. 23
( 33)


al will
the 1997 budget de
occasional indications to the contrary such as the one
e next
remain in effect for th
discussed in the cover story.
ten years.
But [politicians] are play
by clas-
games with the budget
The Changing Nature of
sts the
sifying spending that bu
opria- Census worker
caps as “emergency appr
Economic Policy
compiles data
pt from
tions,” which are exem
all lim-
those agreed-upon over -
e 2000 Census an “emer As you know, fiscal policy is the federal gov-
. . calling the cost of th
its . s
the Constitution require ernment™s attempt to stabilize the economy
y,” despite the fact that
genc e
this one has been in th through taxing and government spending. Fiscal
nsus every 10 years and
a Ce
ce 1990. policy involves planning a budget that has either
planning stage ever sin
surpluses or deficits that are intended to maintain
August 4, 1999
”The Washington Post,
a steady level of total spending in the economy.

Fiscal policy can be either discretionary, passive, or tax cut proposal, the federal government could
structural. Discretionary fiscal policy is policy that not use fiscal policy to shape the economy.
someone must choose to implement. It requires an Fifth, Congress imposed budget caps designed
action by either the Congress and the president, or to limit federal government spending. The caps
by an agency of government, to take effect. Passive gave Congress little leeway to pursue discretionary
fiscal policy does not require new or special action policies. As a result, some spending for agriculture,
to go into effect. It reacts automatically when the military operations in Kosovo, and even routine
economy changes. Structural fiscal policy includes expenditures such as those required to carry out the
plans and programs put in operation to strengthen 2000 census, were classified as “emergency expen-
the economy in the long run. ditures” to get around the budget caps.

The Decline of Discretionary Fiscal Policy The Importance of Passive Fiscal Policies
Discretionary fiscal policy is used less today for Despite the declining use of discretionary fiscal
several reasons. The first is the “recognition lag.” policies, several passive fiscal programs contribute
This lag is the time between the beginning of a to the stability of the American economy.
recession or a period of inflation and the aware- All of the automatic stabilizers”unemployment
ness that it is actually happening. Most people do insurance, social security, and other programs dis-
not believe that a recession is imminent until it cussed on page 449”protect consumers and the
actually occurs. Meanwhile, the economic prob- economy if economic conditions worsen. Other
lem may grow more severe than it would have if programs, such as the progressive individual
the situation had been recognized and dealt with income tax, discussed on page 450, provide the
sooner. This recognition lag is often followed by same relief.
an “implementation lag,” which is the amount of
time it takes to do something once the problem is
In November of 1973, for example, the
American economy entered a severe recession that
was to last for 16 months. At the time, it was con- Credit Manager
sidered the worst recession since the 1930s. To
stimulate the economy, Congress approved a $100 Credit managers decide
income tax refund. However, the refunds were not whether to extend credit
mailed until the second quarter of 1975”shortly to clients”either compa-
after the recession ended. nies or individuals.
A third reason contributing to the decline of dis-
The Work
cretionary fiscal policy is the relatively short dura-
Credit managers™ duties
tion of recessions”about 11 months on average. To
include analyzing finan-
illustrate, when the 1990 recession began, political
cial reports submitted by
leaders waited for it to end rather than enact any
client companies and reviewing credit agency reports on
programs to stimulate the GDP. The Fed used
their promptness in paying bills. Credit managers also
monetary policy to help move the economy out of
draw up credit policies to be met by individuals applying
the recession, but recovery was weak.
for credit. They set up office procedures and oversee
The fourth reason contributing to the decline
other employees in the credit department.
of fiscal policy is the gridlock that has character-
ized our government since the 1990s. In both
1995 and 1996, Congress shut the federal govern- To succeed in their work, credit managers must be able
ment down when the parties could not agree on to analyze detailed information, draw conclusions, and
the federal budget. When Republicans and speak and write effectively. A degree in business admin-
Democrats deadlocked in 1999 over a $792 billion istration is a must.

For example, if the economy slows down, workers done. Because many people are often reluctant to
earn less and drop into lower tax brackets, which change, however, many proposals remain just that”
helps offset their lost income. On the other hand, if plans rather than courses of action.
the economy accelerates, as it did in the late 1990s,
workers earn more and move into higher tax brack-
The Dominance of Monetary Policy
ets. The higher tax brackets help put a break on over-
The declining use of discretionary fiscal policy
expansion, and generate substantial tax revenues in
left a void filled by the Federal Reserve System
the process. These surpluses can then be used to
(Fed), which conducts monetary policy. The aban-
repay money that was previously borrowed”as the
donment of discretionary fiscal policy also means
Democrats suggested in 1999. Or, they can be
that monetary and fiscal policies are less likely to
returned to the American people in the form of
clash”although monetary policy is still subject to
lower taxes”as the Republicans preferred to do.
criticism by political leaders.
Such a situation occurred during the 1992 presi-
Structural Fiscal Policies dential election campaign. Because of the threat of
Structural fiscal policies are policies designed to inflation, the Fed was pursuing a tighter monetary
strengthen the economy in the long run. They are policy than President Bush wanted. The high inter-
not designed to deal with temporary problems such est rates caused by the Fed™s policy also contributed
as recession and unemployment. to the length of the 1991 recession. Eventually, the
One example of a structural program is the high interest rates and the recession during the
national health-care program President Clinton election year”along with President Bush™s broken
proposed in the early 1990s. Another is the $792 promise not to raise taxes”paved the way for Bill
billion tax cut proposed by Republicans in 1999, or Clinton™s narrow election victory.
any of the flat-tax income tax proposals of the For this and other reasons, the Fed frequently
1990s. The 1996 welfare overhaul that replaced the comes under attack by politicians. Steve Forbes, Jack
Aid to Families with Dependent Children (AFDC) Kemp, and former Vice President Dan Quayle”all
with the Temporary Aid to Needy Families (TANF) candidates at one time for the 2000 Republican
would also be classified as a structural change in presidential nomination”sharply criticized the Fed
the way the economy operates. during their campaigns. So far, however, Congress
The sponsors of these new structural fiscal poli- has not been willing to make the Fed less inde-
cies believed that their proposals would strengthen pendent. Most members of Congress continue to
the American economy. Their proposals were believe that the power to create money should
designed to have long-term effects, and most repre- remain with an independent agency rather than
sented a dramatic change in the way things are with elected officials.

