Chapter 9: Comparative Advantage, Exchange Rates, and Globalization

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinChapter GoalsExplain the principle of comparative advantageDiscuss how exchange rates are determined and what their role is in equalizing trade flowExplain why economists’ and laypeople’s views of trade differSummarize the sources of U.S. comparative advantage and discuss some concerns about the future in the U.S. economyThe Principle of Comparative AdvantageOpportunity cost is what must be given up in one good in order to get another goodThe principle of comparative advantage is that as long as the relative opportunity costs of producing goods differ among countries, then there are potential gains from tradeDividing Up the Gains from TradeThe more competition, the less the trader getsSmaller countries get a larger proportion of the gain than larger countriesCountries producing goods with economies of scale get a larger gain from tradeThree determinants of the terms of trade are:Why Economists and Laypeople Differ in Their Views of TradeThe gains of trade, lower prices, are harder to see than the cost, lost jobsThe public believes that lower wages in other countries give them the comparative advantage in everything, so we will lose all jobsIf trade is good, why do so many people oppose it?Laypeople often think of trade as trade only in manufactured goodsLaypeople are extremely concerned about the impact of trade on the distribution of incomeSources of U.S. Comparative AdvantageU.S. physical and technological infrastructure is the best in the worldWealth from past production and borrowing allows the U.S. to be the world’s largest consumerU.S. companies and individuals hold a large number of intellectual property rightsThe U.S. has a relative open immigration policySome Concerns about the FutureTransferable comparative advantages are based on factors that can change relatively easily, such as capital, technology, and types of laborWhether a country can maintain a much higher standard of living in the long run depends in part on whether its comparative advantage is inherent or transferableInherent comparative advantages are based on factors that are relatively unchangeable, such as resources and climateInherent and transferable comparative advantageSome Concerns about the FutureIf factor prices aren’t equal, firms can reduce costs by redirecting production to countries with lower factor pricesThe convergence hypothesis is the tendency of economic forces to eliminate transferable comparative advantage.The law of one price means that in a competitive market, there will be pressure for equal factors to be priced equallyThe law of one priceSome Concerns about the FutureWages rise in the surplus countries, making their goods more expensiveThe exchange rate of the deficit country falls and makes its goods less expensiveAdjustments eventually occur to make surplus countries less competitive and deficit countries more competitiveMethods of equalizing trade balancesDetermination of Exchange Rates and TradeThe exchange rate is the rate at which one country’s currency can be traded for another’sPeople exchange currencies to buy goods or assets in other countriesThe market for euros is in equilibrium when quantity supplied equals quantity demanded To demand one currency, you must supply anotherThe supply curve of euros is upward-slopingThe demand curve for euros is downward-slopingSupply and Demand in Currency MarketsDetermination of Exchange Rates and TradeThe exchange rate plays an important role in the demand for a country’s domestic goodsAs the quantity supplied of tradable goods rises, suppliers have to charge higher prices Exchange rate adjustments can bring comparative advantages into alignment, eliminating trade imbalancesTrade for an economy that faces global competition needs to take into account world supplyExchange Rates and TradeDetermination of Exchange Rates and TradeThe presence of the resource curse: the paradox that countries with an abundance of resources tend to have lower economic growth and more unemployment than countries with fewer natural resources The fact that demand for a country’s currency also reflects a demand for its assets Some Complications in Exchange RatesTrade imbalances arise due to:Chapter Summary According to the principle of comparative advantage, as long as the relative opportunity costs of producing goods differ among countries, there are potential gains from trade The more competition exists in international trade, the less the trader gets and the more the involved countries getOnce competition prevails, smaller countries tend to get a larger percentage of the gains from trade than do larger countriesGains from trade go to countries that produce goods that exhibit economies of scaleChapter Summary Economists and laypeople differ in their views on tradeThe gains from trade are not easily recognized, while the costs in jobs lost tend to be readily identifiableThe U.S. has comparative advantages based on its skilled workforce, its institutions, and its language, among other thingsThe prices of currencies—foreign exchange rates—can be analyzed with the supply and demand modelThe resource curse leads to trade imbalances