1. CHAPTER 6 PART I

2. LINKAGES
A. Several economic flows link the U.S. economy
with the economies of other nations.
B. These linkages are:
1. Goods and services flows
2. Capital and labor (resource) flows
3. Information and technology flows
4. Financial flows.

3. U.S. AND WORLD TRADE
A. Volume and Pattern:
1. Table 6.1 gives an index of the importance of
world trade to several countries.
2. Figure 6.2 reveals the growth in U.S. imports
and exports over past decades. Currently,
exports and imports are 12 percent and 17
percent of GDP, which is more than double
their importance of twenty-five years ago.

4. U.S. AND WORLD TRADE
3. The U.S. is world’s leading trading nation,
although its share has diminished from post-
World War II level of one-third of total trade to
one-eighth today.

5. DEPENDENCE
1. U.S. depends on imports for many food items
(bananas, coffee, tea, spices); raw silk,
diamonds, natural rubber, much petroleum.
2. On the export side, agriculture relies on foreign
markets for one-fourth to one-half of sales;
chemical, aircraft, auto, machine tool, coal, and
computer industries also sell major portions of
output in international markets (see Table 6-2).

6. TRADE PATTERN
1. The U.S. has a trade deficit in goods. In 1999 U.S.
imports exceeded exports of goods by $346 billion.
2. While we have a deficit in goods trade, U.S. export
of services exceeds the import of services by $81
billion.
3. The U.S. imports some of the same categories it
exports.
Specifically, automobiles, computers, chemicals, an
d semiconductors. (See Table 6 2)
4. Most U.S. trade is with industrially advanced
countries. (See Table 6 3)

7. TRADE PATTERN
5. Canada is the United States’ most important trade
partner quantitatively. Twenty four percent of U.S.
exports sold went to Canadians, who in turn
provided 20 percent of U.S. imports. (See Table 6
3)
6. The U.S. has sizable trade deficits with Japan and
China. In 1999, the U.S. trade deficit with Japan
was $75 billion. There was also a sizable trade
deficit with China. (See Table 6 3)
7. In 1999 the U.S. imported $24 billion of goods
(mainly oil) from OPEC nations, while exporting
$12 billion to those countries.

8. TRADE PATTERN
D. Financial Linkages: (International trade implies
complex financial linkages among nations.)
Trade deficits must be financed by borrowing or
earning foreign exchange, which is
accomplished by selling U.S. assets through
foreign investment in the U.S. The U.S.
borrows from citizens of other nations; the U.S.
is the world’s largest debtor nation.

9. TRADE PATTERN
E. Facilitating factors that explain the growth of
trade:
1. Transportation technology has improved over
the years.
2. Communications technology allows traders to
make deals in trade and global finance very
easily.
3. Trade barriers declined dramatically since
1940, and the trend toward free trade
continues.

10. TRADE PATTERN
F. Participants in international trade:
1. Global Perspective 6-1 shows the major
participants in world trade.
2. New participants have become important,
especially the Asian countries of Hong Kong,
Singapore, South Korea, and Taiwan. China is
also emerging as important in global trade.
Collapse of communism has led to the
emergence of former Soviet republics and
Eastern bloc countries as world trade
participants.

11. SPECIALIZATION AND
COMPARATIVE ADVANTAGE
A. The U.S. is referred to as an “open economy”
when it is placed in the global economy.
B. Adam Smith observed in 1776 that
specialization and trade increase the
productivity of a nation’s resources. His
observation related to the principle of absolute
advantage whereby a country should buy a
good from other countries if they can supply it
cheaper than we can.

12. SPECIALIZATION AND
COMPARATIVE ADVANTAGE
C. Basic principle of comparative advantage was
first observed and explained in early 1800s by
David Ricardo. This principle says that it pays
for a person or a country to specialize and
exchange even if that person or nation is more
productive than potential trading partners in all
economic activities. Specialization should take
place if there are relative cost differences in
production of different items.

13. SPECIALIZATION AND
COMPARATIVE ADVANTAGE
D. Example: A CPA can paint her house faster
and better than a painter. She earns $50 per
hour as accountant and can hire a painter for
$15 per hour. The CPA can do the painting job
in 30 hours; it takes the painter 40 hours.
Should she hire the painter? On economic
grounds, the opportunity cost is greater for the
accountant to paint her house. She is better off
to specialize in accounting rather than sacrifice
30 x $50, or $1500, to paint her house, when
she can hire the painter for 40 x $15, or $600.

14. SPECIALIZATION AND
COMPARATIVE ADVANTAGE
The accountant will gain, and the painter will also
gain because he is very inefficient in accounting. It
may take him 10 hours to prepare his tax return
which would mean 10 x $15, hours or $150, in
opportunity cost, whereas the accountant could
probably complete the forms in 2 hours for a cost
of $100. This example shows that even if a person
(the accountant) has an absolute advantage in
production of two products (painting and
accounting), it is still advantageous to specialize
and trade. The same is true for nations.

