International Trade
Chapter 17
Chap 17 Vocabulary
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Exports
Imports
Absolute advantage
Comparative advantage
Tariff
Quota
Most favored nation clause
World Trade Organization
NAFTA
Foreign exchange rate
Trade deficit
Trade surplus
Why We Trade
• Factors of Production (resources) are
widely dispersed around the world
• Efficient production requires different
combinations of technologies and
resources.
• As a result, countries specialize and
produce what they produce best and
trade for the rest.
Benefits from Specialization
and Trade
• If a nation produced everything it
consumed, it would not depend on any
other nation for its livelihood.
• Although self-sufficiency sounds appealing,
countries are better off if they specialize in
the production of some products and trade
some of them to other countries.
• Specialization and trade are concepts
based on the principle of opportunity cost.
Comparative and Absolute
Advantage
• Absolute Advantage: when a country is able
to produce MORE of a good than another
country. For example the U.S. can produce
more jet fighters than Saudi Arabia.
• Comparative Advantage: when a nation can
produce a good more efficiently, or has a
lower opportunity cost in producing a good.
Saudi Arabia has a comparative advantage
in producing oil and trades oil for jet aircraft.
Barriers to International Trade
•Tariffs – taxes on imports
•Revenue tariffs – to raise revenues for government
•Protective tariffs – tax to protect domestic
industries
•Import Quotas – limits numbers of imports
•Nontariff Barriers – administrative or
“red tape” (For example slowing
“health” or “safety” concerns.
bureaucratic
trade due to
ARGUMENTS FOR PROTECTIONISM
• National Defense*
• Infant-Industry Argument*
• Protect Domestic Employment
• Keep money at home
• Diversification-For-Stability
• Protection-Against-Dumping
*only legitimate arguments
FREE TRADE MOVEMENT
• Smoot-Hawley Tariff Act, 1930
• Reciprocal Trade Agreements Act, 1934
•Generalized Reductions
•Most-Favored-Nation Clauses
• General Agreement on Tariffs and
Trade (GATT), 1947
• World Trade Organization (WTO),
1990s (replaced GATT)
• NAFTA (North American Free Trade
Association)
THE WORLD TRADE ORGANIZATION
Goals of the World Trade Organization
(WTO)
•Reductions in Tariffs Worldwide
•New Rules to Promote Trade in Services
•Reduction in Agricultural Subsidies
•Intellectual Property Protections
•Phasing Out Textile Quotas and Tariffs
Foreign Exchange Markets
• Foreign Currency Exchange is conducted by
the major banks in the world.
• To buy imports from Mexico, a U.S.
business would exchange $ for pesos on
the foreign exchange market.
• This action would decrease the supply of
pesos and increase the supply of $.
• As a result of this transaction, the $ would
depreciate (more dollars) and the peso
would appreciate (fewer pesos).
Exchange Rates
• Today $1 = 13 Pesos. It takes $25 to
buy a shirt that costs 325 pesos.
• If in the future $1 = 14 pesos, the dollar
has appreciated and the peso has
depreciated, or the dollar buys MORE
pesos. With the appreciated dollar, it
now takes $23.21 to buy the shirt priced
at 325 pesos.
DETERMINANTS OF EXCHANGE RATES
Changes in Tastes
Relative Income Changes
Relative Price Changes
Purchasing Power Parity Theory
Relative Interest Rates
Speculation
**Flexible exchange rates
automatically adjust to eliminate
balance of payments deficits or
surpluses.
U.S. IMPORT TRANSACTION
American exports create a foreign
demand for dollars which creates a
supply of foreign currencies which
are available to American buyers...
Financing an American export
reduces the supply of foreign
currencies available and increases
the domestic money supply.
INTERNATIONAL EXCHANGERATE SYSTEM
Today we use a “Flexible”
exchange rate system.
The value of a currency
is adjusted based upon the
laws of supply and demand.
Dollar price of one pound
THE MARKET FOR CURRENCY
P
EXCHANGE
RATE: $2 = £1
S
3
2
Dollar
depreciates
Dollar
appreciates
1
D
Quantity of pounds
Q