Chapter 17 & 18
Answer the following from the Problems Appendix in the back of your textbook on pp. 337, and upload your answers through Blackboard:Chapter 17: Questions 9 and 10Chapter 18: Questions 1 and 2All cited information and refenences must be in APA formatTextbook: McEachern, W. A. (2015). ECON macroeconomics (4th ed.). Stamford, CT: Cengage Learning.
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UNIT VIII STUDY GUIDE
International Economy
Course Learning Outcomes for Unit VIII
Upon completion of this unit, students should be able to:
8. Analyze the international economy through trade interdependences and financial interactions.
Reading Assignment
Chapter 17:
International Trade
Chapter 18:
International Finance
Unit Lesson
International economics and world economy are some words that perhaps strike fear in our hearts as we wrap
up our study of macroeconomics. However, keep in mind that the same general principles of supply and
demand, as well as price of money hold true. It is not much different than the study of U.S. economics.
The laws of supply and demand still hold true. The equilibrium price for foreign money is based on the supply
and demand for that currency in U.S. dollar terms. The supply and demand for foreign exchange (foreign
money) is influenced by the interest rates, prices, and relative income, just like in the U.S. macroeconomics,
except now on a global basis.
Money in the international economies serves the same purpose, and that is to facilitate market exchanges for
the goods and services demanded and supplied internationally. The major difference in macroeconomics
internationally is how to set the value of the various currencies for the various countries. For example, how
much is a U.S. dollar worth in Euros (the currency of the European Union)?
Foreign currencies have value because they are used to obtain the goods and services from another country.
Keep in mind that due to the principle of comparative advantage, just like in the U.S., countries have
comparative advantage in certain areas. For example, in parts of India and China there is plenty of labor
available to make the clothes that we wear. Whereas, in the U.S., due to automation, there is a comparative
advantage in growing of food and providing of knowledge work. It is to the advantage of these countries to
exchange for the benefit of all. These foreign currencies then are used to exchange goods and services. The
value or price is set for the goods and services by the supply and demand for those goods and services.
The balance of payments summarizes the countrys international trade and is measured in deficits and
surpluses. If the balance of payments gets out of balance, then equilibrium is achieved by changes in the
exchange rate. Keep in mind that producers of goods and services from the U.S. do not want the value of
exports to rise in price, since due to law of supply and demand, at a higher price less goods and services will
be demanded. In addition, travelers and importers do not like it when a currency falls in value because travel
becomes much more expensive to other countries, and the price of imports increases, which means one can
purchase less goods and services at the same price.
Let us now consider one macroeconomic situation, and that is the U.S. as a debtor. As you have likely read in
the newspaper or heard on the news, the U.S. is a debtor nation. What does this mean in terms of
macroeconomics? Since the mid-1980s, the U.S. has consistently run a trade deficit. This means that the
U.S. has much less money or assets abroad, and other nations have more money or assets in the U.S. This
makes the U.S. a debtor nation.
BBA 2401, Principles of Macroeconomics
1
What might be some ramifications of this situation on international macroeconomics?
The U.S.GUIDE
must be very
UNIT x STUDY
careful in all of its domestic policies. If foreign entities all of a sudden feel threatened
Title by a policy intervention,
then they could take their assets, leave, and hurt the U.S. economy very bad and cause major disruptions. On
the other hand, the continual investment by other countries into the U.S. does indicate a positive level of
confidence in the stability of the U.S. economy, or the investments in assets would not continue to occur.
Keep in mind, the foreign investors are taking on major risk because if the value of the U.S. dollar falls, then
the value of their assets falls as well, and a strong dollar increases the value of their assets.
Now let us drill down to a specific country, Russia, and take a look at how the Russian economy has changed
in recent times since the collapse of the Soviet Union. One has to consider that this country actually has a
relatively new economy and has had some growing pains.
Russia joined the World Trade Organization (WTO) in 2012, and one can just imagine what the potential
means for the worlds economies as Russia agrees to abide by standards and rules of the WTO. There
should be much greater transparency, a leveling of the playing field, and risk reduction in trade
(Schewe, 2013).
