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ECONOMICS UNIT FOURInternational Economics
UNIT 4 LEARNING STANDARD #1 OF 3
SSEIN1 Explain why individuals, businesses, and governments trade goods and services.
a. Define and distinguish between absolute advantage and comparative advantage.
b. Explain that most trade takes place because of comparative advantage in the production of a good or service.
c. Define balance of trade, trade surplus, and trade deficit
SPECIALIZATION AND TRADEEVERYONE BENEFITS!
We already know 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
Increases the amount and variety of goods available to all nations; increases efficiency
THE WORLD ECONOMY
Each nation sells some of its products to other nations and then buys things from other nations that it can’t easily produceThis 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
The benefit that comes from specialization depends on the concepts of comparative advantage and absolute advantage
ABSOLUTE ADVANTAGE
The ability of a nation or region to produce more of a certain product than another country of region
COMPARATIVE ADVANTAGE
The ability of one country/region to produce a good at less of an opportunity cost than another country/region
HOW TO CALCULATE COMPARATIVE ADVANTAGE
Remember this formula
We Give Up = Your Opportunity Cost
If We Make
EXAMPLESugar Fertilizer
United States 80 100
Nicaragua 70 50
TOTAL 150 150
•Which country has an absolute advantage in producing sugar?•Which country has an absolute advantage in producing fertilizer?•Which country has a comparative advantage in producing sugar?•Which country has a comparative advantage in producing fertilizer?
EXAMPLESugar Fertilizer
United States 80 100
Nicaragua 70 50
TOTAL 150 150
•Which country has an absolute advantage in producing sugar?
• USA
• Which country has an absolute advantage in producing fertilizer?
• USA
EXAMPLESugar Fertilizer
United States 80 100
Nicaragua 70 50
TOTAL 150 150
•Which country has a comparative advantage in producing sugar?• USA - What we give up (100) / If we make (80) = 1.25 Opportunity Cost
• Nicaragua –What we give up (50) / If we make (70) = .71 Opportunity Cost
• So Nicaragua has a lower opportunity cost of making sugar!• Therefore, they have a Comparative Advantage with sugar
Remember We Give Up = Opportunity Cost (OC)
Our Formula>> If We Make
EXAMPLESugar Fertilizer
United States 80 100
Nicaragua 70 50
TOTAL 150 150
•Which country has a comparative advantage in producing fertilizer?• USA - What we give up (80) / If we make (100) = 0.80 Opportunity Cost
• Nicaragua –What we give up (70) / If we make (50) = 1.40 Opportunity Cost
• So USA has a lower opportunity cost of making fertilizer!• Therefore, they have a Comparative Advantage with fertilizer
Remember We Give Up = Opportunity Cost (OC)
Our Formula>> If We Make
BALANCE OF TRADE
balance of trade = exports – imports
A positive balance of trade is a trade surplus
(If a nation imports $1 million worth of goods/services and exports $4 million worth of goods/services; trade surplus of $3 million
A negative balance of trade is a trade deficit
(If a nation imports $2 million worth of goods/services and exports $1 million worth of goods/services; trade deficit of -$1 million
BALANCE OF PAYMENTS
Looks at all transactions between households, firms, and govts. of one nation and those of other nations
Balance of payments = credits – debits
Ideally, the balance of payments should be 0 or a positive number
SO…LET’S THINK LIKE LEBRON JAMES!
Why do you think LeBron James decided to go straight into the NBA instead of going to college, play college hoops and get a degree like most NBA players?
Hmmm…so the opportunity cost of postponing the NBA for college was too high!
SO…SHOULD LEBRON MOW HIS OWN GRASS?
Let’s assume that LeBron is a great basketball player and a great lawn mower.
However, LeBron has a young neighbor named Scotty who is willing to mow his lawn.
LeBron Choices: 1. Mow his lawn in two hours
2. Make a Nike commercial in two hours for $10,000
So, the opportunity cost of mowing his own yard is $10,000
SCOTTY…LEBRON’S NEIGHBOR
Neighbor Scotty’s choices:
1. Mow LeBron’s yard in 4 hours
2. Work at McDonalds for 4 hours and
earn $8.00/hour
Scotty’s opportunity cost for mowing LeBron’s yard is $32.
SO WHO HAS THE ABSOLUTE ADVANTAGE?
LeBron needs 2 hours to mow Scotty needs 4 hours
His yard to mow LeBron’s yard
Absolute Advantage – LeBron can do it in less time, so LeBron is better at mowing than Scotty.
SO WHO HAS THE COMPARATIVE ADVANTAGE?
LeBron’s Opportunity Cost Scotty’s Opportunity Cost
$10,000 $32
Scotty has the comparative advantage because his opportunity cost is lower!
SO WOULD LEBRON BENEFIT FROM A TRADE?
