Unit 7: Absolute Advantage v. Comparative Advantage (4/29)

Absolute Advantage: faster, more, more efficient 

Individual: exists when a person can produce more of a certain good/service than someone else in the same amount of time. 

National: exists when a country can produce more of a good/service than another country can in the same time period. 

Comparative Advantage: lower opportunity cost 

Individual/National: exists when an individual or nation can produce a good/service of a lower opportunity cost than can another individual or nation. 

Input Problems:

The country or individual that uses the least amount of resources, land, or time has the absolute advantage. 

Output Problems:

The country that can produce the most has the absolute advantage. The country that has the lowest opportunity cost has the comparative advantage in that product. Deals with production. 

Unit 7: Foreign Exchange pt. 2 (4/27)

Purchasing Power Parity: When the currency rates are set by international markets, changes will be based on the actual purchasing power of the currencies. 

For example, if the U.S. dollar to the European Euro is $1.50 to 1, then each $1.50 will buy 1 Euro. However, if an item in the US costs $1.50 and then costs more or less than 1 Euro, the parity is lost. Markets will adjust quickly in floating rates or pressure for change will occur in fixed rates. 

Why do we exchange currencies?

1) To invest in other countries' stocks and bonds

2) To sell exports and buy imports

3) To build factories or stores in other markets

4) To hold currencies in bank accounts for future imports, exports, or business loans

5) To speculate on currency values 

6) To control excessive imbalances

Unit 7: Foreign Exchange Market (4/15)

Foreign Exchange: the buying and selling of currency. 

- Ex. In order to purchase souvenirs in France, it is first necessary for Americans to sell (supply) their dollars and buy (demand) Euros)

- The exchange rate (e) is determined in the foreign currency markets. 

- Simply put, the exchange rate is the price of a currency. 

- Do not try to calculate the exact exchange rate. 

Tips:

- Always change the D line on one currency graph, the S line on the other currency's graph. 

- Move the lines of the two currency graphs in the same direction (right or left) and you will have the correct answer. 

- If D on one graph increases, S on the other will also increase. 

- If D moves to the left, S will move to the left on the other graph. 

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 make it cheaper to buy one unit of that currency. 

- A decrease in supply of a currency will make it more expensive to buy one unit of that currency. 

- An increase in demand for a currency will make it more expensive to buy one unit of that currency. 

- A decrease in demand for a currency will make it cheaper to buy one unit of that currency

Appreciation of a currency occurs when the exchange rate of that currency increases (e goes up)

Depreciation of a currency occurs when the exchange rate of that currency decreases (e goes down)

- One hundred yen used to buy one dollar. Now 50 yen buys one dollar. 

- The dollar is weaker because it takes fewer Yen to buy one dollar. 

Exchange Rate Determinants

- Consumer Tastes

- Relative Income 

- Relative Price Level

- Speculation

Unit 7: Balance of Payments pt. 3 (4/14)

Balance of Trade = (goods and services of exports) - (goods and services of imports)

Trade Deficit: Imports > Exports

Trade Surplus: Exports > Imports

= Goods Exports + Good Imports

Current Account = Balance of Trade + Net Investment + Net Transfers

Capital Account = foreign purchases of U.S. assets + U.S. purchases of assets abroad

Official Reserves = Current Account + Capital Account 

Goods & Services = Goods Imports + Service Imports

Unit 7: Balance of Payments pt. 2 (4/10)

Balance of Payments - 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 of payments is divided into 3  accounts

-current account

-capital/financial account

-official reserves account

Every transactions in the balance of payments is recorded twice in accordance with stand accounting practice

-Ex. US manufacturer, John Deere, exports $50 million worth of farm equipment to Ireland

A credit of $50 million to the current account (- $50 million worth of farm equipment or physical assets)

A debit of $50 million to the capital/financial account 

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

-income earned by US owned foreign assets - income paid to foreign held US assets

- ex. Interest payments on us owned Brazilian bonds - interest payments on German owned US Treasury bonds

Net Transfers (tend to be unilateral)

-foreign aid to 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 in the US is a credit to the capital account

-ex. The Toyota Factory in San Antonio

-direct investment by US firms/individuals in a foreign country are debits to the capital account

-ex. The Intel Factory in San Jose, Costa Rico

Capital/Financial Account

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

-ex. Warren Buffet buys stock in Pentrochina

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

-ex. The United Arab Emirates sovereign wealth fund purchases a large stake in the NASDAQ

Relationship between Current and Capital Account

-the current account and the capital account should zero each other out.

