International Economics James B. Wilcox RESOURCES PROVIDED BY: THE UNIVERSITY OF SOUTHERN MISSISSIPPI CENTER FOR ECONOMIC AND ENTREPRENEURSHIP EDUCATION,

International Economics

James B. Wilcox

RESOURCES PROVIDED BY:

THE UNIVERSITY OF SOUTHERN MISSISSIPPICENTER FOR ECONOMIC AND ENTREPRENEURSHIP EDUCATION,

MISSISSIPPI STATE UNIVERSITY, & VIRTUAL ECONOMICS

Economics…is the study of how individuals and society choose, with or without the use of money, to employ scarce productive resources to produce various commodities over time and distribute them for consumption, now and in the future, among various people and groups in a society.

Why People and Nations Trade

What Would Your Life Be Like If You Could Not Trade

with Anyone?

Self-Sufficiency

International Trade• International trade increases world economic

efficiency for the same reasons that domestic trade

increases national economic efficiency.

• People gain when they trade voluntarily

– Review Circular Flow

– Review Comparative Advantage

– Review Opportunity Cost

– Review Specialization

Activity

• The Iowa Car Crop Example

THE IOWA CAR CROPThere are two technologies for producing automobiles in America. One is to manufacture them in Detroit, and the other is to grow them in Iowa. Everybody knows about the first technology; let me tell you about the second. First you plant seed, which are the raw material from which automobiles are constructed. You wait a few months until corn appears. Then you harvest the corn, load it onto ships, and sail the ships eastward into the Pacific Ocean. After a few months, the ships reappear with Toyotas on them.

International trade is nothing but a form of technology. The fact that there is a place called Japan, with people and factories, is quite irrelevant to Americans' well-being. To analyze trade policies, we might as well assume that Japan is a giant machine with mysterious inner workings that convert corn into cars.

Any policy designed to favor the first American technology over the second is a policy designed to favor American auto producers in Detroit over American auto producers in Iowa. A tax or a ban on "imported" automobiles is a tax or a ban on Iowa-grown automobiles. If you protect Detroit car makers from competition, then you must damage Iowa farmers, because Iowa farmers are the competition.

That means that protection for Detroit does more than just transfer income from farmers to autoworkers. It also raises the total cost of providing Americans with a given number of automobiles. The efficiency loss comes with no off-setting gain; it impoverishes the nation as a whole.

There is much talk about improving the efficiency of American car manufacturing. When you have two ways to make a car, the road to efficiency is to use both in optimal proportions. The last thing you should want to do is to artificially hobble one of your production technologies. It is sheer superstition to think that an Iowa-grown Camry is any less "American" than a Detroit-built Taurus. Policies rooted in superstition do not frequently bear efficient fruit.

In 1817, David Ricardo--the first economist to think with the precision, though not language, of pure mathematics--laid the foundation for all future thought about international trade. In the intervening nineteen decades his theory has been much elaborated but its foundations remain as firmly established as anything in economics. Trade theory predicts first if you protect American producers in one industry from foreign competition, then you must damage American producers in other industries. It predicts second that if you protect American producers in one industry from foreign competition, there must be a net loss in economic efficiency. Ordinarily, textbooks establish these propositions through graphs, equations, and intricate reasoning. The Iowa Car Crop story makes the same propositions blindingly obvious with a single compelling metaphor portraying economics at its best.

Iowa Car Crop• Who is helped by restricting car imports?

– U.S. auto industry• Owners• Workers

• Who is hurt by restricting car imports?– U.S. consumer

• Fewer choices• Higher prices for cars

– U.S. agricultural industry

– Japanese auto industry and workers

Iowa Car Crop

• Why does trade result in the most efficient production of goods and services?

– Free trade allows for specialization

• Why do people and nations gain when they trade?– Efficiency

• Can produce & consume more goods

– More choice

Adam Smith

• Is this statement true or false?– “The economic goal of international trade

is to maximize our exports and to provide jobs for U.S. citizens.”

• False. The purpose of trade is to improve the welfare of consumers– Improve efficiency– More & better products

Consumption is the sole end and purpose of all production, and the

interest of the producer ought to be attended to only as far as it may be necessary for promoting that of the

consumer.

The Nature & Causes of the Wealth of Nations• A engineer who, while visiting China, came across a large crew

of men building a dam with picks and shovels.

• When the engineer pointed out to the supervisor that the job could be completed in a few days, rather than many months, if the men were given motorized earthmoving equipment, the supervisor replied:

. . . such equipment would destroy many jobs.

The Real Source of Wealth?• Oh, the engineer responded,

– “I thought you were interested in building a dam. – If it’s more jobs you want, why don’t you have your men use

spoons instead of shovels.”

• Moral:– Purpose of economic activity

• produce as much VALUE as possible with scarce resources.

– Always jobs to do– Creating jobs is not the problem

• Problem: – creating jobs in which people produce the most value.

A Key Concept

• A country’s standard of living depends on its ability to produce goods and services.

Activity you might use in class

The Story of the Potatoes & the Oranges

Getting Started

• Split into pairs:– Decide who’s Mary, who’s John

• Each person can produce 2 goods:– Potatoes (P) and oranges (O)

Mary has 10 oranges and 5 potatoes

In class you could have envelopes labeled “Mary” prepared with 10 orange circles and 5 brown squares for ½ of your class

John has 3 oranges and 3 potatoes

In class you could have envelopes labeled “John” prepared with 3 orange circles and 3 brown squares for ½ of your class

Production Capabilities

Mary can produce Oranges Potatoes 10 0

8 16 24 32 40 5

John can produce Oranges Potatoes 3 0

2 11 20 3

John wants at least 3 O & 1 P

Mary wants at least 7 O & 2 P

“Year” One: No Contact with Partner

Mary can produce O P 10 0

8 16 24 32 40 5

John can produce O P 3 0

2 11 20 3

John: at least 3 O & 1 PMary: at least 7 O & 2 P

Objective: achieve your desired consumption bundle below.

