CHAPTER 5: THE UNITED STATES IN THE GLOBAL ECONOMY

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1 CHAPTER 5: THE UNITED STATES IN THE GLOBAL ECONOMY Intoducton Globalzaton has damatcally changd makts, as poducs and consums aound th wold a ncasngly ntconnctd though makts. Chapt 5 ntoducs th global conomy by dscbng th mpotanc of compaatv advantag n dtmnng tad pattns, dntfyng th causs and ffcts of changng cuncy valus, and xplanng th hstoy of govnmnt ntvnton n ntnatonal tad. Matal fom Chapt 5 consstntly appas on both AP conomcs xams, wth a quston o two about compaatv advantag and spcalzaton appang on th multpl-choc poton of th mcoconomcs xam. Matal on compaatv advantag, ntnatonal tad, and cuncy makts consstntly appas on th macoconomcs xam n both multpl-choc and f-spons sctons. Th macoconomcs f-spons scton, n patcula, vy oftn ncluds a full quston o a poton of th lag fst quston on cuncy makts o compaatv advantag. U.S. Connctons n Intnatonal Tad Natons a ntconnctd though a vast aay of makts, ncludng mpots and xpots of poducts and soucs, mgaton of woks, nfomaton and tchnology flows, and fnancal tansactons. Intnatonal tad sults fom dffncs n soucs and th ffcncy wth whch natons can poduc poducts. Intnatonal tad has ncasd sgnfcantly snc Wold Wa II, pmaly du to mpovmnts n tanspotaton and communcaton tchnology and ducd taffs and oth tad bas among natons. Th Untd Stats s th ladng tadng naton n both mpots and xpots, and both hav ncasd sgnfcantly ov th past sval dcads. Howv, th Untd Stats now poducs a small pcntag of th wold's xpots bcaus th xpots of oth counts hav gown mo quckly. Ladng U.S. xpots nclud chmcals, agcultual goods, and consum duabl goods, whl th man U.S. mpots nclud ptolum, autos, and lctoncs. Canada s ou most mpotant tadng patn, followd by counts blongng to th Euopan Unon, Mxco, Chna, Japan, and counts blongng to OPEC. Th Balanc of Tad A tad suplus sults whn a naton xpots mo than t mpots. Tad dfcts occu whn mpots xcd xpots. Th Untd Stats has had tad dfcts snc th aly 1980s. Ba n Mnd Th AP conomcs xams hav not ncludd qustons qung knowldg of spcfc ntnatonal tad statstcs. It s mpotant, though, to undstand tnds such as ncasng mpots and xpots and th psstnt U.S. tad dfct. Spcalzaton and Tad Natons opn th conoms to tad n od to mpot poducts thy cannot poduc domstcally o poducts thy can buy at a low pc than th cost of poducng thm domstcally. Just as ndvduals spcalz n cas and buy oth poducts thy nd, counts spcalz n what thy poduc most ffcntly and thn tad fo oth goods. Economst Adam Smth xpland that spcalzaton and tad allow natons to us th soucs mo ffcntly, ncasng wold output. Economst Davd Rcado xpland that a naton can bnft fom tad, vn f that naton has an absolut advantag-th ablty to poduc mo of all poducts than anoth county. H sad that th focus nstad should b on compaatv advantag-th ablty to poduc mo ffcntly. 36 Chapt 5: Th Untd Stats n th Global Economy

