Unit Six

A. International Trade
1. Comparative Advantage
-The principal of comparative advantage states that total output will be largest when each good
produced by the nation that has the lowest opportunity cost to produce that good.
-Take, for example a hypothetical trade scenario between Canada and Brazil. Each country has
the option to produce either steel or soybeans, or a combination of both. However, both countries
could be better off if they specialized and traded afterwards. This is where comparative
advantage and absolute advantage come into play. Canada has an absolute advantage in both
soybeans and steel, being able to produce 30 tons of each good. The opportunity cost for Canada
to produce steel and soybeans is 1; for every ton of steel that is produced, a ton of soybeans must
be sacrificed in its place. Likewise, Brazil has an opportunity cost of 2/1 to produce steel, but
only 1/2 for soybeans. Since Brazils opportunity cost is less for soybeans, it has a comparative
advantage in producing soybeans. Brazil should produce soybeans and Canada should produce
steel. After specialization, the world output of soybeans and steel would be 20 tons and 30 tons
respectively.
2. Gains From Trade
- A countrys opportunity cost and production possibilities can be seen in the trading possibilities
line (curve) for that country. The graph of the hypothetical trade scenario between Canada and
Brazil (above) is an excellent example.
- By specializing on the basis of comparative advantage, and by exchanging goods produced by
the country with greater efficiency, two countries can achieve combinations of production far
beyond each countrys production possibilities curve.
- Gains from trade are also determined by the terms of trade between two countries. Suppose that
Canada chooses to exchange 1 tons of steel for every ton of soybeans received from Brazil.
The terms of trade would be 1 S = 1SB.
- Point A on the above graph shows that Canada originally chose to produce 12 tons of soybeans
and 18 tons of steel; After trading with Brazil however, Canada has reached point A (15 tons of
soybeans and 20 tons of steel) which was previously impossible.
3. Consequences of government intervention into international trade
Trade Barriers
Tariffs
-Excise taxes on imported goods. Tariffs exist for many goods, including alcohol from France,
cigarettes and cigars from Columbia, chocolate from Germany, etc.
Import Quotas
-Specifies the max amount of a good that may be imported by a country at any given time. These
quotas are a direct limitation on how many of a certain good a country can receive at any time,

and is executed by the government of the nation importing the goods.

Nontariff Barrier
-A licensing requirement that specifies unreasonable standards pertaining to quality and safety,
or unnecessary bureaucratic red tape that is used to restrict imports. (MCConnell and Brue 700)
Voluntary Export Restriction
-A trade barrier in which foreign countries voluntarily limit how much of a certain good is
exported from that country. (This is not to be confused with import quotas; Canada
restricting how much of its own steel it exports to Brazil, rather than Brazil limiting how
much steel it imports from Canada.)

B. International Finance
1.The current account, capital account, and the balance of payments
- A nation's balance of payments includes all transactions that take place between its residents
and the residents of all foreign nations (McConnell and Brue 712).
-The current account is a part of a nation's balance-of-payments account that records exported
and imported goods and services, net investment income, and net transfers (McConnell and Brue
712). Components of a Current Account
-The capital account is a part of a nation's balance-of-payments account that records foreign
purchases of assets within a nation, as well as the nation's purchases of assets from abroad
(MCConnell and Brue 714).
2. Exchange markets
- By trading goods/services, nations are trading currency. The exchange rate is determined by the
foreign exchange markets. Flexible exchange markets "float" their exchange rates according to
supply and demand. (Eric Dodge, Five Steps to a Five, 2005).
- An example of exchange rates: $1=500 colones, 500 colones=1/500 dollar. Try this really fun
currency converter!
Sample Graph: Changes in an exchange rate
3. How domestic and foreign economics affect the exchange rate
- Exchange rates can change based on many reasons: consumer tastes, relative incomes, relative
inflation, and speculation (Eric Dodge, Five Steps to a Five, 2005).
- Another important determinant is the difference in interest rates. Example: If the U.S.'s interest
rates decline, foreign investors don't want to invest their money in the U.S., therefore
depreciating the dollar relative to foreign currencies. This makes goods/services cheaper for
individuals abroad to buy U.S. products, increasing U.S. net exports (Eric Dodge, Five Steps to a
Five, 2005). How 2007 Changed the Foreign Exchange Market
Dollar falls against Euro, Pound, Yen

C. Domestic Monetary and Fiscal Policy and International

Economics

1. Income effects- Changes in taxation and government spending (the main components of fiscal
policy), can effect the distribution of income in various ways.
- Expansionary fiscal policy can include a deacrease in taxes, leading to a greater amount of
disposable income. It can also create an increase in aggregate demand which, if left unchecked,
will lead to inflation.
Crowding Out- Funding a budget deficit by realeasing government bonds can increase the
market interest rates. Government borrowing creates a higher demand for creditin the financial
markets. The lack of disposable income will cause aggregate demand to increase. This is the
opposite of the intended effect of budget deficit.
2. Price effects- Price stability can be achieved by implementing a budget surplus when inflation
is high.
-The difference between nominal and real/relative price is used to make up for inflation.
3. Interest rate effects- Part of a contractionary policy can include raising interest rates. A higher
interest rate will discourage borrowing and encourage saving, which will reduce the money
supply.
-In the U.S., the Federal Reserve can set the discount rate as well as participate in open market
operations in order to achieve a certain Federal funds rate, which has a significant effect on other
market interest rates.
-The governments of other countries may be able to set specific interest rates on loans and
savings accounts, as well as other financial assets.
user-14387

