Unit 7

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: exist when a country can produce more of a good/service than another country 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.
• Ex. for input: number of hours to do a job, number of acres to feed a horse, number of gallons of paint to paint a house.
• Ex. for output:

Specialization and Trade

• Gains from trade are based on comparative advantage, not absolute or advantage.

Unit 7

Mechanics of Foreign Exchange (FOREX)

• Foreign Exchange (FOREX)
• The buying and selling of currency
• Ex. In order to purchase souvenirs in France, it is first necessary for Americans to sell their Dollars and buy Euros.
• Any transaction that occurs in the balance of Payments necessitates foreign exchange.
• The exchange rate (e) is determined in the foreign currency market.
  
• Changes in Exchange Rates
• Exchange rates (e) are a function of the supply and demand for currency.
• An increase in the supply of a currency will decrease the exchange rate of a currency.
• An decrease in the supply of a currency will increase the exchange rate of a currency.
• An increase in the demand of a currency will increase the exchange rate of a currency.
• An decrease in the demand of a currency will decrease the exchange rate of a currency.
• Appreciation and Depreciation
• Appreciation of a currency occurs when the exchange rate of that currency increase (e↑)
• Depreciation of a currency occurs when the exchange rate of that currency decrease (e↓)
• Exchange Rate Determinants
• Consumer Tastes
• Relative Income
• Relative Price Level
• Speculation
• Exports and Imports
• The exchange rate is a determinants 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.
• Floating/Flexible Rates
• Depends on demand and supply of that currency vs. other currencies.
• It is very sensitive to the business cycle
• Provide options for investment
• Fixed Rates
• Based upon a country's willingness to distribute currency and the ability to control the amounts.

Unit 7

Formulas

• Balance of Trade:
  Goods Exports + Goods Imports
• Balance on goods and services:
  Goods Exports + Service Exports + Goods Imports + Service Imports
• Current Account:
  Balance on goods and services + Net Investment + Net Transfers
• Capital Account:
  Foreign Purchases + Domestic Purchases

Unit 7

Balance of Payment Chart

	Assets (+) Demand for the $ "Inflows"	Debits/Liabilities (-) Supply of the $ "Outflows"
Current Accounts (CA)
Balance on Goods & Services Net Exports (Xn) Balance of Trade	Exports Tourism here	Imports Tourism there
Net Investment	Interest/dividend payments foreigner paid to the U.S. for use of exported capital.	Interest/dividend payments the U.S. made for use of foreign capital invested in the U.S.
Net Transfers	Aid to the U.S. Transfers back to the U.S. Our royalties	Aid to them Remittances from the U.S. Their royalties
Financial Accounts (K) or (KA) -or- "Financial and Capital Accounts" -or-     "Capital Accounts"	Capital inflows Direct investment in the U.S by  foreigners Purchases of stocks and bonds by foreigners.	Capital outflows Direct investment by the U.S. over there Purchases of stocks and bonds by the U.S.
Official Reserves or Official Settlements or Special Drawing Rights	Currencies IMF holdings Gold	Currencies IMF holdings Gold

Unit 7

The Balance of Payment

• Balance of Payment
• Measure of money inflows and outflows between the united States and the Rest of the World (ROW).
• Inflows are referred to as CREDITS.
• Outflows are referred to as DEBITS.
• The Balance Payments is divided into 3 accounts
• Current Account
• Capital/Financial Account
• Official Reserves Account
• Current Account
• Balance of Trade or Net Exports
• Exports of Goods/Services - Imports of Goods/Services
• Exports create a credit to the balance of payments.
• Imports create a debit to the balance of payments.
• Net Foreign Income
• Income earned by U.S. owned foreign assets - Income paid to foreign held U.S. assets
• Ex. Interest Payments on U.S. owned Brazilian bonds - Interest payments on German owned U.S. Treasury bonds.
• Net Transfers (tend to be unilateral)
• Foreign Aid → a debit to the current account
• Ex. Mexican migrant workers send money to family in Mexico.
• Capital/Financial Account
• The balance of capital ownership
• Includes the purchase of both real and financial assets.
• Direct investment by U.S. firms/individuals in a foreign country are debits to the capital account.
• Purchase of foreign financial assets represents a debit to the capital account.
• Purchase of domestic financial assets by foreigners represents a credit to the capital account.
• Relationship between Current and Capital Account
• The Current Account and Capital Account should zero each other out.
• That is...If the Current Account has a negative balance (deficit), then the Capital Account should then have a positive balance (surplus)
• Official Reserves
• The foreign currency holdings of the United States Federal Reserve System.
• When there is a balance of payments surplus, the Fed accumulates foreign currency and debits the balance of payments.
• When there is a balance of payments deficit the Fed depletes its reserves of foreign currency and credits the balance of payments.
• Where there's a balance of payments the Fed depletes
• Active v. Passive Official Reserves
• The United States is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate.

Unit 6

Economic Growth & Productivity

• Economic Growth Defined
• Sustained increase in Real GDP over time.
• Sustained increase in Real GDP per Capita over time.
• Why Grow?
• Growth leads to greater prosperity for society.
• Lessens the burden of scarcity.
• 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
• Tools, machinery, factories, infrastructure
• Physical Capital is the product of investment
• Investment is sensitive to interest rates and expected rates of return.
• It takes capital to make capital.
• 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 and debt increasing long term interest rates
• Increased income inequality → Populist policies
• Restriction on Free International Trade

Unit 5

Supply Side Economics

Changes inAS and not AD are the main active force in determining the level of inflation, unemployment rates, and economic growth.

• Supply side Economist: 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 welfare programs provide disincentives to work, invest, innovate, and undertake entrepreneur ventures.
• Incentive to Save & Invest
1. High marginal tax rates reduce the rewards for saving and investment.
2. Consumption might increase but investments depend upon savings.
3. Lower marginal tax rates encourage saving and investment.

Laffer Curve

• A theoretical relationship between tax rates and tax revenues.
• As tax rate increase from zero, tax revenue increase from zero to some maximum level and then decline.
• 3 Criticisms
1. Evidences suggest that the impact of tax rates on incentives to work, save, and invest are small.
2. Tax cuts also increase demand which can fuel inflation, and demand may exceed supply.
3. Where the economy is actually located on the curve is difficult to determine.

Unit 5

Misery Index

• A combination of inflation and unemployment in any given year. Single digit misery is good.
• Supply Shocks: rapid and significant increase in resource cost.
• Disinflation: reduction and inflation fro year to year. Found in the LRPC.
• Deflation: general decline in prices.
• Inflation: general rise in prices.
• Stagflation: unemployment and inflation rise/increase at the same time.