2 Compaatv Advantag: Th Exampl of Indvduals Assum Camon s an achtct anng $40 p hou. H wants to dvlop a wbst fo hs busnss and stmats t would tak hm 20 hous to bng t onln. Andw s a comput pogamm anng $30 p hou. Though h knows computs, h woks mo slowly and would qu 25 hous to do th wok. Should Camon h Andw to poduc th wbst o do t hmslf? W must calculat ach of th costs to fnd out. If Camon dvlops hs wbst, h loss 20 hous of achtctu wok at $40 p hou, fo a cost of $800. Andw qus 25 hous of wok at $30, fo a cost of$750. Bcaus Camon can h Andw fo lss than th valu of hs lost achtctu wok, Camon should h Andw and pay hm wth th mony h ans dong achtctual wok. Ba n Mnd Th AP mcoconomcs and macoconomcs xams consstntly hav a multpl-choc quston about ndvdual compaatv advantag. Evn f on pson s btt at both tasks, on wll hav th compaatv advantag n ach task, and ach should spcalz n that task to maxmz poducton at th lowst cost. Compaatv Advantag: Th Exampl of Natons To dtmn compaatv advantag btwn counts, w must assum that ths a th only two counts nvolvd n th tad, th counts us qual amounts of soucs to mak only ths two poducts, th costs of poducng both poducts a constant, and th natons wll us bat to tad poducts ath than us mony. Of cous, ths sn't alstc, but mmb th smly ( )? You can s th pncpls of oppotunty cost, compaatv advantag, and gans fom tad n spcalzaton fom ths scnao. Assum that Canada could poduc 120 tons of what o 30 tons of com. Usng an qual amount of soucs, Mxco could poduc 75 tons of what o 25 tons of com. Canada can poduc mo what and mo com than Mxco, so t holds an absolut advantag n th poducton of both cops. But that sn't th ky to tad-w hav to fnd out who holds th compaatv advantag n poducng ach cop. To do ths, st up quatons llustatng th poductv capacty of ach county. Fo xampl, Canada 120 tons of what = 30 tons of com Rduc th numbs to fnd Canada's oppotunty cost fo poducng what and com. Canada 4 tons of what = 1 ton of com 1 ton of what = 114 ton of com Thn do th sam fo Mxco. Mxco 75 tons of what = 25 tons of com 3 tons of what = 1 ton of com 1 ton of what = 113 ton of com Now w must dtmn whch naton has th lowst oppotunty cost to fnd who has th compaatv advantag n ach poduct. To poduc 1 ton of com, Canada's oppotunty cost s 4 tons of what; Mxco's oppotunty cost s 3 tons of what. So Mxco has th compaatv advantag and should spcalz n poducng com. Canada's oppotunty cost fo poducng 1 Chapt 5: Th Untd Stats n th Global Economy 37

3 ton of what s 114 ton of com, whl Mxco poducs 113 ton of com. Thfo, Canada s th lowst-cost poduc and should spcalz n what. Tms of Tad Now that w hav found that Mxco should poduc com and Canada should poduc what, w nd to dtnnn th tnns of tad, o th bat pc of com and what. It s mpotant to mmb that th tnns of tad wll always fall btwn th two natons' oppotunty costs. Mxco's oppotunty cost fo 1 ton of com s 3 tons of what, so Mxco wll not accpt anythng lss n paymnt fo com. Canada wll not pay mo than 4 tons of what fo 1 ton of com, bcaus thy could poduc t domstcally at a low cost. Thfo, th tnns of tad fo a ton. of com a btwn 3 and 4 tons of what. Gans fom Tad Th tnns of tad llustat how ach county wll gan fom spcalzaton and tad. Lt's assum Canada and Mxco ag to a pc of 3.5 tons of what p ton of com. At that pc, Mxcan poducs gan bcaus th pc thy an fo com s hgh than th cost of poducng t. At th sam tm, Canadan consums gan, bcaus thy can buy Mxcan com fo a low pc than t would hav cost thm to poduc t at hom. Bcaus of spcalzaton and tad, both counts gan fom th xchang. By opnng th conoms to tad, ach county s abl to ach byond ts poducton possblts cuv that lmtd domstc poducton. As ach county spcalzs n what t poducs mo ffcntly, soucs a allocatd to th most ffcnt poduc, output ncass, and both