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The role of foreign trade on economy

Updated on May 8, 2011

Top U.S. Trade Partners

Foreign trade is a very important part of the America economy. A lot of the products we buy have been imported from other nations. Our nation trades with many other nations, and its trading practices have changed greatly over the years in order the function the best, and to benefit the US to the greatest degree.

The history of trade is fascinating. Europe pursued economic philosophies of mercantilism: that precious metals determined a nation's wealth, and that a nation should export more than it imports. By these philosophies, trade depended a lot on finding more natural resources. Later on, Adam Smith wrote in his famous book on economics that a nation's wealth should depend on its holding assets, such as household items. He also believed that exporting and the profits it brought should be used to import things that people needed but couldn't produce or get themselves. This sort of thinking shaped the modern practices and processes of trade that we know and use today, because of its practicality and fairness.

Trading with other nations usually means profits. If one nation is better at making a certain item than another, then it would be cheaper and less time-consuming for them to make it than for another to have to train employees, garner the resources, and develop new production techniques in order to make enough just for themselves; the opportunity costs are cheaper with trade. Being able to produce something at a lower opportunity cost than another nation is known as having the comparative advantage. Being able to do so by using fewer resources than another is known as having the absolute advantage.

Transactions with foreign countries are used as monetary policy tools to affect the economy in America. When the value of the American dollar is strong (high), people spend less by buying abroad, where prices are higher; this causes deflation in the U.S. because Americans aren't spending enough in their own country, and the value of the dollar rises. When its value is weak (low), import prices rise and inflation can occur because not enough money is being spent abroad, and there is too much in circulation in America. In Fed intervention, the Fed works to balance the economy through the FX (foreign exchange) market. For instance, to push up the value of the American dollar, it raises interest rates. Foreigners then invest funds in the U.S. Their currencies are converted and the demand for the dollar is increased. The Fed can raise the value of the American dollar by using foreign currency to buy them, and can lower its value by selling them.

Many people also fight for free trade, because they believe it would make the process of trade cheaper, and it would be easier for nations to trade. It also raises a nation's standard of living.

Sometimes the government will try and discourage trade when appropriate. This is known as creating trade barriers. Protectionism is a government's use of tariffs, quotas, and other measures to protect particular domestic producers from foreign competition, so that people spend their money on that nation's products rather than another nation's, and so that nation's economy itself is directly promoted and a citizen's dollars aren't being spent overseas and supporting that other nation. War is also something that impedes trade; two nations at war will not want to trade with each other.


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