(1) Decide production level (whole # only). (2) “Produce” by removing that number of P & O from the envelope & place on

desk in front of you. Leave the rest of P & O in envelope.

Ask…. “Year 1 Results?”

• John, have you achieved your objective?

• Mary, you appear rich, certainly you’ve achieved the objective . . . haven’t you?

• Rich or poor, we appear to face scarcity.

• Have students return all P and O to their envelopes.– Completely new round – do not have to produce combination

of first round; free to produce any acceptable combination.

“Year” 2: Allow Trade

Mary can produce O P 10 0

8 16 24 32 40 5

John can produce O P 3 0

2 11 20 3

John: at least 3 O & 1 PMary: at least 7 O & 2 P

Objective: achieve your desired consumption bundle below.

1. Discuss with partner. 2. Decide production (whole # only). 3. Circle production on the table. 4. Remove “production” from envelope & lay on desk in front of you. 5. If desire, trade with partner & record.

Discussion

• Mary, are you better off than in Round 1?

– 4

• John, certainly Mary’s gain has come at your expense . . . – … you must be worse off?

• Then both of you are better off?– How did you accomplish this miracle?!

Free Trade Allows …

• Specialization• Mary: produce 10 oranges and 0 potatoes• John: produce 0 oranges and 3 potatoes

• Trade: • Mary: trades 3 oranges for 2 potatoes

–achieves objective with 7 oranges & 2 potatoes

• John: trades 2 potatoes for 3 oranges

–achieves objective with 3 oranges & 1 potato

In Other Words,

Both Mary and John are simultaneously and unambiguously

better off!

Miracle of Trade – Source of Gains?

• Exchange only• No specialization• No production• Merely trade the already existing items

– People are made better off– You can demonstrate this with a “bag trade

game” which is another NCEE lesson

• Free trade allows– Specialization in production

• Theory of comparative advantage

Together, Let’s Complete “Opportunity Cost”

First, John and Mary return to your original number of Oranges and

Potatoes in your envelope:

Mary – 10 oranges and 5 potatoes

John – 3 oranges and 3 potatoes

Together, Let’s Complete “Opportunity Cost”

1. John's cost to produce a potato is ___ oranges (s).

2. Mary's cost to produce a potato is ___ oranges (s).

3. John's cost to produce an orange is ___ potato(es).

4.Mary's cost to produce an orange is ___ potato(es).

…….. Go to the table…..

Determine Opportunity Cost – Physically Verify

Mary can produce O P

10 08 16 24 32 40 5

John can produce

O P

3 0

2 1

1 2

0 3

Opportunity cost of a P is 2 O’s

Opportunity cost of a P is 1 O’s

Determine Opportunity Cost – Physically Verify

Mary can produce O P

10 08 16 24 32 40 5

John can produce

O P

3 0

2 1

1 2

0 3

Opportunity cost of a O is 1 P

Opportunity cost of a O is 0.5 P’s

Concept: Comparative AdvantageSpecialize in lowest cost – most efficient production

• Oranges:–Mary: cost of one Orange = 0.5 Potato–John: cost of one Orange = 1.0 Potato

»Mary specialize in O production

• Potatoes:–Mary: cost of one Potato = 2.0 Orange–John: cost of one Potato = 1.0 Orange

»John specialize in P production

Key Points

• Free trade is not a zero-sum game

– Zero-sum game: Mary’s gains = John’s losses +10 = -10 → net gain = 0 (zero sum)

• Instead,– both parties gain – positive-sum game

Trade Creates Wealth. . . not merely redistributes it!

Pre-specialization & trade size of pie?

After-specialization & trade size of pie?

Orange Potato

Mary 6 2

John 2 1

Total 8 3

Orange Potato

Mary 10 0

John 0 3

Total 10 3

Key Points

• Mary has “absolute advantage” in production of both goods

but, she still gains!

• Are both countries now equally wealthy?– Mary is still wealthier than John

has absolute advantage in both

• But both have gained from voluntary trade

Production Possibilities

• Production possibilities curves (PPC or PPF)–

Remember?

• This model helps describe – production, – efficiency, – choice, and – scarcity.

Graphical Treatment

Mary’s PPC John’s PPCO

P P5

3

3

7

2 10 0

PPF = “production possibilities curve”

Unattainable with your own production

10

O

Comparative Advantage in Potatoes?

Mary’s PPC John’s PPCO O

P P

10

5

3

30 0

Opportunity cost

of P: two O

Opportunity cost

of P: one O

Specialize in Potatoes

Mary’s PPC John’s PPCO O

P P

10

5

3

30 0

Comparative Advantage in Oranges

Opportunity cost

of O: 0.5P

Opportunity cost

of O: 1P

Specialize in O

Gains from Specialization & Trade

Mary’s PPC John’s PPCO O

P P

10

5

3

320 0

7

1

Production Possibilities Curve/Frontier

• All points on curve are possible & equally efficient in production (satisfy comparative advantage)

– Outside the curve impossible now, with own production

• Inside the curve → inefficient

– Inconsistent with comparative advantage

– Some unemployment exists

O

P

Beyond Present PPC?

O

P

How can a country achieve this point?

1. Specialize & trade

2. Economic growth

1. Specialization & Trade

O

P

specialize

tradeAssume

comparative advantage in

Oranges

2. Dynamic Gains from Competition

O

P

Economic Growth

In Conclusion:

Free Trade Consensus

• Clear that free trade is beneficial

• Issue closest to unanimity among economists

Benefits to Trade• Review of Absolute Advantage

– Production using the fewest resources – doesn’t take into account opportunity cost

• Review of Comparative Advantage– Focus on producing the good which has the lowest

opportunity cost– Leads to specialization

• Benefits to Trade– Greater choice at lower prices to consumers– Increase consumer surplus at the “cost” of reduced

producer surplus

Free Trade Consensus

• It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy . . .

• What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom . . .

• . . . very good wine can be made [in Scotland] at thirty times the expense for which equally good can be bought from foreign countries . .

• Would it be reasonable law to prohibit the importation of all foreign wines merely to encourage the making of ... burgundy in Scotland?

Adam Smith

The Wealth of Nations 1776

WHY TRADE MONEY?

Lesson

MALL OF AMERICA

• Over 500 stores• Employs over 12,000 people• Attracts more visitors than

– Walt Disney World– Graceland – The Grand Canyon

. . . . . . COMBINED

The Wide World of Taste

• Select lunch at the International Food Court

• You may spend 10 USD (US dollars)

Australian AppetizersDown Under Cheese Hoppers

Great Barrier Reef Finger FoodsOutback Croc Pot Stickers

Sydney Sheep Sizzlers

Chinese Chow Great Wall Egg Roll

Mandarin Garlic ChickenSzechwan Spicy ShrimpShanghaied Fried Rice

Continental Cuisine French Onion Soup

Greek SaladGerman Brats (best of the wurst)

Luck of the Irish StewItalian Spaghetti and MeatballsSpanish Flan (a rich custard)

Belgian Chocolates Finnish Cranberry Drink

Mexican MouthfulsTijuana Taco

Chihuahua EnchiladaBurrito Yucatan

Fajitas de FranciscoRefried beans de guerrero

Nachos de Tabasco

Egyptian ElixirsCold Camel Cairo Coffee

Luscious Luxor LemonadeMango Juice Masterpiece

Suez-Sinai Soda

Make a list of items you’d like to eat and drink

Australian Appetizers Down Under Cheese Hoppers 4.50 dollars AUDGreat Barrier Reef Finger Foods 2.70 dollars AUD Outback Croc Pot Stickers 1.80 dollars AUD Sydney Sheep Sizzlers 3.60 dollars AUD

Chinese Chow Great Wall Egg Roll 6 yuan CNYMandarin Garlic Chicken 20 yuan CNYSzechwan Spicy Shrimp 26 yuan CNYShanghaied Fried Rice 14 yuan CNY

Continental Cuisine French Onion Soup 1.80 euros EURGreek Salad 2.52 euros EURGerman Brats (best of the wurst) 2.97 euros EURLuck of the Irish Stew 2.25 euros EURItalian Spaghetti and Meatballs 2.70 euros EURSpanish Flan (a rich custard) 1.98 euros EURBelgian Chocolates 3.60 euros EURFinnish Cranberry Drink 1.62 euros EUR

Mexican Mouthfuls Tijuana Taco 15.30 pesos MXNChihuahua Enchilada 18.36 pesos MXNBurrito Yucatan 22.44 pesos MXNFajitas de Francisco 35.70 pesos MXNRefried beans de Guerrero 8.16 pesos MXNNachos de Tabasco 20.40 pesos MXN

Egyptian Elixirs Cold Camel Cairo Coffee 6.90 pounds EGPLuscious Luxor Lemonade 9.20 pounds EGPMango Juice Masterpiece 10.35 pounds EGPSuez-Sinai Soda 5.75 pounds EGP

The Wide World of

Taste Menu

On your sheet, check the items you chose for lunch

• As an international mall, the restaurant owners will want to be paid in their own currency, but you have USDs

• You will need to use a foreign exchange market to convert currencies

This example is analogous to how international trade actually works

Fortunately, there is a bank at the mall

The Mall of the World Currency Bank

Exchange Rates 

1 USD = 1.4 AUD (1.1)*

 1 USD = 8.0 CNY (6.8)*

 1 USD = 0.8 EUR (0.8)*

 1 USD = 11.1 MXN (12.7)*

 1 USD = 5.8 EGP (5.7)*

 Rates in effect April 7, 2006.

*Rates in effect July 15, 2010.

USD = U.S. dollar AUD = Australian dollar CNY = Chinese Yuan EUR = European euro MXN = Mexican peso EGP = Egyptian pound 

HOW MUCH DOES IT REALLY COST?

Instructions: Indicate the quantity of each item that you want to buy in the first column.

1. Multiply the quantity by the price and enter the total amount that would be spent in the foreign currency.

2. Using the exchange rate at the currency exchange bank, convert to the amount in U.S. dollars.

3. Calculate the total U.S. dollar cost of your lunch.

Calculators and Table (next slide)

Item Quantity Price Total amount in foreign currency

Amount in USD ($)

Down Under Cheese Hoppers 4.50 AUDFinger Foods 2.70 AUDOutback Croc Pot Stickers 1.80 AUDSydney Sheep Sizzlers 3.60 AUDGreat Wall Egg Roll 6 CNYMandarin Garlic Chicken 20 CNYSpicy Shrimp 26 CNYShanghaied Fried Rice 14 CNYFrench Onion Soup 1.80 EURGreek Salad 2.52 EURGerman Brats (best of the wurst) 2.97 EURLuck of the Irish Stew 2.25 EURItalian Spaghetti and Meatballs 2.70 EURSpanish Flan (a rich custard!) 1.98 EURBelgian Chocolates 3.60 EURFinnish Cranberry Drink 1.62 EURTaco 15.30 MXNEnchilada 18.36 MXNBurrito 22.44 MXNFajitas de Francisco 35.70 MXNRefried Beans de Guerrero 8.16 MXNNachos de Tabasco 20.40 MXNCold Camel Coffee 6.90 EGPLuscious Lemonade 9.20 EGPMango Juice Masterpiece 10.35 EGPSuez-Sinai Soda 5.75 EGP

TOTAL COST OF LUNCH IN U.S. DOLLARS

Example: Lindsey buys 3 Tijuana Tacos

The price is 15.30 pesos for each taco, so the amount she would spend in pesos would be

15.30 x 3 = 45.90 pesos

The exchange rate is 1 USD = 11.1 MXN pesos.