Interest Rates and Housing Market

BenKretschman Jan 2, 2008

http://www.youtube.com/watch?v=_WX7UQvnamE

Foreign Exchange Market

LizaGurley Dec 26, 2007
http://www.dailyfx.com/story/dailyfx_reports/daily_fundamentals/How_2007_Changed_the_For
eign_1198522005753.html
This article discusses how the presence of "cheap and easy" money in the year 2007 tempted
people to invest beyond a reasonable limit. In retrospect, many people became too frivilous with
their investments, taking on risk after risk. However, most soon found this notion to be
dissatisfying as their investments plummeted. This is going to negativley impact on the foreign
exchange markets. With people recognizing their mistakes of 2007, as well as the dwindling
USD/EURO exchange rate, they will be less likely to invest abroad. However, the article notes
that because of a slight surplus in some nations abroad, a few countries have made major
investments in American corporations (such as Singapore investing $4.4 billion in Merril
Lynch), thus improving the U.S. dollar worth.

US Dollar Worth
PaulD128 Dec 10, 2007
http://biz.yahoo.com/ap/071210/dollar.html?.v=2
We started talking about this in class today, and I found this article about the International
Money Demand. This proves my theory that we need to start exporting more, importing less and
reduce the supply of money. With all of this, we could greatly increase the value of our money.
Its time for a recession, and I think this proves that all prosperity has to come to an end.

rchan1 Dec 17, 2007

Paul, I would have to agree with you on this matter. Unfortunately, from what I can recall, the
US has always been weak against the Euro, Pound and Yen.

The article mentions that lowering interest rates can jump start an economy; however, even if
loans and mortgages become more affordable, the economy would be sure to fall into a
recession. By lowering interest rates, people no longer have a reason to save (incentives!). This
increases GDP and investment, but raises inflation. Also, banks do not have money to loan out
because everyone has already taken loans out. As a result, our economy falls into recession
where banks must then be forced to raise interest rates. But this is what you think we need right
(Paul)? A recession would certainly hurt the economy (though it's not like our economy is doing
poorly at the moment) in the beginning, but in the end, I believe it can increase our GDP output
and eventually raise the worth of our dollar. (I hope this makes sense...)

peytonrocks Dec 31, 2007

This stinks because foreign goods are going to cost more for us (such as Wiis) and due to the
growth in online shopping (1/3 of all things bought this Christmas season were bought online) it
means we're squandering more money. Our country should make an effort to produce more
goods and therefore export more as Pail said. I work hard at Foster's Grille and I want to be able
to buy more with my money. And as the value of my money goes down, others' money goes up
making them richer than me. What makes me wonder however, is how the Pound is worth more
than the Dollar. What in the world does England produce besides cool accents, nice manners, and
smart people like Mr. Jones? But anyway, instead of importing all our needs so we can continue
to sit back and let the rest of the world produce everything, we should get off our lazy rears and
stop living off government support. Make people get jobs.

rchan1 Jan 1, 2008

(172 words)

rachelw3 Jan 2, 2008

Peyton, in response to your query as to what England produces (other than cool accents, etc.), I
have two words: The Office. I know you are well aware of the fact that The Office originated
from the BBC (British Broadcasting Channel), and to be honest, I am astounded at your lack of
consideration of this important factor. Anyway, Office references aside, I agree that employment
needs to increase and people need to stop depending so much on government support. However,
in order for people to get jobs there has to actually be jobs available...

BenKretschman Jan 2, 2008

In order for there to be more jobs, people have to be wiling to work. Even if the government
creates new jobs, most people will turn their noses up at the salary. This is a product of the weak

dolalr. If the dollar was worth more relative to other countries then people would find it easier to
accept lower paying jobs. Just like in class a while ago, when a survey asked if you would rather
have $180,000 and everyone else has $200,000? Or would you rather have $100,000 and
everyone else have $80,000? The overwhelming majority chose the latter simply because man is
inherently greedy. We base our wealth on those around us. So, if the dollar could increase in
value then people would take lower paying jobs. But, in order for the dollar to increase in value,
people need to start taking lowering paying jobs. It's a double edged sword.

PaulD128 Jan 2, 2008

I think this is just what the economy needs: a shock. People have been too prosperous these last
few decades. Look at the rest of the world. Half the world is starving as we can afford to throw
our leftovers into the garbage. How many of us live in a upper middle class house and drive a
car?
We pride ourselves in our possessions and that's were we get kicked in the can. China lives well
by their historic standards because they know they will always have a market to sell to. If the
United States would stop buying all this "stuff" we wouldn't be in a national debt of $4 trillion.
After the Great Depression, people were careful. They didn't just go out and buy a new fandangle
TV set because they had the money; they waited until they were sure the sky wasn't going to
crash and burn on the economic market.
I am not saying that we need a Great Depression to solve our problems. In fact, that would
possibly be the worst thing to happen, considering how much of the world depends on our sales.
What I think we need is a reality check. When people see that their money is worth less then the
thought, they will want to save it for later.
We can look to Alpharetta as an example. Has anyone else notice how many new houses are
being built? A lot. How many of these are actually being sold? Not many. No one wants these
houses because as the market stands they're worth less than they were to build. Contractors get
these crazy ideas that if they build a million dollar house their going to make a fast one million
dollars. No. The truth be told, these houses don't sell because people can't afford them, or more
realistically they don't want them. Everyone knows the markets on the rise, so all the people have
to do is wait for it to drop. And drop is shall. The only real question is when. In my opinion, the
sooner, the better.