Russia prior to the collapse of the Soviet Union in 1991:
It is probably Russian history in international trade which had led to the overall perception that,
despite being one of the major world powers over the nineteenth and twentieth centuries, the Western
world has never seemed to accept Russia as a major trade power. While, for the earlier times, this
assessment is mostly attributed to the backwardness of the system under the Tsar regimes, for the
later Soviet Union it is described as a result of the inherent deficiencies of the political and economic
structure of the communist system. Given that international trade had played only a minor role in
Russian history, it is not astonishing that the number of trade agreements concluded before 1991 was
very limited. (Schewe, 2013, para. 13)
Russia after 1991:
Despite a banking and economic crisis after 1998, during the last decade Russia has managed to
achieve high gains for the export of commodities mainly in the petro-industry. This development was
favoured by the worldwide dependency on energy. In particular, the energy-intense economy of the
EU contributed to the rapid economic growth of Russia since 2000. Notwithstanding overall growth,
the economic crisis from 2008 led to a strong decrease of the Russian economy, revealing the risks
of its dependency on energy exports. Today, for its position as the world’s top producer of oil and gas
Russia has achieved a high trade surplus. Russia’s most important trading partner is the EU – which
imports 49.4% of Russia’s exports, of which 80% are attributed to oil and gas. The second trading
partner of Russia is China, with 5.3% whereas the US only rates sixth in regard to imports, among
which 90% account to oil and gas. (Schewe, 2013, para. 21)
As one considers international trade, one cannot ignore the WTO that Russia has joined and all of the
potential advantages for world trade. At the same time, with recent world events, one sees that monetary
factors are also subject to punishments and restrictions on trade due to political changes, such as Russian
involvement in the Ukraine. It is a delicate, but interesting, economic study to see how economies are affected
by world events, and world events cannot be separated from economics effects.
References
Schewe, C. J. (2013). Russia in the WTO: The bear on a leash? Russia in international trade disputes and the
added value of a WTO membership. Journal of World Trade, 47(6), 1171-1201. Retrieved from
http://search.proquest.com/docview/1467948682?accountid=33337
BBA 2401, Principles of Macroeconomics
2
Suggested Reading
UNIT x STUDY GUIDE
Title
Click here for the Chapter 17 Presentation in PowerPoint form. Click here to access a PDF version of the
presentation.
Click here for the Chapter 18 Presentation in PowerPoint form. Click here to access a PDF version of the
presentation.
European Commission. (2014). The euro. Retrieved from
http://ec.europa.eu/economy_finance/euro/index_en.htm
Office of U.S. Trade Representative. (2014). Home. Retrieved from http://www.ustr.gov/
Learning Activities (Non-Graded)
Review the links to learn more about country specific economic trade activity in a country other than the U.S.
Adding international economic knowledge can prove to be a valuable knowledge commodity.
Exports
http://legacy.intracen.org/appli1/TradeCom/TP_EP_CI.aspx?RP=643&YR=2009
Imports
http://legacy.intracen.org/appli1/TradeCom/TP_IP_CI.aspx?RP=643&YR=2008
http://legacy.intracen.org/appli1/TradeCom/RS_TP_CI.aspx?RP=643&YR=2009
International Trade Centre
http://www.intracen.org/
TPI
http://legacy.intracen.org/appli1/TradeCom/TPIC.aspx?RP=643&YR=2009
BBA 2401, Principles of Macroeconomics
3
Chapter 17
ECON4 William A. McEachern
International
Trade
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1
The Gains from Trade
Law of comparative advantage
The individual with the lowest opportunity
cost of producing a particular good
Should specialize in that good
Each country specializes
In making goods with the lowest
opportunity cost
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
2
The Gains from Trade
U.S. exports
$2.2 trillion (14% of GDP) in 2012
Services (29% of U.S. exports)
U.S. imports
$2.7 trillion (17% of GDP) in 2012
Industrial supply (27% of U.S. imports)
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
3
Exhibit 1
Composition of U.S. Exports and Imports in 2012
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
4
The Gains from Trade
U.S. trading partners, 2010
Top 10 destinations for merchandise
exports
Canada, Mexico, China, Japan, United
Kingdom, Germany, Brazil, South Korea, the
Netherlands, and France
Top 10 sources of merchandise imports
China, Canada, Mexico, Japan, Germany,
United Kingdom, South Korea, France, India,
and Taiwan
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
5
Production Possibilities without Trade
Production possibilities
With existing resources
No trade
Production possibilities = consumption
possibilities
Production possibilities frontiers
Straight lines
Different slopes different opportunity
costs
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
6
Exhibit 2
Production Possibilities Schedules for the U.S. and Izodia
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7
Exhibit 3
Production Possibilities Frontiers for the United States and
Izodia Without Trade (millions of units per day)
(b) Izodia
(a) United States
500
Food
400
300
200
100
U1
600
500
U2
400
U3
Food
600
U4
300
200
U5
100
U6
0
100 200 300 400 Clothing
0
I1
I2
I3
I4
I5
I6
100 200 300 400 Clothing
Panel (a) shows the U.S. production possibilities frontier; its slope indicates that the
opportunity cost of an additional unit of clothing is 2 units of food. Panel (b) shows
production possibilities for Izodia; an additional unit of clothing costs 1/2 unit of food.