Why Economists Differ
Choosing which economic policies will work
best is difficult. The proposals economists
Early Americans believed so
Private Property
offer often seem contradictory, which adds to the
strongly in the right to private property that they
difficulty. These differences, however, are smaller
incorporated this right into law. The first Congress
than most people realize.
proposed the Fifth Amendment, which was ratified
in 1791. The amendment states that private prop-
erty shall not be taken for public use without just
Different Criteria
compensation. The Fourteenth Amendment pre-
Economists who choose one policy over
vents any state from depriving people of their prop-
another normally do so because they think that
erty without due process of law.
some problems are more critical than others. For

example, one economist might think that unem- Economic Policy
ployment is the crucial issue, while another
believes that inflation is. If you were to survey all
economists on the best way to deal with a specific
problem, their recommendations would be much
more consistent.

Different Eras
Another reason economists differ is that most
economic explanations and theories are a product
of the problems of the times. The unemployment
and other problems that occurred during the Great
Depression of the 1930s, for example, influenced
demand-side economists. Because the government
sector was so small at the time, supply-side policies
designed to make government™s role even smaller
probably would not have helped much.

The Monetarist Point of View
The monetarist point of view emerged in the
1960s and 1970s when inflation soared. Because
demand-side economic policies were not designed
to deal with inflation, new solutions were needed. Difference of Opinion Although economists do
The problem with the monetarist view, however, not come to blow like the ones in this cartoon,
was that it offered long-term solutions but little they often do not agree on economic policies.
Why do economists differ in their policies?
short-term relief.

Supply-Side Policies
Economic Politics
Supply-side policies eventually grew out of
frustration with stagflation and the failure of In the 1800s, the science of economics was
demand-siders and monetarists to address this known as “political economics.” After a while,
issue. Again, changing times led to changing prob- economists broke away from the political theorists
lems, and so something new and different seemed and tried to establish economics as a science in its
to be needed. own right.
For the most part, economists do not normally In recent years, the two fields have merged
define their positions as being purely demand-side, again. This time, however, they have done so in a
supply-side, or monetarist. Many demand-siders way best described as “economic politics.” Today,
are monetarists when it comes to controlling infla- politicians are concerned with the economic con-
tion. Many monetarists are supply-siders when it sequences of what they do. Most of the major
comes to agreeing on the potential burden of the debates in Congress, for example, are over spend-
tax structure. Most economists take a middle road ing, taxes, or other budgetary matters.
that incorporates many points of view.
As long as society keeps changing, new prob-
Council of Economic Advisers
lems will continue to arise. From each new set of
problems, new theories”and advocates for those Generally, economists and politicians work
theories”are bound to emerge. together fairly closely. The president relies on a

Council of Economic Advisers, a three-member In the process, economists have helped the
group that reports on economic developments and American people become more aware of the work-
proposes strategies. The economists basically are ings of the economy. This awareness has benefited
the advisers, while the politicians direct or imple- everyone, from the student just starting out to the
ment the policies. In its role as “the president™s politician who must answer to the voters.
intelligence arm in the war against the business Today, economists know enough about the
cycle,” the council gathers information and makes economy to prevent a depression like the one in
recommendations. the 1930s. It is doubtful that economists know
The president listens to the economists™ advice, enough”or can persuade others that they know
but may not be willing or able to follow it. To illus- enough”to avoid minor recessions. They can, how-
trate, if the president advocates a balanced budget, ever, devise policies to stimulate growth, help dis-
the economic advisers may recommend raising advantaged groups when unemployment rises or
taxes to achieve this goal. If one of the president™s inflation strikes, and generally make the American
campaign pledges was not to raise taxes, however, economy more successful.
the president might reject the advisers™ suggestion.

Increased Understanding and Awareness
Despite disagreeing on some points, economists
have had considerable success in the description,
analysis, and explanation of economic activity.
Student Web Activity Visit the Economics: Principles
They have developed many statistical measures of and Practices Web site at epp.glencoe.com and click
the economy™s performance. Economists also have on Chapter 16”Student Web Activities for an activ-
constructed models that are helpful in the tasks of ity on the Council of Economic Advisers.
economic analysis and explanation.

Checking for Understanding Applying Economic Concepts
1. Main Idea Using your notes from the graphic 6. Diversity of Opinion Why do monetary and
organizer activity on page 456, explain the fiscal policies often operate at cross-purposes?
difference between automatic and discre- What impact does this conflict have on the
tionary fiscal policy. List examples of each in economy?
your answer.
2. Key Term Define Council of Economic
7. Making Inferences Suppose that, in an elec-
3. Describe monetary policy and its goals. Then tion year, Congress passes a massive tax cut
explain how monetary policy can sometimes even though inflation is at 9 percent. What
conflict with economic policy. actions might the Fed take in response dur-
ing such economic times?
4. List several reasons economists differ over
8. Analyzing Information Why might mone-
policies and issues.
tary and fiscal policy be at odds during an
5. Explain what “economic politics” means in
election year?
your own words.
Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

Section 1 Section 3

The Cost of Economic Instability Stabilization Policies (pages 447“454)

(pages 437“440) Demand-side policies, or fiscal policies, are policies
designed to affect the aggregate demand curve through
• Low economic growth
federal spending and taxing decisions. Fiscal policies
and economic instabil-
are derived from Keynesian economics, which assigns
ity in the form of infla-
the government a key role in offsetting fluctuating
tion and high unem-
spending by the business sector.
ployment rates have
• Automatic stabilizers are an important part of
both economic and
demand-side economics.
social costs.
• Supply-side economics recommends a smaller role for
• The economic costs
governments and a lower federal tax structure.
can be measured with

the misery index or The outcome of monetary
the GDP gap. policy is a change in the
size of the money supply
• The social costs
that, in turn, affects the
include unemployment, wasted resources, potential
cost and availability of
political instability, increased crime, and damage to
family financial security.
• The short-run impact of
• Strong economic growth is more than an economic
monetary policy is on
ideal. It is one of the foundations of a healthy society.
interest rates. The long-run
impact is on the rate of
Section 2

