BOP chart

Purchasing Parity:

When the currency rate is set by international market, changes will be based on the actual power of the currency

- For example: If the U.S. Dollar, to the European euro is a dollar fifty to one, then each one dollar and fifty cents will buy one euro. However, if an item in the US costs a dollar fifty, and then cost more or less than one 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 country's 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, which come from

Absolute Advantage v. Comparative Advantage

Absolute Advantage

- 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

- Faster, more efficient

Comparative Advantage

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

- Lower opportunity cost

Input Problems v. Output Problems

Input Problem: Any time you need to distinguish the difference, the country or individual that uses the least amount of resources, land or time, has the absolute Advantage. Least amount of resource, land or time

Output Problem: the country or individual who can produce the most had the absolute advantage. The country or individual with the lowest opportunity cost has the comparative advantage in that product. Always keep in mind this always deals with production.

Foreign Exchange 

• The buying and selling of currency

- Example: in Oder 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

- Ex: The current exchange rate is approximately 77 Japanese Yen to 1 US dollar

• Simply put the exchange rate is the price of a currency

• do not try to calculate the exact exchange rate

• Always change the Demand (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 on the other graph

• If D moved to the left, S will move to the left on the other graph

Changes in exchange rate

• 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 but one unit of that currency

Appreciation

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

- Hypothetical: 100 Yen used to buy $1, now two hundred Yen buy $1

Depreciation

• Occurs when the exchange rate of that currency decrease (e down)

- 50 yen now buys one dollar

Example:

If more German tourist visit America, then the demand of the U.S. Dollar will increase, cause the US dollar to appreciate, the supply of the Euro will increase, causing it to depreciate

Exchange rate Determinants

• Consumer Tastes

• Relative Income

- Imports tend to be normal goods

• Relative Price Level

• Speculation

Official Reserves

- The Foreign Currency holdings of the United States Federal Reserve’s 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 zeros out the balance of payment

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

- The People Republic of China is active in its use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate with the United States

Balance of Trade:

• most correct way:Take your Goods and Services exports minus your goods and services imports (Ge - Gi)

•  trade deficit or trade surplus

• Imports > Exports = Trade deficit

• Exports < Imports = Trade Surplus

• Second way to Calculate: Goods exports plus goods inputs (Ge + Gi)

Current Account:

Take your balance of trade plus your net investment plus your net transfer (BoT + NI + NT)

Capital Account:

Take your foreign purchases of US assets plus US purchase of assets abroad (FUS + USAB)

Official Reserves:

Current Account plus Capital Account (CA + CAP)

How to calculate goods and services:

Goods Imports + Service Imports

Unit 7

Balance of Payments:

Current Account

·         Balance on Goods and Services

·         Net Exports

·         Balance of Trades

·         Net Investments

·         Net Foreign Income

·         Net Transfers

Current Account Credits: (Assets, Demand for the $, “Inflows”) and Debits (Liabilities, Supply of the $, “Outflows”)

    Credits

  Exports

 Tourism here

  Interest/dividends payments

  Foreigners paid to the US use of exported capital

  Aid to the US

  Transfers back to the US

  Our Royalties

      Debits

  Imports

 Tourism there

 Interest/Dividend payments the US made for use of foreign capital invested in the US

 Aid to them

  Remittances from the US

  Their Royalties

Financial Accounts/“Capital Accounts”

       Credits

   Capital inflows

   Direct investments in US by foreigners

   Purchase of stocks and bonds by foreigners

       Debits

  Capital Outflows
  Direct invest by the US over there

 Purchases of stocks and bonds by the US

Official Reserves of Official Settlements or Special Drawing Rights

     Credits/Debits

   Currencies

   IMF holdings

   Gold

               

Reaganomics

Supply side economics (Reaganomics):  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. Named after Reagan because he lowered the marginal tax rate to get the US out of a recession which led to a deficit.

Supply side economists focus on the marginal tax rate. 
They support policies that promote GDP growth by arguing that the high marginal tax rate along with the current system of transfer payments provide disincentives to work, invest, innovate, and undertake entrepreneurial ventures.

Marginal tax rate: 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

Laffer Curve: It is a tradeoff between tax rates and government revenue. It is used to support the supply side argument. When people save money, money "flees" which means it's not in circulation.

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 increased 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

The Long Run Philips Curve (LRPC)

• Because the LRPC exists at the Natural Rate of Unemployment (Un), structural changes in the economy that affect Un will also cause the LRPC to shift with increases to the right and decreases to the left

Short Run Philips Curve

• Increases in AD = Up/Left movement along SPRC

• SRAS right = SRPC left which signals changes in taxes, subsidies, etc...

Stagflation: A period with high inflation and high unemployment at the same time

• Examples: After Vietnam, Oil Embargo of 1973/1979, Baby Boomers, Women's Movement could go into recession

Disinflation: A reduction in the inflation rate from year to year, nominal wages increases

Deflation: A situation in which there is an actual drop in the price level, opposite to Inflation

Short Run Aggregate Supply (SRAS): 

Time to short for wages to adjust to the price level. 
Workers may not be aware of changes in their real wages due to inflation and have adjusted their labor supply decisions and wage demands accordingly. 

- Nominal Wages: The amount of money received per day, per hour, or per year

- Real Wage: Wages adjusted for inflation

- Sticky Wages: Nominal wage level is set according to an initial price level and it does not vary (Examples: Stamps)

The Keynesian or Horizontal Range has a fixed price level, fixed wage level and flexible employment which implies that output depends on change in employment.

The Intermediate Range has a flexible price level, fixed wage level, and flexible employment which implies that output depends upon changes in price level and employment

The Classical or Vertical Range has a flexible price level, fixed wage level and fixed employment which implies that output depends upon changes in price level.

*fixed because of sticky wages

Demand Pull inflation is inflation due to an increase in price level via demand

Cost push Inflation is inflation due to a rise in the cost of production

 Long Run Aggregate Supply (LRAS): 

Time long enough for wages to adjust to the price level.

- In the Long Run, you have a flexible wage and price level

- They both offset each other

- LRAS shifts due to PPF shifts

Demand Pull Inflation: You're pulling something to you, AD moves to the right. Ever you'll equal growth

Cost-Push: You're pushing away, decrease to the left