Unit 7 - International Trade

Unit 7 - International Trade

This unit solely focuses on the various aspects of international trade, (e.g. trade among countries worldwide, foreign exchange rates, credit and current accounts, and a lot more.)

Balance of payments

• The measure of money inflows and outflows between the US and the rest of the world.

        - Inflows are referred to as "credits".

        - Outflows are referred to as "debits".

• There are three categories:

        1. Current account - (exports of goods and services) - (imports of goods and services)

     

             - Exports create a "credit" to a balance of payments.

             - Imports create a "debit" to a balance of payments.

        2. 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. 

             - Ex: Toyota factory in San Antonio.

        3. Official reserves account - the foreign currency holdings of the U.S. Federal Reserve.

             - When there is a balance of payments "surplus", 

                the Fed accumulates foreign currency and debts.

             - When there is a balance of payments "deficit",

                the Fed depletes its reserves of foreign currency.

             - The official reserves zero out the balance of payments.

•  The relationship between current and capital/financial account:

        1. They should zero each other.

        2. Current account has a negative balance (deficit).

        3. Capital account has a positive balance (surplus).

Double entry bookkeeping

• Every transaction in the balance of payments is recorded twice in accordance with standard accounting practice.

            - U.S. manufacturer, John Peere, exports $50M worth of farm equipment to Ireland.

                - Credit of $50M to the current account.

                - Debit of $50M to the capital/financial account, (+$50M financial assets).

Balance of Payments (example)

Calculating Balance of Payments

• Balance on trade

            -> (merchandise + service exports) - (merchandise + service imports) 

            - trade deficit occurs when the balance on trade is negative (imports > exports)

            - trade surplus occurs when the balance of trade is positive (exports > imports)

• Balance on current account

           -> (balance on trade) + (net Investments Income) + (transfer payments)

• Official Reserves

           -> (△ in CA) + (△i n FA) + (△in official reserves) = Ø.

Foreign Exchange (ForEx)

• The buying and selling of money.

         - Ex: In order 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 approx. 77 Japanese Yen to 1 US Dollar.

    

         - Simply put: the exchange rate is the price of a currency.

Changes in Foreign Exchange Rates

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

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

      

         - Decrease in supply will increase exchange rate.

         - Increase in demand, increase in exchange rate.

         - Decrease in demand, decrease in exchange rate.

Exchange Rate Determinants / Appreciate & Depreciation

      - Buyers' taste.

      - Relative income.

           - Ex: Mexico is strong and the U.S. economy is in a recession. Mexicans will buy

             more American goods, there is an increase in demand in dollar, causing the dollar

             to appreciate, and the Mexican Peso to depreciate.

      - Relative Price Level:

           - Ex: If the price level is higher in Canada than in the U.S., American goods 

             are relatively cheaper than Canadian goods, thus Canadians will imports more

             American goods causing the U.S. Dollar to appreciate, and the Canadian Dollar

             to depreciate.

      - Appreciation: currency increase in value.

      - Depreciation: exchange rate decreases.

Absolute and Comparative Advantage / Specialization and Trade

Unit 5 and 6 (revised)

Unit 5 and 6

Long Run and Short Run Curves

• AS curve doesn’t shift in response to changes in the AD curve in the short run.
• Nominal wages do not respond to price-level changes
• Workers may not realize impact of the changes or may be under contract.
• Long Run – period in which nominal wages are fully responsive to previous changes in price level
• When changes occur in the short run they result in either increased or decreased producer profits – not changes in wages paid.
• Nominal wages – money getting paid, Real wages – actual value of money, actual gross pay

1. In the long run, increases in AD result in a higher price level, as in the short run, but as workers demand more money the AS curve shifts left to equate production at the original output level, but now at a higher price.
2. In the long run, the AS curve is vertical at the natural rate of unemployment (NRU), or full employment (FE) level of output. Everyone who wants a job has one & no one is enticed (tempt) into or out of the market.
3. Demand-pull inflation will result when an increase in demand shifts the AD curve to the right, temporarily increasing output while raising prices.
4. Cost-push inflation results when an increase in input costs that shifts the AS curve to the left. In this case, the price level increase is not in response to the increase in AD, but instead the cause of price level increasing.

