Week 13

Colombia produces coffee with less labor and land than any other country; it therefore necessarily has: (13.2)

an absolute advantage in coffee production

current account (13.1)

- A broad measure of the balance of trade that includes trade in goods and services, as well as international flows of income and foreign aid. - The current account summarizes U.S. trade in currently produced goods and services. Exports are a plus and imports are a minus.

key ideas (13.2)

- A country has an absolute advantage in those products in which it has a productivity edge over other countries; it takes fewer resources to produce a product. - A country has a comparative advantage when it can produce a good at a lower cost in terms of other goods. - By specializing in a good that it gives up the least to produce, a country can produce more and offer that additional output for sale. - In the case of intra-industry trade between economies with similar income levels, the gains from trade come from specialized learning in very particular tasks and from economies of scale. - Tariffs are placed on imported goods as a way of protecting sensitive industries, for humanitarian reasons, and for protection against dumping.

economies of scale (13.2)

- Economies of scale refers to the idea that, for a time, larger plant sizes will lead to lower unit costs. An increase in inputs where there are economies of scale will lead to a more than proportionate increase in output. - labor specialization and efficient capital lead to economies of scale

intra-industry trade (13.2)

- International trade of goods within the same industry. - It stems from the division of labor leads to learning, innovation, and unique skills; and economies of scale.

value chain (13.2)

- The value chain is how a good is produced in stages. Automobiles demonstrate this well, as their parts come from all over the world, and can be assembled in the U.S.

comparative advantage (13.2)

- When a country can produce a good at a lower cost in terms of other goods; or, when a country has a lower opportunity cost of production. - Trade really occurs because of comparative advantage. - A nation will specialize in the production of a product that it is the lowest (opportunity) cost producer of.

absolute advantage (13.2)

- When one country can use fewer resources to produce a good compared to another country; when a country is more productive compared to another country. - Absolute advantage can be the result of a country's natural endowment. For example, extracting oil in Saudi Arabia is pretty much just a matter of "drilling a hole." Producing oil in other countries can require considerable exploration and costly technologies for drilling and extraction if they have any oil at all.

x = m (13.1)

- exports = imports - net exports = 0

point (13.1)

- if a country has a current account deficit, they will have a capital account surplus cuz their net capital outflow is negative - if a country has a current account surplus, they will have a capital account deficit cuz their net capital outflow is positive

positive net capital outflow (13.1)

- means that a country invests outside more than other countries invest inside it - net capital inflow is negative

current account deficits/surpluses (13.1)

A current account deficit means that the country is a net borrower from abroad. Conversely, a positive current account balance means a country is a net lender to the rest of the world. An inflow and outflow of foreign capital does not necessarily refer to a debt that governments owe to other governments (although government debt may be part of the picture).

Can a nation's comparative advantage change over time? What factors would make it change? (13.2)

A nation's comparative advantage can change over time. Comparative advantage is considered dynamic, which means that it can evolve and change over time as new skills are developed and as the value chain is split up in new ways. Therefore, counties must be flexible in response to ongoing changes in comparative advantage.

State whether each of the following events involves a financial flow to the U.S. economy or away from the U.S. economy: Export sales to Germany (13.1)

An export sale to Germany involves a financial flow from Germany to the U.S. economy.

State whether each of the following events involves a financial flow to the U.S. economy or away from the U.S. economy: Foreign aid from the U.S. government to Egypt (13.1)

Foreign aid from the United States to Egypt is a financial flow from the United States to Egypt.

State whether each of the following events involves a financial flow to the U.S. economy or away from the U.S. economy: Imported oil from the Russian Federation (13.1)

Importing oil from the Russian Federation means a flow of financial payments from the U.S. economy to the Russian Federation.

State whether each of the following events involves a financial flow to the U.S. economy or away from the U.S. economy: Japanese investors buying U.S. real estate (13.1)

Japanese investors buying U.S. real estate is a financial flow from Japan to the U.S. economy.

balance of trade (13.1)

The gap, if any, between a nation's exports and imports.