Macroeconomic Equilibrium Section 4
(pages 442“445)
Economics and Politics (pages 456“460)
• Macroeconomic equilibrium is similar to equilib-

rium in individual markets. It can be analyzed with Discretionary policy is increasingly difficult to exe-
the help of aggregate supply curves and aggregate cute due to recognition lags, implementation lags,
demand curves. Congressional gridlock, the brevity of recessions,
and conservative budget caps.
• Most of the factors that influence the individual

supply and demand curves also affect the aggregate Passive fiscal policy in the form of automatic
curves. They shift to the right to represent an stabilizers still provides much stability, but
increase, and to the left to represent a decrease. monetary policy has filled the void and has
become dominant.
• The intersection of aggregate supply and aggregate

demand determines macroeconomic equilibrium. The fields of economics and politics are closely
This equilibrium is defined in terms of a certain intertwined. The president has a Council of
amount of real GDP being produced at a specific Economic Advisers but, for political reasons, may
price level. not always be able to follow the Council™s advice.

4. Identify the factors that would cause the aggregate
demand curve to increase.
5. Discuss what is meant by macroeconomic
Self-Check Quiz Visit the Economics: Principles
and Practices Web site at epp.glencoe.com and
Section 3 (pages 447“454)
click on Chapter 16”Self-Check Quizzes to pre-
pare for the chapter test.
6. Identify the major tools of fiscal policy.
7. List the main assumptions of supply-siders.
Identifying Key Terms 8. Describe the short-term and long-term impacts of
monetary policy.
Classify each of the terms below into one of the following
Section 4 (pages 456“460)
• supply-side policies
9. Explain why discretionary fiscal policy is so diffi-
• demand-side policies
cult to use.
• monetary policies
10. Explain why new problems will arise in the econ-
1. aggregate demand curve
omy, even as old ones are solved.
2. aggregate supply curve
11. State an example of how politics sometimes over-
3. automatic stabilizer rides sound economic policies.
4. multiplier
5. deregulation
Thinking Critically
6. entitlements
1. Drawing Conclusions Why is the misery index a
7. fiscal policy
more personal measure of the social costs of insta-
8. Keynesian economics
bility than other concepts, such as the GDP gap?
9. Laffer curve
2. Making Comparisons How do aggregate supply
10. wage-price controls and demand differ from simple supply and
demand? Use a chart similar to the one below
to answer the question.
Reviewing the Facts
Section 1 (pages 437“440) Description

1. List two measures used to describe the problems
of growth and economic instability.
2. Name some of the social costs of instability. Aggregate Demand

Section 2 (pages 442“445)
3. Describe the difference between the supply curve Aggregate Supply
of a firm and the aggregate supply curve.

3. Making Comparisons Analyze the use of dis- Thinking Like an Economist
cretionary fiscal policy and monetary policy to
Both demand-side and supply-side policies are
offset the effects of a short recession. Which
designed to ensure stable economic growth. The
policy would you choose? Include reasons to
approaches differ, however, on what should be done
support your choice.
to achieve this goal. Assume that real GDP growth
was negative during the last quarter. Make a two-
column chart. In the left column, list the policies
Applying Economic Concepts that demand-side economists would follow to help
the economy. Place the supply-side solution in the
1. Automatic Stabilizers What automatic stabiliz- right column. How do they differ?
ers have benefited you or your family in the
recent past? Could you have managed without
Technology Skill
2. Multiplier Provide an example of how a
$100,000 expenditure in your community Using the Internet Log on to the Internet. Then,
would have a magnified effect as described by using a search engine, type in the following key
the multiplier. words:

3. Diversity of Opinion Some economists favor John Maynard Keynes
policies that stimulate demand, while others favor
• Unemployment
those that stimulate the supply of goods and ser-
• Stabilization policies
vices. Still other economists prefer policies based
• Inflation
on the growth of the money supply. With which
group of economists do you agree? Provide reasons
• Fiscal policy
to support your choice.
Print out (or download) any articles or reports on
4. Monetary Policy The Federal Reserve System these topics. Using the information you retrieved,
conducts monetary policy. At one time or another, prepare a two-paragraph report on each topic listed
most presidents have complained about the inde- above”defining the terms and summarizing their
pendence of the Fed. Do you think this indepen- significance to economic security. Add a list of
dence should be maintained, or that elected officials Web sites and bibliography entries at the end of
should have more control over monetary policy? your report.
Support your answer.

Math Practice Applying the Writing Process Go to a library
to look up advertisements for airfares from
19 years ago. Find out what the current air-
According to Keynesian economics, what action
fares are when traveling to the same loca-
should government take if business investment fell
tions. Write an essay that explains the effect
by $20 billion? Show your findings using the output- these price changes may have had on con-
expenditure model: sumers. What might they have to do with the
deregulation of the airline industry?
=C+ I +G+
Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

International Trade
Comparative Economic Systems
Developing Countries
Global Economic Challenges

As you read this unit, learn how the study of
economics helps answer the following questions:

Why do imported goods sometimes
cost more than domestically
produced goods?
Why did capitalism triumph over
How do population growth rates
on the other side of the world
affect you?
International trade”both
the importing and export-
ing of goods”is essential
to the U.S. economy.

To learn more about global economics through infor-
mation, activities, and links to other sites, visit the
Economics: Principles and Practices Web site at
Look at the labels on
your clothes, in your
shoes, on food products you
buy, or even on the car you
drive”and you see why
international trade is important
to everyone. In Chapter 17, you
will learn about the role
international trade plays in the
American economy. To learn
more about global commerce,
view the Chapter 24 video
International Trade

Chapter Overview Visit the Economics: Principles
and Practices Web site at epp.glencoe.com and
click on Chapter 17”Chapter Overviews to pre-
view chapter information.

