good using smaller quantities of resources than can the other country. The Law of Comparative Advantage:  One country is said to have a comparative advantage over another in the production of a particular good if it produces that good less inefficiently than the other country. The Law of Comparative Advantage The Law of Comparative Advantage:  The Law of Comparative Advantage The law of comparative advantage applies even if one country is at an absolute disadvantage relative to another country in the production of every good. Both countries gain from trade even if one of them is more efficient than the other in producing everything. The Law of Comparative Advantage:  The Law of Comparative Advantage The Arithmetic of Comparative Advantage When countries differ in the relative efficiency with which they produce different goods: Both world output and the welfare of each country can be increased if: Each country specializes in producing the goods for which it has a relative advantage; And then trades with the other. The Law of Comparative Advantage:  The Law of Comparative Advantage The Graphics of Comparative Advantage Production possibilities frontiers for two countries can show: Different opportunity costs The potential gains from trade FIGURE 1: Per-Capita PPFs for Two Countries:  FIGURE 1: Per-Capita PPFs for Two Countries Copyright © 2006 South-Western/Thomson Learning. All rights reserved. 60 60 50 40 30 10 10 0 20 30 40 50 20 FIGURE 2: The Gains from Trade:  FIGURE 2: The Gains from Trade Copyright © 2006 South-Western/Thomson Learning. All rights reserved. 100 90 80 70 60 50 40 30 20 10 60 50 40 20 10 30 0 Television Sets 100 90 80 70 60 50 40 30 20 10 60 50 40 20 10 30 0 Television Sets Comparative Advantage: “Cheap Foreign Labor”:  Comparative Advantage: “Cheap Foreign Labor” A country can benefit from trade, even if wages in the other country are considerably lower than its own wages. ? Tariffs, Quotas, and Other Interferences with Trade:  Tariffs, Quotas, and Other Interferences with Trade Countries can reduce imports by setting tariffs or quotas. They can promote exports by subsidizing export goods. Tariffs, Quotas, and Other Interferences with Trade:  Tariffs, Quotas, and Other Interferences with Trade Tariff = tax on imports Quota = legal limit on the amount of a good that may be imported Export subsidy = government payment to an exporter Tariffs, Quotas, and Other Interferences with Trade:  Tariffs, Quotas, and Other Interferences with Trade Tariffs versus Quotas When imports are to be reduced, tariffs are generally preferable to quotas because: Tariffs generate income for the government Unlike quotas, tariffs offer no special benefits to inefficient exporters Why Inhibit Trade?:  Reasons why countries may restrict trade: Gain a price advantage Protect particular industries National defense and other non-economic reasons Infant-industry argument Strategic trade policy Why Inhibit Trade? Can Cheap Imports Hurt a Country?:  Dumping = selling goods in a foreign market at lower prices than those charged in the home market Cheap imports: Benefit consumers Hurt some domestic businesses and their workers Can Cheap Imports Hurt a Country? Can Cheap Imports Hurt a Country?:  Can Cheap Imports Hurt a Country? Those who are hurt by cheap imports may fight to prevent their losses. Politics often leads to the adoption of protectionist measures that would be rejected on strictly economic terms. A Last Look at the “Cheap Foreign Labor” Argument:  A Last Look at the “Cheap Foreign Labor” Argument Labor is cheap in countries where productivity is low. Labor is expensive in countries like the United States where labor productivity is high. ? A Last Look at the “Cheap Foreign Labor” Argument:  A Last Look at the “Cheap Foreign Labor” Argument Under most circumstances, international trade enhances our standard of living. ? Supply, Demand, and Pricing in World Trade:  Supply, Demand, and Pricing in World Trade In a two-country supply-demand model without trade restrictions: The price of a good must be the same in both countries The quantity of a good exported from one country must equal the quantity imported by the other FIGURE 3: Supply-Demand in the International Wheat Trade:  FIGURE 3: Supply-Demand in the International Wheat Trade Price of Wheat per Bushel 0 Price of Wheat per Bushel 2.50 $3.25 0 *Supply, Demand, and Pricing in World Trade:  *Supply, Demand, and Pricing in World Trade How Tariffs and Quotas Work Both tariffs and quotas   price of imports  quantity of imports Any restriction of imports that is accomplished by a quota normally can also be accomplished by a tariff FIGURE 4: Quotas and Tariffs in International Trade:  FIGURE 4: Quotas and Tariffs in International Trade Copyright © 2006 South-Western/Thomson Learning. All rights reserved. 