natons hav mo what and com than thy could hav catd alon. Ba n Mnd Both AP conomcs xams consstntly nclud qustons about compaatv advantag, spcalzaton, and tad n th multpl-choc and f-spons potons ofth xam. Somtms qustons appa n th fonn of nput modls ath than output modls. In oth wods, ath than statng wth data on th poducton of fnal poducts lk com and what, th quston wll tll you how many hous o soucs a ndd to poduc ach poduct. A quck convson wll calculat th oppotunty costs of fnal poducts. Assum ths data psnt th soucs qud to poduc on poduct n ach county. Cas Motocycls County A 30 souc unts 10 souc unts County B 20 souc unts 4 souc unts Ths a th soucs qud to poduc th good, not th numb of goods poducd. Ths confuson s on of th most common mstaks studnts mak n ths analyss. To dtnnn compaatv advantag, fnd a common numb of souc unts wthn a county. Fo County A, assum you hav 30 souc unts avalabl to poduc goods. County A could poduc 1 ca o 3 motocycls. Fo County B, stat wth a total of20 souc unts, whch would allow County B to poduc 1 ca o 5 motocycls. Aft that convson, you can dtnnn compaatv advantag, spcalzaton, and tnns of tad n th sam way as wth th output modl. Don't woy about tyng to fnd a common numb of souc unts btwn th two counts to dtnnn compaatv advantag, bcaus you a only tyng to fnd th oppotunty cost of poducton wthn ach county. That oppotunty cost s what wll b compad to th oth county. 38 Chapt 5: Th Untd Stats n th Global Economy

4 Fogn Exchang Makts Tad dos not ly on bat; mony facltats tad. But fms want to b pad n th cuncy of th own county n od to pay th poducton costs. Thfo, n od fo a fm to buy a poduct fom anoth county, t must fst puchas that county's cuncy n th fogn xchang makt. Th xchang at s th valu of on cuncy n tms of anoth. Fo xampl, f$1 US = 50 Indan ups, and you wantd to buy an Indan shawl pcd at 1,500 ups, that pc would b th quvalnt of $30 US. Cuncy valus n fogn xchang makts a dtmnd by supply and dmand. Rmmb that th pc s xpssd n tms of th oth cuncy. In ths xampl, th pc of on uo s $1.25 US. ' EuoMakt p s o f E u o D Quantty of Euos Changs n Cuncy Valus Changs n th dmand fo cuncy can affct th valu of that cuncy n th fogn xchang makt. If U.S. consum ncoms ncas o consum tasts chang to pf mpotd poducts fom Euop, dmand fo th uo must ncas n od to pay fo thos addtonal mpots. Th ncasd dmand pushs up th pc of th uo, so th valu of th uo appcats, manng t ncass n valu. At ths appcatd valu, t taks mo dollas to pay fo ach uo. If dmand fo th uo falls, th uo dpcats, losng valu bcaus Amcans can buy th uo fo fw dollas. It s mpotant to undstand that n cuncy xchang, two makts a n moton at th sam tm-th makt fo uos and th makt fo dollas. If an Amcan fm wants to buy a poduct fom Gmany, t must buy thos uos fst. How s th Amcan fm payng fo th uos? Wth U.S. dollas! So w must vw ffcts n both makts at onc. Chapt 5: Th Untd Stats n th Global Economy 39

