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)