Unit 7

Unit 7

Balance of payments

• Measure of $ inflows and outflows between the US and the rest of the world (Row)

     *inflows are referred to as CREDITS
     *outflows are referred to as DEBITS

• The balance of payments is % into 3 accounts

     *current account
     *capital/financial account
     *official reserves account

Current Account

• Balance of trade and net exports

     *exports of goods /services -import of goods and services
     *exports create a credit to 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)

    
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
• Direct investment by US firms/individuals in a foreign country are debits to the capital accounts
• 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

Official Reserves

• The foreign currency holdings of the US 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 
• The official reserves 0 out the balance of payments

Active VS passive official reserves:

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

Formula!!
Balance of trade:
     Goods exports + Good 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

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

Changes in exchange rates

• Exchange rates (e) are a function of the supply and demand for currency.

1.      An increase in the S of a currency will decrease the exchange rate of a currency
2.      A decrease in S of a currency will increase the exchange rate of a currency
3.      An increase in D for a currency will increase the exchange rate of a currency
4.      A decrease in D for 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 increases
• Depreciation of a currency occurs when the exchange rate of that currency decreases

Exchange rate determinants


1. Consumer's taste
2. Relative income
3. Relative price level
4. Speculation

Exports and imports

• The exchange rate is a determinant of both exports and imports
• Appreciation of the $ causes American goods to be relatively more expensive and foreign goods to be relatively cheaper thus reducing exports and increasing imports

Fixed rates

• Based on a country's willingness to distribute currency and to control the amounts
• The US uses a fixed rate the $1 stays $1

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 of a good/service than another country 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

Specialization and trade

• Gains from trade are based on comparative advantage, not absolute advantage-Examples output:

• tons per acre
• miles per gallon
• words per minute
• apples per tree
• television produced per hour

     Examples input:
-# of hours to do a job
-# of acres to feed a horse
-# of gallons of paint to paint a house

Unit 5

Chapter 16. Extending the Analysis of Aggregate Supply

Short Run:

In macroeconomics, this is the period in which wage (and other inout prices) remain fixed as price level increase or decrease.

Long Run:

-period of time in which wages have become fully responsive to change in price level.

Effects in Short Run:

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

- In LR, wages will adjust to the price level and previous output level will adjust accordingly

Equilibrium in the Extended Model

Long aggregate supply curve is represented without vertical lone at full employment level of real GDP.

Demand Pull Inflation in the AS Model

• Demand-Pull: prices increase based on increase in AD
• SR, Demand pull will drive up prices and increase production
• Long run increases in aggregate demand will return to previous levels

Cost Push and 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 Government

• An effort to flight cost-push, the government can react in two different ways.
• Action such as spending by the government could begin an inflationary spinal
• No action however could lead to recession by keeping production and employment levels declining


The Phillips Curve

Long Run Phillips Curve

note: natural rate of unemployment is held constant

• Because the LRPC exists at the natural rate of unemployment (Un), structural changes in the economy that effect Un will also cause the LRPC to shift

•  Increase in Un will shift LRPC to the right
• Decrease in Un will shift LRPC to the left
• There is no trade-off between inflation and unemployment in the long run
• It occurs at the natural rate of unemployment
• It is represented by a vertical line
• LRPC will shift if the LRAS curve shifts

Short Run Phillips Curve

    

• There is a trade-off between inflation and unemployment
• When one goes up the other goes down. (inverse)

Supply Shocks 

• A rapid and significant increase in resourse cost which causes SRAS curve to shift
• SRAS most likely to shift left and SRPC to shift right

Misery Index

• The combination of inflation and unemployment in any given year
• Single digit misery is good