UNIT 7

absolute and comparative advantage

absolute and comparative advantage

unit 7

Balance of payments

• measure of money inflows and outflows between the US and the Rest of the World (ROW)

     -Inflows are referred to as CREDITS

     -out flows are referred to as DEBITS

• the balance of payments is divided by 3 accounts

      - current account
      - capital/ financial accounts
      - official reserves accounts

Current Accounts

- balance of trade or net exports

-net foreign income

-net transfers (tend to be unilateral)

Capital/ Financial Accounts

- the balance of capital ownership

-includes the purchase of both real and financial assets

-direct investment in the US is a credit to the capital account

-direct investment by US Firms/ individuals in foreign country are debits to capital accounts

-purchase of foreign financial assets represents a debit to a capital account

-purchase of domestic financial assets by foreigners represents a credit to the capital accounts

          Important Info:the current account and the capital account should zero each other out***

Official Reserves 

-foreign currency holdings of US Federal Reserve System

-when there is a balance of payments surplus the FED accumulates foreign currency and debits balance of payments

-when there is a balance of payments deficit FED depletes its reserves of foreign currency and credits balance of payments

Active US passive official reserves

-the US is passive in its use of official reserves

Exchanges

• Foreign Exchange (FOREX)

- the buying and selling of currency

      Example: in order to purchase souvenirs in France, it is first necessary for Americans to sell their dollars and buy Euros

- any transactions that occurs in the balance of payments necessitates foreign exchange

-Exchange Rate (e) is determined in foreign currency markets

• Changes in Exchange Rates

-exchange rates (e) are a function of supply and demand for currency

•        an increase in the supply of a currency

•        a decrease in supply of a currency will increase the exchange  rate of currency

•        increase in demand for currency will increase the exchange rate of currency

•        decrease in demand for a currency will decrease the exchange rate of currency

• Appreciation and Depreciation

-appreciation of currency occurs when exchange rate of that currency increases (e^)

-depreciation of a currency occurs when the exchange rate of that currency decreases

• Exchange Rate Determinants

-consumer tastes

-relative income

-relative price level

-speculation

• Exports and Imports

-exchange rate is a determinant of both exports and imports

-appreciation of the dollar causes american goods to be relatively more expensive and foreign goods to be relatively cheaper, thus reducing exports and increasing imports

-depreciation of the dollar causes american goods to be relatively cheaper and foreign goods to be relatively more expensive thus increasing exports and reducing imports

• Absolute Advantage

-Individual- exists when a person can produce more of a certain good/ service than someone else in the same amount of time (or can produce a good using the least amount of resources.)
-National-exists when a country can produce more o a good/ service than another county can in the same time period.

• Comparative Advantage

-A person or a nation has a comparative advantage in the production of a product when it can produce the product at a lower domestic opportunity cost than can a trading partner.

• Examples of output problem:

-word per minute

-miles per gallon

-tons per acre

-apple per tree

-television produced per hour

• Examples of Input problems:

-number of hours to do a job

-number of acres to feed a horse

-number of gallon of paint to paint a house

• Specialization and trade

-Gains from trade are based on comparative advantage, not absolute advantage

(who can d what in a certain amount of time)

(Smallest number is who has opportunity cost)

Economic Growth and LRAS- Macro 3.14

UNIT VI

Economic Growth Defined

                   -Sustained increase in Real GDP over time.

                   -Sustained increase in Real GDP per Capital over time.

Why Grow?

               A.)Growth leads to greater prosperity for society.

               B.)Lessens the burden of scarcity.

               C.)Increases the general level of well-being.

Conditions for Growth

            -Rule of Law

            -Sound Legal and Economic Institutions

            -Economic Freedom

            -Respect for Private Property

            -Political & Economic Stability

Low Inflationary Expectations

            •Willingness to sacrifice current consumption in order to grow

            •Saving

            •Trade

Physical Capital

                                I. Tools, machinery, factories, infrastructure

                                II.Physical Capital is the product of Investment.

                                 III.Investment is sensitive to interest rates and expected rates of return.

                                  IV.It takes capital to make capital.

                             V.Capital must be maintained.

Technology & Productivity

•Research and development, innovation and invention yield increases in available technology.

•More technology in the hands of workers increases productivity.

•Productivity is output per worker.

•More Productivity = Economic Growth.

Human Capital

                   -People are a country’s most important resource. Therefore human capital must be developed.

