International Economics
James B. Wilcox
RESOURCES PROVIDED BY:
THE UNIVERSITY OF SOUTHERN MISSISSIPPI
CENTER 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 CROP
There 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
• 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.
Adam Smith
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
1
6
2
4
3
2
4
0
5
John can produce
Oranges Potatoes
3
0
2
1
1
2
0
3
John wants at least 3 O & 1 P
Mary wants at least 7 O & 2 P
“Year” One: No Contact with Partner
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.
Mary can produce
O
P
10
0
8
1
6
2
4
3
2
4
0
5
Mary: at least 7 O & 2 P
John can produce
O
P
3
0
2
1
1
2
0
3
John: at least 3 O & 1 P
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
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.
Mary can produce
O
P
10
0
8
1
6
2
4
3
2
4
0
5
Mary: at least 7 O & 2 P
John can produce
O
P
3
0
2
1
1
2
0
3
John: at least 3 O & 1 P
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:
• John:
produce 10 oranges and 0 potatoes
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
8
6
4
2
0
0
1
2
3
4
5
John can produce
O
P
3
2
1
0
0
1
2
3
Opportunity cost of a P is 1 O’s
Opportunity cost of a P is 2 O’s
Determine Opportunity Cost – Physically Verify
Mary can produce
O
P
10
8
6
4
2
0
0
1
2
3
4
5
John can produce
O
P
3
2
1
0
0
1
2
3
Opportunity cost of a O is 1 P
Opportunity cost of a O is 0.5 P’s
Concept: Comparative Advantage
Specialize 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
→ net gain =
•
=
-10
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
O
John’s PPC
O
Unattainable
with your own
production
10
7
3
0
2
5
P
0
1
3
PPF = “production possibilities curve”
P
Comparative Advantage in Potatoes?
Mary’s PPC
John’s PPC
O
O
10
Opportunity cost
Opportunity cost
of P: two O
of P: one O
Specialize in
Potatoes
3
0
5
P
0
3
P
Comparative Advantage in Oranges
Mary’s PPC
John’s PPC
O
O
Specialize in O
10
Opportunity cost
Opportunity cost
of O: 0.5P
of O: 1P
3
0
5
P
0
3
P
Gains from Specialization & Trade
Mary’s PPC
John’s PPC
O
O
10
7
3
0
2
5
P
0
1
3
P
Production Possibilities Curve/Frontier
O
• 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
P
Beyond Present PPC?
O
How can a country
achieve this point?
1. Specialize & trade
2. Economic growth
P
1. Specialization & Trade
O
trade
Assume
comparative
advantage in
Oranges
specialize
P
2. Dynamic Gains from Competition
O
Economic
Growth
P
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 . .
Adam Smith
The Wealth of Nations
1776
• Would it be reasonable law
to prohibit the importation
of all foreign wines merely
to encourage the making
of ... burgundy in Scotland?
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 Appetizers
Down Under Cheese Hoppers
Great Barrier Reef Finger Foods
Outback Croc Pot Stickers
Sydney Sheep Sizzlers
Chinese Chow
Great Wall Egg Roll
Mandarin Garlic Chicken
Szechwan Spicy Shrimp
Shanghaied Fried Rice
Continental Cuisine
French Onion Soup
Greek Salad
German Brats (best of the wurst)
Luck of the Irish Stew
Italian Spaghetti and Meatballs
Spanish Flan (a rich custard)
Belgian Chocolates
Finnish Cranberry Drink
Mexican Mouthfuls
Tijuana Taco
Chihuahua Enchilada
Burrito Yucatan
Fajitas de Francisco
Refried beans de guerrero
Nachos de Tabasco
Egyptian Elixirs
Cold Camel Cairo Coffee
Luscious Luxor Lemonade
Mango Juice Masterpiece
Suez-Sinai Soda
Make a list of items you’d like to
eat and drink
The Wide
World of
Taste Menu
On your sheet, check the
items you chose for lunch
Australian Appetizers
Down Under Cheese Hoppers
Great Barrier Reef Finger Foods
Outback Croc Pot Stickers
Sydney Sheep Sizzlers
Chinese Chow
Great Wall Egg Roll
Mandarin Garlic Chicken
Szechwan Spicy Shrimp
Shanghaied Fried Rice
Continental Cuisine
French Onion Soup
Greek Salad
German Brats (best of the wurst)
Luck of the Irish Stew
Italian Spaghetti and Meatballs
Spanish Flan (a rich custard)
Belgian Chocolates
Finnish Cranberry Drink
Mexican Mouthfuls
Tijuana Taco
Chihuahua Enchilada
Burrito Yucatan
Fajitas de Francisco
Refried beans de Guerrero
Nachos de Tabasco
Egyptian Elixirs
Cold Camel Cairo Coffee
Luscious Luxor Lemonade
Mango Juice Masterpiece
Suez-Sinai Soda
4.50 dollars
2.70 dollars
1.80 dollars
3.60 dollars
AUD
AUD
AUD
AUD
6 yuan
20 yuan
26 yuan
14 yuan
CNY
CNY
CNY
CNY
1.80 euros
2.52 euros
2.97 euros
2.25 euros
2.70 euros
1.98 euros
3.60 euros
1.62 euros
EUR
EUR
EUR
EUR
EUR
EUR
EUR
EUR
15.30 pesos
18.36 pesos
22.44 pesos
35.70 pesos
8.16 pesos
20.40 pesos
MXN
MXN
MXN
MXN
MXN
MXN
6.90 pounds
9.20 pounds
10.35 pounds
5.75 pounds
EGP
EGP
EGP
EGP
• 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
Down Under Cheese Hoppers
Finger Foods
Outback Croc Pot Stickers
Sydney Sheep Sizzlers
Great Wall Egg Roll
Mandarin Garlic Chicken
Spicy Shrimp
Shanghaied Fried Rice
French Onion Soup
Greek Salad
German Brats (best of the wurst)
Luck of the Irish Stew
Italian Spaghetti and Meatballs
Spanish Flan (a rich custard!)