Trade surpluses and trade deficits can be __________________ for an economy in certain circumstances. (13.1)

can be either beneficial or harmful

A country's current account balance refers to a broad measure of the balance of trade that includes: (13.1)

goods and services, international flows of income, and foreign aid

According to international trade theory, a country should: (13.2)

import goods in which it has a comparative disadvantage

An economy with a larger involvement in foreign trade: (13.1)

is more likely to suffer a larger trade imbalance

trade deficits (13.1)

the amount by which the cost of a country's imports exceeds the value of its exports.

trade surplus (13.1)

the amount by which the value of a country's exports exceeds the cost of its imports.

production matrix (13.2)

Refer to Figures 2+3!!! - This looks pretty intensive, but it's not. You're going to create a 2x2 matrix of two nations (see Figure 2) with the maximum output of two goods (Keep It Simple: the kiss method). Then for each nation, divide the maximum of one product into the max amount of the other product to get the domestic opportunity cost of one product in terms of the other. If opportunity cost ratios in the two nations are not constant (if there is increasing costs), specialization may not be complete. - For example, the slope of the production possibility frontier illustrates the opportunity cost of producing oil in terms of corn. Using all its resources, the United States can produce 50 barrels of oil or 100 bushels of corn; therefore, the opportunity cost of one barrel of oil is two bushels of corn—or the slope is 1/2. Thus, in the U.S. production possibility frontier graph, every increase in oil production of one barrel implies a decrease of two bushels of corn. Saudi Arabia can produce 100 barrels of oil or 25 bushels of corn. The opportunity cost of producing one barrel of oil is the loss of 1/4 of a bushel of corn that Saudi workers could otherwise have produced. In terms of corn, notice that Saudi Arabia gives up the least to produce a barrel of oil (as shown in Figure 3). - Since Saudi Arabia gives up the least (in terms of corn) to produce a barrel of oil, it has a comparative advantage in oil production. The United States gives up the least (in terms of oil) to produce a bushel of corn, so it has a comparative advantage in corn production.

point (13.2)

Remember, absolute advantage simply compares the productivity of a worker between countries. It answers the question, "How many inputs do I need to produce shoes in Mexico?" Comparative advantage asks this same question slightly differently. Instead of comparing how many workers, it takes to produce a good, it asks, "How much am I giving up to produce this good in this country?" Another way of looking at this is that comparative advantage identifies the good for which the producer's absolute advantage is relatively larger, or where the producer's absolute productivity disadvantage is relatively smaller.

trade deficit w/China (13.1)

The U.S. also has an enormous trade deficit with China as it imports more and more goods and services from them. China's standard of living is still low, relatively speaking, which means they do not yet have a large demand for imported items. China also has a fixed exchange rate, which prevents their currency, the yuan, from appreciating relative to other currencies. This continues to make U.S. imports more expensive in China which further reduces the demand.

State whether each of the following events involves a financial flow to the U.S. economy or away from the U.S. economy: Returns being paid on past U.S. financial investments in Brazil (13.1)

The issue here is not U.S. investments in Brazil, but the return paid on those investments, which involves a financial flow from the Brazilian economy to the U.S. economy.

point (13.1)

The second component of the balance of payments summarizes the international asset transactions. The capital and financial account consists of the capital account, which mainly measures debt forgiveness, and the financial account, which deals with international purchases and sales of real or financial assets.

capital outflow (13.1)

There is a capital outflow from the U.S. when an investor in the U.S. buys a bond issued by a foreign company or government or when a U.S. firm builds a factory in another country.

capital inflow (13.1)

There is capital inflow into the U.S. when an foreign investor buys a bond issued by a U.S. firm or by the government or when a foreign firm builds a factory in the U.S.

unilateral transfer (13.1)

- "One-way payments" that governments, private entities, or individuals make that they sent abroad with nothing received in return. - This includes foreign aid, retirement funds paid to U.S. citizens living abroad, and money sent by immigrants back to their native country.

