AP Macroeconomics
Unit 5
I. Trade Basics
Balance of trade: X - M Negative=trade deficit Positive=trade surplus
Balance of payments: $ entering - $ leaving includes investment, foreign aid, etc.
II. Absolute Advantage
8 4
Old
Guy
10 10
Young
Guy
FishCoco-nuts
Max they can produce of each
When 1 country is better at making something.
Young guy has absolute adv. in coconuts Young guy has absolute adv. in coconuts && fish. fish.
II. Absolute Advantage
8 4
Old
Guy
(B)
10 10
Young
Guy
(A)
FishCoco-nuts
Max they can produce of each good
III. Comparative Advantage
4 2
Old
Guy
4 6
Young
Guy
FishCoco-nuts
Amounts they consume before trade
What is young guy’s opportunity cost of coconuts?
Fish? What is old guy’s
opportunity cost of coconuts?
Fish?
III. Comparative Advantage
0.5 2
Old
Guy
1 1
Young
Guy
FishCoco-nuts
Opportunity Cost
III. Comparative Advantage Lower opportunity cost in a good = comparative
advantage in that good Countries benefit by making the things they
have a comparative advantage in, and trading.
III. Comparative Advantage
0.5 c-nut
2 fish
Old
Guy
1 c-nut
1 fish
Young
Guy
FishCoco-nuts
Opportunity Cost
III. Comparative Advantage The Big Trick
“Steeper” PPF’s have the comparative advantage in the good on the vertical axis!
III. Comparative Advantage
4 2
Old
Guy
4 6
Young
Guy
FishCoco-nuts
Amounts they consume before trade
III. Comparative Advantage
8 0
Old
Guy
0 10
Young
Guy
FishCoco-nuts
Amounts they produce with
trade
III. Comparative Advantage
4 2
Old
Guy
4 6
Young
Guy
FishCoco-nuts
Amounts they produce without trade
8 0
Old
Guy
0 10
Young
Guy
FishCoco-nuts
Amounts they produce with
trade
Totals: 8 8 10 8
III. Comparative Advantage
4 2
Old
Guy
4 6
Young
Guy
FishCoco-nuts
Amounts they consume before trade
4 3
Old
Guy
4 7
Young
Guy
FishCoco-nuts
Amounts they consume after trade
III. Comparative Advantage
4 3
Old
Guy
4 7
Young
Guy
FishCoco-nuts
Amounts they consume after trade
Terms of trade: Old man trades 4 fish
for 3 coconuts.
III. Comparative Advantage
4 3
Old
Guy
4 7
Young
Guy
FishCoco-nuts
Amounts they consume after trade
III. Comparative Advantage
III. Comparative AdvantageCoconuts
Fish
B
A
10
10
6
6
III. Comparative Advantage
Product per hour Corn Wheat Mike 8 6 John 2 4
Corn Wheat
Mike’s O.C.: 6/8 8/6
John’s O.C.: 4/2 2/4
Who should make what?
III. Comparative Advantage
Input Method Apples needed to make
one: Pie Juice Jeff 5 3 Judy 6 3
Convert to outputs Units per apple: Pie Juice Jeff 1/5 1/3 Judy 1/6 1/3
Jeff’s OC 5/3 3/5 Judy’s OC 6/3 3/6
Who should make what?
III. Comparative Advantage Terms of Trade: the rate by which one unit of
one good will be traded for another good. Determine each country’s O.C. of each good.
Nebraska
III. Comparative Advantage Nebraska-Wheat; Florida-Pears Now, Nebraska is willing to give up up to 4 wheat
per pear, & Florida wants at least 3 wheat per pear. Terms of Trade: 1 Pear will be traded for between 3
& 4 Wheat
Nebraska
III. Comparative Advantage
Other benefits of specialization: More efficient use of resources. Increased production without increase in
resources. Effects of specialization on PPC?
Comparative Advantage
What is O.C. of each good for each country? Who has comparative advantage in what? What are the terms of trade?
IV. Trade Barriers
tariff: tax on imports revenue protective
IV. Trade Barriers
quota: limit on # of imports link
IV. Trade Barriers
embargo: all trade with a certain country made illegal
link
IV. Trade Barriers
Trade embargo with Iran Airplanes- 17 Iranian passenger jets have
crashed in 25 years, killing 1,500 people Oil- free trade with Iran would reduce the world
price of oil by 10%.
