WHY AND HOW NATIONS TRADE

Chapter 24, Lesson 1

Trade Between Nations

Individual nations do not always have the necessary resources to make the products their people need and want.

To solve this problem of scarcity, nations trade with one another.

Nations import, or bring into the country, goods produced in other nations.

They export, or sell to other nations, goods they produce.

Some less advanced economies, known as single-resource economies, specialize in a single export.

This makes them very vulnerable to price changes in the marketplace.

Comparable Advantage

The main reason countries trade is because of comparable advantage, the ability to produce something at a lower opportunity cost than another country can.

For instance, if a country can make 1 product in less time or for less money than another product, their time is better spent making more of the first product.

A country’s factors of production – natural resources, labor, capital, and entrepreneurs – often determine its comparable advantage.

For example, China has a large labor force, so they are better at manufacturing goods that require a large pool of labor.

The United States has abundant farmland, so we produce much of the world’s food.

Managing Trade

Because many consumers want low prices, many of the nation’s stores line their shelves with products from nations with low labor costs, such as China.

China can produce many goods more cheaply than the United States can.

However, when consumers buy these products, they are hurting American companies who are then forced to cut production and lay off workers.

Trade Barriers

Protectionism is the use of tactics that make imported goods more expensive than domestic goods.

A tariff is a tax on imports. It raises the cost of foreign goods to

make domestic ones more attractive.

An import quota limits the amount of a particular good that enters a country.

This allows domestic producers of the product to be able to compete.

A subsidy is a payment or other benefit given by government to help a domestic producer.

The problem with these methods is that they raise the prices on goods.

Free Trade Agreements

Most countries now try to reduce trade barriers, a policy known as free trade.

To increase trade, countries often join together with a few key trading partners to set up areas of free trade.

In 1994 the United States, Canada, and Mexico joined together in the North American Free Trade Agreement (NAFTA), creating the largest free trade zone in the world.

Since then, trade among the 3 nations has more than tripled.

Other Free Trade Organizations

The European Union (EU) includes 27 countries and is currently the largest economy in the world.

Most EU nations even share a common currency called the euro, making trade easier.

The African Union (AU) promotes unity among nations and economic development in Africa.

The Asia-Pacific Economic Cooperation (APEC) promotes free trade among members in that part of the world.

The World Trade Organization (WTO), formed in 1995, includes 153 member nations, oversees trade agreements, and tries to settle trade disputes among member nations.

Balance of Trade

The difference between the value of a nation’s imports and the value of its exports is the balance of trade.

When the value of a nation’s exports is greater than the value of its imports, it has a positive balance of trade, also known as a trade surplus.

This is good because when a country has a trade surplus for a long period of time, the value of its currency increases.

When a nation imports more than it exports, it has a negative balance of trade, also known as a trade deficit.

For period of long deficits, the demand for domestic goods decreases, so workers lose their jobs and the value of currency decreases.

Role of Currency and Exchange Rates

The value of one nation’s currency in relation to another is its exchange rate.

Nations like to carry out trade using their own currency.

For instance, if the United States has to pay for imports from Japan in yen, then they have to sell U.S. dollars to get it.

The higher supply of dollars in the market drives down the value of the dollar, so the United States much prefers to pay in U.S. dollars.