Balance of payments flow chart part 1(13.1)

- Refer to Figure 5!!! The flow chart below (Figure 5) shows shows the flow of goods and services and payments between the United States and the rest of the world. The top line shows U.S. exports of goods and services, while the second line shows financial payments from purchasers in other countries back to the U.S. economy. The third line then shows U.S. imports of goods, services, and investment, and the fourth line shows payments from the home economy to the rest of the world. Flow of goods and services (lines one and three) show up in the current account, while we find flow of funds (lines two and four) in the financial account.

tariffs (13.2)

- Taxes that governments place on imported goods. - Low-income nations benefit more from trade than high-income nations. Small gains per year add up. Not only do we gain income from trade, but also more products to choose from (increased competition), new knowledge, technology, finance, and law. - Even though a nation gains from trade as a whole, some domestic industries may be hurt by trade and some industries may need to be maintained even if they are not cost effective for reasons such as national security or defense.

key ideas (13.1)

- The trade balance measures the gap between a country's exports and its imports. - In most high-income economies, goods comprise less than half of a country's total production, while services comprise more than half. - The current account balance includes the trade in goods, services, and money flowing into and out of a country from investments and unilateral transfers. - The United States developed large trade surpluses in the early 1980s, swung back to a tiny trade surplus in 1991, and then had even larger trade deficits in the late 1990s and early 2000s. - International flows of goods and services are closely connected to the international flows of financial capital. - A recession tends to increase the trade balance (meaning a higher trade surplus or lower trade deficit), while economic boom will tend to decrease the trade balance (meaning a lower trade surplus or a larger trade deficit).

splitting up the value chain (13.2)

- When one country can use fewer resources to produce a good compared to another country; when a country is more productive compared to another country. - In producing a car, many parts make up that one car. Many of those parts are produced in different parts of the world to take advantage of the specialization of skills. For example, transmissions can be produced in Japan, France, Mexico, Hungary, China, Germany, while engines can be produced in Canada, Germany, Hungary, and the U.S. - This is known as splitting up the value chain where many of the different stages of producing a good happen in different geographic locations.

scenario (13.1)

- if we are in trade deficit w/China, China may have excess cash while we don't have much - that could affect financial/capital account - our inflows could be greater than our outflows for f+c account, while China's inflows could be less than its outflows for f+c account

financial account (13.1)

- international purchases and sales of real or financial assets - The international flows of money that facilitates trade and investment

capital account (13.1)

- mainly measures debt forgiveness - capital account is the third component of the balance of payments - records relatively minor transactions, such as migrants' transfers and sales and purchases of non-produced, non-financial assets (i.e. copyright, patent, right to natural resources, etc.)

balance of payments statement (13.1)

- organized into two main categories - the current account and the capital and financial account - current account balance is the sum of the trade balances of goods, services, income receipts and payments, and unilateral transfers - trade deficits are shown as negative - trade surpluses are shown as positive - also included in the current account is income payments, which represents the difference between (1) the interest and dividend payments foreigners paid U.S. citizens and companies for services provided (money flowing into the U.S.), and (2) the interest and dividends the U.S. citizens and companies paid for the services provided by foreign capital invested here (money flowing out of the U.S.).

balance of payments (13.1)

- sum of all international financial transactions taking place between a nation's residents and the residents of foreign nations - transactions primarily fall into either international trade or international asset exchange categories.

point (13.2)

- with the way the questions are written you can't have a comparative advantage in more than one product

What has caused U.S. trade deficits? (13.1)

In recent years, the U.S. has experienced record large trade deficits, reaching a record high deficit of $762 billion in 2006, an amount equal to 5.8% of GDP (attributed to: https://files.stlouisfed.org/files/htdocs/publications/es/07/ES0724.pdf (Links to an external site.)). There are several causes to these deficits. During 2002-2007, the U.S. economy grew at a faster pace than many of its trading nations. This growth enabled Americans to increase their demand for imports. The implications of the continued trade deficits are serious. It reflects the fact that we continue to consume far more of the world's resources than we produce and have increased indebtedness to foreign entities. Notice that the deficit did peak in 2006 and since then has declined somewhat, mainly due to the recession of 2008-2009. During the recession, the demand for both domestic and imported goods and services declined dramatically. It remains to be seen what effect the current recovery will have on future trade deficits.

point (13.1)

In the short run, whether an economy is in a recession or on the upswing can affect trade imbalances. A recession tends to make a trade deficit smaller, or a trade surplus larger. While a period of strong economic growth tends to make a trade deficit larger, or a trade surplus smaller.

In France it takes one worker to produce one sweater, and one worker to produce one bottle of wine. In Tunisia it takes two workers to produce one sweater, and three workers to produce one bottle of wine. Who has the absolute advantage in production of sweaters? Who has the absolute advantage in the production of wine? How can you tell? (13.2)

In this example, France has an absolute advantage in the production of both sweaters and wine. You can tell because it takes France less labor to produce a unit of the good.