15. SPECIALIZATION AND
COMPARATIVE ADVANTAGE
E. Comparative advantage and terms of trade:
Tables 6-4 and 6-5 illustrate the principle of
comparative advantage for two countries, U.S.
and Mexico, with a simplified example. In
Mexico, the opportunity cost of 1 ton of
soybeans is giving up 4 tons of avocados. In
the U.S., the opportunity cost of 1 ton of
soybeans is 3 tons of avocados. In other
words, the comparative cost of soybeans is
less in U.S. than in Mexico when the alternative
is producing avocados. Thus the U.S. should
specialize in soybeans, and Mexico should
specialize in avocados.

16. SPECIALIZATION AND
COMPARATIVE ADVANTAGE
1. If the two nations specialize according to
comparative advantage, then to get the other
product they must trade. A nation has a
comparative advantage in some product when it
can produce that product at a lower domestic
opportunity cost than can a potential trading
partner.
2. Table 6-6 summarizes which nation has a
comparative advantage in each product.
3. The rate of exchange of these two products will
be determined through negotiation; the outcome
is called the terms of trade.

17. SPECIALIZATION AND
COMPARATIVE ADVANTAGE
4. The terms of trade will be limited by the relative
costs of production within each country. The U.S.
will not forgo more than 1 ton of soybeans to get
3 tons of avocados and Mexico will not give up
more than 4 tons of avocados for 1 ton of
soybeans.
5. Somewhere between these limits, trade is
possible. In the text example, the terms of trade
are assumed to be 3.5 tons of avocados for each
ton of soybeans. Americans would specialize in
soybeans only if they could obtain more than 3
tons of avocados for 1 ton of soybeans by trading
with Mexico.

18. GAINS FROM SPECIALIZATION
AND TRADE
1. Table 6-7, column 1, shows the optimal outputs
for Mexico and U.S. in soybeans and avocados
before specialization and trade.
2. Column 2 of Table 6-7 shows the amount each
country produces when it specializes.
3. Column 3 of Table 6-7 shows quantities in each
country after trade takes place at the rate of
1S = 3.5A
1. Mexico will give up 35 tons of avocados for 10
tons of U.S. soybeans.

19. GAINS FROM SPECIALIZATION
AND TRADE
5. Now each country will have more than they had
originally: Mexico now has 25 tons of
avocados left plus 10 tons of soybeans. U.S.
now has 35 tons of avocados and keeps 20
tons of soybeans. Mexico has gained 1 ton of
each; U.S. has gained 2 tons of avocados and
1 ton of soybeans, and these gains have
occurred using the same resources as before
specialization.

20. GAINS FROM SPECIALIZATION
AND TRADE
6. This example illustrates that specialization and
trade can improve overall output even when
one country (U.S.) can produce more of both
items compared to the other without trade.
Specialization and trade have the same effect
as an increase in resources or technological
progress.
STOP AND DO Key Questions 4 and 5

21. CHAPTER 6 PART II

22. WHAT IS A FOREX?
A. In a foreign exchange market,
various national currencies are
exchanged for one another so that
international trade can take place.
Germans want euros, Mexicans want
pesos, and the Japanese want yen
when they sell their products.

23. WHAT DOES A FOREX DO?
Two points require emphasis with respect to these
markets.
1. Real-world foreign exchange markets are
competitive, with large numbers of buyers and
sellers dealing with a standardized product, the
currency of some country.

24. WHAT DOES A FOREX DO?
2. Exchange rates link domestic (one country’s)
prices with all foreign prices. They enable you
to translate the price of foreign products into
dollars. For example, if the dollar/yen
exchange rate is 1 cent/per yen, a Sony T.V. set
priced at ¥20,000 will cost an American $200 =
(20,000 x .01).

25. EXAMPLE IN THE
TEXTBOOK
C. The dollar-yen exchange market is depicted in
Figure 6.3. The demand for yen and the supply
of yen curve will establish the equilibrium dollar
price of yen.

26. Appreciation and Depreciation
1. If the demand for yen rises, the dollar price of
yen rises. That means the dollar depreciates
relative to the yen. This could happen for many
reasons including an increase in U.S. incomes
that enables Americans to buy more Japanese
goods, or an increase in preference for
Japanese products. The result is that
Japanese goods would become more
expensive to Americans and U.S. products
would become less expensive to us.

27. Appreciation and Depreciation
2. If the opposite occurred and Japanese incomes
increased more than U.S. incomes and/or
Japanese preferences for U.S. products
increased, then the dollar would appreciate
relative to the yen as the yen supply increased.
Americans will purchase a greater quantity of
Japanese products because they have become
less expensive in dollar terms.