To convert to dollars

(45.90 MXN/tacos) 11.1 MXN/USD, or

(45.90 MXN/tacos) 1/11.1 USD/MXN = 4.14 USD

Calculation Table (again)

• Now, adjust purchases to spend entire 10 USD (as close as you can)

Item Quantity Price Total amount in foreign currency

Amount in USD ($)

Down Under Cheese Hoppers 4.50 AUDFinger Foods 2.70 AUDOutback Croc Pot Stickers 1.80 AUDSydney Sheep Sizzlers 3.60 AUDGreat Wall Egg Roll 6 CNYMandarin Garlic Chicken 20 CNYSpicy Shrimp 26 CNYShanghaied Fried Rice 14 CNYFrench Onion Soup 1.80 EURGreek Salad 2.52 EURGerman Brats (best of the wurst) 2.97 EURLuck of the Irish Stew 2.25 EURItalian Spaghetti and Meatballs 2.70 EURSpanish Flan (a rich custard!) 1.98 EURBelgian Chocolates 3.60 EURFinnish Cranberry Drink 1.62 EURTaco 15.30 MXNEnchilada 18.36 MXNBurrito 22.44 MXNFajitas de Francisco 35.70 MXNRefried Beans de Guerrero 8.16 MXNNachos de Tabasco 20.40 MXNCold Camel Coffee 6.90 EGPLuscious Lemonade 9.20 EGPMango Juice Masterpiece 10.35 EGPSuez-Sinai Soda 5.75 EGP

TOTAL COST OF LUNCH IN U.S. DOLLARS

What is the price of an egg roll in yuan? 6 CNY

What is the price of an egg roll in U.S. dollars? 6/8.0 = 0.75 USD)

Assume that the exchange rate changed from 1 USD = 8.0 CNY to 1 USD = 12 CNY.

What is the price of an egg roll with the new exchange rate?

6/12 =0.5 USD

Why have egg rolls become less expensive in terms of U.S. dollars. The U.S. dollar can now purchase more Chinese yuan, so the customer can purchase more egg rolls.

The US dollar appreciated relative to the Chinese yuan.

The yuan has depreciated relative to the US dollar

• How has the U.S. dollar appreciated relative to the Chinese yuan? One dollar will now buy more CNY :

12 CNY instead of 8.0 CNY

• How has the Chinese yuan depreciated relative to the U.S. dollar? 8.0 CNY could purchase 1 USD before the exchange rate change. After the rate change, 8.0 CNY will only purchase 0.69 USD

• If the exchange rate between the U.S. dollar and the Egyptian pound changed from

1 USD = 5.8 EGP to 1 USD = 2.76 EGP,

has the U.S. dollar appreciated or depreciated relative to the EGP? Why? The U.S. dollar has depreciated relative to the Egyptian pound because one dollar will not buy as many Egyptian pounds.

• If prices of Egyptian drinks remained the same, will customers be able to buy more or fewer drinks with a fixed amount of U.S. dollars?

Fewer. The dollars aren’t worth as much in Egyptian pounds.

Current Exchange rates at

http://www.oanda.com/convert/classic

Closure1. Why can’t U.S. citizens use their U.S. dollars to pay for goods and

services in other countries? People in other countries prefer to be paid in their currencies.

2. If a group of U.S. citizens wanted to pay for a tour in Paris, France, what must the citizens do? They must convert their U.S. dollars into European Union euros.

3. What is an exchange rate? The price of one nation’s currency in terms of another nation’s currency

4. If 1 USD = 11.1 MXN and 1 USD = 0.8 EUR, what is the exchange rate between Mexican pesos and European Union euros? 11.1 MXN =0.8 EUR or 13.9 MXN = 1 EUR

Closure5. If the exchange rate between the Mexican peso and

the European Union euro changed from

13.9 MXN = 1 EUR to 10 MXN = 1.00 EUR,

has the peso appreciated or depreciated relative to the euro? It has appreciated relative to the euro.

What happened to the euro? It depreciated relative to the Mexican peso.

Closure6. If the exchange rate between the Australian dollar and the

Egyptian Pound changed from

1 AUD = 2.5 EGP to1 AUD = 2 EGP,

has the Australian dollar appreciated or depreciated relative to the Egyptian Pound? Why? It has depreciated because one Australian dollar will not buy as many Egyptian pounds.

What has happened to the Egyptian pound? It has appreciated relative to the Australian dollar because it now only takes 2 EGP instead of 2.5 EGP to buy 1 Australian dollars.

AssessmentIf people in Mexico want to buy cotton from Egypt, then:

A.They must exchange Egyptian pounds for Mexican pesos.

B.They will be better off if the Mexican peso depreciates relative to the Egyptian pound.

C. They must exchange Mexican pesos for Egyptian pounds.

D.They will be better off if the Egyptian pound appreciates relative to the Mexican peso.

AssessmentIf people in Mexico want to buy cotton from Egypt, then:

A.They must exchange Egyptian pounds for Mexican pesos.

B.They will be better off if the Mexican peso depreciates relative to the Egyptian pound.

C.They must exchange Mexican pesos for Egyptian pounds.

D.They will be better off if the Egyptian pound appreciates relative to the Mexican peso.

Assessment

If the exchange rate between U.S. dollars and Australian dollars changes from 1 USD = 1.3 AUD to 1USD = 1.1 AUD, then:

A. The U.S. dollar has appreciated relative to the Australian dollar.

B. The Australian dollar has appreciated relative to the U.S. dollar.

C. The Australian dollar has depreciated relative to the U.S. dollar.

D. Australian goods will be cheaper to Americans.

Assessment

If the exchange rate between U.S. dollars and Australian dollars changes from 1 USD = 1.3 AUD to 1USD = 1.1 AUD, then:

A. The U.S. dollar has appreciated relative to the Australian dollar.

B. The Australian dollar has appreciated relative to the U.S. dollar.

C. The Australian dollar has depreciated relative to the U.S. dollar.

D. Australian goods will be cheaper to Americans.

WHY ARE THERE CURRENCY EXCHANGE MARKETS?