Belgian Chocolates
Finnish Cranberry Drink
Taco
Enchilada
Burrito
Fajitas de Francisco
Refried Beans de Guerrero
Nachos de Tabasco
Cold Camel Coffee
Luscious Lemonade
Mango Juice Masterpiece
Suez-Sinai Soda
Quantity
Price
Total amount
Amount in USD
in foreign currency
($)
4.50 AUD
2.70 AUD
1.80 AUD
3.60 AUD
6 CNY
20 CNY
26 CNY
14 CNY
1.80 EUR
2.52 EUR
2.97 EUR
2.25 EUR
2.70 EUR
1.98 EUR
3.60 EUR
1.62 EUR
15.30 MXN
18.36 MXN
22.44 MXN
35.70 MXN
8.16 MXN
20.40 MXN
6.90 EGP
9.20 EGP
10.35 EGP
5.75 EGP
TOTAL COST OF LUNCH IN U.S. DOLLARS
Example:
Lindsey buys 3 Tijuana Tacos
 The price is 15.30 pesos for each taco, so the amount she
would spend in pesos would be
15.30 x 3 = 45.90 pesos
 The exchange rate is 1 USD = 11.1 MXN pesos.
 To convert to dollars
(45.90 MXN/tacos)
(45.90 MXN/tacos)
11.1 MXN/USD, or
1/
USD/
11.1
MXN =
4.14 USD
Calculation Table (again)
• Now, adjust purchases to spend entire 10 USD
(as close as you can)
Item
Down Under Cheese Hoppers
Finger Foods
Outback Croc Pot Stickers
Sydney Sheep Sizzlers
Great Wall Egg Roll
Mandarin Garlic Chicken
Spicy Shrimp
Shanghaied Fried Rice
French Onion Soup
Greek Salad
German Brats (best of the wurst)
Luck of the Irish Stew
Italian Spaghetti and Meatballs
Spanish Flan (a rich custard!)
Belgian Chocolates
Finnish Cranberry Drink
Taco
Enchilada
Burrito
Fajitas de Francisco
Refried Beans de Guerrero
Nachos de Tabasco
Cold Camel Coffee
Luscious Lemonade
Mango Juice Masterpiece
Suez-Sinai Soda
Quantity
Price
Total amount
Amount in USD
in foreign currency
($)
4.50 AUD
2.70 AUD
1.80 AUD
3.60 AUD
6 CNY
20 CNY
26 CNY
14 CNY
1.80 EUR
2.52 EUR
2.97 EUR
2.25 EUR
2.70 EUR
1.98 EUR
3.60 EUR
1.62 EUR
15.30 MXN
18.36 MXN
22.44 MXN
35.70 MXN
8.16 MXN
20.40 MXN
6.90 EGP
9.20 EGP
10.35 EGP
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
Closure
1. 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
Closure
5. 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.
Closure
6. 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.
Assessment
If 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 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.”
The Circular Flow of Productive Resources, Goods and
Services, and Money Payments
Money Payments (sales)
PRODUCT
MARKET
Goods and Services
HOUSEHOLDS
BUSINESSES
Productive Resources
FACTOR
MARKET
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
Japanese
People
and
Organizations
$$$$
$$$$
Goods and
Services
Markets
Currency
Exchange
Markets
¥¥¥¥
¥¥¥¥
United States
People
and
Organizations
Currency Flow
• To buy a good or service from another
country, a consumer will sell their home
currency in exchange for the foreign currency
for the trade
• This same exchange happens if it is
consumers, businesses, or investors
A U.S. bank is an organization in the United States. If the bank wants to buy a
building and open a branch office in Tokyo, it will buy yen and pay for those
yen with U.S. dollars.
