macroeconomics: the usa and the world janet orr ctl teaching retreat april 21-22, 2005
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Global Connections for US
Market Systems vs. Command EconomyEconomic FreedomCircular Flow Model of the US EconomyInternational TradeForeign ExchangeNet ExportsEffects of international economy on US Fiscal and Monetary Policy
Market Economy vs. Command Economy
Economic Systems
Market economy (capitalism)
Private ownership of resources
Allocation of resources determined by actions of sellers and buyers (prices and profits)
Laissez-faire capitalism Let-it-be, keep gov’t out
of business
US capitalism has a major role for gov’t.
Command economy (communism, socialism, feudalism)
Public or state ownership of resources
Allocation of resources determined by a central planning authority (shadow prices)
Only Cuba and North Korea currently have largely centrally planned economies
Economic FreedomFreedom of Enterprise and Choice “Economic freedom is defined as the
absence of government coercion or constraint on the production, distribution, or consumption of goods and services beyond the extent necessary for citizens to protect and maintain liberty itself. In other words, people are free to work, produce, consume, and invest in the ways they feel are most productive.” Heritage Foundation
Index of Economic Freedom
Index of Economic Freedom www.heritage.org studies 50 factors arranged in 10 broad
categories Trade policy, Fiscal burden of government, Government intervention in the economy, Monetary policy, Capital flows and foreign investment, Banking and finance, Wages and prices, Property rights, Regulation, and Informal market activity
Published by Heritage Foundation and Wall Street J ournal
Circular Flow Model of the US Economy
International Linkages
Goods and servicesCapital and laborInformation and technologyMoneyLinkages flow both ways
International Trade
USA & World TradeVolume
Increased in absolute size since 1950Increased as a percentage of GDPExports & imports are 12% and 17% of GDP, double their importance from 25 years agoJust after WWII, USA was 1/3 of all tradeCurrently, USA is 1/8 of all trade
USA & World Trade
DependenceUSA imports many food items, raw silk, diamonds, natural rubber, petroleumUSA exports agricultural products, chemicals, aircraft, cars, computers
International Trade
USA & World Trade
Trade PatternsTrade deficit in goodsTrade surplus in servicesNet trade deficitMost trade is with industrialized nationsCanada is our largest trading partner• 24% of exports• 20% of imports
USA & World Trade
Growth of trade facilitated byTransportationCommunicationReduction in trade barriers
International Trade
Specialization
Absolute advantage:You should buy a good from someone else if the other person can produce it more cheaply than you can.
Comparative advantage:
Goods should be produced by the person having the lowest opportunity cost to produce the good.
International Trade
Specialization and Trade
Improves world-wide production.Allows both trading partners to move beyond their domestic production possibilities curve.
Additional Benefits of Free Trade
Promotes competition and deters monopoly power.Specialization may increase the productivity of the resources used to produce certain goods and thereby expand the production possibilities frontier.Linking of national interests may reduce nationalistic animosities.
International Trade
Barriers to Free Trade
Tariffs--excise taxes on importsRevenue tariffProtective tariff
Import quotas--maximum amount of imports allowed in a certain period of time (immigration quotas?)
Barriers to Free Trade
Non-tariff barriers include licensing requirements, standards, bureaucratic red tapeVoluntary Export Restriction (VER)
Pros/Cons of Free Trade
Arguments for Trade Barriers:Are the arguments valid?