Lesson

Markets • Markets exists any time buyers and sellers

interact to make voluntary exchanges of goods and services for money or for other goods and services

• Some are huge and highly organized involving millions of buyers and sellers all over the world (stocks/bonds)

• Other are smaller and less formal.

Foreign Exchange Rates and Markets

• Foreign Exchange• The Demand for Foreign Exchange• The Supply of Foreign Exchange• Determining the Exchange Rate• Arbitrageurs and Speculators• Purchasing Power Parity• Flexible Exchange Rates – market forces• Fixed Exchange Rates – Central Bank• “The ideal system will foster international trade, lower

inflation and promote a more stable world economy.”

HOUSEHOLDS BUSINESSES

PRODUCTMARKET

Goods and Services

FACTORMARKET

The Circular Flow of Productive Resources, Goods and Services, and Money Payments

Productive Resources

Money Payments (sales)

Money income payments (rent, interest, wages, profits)

Exchange among people and organizations in other countries is called international trade

• Make a list of goods and services that consumers in the U.S. purchase from other countries.

• To help with your list:– Check labels on clothes– Other items in the room– Foods?– Electronics?

Top Ten U.S. Imports (millions of dollars)March 2002

• Computer accessories: $15,591• Crude oil: $14,220• Pharmaceutical preparations: $9,266• Apparel, household goods-cotton: $8,449• Other household goods: $7,388• Semiconductors: $6,622• Apparel, textiles, non-wool or cotton: $5,799• Telecommunications equipment, $5,596• TVs, VCRs, etc: $5,468• Electric Apparatus: $5,397

• Create a list of goods and services that producers in the U.S. sell to consumers and companies in other countries

Top Ten U.S. Exports (millions of dollars)March 2002

• Semiconductors: $10,303• Computer accessories: $7,305• Civilian aircraft: $6,523• Telecommunications equipment: $6,044• Electric apparatus: $5,270• Pharmaceutical preparations: $3,948• Medicinal equipment: $3,526• Plastic materials: $3,341• Chemicals-organic: $3,171• Measuring, testing, control instruments: $3,171

• To facilitate international trade you need to make payments in different currencies.

You can’t buy dinner in the U.S. with Yen or pesos.

Sellers will want to have payments in their home currencies.

Currency Exchange Market

CurrencyExchangeMarkets

Goods and Services Markets

Japanese People

and Organizations

$ $ $ $ $ $ $ $

¥ ¥

¥ ¥

US goods & services

United States People

and Organizations

¥ ¥ ¥ ¥

Japan

ese

goods & s

ervi

ces

$ $ $ $

¥ ¥ ¥ ¥

Currency Flow

• To buy a good or service from another country, a consumer will sell their home currency in exchange for the foreign currency for the trade

• This same exchange happens if it is consumers, businesses, or investors

A U.S. bank is an organization in the United States. If the bank wants to buy a building and open a branch office in Tokyo, it will buy yen and pay for those

yen with U.S. dollars.

CurrencyExchangeMarkets

Goods and Services Markets

Japanese People

and Organizations

$ $ $ $ $ $ $ $

¥ ¥

¥ ¥

US goods & services

United States People

and Organizations

¥ ¥ ¥ ¥

Japan

ese

goods & s

ervi

ces

$ $ $ $

¥ ¥ ¥ ¥

The bank will use the yen to buy a building and equipment and hire workers in Japan.

CurrencyExchangeMarkets

Goods and Services Markets

Japanese People

and Organizations

$ $ $ $ $ $ $ $

¥ ¥

¥ ¥

US goods & services

United States People

and Organizations

¥ ¥ ¥ ¥

Japan

ese

goods & s

ervi

ces

$ $ $ $

¥ ¥ ¥ ¥

A Japanese automobile company is an organization in Japan. If the company decides to build a factory in the United States it will buy

dollars with yen.

CurrencyExchangeMarkets

Goods and Services Markets

Japanese People

and Organizations

$ $ $ $ $ $ $ $

¥ ¥

¥ ¥

US goods & services

United States People

and Organizations

¥ ¥ ¥ ¥

Japan

ese

goods & s

ervi

ces

$ $ $ $

¥ ¥ ¥ ¥

The automobile company will use the dollars to build the factory, buy equipment, and hire workers.

CurrencyExchangeMarkets

Goods and Services Markets

Japanese People

and Organizations

$ $ $ $ $ $ $ $

¥ ¥

¥ ¥

US goods & services

United States People

and Organizations

¥ ¥ ¥ ¥

Japan

ese

goods & s

ervi

ces

$ $ $ $

¥ ¥ ¥ ¥

International Trade

• Is fundamentally the same as trade within a country (buying and selling)

• If involves an extra step (currency trade)

• Currency trade internationally is actually easier than international trade of goods and services.

Closure

1. When do markets exist? whenever buyers and sellers interact

2. What does the circular flow model illustrate?

movement of goods, services, resources, and money in the economy

3. Why do people and organizations in one country buy currency from another country? to buy goods and services produced in the other country or to make

investments in the other country

Closure4. What do people and organizations in one country sell in order

to buy currency from another country? their country’s currency

5. Where does currency exchange take place? in currency exchange markets

6. How is trade within a country like trade with other countries? In both cases there are people who want to sell goods, services, and

resources and people who want to buy goods, services and resources. Both involve the use of currency.

Closure

7. How is trade within a country different from trade with other countries? Trade with other countries requires currency exchange

8. What is currency exchange? buying one country’s currency with another country’s

currency

Activity

ECONOMIC GROWTH

Investigate the causes of, and obstacles to, economic growth by comparing data for high, middle, and low-income nations.

Participate in an activity (Lesson D14-1) to see how changes in the quantity or quality of inputs can have different effects in different nations.

Measuring Economic Well-Being

• Gross Domestic Product

– Dollar Value of all finished goods and services produced in the Economy

– C+G+I+Xn (Expenditures Approach)• C=Consumption• G=Government• I=Investment• Xn=Net Exports (Exports minus Imports)

• GDP per capita

• France and Argentina had roughly the same income per capita in 1900.