IV. Trade Barriers
standards: regulations on imports
Example (Listen, Don’t Write): On imported beef, the U.S. requires
farm to fork trace-ability enter U.S. through specified inspection posts country of origin to have adequate food safety system
Reinheitsgebot
Germany’s purity law Lasted from 1516 to 1993. “Beer can only be made using barley, hops,
and water.” Restricted trade because beer-makers in
many other countries used wheat and rye instead of barley.
IV. Trade Barriers
subsidies: gov’t payments to domestic producers
IV. Trade Barriers
Protectionism independent our producers of
protected products are helped
infant industries
Free Trade lower P’s most efficient no retaliation minimal gov’t
involvement foreign relations
IV. Trade Barriers
Arguments for Protectionism The Preserve-Jobs Argument The Infant Industry Argument The Protect Against Dumping Argument The National Defense Argument
AKA The Diversity of Production Argument
Harmful Effects of Protectionism Retaliation Higher Prices
IV. Trade Barriers
Q: Who is hurt by import barriers? A:
foreign producers domestic consumers who must pay higher prices domestic producers that produce complementary
goods to the import goods
IV. Trade Barriers
Q: Who gains and who loses when subsidies are paid to our export industries?
A: export producers gain taxpayers lose by paying more in taxes
IV. Trade Barriers Trade barriers protect domestic industries,
but… keep them from becoming more efficient. Many countries have benefited from trading
blocks: EU-27 countries in Europe (France,
Germany, Italy, UK) NAFTA-U.S., Mexico, Canada ASEAN-10 countries in Asia (Philippines,
Indonesia, Thailand)
V. Balance of Payments
Current Account = Balance of Trade + Net factor & investment income
Capital (or Financial) Account = Net Investment. includes: real estate stock purchases/sales bank accounts
V. Balance of Payments The Balance of Payments = Current Acct Balance + Capital Acct Balance
The Balance of Payments must equal zero!
V. Balance of Payments
If a US citizen buys stock in Toyota how would this be entered into the Balance of Payments?
If this person receives dividends on this stock, how would they be entered?
V. Balance of Payments Balance of Payments in the U.S. For the last three decades, the U.S. has run a current
account deficit. Of the components of the current account, which do you
think contributed the most towards this deficit? What do you think our capital account has looked like
over this period? What are some implications of this?
Persistent trade deficits are often the result of a national savings rate that is too low.
Trade deficits often lead to foreign ownership of domestic capital. If Nx is negative, capital is flowing out of the country, & vice versa.***
VI. Reading Exchange Rate Charts
“Per” means “per 1” Most countries have a flexible exchange rate
system- -supply/demand determine value.
VII. Conversion
If 1 dollar is worth 0.5 pesos… $2 = __ peso $10 = __ pesos $100 = __ pesos
VIII. Rise and Fall If dollar rises, it gains value. If dollar rises against yen,
it takes more yen to buy a dollar. one dollar buys more yen.
VIII. Rise and Fall
Year 1 Yen for sale!
Year 2 Yen for sale!
What appreciated? Depreciated?
VIII. Rise and Fall
Year 1 Dollars for sale!
Year 2 Dollars for sale!
What appreciated? Depreciated?
VIII. Rise and Fall
What happens to value of Pound if: there is an increase in UK interest rates?
Dollars
Pound
VIII. Rise and Fall
What happens to value of Pound if: US interest rates rise?
Dollars
Pound
VIII. Rise and Fall
What happens to value of Pound if: UK speculators predict that the value of gold is
about to fall?
Dollars
Pound
VIII. Rise and Fall
What happens to value of Pound if: UK inflation increases relative to US inflation?
Dollars
Pound
VIII. Rise and Fall
1: large demand for British goods 2: demand for pounds goes up 3: “Price” of Pounds goes up. The Pound
appreciates against the dollar. 4: British goods are no longer so attractive 5: The floating exchange rates have “fixed”
the excessive demand for imported British goods.
VIII. Rise and Fall
losebenefitbenefit lose rise fall
If the Dollar rises in value against the Euro
U.S. producers………….
U.S. consumers………..
European producers….
European consumers..
U.S. exports………………
U.S. imports……………..
IX. Why Exchange Rates Change
Business owners in U.S. want to be paid in ______.
If U.S. goods or investments become more popular, the demand for dollars _______.
This makes the dollar ______ value. Higher inflation in U.S. would make dollar
______ value.
X. Keynesian vs. Classical
AD reflects price levels & employment
There is no natural equilibrium in the economy, except where spending equals income
Fiscal policy can remedy unemployment and inflation
Short-run, sticky wages
Supply creates its own demand
Economies are naturally in equilibrium at FE
Recessions & inflation are temporary
Long run, flexible wages