95 87.5 57.5 50 125 115 85 80 2.50 $3.25 0 Price of Wheat per Bushel Price of Wheat per Bushel 2.00 $2.50 0 35:  35 The International Monetary System: Order or Disorder? Cecily, you will read your Political Economy in my absence. The chapter on the Fall of the Rupee you may omit. It is somewhat too sensational. MISS PRISM IN OSCAR WILDE’S THE IMPORTANCE OF BEING EARNEST What are Exchange Rates?:  Exchange rate = price, in terms of one currency, at which another currency can be bought A currency appreciates when it becomes more expensive in terms of another; the other currency depreciates. What are Exchange Rates? TABLE 1: Exchange Rates with the U.S. Dollar:  TABLE 1: Exchange Rates with the U.S. Dollar Copyright © 2006 South-Western/Thomson Learning. All rights reserved. What are Exchange Rates?:  What are Exchange Rates? Appreciation and depreciation refer to exchange rate changes in free markets. In a system of fixed exchange rates, the corresponding movements are called revaluation and devaluation. The exchange rate of a currency is determined by its supply and demand. FIGURE 1: Determination of Exchange Rates in a Free Market:  FIGURE 1: Determination of Exchange Rates in a Free Market Copyright © 2006 South-Western/Thomson Learning. All rights reserved. Number of Euros $1.30 Price of a Euro Exchange Rate Determination in Free Market:  Sources of supply and demand: International trade in goods and services Purchases of physical assets (factories and machinery overseas) International trade in financial instruments (stocks and bonds) Exchange Rate Determination in Free Market Exchange Rate Determination in Free Market:  Sources of supply and demand: Demand for a country’s currency is derived from the demands of foreigners for its export of goods and services and its assets Supply of a country’s currency is derived from the import of goods and services and its assets by its own citizens Exchange Rate Determination in Free Market FIGURE 2: Stock Market Boom on the Exchange Rate:  FIGURE 2: Stock Market Boom on the Exchange Rate Copyright © 2006 South-Western/Thomson Learning. All rights reserved. Number of Euros 1.00 $1.30 Exchange Rate Determination in Free Market:  Exchange Rate Determination in Free Market Interest Rates and Exchange Rates: The Short Run Massive amounts of liquid capital cross national boundaries in search of interest rate differentials. Thus, a country that increases its interest rates will experience a capital inflow  demand for its bonds Appreciation of its currency Exchange Rate Determination in Free Market:  Exchange Rate Determination in Free Market The Medium-Run: Economic Activity and Exchange Rates A country’s imports will rise quickly when its economy booms, but rise only slowly when its economy stagnates. Thus, a country with a relatively high growth rate will experience:  imports  demand for foreign currency Depreciation of its own currency Exchange Rate Determination in Free Market:  Exchange Rate Determination in Free Market The Purchasing-Power Parity Theory: The Long Run Purchasing-power parity = exchange rates adjust so that the same good costs the same, whatever currency it is measured in Only applies over the long run Thus, the exchange rate should reflect differences in price levels Deviations from Big Mac PPP, December 2004:  Deviations from Big Mac PPP, December 2004 Copyright © 2006 South-Western/Thomson Learning. All rights reserved. Exchange Rate Determination in Free Market:  Exchange Rate Determination in Free Market Market Determination of Exchange Rates: Summary Exchange rates will appreciate in countries whose: Inflation rates are lower than other countries’ Economic growth rates are slower Interest rates are higher When Governments Fix Exchange Rates:  When Governments Fix Exchange Rates Countries can maintain fixed exchange rates by buying or selling reserves. Compensates for shifts in the demand or supply of their currencies With a fixed exchange rate, the balance of payments will likely be in either surplus or deficit. A deficit cannot be maintained forever since the country will run out of reserves. FIGURE 5: A Balance of Payments Deficit:  FIGURE 5: A Balance of Payments Deficit Copyright © 2006 South-Western/Thomson Learning. All rights reserved. 8 4 Billions of Pesos per Year 0.50 Price of a Peso 1.00 FIGURE 6: A Balance of Payments Surplus:  FIGURE 6: A Balance of Payments Surplus Copyright © 2006 South-Western/Thomson Learning. All rights reserved. 