Understanding International Trade: Resource Distribution and Comparative Advantage

1. Chapter 17 International Trade

2. Why Do Nations Trade? • There is an unequal distribution of resources • High school terms – other countries have stuff that we don’t • All nations need goods and services, but may not have the factors of production required

3. Resource Distribution • Natural Resources – Farm land, mineral deposits, oil, natural gas, water, woodlands • U.S. Strengths – farm land • U.S. Weaknesses – none (though oil consumption far exceeds supply)

4. Resource Distribution • Human Capital – knowledge and skills of workers, overall education level • U.S. Strengths – very high literacy rate, largest network of universities • U.S. Weaknesses – none

5. Resource Distribution • Physical Capital – manmade objects used to produce other goods and services • U.S. Strengths – extensive communications network, roads and transportation • U.S. Weaknesses – none

6. How Do Nations Decide What to Produce and Trade? • David Ricardo’s Law of Comparative Advantage • Absolute Advantage – you can produce it at a lower cost than other countries (effectively meaningless) • Comparative Advantage – your opportunity cost is lower than other countries for producing that good • The best results come from trading based on comparative advantage

7. Huh? • U.S. can make 2 barrels of oil, or 6 bales of wheat • Mexico can make 1 barrel of oil, or 1 bale of wheat • Who has the absolute advantage for oil? • For wheat?

8. Huh? • What is the U.S. opportunity cost for each barrel of oil? • What is Mexico’s opportunity cost for each barrel of oil? • Who has the comparative advantage for oil? • For wheat?

9. Benefit of Trading Based on Comparative Advantage • Each side will bargain to make the best deal possible • The U.S. can produce its own oil, or send wheat to Mexico in exchange for oil • If Mexico accepts 2 wheat for 1 oil, both side profit

10. Trade and Employment • Trading based on comparative advantage creates specialization – countries only produce what they can produce at lower opportunity costs than others • Specialization can cause unemployment in an individual sector, but it also makes goods cheaper, overall

11. U.S. Exports and Imports • U.S. is the world’s largest exporter and importer • Imports: • 1. Industrial supplies and materials • 2. Consumer goods • 3. Capital goods • Exports: • 1. Capital goods • 2. Industrial supplies and materials • 3. Consumer goods

12. U.S. Exports and Imports • Trade Surplus – when a country exports more than it imports (more money coming in to the country than going out) • Trade Deficit – when a country imports more than it exports (more money going out than coming in) • U.S. Balance of Trade for 2007 - $708.5 Billion Trade Deficit ($1.6 trill. in exports - $2.3 trill. in imports)

13. Trade Barriers • Definition – restriction on trade of goods to or from foreign countries

14. Trade Barriers • Import Quota – limit on number of goods that can be imported • Voluntary Export Restraint (VER) – reduction in exports, done to encourage another country to reduce trade barriers • Often NOT really voluntary… done at another country’s request

15. Trade Barriers • Tariff – tax on imported goods, discourages consumers from buying those goods • Embargo – total ban on trade • U.S. currently has 4 embargos – Cuba, North Korea, Iran, Syria

16. What is the Goal of Trade Barriers? • Protectionism - Preserve jobs and industries in your country

17. What is the Goal of Trade Barriers? • Reasons for protectionism: • Save jobs that would go to countries with cheap labor

18. What is the Goal of Trade Barriers? • Reasons for protectionism: • Protect an infant industry that needs time to develop

19. What is the Goal of Trade Barriers? • Reasons for protectionism: • Protect national security for critical industries needed in a war

20. Current Free Trade Agreements • World Trade Organization (WTO) • Acts as a referee in trade to reduce tariffs and restrictions • 150 Members

21. Current Free Trade Agreements • European Union (EU) • Unified economy of 27 European countries • Same currency, free trade

22. Current Free Trade Agreements • North American Free Trade Agreement (NAFTA) • Eliminates all trade barriers between Canada, the U.S., and Mexico by 2009

23. Current Free Trade Agreements • Asian Pacific Economic Cooperation • Countries along the Pacific (U.S. China, Russia etc.) agree to reduce barriers

24. Multinational Corporations and Trade • Integrate a variety of countries into production of a good • Reduce distinction between foreign and domestic goods

25. Multinational Corporations and Trade • Some fears that corporations take advantage of under-developed countries, and destroy local cultures • This is often referred to as cultural imperialism

26. Exchange Rates • Exchange Rate – amount of another currency you can trade your currency for • Ex. Trading a dollar for 10 pesos • Exchange Rates change daily, based on supply and demand

27. Exchange Rates • Strong Currency vs. Weak Currency • A strong currency is appreciating – growing in value compared to other currencies • A weak currency is depreciating – decreasing in value

28. Exchange Rates • Effects of strong and weak currencies • A strong dollar discourages other countries from buying American goods (decreases exports) • A weak dollar makes American goods cheaper for other countries (increases exports)