Tourism is an important part
of the global economy.
Absolute and
Comparative Advantage
Main Idea Key Terms
Nations trade according to the theory of comparative exports, imports, absolute advantage, comparative
advantage. advantage
Reading Strategy Objectives
Graphic Organizer As you read the section, complete After studying this section, you will be able to:
graphic organizers similar to the ones below by defin- 1. Explain the importance of international trade
ing each term and providing an example of each. in today™s economy.
2. Describe the basis for international trade.
3. Explain why total world output increases when
Absolute Comparative
countries specialize to engage in trade.
advantage advantage
Applying Economic Concepts
Comparative Advantage When you do the chores
Definition Definition
around the house, you are probably better at some
than others. Read to find out how the concept of
comparative advantage helps everyone become
Example Example
more productive.

he key to trade”whether among people, states,
Cover Stor y or countries”is specialization. Some people
specialize in cutting hair. Others specialize in
Study: U.S. Still Biggest fixing computers. These people exchange their serv-
ices for money, which they then use to buy the spe-
Arms Provider cialized goods and services they need from others.
WASHINGTON”Wor Different regions of a country specialize in cer-
, but
wide demand is slumping tain economic activities in much the same way.
that hasn™t kept the New York, for example, is a center of the U.S.
ess, a
out of the arms busin financial industry, and Detroit specializes in auto-
ds. In
congressional study fin mobiles. The Midwest and High Plains areas are
1998, the USA led in known for wheat farming. Texas is recognized for
U.S. warship at sea
arms deals, with $7.1 billi oil and cattle, while Florida and California are
e year
up from $5.7 billion th in
second, with $5.5 billion famous for citrus fruit. All of these states trade
fore. Germany ranked
be lue
, with $3 billion. The va with one another so that people in one area can
w sales, and France third
wide was $23 billion, up consume the goods and services that workers in
all new arms sales world
of port
before. However, the re other areas offer.
m $21.4 billion the year
fro rally
s of arms sales has gene
id that the trend in term If you want to find out what a country special-
sa ng
larly among developi
en downward, particu izes in, look at its exports”the goods and services
est buyers of weapons.
tions, which are the bigg that it produces and then sells to other nations.
”USA Today, August 6,

Figure 17.1

United States Merchandise Trade by Area
$58 Western Europe
Japan Western Europe

$176 $156

OPEC Members
United States $ billions % of GDP $23
Imports $913 11% Algeria
Exports 667 8% Venezuela
Trade Deficit 246 3% Indonesia
United Arab
Saudi Arabia
$10 Qatar
$381 Kuwait
$17 Iran
Rest of the world
New Zealand
South Africa

Source: Economic Report of the President, 1999

Using Charts The United States exports merchandise (goods) all over
the world. The biggest trade imbalance is with Japan, followed by
Western Europe and by OPEC members. Which single area of the
Visit epp.glencoe.com and click on
world trades the most with the United States?
Textbook Updates”Chapter 17 for
an update of the data.

The U.S. and International Trade bigger if we counted the value of services in addi-
tion to the merchandise, or goods, shown in the fig-
International trade is important to all
ure. The sheer volume of trade between nations of
nations, even a country as large as the
such different geographic, political, and religious
United States. Most of the products exchanged
characteristics is proof that trade is beneficial.
are goods, although services, such as insurance
In fact, nations trade for the same reasons that
and banking, are being bought and sold in
individuals do”they trade because they believe that
increasing numbers.
the products they receive are worth more than the
In 1999, imports”goods and services that one
products they give up.
country buys from other countries”amounted to
Without international trade, many products
about $1,150 billion. This number corresponds to
would not be available on the world market.
nearly $4,200 for every person in the country, and
Bananas, for example, would not leave Honduras,
it has grown steadily over the years.
nor would coffee beans leave Colombia or Brazil.
Figure 17.1 shows the merchandise trade patterns
Some people may think of international trade as a
for the United States and the rest of the world. As
way to obtain exotic products and fancy consumer
large as these numbers are, they would be even

goods, but trade is much more than that. Many
Figure 17.2
imports are necessities, such as crude oil, clothing,
and shoes. In the United States, many minerals,
The Gains From Trade
metals, and raw materials that are not available
must be imported.

The Basis for Trade a™ After specialization
Before specialization
In many cases, it may be cheaper for a coun-

try to import a product than to manufacture Alpha™s opportunity cost
it. This becomes clear when we examine the differ- of production:
8 cashews = 40 coffee,
ence between absolute and comparative advantage.
or 1 cashew = 5 coffee

Absolute Advantage
A country has an absolute advantage when it is 4 8
able to produce more of a given product than Cashew Nuts
another country can. Consider, for example, the
hypothetical case of two countries”Alpha and
Beta”which are the same size in terms of area, pop-
ulation, and capital stock. Only their climate and Before specialization
soil fertilities differ. In each country, only two
crops can be grown”coffee and cashew nuts. Beta™s opportunity cost:

