Chapter 5  - The U.S. in the Global Economy 

This chapter focuses on the importance of international trade as it relates to the performance of the U.S. economy.  Read the entire chapter!!

In classroom discussion, we will focus on pages 96 through 101.  These pages cover two important topics. First, specialization and the theory of comparative advantage and second, exchange rates.

Comparative Advantage:  The argument for the benefits of free trade.

David Ricardo's law of comparative advantage postulates that if a country specializes in producing those goods for which it has a comparative advantage and trades for those goods for which it has a comparative disadvantage, it may be able to have "consumption possibilities" that exceed its domestic production possibilities.  This is the economic argument for free trade among nations.

A country has a comparative advantage in the production of a good if it can produce the good at a lower opportunity cost than can the other country.  For example, if the U.S. has to give up 50 bushels of corn for each additional computer it produces, but Mexico has to give up 100 bushels of corn in order to produce another computer, then the U.S. would have a comparative advantage in the production of computers.  But, notice that, in order to produce an additional 50 bushels of corn, the U.S. must forego one computer.  For Mexico, the opportunity cost of fifty additional bushels of corn is only one-half computer.  Therefore, Mexico has a comparative advantage in the production of corn.  According to the theory, if each country specializes in producing the good for which it has a comparative advantage and they trade computers for corn, both nations can consume more of each good than they could without trade.  This assumes, of course, that the two countries can agree on terms of trade that are mutually beneficial.

Exchange Rates:  How they affect the U.S. balance of trade

An appreciated dollar (value of the dollar rises relative to other currencies) makes imported goods look less expensive in U.S. but our goods look relatively more expensive in other countries.  As a result, imports rise and exports fall and the trade deficit increases.

A depreciated dollar makes imported goods look more expensive in the U.S. and our goods less expensive in foreign countries.  As a result, imports fall and exports increase and the trade deficit decreases.