5 EuoMakt Dolla Makt p c 0 f E u S D2 Dl 100 p o f D o 1 1 a s SI S2 D o+o----l~0--~ ~~ioo Quantty of Euos Quantty of Dollas Ou ncasd dmand fo uos causs th uo to appcat n th uo makt. Whn w us dollas to buy uos, th supply of dollas ncass n th dolla makt, causng th dolla to dpcat n valu. It s mpotant to mmb that w a lookng at a latonshp btwn two cuncs. If on appcats, th oth must dpcat. If on cuncy s gttng latvly stong, th oth must b gttng latvly wak. Takng th EEK! Out of Economcs Whn dawng sd-by-sd cuvs fo cuncs, t s vy mpotant to cafully labl ach makt to avod confuson. Rmmb that f dmand movs n on gaph, supply movs th sam dcton n th oth gaph. If Amcan ftms buy fw mpots, th dmand fo th fogn cuncy falls. Thfo, th supply of dollas to pay fo that fogn cuncy n th fogn xchang makt falls, as wll. Th Effcts of Changs n Cuncy Valus As th uo appcats and th dolla dpcats, t taks mo dollas to buy ach uo. As a sult, t costs mpots mo to buy Gman poducts. Although th Gman ftm dd not chang th poduct pc, bcaus th uo s now mo xpnsv, th poduct looks mo xpnsv to mpots. As a sult, th quantty mpotd bgns to fall. At th sam tm, dollas dpcat and a lss xpnsv fo Gman mpots. Although U.S. ftms dd not chang pcs, poducts now look lss xpnsv to Gman mpots. As a sult, U.S. xpots s. Whn th dolla dpcats, U.S. mpots fall and xpots ncas. And whn th dolla appcats, U.S. mpots s and xpots dcas. Bas to Tad Although w cognz gans fom tad, govnmnts somtms ntvn n makts to ct bas to tad. Potctv taffs a taxs on mpots, whl mpot quotas lmt th numb of poducts mpotd. Both polcs a dsgnd to ncas th pc o lmt th quantty of mpots to ncouag consums to buy Amcan-mad poducts nstad. 40 Chapt 5: Th Untd Stats n th Global Economy

6 Makt fo Chns-Poducd Cloths Makt fo US-Poducd Cloths 50 s 50 s p P 30 c D2 Dl Quantty Quantty In ths xampl, $30 Chns-poducd cloths a mo attactv to consums than th $32 cloths poducd by Amcan fms. If th U.S. govnmnt placd a $7 taff on Chns cloths, ncasng th pc to $37, Amcan consums would duc th quantty dmandd fo mpotd cloths and nstad ncas th dmand fo substtut Amcan cloths. Ths ncas n dmand would push th pc of U.S.-poducd cloths up, but phaps not as hgh as th pc of th Chns cloths wth th taff n plac. Counts can us oth bas such as lcnsng o nspcton qumnts that mak t mo dffcult and xpnsv fo fogn fms to gt th poduct nto th county. Govnmnts can also subsdz Amcan fms, ducng th costs of poducton to allow thm to xpot th poducts fo low pcs to attact fogn dmand. Rasons fo Govnmnt Intvnton n Tad Although consums of mpots and poducs of xpots gan fom ntnatonal tad, domstc poducs who must compt wth thos mpots-and th mploys who wok fo thos fms-hav a stong ncntv to suppot th cton of tad bas. Th bnfts of tad bas a concntatd on domstc poducs, and th costs a dspsd among th many consums of mpots who now hav to pay hgh pcs. Som ntpt ncasd mpots as causng a loss of jobs wthout consdng that th ncas n xpots wll cat jobs n xpot ndusts. Many oppos opn tad bcaus t s dffcult to tanston btwn cas, somtms qung job tanng, a mov, o low wags. Govnmnts can assst n ths tanston by povdng o subsdzng job tanng o xtndng unmploymnt bnfts. It s mpotant, howv, to mmb that th gans fom tad n th fom of low poduct pcs and a wd vaty of poducts hlp offst som of ths tanston costs. Wold Tad Agmnts Snc th 1930s, tad bas hav stadly dcasd. Th Noth Amcan F Tad Agmnt (NAFTA) foms a tad bloc among th Untd Stats, Canada, and Mxco, lmnatng most tad bas among th counts. Th Euopan Unon s a smla tad bloc of mo than a dozn counts. Poducton ffcncy has mpovd, and mpots and xpots hav sgnfcantly ncasd among counts nvolvd n tad. Th W oid Tad Oganzaton woks to duc tad bas and solv tad dsputs on a global scal. I b Chapt 5: Th Untd Stats n th Global Economy 41 d

