Introduction
The questions on the AP Macroeconomics Exam that students often find the most difficult are those on international economics. Although the AP Macroeconomics course introduces international ideas relatively early in the course (when the principles of national income accounting and aggregate demand are introduced), instructors often leave the formal analysis of international transactions for the end of the course. The purpose of this essay is to offer a few suggestions for integrating international ideas into material covered earlier in the Principles of Macroeconomics course. By showing students where international economic ideas fit into the course's initial, most elementary analyses, the teacher can help them begin to apply global concepts to everything they learn in the course, thus laying the foundation for focused discussion later in the term. I have discovered in all of my courses that a "preview" serves students well. The basic ideas become part of how a student thinks, or at least the ideas "ferment," providing a context for more formal analysis.
Beginning with Opportunity Cost
A natural point at which to introduce international economic ideas is when the text or the syllabus reaches opportunity cost. The idea of opportunity cost establishes the basis of comparative advantage and exchange. If you are using a text that does not take this chance to extend the idea to international trade, adding a few relatively simple examples can easily make the point. In addition to demonstrating comparative advantage by considering the productivity of, say, Bill and Beth, or Farm A and Farm B, use the same framework for Belgium and France. This emphasizes the idea that specialization and exchange are ideas that apply to relationships between nations as well as between individuals and firms.
The idea of comparative advantage can be easily elaborated by pointing out that the sources of comparative advantage, domestic and international, are natural and/or acquired. For instance: The U.S. has cheap food relative to much of the world in part due the natural relative abundance of arable land in the U.S. Jockeys have a comparative advantage in horse racing due to their size. The Middle East has cheap oil relative to much of the world due to the region's relative abundance of oil fields. These are natural advantages that exist because of the initial endowment of resources. On the other hand, New York has a comparative advantage in financial services, doctors have a comparative advantage in medicine, and Hollywood has a comparative advantage in making movies, not primarily due to initial endowments (there is nothing natural about the geography of New York that confers a comparative advantage in financial services), but due to productivity acquired through time due to historical circumstances. Few of us are natural teachers of economics, but have become so due to the history of our personal lives.
Using the Supply-and-Demand Framework
The supply-and-demand framework is a versatile framework for many international economic examples. The relationship between the world's supply of shoes and the demand for them shown in figure 1 demonstrates comparative advantage. In the graph, the number of exchanges is
Qe. These exchanges take place because of comparative advantage. For, say, the tenth unit, the price that a buyer is willing to pay is above the price at which a producer is willing to sell. The producer clearly has a comparative advantage relative to the buyer. If the buyer had a comparative advantage, then he could produce the goods himself at a cheaper price and so would not be willing to pay more than the seller's asking price. This exchange could occur domestically, or between a foreign buyer and a domestic seller, or between a domestic buyer and a foreign seller.
The supply-and-demand framework can also be applied to many international markets. Figure 2 shows the foreign exchange market for dollars. As with any other market, the horizontal axis shows quantity of a good and the vertical axis shows the price of that good. Thus, the vertical axis is the price of the dollar, or the number of foreign currency units per dollar. (The foreign currency market could also be shown with foreign currency on the horizontal axis. The vertical axis in this case would show the number of dollars per unit of foreign currency.)
The supply-and-demand curves for the dollar are affected by a number of economic variables. For example, an increase in income in the U.S. will lead to greater consumption, some of which will be consumption of foreign goods -- that is, imports. The increase in U.S. imports means that U.S. citizens will sell more dollars to buy foreign currency in order to buy foreign goods. The supply of dollars in figure 2 will shift to the right, resulting in a lower exchange rate (
E), meaning a depreciation of the dollar (an appreciation of foreign currency).
If the real return on U.S. financial assets increases, then investors in the U.S. who hold foreign assets will shift some of their foreign holdings to U.S. assets, reducing the supply of dollars on the foreign exchange market. Foreign investors will also shift to higher-yielding U.S. assets, so the demand for the U.S. dollar will increase. The decreased supply and increased demand will cause an appreciation of the dollar. The effect of the decreased supply and increased demand on the equilibrium amount of dollars exchanged on foreign exchange markets is indeterminate.
The Market for Imports
Another example that uses the supply-and-demand concept is the market for imports in the U.S. shown in figure 3. The supply of imports is the total amount of exports of foreign nations; the demand for imports is the amount of imports of the U.S. If U.S. income increases, then the demand for imports will increase, shifting the demand curve to the right and increasing the equilibrium price and quantity of imports. With both the equilibrium price and quantity increasing, the value of imports will increase. If foreign incomes increase, then foreign consumption will absorb some of the goods previously exported. The supply of goods to the U.S. will decrease, shifting the supply curve to the left and causing a higher equilibrium price and lower equilibrium quantity. In this case, the value of imports is indeterminate and depends upon the proportionate size of the price increase relative to the quantity decrease.
A deprecation of the dollar means that foreigners who earn dollars selling to the U.S. will now earn less of their own currency units. Thus, foreign suppliers will reduce the supply to the U.S. market. The S of imports to the U.S. market will shift to the left, increasing the price of imports and reducing the quantity of imports. The net effect on the value of imports (price times quantity) is indeterminate, but estimates of the effect show that the value of imports fall. As textbooks claim, a depreciation of the dollar (appreciation of foreign currency) causes a decrease in the value of U.S. imports.
Further examples include the effect of an increase or decrease in the cost to foreigners of producing goods exported to the U.S. in foreign markets. A decrease in this cost will increase the supply to the U.S. market while an increase in this cost will decrease the supply to the U.S. market.
Classroom Activities
To give students a chance to think the ideas through, I often use examples like those above as homework problems, along with standard supply-and-demand examples, such as the market for gasoline or for MP3 players. The students can often work out these problems by themselves. In the more complex cases, even though they may not work out all of the results, my students will have thought about the issue, which makes them more prepared to follow explanations provided in class. Just as important, when the analysis turns to a more formal treatment of international economics, they are more receptive, having already been exposed to the basic ideas. The point is not to provide every international example that a student needs to know to pass the AP Exam, but to promote thinking about international economics. In turn, this experience will empower students to think through questions rather than fostering rote memorization of what may be asked. The AP course is intended to promote thinking like an economist, not to urge students to memorize what we think will appear on the exam. It can be argued that this approach will further genuine learning, which is the goal of the AP course and exam.
Although the earlier introduction of international economics into the Principles of Macroeconomics course is not a perfect substitute for the in-depth treatment we hope to provide at the end of our courses, it can nicely complement that in-depth treatment with little loss of time. For many of us, early exposure might also ease the end-of-semester crunch. Just as important, it can help students understand, and help us remember, that the principles of analysis underlying the distinct and complex field of international economics are the same, familiar concepts we apply in macroeconomics.
Arthur Raymond is the head of the Accounting, Business, and Economics Department at Muhlenberg College in Allentown, Pennsylvania. A former member of the Development Committee, he currently serves as the Chief Reader for AP Microeconomics and AP Macroeconomics.
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