International Economics

International Trade and Exchange

Arguments for free tradeArguments for free trade

Countries benefit from trading for goods and services they don’t have

Countries benefit by producing what they are most efficient in producing (comparative advantage)

US producers benefit from exporting items to foreign countries

US consumers benefit from lower prices of foreign products

Countries benefit from trading for goods and services they don’t have

Countries benefit by producing what they are most efficient in producing (comparative advantage)

US producers benefit from exporting items to foreign countries

US consumers benefit from lower prices of foreign products

Arguments for Trade Restrictions

Arguments for Trade Restrictions

Increased imports hurts domestic industries leading to domestic unemployment (e.g. textiles)

Tariffs or quotas may be instituted to protect workers in the home country

Tariffs or quotas may be used to protect infant industries

Nations also want to maintain productive diversity (eg. Steel for defense industries)

Some nations dump products or restrict US imports

Increased imports hurts domestic industries leading to domestic unemployment (e.g. textiles)

Tariffs or quotas may be instituted to protect workers in the home country

Tariffs or quotas may be used to protect infant industries

Nations also want to maintain productive diversity (eg. Steel for defense industries)

Some nations dump products or restrict US imports

Trade TermsTrade Terms

Import quota - a limit on the amount of a product that can be imported

Import tariff - a tax on a specified product

Infant industries - those industries just getting started

Open economy- an economy with foreign trade

Import quota - a limit on the amount of a product that can be imported

Import tariff - a tax on a specified product

Infant industries - those industries just getting started

Open economy- an economy with foreign trade

Balance of Trade TermsBalance of Trade Terms

A Nation’s balance of trade is its exports minus its imports

A nation that exports more than it imports has a trade surplus

A nation that imports more than it exports runs a trade deficit

The US in 2010 had a trade deficit of approximately 498 billion dollars

A Nation’s balance of trade is its exports minus its imports

A nation that exports more than it imports has a trade surplus

A nation that imports more than it exports runs a trade deficit

The US in 2010 had a trade deficit of approximately 498 billion dollars

Possible Reasons for a nation’s trade deficit

Possible Reasons for a nation’s trade deficit

Exports may be of inferior qualityCountry may not have many products to

exportA nation’s currency may be

overpriced,making imports cheapA nation may have higher incomes than

its trading partnersPoorer nations can’t afford richer

nation’s products

Exports may be of inferior qualityCountry may not have many products to

exportA nation’s currency may be

overpriced,making imports cheapA nation may have higher incomes than

its trading partnersPoorer nations can’t afford richer

nation’s products

More Balance of Payments Terms

More Balance of Payments Terms

Balance of Payments an accounting of funds that flow into and out of a country comprised of capital account and current account.

Current account - a portion payments comprised of the trade balance of goods and services

Capital account - a portion of the balance payments comprised of foreign purchases of US assets minus US purchases of foreign assets, plus the change in official reserves

Balance of Payments an accounting of funds that flow into and out of a country comprised of capital account and current account.

Current account - a portion payments comprised of the trade balance of goods and services

Capital account - a portion of the balance payments comprised of foreign purchases of US assets minus US purchases of foreign assets, plus the change in official reserves

Current and Capital Account Balances

Current and Capital Account Balances

The capital and current account must equal 0

. There is an identity between the current and capital accounts. If we run a trade deficit, we have a deficit in the current account, but a corresponding surplus in the capital account.

Investments are part of capital accounts, but income from investments are part of current accounts

The capital and current account must equal 0

. There is an identity between the current and capital accounts. If we run a trade deficit, we have a deficit in the current account, but a corresponding surplus in the capital account.

Investments are part of capital accounts, but income from investments are part of current accounts

Exchange RatesExchange Rates

Exchange rate the value of one nation’s currency in terms of another’s

Most countries have a floating exchange rate that changes with the supply and demand of currency

For example, if Europeans want more US products they demand more dollars, leading to a rise in the value of the dollar vis a vis the Euro. The dollar appreciates

Conversly, if the US demands more Yen to buy Japanese products, the dollar falls in relation to the Yen. The dollar depreciates.

Exchange rate the value of one nation’s currency in terms of another’s

Most countries have a floating exchange rate that changes with the supply and demand of currency

For example, if Europeans want more US products they demand more dollars, leading to a rise in the value of the dollar vis a vis the Euro. The dollar appreciates

Conversly, if the US demands more Yen to buy Japanese products, the dollar falls in relation to the Yen. The dollar depreciates.

Determinants in Exchange Rates

Determinants in Exchange Rates

Demand for a nation’s productsRelative prices of a nationRelative incomes, wealth or poverty of a

nationSpeculation by currency brokersRelative interest rates

Demand for a nation’s productsRelative prices of a nationRelative incomes, wealth or poverty of a

nationSpeculation by currency brokersRelative interest rates

Weak DollarWeak Dollar

Dollar is worth less relative to other currencies

Benefits: expands US exports, helps trade deficit, leads to growth in GDP through NX

Problems: imports are more expensive, inputs in production bought abroad are more expensive, tough on US tourists

Dollar is worth less relative to other currencies

Benefits: expands US exports, helps trade deficit, leads to growth in GDP through NX

Problems: imports are more expensive, inputs in production bought abroad are more expensive, tough on US tourists

