International Economics

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International Economics
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Study Questions

• 1. Why is international economics significant?
• 2. What is meant by a trade deficit or surplus?
• 3. Why do we organize, both domestically and
  internationally, based on comparative advantage
  and specialization?

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Study Questions

• 4. Who wins and who loses in free international
  trade?
• 5. What are the two typical ways trade is
  protected?
• 6. Who wins and who loses in protected
  international trade?

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Study Questions

• 7. How does free international trade affect jobs
  and the standard of living in the trading
  countries?
• 8. What is outsourcing?
• 9. How does a floating exchange rate system work?

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Why is Trade Important?

• We cannot produce some things we want at all (or
  in inadequate quantities).
• We get benefits from specialization.
• We get more choices.

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Imports and Exports

• Imports goods we buy that are produced in
  another country.
• Exports goods we produce that we sell to people
  in another country.

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Trade Deficits and Surpluses

• Deficit imports exceed exports
• Surplus exports exceed imports
• With few exceptions, the US has had a trade
  deficit every year for the past 30 years.

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Figure 33-1 The Growth of World Trade, Panel (a)
Source Steven Husted and Michael Melvin,
International Economics, 3rd ed. (New York
HarperCollins, 1995), p. 11, used with
permission World Trade Organization Federal
Reserve System U.S. Department of Commerce.
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Figure 33-1 The Growth of World Trade, Panel (b)
Source Steven Husted and Michael Melvin,
International Economics, 3rd ed. (New York
HarperCollins, 1995), p. 11, used with
permission World Trade Organization Federal
Reserve System U.S. Department of Commerce.
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How Free International Trade Begins

• Assume, at first, no international trade.
• The American market for a good is made up of US
  consumers and US producers only.
• Also, assume many US producers are high-cost
  producers compared to, say, European producers.
• They can sell at a lower price than US producers.

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Figure 6-1. The American Market Before Imports
SUS
P
PUS
PW
DUS
Q
QUS
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How Free International Trade Begins

• Now, let the European firm enter the American
  market and compete with US producers.
• Supply curve shifts right.
• Price falls to the world price.

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Figure 6-2. The American Market After Imports
SUS
SUSW
P
PUS
PW
DUS
Q
Q1US
Q2US
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How Free International Trade Begins

• US customers buy more at lower prices.
• US customers can choose between US and European
  goods.
• Some high-cost US producers cant compete
  profitably and stop producing.
• Instead of all US goods, US customers buy some US
  goods and some imported goods.

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Winners and Losers in Free International Trade

• US consumers win more choice, lower prices, more
  wants and needs satisfied, have money left over
  to buy other goods.
• European low-cost importers win increase sales,
  increase production, create jobs.
• US high-cost producers lose lose sales, decrease
  production, lay off workers.
• International transport industry wins More
  trade, create jobs.

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What about US exports?

• The story is the same.
• Low-cost US firms penetrate the European market.
• Increase sales of US products, create US jobs.
• High-cost European producers lose sales, decrease
  production, lay off workers.

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More Winners and Losers

• European customers win (just like US consumers)
• European high-cost producers lose (just like US
  high-cost producers)
• US low-cost producers win (just like European
  low-cost producers)
• International transport wins.

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Results of Free International Trade (Both
Countries)

• Consumers More goods and services at lower
  prices.
• Standard of living increases.
• Low-cost, internationally competitive industries
  expand and create jobs.
• High-cost, internationally uncompetitive
  industries decrease production and lay off
  workers.
• International transportation grows and creates
  jobs.

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Comparative Advantage

• This applies to an individual, to a firm, or to a
  nation
• If you can produce a good at a lower opportunity
  cost than someone else, you have a comparative
  advantage over them.
• You should specialize in that good they should
  rely on you to make it for them.
• They become your customers.

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So Whats the Problem?

• High-cost producers do not like to
• see their markets invaded by foreign competitors.
• lose sales.
• cut back production or quit the industry.
• lay off workers.

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So Whats the Problem?

• High-cost producers appeal to their
  Congresspersons to protect them from
  competition by foreign importers.
• To restrict trade.
• To make the imported good less desirable to the
  consumer.