                   -Education

                    -Economic Freedom

                    -The right to acquire private property

                    -Incentives

                     -Clean Water

                      -Stable Food Supply

                  •Access to technology

Hindrances to Growth

*Economic and Political Instability

–High inflationary expectations

*Absence of the rule of law

*Diminished Private Property Rights

*Negative Incentives

–The welfare state

*Lack of Savings

*Excess current consumption

*Failure to maintain existing capital

*Crowding Out of Investment

–Government deficits & debt increasing long term interest rates!

*Increased income inequality à Populist policies

*Restrictions on Free International Trade

The Phillips Curve (Macro Review) Macro 3.4

Example of the Phillip Curve

UNIT V

4/11/16
DEFINTION  

1. INFLATION- a general rise in the price level
2. DEFLATION- a general decline in the price level
3. DISINFLATION- a decrease inflation rate over time.
4. STAGFLATION- unemployment and inflation increasing at the same time.
5. SUPPLY SIDE ECONOMICS- change AS not AD. Determines the level of inflation, unemployment rates, and economic growth
6. SUPPLY SIDE ECONOMIC – support policies that promote GDP growth by arguing that high marginal  tax rates along with the current system of transfer payments such as unemployment compensation or warfare programs , provide disincentive to work , save , innovate , and undertake enterperal ventures.
7. Lower Marginal tax rates – induce more work , this causes as to increase. Al6 makes leisure more expensive, and work more attractive.

INCENTIVE TO SAVE AND INVEST

-High marginal tax rates reduce the rewards for saving and investment.

-Consumption might increase , but investment depends upon savings

- Lower marginal tax rates encourage savings and investment

LAFFER CURVE

- Theoretical relationship between tax rates and government revenue.

- As tax rates increase from 0 , government revenues increase increase from 0 to

- Criticisms : 

                  A.)Research suggests that the impact of tax rates on incentives to work , save , and invest are small.

                               B.) Tax units also increase demand, which can fuel inflation, and demand may exceed supply
                               C.) Where the economy is actually located on the curve , is difficult to determine


4/26/16

• BALANCE OF PAYMENTS 

-measure of money inflows and outflows between then US and the post of the world (grow)

• Inflows = credits
• Outflows = debits

•  The balance of payments is divided into 3 accounts

1. Current account
2. Capital / financial account
3. Official reserves account

• Double entry bookkeeping
• Current account

- Balance of trade or net exports

- Exports of goods / services-import of goods /services

- Exports create a credit to the balance of payments

- Imports create a debit to the balance of payments

• Net foreign

- Income earned by US owed foreign assets – income paid to foreign held US assets

- Ex: interest payments on US own Brazilian bonds – interests payments on German owed US  treaty bonds

•  Net transfer (tend to be unilateral)

- foreign aid  a debit  to the current account

****Ex : Mex . Migrant workers send $ to farm in Mexico

• CAPITAL/ FINANCIAL ACCOUNT

                           -The balance of capital ownership
                           - Includes the purchase of both real and financial assets
                           - Direct investment in the US is a credit to the capital account

              - Toyota factory in San Antonio (EX)

•  Direct investment in the US firms (individual in a foreign country are debits to the capital account

- the Intel factory in San Jose , Costa Rica

• Purchase of domestics financial assets by foreigners represents a credit to the capital account

- The United Arab Emirates Sovereign wealth funds purchases a large stake in the NASDAQ

        RELATIONSHIP BETWEEN CURRENT AND CAPITAL ACCOUNT

- double entry bookkeeping

- The current account and capital account should sew each other out

- That is…. If the current account has a negative balance (DefIcit)

OFFICIAL RESERVES

- The current foreign currency holdings of the US federal reserve system

- When there is a balance of payments supply the federal accumulate foreign currency and debits the balance of payments

- When there is reserves of foreign currency and credits the balance of payments

- The official reserves sew out the balance of payments

ACTIVE VS. PASSIVE OFFICIAL RESERVES

• The US is passive in its use of official reserves. It dives not seek to manipulate the dollar exchange rate

• The people republic of China is active in its use of official reserves. It actively buys and sells dollars In order to maintain a steady exchange rate with the US

         BALANCE OF TRADE
            Goods             +             Goods
            Exports                           Imports

BALANCE ON GOODS AND SERVICES
             Goods           +                Service         +            Goods
              Exports                           Exports                      Imports 

Unit V: The Phillips Curve

4/8/16

The Phillips Curve

-The Long-Run Phillips Curve measures unemployment and (? inflation?)

Note: Natural rate of unemployment is held constant.

-Because the Long-Run Phillips Curve exist at the natural rate of unemployment, structural changes in the economy that affect unemployment will also cause the LRPC to shift.

-Increases in unemployment will shift LRPC to the right

-Decreases in unemployment will shift LRPC to the left.