Japanese
People
and
Organizations
$$$$
$$$$
Goods and
Services
Markets
Currency
Exchange
Markets
¥¥¥¥
¥¥¥¥
United States
People
and
Organizations
The bank will use the yen to buy a building and equipment and hire
workers in Japan.
Japanese
People
and
Organizations
$$$$
$$$$
Goods and
Services
Markets
Currency
Exchange
Markets
¥¥¥¥
¥¥¥¥
United States
People
and
Organizations
A Japanese automobile company is an organization in Japan. If the
company decides to build a factory in the United States it will buy
dollars with yen.
Japanese
People
and
Organizations
$$$$
$$$$
Goods and
Services
Markets
Currency
Exchange
Markets
¥¥¥¥
¥¥¥¥
United States
People
and
Organizations
The automobile company will use the dollars to build the factory, buy
equipment, and hire workers.
Japanese
People
and
Organizations
$$$$
$$$$
Goods and
Services
Markets
Currency
Exchange
Markets
¥¥¥¥
¥¥¥¥
United States
People
and
Organizations
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
Closure
4. 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
currency
country’s
currency
with
another
country’s
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 GROW
AND 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 Data
GDP per GDP per
capita
Argentina
Brazil
Chile
China
Ecuador
Egypt, Arab Rep.
Germany
India
Indonesia
Jordan
Mexico
Paraguay
Peru
Poland
Russian Fed.
South Africa
Thailand
United Kingdom
United States
Uruguay
Vietnam
(1)
(2)
capita
Population Population
PPP
growth
total
U.S. $
annual %
millions
2005
2005
2005
14,280
8,402
12,027
6,757
4,341
4,337
29,461
3,453
3,843
5,530
10,751
4,642
6,039
13,847
10,845
11,110
8,678
33,238
41,890
9,962
3,071
8.1
38.7
0.9
186.4
5.2
16.3
9.5 1,304.5
3.3
13.2
3.0
74.0
1.0
82.5
7.7 1,094.6
4.2
220.6
4.8
5.5
1.9
103.1
1.0
5.9
4.9
28.0
3.4
38.2
6.9
143.1
3.7
46.9
3.6
64.2
1.2
60.2
2.2
296.4
5.8
3.5
7.2
83.1
growth
Gross
Gross
Foreign
Cost of
fixed
fixed
direct
business
Ease of
Info(3)
Health
Life
Labor force
capital
capital
investment
start-up
doing
technology
Expend
expectancy
participation
formation formation net inflows
annual % (% of GDP) annual %
2006
2005
0.97
1.35
1.06
0.64
1.44
1.90
(0.06)
1.37
1.36
2.30
1.01
1.91
1.46
(0.04)
(0.51)
1.14
0.84
0.66
0.96
0.69
1.16
21.5
18.3
22.1
42.3
21.9
18.0
17.1
28.1
22.0
23.7
19.3
20.3
18.8
18.2
18.2
17.2
29.0
16.6
18.7(1)
12.9
33.1
2005
22.7
-0.6
24.7
14.8
8.1
11.5
-0.2
15.3
9.9
5.0
7.6
4.8
13.6
6.5
10.5
9.2
11.4
3.2
8.3(1)
23.8
11.0
2004
low = more business friendly
Information and Communication Technology
Sources of data: 2007 World Development Indicators . The World Bank.
(3)
(% of GNI
(% GDP)
per capita)
2005
2006
2.6
1.9
5.8
3.5
4.5
6.0
1.1
0.8
1.8
12.1
2.4
0.9
3.2
3.2
2.0
2.6
2.6
7.2
0.9
4.2
3.7
12.1
9.9
9.8
9.3
31.8
68.8
5.1
73.7
86.7
73
14.2
136.8
32.5
21.4
2.7
6.9
5.8
0.7
0.7
44.2
44.5
business expenditure per capita at birth, total rate, total %
index(2) % of GDP
(U.S. $)
years
of pop 15-64
2005
101
121
28
93
123
165
21
134
135
78
43
112 ..
65
75
96
29
18
6
3
64
104
7.1
7.8
6.1
5.3
3.2
1.5
6.1
5.8
3.4
8.4
3.3
6.6
4.2
3.6
9.9
4.1
7.3
8.8
7.9
15.1
2004
383
290
359
71
127
64
3,521
31
33
200
424
88
104
411
245
390
88
2,900
6,096
315
30
2005
74.8
71.2
78.2
71.8
74.7
70.5
78.9
63.5
67.8
72.0
75.4
71.4
70.7
75.0
65.5
47.7
70.9
78.9
77.7
75.6
70.7
2005
71.6
72.1
58.4
82.0
74.7
49.3
73.4
60.9
70.1
55.6
62.1
77.8
72.4
63.2
71.0
65.3
77.6
75.6
75.7
76.1
79.9
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
L
K
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
1050
1248
1382
1485
1570
1643
1708
1766
1819
1867
1912
1954
1994
2031
2066
2100
2132
2163
2192
2221
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
L
K
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
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