Philips Curve

The Philips Curve

• represents the relationship between unemployment and inflation
• The trade-off between the inflation and the unemployment occurs in the short run
• Each point on the Philips curve corresponds to a different level of output

Long Run Philips Curve

• It occurs at the Natural Rate of Unemployment (NRU)
• It is represented by a vertical line
• There is no trade-off between unemployment and inflation in the long run
• The economy produces at the full-employment output level
• The nominal wages of workers fully incorporate any changes in price level as wages adjust to inflation over the long run.

Determinants of the Philips Curve

Increase in AD = Up/left movement along SRPC
Determinants (increase): AD to the right, GDPR up & PL down: u% down & π% up: up/left along the curve

Decrease in AD = Down/right movement along SRPC
Determinants (decrease): AD to the left, GDPR up & PL down: u% up & π% down: down/right along the curve

SRAS down = SRPC to the left
Determinants (Inflationary Expectations, Input Prices, Productivity, Business Taxes, and/or Deregulation) (decrease): SRAS to the right, GDPR up & PL up: u% down & π% down: SRPC to the left

Supply shock - a rapid and significant increase in resource cost which causes the SRAS curve to shift
Natural Rate of Unemployment (NRU) = frictional + structural + seasonal

• The natural rate at fewer worker benefits creates a lower NRU

Misery Index – the combination of inflation and unemployment in any given year

• Single digit misery is good

If the inflation rate persists and the expected rate of inflation rises, then the entire SRPC moves upward. If inflation expectations drop (new technology, efficiencies), then the SRPC moves downward. Stagflation occurs when you have high unemployment and high inflation at the same time.
Disinflation – when inflation decreases over time:

1. Nominal
2. Business profits fall
3. Firms reduce employment, thus unemployment increases

Laffer Curve – trade-off between tax rates and government revenue; As tax rates increase from 0, tax revenues increase from 0 to some maximum level and then decline.

The higher the tax rate you set, the less money you will collect. Laffer Curve is controversial and debatable.

Criticisms on the Laffer Curve

1.      Where the economy is located on the curve is difficult to determine.
2.      Tax cuts also increase demand which can fuel inflation
3.      Empirical evidence suggests that the impact of tax rates on incentives to work, save, and invest are small

Supply-side economics or Reaganomics

They support policies that support GDP growth by arguing that high marginal tax rates along with the current system of transfer payments (unemployment compensation and social security) provide disincentives to work, invest, innovative, and undertake entrepreneurial ventures. They believe that the AS curve will determine levels of inflation, unemployment, and economic growth.

Trickle-down effect: Rich → Poor
Marginal Tax-Rate: The amount paid on the last dollar earned or on each additional dollar earned.

Supply-side economists believe that if you reduce the marginal tax rate then more people will be able to work longer thus forgoing leisure time.


Edit: Added Trickle-down effect and marginal tax-rate.

Unit IV: Monetary Policy

Unit IV: Monetary Policy

This unit was all about money, how it flows through our economy, how the Federal Reserve can manipulate the money supply, as well as policies, and how banks and banking systems work. I think it is best to start with breaking down what "money" really is.

I. Uses of money:

    a. Medium of exchange - as we all know, money is well known for exchanging goods and services, (remember that from the beginning of the year?).

    b. Unit of account - since money is very important to the economy, or let's better say, most important for the economy, it establishes economic growth.

    c. Store of value - in present time, money holds a certain value, or "stores" a certain value over a period of time.

Besides the uses of money, there are also types of money...

II. Types of money:

    a. Fiat money - this simply means it is money because the government says so.

    b. Commodity money - a commodity gets its value from the type of material it is made of.

    c. Representative money - this could be anything ranging from gold to paper, and even peanuts.

There are also some characteristics of money...

III. Characteristics of money

    a. Durability - money is durable.

    b. Portability - in the form of bills, coins, etc.

    c. Divisibility - divided into many bills, coins, etc. 

    d. Uniformity - no matter where you go in the US, money has some value.

    e. Scarcity - 2 dollar bill.

    f. Acceptability - money is accepted in foreign countries.