28. GOVERNMENT AND
TRADE impediments are sometimes enacted
Several trade
by governments.
1. Protective tariffs are excise taxes or duties on
imported goods. Governments enact these
tariffs to protect domestic producers by making
foreign goods more expensive.
2. Import quotas are maximum limits on the
number or total value of specific imports. Once
quotas are filled, no more imports are allowed
into the country.

29. GOVERNMENT AND
TRADE
3. Nontariff barriers include licensing
requirements, unreasonable standards, and
unnecessary bureaucratic “red tape.”
4. Governments have used export subsidies to
promote the sale of products aboard.

30. WHY DO GOVERNMENTS
ENACT TRADE BARRIERS?
1. They don’t understand the benefits from
international trade and see only the damage in
certain industries that can’t compete
successfully with imports.

31. WHY DO GOVERNMENTS
ENACT TRADE BARRIERS?
2. Political considerations are important because
consumers don’t see the effects of a tariff or
quota directly, but they do see the impact of
import competition on some workers. Also, the
benefits of free trade tend to be spread among
all consumers, but the benefits of a protective
policy are realized almost immediately in the
short run by the affected industry may have a
large and vocal stake in the outcome.

32. WHO IS HURT BY TRADE
BARRIERS?
C. Trade barriers hurt American consumers who
must pay higher than world prices. Interference
with international trade through protective tariffs
and quotas is shown to cost society more than
the benefits that are received by the protected
firms and workers.

33. LET’S PRACTICE!
Do Key Questions 6 and 7 from page 109;
answer in your notebook.

34. MULTILATERAL
AGREEMENTS AND
FREE-TRADE ZONES

35. THE SMOOT-HAWLEY
TARIFF ACT
A. Trade barriers can cause a “trade war,” in
which all nations retaliate with trade barriers of
their own. The Smoot-Hawley Tariff Act of 1930
was a classic example of this. It prompted
other nations to increase tariffs and global trade
fell as well as U.S. output.

36. THE RECIPROCAL AGREEMENTS
ACT
B. Reciprocal Trade Agreements Act had the goal
of reducing tariffs.
1. It gave the President the power to negotiate
reductions up to 50 percent if the trading
partner also reduced its tariffs.
2. This act included “most-favored-nation”
clauses in agreements so other nations also
benefit when negotiations succeeded with one
particular country. For example, if the U.S.
negotiated a reduction in tariffs with France, to
lower American tariffs on French imports, the
imports of other nations having most favored
nation status, say, Sweden would also be
reduced.

37. THE GENERAL AGREEMENT OF TARIFFS
AND TRADE (GATT)
C. The General Agreement of Tariffs and Trade:
1. In 1947 after WWII, the U.S. signed an
agreement to negotiate reductions on a
multilateral basis. Twenty-three nations
originally signed, but now 128 nations belong to
GATT.
2. The latest round of GATT negotiations was the
eighth set of negotiations. It began in Uruguay
in 1986 and concluded at the end of 1993. The
agreement was passed by Congress in the fall
of 1994, went into effect in 1995, and was
phased in through 2005. Its major provisions
include the following:

38. TRADE AGREEMENTS
a. Tariff reductions will average 33 percent.
b. Services are included in the treaty’s trade rules.
c. Quotas on textiles and apparel imports will be
replaced by tariffs and these, too, will be
eliminated gradually.
d. Agriculture will also be affected with members
agreeing to cut subsidies to agriculture and
quotas on agricultural imports.

39. TRADE AGREEMENTS
e. Intellectual property will be protected by
international patent, trademark, and copyright
agreements.
f. When fully implemented, experts estimate the
GATT agreement will boost world GDP by $6
trillion or 8 percent, and U.S. consumers will
save about $30 billion each year.

40. THE WORLD TRADE ORGANIZATION
D. World Trade Organization (WTO):
1. The Uruguay Round of the GATT established
the WTO as the GATT’s successor, which
replaced it.
2. The WTO oversees trade agreements and
rules on trade disputes, acting as a supervisor
and liberalizing international trade.
3. The organization deals with regulation of trade
between participating countries; it provides a
framework for negotiating and formalizing trade
agreements, and a dispute resolution process
aimed at enforcing participants' adherence to
WTO agreements.

41. THE WORLD TRADE ORGANIZATION
4. The organization is currently in a trade
negotiation called the Doha Development
Agenda (or Doha Round), which was launched
in 2001 to enhance equitable participation of
poorer countries which represent a majority of
the world's population.
5. The negotiations have been intense and
agreement has not been reached;
disagreements still continue over several key
areas including agriculture subsidies.
6. WTO has 157 members, representing more
than 97% of the world's population.