7 Ba n Mnd Qustons about th hstoy of tad bas and tad blocs hav not appad on th AP conomcs xams and a only lghtly covd h. Multpl-Choc Qustons 1. Th condton n whch a county mpots mo than t xpots s a (A) compaatv advantag. (B) tad dfct. (C) absolut advantag. (D) xchang at. (E) tad suplus. 2. Bob s a mchanc who ans $30 p hou pang fam machny. H s also an xcllnt pant who can pant hs hous twc as quckly as a pant h could h fo $10 p hou. Whch of th followng s tu? (A) Bob has an absolut advantag as both a mchanc and a pant, and h should vnly dvd hs tm btwn both jobs. (B) Bob has a compaatv advantag n pantng and should gv up hs ca as a mchanc to bcom a pant. (C) Bob has a compaatv advantag as a mchanc and should h a pant to pant hs hous. (D) Bob has an absolut advantag as a mchanc and a compaatv advantag n pantng, so h should stop wokng long nough to pant hs hous, and thn tun to wok as a mchanc. (E) Bob has a compaatv advantag n pantng and should spnd twc as much tm pantng as h spnds wokng as a mchanc. Us th poducton possblts p wk blow to answ qustons 3-5. Cas Machns Swdn 100 1,000 Fanc Whch of th followng statmnts s tu? (A) Swdn has a compaatv advantag n poducng cas. (B) Fanc has an absolut advantag n poducng both cas and machns. (C) Swdn has an absolut advantag n poducng both cas and machns. (D) Fanc has a compaatv advantag n poducng cas. (E) Fanc has a compaatv advantag n poducng machns. 4. In od to obtan gans fom tad, (A) Swdn should mpot machns fom Fanc. (B) Swdn should mpot cas fom Fanc. (C) Swdn should poduc cas and machns and xpot both. (D) Fanc should poduc machns and mpot cas fom Swdn. (E) Fanc should mpot both cas and machns fom Swdn.. 42 Chapt 5: Th Untd Stats n th Global Economy

8 5. Both counts would gan fom th tad f th pc of on ca s (A) 750 machns. (B) 100 machns. (C) 3 machns. (D) 11 machns. (E) 500 machns. 6. If U.S. dmand fo Mxcan ol ncass, (A) th dmand fo U.S. dollas ncass. (B) th supply of Mxcan psos ncass. (C) th pc of Mxcan ol dcass. (D) th valu of Mxcan psos dcass. (E) th dmand fo Mxcan psos ncass. 7. If th U.S. dolla appcats n laton to th Japans yn, (A) U.S. mpots fom Japan wll ncas. (B) Japans poducts wll appa to b mo xpnsv to Amcans. (C) U.S. xpots to Japan wll ncas. (D) th U.S. dolla has bcom latvly lss valuabl. (E) U.S. xpots appa lss xpnsv to Japans consums. 8. If U.S. ncoms fall and mpotd Italan shos a nomal goods, (A) th dmand fo mpotd shos ncass. (B) th dmand fo uos ncass. (C) th uo appcats n valu. (D) th supply of U.S. dollas n th fogn xchang makt ncass. (E) th U.S. dolla appcats n valu. 9. A taff s a (A) p-unt tax on mpots. (B) lmt on th numb of mpotd poducts. (C) mthod by whch govnmnts suppot ncass n ntnatonal tad. (D) govnmnt subsdy to suppot xpots. (E) dscount n th valu of a cuncy. 10. Th ffcts of tad bas nclud all of th followng EXCEP.T (A) th pcs of mpotd poducts ncas. (B) ffcncy n th makt dcass. (C) U.S. xpots dcas. (D) mploymnt among poducs of xpots ncass. (E) U.S. mpots dcas. I < 1 Chapt 5: Th Untd Stats n th Global Economy 43 d