0.12 D S S 1000 600 Billions of Yuan per Year D Price of a Yuan (in Dollars) $0.15 When Governments Fix Exchange Rates:  When Governments Fix Exchange Rates Defining the Balance of Payments in Practice The current account totes up exports and imports of goods and services. The United States has been running large current account deficits for years. China on the other hand got a large surplus When Governments Fix Exchange Rates:  When Governments Fix Exchange Rates Defining the Balance of Payments in Practice The capital account includes purchases and sales of financial assets to and from citizens and companies of other countries. In recent years, this part of our balance of payments accounts has registered persistently large surpluses, as foreigners have acquired U.S. assets. When Governments Fix Exchange Rates:  When Governments Fix Exchange Rates Defining the Balance of Payments in Practice In a system of floating exchange rates, the exchange rates adjust in order to balance the balance of payments. In a system of fixed exchange rates, the balance of payments need not balance. *The Gold Standard and the Bretton Woods System:  *The Gold Standard and the Bretton Woods System The Classical Gold Standard Currencies defined in terms of gold. Balance of payments deficit → government had to sell gold to finance the deficit → reduced money supply and raised interest rates Discovery of gold would mean higher world prices. Supply of gold failed to keep pace with growth in world economy *The Gold Standard and the Bretton Woods System:  *The Gold Standard and the Bretton Woods System The Bretton Woods System Similar to gold standard Currencies fixed to the U.S. dollar. U.S. dollar’s value fixed to gold. Readjustments in exchange rates were permitted only in as a last resort *The Gold Standard and the Bretton Woods System:  *The Gold Standard and the Bretton Woods System The Bretton Woods System Deficit nations were expected to follow restrictive monetary and fiscal policies voluntarily just as they would have done automatically under the gold standard. However, just as under the gold standard, this medicine was often unpalatable. The Bretton Woods system collapsed in 1971 in the face of the U.S. chronic balance of payments deficit. Adjustment Mechanisms Under Fixed Exchange Rates:  Under a system of fixed exchange rates, a country’s government loses some control over its domestic economy. Adjustment Mechanisms Under Fixed Exchange Rates Adjustment Mechanisms Under Fixed Exchange Rates:  There may be times when balance of payments considerations force it to contract its economy even though domestic needs call for expansion  AD  demand for imports  demand for foreign currency Adjustment Mechanisms Under Fixed Exchange Rates Adjustment Mechanisms Under Fixed Exchange Rates:  Adjustment Mechanisms Under Fixed Exchange Rates Conversely, there may be times when the domestic economy needs to be reined in, but balance of payments considerations suggest expansion. Why Try to Fix Exchange Rates?:  Why Try to Fix Exchange Rates? Those in favor of fixed rates think that floating rates are so unpredictable that they reduce the amount of international trade. However, the experience with so-called “fixed rates” was that they were unpredictable and unstable. Why Try to Fix Exchange Rates?:  Why Try to Fix Exchange Rates? Speculation in foreign exchange markets smoothes out the highs and lows. Speculators can destabilize prices only if they are systematically willing to lose money. Consequently, floating rates are usually less variable than feared. The Current “Nonsystem”:  The Current “Nonsystem” Currently, some exchange rates are fixed and some are floating. Few people think that rates can or should be fixed for a long time. Even in the case of floating rates, central banks often intervene. Today, gold is a purely private commodity. Has virtually no role in international finance *The Current “Nonsystem”*:  *The Current “Nonsystem”* The Role of the IMF The role of the International Monetary Fund (IMF) in the current non-system is quite different from what it was under the old Bretton Woods system. No longer the policeman of fixed exchange rates IMF has evolved into a general-purpose international fire-and-rescue squad *The Current “Nonsystem”:  *The Current “Nonsystem” The Volatile Dollar The U.S. dollar depreciated in 1977 and 1978 Appreciated sharply from 1980 through 1985 Depreciated even more sharply from 1985 to 1988 Fluctuated without much trend since then FIGURE 7: The Ups and Downs of the Dollar:  FIGURE 7: The Ups and Downs of the Dollar Copyright © 2006 South-Western/Thomson Learning. All rights reserved. 