If you observed a country with a rapidly growing trade surplus over a period of a year or so, would you be more likely to believe that the economy of that country was in a period of recession or of rapid growth? Explain. (13.1)

It is more likely that the economy is in recession, since the prices of its goods and services would be falling and attracting foreign buyers.

point (13.2)

Refer to Figure 4!!! - Since the post-trade consumption point D is beyond its production possibility frontier, Saudi Arabia has gained from trade. - It will be mutually beneficial to both countries if the comparative costs of producing the two products within the two nations differ. The comparative cost looks at what each country must give up to produce one more unit of the other product. This allows each nation to profit from the lower opportunity costs, and use fewer resources.

Balance of payments flow chart part 2 (13.1)

Refer to Figure 5!!! The bottom four lines show the flows of investment income. In the first of the bottom lines, we see investments made abroad with funds flowing from the home country to the rest of the world. Investment income stemming from an investment abroad then runs in the other direction from the rest of the world to the home country. Similarly, we see on the bottom third line, an investment from the rest of the world into the home country and investment income (bottom fourth line) flowing from the home country to the rest of the world. We find the investment income (bottom lines two and four) in the current account, while investment to the rest of the world or into the home country (lines one and three) is in the financial account. This figure does not show unilateral transfers, the fourth item in the current account.

In Germany, it takes three workers to make one television and four workers to make one video camera. In Poland, it takes six workers to make one television and 12 workers to make one video camera. a. Who has the absolute advantage in the production of televisions? Who has the absolute advantage in the production of video cameras? How can you tell? b. Calculate the opportunity cost of producing one additional television set in Germany and in Poland. (Your calculation may involve fractions, which is fine.) Which country has a comparative advantage in the production of televisions? c. Calculate the opportunity cost of producing one video camera in Germany and in Poland. Which country has a comparative advantage in the production of video cameras? d. In this example, is absolute advantage the same as comparative advantage, or not? e. In what product should Germany specialize? In what product should Poland specialize?

a. In Germany, it takes fewer workers to make either a television or a video camera. Thus Germany has an absolute advantage in the production of both goods. b. Producing an additional television in Germany requires three workers. Shifting those three German workers will reduce video camera production by 3/4 of a camera. Producing an additional television set in Poland requires six workers, and shifting those workers from the other good reduces output of video cameras by 6/12 camera, or 1/2. Thus, the opportunity cost of producing televisions is lower in Poland, so Poland has the comparative advantage in the production of televisions. (Note: Do not let the fractions like 3/4 of a camera or 1/2 of a video camera bother you. If either country was to expand television production by a significant amount-that is, lots more than one unit-then we will be talking about whole cameras and not fractional ones.) You can also spot this conclusion by noticing that Poland's absolute disadvantage is relatively lower in televisions, because Poland needs twice as many workers to produce a television but three times as many to produce a video camera, so the product with the relatively lower absolute disadvantage is Poland's comparative advantage. c. Producing a video camera in Germany requires four workers, and shifting those four workers away from television production has an opportunity cost of 4/3 television sets. Producing a video camera in Poland requires 12 workers, and shifting those 12 workers away from television production has an opportunity cost of two television sets. Thus, the opportunity cost of producing video cameras is lower in Germany, and video cameras will be Germany's comparative advantage. d. In this example, absolute advantage differs from comparative advantage. Germany has the absolute advantage in the production of both goods, but Poland has a comparative advantage in the production of televisions. e. Germany should specialize, at least to some extent, in the production of video cameras, export video cameras, and import televisions. Conversely, Poland should specialize, at least to some extent, in the production of televisions, export televisions, and import video cameras.

The concept of _________________ means that as the measure of output goes up, average costs of production decline, at least up to a point. (13.2)

economies of scale

Goods and services produced in one country that are then sold in other countries are called ____________. (13.1)

exports

The underlying reason why trade benefits both sides of a trading arrangement is rooted in the concept of __________________. (13.2)

opportunity cost

The surge in international trade related to services to be performed in one country and sold in another that began in the 1990s has been powered by which of the following? (13.1)

technological advances