6 cashews = 6 coffee,
Figure 17.2 shows the production possibilities 6
or 1 cashew = 1 coffee,
frontiers for Alpha and Beta. Note that if both b
5 Beta is the lower cost
countries devote all of their efforts to producing cashew nut producer.
coffee, Alpha could produce 40 million pounds and
Beta six million”giving Alpha an absolute advan- After specialization
tage in the coffee production. However, if both
1 6
countries devote all their efforts to the production
Cashew Nuts
of cashew nuts, Alpha could produce eight million
pounds and Beta six million. Alpha, then, also has
an absolute advantage in the production of cashew Total Output Total Output
nuts because it can produce more than Beta. Before Specializing After Specializing
For years, people thought that absolute advantage Alpha Beta Alpha Beta
was the basis for trade because it enabled a country Coffee 20 + 5 = 25 Coffee 40 + 0 = 40
to produce enough of a good to consume domesti-
Cashews 4 + 1 = 5 Cashews 0 + 6 = 6
cally while leaving some for export. However, the
concept of absolute advantage did not explain how (Coffee and nuts measured in pounds)
a country with a large output like Alpha could
trade with a country having a smaller output like Using Graphs If Alpha and Beta each
Beta”and yet have both countries benefit from the specializes in the product it can produce
exchange. relatively more efficiently, total output for
both countries goes up. After specialization,
each country would trade its surplus
Comparative Advantage production with its neighbor. Does Alpha
Even when one country enjoys an absolute or Beta have a comparative advantage
advantage in the production of all goods”as in the in the production of coffee?
case of Alpha above”trade between it and another

country is still beneficial. This happens whenever a
The Gains From Trade
country has a comparative advantage”the ability
to produce a product relatively more efficiently, or The concept of comparative advantage is
at a lower opportunity cost. based on the assumption that everyone will be
To illustrate, because Alpha can produce either better off producing the products they produce rela-
40 pounds of coffee or 8 pounds of cashew nuts, tively best. This applies to individuals, companies,
the opportunity cost of producing 1 pound of states, and regions as well as to nations. The final
cashew nuts is 5 pounds of coffee (40 pounds of result is that specialization and trade increases total
coffee divided by 8). At the same time, Beta™s world output, just as in the case of Alpha and Beta.
opportunity cost of producing 1 pound of cashew This explains the nature of trade between the
nuts is 1 pound of coffee (6 pounds of coffee United States and a country such as Colombia. The
divided by 6). Clearly, Beta is the lower-cost pro- United States has excellent supplies of iron and
ducer of cashew nuts because its opportunity cost of coal. It also has the capital and the labor that are
producing 1 pound of nuts is 1 pound of coffee” needed to produce tractors and farm machinery
whereas Alpha would have to give up 5 pounds of efficiently. Colombia, in contrast, does not have as
coffee to produce the same amount of cashews. much capital or skilled labor. It does, however,
If Beta has a comparative advantage in produc- have the land, labor, and climate to produce coffee
ing cashews, then Alpha must have a comparative efficiently. Because the United States has a com-
advantage in coffee production. Indeed, if we try parative advantage in the production of farm
to find each country™s opportunity cost of pro- machinery, it will trade these products for
ducing coffee, we would find that Alpha™s oppor- Colombian coffee. Because Colombia has a com-
tunity cost of producing 1 pound of coffee is 1/5 parative advantage in the production of coffee, it
of a pound of cashews (8 pounds of cashews will export coffee and import farm equipment.
divided by 40). Using the same computations, For similar reasons, a country like Saudi Arabia
Beta™s opportunity cost is 1 pound of cashews (6 produces more crude oil than it can consume”
pounds of cashews divided by 6). Alpha, then, has enabling it to export the surplus. The United
a comparative advantage in coffee production, States, in turn, produces more military aircraft than
because its opportunity cost of production is it consumes”allowing it to sell aircraft to Saudi
lower than Beta™s. Arabia in exchange for oil.

Checking for Understanding Applying Economic Concepts
1. Main Idea What does the theory of compara- 6. Comparative Advantage If you were to open
tive advantage offer as a guideline to a business with two of your best friends, how
countries? would you divide the work to be done?
Would your decisions regarding who does
2. Key Terms Define exports, imports, absolute
what reflect comparative advantage? Explain.
advantage, comparative advantage.
3. Explain why international trade is important
in today™s economy.
7. Making Generalizations Do you know of a
4. Compare the concepts of absolute advantage
product for which your state has a compar-
and comparative advantage.
ative advantage? Explain how this might
5. Explain why total world output increases as
affect trade with another state.
countries specialize to engage in trade.
Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

Marketing Savvy:
Bill Gates

One unavoidable fact about
Bill Gates, cofounder of Microsoft,
is that with a net worth of billions
of dollars, he is one of the richest
men in the world.
Gates is matter-of-fact about INTO THE BIG LEAGUES
the reason for his wealth. “Our CONTROVERSIAL SUCCESS
In 1980 computer industry
success,” he says, “is based on
By 1993 Microsoft operating
giant IBM asked Gates to develop
only one thing: good products.
systems ran nearly 90 percent of
an operating system for its new
It™s not very complicated.” To his
the world™s PCs. Much of Gates™s
personal computer. Gates bought
many critics, however, the story is
success came from his unique com-
an operating system from a small
not so simple.
bination of technological expertise
company, revamped it, and
and an understanding of the com-
licensed it to IBM. The system
A TEENAGE WIZARD puter needs of the average user.
was called MS-DOS, for
But not everyone attributes Gates™s
Microsoft Disk Operating System.
While in high school, Gates
success to know-how and market-
The key fact is that Gates licensed
designed a class scheduling pro-
ing. Many view Gates™s Microsoft
MS-DOS to IBM”he didn™t sell it
gram so that he could take courses
as an industry bully, forcing would-
to them. Because he retained
with the prettiest girls in his school.
be competitors out of the market.
ownership of MS-DOS, he was
He also started Traf-O-Data, a
In fact, the Justice Department and
able to market it to other compa-
computer traffic analysis company.
many states have pursued antitrust
nies. In 1981 IBM unveiled its
At age 19, Gates dropped out
legislation against Microsoft.
PC, setting off the personal com-
of Harvard University to pursue
puter boom. MS-DOS became
his interest in computers. He and
the dominant operating system in
his friend Paul Allen developed a
Examining the Profile
the market, and propelled Gates
condensed operating-system lan-
to wealth.
guage, which they licensed to a 1. Predicting Consequences How
When Microsoft went public in
computer manufacturer. Based on might the Microsoft story have been
different if Gates had sold MS-DOS to
1986, Gates, who owned 45 percent
this success, Gates and Allen
IBM rather than licensing it?
of the company, became a million-
established Microsoft Corporation
aire several hundred times over.
in 1975. 2. For Further Research Report the
current status of the lawsuits against

