Microeconomic Principles ECON 103
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This 31 page Class Notes was uploaded by Junior Yost on Monday September 28, 2015. The Class Notes belongs to ECON 103 at George Mason University taught by Stephen Gillespie in Fall. Since its upload, it has received 51 views. For similar materials see /class/215201/econ-103-george-mason-university in Economcs at George Mason University.
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Date Created: 09/28/15
International Trade Weak of April 14 Goals 1 Demonstrate the advantage to trade 2 Show how restrictions on trade work 3 Understand how exchange rates work UMZOZmHWgt m HEM gtUltgt2Hgt m HO HWgtUH Why do people trade Robinson Crusoe was selfsufficient whatever goods and services he wanted he had to make them himself no opportunity for trade A frontier family was largely selfsufficient little trade with other families there was trade within the family Division of labor and specialization some people are better at some tasks than other people easier to learn a few tasks than many many tasks Why do people trade A feudal Village was largely selfsufficient but much specialization within Village Until 100 years ago Japan was largely self sufficient Sphere of trade continued to eXpand European Common Market North American free trade zone Opportunities for diVision of labor and specialization eXpanded Absolute Advantage Country A 39 Demonstrate absolute advantage c Number represents units of grain that can he produced With one unit of labor Assume r each country has 3 units of labor each prefers equal supply of grains Absolute Advantage 39 If self sufficient both have 4 rice and 4 corn With specialization A produces 12 com B produces 12 rice 39 Gain from specialization 4 corn 4 rice Comparative Advantage Number represents units of grain that can be produced with one unit C of labor Assume each country has 3 units of labor each prefers equal supply of grains If self sufficient A has 4 rice and 4 1 corn B has 2 rice and 4 corn 9 l A 2 4 B 2 2 Comparative Advantage With specialization A produces 12 corn B produces 6 rice 39 Gain from specialization 4 corn Convert the production levels to relative prices A 2 12 B 1 1 Comparative Advantage Corn is relatively less expensive in A so A specializes in corn Rice is relatively less expensive in B so B specializes in rice Worksheet on TRADE 39 Two men live on a small isolated island in the South Pacific Robinson Crusoe and his trusted friend Friday These are simple men they only work at two things catching fish and collecting coconuts Both men work 8 hours each day Worksheet on TRADE Robinson Crusoe can catch fish at the rate of 2 fish per hour and can collect coconuts at the rate of 6 coconuts per hour Friday can catch fish at the rate of 1 fish per hour and can collect coconuts at the rate of 5 coconuts per hour 39 If he lived alone Robinson Crusoe would catch 12 fish and collect 12 coconuts each day If Friday lived alone he would catch 4 fish and collect 20 coconuts each day Worksheet on TRADE QUESTIONS 1 Which man has the absolute advantage in fishing 2 Which man has the absolute advantage in collecting coconuts 3 For Robinson Crusoe What is the relative price of fish in terms of coconuts 4 For Friday What is the relative price of fish in terms of coconuts 5 Which man has the comparative advantage in fishing Worksheet on TRADE 6 Which man has the comparative advantage in collecting coconuts Since the two men live together they can both be better off if they specialize and then trade with each other QUESTIONS 7 Should Robinson Crusoe specialize in catching fish or in collecting coconuts 8 What is the largest number of coconuts Friday would be Willing to trade for one fish Worksheet on TRADE 9 What is the least number of coconuts Robinson Crusoe would accept in trade for one fish 10 If the two men equally share the gains from trade how many coconuts Will Friday end up With Gains from Trade Voluntary trade is mutually beneficial Edgeworth exchange bOX Total height of box I A39s books B39s books 2 4 l 5 Total Width of box I A39s food B39s food I 2 8 10 Gains from Trade PEI S B Person A a fan 1 Gains from Trade Indifference curves through endowment point show the set of Pareto efficient trades Contract curve shows the places where the 2 traders can end up these points are pareto optimal any move from contract CUI39VC makes one party worse off Position on contract curve determined by skill at trading market prices draw in line that is ratio of prices SHOW HOW RESTRICTIONS ON TRADE WORK Tariffs How does a tariff work If no trade 10 unit sold at 6 With foreign trade domestic producers can39t charge more than 4 if they try to charge more someone will import at the world price of 4 and undersell them Domestic producers are price takers Tariffs 3391 3 1113 sti 1 111 ark3t Tariffs At world price domestic production is 8 units and 4 units are imported Now add a 1 dollar tariff 1 Price rises to 5 2 Domestic production eXpands to 9 units 3 Imports decline to 2 units Area D deadweight welfare loss C 2 government taX revenue B I increased cost of production A I increased profit to domestic producers Import Quotas E39IZIIIlEEItiC marl31 Why Restrict Trade Nice quote quotThere is nothing a tariff can do for a country that an earthquake can39t do betterquot 39 Keynes So Why restrict trade a Risk in specialization 39 diversification lowers national income but also makes it more certain b National defense 39 specialization is a benefit only when trade actually occurs Why Restrict Trade c Other possible reasons Reducing structural unemployment Protecting infant industries Protecting against subsidized foreign producers All these are smokescreens d Real reason for most restrictions is income redistribution transfers from consumers to particular producers and importers UNDERSTAND HOW EXCHANGE RATES WORK Reason for Foreign Exchange Complication of foreign trade different countries have different money How many people have travelled to Canada recently did you spend US dollars While there if you did you made the Canadians happy Canadian tourists can39t spend their dollars here you used to get Canadian coins in circulation quite frequently but you hardly ever do any more Reason for Foreign Exchange the exchange rate between US and Canadian dollars used to be almost 1 to l but now is significantly higher Why would anyone want foreign currency in order to purchase imports from that country Why would anyone sell you foreign currency for dollars in order to buy exports from the US Exchange rate between 2 countries is basically a re ection of the volume of trade between the countries Text lists many more factors but this is the longrun reason Floating vs Fixed Exchange Rates Exchange rates are published in the paper every day for all the major currencies they also change every day this didn39t used to be so the pound was equal to 487 for years and years They change today because of oating exchange rates The exchange rate is the price of one currency in terms of the other that is a relative price it is the equilibrium price in the foreign exchange market Floating VS Fixed Exchange Rates 39 The foreign exchange market works just like any other market Pij39at 3921 Egg Cir1311313 Floating vs Fixed Exchange Rates 39 What shifts the demand curve One answer the price of related goods 39 Changes in the general price level are in ation in ation in US causes US products to be more expensive foreigners want to purchase less US goods lower demand for US dollars exchange rate falls devalue the dollar
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