• During the 20th century – France grew at an average 2.2% per year while – Argentina grew at 1.1%.

• In 2000, income per capita – in France was $24,000, and – in Argentina it was $8,000.

• Small differences in average annual growth rates in different nations are compound, resulting in very large differences in average levels of income

• Institutions and policies that promote a stable political and economic climate, and help to encourage economic growth, are therefore extremely important.

• Investment in factories, machinery, new technology, and the health, education, and training of people can raise future standards of living.

Objectives• Recognize the direct long-run link between

economic growth and material standards of living.

• Identify the major factors that promote economic growth, and some of the major factors that hinder economic growth.

WHAT MAKES AN ECONOMY GROWAND WHY DO WE CARE?

There is a very basic answer to the second part of this question. As U.S. President Kennedy once said, economic growth is a "rising tide that lifts all boats" -- meaning that historically in the United States economic growth improved material standards of living for high, middle, and low-income families. Globally, nations that have experienced sustained economic growth -- for decades or even centuries -- have enjoyed much higher levels of production, income, and consumption than the economies that have achieved little or no growth.

What makes an economy grow is a more difficult question to answer. One place to start is by reviewing the basic categories of the factors of production: natural resources, capital resources, and human resources.

Certainly it helps to have large amounts of natural resources, as in the United States and Canada. But economies such as Japan and Netherlands grew rapidly with comparatively little land and few other natural resources.

Investment in capital resources such as factories and machines can increase an economy's productive capacity and future levels of production and growth. But despite emphasizing capital investments in a series of five-year plans, the former Soviet Union faced falling levels of output and income in the 1980's, and eventually collapsed. That demonstrates that the “how” and “where” resources are invested is important, as well as the overall level of investment.

Human resources are important to economic growth in several ways. First, labor is the single largest input used in most economies, including the United States. This is especially true in providing services to consumers and businesses, which is the fastest growing sector in most industrialized nations. (Services include professions such as health care, government, law, education, architecture, engineering, software development, and the arts -- not just retail and fast food services.) Second, the education, training, and health of workers -- which economists refer to as human capital -- is directly related to workers' productivity, and therefore to levels of economic growth and income. Third, entrepreneurship and technological innovations developed through human innovation and creativity are key to the process of economic growth.

Despite all these positive effects that human resources can bring to the process of economic growth, it also seems clear that very rapid rates of population growth make it difficult, if not impossible, for economies to maintain high levels of economic growth and income. One of the most pervasive characteristics of low-income nations is a rapid rate of population growth.

The system of incentives established by a nation's political and economic institutions can also have a crucial effect on economic growth. Are people allowed to own houses and cars as consumers, and are they allowed to own and operate businesses as producers? Are income levels set by the government or in the marketplace? How much of that income is then taxed away by the government? How much competition is there in the economy, and does the government try to increase or reduce the level of competition? How stable are a nation's political and economic institutions? Is there an orderly and predictable way for electing new administrations, or frequent and irregular turnovers? How high are inflation and unemployment?

It is sometimes said that recipes for economic growth are somewhat like recipes for making soups that have many ingredients. The most important ingredient is often the one that you don't have, or at least the one of which you have least. But sometimes there are ways to make up for what you don't have by substituting more of other things.

Look over the following table, which shows basic data related to these different kinds of inputs from countries that the World Bank has assigned to three different categories: High Income, Moderate Income, and Low Income. Notice how large some of the differences are between the wealthiest and poorest nations. Then answer the questions that follow.

Handout- Country DataGross Gross Foreign Cost of

GDP per GDP per fixed fixed direct business Ease of Info(3)Health Life Labor force

capita capita Population Population capital capital investment start-up doing technology Expend expectancy participation

PPP growth total growth formation formation net inflows (% of GNI business expenditure per capita at birth, total rate, total %

U.S. $ annual % millions annual % (% of GDP) annual % (% GDP) per capita) index(2)% of GDP (U.S. $) years of pop 15-64

2005 2005 2005 2006 2005 2005 2005 2006 2005 2004 2005 2005

Argentina 14,280 8.1 38.7 0.97 21.5 22.7 2.6 12.1 101 7.1 383 74.8 71.6Brazil 8,402 0.9 186.4 1.35 18.3 -0.6 1.9 9.9 121 7.8 290 71.2 72.1Chile 12,027 5.2 16.3 1.06 22.1 24.7 5.8 9.8 28 6.1 359 78.2 58.4China 6,757 9.5 1,304.5 0.64 42.3 14.8 3.5 9.3 93 5.3 71 71.8 82.0Ecuador 4,341 3.3 13.2 1.44 21.9 8.1 4.5 31.8 123 3.2 127 74.7 74.7Egypt, Arab Rep. 4,337 3.0 74.0 1.90 18.0 11.5 6.0 68.8 165 1.5 64 70.5 49.3Germany 29,461 1.0 82.5 (0.06) 17.1 -0.2 1.1 5.1 21 6.1 3,521 78.9 73.4India 3,453 7.7 1,094.6 1.37 28.1 15.3 0.8 73.7 134 5.8 31 63.5 60.9Indonesia 3,843 4.2 220.6 1.36 22.0 9.9 1.8 86.7 135 3.4 33 67.8 70.1Jordan 5,530 4.8 5.5 2.30 23.7 5.0 12.1 73 78 8.4 200 72.0 55.6Mexico 10,751 1.9 103.1 1.01 19.3 7.6 2.4 14.2 43 3.3 424 75.4 62.1Paraguay 4,642 1.0 5.9 1.91 20.3 4.8 0.9 136.8 112 .. 88 71.4 77.8Peru 6,039 4.9 28.0 1.46 18.8 13.6 3.2 32.5 65 6.6 104 70.7 72.4Poland 13,847 3.4 38.2 (0.04) 18.2 6.5 3.2 21.4 75 4.2 411 75.0 63.2Russian Fed. 10,845 6.9 143.1 (0.51) 18.2 10.5 2.0 2.7 96 3.6 245 65.5 71.0South Africa 11,110 3.7 46.9 1.14 17.2 9.2 2.6 6.9 29 9.9 390 47.7 65.3Thailand 8,678 3.6 64.2 0.84 29.0 11.4 2.6 5.8 18 4.1 88 70.9 77.6United Kingdom 33,238 1.2 60.2 0.66 16.6 3.2 7.2 0.7 6 7.3 2,900 78.9 75.6United States 41,890 2.2 296.4 0.96 18.7(1) 8.3(1) 0.9 0.7 3 8.8 6,096 77.7 75.7Uruguay 9,962 5.8 3.5 0.69 12.9 23.8 4.2 44.2 64 7.9 315 75.6 76.1Vietnam 3,071 7.2 83.1 1.16 33.1 11.0 3.7 44.5 104 15.1 30 70.7 79.9