Barriers to International Trade
Main Idea argument, balance of payments, most favored
Tariffs and quotas are two restrictions on interna- nation clause, World Trade Organization (WTO),
tional trade. North American Free Trade Agreement (NAFTA)

Reading Strategy Objectives
Graphic Organizer As you read the section, complete After studying this section, you will be able to:
a graphic organizer similar to the one below by 1. Explain how international trade can be restricted
describing the differences between a tariff and a to protect special interests.
quota. 2. Cite the main argument used in support of
3. Relate the history of the free trade movement.
Tariff/Quota Differences

Applying Economic Concepts
Key Terms Quotas Do you think the prices of some goods are
tariff, quota, protective tariff, revenue tariff, dump- too high? Read to find out how international trade
ing, protectionists, free traders, infant industries can help keep some prices low.

lthough international trade can bring many
Cover Stor y benefits, some people object to it because it
can displace selected industries and groups
US Gets Go-Ahead for Euro
of workers in the United States. The European ban
on American hormone-treated beef discussed in
Sanctions the cover story is just one example of attempts to
restrict trade.
The World Trade
Organization yesterday
authorized the US to
Restricting International Trade
impose trade sanctions
on European Union Historically, trade has been restricted in
goods in retaliation to
French delicacies subject two major ways. One is through a tariff”a
™s ban on
for the EU U.S. duties tax placed on imports to increase their price in the
ated beef.
hormone-tre r-
ll impose punitive 100 pe domestic market. The other is with a quota”a
From July 29, the US wi lica-
m the EU, including de limit placed on the quantities of a product that
cent duties on imports fro eese
ffles, and Roquefort ch
cies such as foie gras, tru can be imported.
nned tomatoes and mus
as well as beef, pork, ca sanctions, worth a
ials said last week the
US offic from
n] would target goods Tariffs
total of $116.8 [millio were
and Denmark as these
France, Germany, Italy Governments levy two kinds of tariffs”protec-
eserving the 10-
es most influential in pr
the countri tive and revenue. A protective tariff is a tariff high
year-old beef hormone enough to protect less-efficient domestic industries.
July 27, 1999
”The Financial Times, Suppose, for example, that it costs $1 to produce a
mechanical pencil in the United States. The exact

country. Quotas can even be set as low as zero to
INFOBYTE keep a product from ever entering the country.
More typically, quotas are used to reduce the total
supply of a product to keep prices high for domes-
The Trade Balance This term refers to the dif-
tic producers.
ference between exports and imports. In the
In 1981, for example, domestic automobile pro-
United States, we continue to import more than
ducers faced intense competition from lower-
we export and are therefore experiencing a trade
priced Japanese automobiles. Rather than lower
deficit. Because international trade is significant to
their own prices, domestic manufacturers wanted
GDP forecasts, this Department of Commerce sta-
President Ronald Reagan to establish import quo-
tistic is important. The standard release time is
tas on Japanese cars. The Reagan administration
around the 22nd of each month.
told the Japanese to voluntarily restrict auto
exports, and they reluctantly agreed. As a result,
Americans had fewer cars from which to choose,
and the prices of all cars were higher than they
same product, however, can be imported for 35 cents
would otherwise have been.
from another country. If a tariff of 95 cents is placed
During the Bush administration, “voluntary”
on each imported pencil, the cost climbs to $1.30”
import quotas were imposed on steel. The quotas
more than the cost of the American-made one. The
protected jobs in the domestic steel industry, but at
result is that a domestic industry is protected from
the cost of higher steel prices for the rest of the
being undersold by a foreign one.
The revenue tariff is a tariff high enough to gen-
erate revenue for the government without actually
prohibiting imports. If the tariff on imported
mechanical pencils were 40 cents, the price of the
imports would be 75 cents, or 25 cents less than the
American-made ones. As long as the two products
are identical, people would prefer the imported
one because it was less expensive”so the tariff
would raise revenue rather than protect domestic
producers from foreign competition.
Traditionally, tariffs were used more for revenues
than for protection. Before the Civil War, tariffs
were the chief source of revenue for the federal gov-
ernment. From the Civil War to 1913, tariffs pro-
vided about one-half of the government™s total
revenue. In 1913 the federal income tax was passed,
which gave the government a new and more lucra-
tive source of revenue. Modern tariffs”also called
customs duties”only account for a small portion of
total government revenue, as shown in Figure 9.4
on page 232.

Jobs These citizens are protesting the loss of
Foreign goods sometimes cost so little that
manufacturing jobs in the face of competition
even a high tariff on them may not protect the
from other countries. What is the purpose of a
domestic market. In such cases, the government protective tariff?
can use a quota to keep foreign goods out of the

country. A trade crisis emerged in mid-1997 when Arguments for Protection
charges of dumping, or selling products abroad at
Freer international trade has been a subject of
less than it cost to produce them at home, were
debate for many years. Some people, known
levied against Japan and Russia.
as protectionists, favor trade barriers that protect
domestic industries. Others, known as free traders,
Other Barriers favor fewer or even no trade restrictions. The debate
between the two groups usually centers on the five
Tariffs and quotas are not the only barriers
arguments for protection discussed below.
to trade. Many imported foods are subject to
health inspections far more rigorous than those
given to domestic foods. For years this tactic was
National Defense
used to keep beef grown in Argentina out of the
The first argument for trade barriers centers on
United States. Another tactic is to require a license
national defense. Protectionists argue that with-
to import. If the government is slow to grant the
out trade barriers, a country could become so
license, or if the license fees are too high, interna-
specialized that it would end up becoming too
tional trade is restricted.
dependent on other countries.
The United States is not the only country to use
During wartime, protectionists argue, a country
health issues to restrict trade. Many Europeans are
might not be able to get critical supplies such as oil
reluctant to consume corn, wheat, and other crops
and weapons. As a result, even some smaller coun-
that have been genetically altered for superior
tries such as Israel and South Africa have developed
yield, taste, and disease resistance. A more sensi-
large armaments industries for such crises. They
tive case is that of American beef raised on artifi-
want to be sure they will have a domestic supply if
cial hormones, a product that Europeans refuse to
hostilities break out or other countries impose
import. While most Americans feel that their food
economic boycotts.
is safe, Europeans are not so sure. After all, they
Free traders admit that national security is a
point out, an experiment by U.S. scientists
compelling argument for trade barriers. They
demonstrated that Monarch butterflies died when
believe, however, that the advantages of having a
they ate the pollen from genetically altered corn
reliable source of domestic supply must be
weighed against the disadvantages that the supply
Nationalism and culture often play a role in
will be smaller and possibly less efficient than it
these debates, with Europeans frequently claiming
would be with free trade. The political problem of
that they prefer regional and traditional foods to
deciding which industries are critical to national
genetically altered ones. While these may or may
defense and which are not must also be consid-
not be legitimate arguments, they do restrict trade
ered. At one time, the steel, auto, ceramic, and
between nations.
electronics industries all have argued that they are
critical to national defense and so should receive