Strong dollarStrong dollar

US dollar worth more relative to other currencies

Benefits: imports are cheaper, foreign inputs in production are cheaper, good for US tourists

Problems: hurts exports, makes trade deficit worse, lowers GDP

US dollar worth more relative to other currencies

Benefits: imports are cheaper, foreign inputs in production are cheaper, good for US tourists

Problems: hurts exports, makes trade deficit worse, lowers GDP

Price Levels and Interest Rates in NX

Price Levels and Interest Rates in NX

Higher price levels discourage foreigners from buying US products --> NX falls

Lower price levels encourage foreigners to buy US products --> NX rises

Higher interest rates encourage foreign investors in US --> capital account increases --> NX falls

Lower interest rates discourage foreign investors in the US --> captial account decreases --> NX rises

Higher price levels discourage foreigners from buying US products --> NX falls

Lower price levels encourage foreigners to buy US products --> NX rises

Higher interest rates encourage foreign investors in US --> capital account increases --> NX falls

Lower interest rates discourage foreign investors in the US --> captial account decreases --> NX rises

First View Expansionary Policy- interest rate focus First View Expansionary

Policy- interest rate focusExpansionary Fiscal Policy Gov borrowing to increase AD --> crowding out -->

interest rate increases -->capital flows into US --> dollar appreciates --> imports go up --> NX down

Expansionary Monetary Policy Fed increases Money Supply --> interest rates fall -->Capital flows out of US -->dollar depreciates --> exports

go up --> NX up

Contractionary policies would be opposite for each. E.g. Contractionary fiscal policy would raise NXContractionary monetary policy would lower NX

Expansionary Fiscal Policy Gov borrowing to increase AD --> crowding out -->

interest rate increases -->capital flows into US --> dollar appreciates --> imports go up --> NX down

Expansionary Monetary Policy Fed increases Money Supply --> interest rates fall -->Capital flows out of US -->dollar depreciates --> exports

go up --> NX up

Contractionary policies would be opposite for each. E.g. Contractionary fiscal policy would raise NXContractionary monetary policy would lower NX

Second ViewPrice Level Focus

Second ViewPrice Level Focus

Expansionary policies lead to higher price levels --> inflation means our products are more expensive --> exports fall --> NX falls

Contractionary policies lead to lower price levels --> falling prices --> exports increase --> NX rises

(suggestion: look to see if the question focuses on interest rates or price levels to determine which view to use on AP)

Expansionary policies lead to higher price levels --> inflation means our products are more expensive --> exports fall --> NX falls

Contractionary policies lead to lower price levels --> falling prices --> exports increase --> NX rises

(suggestion: look to see if the question focuses on interest rates or price levels to determine which view to use on AP)

Which of the following is most likely to cause an increase in the international

value of the US dollar?

Which of the following is most likely to cause an increase in the international

value of the US dollar?

1. Higher US real interest rates2. Lower US government

expenditures3. Higher real interest rates abroad4. Expansionary monetary policy5. Reduced inflation abroad

1. Higher US real interest rates2. Lower US government

expenditures3. Higher real interest rates abroad4. Expansionary monetary policy5. Reduced inflation abroad

An increase in which of the following would reduce the US balance of trade

deficit?

An increase in which of the following would reduce the US balance of trade

deficit?1. US rate of inflation compared to

other countries2. The value of foreign currency

relative to the US dollar3. US demand for foreign goods4. The federal budget deficit5. US interest rates compared to

other countries

1. US rate of inflation compared to other countries

2. The value of foreign currency relative to the US dollar

3. US demand for foreign goods4. The federal budget deficit5. US interest rates compared to

other countries

Assume Canadian consumers increase their demand for Mexican financial assets

Assume Canadian consumers increase their demand for Mexican financial assets

Supply of Canadian Dollars Value of Peso Canadian Net Exports

1. Increase IncreaseIncrease

2.. Increase IncreaseDecrease

3.. Decrease Increase Decrease 4.. Decrease Decrease Increase 5.. Not Change Increase Decrease

Supply of Canadian Dollars Value of Peso Canadian Net Exports

1. Increase IncreaseIncrease

2.. Increase IncreaseDecrease

3.. Decrease Increase Decrease 4.. Decrease Decrease Increase 5.. Not Change Increase Decrease

Suppose the real interest rate in Canada increases relative to that of

Mexico

Suppose the real interest rate in Canada increases relative to that of

Mexico Will this rise in interest rate initially affect Canada’s

current account or capital account? Design a correctly labeled graph of the foreign

exchange market for the Canadian dollar, show the effect of the change in the real interest rate in Canada on the international value of the Canadian dollar (expressed as Mexican pesos per Canadian dollar.

How will the change in the international value of the Canadian dollar that you identified affect Canadian exports to Mexico?

Will the Canadian GDP rise or fall? Explain.

Will this rise in interest rate initially affect Canada’s current account or capital account?

Design a correctly labeled graph of the foreign exchange market for the Canadian dollar, show the effect of the change in the real interest rate in Canada on the international value of the Canadian dollar (expressed as Mexican pesos per Canadian dollar.

How will the change in the international value of the Canadian dollar that you identified affect Canadian exports to Mexico?

Will the Canadian GDP rise or fall? Explain.