(1) 2004

(2) low = more business friendly(3) Information and Communication TechnologySources of data: 2007 World Development Indicators . The World Bank.

List the five countries that have the highest and lowest values reported for GDP per capita

HIGH LOW

List the five countries that have the highest and lowest values reported for Growth in GDP per capita

HIGH LOW

List the five countries that have the highest and lowest values reported for Population

HIGH LOW

List the five countries that have the highest and lowest values reported for Population Growth

HIGH LOW

List the five countries that have the highest and lowest values reported for Gross fixed capital formation as % of GDP

HIGH LOW

List the five countries that have the highest and lowest values reported for Gross fixed capital formation, annual percentage increase

HIGH LOW

List the five countries that have the highest and lowest values reported for Foreign direct investment, net inflows as % of GDP

HIGH LOW

List the five countries that have the highest and lowest values reported for Cost of business start-up

(% of GNI per capita)

LOW HIGH

List the five countries that have the highest and lowest values reported for ease of doing business index

(low = more business friendly)

LOW HIGH

List the five countries that have the highest and lowest values reported for Information and Communication Technology Expenditure (% of GDP)

HIGH LOW

List the five countries that have the highest and lowest values reported for Health Expenditures per capita

HIGH LOW

List the five countries that have the highest and lowest values reported for Life Expectancy

HIGH LOW

List the five countries that have the highest and lowest values reported for Labor force participation rate

(% of population ages 15-64)

HIGH LOW

Which of the other variables seem to be closely related to a country's level of annual income and growth rate in real GDP?

Which of the other variables seem to be closely related to a country's level of annual income and growth rate in real GDP?

High population growth rates are more likely to occur in low economic growth economies

High per capita GDP countries tend to have ◦ low population growth rates◦ lower ease of doing business indices◦ lower business start-up costs◦ higher per capita health expenditures◦ higher life expectancies.

Higher growth rate economies tend to have ◦ higher rates of capital formation◦ higher labor force participation rates◦ higher expenditures on information and communication

technology.

Which of the variables listed are most likely to be determinants of a nation's levels of average income and

economic growth - a sustained increase in GDP?

• Investment in human and physical capital

• Technology

• Labor force quality

• Labor force participation rates.

Which of the variables listed in the columns are most likely to be results or effects of a nation's levels of income and

growth?

• Low population growth rates

• Higher health care expenditures

• Higher life expectancies

Economic Development

• Push the PPF Outward!• More than Economic Growth• Sustained increase in the standard of living• Rise in average incomes

– Real GDP per capita– Improvements in health and education– Social protection from poverty– Rule of law

Facilitation of Economic Development

• High levels of investment in physical and human capital• Technological Innovation• Higher productivity• Competitive markets• Low inflation• Political stability• Free trade

• World peace???

Incentives

• Economic Freedom• Protection of Property Rights• Sound Monetary Policy

• Profit Motive???

Misconceptions

• “Job Development” and “Bringing in New Businesses”– More foundational than that

• “It’s all about Natural Resources”– Russia and Nigeria are rich in natural resources– Japan, Singapore and Switzerland are poor in natural resources

• “Economic Development is the same as Economic Growth”– Economic Growth can be measured in purely quantitative terms– Economic Development encompasses more qualitative measures

Why Are Some Nations Wealthy?• Process not event• Beyond GDP…• “Using up accumulated wealth...as opposed to

earning income from capital assets”• Distribution of Income?• Quality of Life?• Sustainability?• Organization for Economic Cooperation and

Development– http://www.oecd.org

What has allowed some nations to experience high and sustained rates of economic growth for decades or even centuries, while other economies have not been able to do that? . . . .

What has allowed some nations to experience high and sustained rates of economic growth for decades or even centuries, while other economies have not been able to do that?

• Here is a simulation you can do in class that helps illustrate answers to this questions– Break your class into groups of 3 or 4 students– Assign groups to be a certain shape:

• TRIANGLE groups• STAR groups• SQUARE groups

Numerical production function

• Assume each economy produces one product—stancrafs– Sufficient quantity of stancrafs keep people alive and

happy– Too few stancrafs and people are miserable and may

die.