Promoting Infant Industries
A Safety Net To minimize the price changes caused
The infant industries argument”the belief that
by the Arab oil embargoes of the 1970s, the United
new or emerging industries should be protected
States in 1977 created the Strategic Petroleum
from foreign competition”is also used to justify
Reserve, to store millions of barrels of oil. The
reserve can be used as an emergency supply of oil in trade barriers. Protectionists claim that these
case of a complete oil embargo. The reserve holds industries need to gain strength and experience
enough oil to provide a normal level of petroleum before they can compete against developed indus-
use in the United States for 60 days.
tries in other countries. Trade barriers would give
them the time they need to develop. If infant

industries compete against foreign in- International Trade
dustries too soon, they argue, they
might fail.
Many people are willing to accept
the infant industries argument, but
only if protection will eventually be
removed so that the industry is forced
to compete on its own. The problem is
that industries used to having some
protection are normally unwilling to
give it up”making for difficult political
decisions later on.
To illustrate, some Latin American
countries have used tariffs to protect
their own infant automobile industries,
with tariffs as high as several hundred
percent. In some cases, the tariff raised
the price of used American-made cars
to more than double the cost of new
ones in the United States. In spite of
this protection, no country in Latin
America has been able to produce a Expansion With the great expansion of trade, many U.S.
competitive product on its own. To companies set up operations in other countries. Protectionists
favor trade barriers that protect domestic industries. What is
make matters worse, governments have
the assumption behind the infant industries argument?
come to rely on the revenue supplied
by tariffs, so prices for automobiles
remain high for their citizens.
best not to interfere, and thereby keep pressure on
threatened industries to modernize and improve.
Protecting Domestic Jobs When inefficient industries are protected, the
economy produces less and the standard of living
A third argument”and one used most often”is
goes down. Because of unnecessarily high prices,
that tariffs and quotas protect domestic jobs from
people buy less of everything, including those
cheap foreign labor. Workers in the shoe industry,
goods produced by protected industries. If prices
for example, have protested the import of lower-
get too high, substitute products will be found and
cost Italian, Spanish, and Brazilian shoes. Garment
protected jobs will still be lost. Free traders argue
workers have opposed the import of lower-cost
that the profit-and-loss system is one of the major
Korean, Chinese, and Indian clothing. Steelworkers
features of the American economy. Profits reward
have blocked foreign-made cars from company
the efficient and hard working, while losses elimi-
parking lots to show their displeasure with the
nate the inefficient and weak.
foreign-made steel used in producing the cars.
In the short run, protectionist measures provide
temporary protection for domestic jobs. This is
Keeping the Money at Home
especially attractive to people who want to work in
the communities where they grew up. In the long Another argument for trade barriers claims that
run, however, industries that find it hard to com- limiting imports will keep American money in the
pete today will find it even harder to compete in the United States instead of allowing it to go abroad.
future unless they change the way they are doing Free traders, however, point out that the American
things. As a result, most free traders believe that it is dollars that go abroad generally come back again.

Space is one of those seemingly inconsequential
aspects of human interaction that can have major
THE ART OF consequences elsewhere. The American personal

COMMUNICATION bubble of space is much greater than that of an
Arab or a Russian, but smaller than that of a Briton.
Infringing upon another™s personal space or inad-
With the globalization of business, it is necessary
vertently backing away when someone enters your
to understand and to adjust to the communica-
bubble can send unintended negative messages.
tion style of other cultures.
Touching someone”a hand on the forearm, an arm
Only in the Germanic countries will the people
around the shoulder, or a pat on the back”is one of
be as eager to get down to business as in the
the easiest ways to violate personal space.
United States of America. Almost anywhere else in
”Etiquette International
the world, but especially in Asian and Latin coun-
tries, it™s important to first get to know the person
Critical Thinking
with whom you™re dealing to build a bond of trust.
Three f™s of business in Asian cultures are family, 1. Analyzing Information What does the
friends and favors. If you™re not part of an writer mean by “space”? Explain the con-
extended Asian family or if you don™t have close cept in your own words.
Asian chums from your school days, find the time to 2. Summarizing Information What does it
develop a friendship with a well-connected inter- mean to say that “the American bubble of
mediary [agent]. Relationships, once formed, are space is much greater than that of an Arab
long lasting bonds of loyalty that must be or Russian”?
respected. . . .
3. Drawing Conclusions Why is it important
to understand the values of another cul-
ture when doing business?

