Notes on International Economics
International Economics-is the study of how economies in different countries and regions of the world interact and affect one another.
I. International Trade-is the buying and selling of Goods and Services across national borders. It is the process of all nations exchanging goods with one another. It allows a country to concentrate on what it does best and trade for what it can’t or doesn’t produce. When each country Specializes in what it does best, each country has more to trade. As both countries take advantage of their strengths, both countries increase their overall economic well-being.
A) Absolute Advantage- simply means that a country can produce more of a good than another country. This usually describes large countries.
B) Comparative Advantage-means that given two countries that can both produce the same products, one should specialize in producing one product while the other country should specialize in another for the purposes of trade. This is mostly associated with smaller countries. Even if the larger nation produces both products, there are still benefits to trading. Costs and efficiency associated with production may be considered a benefit to the larger country.
Economic Practice Question:
In the country of Balmoria, it takes 9 hours of labor to harvest a bushel of wheat and 6 hours of labor to build a wooden bookcase. In the nearby country of Dashmund, it takes 8 hours of labor to harvest a bushel of wheat and 7 hours to build a wooden bookcase. In terms of labor on these identical goods, which answer choice describes the situation accurately?
a. Dashmund has an absolute advantage in both wheat and bookcases.
b. Balmoria has an absolute advantage in both wheat and bookcases.
c. Dashmund has a comparative advantage in wheat harvesting.
d. Balmoria has a comparative advantage in wheat harvesting.
II. Market Advantages- occur when one country has an abundance of resources and/or can produce certain products more efficiently and in greater quantity than a competing nation. Balance of Trade-the rate at which a nation trades with other nations. It records the values of all goods and services exported from a country minus the values of all goods and services imported from outside the country. It is often referred to as a “Trade Surplus” (if exports exceed imports) or a “Trade Deficit” (if imports exceed exports).
A. Favorable-country exports more than it imports. (brings money into the economy)
B. Unfavorable-when a country imports more than it exports.
Balance of Payments-is the value of all money coming into the country thanks to exports minus all of the money going out of the country as it pays for imports.
2 areas of division-
a. current-includes the trade in goods and services.
b. capital-includes foreign investments or the transfer of capital goods and changes in a country’s official reserves.
The US had current account deficit =a capital account surplus.
This means that the US has had a trade deficit that was able to finance because foreigners have invested their funds in the US.
The US buys more from Japan than it buys from the US. As a result:
The Japanese have and increase in the # of US $’s available in their country. The Japanese take the US $’s and invest them back into the US. (Office building, golf courses, factories, and other property). This puts $’s back into the US economy.
5 Barriers to Trade-
1) Tariff-or a tax on an imported good. This increases the price of that good, thereby decreasing the quantity demanded. A tariff might help a domestic producer stay in business, even though an imported good would (without the tax) be cheaper for domestic consumers.
2) Quota-is similar to a tariff, but instead of taxing the import, a quota limits the amount of a good that is allowed into the country. That way, while a foreign good may be cheaper, domestic consumers can only buy so much of it before they have to by comparable domestic goods instead.
3) Embargo-on a particular good is like a quota set at zero; a government completely prohibits the import of that item. While there are embargoes on particular goods and services, governments also place trade embargoes on nations they disagree with, politically or otherwise. These embargoes prohibit trade in goods or services with businesses from the embargoed nation.
4) Standards-governments employ standards to ensure the safety of imported goods and to make sure these goods comply with local laws. (China-Lead Paint)
5) Subsidy- the government makes payments to local suppliers to reduce the supplier’s production costs. Lowered production cost should allow the local supplier to charge less for his/her goods and services, thereby making the local supplier more competitive in comparison to foreign firms offering the same good or service.
