Unit+Six

=Unit Six=

__A. International Trade__
__-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 Brazil’s 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.
 * 1. Comparative Advantage**

- 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 country’s production possibilities curve. - Gains from trade are also determined by the //terms of trade// between two countries. Suppose that Canada chooses to exchange 1 ½ tons of steel for every ton of soybeans received from Brazil. The terms of trade would be 1 ½S = 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.
 * 2. Gains From Trade**
 * -** A country’s 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.


 * 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**__
- 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). - 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] - 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]
 * 1**.The current account, capital account, and the balance of payments
 * 2**. Exchange markets
 * 3**. How domestic and foreign economics affect the exchange rate

[|Dollar falls against Euro, Pound, Yen]

__C. **Domestic Monetary and Fiscal Policy and International Economics**__
- 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.
 * 1.** Income effects- Changes in taxation and government spending (the main components of fiscal policy), can effect the distribution of income in various ways.
 * 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.

-The difference between nominal and real/relative price is used to make up for inflation.
 * 2.** Price effects- Price stability can be achieved by implementing a budget surplus when inflation is high.

-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.
 * 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.