0 60 80 100 120 140 160 180 Exchange Rate Years 197 4 197 8 198 2 198 6 199 0 199 4 199 8 200 2 The Current “Nonsystem”:  The Current “Nonsystem” The Birth of the Euro As part of the long-range goal of the European Union (EU) to create a unified market like that of the U.S., the EU perceived a need to establish a single currency for all member countries--a monetary union. *The Current “Nonsystem”:  *The Current “Nonsystem” The Birth of the Euro Since January 1999, electronic and checking transactions in eleven of the fifteen EU nations have been denominated in euro rather than in national currencies. *The Current “Nonsystem”:  *The Current “Nonsystem” The Birth of the Euro Three member nations (the United Kingdom, Sweden, and Denmark) have decided to opt out of the common currency project for now. One country (Greece) has so far been unable to qualify because its inflation rate and budget deficit are too high. *The Current “Nonsystem”:  *The Current “Nonsystem” The Birth of the Euro In the year 2002, euro coins and paper money are scheduled to be introduced. Then French francs, German marks, Italian lira, and at least eight other national currencies will be withdrawn from circulation--and will become relics of the past. *The Current “Nonsystem”:  *The Current “Nonsystem” The Birth of the Euro The establishment of the euro marks a giant step beyond fixed exchange rates. Abolishes exchange rates among the participating nations Just as there has long been no exchange rate between New York and New Jersey, there is now no exchange rate between Germany and France. 36:  36 Exchange Rates and the Macro economy No man is an island, entire of itself. JOHN DONNE International Trade, Exchange Rates, and AD:   exports and imports  multiplier effects on GDP. Booms or recessions in one country affect other countries through international trade. International Trade, Exchange Rates, and AD International Trade, Exchange Rates, and AD:  International Trade, Exchange Rates, and AD Relative Prices, Exports, and Imports  relative prices of a country’s exports   that country’s net exports  its real GDP International Trade, Exchange Rates, and AD:  International Trade, Exchange Rates, and AD Relative Prices, Exports, and Imports  relative prices of a country’s exports   that country’s net exports  its real GDP FIGURE 1: The Effects of Higher Net Exports:  FIGURE 1: The Effects of Higher Net Exports Copyright © 2006 South-Western/Thomson Learning. All rights reserved. Price Level Real GDP International Trade, Exchange Rates, and AD:  International Trade, Exchange Rates, and AD The Effects of Changes in Exchange Rates A currency depreciation   relative prices of the country’s goods in international trade  its net exports and AD A currency appreciation has the opposite effects. TABLE 1: Exchange Rates and Home Currency Prices:  TABLE 1: Exchange Rates and Home Currency Prices Copyright © 2006 South-Western/Thomson Learning. All rights reserved. FIGURE 2: The Effects of Exchange Rate Changes on AD:  FIGURE 2: The Effects of Exchange Rate Changes on AD Copyright © 2006 South-Western/Thomson Learning. All rights reserved. (depreciation) (appreciation) Price Level Real GDP Aggregate Supply in an Open Economy:  Open Economy: one that trades with other nations in goods and services, and perhaps also in financial assets Closed Economy: one that does not trade with other nations in either goods or assets Aggregate Supply in an Open Economy Aggregate Supply in an Open Economy:  Aggregate Supply in an Open Economy A currency depreciation   price of foreign goods AS shifts inward A currency appreciation has the opposite effects. FIGURE 3: The Effects of Exchange Rate Changes on AS:  FIGURE 3: The Effects of Exchange Rate Changes on AS Copyright © 2006 South-Western/Thomson Learning. All rights reserved. (depreciation) (appreciation) Price Level Real GDP The Macroeconomic Effects of Exchange Rates:  Currency depreciation   AD and  AS Net result is inflation Probably also expansionary Impact on AD dominates impact on AS A currency appreciation has the opposite effects. The Macroeconomic Effects of Exchange Rates FIGURE 4: The Effects of a Currency Depreciation:  FIGURE 4: The Effects of a Currency Depreciation Copyright © 2006 South-Western/Thomson Learning. All rights reserved. Price Level Real GDP FIGURE 5: The Effects of a Currency Appreciation:  FIGURE 5: The Effects of a Currency Appreciation Copyright © 2006 South-Western/Thomson Learning. All rights reserved. Price Level Real GDP The Macroeconomic Effects of Exchange Rates:  The Macroeconomic Effects of Exchange Rates Interest Rates and International Capital Flows  interest rates  Attracts foreign capital flows Appreciates the currency  net exports  GDP  interest rates has the opposite effects Fiscal and Monetary Policies in an Open Economy:  Fiscal and Monetary Policies in an Open Economy Fiscal Policy