The Global Economy

“Is the world really flat?”

Global Trade Issues

Outsourcing jobsIllegal immigration – jobs takenMigration for jobsBalance of trade (trade deficit)Environment vs. economic growthPoverty in third world nations – does trade help or hurt?

Outsourcing vs. Insourcing

Trade Flows

Nations are linked by the exchange of:Trade flows = Goods and services

[exports (X) and imports (M)]

Resource flows = capital (production facilities) and labor move from nation to nation

Information and technology flows = info on prices, products, interest rates & investment opportunities; new technology

Financial flows = Money for imports, assets, interest on debts & foreign aid

Why Trade?

For resources we don’t produce ourselves

Climate and natural resource limitationsLack of skilled labor Lack of low cost laborLack of capital resources (factories, equipment, technology, etc.)

Why Trade?For political reasons

To help allies – strengthen relationsEX: U.S. and Taiwan in 1950’s

To show disapproval or force a change in political policies through embargo or boycott

EX: Boycott of S. Africa due to apartheid

No trade with China (1949-1972) and Cuba (1950-present)

Why Trade?For economic reasons

ABSOLUTE ADVANTAGE – when a nation can produce MORE of a good or service with the same or fewer resources

EX: Diamonds from S. AfricaCOMPARATIVE ADVANTAGE – when a nation can produce a good or service at the lowest opportunity cost

EX: wheat from U.S.

Comparative Advantage

Specialization – allows nations with the lowest opportunity cost to do what they do best, then tradeArbitrage – buy low and sell highAll participants in a voluntary exchange will benefitAllows total output to increaseIllustrated with PPC

AvocadosAvocados 90

60

Soybeans Soybeans

24 33

15 30 9 19

MEXICO U.S.

Comparative Advantage

Graph indicates that when self sufficient……

Mexico produces 24 avocados & 9 soybeans when most efficientU.S. produces 33 avocados & 19 soybeans when most efficient

To Find Opportunity cost = take max production #, put in fraction & reduce to show ratio

Comparative Advantage

To Find Opportunity cost for Mexico = take max production #, put in fraction & reduce

60 avocados/15 soybeans is an opportunity cost of 4 tons of avocados for each additional 1 ton of soybeans (1s=4a)

AND 15 soybeans/60 avocados =¼ ton soybeans for each additional 1 ton of avocados (1 a = ¼ s)

Comparative Advantage

To Find Opportunity cost for U.S. = take max production #, put in fraction & reduce

90 avocados/30 soybeans is an opportunity cost of 3 tons of avocados for each additional 1 ton of soybeans (1s=3 a)AND 30 soybeans/90 avocados = 1/3 ton soybeans for each additional 1 ton of avocados (1 a = 1/3 s)

Comparative Advantage

After determining opportunity cost for each nation – compare them to find the “lowest op cost” – that shows what they should specialize in & trade Mexico has the advantage in avocados (1/4 is less “cost” than 1/3 tons of soybeans)U.S. has the advantage in soybeans

(3 is less “cost” than 4 tons of avocados)

Gains from trade

When Mexico specializes in avocados, they produce 60 tonsWhen the U.S. specializes in soybeans, they produce 30 tonsWithout trade, the maximum production (by both nations combined) would be:

24 + 33 = 57 tons of avocados (gain of 3 tons) 9 + 19 = 28 tons of soybeans (gain of 2 tons)

Trade Barriers

Tariff – tax on imports (revenue & protective)

Quota – limit on number of imports Informal barriers – licenses, fees, health inspections, & regulations on transportation

Cultural and language differences

Protectionism vs. Free Trade

Pro Protectionism – National defense (keep tech safe)Avoid dependency on other nations (ex:oil)Protect jobs (keep $$ & jobs at home)Infant industries need time to developKeep balance of trade (exports = imports)

Protectionism vs. Free Trade

Pro Free TradeCompetition forces producers to lower prices & provide higher quality Trade raises the standard of living for all partiesMore efficiency when businesses specialize & trade = higher profits for owners Lost jobs are replaced with others Barriers lead to retaliation

Balance of Trade

Difference between exports and imports

(ideal is to have equal amounts; more exports = trade surplus; more imports = trade deficit)Surplus sounds good; deficit sounds bad; but this is not always trueU.S. has had a negative trade balance since 1981 – economists do not agree on how serious this is!

U.S. Trade Deficit for over 20 yrs

Balance of Trade

Balance of payments is based on:Credits (value of things sold abroad):

Goods & servicesU.S. securities (Treasury bonds or stocks)Factories or businesses in the U.S.Interest owed to U.S. citizens for investments abroad

Balance of Trade

Debits (value of things bought from firms abroad)

Goods and servicesForeign securities (stocks in foreign businesses)

Factories or businesses abroadInterest paid to foreign citizens on their investments here

Balance of Payments Account

There are two main accounts – Current Accounts (CA) & Financial Accounts (FA) previous“Capital Account”

If an account is positive it is said to have a surplus; if negative = a deficitThe overall account must be balanced (or total zero) CA + FA = zero

Balance of Payments AccountCurrent Account (CA) trade in goods & services:

Exports of goods & services + (plus)Imports of goods & services - (minus)

Financial Account (FA) summarizes trade in assets

U.S. assets owned by foreigners + (plus)Foreign assets owned by U.S. - (minus)

1999 Changes to BOT Categories

Old Current Account became 2 accounts:

the “New Current Account” –G & S; Income pmts & receiptsand the “New Capital Account” –account to record capital transfers

(ex: assets a migrant brings when moving here or debt forgiveness);

It is a small account for U.S., but more impt for other nations

1999 Changes to BOT Categories

Old Capital Account is now the “New Financial account” – trade in assets2008 Macro AP Exam had question using the terms: “Capital & Current Accounts” which was confusing to students (because they had not learned BOT or learned the new terms & didn’t know the old ones!)

Foreign Exchange Rates

Exchange rate – price of one currency in terms of another (multiply foreign price by exchange rate to get U.S. price)

Fixed rate – rate of exchange stays the same; in past basis was goldFlexible rate (floating) – based on supply and demand for each currency

Foreign Exchange Rates

Flexible rates – began in 1971 when U.S. went off the gold standard U.S. imports increased and foreigners were gaining U.S. dollars & exchanging them for U.S. goldForeign exchange market - wherever one currency is exchanged for another

Foreign Exchange

Appreciation (strong dollar) – dollar buys more of another currency & results in less expensive imports and more expensive exports (SID)Depreciation (weak dollar) – dollar buys less of another currency & results in more expensive imports and less expensive exports (WES)

Foreign Exchange $ price for yen

$/Y

Yen price for $

Y/$

Qty of yen

Qty of $

S

D

S

D

Supply of yen from Japanese importers who must exchange them for $$ to buy U.S. goods

Demand for yen by U.S. importers who need them to buy Japanese goods

Foreign ExchangeCauses of S & D change - shifts (leads to exchange rate change):

Incomes go up or down (can buy more or less of foreign goods)

TastesRelative price level (inflation in one nation makes foreign goods cheaper)Real Interest Rates (want to earn on financial assets abroad if rates are higher)

Foreign Exchange

Must practice the supply and demand graphs for exchange rates PRACTICE – PRACTICE – PRACTICE!!!

AP Problem Areas – Increasing Questions on the Exam

Comparative Advantage problems in FRQ’sFOREX graphs & resulting changes in currency values, export/imports BOT questions