• Stancrafs are produced using capital (K) and labor (L) as shown on the chart

LK

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

1 100 118 131 141 149 156 162 168 173 177 182 186 189 193 196 200 203 205 208 211

2 168 200 221 237 251 263 273 282 291 299 306 313 319 325 330 336 341 346 351 355

3 227 271 300 322 340 356 370 383 394 405 415 424 432 440 448 455 462 469 475 482

4 282 336 372 400 422 442 460 475 489 502 515 526 537 547 556 565 574 582 590 598

5 334 397 440 472 500 523 543 562 579 594 608 622 634 646 658 668 678 688 698 707

6 383 455 504 542 573 600 623 644 664 681 698 713 727 741 754 766 778 789 800 810

7 430 511 566 608 643 673 700 723 745 765 783 800 817 832 846 860 873 886 898 910

8 475 565 626 672 711 744 773 800 823 845 866 885 903 920 936 951 965 979 993 1005

9 519 617 683 734 777 813 845 873 900 924 946 967 986 1005 1022 1039 1055 1070 1084 1098

10 562 668 740 795 840 880 914 945 974 1000 1024 1046 1067 1087 1106 1124 1141 1158 1174 1189

11 604 718 794 854 903 945 982 1015 1046 1074 1100 1124 1146 1168 1188 1208 1226 1244 1261 1277

12 644 766 848 911 964 1009 1048 1084 1116 1146 1174 1200 1224 1247 1268 1289 1309 1328 1346 1363

13 684 814 901 968 1023 1071 1113 1151 1185 1217 1246 1274 1300 1324 1347 1369 1390 1410 1429 1447

14 723 860 952 1023 1082 1132 1177 1217 1253 1287 1318 1347 1374 1400 1424 1447 1469 1490 1511 1530

15 762 906 1003 1077 1139 1192 1239 1281 1320 1355 1388 1418 1447 1474 1500 1524 1547 1569 1591 1611

16 800 951 1052 1131 1196 1252 1301 1345 1385 1422 1456 1488 1519 1547 1574 1600 1624 1647 1670 1691

17 837 995 1101 1183 1251 1310 1361 1408 1450 1488 1524 1558 1589 1619 1647 1674 1700 1724 1747 1770

18 873 1039 1150 1235 1306 1367 1421 1469 1513 1554 1591 1626 1659 1690 1719 1747 1774 1800 1824 1848

19 910 1082 1197 1287 1360 1424 1480 1530 1576 1618 1657 1693 1728 1760 1790 1820 1847 1874 1900 1924

20 945 1124 1244 1337 1414 1480 1538 1590 1638 1681 1722 1760 1795 1829 1861 1891 1920 1948 1974 2000

21 980 1166 1291 1387 1466 1535 1595 1649 1699 1744 1786 1825 1862 1897 1930 1961 1991 2020 2048 2074

22 1015 1208 1336 1436 1519 1589 1652 1708 1759 1806 1849 1890 1928 1964 1999 2031 2062 2092 2120 2148

23 1050 1248 1382 1485 1570 1643 1708 1766 1819 1867 1912 1954 1994 2031 2066 2100 2132 2163 2192 2221

24 1084 1289 1427 1533 1621 1697 1763 1823 1878 1928 1974 2018 2058 2097 2133 2168 2201 2233 2263 2293

Triangles

• Begin at an output level of – 1790 stancrafs

– Produced using • 15 units of labor (L)

and • 19 units of capital (K)

• Triangle Group--mark this output level with a triangle

LK

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

1 100 118 131 141 149 156 162 168 173 177 182 186 189 193 196 200 203 205 208 211

2 168 200 221 237 251 263 273 282 291 299 306 313 319 325 330 336 341 346 351 355

3 227 271 300 322 340 356 370 383 394 405 415 424 432 440 448 455 462 469 475 482

4 282 336 372 400 422 442 460 475 489 502 515 526 537 547 556 565 574 582 590 598

5 334 397 440 472 500 523 543 562 579 594 608 622 634 646 658 668 678 688 698 707

6 383 455 504 542 573 600 623 644 664 681 698 713 727 741 754 766 778 789 800 810

7 430 511 566 608 643 673 700 723 745 765 783 800 817 832 846 860 873 886 898 910

8 475 565 626 672 711 744 773 800 823 845 866 885 903 920 936 951 965 979 993 1005

9 519 617 683 734 777 813 845 873 900 924 946 967 986 1005 1022 1039 1055 1070 1084 1098

10 562 668 740 795 840 880 914 945 974 1000 1024 1046 1067 1087 1106 1124 1141 1158 1174 1189

11 604 718 794 854 903 945 982 1015 1046 1074 1100 1124 1146 1168 1188 1208 1226 1244 1261 1277

12 644 766 848 911 964 1009 1048 1084 1116 1146 1174 1200 1224 1247 1268 1289 1309 1328 1346 1363

13 684 814 901 968 1023 1071 1113 1151 1185 1217 1246 1274 1300 1324 1347 1369 1390 1410 1429 1447

14 723 860 952 1023 1082 1132 1177 1217 1253 1287 1318 1347 1374 1400 1424 1447 1469 1490 1511 1530

15 762 906 1003 1077 1139 1192 1239 1281 1320 1355 1388 1418 1447 1474 1500 1524 1547 1569 1591 1611

16 800 951 1052 1131 1196 1252 1301 1345 1385 1422 1456 1488 1519 1547 1574 1600 1624 1647 1670 1691

17 837 995 1101 1183 1251 1310 1361 1408 1450 1488 1524 1558 1589 1619 1647 1674 1700 1724 1747 1770

18 873 1039 1150 1235 1306 1367 1421 1469 1513 1554 1591 1626 1659 1690 1719 1747 1774 1800 1824 1848

19 910 1082 1197 1287 1360 1424 1480 1530 1576 1618 1657 1693 1728 1760 1790

1820 1847 1874 1900 1924

20 945 1124 1244 1337 1414 1480 1538 1590 1638 1681 1722 1760 1795 1829 1861 1891 1920 1948 1974 2000

21 980 1166 1291 1387 1466 1535 1595 1649 1699 1744 1786 1825 1862 1897 1930 1961 1991 2020 2048 2074

22 1015 1208 1336 1436 1519 1589 1652 1708 1759 1806 1849 1890 1928 1964 1999 2031 2062 2092 2120 2148

23 1050 1248 1382 1485 1570 1643 1708 1766 1819 1867 1912 1954 1994 2031 2066 2100 2132 2163 2192 2221

24 1084 1289 1427 1533 1621 1697 1763 1823 1878 1928 1974 2018 2058 2097 2133 2168 2201 2233 2263 2293

Star

• Begin at an output level of – 1000 stancrafs

– Produced using • 10 units of labor (L)

and • 10 units of capital (K)

• Mark this output level with a star