-SRPC has a tradeoff between inflation and unemployment (when one increases the other decreases). (inverse relationship)

-LRPC: There is no tradeoff between inflation and unemployment.

1. The economy produces at the full employment output level.

2.It is represented by a vertical line.

3. It occurs at the natural rate of unemployment.

Natural unemployment rate (NRU)= Frictional +Structural +Seasonal

Fe= 4-5%

LRAS shifters also shifts LRPC.

-The major LRPC assumption is that more worker benefits create higher natural rates and fewer worker benefits create lower natural rates.

-The misery index, a combination of inflation and unemployment in any given year.

-Single digit misery is good.  

Unit V: Long-Run and Short Run Aggregate Supply

4/7/16

Short Run Aggregate Supply

In macroeconomics, this is the period in which wages (and other input prices) remain fixed as price level increases or decreases.

Long Run Aggregate Supply

Period of time in which wages have become fully responsive to changes in price level.

Effects over Short-Run

-In the short run, price level changes allow for companies to exceed normal outputs and hire more workers because profits are increasing while wages remain constant.

-In the long run, wages will adjust to the price level and previous output level will adjust accordingly.

Equilibrium in the Extended Model

The Long AS Curve is represented with a vertical at full employment level of real GDP

Demand Pull Inflation in the AS Model

-Demand-pull: Prices increase based on the increase in aggregate demand

-In the short run, demand pull will drive up prices, and increase production

-In the long run, increases in aggregate demand will eventually return to previous levels

Cost Push & the Extended Model

Cost-push arises from factors that will increase per unit costs such as increase in the price of a key resource

Dilemma for the Government

-In an effort to fight cost-push, the government can react in two different ways.

-Action such as spending by the government could begin an inflationary spiral

-No action, however, could lead to recession by keeping production and employment levels declining 

Unit IV: Final Notes

*When a customer deposits cash or withdraws cash from their demand deposit account, it has no effect on the money supply

 It only changes:

1.    The composition of the money

2.    Excess reserve

3.    Required reserves (due to the changes of DD)

Single Bank: loan money from excess reserves (ER) only

Banking system: ER X multiplier = total money supply

When the FED buys or sells bonds, ER is created.

$200 x (1/.2) = $1000

RRR= 20% 

Unit IV: Countercylical Policies: Keynesian Fiscal Policy versus Monetary Policy

In the early 21^st Century, here in the USA:

An efficient, “full employment” economy will probably have:

1.    An annual unemployment rate of 4-5%

2.    An annual inflation rate 2-3%

If the economy goes into recession:

3.    The Real GDP will decrease for at least 6 months.

4.    The unemployment will go to 6% or more.

5.    The inflation rate will probably go to 2% or less.

If the Congress enacts Keynesian Fiscal Policies to attempt to slow/stop the recession, then:

6.    The policy will try to improve C or G (parts of AD)

7.    Congress decrease federal taxes.

8.    Congress will increase job and spending programs.

9.    The federal budget will probably create a deficit,

10.                       Due to the changes in Money Demand, interest will increase. (Crowding out might occur, but Keynesian don’t care)

If the Federal Reserve employs Monetary Policy options to slow/stop the recession, then:

11.                       The policy will target improvement in the Ig (part of AD)

12.                       The Fed will target a lower federal fund rate.

13.                       The Fed can lower the discount rate.

14.                       The Fed can buy bonds (Open Market Operations)

15.                       The Fed can (theoretically) lower the reserve requirement

16.                       These Fed policies will lower the interest rates through changes in the Money Supply.

17.                       These options should increase Ig.

If the economy suffers from too much demand-pull inflation or cost-push inflation, then

18.                       The unemployment rate will go to 4% or less.

19.                       The inflation rate will probably go to 4% or more.

If Congress enacts Keynesian Fiscal Policies to attempt to slow/stop the inflation, then:

20.                       The policy will try to decrease C or G (parts of AD)

21.                       Congress will increase federal taxes.

22.                       Congress will decrease job and spending programs.

23.                       The federal budget will probably create a surplus.

24.                       Due to changes in Money Demand, interest rates will decrease.

If the Federal Reserve employs Monetary Policy options to slow/stop the inflation problems, then:

25.                       The policy will target decreases in Ig (parts of AD).

26.                       The Fed will target a higher federal funds rate.

27.                       The Fed can increase the discount rate.

28.                       The Fed can sell bonds (Open Market Operations).

29.                       The Fed can (theoretically) raise the reserve requirement, but probably won’t because it is too complex for the banks.

30.                       These Fed policies will raise the interest rates through changes in the Money Supply.

31.                       These options should lower Ig.