Unit 7 Part 2

Unit 7 Notes Continued....

Foreign Exchange (FOREX):

• The buying and selling of currency.
• Any transition that occurs in the Balance of Payments necessitates foreign exchange.
• The exchange rate (e) is determined in the foreign currency market. 

Changes in Exchange Rates:

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

• ⬆Supply of a currency à ⬇in exchange rate of a currency 
• ⬇Supply of a currency à ⬆in exchange rate of a currency
• ⬆Demand for a currency à ⬆in exchange rate of a currency
• ⬇Demand for a currency à ⬇in exchange rate of a currency 

Appreciation & Depreciation: 

• Appreciation: When the exchange rate of that currency ⬆ (e⬆) 
• Depreciation: When the exchange rate of that currency ⬇ (e⬇) 

Exchange Rate Determinants:

• Consumer Tastes
• Relative Income
• Relative Price Level
• Speculation 

Exports and Imports: 

• Appreciation: U.S. goods à more expensive
• Foreign goods à cheaper = Reduces exports and increasing imports

• Depreciation: U.S. goods à cheaper
• Foreign goods à more expensive = Increasing exports and reducing imports

Flexible Rates:

• It’s very sensitive to the business cycle and it provides options for investments 

Fixed Rates: 

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

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.

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. # of hrs to do a job
2. # of acres to feed a horse
3. # of gallons of paint to paint a house

Specialization and Trade:

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

Help Links:

Comparative and Absolute Advantage

Comparative and Absolute Advantage

Unit 7 Part 1

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:

o    Current Account

o    Capital/Financial Account

o    Official/Reserves Account

Current Account: 

·         Balance of Trade or Net Exports

o    Exports of Goods/Services

o    Exports create a credit to the balance
      of payments

·         Net Foreign Income 

o    Income earned by U.S. owned foreign assets - income paid to foreign held U.S assets

·         Net Transfers 

·         Foreign Aid:

o    a debit to the current account 

o    Ex: Mexican migrant worker sends money to Mexico

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
• Ex: The Toyota Factory in San Antonio

• Direct investment by U.S. firms/individuals in a foreign country are debits to the capital account
• Ex: The Intel Factory in San Jose, Costa Rica.

• Purchase of foreign financial assets represents a debit to the capital account
• Ex: Warren Buffet buys stock in Petrochina 

• Purchase of domestic financial assets by foreigners represents a credit to the capital account
• Ex: The UAE sovereign wealth fund purchases a large stake in the NASDAQ

Relationship between Current Account & Capital Account:

• 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. Federal Reserve system
• Balance of payments surplus ---> Fed accumulates foreign currency and debits the balance of payments
• Balance of payments deficit ---> Fed depletes its reserves of foreign currency and credits the balance of payments
• Official reserves zero out balance of payments

Active v. Passive Official Reserves:

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

Formulas:

Balance of Trade

• Goods Exports + Goods Imports 

Balance of Goods & Services 

• Goods Exports + Service Exports + Goods Imports + Service Imports

Current Account: 

• Balance of goods & services + Net Investments + Net Transfers 

Capital Account:

• Foreign Purchases + Domestic Purchases

Helpful Links for Further Understanding:

Balance of Payments

Balance of Payments

Unit 6

Economic Growth & Productivity

Economic Growth Defined

§  Sustained increase in Real GDP over time

§  Sustained increase in Real GDP per capita over time

Why grow?

§  Growth leads to greater prosperity for society

§  Lessens the burden of scarcity

§  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

o   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

Hindrances to Growth

• Economic and Political Instability
• High inflationary expectations
• Absence of the rule of law
• Diminished Private Property Rights
• Negative Incentives
• The welfare state
• Lack of Savings
• Excess current consumption
• Failure to maintain existing capital
• Crowding Out of Investment
• Government deficits & debt increasing long term interest rates!
• Increased income inequality à Populist policies
• Restrictions on Free International Trade

Unit 5 Part 2

4/11/16

Ex. Assume that the US economy is in long-run equilibrium with an expected inflation rate of 6% and unemployment rate of 5% Then nominal interest rate is 8%

(a.) Using correctly labeled graph with both the short-run and long-run Phillip curves and the relevant numbers from above. Show current long-run equilibrium as Point A.

(b.) Calculate the real interest rate in the long-run equilibrium.

i%=n%-π%

    =8%-6%=2%

(c.) Assume now that the Federal Reserve decides to target an inflation rate of 3% What open-market operation should the Federal Reserve undertake?