IF THE CURRENT ACCOUNT HAS A NEGATIVE BALANCE (DEFICIT), THEN THE CAPITAL ACCOUNT SHOULD HAVE A POSITIVE BALANCE (SURPLUS)

The U.S. is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate.

The People's Republic of China is active in its use of official reserves. It actively buy sand sells dollars in order to maintain a steady exchange rate with the U.S.

Unit 7: Balance of Payments (4/9)

The Balance of Payments: 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 of Payments is divided into 3 accounts:

1) Current Account

2) Capital Account

3) Official Reserves Account

Double Entry Bookkeeping

Every transaction in the balance of payments is recorded twice in accordance with standard accounting practice. 

Ex. U.S. Manufacturer, John Deere, exports $50 million worth of farm equipment to Ireland. 

- A credit of $50 million to the current account (-$50 million worth of farm equipment or physical assets)

Unit 5: Laffer Curve (4/7)

Supply-Side Economics: It is the belief that the AS curve will determine levels of inflation, unemployment, and economic growth. To increase the economy, the AS curve should shift to the right, which will always benefit the company first. Supply-side economists focus on marginal tax rates. Marginal tax rates is the amount paid on the last dollar earned or on each additional dollar earned. By reducing the marginal tax rate, supply-siders believe that you will encourage more people to work longer and forgo leisure time for extra income. They support policies that promote GDP growth by arguing that the high marginal tax rate along with the current system of transferred payments. They provide disincentives to work, invest, innovate, and undertake entrepreneurial ventures. It is also known as Reaganomics because Reagan lowered the marginal tax rate to get the U.S. out of a recession, which led to a deficit. 

Laffer Curve: It is a tradeoff between tax rates and government revenue. It is used to support the supply-side argument. 

3 Criticisms: 

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

2) Tax cuts increase demand, which can fuel inflation and causes demand to exceed supply. 

3) Where the economy is actually located on the curve is difficult to determine. 

Unit 5: Long-Run Phillips Curve (4/6)

Long-Run Phillips Curve (LRPC)

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

- Increases in natural rate of unemployment will shift LRPC right

- Decreases in natural rate of unemployment will shift LRPC left

Stagflation: period with high inflation and high unemployment occurring at the same time. (VN War, Civil Rights Movement, Women's Movement, Oil Embargo)

Disinflation: reduction in the inflation rate from year to year. Nominal wages increase 

Deflation: situation in which there is an actual drop in the price level. Opposite of inflation.

Unit 5: Phillips Curve (4/2)

Phillips Curve: It represents the relationship between unemployment and inflation. The tradeoff between inflation and unemployment only occurs in the short run. 

Long-Run Phillips Curve: occurs at the natural rate of unemployment (4-5%). If the natural rate of unemployment changes, the LRPC changes. 

- represented by a vertical line

- there is no tradeoff between unemployment and inflation in the long run. The economy produces at a full employment level. 

- LRPC will only shift if the LRAS curve shifts. Otherwise, it is assumed to be stable. 

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

NRU = Seasonal + Frictional + Structural

Short-Run Phillips Curve

- There is an inverse relationship between inflation and unemployment. 

- It has a relevance to Okun's Law. 

- Since wages are sticky, inflation changes move the points on the SRPC. 

- If inflation persists and the expected rate of inflation rises, then the entire SRPC moves upward, which causes stagflation. 

- If inflation expectations drop due to new technology or economic growth, then the SRPC will move downward. 

- Aggregate supply shocks can cause both higher rates of inflation and higher rates of unemployment. 

- Supply shocks are rapid and significant increases in resource cost. 

- Misery Index: the combination of unemployment and inflation in any given year. Single digit misery is good. 

Unit 5: SRAS/LRAS (4/1)

I. SRAS: time too short for wages to adjust to the price level. The rational for SRAS is that workers may not be aware yet of changes in their real wages due to inflation and have adjusted their labor supply decisions and wage demands accordingly. 

- Nominal Wages is the amount of money received per day, per hour, or per year. 

- Real wages is adjusted for inflation 

- Sticky Wages: where the nominal wage level is set according to an initial price level and it does not vary. 

II. LRAS: time long enough for wages to adjust to the price level. In the long run, there is a flexible wage and price level. Both the wage and the price level offset each other. The same factors that move the PPG is the same that move the LRAS.