Clothing has a lower opportunity cost in Izodia.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
8
Consumption Possibilities
Gains from specialization and trade
Each country should specialize
Producing the good with the lower
opportunity cost
Terms of trade
How much of one good exchanges for a
unit of another good
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
9
Consumption Possibilities
Consumption possibilities frontier
Possible combinations of goods
As result of specialization and exchange
Depend on relative preferences
For each good
World production must equal world
consumption
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
10
Exhibit 4
Production (and Consumption) Possibilities Frontiers With
Trade (millions of units per day)
(b) Izodia
(a) United States
600
600
500
500
U
300
200
U4
300
100 200 300 400 Clothing
I
200
100
100
0
400
Food
Food
400
0
I3
100 200 300 400 Clothing
If Izodia and the United States can specialize and trade at the rate of 1 unit of clothing for 1 unit of
food, both can benefit as shown by the blue lines. By trading with Izodia, the U.S. can produce
only food and still consume combination U, which has more food and more clothing than U4.
Likewise, Izodia can attain preferred combination I by trading some clothing for U.S. food.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
11
Reasons for Specialization
Differences in resource endowments
Create differences in opportunity cost
Countries export goods
Produce more cheaply
Countries import
Products unavailable domestically
Cheaper elsewhere
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
12
Exhibit 5 U.S. Production as a Percentage of U.S.
Consumption for Various Resources
If U.S. production is less than 100 percent of U.S. consumption, then imports make up the
difference. If U.S. production exceeds U.S. consumption, then the amount by which
production exceeds 100 percent of consumption is exported.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
13
Reasons for Specialization
Economies of scale
Firms produce more
Reducing average costs
Differences in tastes
Differences in consumption patterns
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
14
Consumer and Producer Surplus
Demand: marginal benefit
Consumer surplus
Difference between what consumer
would pay and what they pay
Supply: marginal cost
Producer surplus
Difference between actual amount
received and what they would accept
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
15
Exhibit 6
Consumer Surplus and Producer Surplus
Price per pound
$3.00
Consumer
surplus
2.00
1.00
0.50
0
S
Producer
surplus
D
60 Apples
(pounds per day)
Consumer surplus, shown by the blue
triangle, indicates the net benefits
consumers reap from buying 60 pounds
of apples at $1.00 per pound. Some
consumers would have been willing to
pay $3.00 or more per pound for the
first few pounds. Consumer surplus
measures the difference between the
maximum sum of money consumers
would pay for 60 pounds of apples and
the actual sum they pay. Producer
surplus, shown by the gold triangle,
indicates the net benefits producers
reap from selling 60 pounds at $1.00
per pound. Some producers would have
supplied apples for $0.50 per pound or
less. Producer surplus measures the
difference between the actual sum of
money producers receive for 60 pounds
of apples and the minimum amount they
would accept for this amount.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16
Trade Restrictions
Tariff: Tax on imports
Specific: $ amount per unit
Ad valorem: Percentage per unit
Effects
Loss of consumer surplus
Increase in producer surplus
Increase in government revenue
Net loss in domestic social welfare
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
17
Exhibit 7
Effect of a Tariff
Price
per pound
S
$0.15
a
0.10
b
c
d
f
0
20 30
D
60 70
Sugar (millions of pounds per month)
At a world price of $0.10 per pound,
U.S. consumers demand 70 million
pounds of sugar per month, and U.S.
producers supply 20 million pounds
per month; the difference is imported.
After the imposition of a $0.05 per
pound tariff, the U.S. price rises to
$0.15 per pound. U.S. producers
supply 30 million pounds, and U.S.
consumers cut back to 60 million
pounds. At the higher U.S. price,
consumers are worse off; their loss of
consumer surplus is the sum of areas
a, b, c, and d. The net welfare loss to
the U.S. economy consists of areas b
and d.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
18
Trade Restrictions
Import quotas: Legal limit on the amount
of a commodity that can be imported
Target imports from certain countries
Effects
Raise the US price above the world price
Reduce quantity below the free-trade level
Lower consumer surplus
Increase in producer surplus
Net loss in domestic social welfare
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
19
Exhibit 8
(a)
Price
per pound
Price
per pound
Effect of a Quota
S
S
e
$0.15
(b)
S
$0.15
a
0.10
0.10
b
c
d
D
D
0
20
S
Sugar
50
70
(millions of pounds per month)
0
Sugar
20 30
60 70
(millions of pounds per mon …
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