Chapter 29- Specialization and Trade
Specialization
- Occurs when productive agents use resources to focus on producing one or a few products at which they are suited best
- Occurs when buyers and sellers in two nations exchange with one another
- Closed economy when it neither imports nor exports products
- Open economy when both imports and exports products
- Provides a method of comparing opportunity costs in producing certain items
- Based on the most of an item each producer could make if it specializes using a set amount of resources
- Based on the least resources each producer needs to make a set amount of an item
- Producers should specialize in making a product only when their cost ratio of doing so is less than that of their trading partners
- No advantage rule states that nations should not specialize or trade if neither trading partner possesses a cost advantage in producing either products
- Absolute advantage rule states that two countries should specialize and trade when each partner has an output advantage over the other
- Comparative advantage rule states that two countries should specialize and trade, even if one produces more output of both products, as long as each partner has a cost advantage over the other
- Shows the amount of two items a country can obtain by specializing in one and trading for the other
o
A nation’s balance
of payments is the sum of all the transactions that take place between its
residents and the residents of all foreign nations.
§
Exports and Imports of Goods, Exports and
Imports of Services, tourist expenditures, interest and dividends received or
paid abroad, and purchases and sales of financial or real assets abroad
o
The US Commerce Department’s Bureau of Economic
Analysis complies the balance-of-payments statement each year.
§
Shows all the payments a nation receives from
foreign countries and all the payments it makes to them.
o
Three Components
§
The Current Account
·
The current
account summarizes U.S. trade in currently produced goods and services
·
US Exports have a plus (+) sign – they credit and create revenue
·
US Imports have a minus (-) sign – they are debit and reduce the stock of foreign
currencies in the United States
·
Balance on Goods
o
A country’s balance
of trade on goods is the difference between its exports and its imports of
goods
·
Balance on Services
o
Services include insurance, consulting, travel,
and brokerage services
·
Balance
on Goods & Services
o
The difference between U.S. exports of goods and
services and U.S. imports of goods and services
§
Trade
deficit – imports > exports
§
Trade
surplus – exports > imports
·
Balance on Current Account
o
Represents the net investment income, represents the difference between
§
1. The interest and dividend payments foreigners
paid the United States for the use of exported U.S. capital
§
2. The interest and dividends the United States
paid for the use of foreign capital invested in the United States
o
Includes Net transfers and Net investment Income
§
Net Transfers include foreign aid, pensions paid
to U.S. citizens living abroad, and remittances by immigrants to relatives
abroad
·
“The exporting of goodwill and the importing of
‘thank-you notes’.”
o
By adding all transactions in the current
account, obtain the balance on current
account
§
The Capital Account
·
The capital
account summarizes the purchase or sale of real or financial assets and the
corresponding flows of monetary payments that accompany them.
o
Items (an office building or bonds) bought from
the U.S. count as exports (+) as they represent in--payments of foreign
currencies
§
Key Point – foreign
purchases of assets in the U.S.
o
Items located in foreign countries and sold to
companies in that country count as imports (-) as they represent out-payments
of domestic currencies
§
Key Point- U.S.
purchases of assets abroad
·
Exports and Imports balance on the balance on capital account
§
The Official Reserves Account
·
The central banks of nations hold quantities of
foreign currencies called official
reserves.
·
Functions just the same as reserves in any other
bank
·
Basically used to make up any final balancing
amount
o
Putting it all Together
§
The three components of the balance of payments
(the current account, the capital account, and the official reserves account)
must together equal zero.
§
Every unit of foreign exchange used (as
reflected in a minus out-payment or debit transaction) must have source (a plus
in-payment or credit transaction)
o
Payments Deficits and Surpluses
§
Balance-of-payments
deficits and surpluses, though the balance of payments must always sum to
zero, this refers to imbalances between the current and capital accounts
·
The US favors balance-of-payments deficits – a
drawing down of official reserves
·
A balance-of-payments surplus is a building up
of official reserves
A BOB "Chart"
Assets/Creditr (Inflow)
|
Debits/Liabilities (Outflow)
|
|
Current Account
|
||
-Balance on goods and services
-Net exports
-Balance of trade
|
-Exports
-Tourism here
|
-Imports
-Tourism there
|
Net Investments
|
-Interest/dividend payments
-Foreign ppay to U.S. for use of exported capital
|
-Interest/dividend payments
-The U.S. made for the use foreign capital invested in U.S.
|
Net Transfers
|
-Aid to U.S.
-Include royalties
|
-Aid to their country
-Their royalties
|
Financial Account
|
-Capital inflows
-Direct investment by foreigners
-Purchases of stocks and bonds by foreigners
|
-Capital ooutflows
-Direct investment by U.S. over there
-Purchases of stocks and bonds by U.S.
|
Official Reserves
|
-Currencies
-Gold
-IMF
|
-Currencies
-Gold
-IMF
|
Comparative and Absolute Advantage
- The division of labor into specific task and roles intended to increase the productivity of workers is called known specialization
- Globalization is the process of increasing the productivity and interdependence of the world's markets and businesses
- Absolute advantage refers to a country's ability to produce a certain more of a good or service than another country
- The absolute advantage rule states that two countries should specialize and trade when each other partner has an output advantage over the other
- Comparative advantage refers to a country's ability to produce a particular good with a lower opportunity cost than another country
- Gains from trade or based on comparative advantage, not absolute advantage
- Comparative advantage is the basis for all trade between individuals, regions, and nations
- A foreign exchange market is a market in which currencies are exchanged for one another
- The equilibrium prices in these markets are called exchange rates
- The rate at which the currency of one nation can be exchanged for the currency of another nation
- Depreciation and Appreciation: an increase in the U.S. demand for Japanese goods will increase the demand for yen and raise the dollar price of yen
Supply of the Dollar
|
Demand of the Dollar
|
-Comes from U.S. citizens, banks, and industries wanting to purchase
foreign goods, investments assets and to make payments to transfer foreigners
|
-Comes from foreigners, banks, and industries wanting to purchase our
goods, investments, assets, and to make transferred payments to U.S.
|
- 5 Determinants of Supply and Demand in Foreign Exchange Market
- Change in buyers taste
- Change in relative incomes
- Change in relative prices
- Change in interest rates
- Change in expectations
- Sell exports and buy imports
- Invest in a countries stocks and bonds
- Build stores and factories in other markets
- Hold currencies in bank accounts for future exports, imports, and business loans
- To speculate on currency values
Here is a video on fixed exchange rates!
- Flexible: determined by market forces with little or no government intervention
- Fixed: determined and periodically adjusted by government
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