Topic 14 Large Country Trade Equilibrium University of Minnesota clar0955 umn edu April 22 2013 U of M Topic 14 Large Country Trade Equilibrium April 22 2013 1 12 We will look at Trade between two countries that are big enough to influence the world price Trade surplus trade deficit Causes of USA trade deficits U of M Topic 14 Large Country Trade Equilibrium April 22 2013 2 12 Large Country Trade Model Suppose USA and Canada don t trade What is the equilibrium price and quantity The equilibrium price in USA is 100 the quantity is 80 pounds The equilibrium price in Canada is 70 the quantity is 80 pounds U of M Topic 14 Large Country Trade Equilibrium April 22 2013 3 12 Large Country Trade Model We want to find the import export equilibrium the world price at which imports exports Process of trial and error but there are some short cuts U of M Topic 14 Large Country Trade Equilibrium April 22 2013 4 12 Large Country Trade Model Take any price below 70 for example 65 which is the red line above For both countries demand supply So both countries want to import Take any price above 100 for example 105 which is the green line above For both countries demand supply So both countries want U to export of M Topic 14 Large Country Trade Equilibrium April 22 2013 5 12 Large Country Trade Model Minimum Price with free trade 70 Maximum Price with free trade 100 Note that this implies Canada exports to the USA U of M Topic 14 Large Country Trade Equilibrium April 22 2013 6 12 Large Country Trade Model Suppose the price is 80 Canada produces 90 consumes 70 Exports 20 USA produces 60 consumes 100 Imports 40 This doesn t work Should we keep guessing No U of M Topic 14 Large Country Trade Equilibrium April 22 2013 7 12 The Graph Technique Instead we can use the following graph technique x axis is amount imported exported depending on which country you re talking about y axis is price We only need to graph between the minimum and maximum which as we just found are the equilibrium prices for each country when they don t trade For each country plot two points for USA and two points and draw a straight line through them Imports exports are a linear function of price for both countries because we made the supply and demand curves linear In this class we stick to this simple model See where they cross U of M Topic 14 Large Country Trade Equilibrium April 22 2013 8 12 The Graph Technique Illustrated We see that when the price is 85 Canada wants to export 30 and USA wants to import 30 Perfect 85 is the import export equilibrium price U of M Topic 14 Large Country Trade Equilibrium April 22 2013 9 12 Remarks Now let s extend this to thinking about the real world with more than two countries Recall that a country has a trade surplus if the total market value of its exports is greater than the total market value of its imports It can t be the case that every country has a trade surplus Why Every country is exporting more than it is importing We will see next time that if a country has a trade deficit in goods then it will have a trade surplus in capital flows asset flows What does this mean Even though the USA has a trade deficit in goods more foreigners are buying financial assets in the USA than the USA is buying in foreign countries This means other countries are making it easier for our firms to do economic investment buy factories machines etc by adding to the supply of loanable funds and thus lowering interest rates U of M Topic 14 Large Country Trade Equilibrium April 22 2013 10 12 Definitions NX Net Exports Value of Exports Value of Imports Also called Trade Balance Trade Surplus Net Exports 0 Export more than import Trade Deficit Net Exports 0 Export less than import Balanced Trade If net exports 0 then we have balanced trade Notice that we don t need a country to export a positive amount of every good just on average they need to export So it s OK if USA runs a trade deficit in for example oil It can still have balanced trade if it has trade surplus in cars U of M Topic 14 Large Country Trade Equilibrium April 22 2013 11 12 Causes of USA Trade Deficit or Current Account Deficit The USA has a trade deficit Click link Be sure to change Partner Country to World Why 1 USA Economy grows faster than major trade partners Real income demand for goods imports increase Major trade partners demand unchanged exports unchanged 2 Increase in oil prices USA imports a lot of oil Average price of barrel 50 in 2005 65 in 2010 8 10 of imports are oil Ex We spent 200 on oil imports in 2005 3 China 1 exporter to US 3 importer from USA Mostly due to fixed exchange rate with USA will discuss in class why would a fixed exchange rate cause this 4 Declining USA savings rate This is related to the Financial Account surplus mentioned earlier which can lead to the Current Account Deficit more later Note Savings rate has actually increased a bit since the recession U of M Topic 14 Large Country Trade Equilibrium April 22 2013 12 12
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