9 F-Rspons Qustons, , Q 500 U a n 400 t t 300 Y 0 f JOO B 100 a d Quantty of Fsh 1. Th fgu abov shows poducton possblts fo Chl and Bazl. Usng all avalabl soucs, Chl can poduc 300 loavs of bad o 100 fsh p day. Wth th sam amount of soucs, Bazl can poduc 400 loavs of bad o 200 fsh p day. (a) Calculat th oppotunty cost of poducng 1 fsh n Chl. (b) Dtmn whch county has th compaatv advantag n th poducton of fsh. Explan how you found you answ. ( c) Idntfy whch county wll mpot fsh. (d) If th tms of tad a that 1 fsh = 2.5 loavs of bad, wll Chl gan fom th xchang? Explan why. 2. Assum th a two compttv makts fo bf: a makt fo bf poducd n th Untd Stats and a makt fo bf mpotd fom Canada. U.S. and Canadan bf a substtut poducts. Now assum Mad Cow Dsas has bn dscovd among Canadan cattl but not among U.S. cattl. (a) Usng a coctly labld gaph of th makt fo mpotd Canadan bf, show th ffct of th dscovy of Mad Cow Dsas on ach of th followng. () Th quantty of mpotd Canadan bf () Th pc of mpotd Canadan bf (b) Usng a coctly labld gaph of th fogn xchang makt fo Canadan dollas, show how th chang n (a) wll affct th ntnatonal valu of Canadan dollas. (c) How wll th chang n (b) affct th ntnatonal valu of U.S. dollas? Explan. Multpl-Choc Explanatons 1. (B) A tad dfct xsts whn mpots xcd xpots. 2. (C) Und ths scnao, f t taks Bob 50 hous to pant th hous, t wll tak th pant 100 hous to pant th hous. Bob's oppotunty cost of 50 hous as a mchanc s $1,500 of ncom, whl t would cost hm $1,000 to pay th pant fo th 100 hous of wok. Bob has a compaatv advantag as a mchanc and should h th pant to pant th hous. 3 (D) Fanc's oppotunty cost fo poducng a ca s 2 machns, whl Swdn's cost s 10 machns; Fanc s th lowst-cost poduc. 44 Chapt 5: Th Untd Stats n th Global Economy

10 4. (B) Swdn can buy cas chap fom Fanc than t can poduc thm, so t wll gan fom th tad. 5. (C) Fanc wll not sll a ca fo any lss than ts cost of2 machns, and Swdn wll not buy a ca fo any mo than ts domstc cost of 10 machns, so any pc n that ang bnfts both counts. 6. (E) Impots must buy Mxcan psos n od to pay fo Mxcan ol. 7. (A) A mo valuabl dolla maks Japans mpots appa chap, so U.S. mpots fom Japan ncas. 8. (E) Th U.S. dolla appcats, bcaus as dmand fo uos falls, th valu of th uo falls, causng th valu of a U.S. dolla to s latv to th uo. 9. (A) A taff s a tax placd on mpots to as th pc of th mpot. 10. (D) Tad bas lmt tad wth oth counts, ducng U.S. xpots, so fw woks a ndd to poduc poducts fo xpot. F-Rspons Explanatons 1. 6 ponts ( I + 2) (a) 1 pont: 1 pont s and fo statng that Chl's oppotunty cost of 1 fsh s 3 loavs of bad. (b) 2 ponts: I pont s and fo statng that Bazl has th compaatv advantag n fsh. 1 pont s and fo statng that Bazl has a low oppotunty cost fo poducng fsh (2 loavs of bad compad to Chl's 3 loavs of bad). (c) I pont: 1 pont s and fo dntfyng Chl as th mpot of fsh. (d) 2 ponts: I pont s and fo dtmnng Chl wll gan fom th tad. 1 pont s and fo xplanng that, at a pc of 2.5 loavs of bad p fsh, Chl can mpot fsh at a low cost than t can poduc fsh ponts ( ) (a) 4 ponts: 1 pont s and fo a coctly labld gaph of th Canadan bf makt. 1 pont s and fo llustatng a dcas n dmand. 1 pont s and fo statng that th quantty of mpotd Canadan bf wll fall. 1 pont s and fo statng that th pc of mpotd Canadan bf wll fall. (b) 3 ponts: 1 pont s and fo a coctly labld gaph fo Canadan dollas. 1 pont s and fo llustatng a dcas n dmand. 1 pont s and fo statng that th ntnatonal valu of Canadan dollas falls. (c) 2 ponts: I pont s and fo statng that th ntnatonal valu of th U.S. dolla ncass. 1 pont s and fo xplanng that, bcaus th supply of dollas n th fogn xchang makt dcass, th valu of th dolla appcats. Chapt 5: Th Untd Stats n th Global Economy 45