The Downside-
a) increased cost to consumers through higher prices
b) it harms the economy by making nations inefficient and unresponsive to long-term economic changes
****Without trade barriers, unprotected businesses are forced to remain competitive against all foreign competitors. Although this can occasionally be painful for individual businesses, in the long run a nation’s economy remains healthier because the increased competition fosters innovation and efficiency.****
Economic Practice Questions:
A tariff placed on foreign steel imports represents:
a. A barrier to trade
b. A balance of payment deficit
c. A subsidy to domestic producers
d. An increase in domestic production
Those who favor protectionist trade policies would most likely:
a. support a reduction in tariffs
b. call for fewer import restrictions
c. cite the need to preserve domestic industries
d. believe that restrictions harm consumers
NAFTA-(North American Free Trade Agreement) was designed to help reduce barriers of trade. Its goal was to eliminate barriers to trade-most notably tariffs-between Canada, Mexico, and the US.
EU-(European Union) was fashioned with the similar goal of reducing barriers to trade between its member nations, which should then reduce prices throughout the trading block while making firms more competitive.
III. Exchange Rate-how much a primary currency in one nation is worth in comparison to the primary form of currency in another nation.
This is important to know because it decides how much currency is transferred between countries in order to complete a trade or purchase. Exchange rates move up and down to reflect the worth of one country’s currency in comparison to that of another country.
3 types of Exchange Rates
1. Fixed Exchange Rates-establish a price for a currency that is tied to a stable currency of a developed country. These currencies are called Hard Currencies.
Examples-China, Belize, and Panama. All have their currencies based on a fixed value with respect to the US Dollar. Their local currency = a Fixed number of US dollars. US $’s Increase or Decrease, then so does their money.
Why do this?
· Allows less developed countries to tie their currency to a more stable currency.
· Assures potential investors of their currency’s stability
· Encourages more investment.
2. Floating Exchange Rate-this is determined by Supply and Demand.
Examples-US, Japan, Canada, Romania, and Bulgaria are examples of nations with Floating exchange rates.
If the demand for US $’s increases or decreases it effects the exchange rate value. Demand for US $’s is synonymous with demand for US products because foreigners must buy US goods with US dollars.
An Increase in Demand for US products = Increase Demand for US $’s and the curve Shifts right.
While the decrease for Demand in US goods = a decrease in the Demand for US $’s and the curve Shifts Left.
3. Managed floating Exchange Rate-This exchange rate Floats within an agreed upon range, but if the value gets above or below a certain value, the central bank intervenes. If the value is too low, then the central bank will reduce the supply of currency or if the value gets to high it will increase the supply to get the value back down.
Examples-China, Greece, Hungary, Israel, and Turkey.
Currency Appreciation-This is when the value of currency becomes greater. This benefits consumers but can be a bad thing for producers. Essentially the nation’s currency is very strong due to high demand of that currency.
The appreciation of a nation’s currency cause that country’s people to buy more foreign made goods because they can afford to buy more of them.
It also means that producer’s products become more expensive to foreigners trying to purchase them.
Because increased appreciation of a country’s money can hurt demand for a country’s exports, many nations do not want their country’s money to appreciate.
A method of reversing the effects of a trade deficit-Nations devalue their currency or make it worthless. Another name for this is Devaluation. It makes it easier for people in other countries to buy their products and it increases the # of Exports.
Currency Depreciation- is a currency that decreases in value or is weakened in comparison to the currency of other nations. Exporters in a depreciating currency are far better off because foreign buyers all will purchase their products. However consumers now in the same country cannot buy as many foreign goods. Currency depreciation is good for producers but bad for consumers in the same country.
What factors affect Exchange Rates?
· Interest rates on Investments-as interest rates increase then demand for that country’s currency will also go up. Foreigners want to invest in the Securities (Stocks) to receive a higher return on their money. If there is not a sudden increase in the supply of $’s then the value of the $ will appreciate.
· Productivity-or the amount of goods a nation is producing. If productivity increases relative to the rest of the world then demand also increases.
· Consumer Tastes-If foreigners began to prefer US goods more than goods from other countries- then the demand for US $’s will also increase.
· Economic Stability-greatly affects the value of currency. The more stable an economy is the foreign investors demand its currency. The less stable there is a decrease in demand.
· Purchasing Power-is the actual amount of goods and services that can be bought with a given unit of money. (How much a dollar will buy.)
Economic Practice Question:
The price of the US dollar as calculated by the exchange rate MOST directly affects American consumers when they:
a. purchase homes
b. purchase imports
c. pay income tax
d. pay credit card balances