Lower discount rate, buy bonds and decrease RR ratio

Inflation- general rise in the price level

Deflation- general decline in the price level

Disinflation- decrease in the rate of inflation over time

Stagflation- unemployment and inflation increasing at the same time

Supply-Side Economics AKA Reaganomics

-          Changes AS and not AD

-          Determines the level of inflation, unemployment rates & economic growths

Supply-Side Economists:

-          support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payments such as unemployment compensation or welfare programs provide disincentives to work, save, innovate and undertake entrepreneurial ventures

Lower Marginal Tax Rates:

-          induce more work thus causing AS to increase

-          also make leisure more expensive and work more attractive

Incentive to Save & Invest:

1.      High Marginal Tax Rates: reduce the rewards for saving and investing

2.      Consumption might be increasing but investing depends on saving

3.      Lower marginal tax rates encourage saving and investing

Laffer Curve

-          There is a theoretical relationship between tax rates and government spending revenue

-          As tax rates increase from zero, government revenues increase from zero to some maximum level and then decline

Criticisms

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

2.      Tax cuts also increase demand, which fuels inflation and demand may exceed supply

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

Unit 5 Part 1

4/7/16

Extending the Analysis of Aggregate Supply

Short-Run Aggregate Supply:

·         Period in which wages (and other input prices) remain fixed as price level increases or decreases

*wages are constant; prices fluctuate*

Long-Run Aggregate Supply:

·         period of time in which wages have become fully responsible to changes in price level

*vertical line at full employment*

Effects over SR

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

·         In long-run, wages will adjust to price level and precious output levels will adjust accordingly

Equilibrium in the Extended Model

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

Demand Pull Inflation in 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, increases in aggregate demand will eventually return to previous levels

Cost Push & the 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 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 as inflationary spiral

►   No action however could lead to recession by keeping production and employment levels declining

                                                                                                                                                               4/8/16

The Phillips Curve

Long-Run Phillips Curve

Note: Natural rate of unemployment is held constant

v  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

v  Increases in Un will shift LRPC à

v  Decrease in Un will shift LRPC ß

Short-Run Phillips Curve

►   There is a tradeoff between inflation and unemployment

Inflation ▲ Unemployment ▼

Inflation ▼ Unemployment ▲

Long Run Phillips Curve

►   There is NO tradeoff between inflation and unemployment

►   It is represented by a vertical line

►   It occurs at the natural rate of unemployment

►   LRPC will only shift if LRAS shifts

NRU= Frictional + Structural + Seasonal Unemployment

Standard Unemployment Rate à 4% to 5%

Major LRPC assumption: is that more worker benefits create higher rates and fewer worker benefits create lower rates

Supply Shocks: caused by rapid, and significant increases in resource cost, which causes the SRAS curve to shift

Misery Index: combination of unemployment and inflation in a given year; single digit misery is good

Unit 4 Notes Part 3

Types and Functions of Money


There are 3 different types of money: 

Commodity Money is a good that has other purposes that also functions as money - an example would be tribes in Africa using cows as money. 

Representative money is whatever you are using as currency represents a specific quantity of a precious metal (gold, silver) - the drawback is when the value of the metal changes, it affects the value of your national currency. 

Fiat Money is not backed by a precious metal - it is money that must be accepted for transactions and is backed by the word of the government that it has value.
Functions of money include the Medium of Exchange, the Store of Value (put money away in hopes to retain its value), and the Unit of Account (Price implies Worth (quality).


Money Market Graphs


When the price is high, the quantity demanded is low and when the price is low, the quantity demanded is high.

When the interest rate is low, people have an incentive to borrow more for transactions, to hold assets, transaction demand, asset demand.

The supply of money does not vary based on the interest rate - demand for money is tied to the interest rate, supply of money is not. The supply of money is fixed, it is set by the Fed - it doesn't move unless the Fed does something to move it.

The Fed's Tools of Monetary Policy

Reserve Requirement is the percentage of the bank's total deposits that they must hang on to, either as vault cash or on reserve w/ a Fed branch. Discount Rate is the rate at which banks can borrow money from the Fed.

For Expansionary Policies (easy $), the RR decreases; the DR decreases (for banks to borrow more money); and if the Fed wants to expand money supply, it buys bonds.

For Contractionary Policies (tight $), the RR increases; the DR increases (to discourage banks form borrowing money); and if the Fed wants to contract or reduce the money available, it sells bonds.

The Loanable Funds Mar

Loanable Funds is money that is available in the banking system for people to borrow.
When the interest rate is lower, people demand more money and when the interest rate is higher, people have a disincentive to borrow.

 Supply of Loanable Funds comes from the amount of money that people have in banks, it is dependent on savings. The more money people save, the more money banks have available to make loan.

 If people have an incentive to save more, then you increase the supply of loanable funds. If people have incentives to save less, you decrease the supply of loanable funds.

Money Creation & Multiple Deposit Expansion

Banks create money by making loans. One of the FED's tools for monetary policy is the ability to control the Reserve Requirement (RR).
Money Multiplier = 1/RR        RR = 20%      Loan amount = $500
What is the total money created? 1/0.2 = 5 × 500 = $2,500. We got $2,500 by using the process of Multiple Deposit Expansion.


Relating the money Mkt., Loanable Funds Mrk., and AD - AS


In the money market, the governemnt is borrowing money from Americans.
A change in the money market will carry through the loanable funds graph, and the aggregate demand and supply graph.
In this case of a government deficit, the increase in demand, results in an increase in the interest in the money market applies to the loanable funds graph. The aggregate demand is an increase, causing a rise in the price level and GDP.
 According to the equation of exchange, MV = PQ, a change in the supply of money causes a change in price, shown as an increase in interest rates will increase the price level.
All three graphs are related by the Fisher Effect, a 1:1 direct ratio.