Trading with Other
Nations
The Benefits of
World Trade

Trade involves imports and exports.
Imports: good bought from other countries for domestic
use
 Exports: goods sold to other countries


Without imports we would have no coffee,
chocolate, or pepper.


Also more than 60% of the radios, television sets, and
motorcycles sold in the US are imported.
More than 40% of the nation’s engineering and
scientific instruments and 50% of wheat produced
in the US are sold to consumers overseas.



Many products are manufactured in more than
one country.
Some parts might be imported and the rest
made in the country.
Economies differ among nations, due to
differing natural resources, types and amount
of labor, and the amount of capital available.



Determining what to export and import
depends on the relative costs of production for
different items.
No country can produce everything more
cheaply than other nations because of
opportunity cost.
All nations must make choices in how they use
their scarce resources.



Absolute advantage: the ability of one country to
produce a product more efficiently than another
country.
The particular distribution of resources in a nation
often gives it an advantage over another nation in
the production o one or more products.
Brazil has a climate more suitable for the growing
of bananas than France.

Brazil has an absolute advantage in bananas over France.


A nation often finds it profitable to produce
and export a limited assortment of goods for
which it is particularly suited in a process
called specialization.
Japan’s specialization in consumer electronics
has led many nations to import these types of
products from Japan.


Comparative advantage: the ability of one
country to produce a product at a lower
opportunity cost than another country.
A nation does not need an absolute advantage
in order to find it profitable to specialize and
then to trade with other countries.



Countries often specialize in and export
products for which they have an absolute or
comparative advantage
The ultimate goal of international trade is to
gain imported products.
Countries benefit when each country
concentrates on that production for which it is
relatively most efficient.
Financing World Trade


The US uses the dollar as its medium of
exchange.
Other countries have their own currency.

In order to engage in world trade people must
have a way of knowing the exchange rate.


Exchange Rate: the price of one nation’s currency in
terms of another nation’s currency
Individuals and businesses can easily and
quickly convert one currency to another by
using foreign exchange markets.

Foreign Exchange Markets: markets dealing in buying
and selling foreign currency for businesses that want
to import goods from other countries


Fixed Rate of Exchange: system under which a
national government sets the value of it
currency in relation to a single standard
Under a system of fixed exchange rates,
national governments valued their currency in
relation to a single standard.



Fixed exchange rates made it easy to compare
different currencies.
Devaluation is to lower a currency’s value in
relation to other currencies by government
order.
It is difficult to hold exchange rates constant in
an international economy.



Flexible Exchange Rate: arrangement in which
the forces of supply and demand set the value
of different currencies.
Depreciation occurs when a currency’s price
falls due to supply and demand.
Political or economic instability in a country
can affect its currency value.




Balance of Trade: difference between the value of a
nation’s exports and its imports
A positive balance of trade means more products are
exported than imported.
A trade deficit occurs when more products are
imported than exported, resulting in a negative balance
of payments, meaning more money is spent abroad
than is taken in.
A trade deficit is not always harmful because it
encourages foreigners to invest in the U.S. economy.
Restrictions on World
Trade

Three major barriers to world trade are:

Tariffs

Quotas

Embargos




Tariffs: tax placed on an imported product
There are two types of tariffs: revenue tariffs and
protective tariffs.
Revenue tariffs: tax on imports primarily to raise
government revenue without restricting imports
Protective Tariff: tax on imports used to raise the
cost of imported goods and thereby protect
domestic producers


Import Quota: restriction imposed on the
number of units of a particular good that can
be brought into the country
The US has placed quotas on imports of sugar,
dairy products, various types of apparel, and
cloth.



Embargo: complete restriction on the import or
export of a particular good
Embargoes are often enacted for political
reasons.
The US has placed an embargo on trade with
Cuba because of the country’s communist
leadership.



There are pros and cons to trade restrictions
and trade is often hotly debated.
Protectionists: argue for trade restrictions to
protect domestic industries.
3 main arguments exist for trade protection:



Job Security
National Economic Security
Infant Industries


Free trade can mean a loss of jobs for national
workers.
Domestic worker could be unemployed if
foreign competitors sell goods at lower prices
than American firms.


Free trade can impact industries that are critical
to a nation’s economy.
Protectionists believe that entire industries
such as oil, should be protected against foreign
competition.


Free trade can negatively impact new
industries.
Protectionists believe that if foreign
competition is restricted for a time, a young
industry may become strong enough to
compete in the world market.


People who argue for free trade believe that
exports and imports should not be restricted.
There are three main arguments in support of
free trade:

Improved Products

Export Industries

Specialization and Comparative Advantage


Free trade can lead to better products, causing
the consumer to benefit and the standard of
living to increase.
Foreign competition encourages the US to
improve technology and production methods.



Free trade benefits a nation’s export industries.
When the US imports fewer goods, there is less
American money available outside the US to
buy American exports.
When the US restricts imports, other nations
may retaliate and restrict their own imports.


The specialization associated with free trade
brings more goods at lower prices.
Specialization benefits consumers because
comparative advantage results in more goods
and a lower price.



The General Agreement on Tariffs and Trade
(GATT) states that member nations agree on
tariff reductions that benefit all members.
The World Trade Organization (WTO) was
established in 1993 to replace GATT.
It is the farthest-reaching global trade
agreement in history.



Regional trade agreements have been reached
in many parts of the world to increase free
trade.
Examples of regional trade agreements:
NAFTA—Canada, U.S., and Mexico.
The European Union—15 European nations,
and 10 other countries that joined in 2004.