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Methods of Protection

• Tariffs.
• Add a tax on imported goods to bring its price
  above the domestic good.
• Quotas.
• Restrict the amount imported.
• This shifts supply to the left, raising price
  above the domestic good.
• Bureaucratic red tape.
• Make it harder to import the good.

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Excuses for Protection

• Military self-sufficiency.
• Increase domestic employment.
• Infant industry.
• Dumping.
• Cheap foreign labor.

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Winners and Losers in Protected International
Trade

• All winners in free international trade lose in
  protected international trade.
• All losers in free international trade win in
  protected international trade.
• Consumers lose Prices are higher choice is
  smaller.
• Standard of living is lower.
• There is a net job decrease in both countries.
• High-cost producers win low-cost producers lose.

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Outsourcing

• A firm hires an outside specialist to take over a
  particular function of a business.
• Families outsource many functions.
• Businesses outsource many functions.
• This became significant when US firms began to
  outsource functions to offshore specialists.

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Outsourcing and Insourcing

• In fact, this is an international event.
• More functions are insourced from other countries
  into the US than outsourced from the US to other
  countries.

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Foreign Exchange Markets

• International trade requires the use of two
  currencies.
• US buyers pay in dollars for imported European
  goods. ( to Germany for BMW)
• European producer pays his bills in Euros.(BMW
  pays in Euros for labor,etc)
• European buyers pay in Euros for imported US
  goods. (Euros paid for Iphones)
• US producer pays his bills in dollars. (Apple
  pays workers in )

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The foreign exchange market

• The Euro market

• S supply of euros
• D demand for euros
• P1 the price of one euro in terms of dollars
• Q1 the total number of euros that will be bought
  and sold

P
S
P1
D
Q
Q1
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The foreign exchange market

• The Euro market

• An increase in demand for the euro increases its
  price in dollars
• The euro appreciates and the dollar depreciates

P
S
P2
P1
D2
D1
Q
Q1
Q2
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The foreign exchange market

• The Euro market

• An decrease in demand for the euro decreases its
  price in dollars
• The dollar appreciates and the euro depreciates

P
S
P1
P2
D1
D2
Q
Q2
Q1
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Floating Exchange Rates

• Any of the following will cause the exchange rate
  to change
• A change in demand for Euros by Americans.
• A change in supply for Euros by Americans.
• A change in demand for dollars by Europeans.
• A change in supply for dollars by Europeans.

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Floating Exchange Rates

• If the dollar appreciates against the Euro
• the Euro depreciates against the dollar.
• the dollar can buy more Euros.
• the Euro can buy fewer dollars.
• If the dollar depreciates against the Euro
• the Euro appreciates against the dollar.
• the dollar can buy fewer Euros.
• the Euro can buy more dollars.

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Foreign Exchange Market

• Floating exchange rates
• the free market prevails.
• Changes in the supply of and demand for
  currencies change the exchange rate.
• Fixed exchange rates
• a government sets a rate that will not change.
• To work, the government must intervene to keep
  demand for and supply of the currency balanced.
• If the government cannot do this, the currency
  will be devalued.
• This was the Gold Standard U.S. left 1971.

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Balance of Payments (3 Accounts)

• 1. Current account includes
• Trade
• Income from Investments
• Unilateral transfers. (money to Sudan)

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Balance of Payments

• 2. Capital (financial) account includes
• investments made by Americans in other countries
• and foreigners investments made in the US.

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Balance of Payments

• 3. Reserve Account
• There is also a reserve account run by the
  central bank
• It has a reserve of foreign currencies used to
  reduce volatility in exchange rates.

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• Figure 6-4. Exchanges between the United States
  and Euroland.

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Figure 6-5. Balance of Payments Current Account
and Capital Account

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Is A Trade Deficit Bad?

• Business cycle and trade deficit.
• Peak? High trade deficit.(have to buy imports)
• Recession? Trade deficit decreases. (incomes low)
  
• Trough? Low (near zero) trade deficit.
• Recovery/prosperity? Trade deficit increases.

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• http//www.econedlink.org/interactives/index.php?i
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