While LeBron is better at mowing than Scotty (absolute advantage), his opportunity cost is much higher so Scotty has the comparative advantage!
Would LeBron benefit from a trade?
Yes!
As long as LeBron pays Scotty more than $32 to mow his yard then they both benefit from the trade.
SO EVERYONE BENEFITS!
If we specialize at what we’re good at and trade with others for other things we want we all benefit.
This is why:
We generally don’t grow our own food
Factories often use assembly lines
Basketball or football players often specialize in one position as apposed to playing all of them
UNIT FOUR LEARNING STANDARD #2 OF 3
SSEIN2 Explain why countries sometimes erect trade barriers and sometimes advocate free trade.
a. Define trade barriers such as tariffs, quotas, embargoes, standards, and subsidies.
b. Identify costs and benefits of trade barriers to consumers and producers over time.
c. Describe the purpose of trading blocs such as the EU, NAFTA, and ASEAN.
d. Evaluate arguments for and against free trade.
TRADE EFFICIENCY
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
WHY NATIONS TRADE
Comparative Advantage
Uneven distribution of resources
Everyone benefits
THE GLOBAL ECONOMY
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!
PROTECTIONISM
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 foreignproducers
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
WHAT ARE TRADE BARRIERS?
Attempts to limit imports into a country
“Protectionism” is government policy
TYPES OF TRADE BARRIERS
#1: Tariffs (tax on certain imports)
These make imports more expensive to buy and earn revenue for the government
Reduces demand for foreign goods => helps nation’s own industries compete
Increases govt. revenue => reduces a nation’s budgetdeficit
AN EXAMPLE
TYPES OF TRADE BARRIERS
#2: Quotas
(limit on the # of certain products that can be imported from another country)
Example: U.S. forced a limit on the number of cars that could be imported from Japan
TYPES OF TRADE BARRIERS
#3: Standards
Rules about the quality of imports
If imports don’t pass a nation’s standards, they will not be accepted
Example: U.S. might ban the import of fruit that has been sprayed with certain pesticides
TYPES OF TRADE BARRIERS
#4: Subsidies
Direct financial aid to certain domestic industries
Lower a firm’s production costs and allow domestic firms to compete with lower-cost imports
TYPES OF TRADE BARRIERS
#5: Embargo
Total ban on one or more products from a particular nation
Often politically motivated => pressures other govts. to change behavior
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.
https://study.com/academy/lesson/trade-barriers-impacts-on-prices-demand.html
ARGUMENTS FOR FREE TRADE
Improves economic efficiency
Offers consumers of all nations a wide variety of goods/services
Offers consumers the lowest possible prices
ARGUMENTS AGAINST FREE TRADE
Protection of national security
National security requires access to certain things (energy, military goods, etc.)
Protection of “infant” industries
New industries with high potential that need help to get started
Protection of domestic jobs
IMPORTANT TRADE AGREEMENTS
USA is member of World Trade Organization (WTO)
Organization that seeks to reduce protectionism around the world.
INTERNATIONAL TRADING BLOCS
#1: North American Free Trade Agreement (NAFTA)
United States, Canada, and Mexico
Gradual elimination of trade barriers between these countries
INTERNATIONAL TRADING BLOCS
#2: European Union (EU)
27 European nations
Shared currency called the “euro”
United Kingdom recently voted to leave the EU – future uncertain
INTERNATIONAL TRADING BLOCS
#3: Association of Southeast Asian Nations (ASEAN)
Brunei, Indonesia, Malaysia, the Philippines, Singapore, Thailand, Cambodia, Laos, Myanmar, and Vietnam
Elimination of most tariffs in this trading region
UNIT FOUR LEARNING STANDARD #3 OF 3
SSEIN3 Explain how changes in exchange rates can have an impact on the purchasing power of groups in the United States and in other countries.
a. Define exchange rate as the price of one nation’s currency in terms of another nation’s currency.
b. Interpret changes in exchange rates, in regards to appreciation and depreciation of currency.
c. Explain why some groups benefit and others lose when exchange rates change
FOREIGN TRADE
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
EXCHANGE RATESRelative value of the American dollar in exchange for foreigncurrencies.
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.
AN EXAMPLE
APPRECIATION AND DEPRECIATION
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
If the currency gains value, it has appreciated
When currencies lose their value, they have depreciated in terms of another currency
EFFECTS OF CHANGING RATES
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 deficitincreases
When the dollar is weak, or depreciates:
US exports increase and the prices of exports go up
Travel abroad is moreexpensive for American tourists
The US trade balance improves
Foreign investment in US businesses increases
So, there are pros and cons of both conditions!
WEAK DOLLARWhat 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
WEAK DOLLARWho 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
STRONG DOLLAR
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
STRONG DOLLAR
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
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