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

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 StatesFederal 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.

  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 theforiegn 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 increasethe exchange rate of a currency.
  • An increase in the demand of a currency will increasethe exchange rate of a currency.
  • An decrease in the demand of a currency willdecrease 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 relativelycheaper 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.

    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 6

Balance of Payments

measure of money inflows and outflows between the U.S. And rest of the world (ROW)

• -inflows are refereed to as credits
• -outflows are refereed to as Debits

the balance of payments is divided into 3 accounts.

• -current account
• -capital / financial accounts

Current Account

Balance of Trade or Net Exports

• -exports or Goods/ services – import of Goods/ services.
• -Exports create a credit to the balance of payments.

Net Foreign Income

• -income earned by U.S. Owned foreign assets income paid to foreign held U.S owned Brazilian bonds – interest

Capital / Financial Account
balance of capital ownership
Includes the purchase of both real/ financial assets .
Direct investment in the U.S is a credit to the capital account.
Direct investment by U.S firms / individual in a foreign.
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

Current account and the capital account should zero each other out.
If the current account has a negative balance (deficit)

Official Reserves
foreign currency holdings of the U.S Fed systems .
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.

Active vs. Passive Official Reserves
U.S. Is passive in the use of official reserves. Does not seek to manipulate exchange dollar.

UNIT 5: Supply side economics and the Laffer curve

  Supply side Economics Reaganomics

    

Makes changes in AS but not AD and it determines the level of inflation, unemployment  and economic growth

-          Lower marginal tax rate induce more work this AS increases. It also makes leisure more expensive and work more attractive.

-           Supply side economist support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transferred payment such as unemployment compensation and welfare programs provide disincentives to work, invest, innovate and undertake entrepreneur inventions

           Incentive to save and invest

        1.      High marginal tax rate can reduce the rewards for savings and investments.
        2.      Consumption might increase,but investment depend upon savings.
        3.      Lower marginal tax rates encourage saving and investment.

L    Laffer Curve

       It depicts a theoretical relationship between tax rate and government revenue. As tax rate increase from zero, government revenues increase from zero to some maximum level and then decline.

Criticisms of the Laffer curve.

        1.     research suggests 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, which causes demand to exceed supply.
        3.      Where the economy is actually located on the curve is difficult to determine