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|Exchange Rate||Balance of Payments||Trade Agreements|
National Content Standards Addressed
Standard 5: Gains from Voluntary Trade
Voluntary exchange occurs only when all participating parties expect to gain. This is true for trade among individuals or organizations within a nation, and among individuals or organizations in different nations.
- People voluntarily exchange goods and services because they expect to be better off after the exchange.
- Free trade increases world wide material standards of living.
- Despite the mutual benefits from trade among people in different countries, many nations employ trade barriers to restrict free trade for national defense reasons or because some companies and workers are hurt by free trade.
- A nation pays for its imports with its exports.
- When imports are restricted by public policies, consumers pay higher prices and job opportunities and profits in exporting firms decrease.
Standard 6: Specialization and Trade
When individuals, regions, and nations specialize in what they can produce at the lowest cost and then trade with others, both production and consumption increase.
- Specialization and division of labor usually increase the productivity of workers.
- Like trade among individuals within one country, international trade promotes specialization and division of labor and increases output and consumption.
- As a result of growing international economic interdependence, economic conditions and policies in one nation increasingly affect economic conditions and policies in other nations.
- Transaction costs are costs (other than price) that are associated with the purchase of a good or service. When transaction costs decrease, trade increases.
- Individuals and nations have a comparative advantage in the production of goods or services if they can produce a product at a lower opportunity cost than other individuals or nations.
- Comparative advantages change over time because of changes in factor endowments, resource prices, and events that occur in other nations.
Standard 7: Markets
Markets exist when buyers and sellers interact. This interaction determines market prices and thereby allocates scare goods and services.
- An exchange rate is the price of one nation’s currency in terms of another nation’s currency. Like other prices, exchange rates are determined by the forces of supply and demand. Foreign exchange markets allocate international currencies.
- Voluntary trade creates wealth.
- People trade when they expect to gain from the exchange.
2. Voluntary trade creates wealth whether the trade is domestic or international.
- People – not nations or societies or governments – engage in trade. Nations do, however, create trade policies that affect people’s willingness and ability to trade.
- The decisions made by people engaged in international trade are not fundamentally different from those made by people engaged in domestic trade.
- Developments in India and China over the last quarter century are testimony to the wealth-creating benefits of engaging in voluntary international trade.
3. The wealth-creating benefits of both domestic and international trade derive from specialization based on the Principle of Comparative Advantage.
- The Principle of Comparative Advantage leads producers to specialize in the production for which they have the lowest opportunity cost.
- Specialization leads to interdependence and greater cooperation among nations.
- Specialization lowers production costs and market prices for traded products.
- Trade based on comparative advantage increases production and raises incomes.
4. Transaction costs in international trade are generally higher than in domestic trade.
- Payment systems may require currency conversions at prevailing exchange rates.
- Currency exchange rates reflect the expected relative purchasing power of national currencies.
- There are benefits and costs to countries from adopting common currencies to facilitate international trade.
- Some benefits include ease of exchange when crossing borders and the simplicity of international contracts using the common currency.
- Some costs include the loss of seigniorage to fund domestic government spending and local control over banking regulations, and, perhaps most importantly, the loss of control over monetary policy.
- Transportation systems may involve detailed logistics of transfer, warehousing, and inspections at borders.
- Trade agreements that specify rules, rights and regulations that govern trade between cooperating countries, may raise or lower transactions costs
5. Policies that restrict international trade inhibit the ability of markets to create wealth.
- Tariffs, quotas, and regulations on content and production processes adversely affect both buyers and sellers.
- Trade protection policies are often short-sighted, focusing on the benefits to import-competing industries and ignoring the impact on export-producing industries and on the prices of traded goods.
- All participating countries benefit from international trade agreements and associations that reduce barriers to trade.
6. Changes in international exchange rates affect the relative purchasing power of a nation’s currency.
- When the U.S. dollar falls in value relative to other another country’s currency, imports from that country become more expensive for American buyers and exports to that country become cheaper for the foreign buyers.
- When the U.S. dollar rises in value relative to another country’s currency, imports from that country become less expensive for American buyers and exports to that country become more expensive for the foreign buyers.
7. The balance of trade always balances.
- The balance of payments measures both goods and services (current account) and financial (capital account) trade flows.
- A trade deficit occurs when imports of goods and services exceed exports. However, a deficit in goods and services (current account) must be accompanied by a surplus in the financial account (capital account.)
- A surplus in financial transactions means Americans are net borrowers from foreign countries and foreign countries are net investors in the U.S.
Ideas To Take Away From This Lesson
- International trade is similar to all other trade – people choose to trade.
- Trade allows people to specialize in their lowest opportunity cost production.
- Comparative advantage encourages specialization and trade, both domestically and internationally.
- Specialization increases productivity and economic growth.
- Exchange rates reflect supply and demand for nations’ currencies and changes in currency values affect the flow of trade.
- Trade in goods, services, capital, and financial assets always balances. Balance of Payments accounting provides information about exchanges of goods, services, and financial transactions among people in different countries.