Military self-sufficiencyIncreasing (or maintaining) domestic employmentDiversity for stabilizationInfant industry (similar to diversity)Strategic trade policyProtection against “dumping”Protection against cheap foreign labor
Evidence for Free Trade
U.S. constitution forbids individual state from levying tariffsCreation of Common Market in Europe eliminated tariffs among member nationsTariff reduction since mid-1930s directly related to expansion of the world economyResult of Smoot-Hartley Act of 1930 was to worsen the Great DepressionDeveloping countries that have relied on import restrictions to protect industries have showed slower economic growth
Trade Agreements
Movement toward Free Trade• Reciprocal Trade Agreements Act,
1934•Presidential Authority•Generalized Reductions•Most-Favored-Nation Clauses
• General Agreement on Tariffs and Trade (GATT)
• World Trade Organization (WTO)
Movement toward Free Trade•The European Union (EU)
•The Euro•North American Free Trade Agreement (NAFTA)
•CAFTA
Foreign Exchange
Equals
Equals
Equals
Equals
Dollar priceof foreigncurrency
rises
Internationalvalue of dollar
falls (dollardepreciates)
Foreigncurrencyprice of
dollar falls
Internationalvalue of foreigncurrency rises
(foreign currencyappreciates)
Currency Appreciation and Depreciation
THE FOREIGN EXCHANGE MARKETThe Market for Yen
Quantity of Yen
Dol
lar
Pric
e of
1 Y
en
0
.01
P
QQe
Sy
Dy
ExchangeRate: $.01 = ¥1
THE FOREIGN EXCHANGE MARKET
Net Exports
Xn = Net Exports
Equals exports minus imports
Xn = X - M
Can be positive or negative
Positive (exports>imports is a trade surplus
Negative (exports<imports) is a trade deficit
Size of US Economy Is Affected by International Economics
GDP= C + G + Ig +Xn
Determinants of Xn Prosperity abroad
Increased prosperity abroad will increase exports and Xn
Tariffs Imposition of tariffs may temporarily increase
Xn by decreasing imports However, retaliation will decrease exports
Exchange rates Depreciation of the U.S. dollar will increase
our exports relative to our imports
Fiscal and Monetary Policies
International Effects on/of Fiscal PolicyInternational Effects on/of Fiscal Policy Recession Recession leads toleads to Expansionary fiscal policy Expansionary fiscal policy leads toleads to
–– Increase G, Decrease TIncrease G, Decrease T–– Government borrowing raises interest rateGovernment borrowing raises interest rate
Higher interest rate Higher interest rate leads toleads to–– Makes lending to US attractiveMakes lending to US attractive
Increased foreign demand for dollars Increased foreign demand for dollars leads leads toto–– Price of dollar in foreign currency risesPrice of dollar in foreign currency rises
Dollar appreciates Dollar appreciates leads toleads to–– Makes US goods relatively more expensiveMakes US goods relatively more expensive–– Decreases exportsDecreases exports
Net Exports decline Net Exports decline leads toleads to AD decreasesAD decreases——ACTS COUNTER TO FISCAL ACTS COUNTER TO FISCAL
POLICYPOLICY
How Does an Easy Money Policy Increase Aggregate Demand?
Increase M1
Interest rate decreases (more supply, lower prices)
Domestic gross investment increases
AD increases
Increase M1
Interest rate decreases (more supply, lower prices)
Dollar depreciates
Net exports increase
AD increases
2 out of 17 chapters covered this semester deal with international tradeMany comparisons between conditions in the USA and other countries throughout the courseInterdependence stressedMany discussion questions for my online macroeconomics course deal with international issues
Open-ended Questions for Online Macroeconomics Class
According to the Heritage Foundation’s Index of Economic Freedom what is the Number one free economy of the world? Does this ranking surprise you? Why or why not? Why isn’t the United States ranked among the top three free economies? Right after WWII, about 1/3 of the world’s trade was with the US. Currently, about 1/8 of the world’s trade is with the US. Do you think that the reduction in percentage dependence on the U.S. for trade has a positive or negative effect on world stability? Explain your reasoning. Find a current political quote in favor of or opposed to a trade barrier. Why do you suppose this politician holds this opinion? Is there an economic basis underlying this position?
Open-ended Questions for Online Macroeconomics Class
Support for trade barriers or protectionism is in seven areas: military self-sufficiency; increased domestic employment; diversification-for-stability; infant industry; strategic trade policy; protection against dumping; and, protection against cheap foreign labor. Pick one of the seven arguments and state both sides. Try to use a real world example to support your pro and con. Are you in agreement with any trade barriers? Why or why not? (Don’t forget barriers to countries whose policies are in direct opposition to ours.) In some of the discussions, we’ve mentioned job outsourcing; trade barriers are one to deal with this problem. Do you feel that the inefficient use of resources caused by trade barriers are a smaller problem than unemployment caused by outsourcing? Can you suggest another way to handle loss of jobs to more efficient countries?
Open-ended Questions for Online Macroeconomics Class
Discuss the protests against the WTO. You can find additional information at www.wto.org. Alternative views can be found at the website of Public Citizen (http://www.citizen.org ). In their words, “Public Citizen is a national, nonprofit consumer advocacy organization founded in 1971 to represent consumer interests in Congress, the executive branch and the courts.
It almost sounds like a “catch 22”: If a country is doing well with high levels of income so that its citizens can afford to buy imported goods, then net exports may be negative which has the effect of reducing that country’s GDP. Is this a sufficient reason to implement trade barriers? Why or why not?
Open-ended Questions for Online Macroeconomics Class
If a country has a trade deficit, what is the effect of depreciation in that nation’s currency relative to the currency of its trading partner with which the deficit is worst? Does this mean that there can be a positive to having a “weak” dollar?Explain one of the two views on the high rates of unemployment in Europe. How does having an open economy affect our fiscal policy? Discuss either shocks originating from abroad (use an example similar to the textbook’s example) or the Net Export Effect.
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