Economic Perspectives

Chapter 17

Why trade?• All trade is voluntary• People trade because they believe that they will be

better off by trading• The factors of production are not evenly distributed

throughout the world– Natural resources are more plentiful in some areas– Human capital is more skilled in nations with higher

literacy rates– Physical capital is deeper in some nations• Better machinery• Infrastructure is better

How does specialization create a need for trade?

–When nations specialize in certain goods, they obtain the goods they cannot produce through importing and exporting.– In some cases, more than 70 percent of a

nation’s export trade depends upon a single resource.• Examples include Kuwait (petroleum and

natural gas), Guinea-Bissau (cashews), and the Marshall Islands (fish).

Benefits from Specialization and Trade

• Specialization and trade increase productivity and the standard of living within a nation.

• Because of specialization and trade, there will be a larger global output of goods and services.

• Everyone can benefit when people trade with one another. Not only can people enjoy a greater quantity of goods and services, but they can also enjoy a greater variety of goods.

Absolute Advantage• Most nations are not self-sufficient.• It is actually better for countries to specialize in

some products and trade for others. This can be understood by looking at absolute and comparative advantage.–A person or nation has an absolute

advantage when it can produce more of a given product than another person or nation using a given amount of resources.

Is Absolute Advantage the only basis for trading?

What if a person or a nation has an absolute advantage in producing

everything….would there still be a reason to specialize and trade?

Comparative Advantage• A country has a comparative advantage in the product

that it can produce most efficiently given all the products it could choose to produce.

• A nation is better off when it produces goods and services for which it has a comparative advantage.– According to the law of comparative advantage,

each person should produce the good for which he or she has a lower opportunity cost.

– Comparative advantage also mutually benefits both parties.

Comparative Advantage and Trade• Comparative advantage as the basis for trade is one of the most

important ideas in economics and also one of the least intuitive• Trade allows countries to obtain could for which they might

have a high opportunity cost. – As a result, one country can use the money it earns from

exporting to import other goods and services that it cannot efficiently produce itself.

• The growth of international trade has led to greater economic interdependence.– Because countries are interdependent, changes in one

country’s economy influences other countries.

Gains from Trade• Gains from trade are based on comparative

advantage, not absolute advantage• Specialization and trade increase productivity within a

nation and increase a nation’s output and standard of living.

• Everyone can benefit when people trade with one another. Not only can people enjoy a greater quantity of goods and services, but they can also enjoy a greater variety of goods.(faster economic growth)

• Nations have strong trade relations that led to increased political stability

So….if economists all agree that free trade is

such a great idea, why do so many people have

problems with the idea?

Barriers to Trade• Tariffs- Tax on imported goods or services• Reasons for tariffs– Raise tax revenues– Reduce consumption of the imported good or service

• Effect – Price of import rises, “cheaper” domestic goods become more attractive

Quota

• Limits the amount of an imported good allowed into the country

• Supply is decreased and price increases• Voluntary Export Restrictions (VER’s) are

similar

Other Barriers to Trade– Embargos-movement of goods–Goods are subjected to health inspections–Required to have a license to import– Some nations use health issues to restrict

trade–Nationalism and culture factors-some

countries prefer regional and traditional foods to foods grown elsewhere

Arguments for Protection

• Protectionists claim that without trade barriers, a country could become so specialized that it would become too dependent on other countries, which might result in severe shortages and even a decrease in national security in time of war.

• The infant industries argument is that new or emerging industries should be protected from foreign competition until they are able to compete against established industries in other countries.

• Protectionists claim that tariffs and quotas protect domestic jobs from cheap foreign labor.

Arguments for Protection

• Protectionists claim that limiting imports will keep American money in the United States.

• Protectionists believe that restrictions on imports reduce trade deficits, helping the balance of payments.

• Some countries protect certain products because of national pride.

• General Agreements on Tariffs and Trade (GATT)

• North American Free Trade Agreement (NAFTA)

• World Trade Organization

Trade agreements regulate international trade between two or more nations. An agreement may cover all imports and exports, certain categories of goods, or a single category. The United States is currently engaged in some 320 trade agreements with various nations.

Trade Agreements

GATT

• “Provisional” agreement (1948 – 1994)• Dramatic tariff reductions were negotiated in

a series of trade rounds• Grew from 23 to 123 countries

WTO• WTO created in the Uruguay trade round • Established in Geneva in 1995• 153 member countries• GATT was updated and still forms the legal

framework for WTO negotiations on the goods trade

• A worldwide organization whose goal is freer global trade and lower tariffs

NAFTA• Created to eliminate all tariffs and barriers

in the region (Canada, Mexico, US)• Ratified in 1994• Although there has been much

controversy, NAFTA has increased trade between the three nations

Foreign Exchange Rates and Currency Valuations

• Exchange rate – The rate at which the money of one country is traded

for the money of another• Values fluctuate, or “float,” depending on supply and

demand for each currency in the international market.

• National governments deliberately influence exchange rates

• Business transactions usually conducted in currency of the region where they happen.

Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 3-20

Fixed Exchange Rates• Fixed Exchange Rates:– Monetary policy is useless.– Fiscal policy is made stronger.

• To be successful, fixed exchange rates require consistency or coordination in these areas.– Multiple objectives within a country may require conflicting

policies, so priorities may be critically important.– Independent monetary policies are not possible.– Tax, interest rate, or inflation rate differences will lead to

capital flows that will undermine the currency fix.– Productivity and productivity growth differences affect

relative inflation rates.

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17-22

Floating Exchange Rates • In a floating (flexible) exchange rate system,

the value of a country’s currency in terms of other currencies can change depending on world market conditions.

• Under a floating exchange rate system, there is no government intervention to attempt to keep the exchange rate at a specific value.

• Today, most of the world uses a floating exchange rate system.

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Trade Surpluses and Deficits• When a country exports more than it

imports, it runs a trade surplus.

• A trade deficit is the situation when a country imports more than it exports.

•The trade-weighted value of the dollar is an index that shows the strength of the dollar against a group of major foreign currencies.•When the dollar weakens, export industries benefit and import industries suffer; the reverse is true when the dollar strengthens.•There is no net gain to the economy by having either a strong or a weak dollar, because in either case, while one sector of the economy is hurt, another is helped.

Value of Currency