42. ARGUMENTS FOR AND AGAINST THE
WORLD TRADE ORGANIZATION
4. Critics of the WTO are concerned that the rules
crafted to expand trade and investment enables
firms to circumvent national laws that protect
workers and the environment.
5. Proponents argue promotion of free trade will
raise output and incomes and that the higher
standards of living will likely result in more
protections for workers and the environment.

43. THE EUROPEAN UNION
E. European Union (EU):
1. In many regions of the world, countries have
formed free-trade zones to reduce tariffs.
2. The EU was formed in 1958 as the Common
Market.
3. The EU was created in the aftermath of the
second world war. The first steps were to foster
economic cooperation: countries that trade with
one another are economically interdependent
and will thus avoid conflict.

44. THE EUROPEAN UNION
4. Since then, the union has developed into a
huge single market with the euro as its
common currency. What began as a purely
economic union has evolved into an
organization spanning all areas, from
development aid to environmental policy.
5. The EU is a unique economic and political
partnership between 27 European countries.

45. MEMBERS OF THE EUROPEAN
UNION
1. Austria (since 1995-01-01) (EUR)
2. Belgium (EUR)
3. Bulgaria (since 2007-01-01)
4. Cyprus (Greek part) (since 2004-05-01) (EUR: 2008-01-01)
5. Czech Republic (since 2004-05-01)
6. Denmark
7. Estonia (since 2004-05-01)
8. Finland (since 1995-01-01) (EUR)
9. France (EUR)
10. Germany (EUR)
11. Greece (EUR)
12. Hungary (since 2004-05-01)
13. Ireland (EUR)
14. Italy (EUR)

46. MEMBERS OF THE EUROPEAN
UNION
15. Latvia (since 2004-05-01)
16. Lithuania (since 2004-05-01)
17. Luxembourg (EUR)
18. Malta (since 2004-05-01) (EUR: 2008-01-01)
19. Netherlands (EUR)
20. Poland (since 2004-05-01)
21. Portugal (EUR)
22. Romania (since 2007-01-01)
23. Slovakia (since 2004-05-01) (EUR: 2009-01-01)
24. Slovenia (since 2004-05-01) (EUR)
25. Spain (EUR)
26. Sweden (since 1995-01-01)
27. United Kingdom of Great Britain and Northern Ireland

47. THE EUROPEAN UNION
6. The EU has delivered half a century of peace,
stability, and prosperity, helped raise living
standards, launched a single European
currency, and is progressively building a single
Europe-wide market in which people, goods,
services, and capital move among Member
States as freely as within one country.

48. THE EUROPEAN UNION
7. The EU actively promotes human rights and
democracy and has the most ambitious
emission reduction targets for fighting climate
change in the world. Thanks to the abolition of
border controls between EU countries, it is now
possible for people to travel freely within most
of the EU. It has also become much easier to
live and work in another EU country.

49. THE EURO
F. The Euro:
1. The euro is a currency established by the EU
that is now being used by 17 of the 27 EU
nations.
2. Starting in 1999, the euro was first used as
electronic payments for credit card purchases
and transfer of funds among banks, while each
country continued to use their currency for cash
transactions.
3. By July 2002, only the euro was accepted for
payments in the EU countries that adopted the
currency.

50. WHO USES THE EURO? SINCE
WHEN?
1999 Belgium, Germany, Ireland, Spain, France,
Italy, Luxembourg, the Netherlands, Austria,
Portugal and Finland
2001 Greece
2002 Introduction of euro banknotes and coins
2007 Slovenia
2008 Cyprus, Malta
2009 Slovakia
2011 Estonia

51. NAFTA
G. North American Free Trade Agreement (NAFTA):
1. This free-trade zone was established in 1993
among Canada, U.S. and Mexico with about the
same combined output as EU, but a larger
geographical area.
2. Free trade with Mexico was controversial
because critics fear a loss of American jobs as
firms can move to Mexico more easily. Also, they
fear Japanese and South Korean firms will build
plants there and import goods duty-free to U.S.
3. The increased trade has increased domestic
employment, reduced unemployment, and
increased the standard of living in all three
countries.

52. NAFTA
2. Free trade with Mexico was controversial
because critics fear a loss of American jobs as
firms can move to Mexico more easily. Also,
they fear Japanese and South Korean firms will
build plants there and import goods duty-free to
U.S.
3. The increased trade has increased domestic
employment, reduced unemployment, and
increased the standard of living in all three
countries.

53. INCREASED GLOBAL
COMPETITION
A. Although imports of many products have
decreased the share of American firms in the
U.S. market, hundreds of U.S. firms have
prospered in the global market.
B. Although some domestic producers will get hurt
and their workers will have to find
employment elsewhere, freer trade benefits the
consumer and society.