The Japanese, for example, use the dollars they employment in other industries. As a result, most
receive for their automobiles to buy American economists do not believe that interfering with free
cotton, soybeans, and airplanes. These purchases trade can be justified on the grounds of helping the
benefit American workers in those industries. balance of payments.
The same is true of the dollars used to buy oil
from the Middle East. The money comes back to
the United States when oil-wealthy foreigners buy
The Free Trade Movement
American-made oil technology. Keeping the
money home also hurts those American industries The use of trade barriers to protect domestic
that depend on exports for their jobs. industries and jobs works only if other coun-
tries do not retaliate with their own trade barriers.
If they do, all countries suffer because they have
Helping the Balance of Payments neither the benefits of efficient production nor
Another argument involves the balance of access to less costly products and raw materials
payments”the difference between the money a from other nations.
country pays out to, and receives from, other nations
when it engages in international trade. Protectionists
Tariffs During the Great Depression
argue that restrictions on imports help the balance of
payments by restricting the amount of imports. In 1930 the United States passed the Smoot-
What protectionists overlook, however, is that Hawley Tariff, one of the most restrictive tariffs in
the dollars return to the United States to stimulate history. It set import duties so high that the price

of many imported goods rose nearly 70 percent. do away with import quotas. Later, the Trade
When other countries did the same, international Expansion Act of 1962 gave the president of the
trade nearly came to a halt. United States the power to negotiate further tariff
Before long, most countries realized that high reductions. As a result of this legislation, more than
tariffs hurt more than they helped. As a result, in 100 countries had agreed to reduce the average level
1934 the United States passed the Reciprocal Trade of tariffs by the early 1990s.
Agreements Act, which allowed it to reduce tariffs More recently, the GATT was replaced by the
up to 50 percent if other countries agreed to do the World Trade Organization (WTO)”an international
same. The act also contained a most favored agency that administers previous GATT trade agree-
nation clause”a provision allowing a country to ments, settles trade disputes between governments,
receive the same tariff reduction that the United organizes trade negotiations, and provides technical
States negotiates with a third country. assistance and training for developing countries. As
Suppose, for example, that the United States and you read in the cover story, the WTO agreed that
China have a trade agreement with a most favored Europe was discriminating against the United States
nation clause. If the United States then negotiates a by banning hormone-treated beef. While the WTO
tariff reduction with a third country, the reduction normally opposes retaliatory measures, it approved
would also apply to China. This clause is very the U.S. measures because the European Union
important to China, because its goods will then sell ignored earlier WTO demands to drop American
at an even lower price in the American market. beef restrictions.
Because so many countries have been willing to
reduce tariffs and quotas under GATT and the
The World Trade Organization WTO, international trade is flourishing. Tariffs that
In 1947, 23 countries signed the General once nearly doubled the price of many goods now
Agreement on Tariffs and Trade (GATT). The increase prices by a small percentage, while other
GATT extended tariff concessions and worked to tariffs have been dropped altogether. As a result,


Protectionism vs. Free Trade Free
traders argue that reducing tariffs and
quotas allows consumers to choose
from a variety of both domestic and
foreign products. What arguments do
protectionists use in support of trade

Figure 17.3

The North American Free Trade Agreement
Population 400 million
GDP $9.9 trillion
Two-Way Trade $511 billion

Population 31 million
GDP $681 billion

U.S. exports to Canada $154 billion
U.S. imports from Canada $178 billion

Canadian exports to Mexico $1 billion
Canadian imports from Mexico $4 billion
Population 270 million
GDP $8.5 trillion

U.S. exports to Mexico $79 billion
MEXICO U.S. imports from Mexico $95 billion
Population 99 million
GDP $729 billion

Source: CIA Fact Book

Using Maps The North American Free Trade Agreement (NAFTA)
makes up the second largest free-trade area in the world, after the
European Union. After NAFTA was implemented, trade between the
three nations began to grow by 10 to 15 percent annually. Do imports Visit epp.glencoe.com and click on
Textbook Updates”Chapter 17 for
or exports comprise the larger portion of Mexico™s trade with
an update of the data.
Canada and the United States?

stores are able to offer a wide variety of industrial find their protective tariff reduced to zero over a
and consumer goods from all over the world. 15-year period. Proponents predicted that trade
among all three nations would increase dramati-
cally, stimulating growth and bringing a wider vari-
NAFTA ety of lower-cost goods to everyone, protectionists
and free traders alike.
The North American Free Trade Agreement
The case for freer trade is a classic case of cost-
(NAFTA) is an agreement to liberalize free trade by
benefit analysis. Some of the costs and benefits
reducing tariffs among three major trading partners:
identified during the NAFTA debate actually
Canada, Mexico, and the United States. It was pro-
occurred, but not to the extent originally pre-
posed by the Bush administration and concluded by
dicted. Trade among the three countries has grown
the Clinton administration in 1993.
dramatically since NAFTA was created. In the end,
Before NAFTA, United States goods entering
freer trade allowed the NAFTA partners to capital-
Mexico faced an average tariff of 10 percent. At
ize on their comparative advantages for everyone™s
the same time, approximately half of the goods
entering the United States from Mexico were duty-
free, while the other half faced an average tax of
only 4 percent. Exceptions did exist, however. A
32 percent tariff on brooms imported from
Mexico protected approximately 3,000 broom
makers in southern Illinois.
Free trade is good in general, but it is not pain-
less. NAFTA was controversial specifically because
Student Web Activity Visit the Economics: Principles
some workers would be displaced when trade barri- and Practices Web site at epp.glencoe.com and click
ers were lowered. Opponents predicted that some on Chapter 17”Student Web Activities for an activ-
high-paid American jobs would be lost to Mexico” ity on the World Trade Organization.
including those held by broom makers who will

Checking for Understanding Applying Economic Concepts
1. Main Idea Explain why protectionists favor 6. Quotas Explain how a quota on a good or
tariffs and quotas. service produced in your community can pro-
tect the jobs in a particular industry. Then
2. Key Terms Define tariff, quota, protective
explain how the same quota might be harm-
tariff, revenue tariff, dumping, protectionists,
ful to consumers.
free traders, infant industries argument,
balance of payments, most favored nation
clause, World Trade Organization (WTO),
North American Free Trade Agreement
7. Drawing Conclusions If you were a mem-
ber of Congress approached by a delegation
3. Describe three barriers to international trade. of autoworkers seeking additional tariff or
quota protection, how would you respond?
4. List five arguments that are commonly used


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