UNIT 7: Absolute And Comparative Advantage

UNIT 7: Absolute And 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 (or can produce a good using the least amount of resources).

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

                                     Comparative Advantage

A person or a nation has a comparative advantage when it can produce the product at a lower domestic opportunity cost than can a trading partner.

                            Examples of output problems

1.      Words per minute.

2.      Miles per gallons.

3.      Tons per acre

4.      Apples per tree

5.      Televisions produced per hour

                                        Examples of input problems

1.      Number of hours to do a job.

2.      Number of acres to feed a horse

3.      Number of gallons of paint to paint a house.

                                      Specialization and trade

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

UNIT 7: Foreign Exchange, Flexible And Fixed Rates.

UNIT 7: Foreign Exchange, Flexible And Fixed Rates.

                                      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 (supply) 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 markets. 

                                             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. 

- A decrease in supply of a currency will increase the exchange rate of a currency.

- An increase in demand for a currency will increase the exchange rate of a currency.

 - A decrease in demand 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 (e decreases)

Note: the more you supply, value depreciate. The more you demand value appreciates.

Exchange rates determinants

1.      Consumer tastes (buyers 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 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.

As two currencies trade:

1.      One supply line will change; the other demand line will change.

2.      They will move in the same direction.

3.      One currency will appreciate, the other will depreciate.

Note: when supply decreases then dollar appreciates. When supply increases them value of dollar depreciates.

                                               Flexible rate

Based on the supply and demand of that currency versus the other currency. It is very sensitive to the business cycle and it provides options for investment.

                                            Fixed rates

It is based on a countries willingness to distribute currency and to control the amount.

UNIT 7: Balance Of Payments

UNIT 7: Balance Of Payments

                                         Balance of payments

·         Measures 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 payment is divided into three accounts:

1.      Current account

2.      Capital/financial account

3.      Official reserves account

                               Double entry book keeping

Every transaction in the balance of payments is recorded twice in accordance.

                                               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 the U.S. owned foreign assets

·         Net transfers (tend to be Unilateral).

-          Foreign aid- a debit to the current account.

-          Example- Mexican migrant worker sends money to family.

                                            Capital / Financial Account

·         The balance of capital ownership.

·         Includes the purchase of both real and financial assets

·         Direct investment in the United States is a credit to the capital account.

-          For example the Toyota company in San Antonio.

·         Direct investment by United States firms/individuals in a foreign country are debits to the capital account.

·         Purchase of foreign financial assets represents a Debit to the capital account. For example Warren buffets buys stock.

·         Purchase of domestic financial assets by foreigners represents a credit to the capital account.

                                          Relationship between current and capital account

·         Remember double entry bookkeeping?

·         The current account and the 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 U.S. fed.

·         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.

Active v. passive official reserves

-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 buys and sells dollars in order to maintain a steady exchange rate w/ the United States.

                         Formulas

1.      Balance of trade

-          Good exports + goods imports

2.      Balance on goods : services :

-          Goods exports + service exports + goods imports + service imports.

3.      Current Account:

-          Balance on goods and services + net investment + net transfers

4.      Capital account:

-          Foreign purchases + domestic purchases. 

UNIT 6: Economic growth, physical and human capital.

UNIT 6: Economic growth, physical and human capital.

                             Economic Growth & Productivity

                     Economic Growth Defined

·         Sustained increase in Real GDP over time.

·         Sustained increase in Real GDP per Capita over time.

The question now is; why grow?

1.      Growth leads to greater prosperity for society.

2.      Lessens the burden of scarcity.

3.      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

Growth illustrated

Growth illustrated on a long run aggregate supply graph

                              Hindrances to Growth

Ø  Economic and Political Instability

Ø  High inflationary expectations

Ø  Absence of the rule of law

Ø  Diminished Private Property Rights

Ø  Negative Incentives

Ø  The welfare state

Ø  Lack of Savings

Ø  Excess current consumption

Ø  Failure to maintain existing capital

Ø  Crowding Out of Investment

Ø  Government deficits & debt increasing long term interest rates!

Ø  Increased income inequality à Populist policies

Ø  Restrictions on Free International Trade

UNIT 5: Supply side economics and the Laffer CURVE

UNIT 5: Supply side economics and the Laffer CURVE

                                         Supply side Economics

                                               Reagonomics

            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.

                                                             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.

UNIT 5: Philips Curve

UNIT 5: Philips Curve

                                          Philips curve

                                                   The long-run Philips curve (LRPC)

-          Because the long-run Philips curve exists of the natural rate of unemployment (Un), structural changes in  the economy that affect Un will also cause the LRPC to shift.

-          Increase in Un will shift LRPC o the right.

-          Decrease in Un will shift LRPC to the left.

                                                 Short run Philips curve (SRPC)

1.      There is a tradeoff between inflation and unemployment. As one increase the other decrease and vice versa.

                                             Long run Philips cure (LRPC)

1.      There is no tradeoff between inflation and unemployment.

2.      LRPC is represented by a vertical line.

3.      The LRPC occurs at the natural rate of unemployment.

4.      The LRPC only shifts if the LRAS shifts

NRU = frictional + structural + seasonal unemployment.

                                                       What changes LRPC

            The major LRPC assumption is that more worker benefits create higher natural rate of unemployment and fewer worker benefit creates lower natural rate.

                                                                      The misery index

                It is a combination of inflation and unemployment in a given year.

-          Single digit misery is good.

Inflation:

It is the general rise in the price level

Deflation:

A general decline in the price level

Disinflation:

Decrease in the rate of inflation over time

Stagflation:

Unemployment and inflation increasing at the same time.

UNIT 5: Extending the analysis of Aggregate Supply.

UNIT 5: Extending the analysis of Aggregate Supply.

                        Extending the analysis of Aggregate Supply

                                                                 SRAS

In macroeconomics this is the period in which wages and other input prices remain fixed as price level increases or decreases. Remember how crucial worker salaries to a businesses  output to bottom line when considering effects of aggregate supply.

                                                                 LRAS
Period of time in which wages have become fully responsive to changes in price level. Remember how crucial worker salaries to a businesses output to bottom line when considering effects on AS.

                                             Effects over Short run

·         In the short run price level changes allow for companies to exceed normal Outputs and hire more workers because profits are increasing while wages remain constant.

·         in the long run wages will adjust to the price level and previous output levels will adjust accordingly.
                         Equilibrium in the extended model

·         The extended model means the inclusion of both the short run and AS curves.

·         The long AS curve is represented with a vertical line at full employment level of real GDP.

   Demand pull inflation in the AS model

-          Demand pull: prices increase based on increase in Aggregate demand.

-          In the short run, demand pull will drive up prices and increase production.

-          In the long run, increase in aggregate demand will eventually return to previous levels.

                                         Cost push and extended models

-          Cost-push arises from factors that will increase per unit costs such as increase in the price of a key resource.

                                    Dilemma for the government

-          In an effort to fight cost-push, the government can react in two different ways:

-          Action such as spending by the government could begin an inflationary spiral.

-          No action however could lead to recession. By keeping production and employment levels declining.