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Personal Finance

Scott Wentland

wentlandsa@longwood.edu

434-395-2160Longwood University

201 High StreetFarmville, VA 23901

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Intro. to International Econ.

Part 1: What is Globalization?

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What is the global economy?

• Last lecture: the “national economy”– This lecture: the “global economy”– Globalization

• Why do we trade?• How do we measure trade?• Trade agreements and trade barriers• Exchange rates

– Strong vs. weak dollar

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What is the global economy?

• Our economy is just one (major) economy in the world– The global economy includes ALL economies in

all countries around the world– Most individuals within market economies trade

or exchange goods and services with one another, across national borders

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Globalization

• Globalization: Competition or Cooperation? – We tend to associate globalization with the

increase in international trade and commerce.– “Globalization is the advance of human

cooperation across national boundaries.”

• Markets allow us to specialize, and extend cooperation across borders

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Globalization

• Virtually every product you see has taken the cooperation of thousands (millions) or people to bring you that product– Most of them don’t know each other– Don’t speak the same language– Don’t practice the same religion– Or even live in the same country

• Made possible by advances in technology, communications, transportation, and trade

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Is globalization good?

• Why not make iPhones entirely in the US? • Why not “buy American”?

• Globalization and the expansion of international trade has been a net benefit for our economy and the world economy

• Why? Trade is a win-win

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Intro. to International Econ.

Part 2: Trade

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Wealth/Income & Trade

• Do trade and globalization make us better off? • Very tight link between the wealth & (freer) trade

and openness to globalization• Openness Wealth

– Trade Openness Index: • Most open = highest real incomes, highest growth• Least open = lowest real incomes, lowest growth

(The graphs in the proceeding slides are from the book Globalization by Donald Boudreaux.

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Trade?

• Trade: paying someone else for something you can do yourself – So, how does this make us richer?

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Trade

• Trade allows us to specialize– Specialization allows us to focus on the work we do

well. The people with whom we trade can focus on the work they do well.

– Collectively, the world produces more and the world is more prosperous.

• Above summarizes the main insights from Adam Smith’s theory of trade (sometimes called the Theory of Absolute Advantage)

– Example: US is best at making airplanes, Japan is best at making cars

• We specialize and focus our resources in certain areas• Then, we trade, and the size of the “pie” is larger

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Comparative Advantage

• What if the US is not the “best” at anything? • Can we still benefit from trade?

– YES. Trade and specialization allows us to focus on what we do relatively well

– David Ricardo, British economist (1772-1823)• He explained that a country being “the best” or “good”

at producing something was irrelevant. Both sides can benefit from trade even if one side is better at producing everything.

• Theory of Comparative Advantage

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Comparative Advantage

• Manager/secretary example– Suppose you have two main things to get done:

typing and managing– When you’re typing, it means you’re not managing

• Managing is the opportunity cost of typing

– Opportunity cost = forgone alternative– Suppose I have an absolute advantage in both

typing and managing, should I hire a secretary?• I have a comparative advantage in managing

– An hour of typing costs a manager an hour of managing. – May have to pay $10 to secretary, but has to forgo $25 for

managing

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Comparative Advantage

• “Time is the ultimate scarce resource. You should use your time wisely. Trying to do everything yourself is actually expensive – it means taking time away from those things you do relatively well.”

• Trade is not just about what you do best• According to the Theory of Comparative

Advantage, all countries benefit from trade, because trade will allow us to specialize and create a win-win– More on the Theory of Comparative Advantage in

International Economics…

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Comparative Advantage & Tiger

• Does Tiger Woods mow his own lawn?

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Intro. to International Econ.

Part 3: Trade, Balance of Payments, and Exchange Rates

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How do we measure trade?

• A country’s balance of payments: • Current Account (typically the trade balance)

– Imports & Exports of goods & services– Income paid/received to/from foreigners– Unilateral transfers

• Capital Account– Net flows of financial assets

• Like stocks & bonds• Direct investment

– Most include official international reserves in here

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Trade Deficit vs. Trade Surplus

• In any given year, a country may have a trade deficit or trade surplus– Trade deficit: Imports > Exports– Trade surplus: Exports > Imports

• Should we worry a lot about trade flows? – Running a trade deficit with China? – The trade flows can be a little misleading

• A trade deficit is not necessarily debt (not like a fiscal deficit)

• Openness to trade is the important thing, deficits and surpluses will fluctuate not really a big deal

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Trade Agreements & Trade Barriers

• While economists generally support free trade, not everyone is on board with it– Businesses don’t like competition– Union labor doesn’t like foreign competition– People misunderstand the benefits and costs of

trade

• Governments sometimes enact trade barriers– Tariffs: taxes on foreign goods (imports)– Quotas: quantity restrictions on imports

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Trade Agreements & Trade Barriers

• Trade barriers– Make trade more costly, reducing trade– Result:

• We gain some jobs• We lose jobs• Consumers pay a lot more for products• NET EFFECT: bad for the economy

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Trade Agreements & Trade Barriers

• Policymakers (after listening to their economic advisors) generally acknowledge that trade has benefits on net– But has pressures from constituents to erect trade

barriers

• Solution: trade agreements– Countries may sign a treaty to agree to lower trade

barriers• Example: North American Free Trade Agreement (NAFTA)

– Result: increase trade and tie policymakers hands thereafter

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Exchange Rates

• What is the exchange rate?– Price of money

• Often quoted in $/Foreign Currency– $1.7 / £ like $10 / movie ticket

» You can think of the foreign currency as a good

• Sometimes quoted Foreign Currency / $– £ 0.566 / $ (this is just 1/$1.7, or the reciprocal)

• In order to make an exchange, both sides want something they can use– You may not be able to use £, so you want $...

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Exchange Rates

• Who wants a strong or weak currency?– Strong currency imports are cheap

• £100 sweater: $200 when $ is weak, $160 when strong• Importers (consumers) want a strong currency

– Weak currency exports are cheap (to foreigners)• $100 jeans: £50.00 when $ is weak, £62.50 when strong• Exporters (producers) want a weak currency

– Except producers who buy inputs from overseas– Imports (their competition) are expensive– Foreigners would want to buy our stuff

– Is a strong currency necessarily better?• No, it usually just a symptom of low inflation and/or high

GDP growth (not a cause!)

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Conclusions

• Free trade and globalization makes us wealthier or better off– Theory of Comparative Advantage

• Trade barriers, limiting trade by restricting quantity or increasing price of foreign goods, make us worse off

• Globalization and international trade are incredibly important topics– More on this in an International Economics course

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Thank You

http://en.wikipedia.org/wiki/International_economics

http://en.wikipedia.org/wiki/International_trade

http://en.wikipedia.org/wiki/Comparative_advantage

http://en.wikipedia.org/wiki/Exchange_rates