Revisited Expansionary fiscal policy   interest rates Attracts foreign capital Appreciates the currency  net exports Fiscal and Monetary Policies in an Open Economy:  Fiscal and Monetary Policies in an Open Economy Fiscal Policy Revisited Part of the expansionary effect of fiscal policy is “crowded out.” Thus, international capital flows reduce the power of fiscal policy. Fiscal and Monetary Policies in an Open Economy:  Fiscal and Monetary Policies in an Open Economy Fiscal Policy Revisited The evidence indicates that the crowding-out effect of fiscal policy is greater on net exports than on investment. FIGURE 6: A Fiscal Expansion in an Open Economy:  FIGURE 6: A Fiscal Expansion in an Open Economy Copyright © 2006 South-Western/Thomson Learning. All rights reserved. Price Level Real GDP TABLE 2: Percentage Shares of Real GDP in the U.S:  TABLE 2: Percentage Shares of Real GDP in the U.S Copyright © 2006 South-Western/Thomson Learning. All rights reserved. Fiscal and Monetary Policies in an Open Economy:  Fiscal and Monetary Policies in an Open Economy Monetary Policy Revisited Expansionary monetary policy   interest rates Outflow of capital Currency depreciation  net exports Thus, international capital flows   power of monetary policy FIGURE 7: A Monetary Contraction in an Open Economy:  FIGURE 7: A Monetary Contraction in an Open Economy Copyright © 2006 South-Western/Thomson Learning. All rights reserved. Price Level Real GDP International Aspects of Deficit Reduction:  According to theory, success in reducing the federal deficit through a policy mix of fiscal contraction and monetary expansion should:  real interest rates  exchange rate of the dollar  net exports Have an uncertain effect on real GDP and inflation International Aspects of Deficit Reduction TABLE 3: Expected Effects of Policy:  TABLE 3: Expected Effects of Policy Copyright © 2006 South-Western/Thomson Learning. All rights reserved. International Aspects of Deficit Reduction:  International Aspects of Deficit Reduction What actually happened? Interest rates did fall, just as predicted. The U.S. economy expanded rapidly between 1992 and 1998. The monetary stimulus overwhelmed the fiscal contraction. International Aspects of Deficit Reduction:  International Aspects of Deficit Reduction Inflation fell despite such rapid growth. The dollar generally declined from 1993 to 1995, as the theory predicted. But then it turned around and rose sharply from 1995 to 1998, just when the budget deficit was turning into a surplus. International Aspects of Deficit Reduction:  International Aspects of Deficit Reduction America’s real net exports sagged from -$30 billion in 1992 to -$238 billion in 1998. The effect on the value of the dollar and net exports did not match the theoretical predictions. *International Aspects of Deficit Reduction:  *International Aspects of Deficit Reduction The Loose Link Between The Budget Deficit and the Trade Deficit (X - IM) = (S - I) - (G - T) Apply this accounting relationship to actual U.S. events in the 1990s:  (G - T)  S and  I   (S - I) *International Aspects of Deficit Reduction:  *International Aspects of Deficit Reduction The Loose Link Between The Budget Deficit and the Trade Deficit Taken by itself:  budget deficit   trade deficit But effect offset by  private economic behavior  S  I Trade deficit depends on private sector behavior as well as public sector behavior. *Is the Trade Deficit a Problem?:  *Is the Trade Deficit a Problem? Pessimists: trade deficit increases long-term indebtedness to foreigners Optimists: trade deficit indicates the attractiveness of the U.S. economy to foreign investors *Is the Trade Deficit a Problem?:  *Is the Trade Deficit a Problem? Each view holds elements of truth. But there is a critical question: How long can a trade deficit continue? *Is the Trade Deficit a Problem?:  *Is the Trade Deficit a Problem? At some point, foreign investors may conclude that they have acquired about all the American assets they want. If and when that happens, the U.S. trade deficit must be eliminated. The only question is how? * Curing the Trade Deficit:  * Curing the Trade Deficit Four basic ways to cure the trade deficit: Tighter fiscal and looser monetary policy  economic growth abroad  savings (good) and/or  investment (bad) Protectionism Would be bad for the U.S. and world economies Might very well fail to cure the problem Conclusion: No Nation is an Island:  Conclusion: No Nation is an Island The fates of nations are intertwined. The major trading countries are linked by exports and imports, capital flows, and exchange rates. Mutual success may well require mutual coordination.

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