IV. Money supply

    a. M1 money - this consists of currency in circulation, plus checkable deposits, or "checks" and travel checks.

    b. M2 money - consists of M1 money, plus savings accounts, plus money market accounts, plus deposits, plus deposits held by banks outside of the US.

The United States has a fractional reserved banking system, which means that a certain reserve requirement exists, meaning that these banks have to keep a certain amount of money, and are able to lend out the rest. The required reserves can be calculated by taking the reserve ratio, let's say 10%, times the checkable deposits / demand deposits, let's say $1,000. In this case, the bank has to keep $100, and the excess reserves are $900. The reserve ratio can also be calculated by the total reserves, which are excess reserves plus required reserves, over the required reserves.

Most economists and business people in finance use a balance sheet so they won't lose track of all the math involved. There is something called assets and liabilities, wherein assets are all things that have value and you own, in this case the bank, and liabilities are the claims of the non-owners against the banking firm's assets. Let's apply this to our example above.

The supply of money (of one commercial bank!) can be calculated by finding the required reserves, and subtracting them from the initial deposit, which are in fact excess reserves. This is different for a banking system. In a banking system, we can find the money supply by using the monetary multiplier, which is 1/reserve ratio, in our case per say, 1/0.10, where the reserve ratio is 10%. If the initial deposit in Bank A was $1,000, then deposited in Bank B, we can find the money supply by multiplying the monetary multiplier by the $1,000, giving us $10,000 of money supply of the banking system.

The Federal Reserve Bank has 3 tools of money that can be used, such as increasing the reserve ratio, but also manipulating the discount rate, and open market operations.

Discount rate - this rate is the interest rate charged by the Fed for overnight loans to commercial banks. It doesn't change money supply directly.

Open market operations - the Fed can buy or sell bonds (securities), it is a very preferred tool of monetary policy, as we shall see in a more visual example.

Federal funds rate - this is the interest rate charged by one commercial bank for overnight loans to another commercial bank. The rate is negotiated.

Money Market

There is also expansionary and contractionary monetary policy, and this table shows how each affects the money supply, etc.

Loanable Funds Market

The loanable funds market is where savers and borrowers exchange funds at the real rate of interest.

I. The demand for loanable funds, or borrowing comes from households, firms, government, and the foreign sector.

II. The demand for loanable funds, or savings comes from households, firms, government, and the foreign sector. The supply of bearable funds is also the demand for bonds. 

III. Changes in the demand for loanable funds

    a. Demand for loanable funds = borrowing (i.e. supplying bonds)

    b. More borrowing = more demand for loanable funds (-->)

    c. Less borrowing = less demand for loanable funds (<--)

        ex) government deficits spending= more borrowing= more demand for loanable funds.

IV. Change in the supply of loanable funds

    a. Remember that supply of loanable funds = saving (i.e. demand for bonds)

    b. More saving = more supply of loanable funds (-->)

    c. Less saving = less supply of loanable funds (<--)

       ex) Government budget surplus = more saving= more supply of loanable funds.

Prime rate - the rate that banks charge to their most credit worthy customers. 

Unit III: Aggregate Demand

Unit III: Aggregate Demand

What is aggregate demand?

1. It shows the amount of real GDP that the private, public and foreign sector collectively desire to purchase at each possible price level.
2. The relationship between the price level and the level of real GDP is inverse.

There are 3 reasons why AD is downward sloping:

1. Real-Balances Effect - When the price level is high, households and firms can't afford to purchase as much output.
2. Interest Rate Effect - The higher price level increases the interest rate, and the lower price level decreases the interest rate.
3. Foreign Purchases Effect - The higher price level increases demand for cheaper imports.

So how does the Aggregate Demand and Supply model look like?

Full Employment equilibrium exists where AD intersects SRAS and LRAS at the same point.

A recessionary gap exists when equilibrium occurs below full employment, (LRAS).

An inflationary gap exists when equilibrium occurs beyond full employment, (LRAS).

The followers of the Keynesian view believe in a horizontal AS curve, because when the economy is below full employment, AD shifts outward. And what happens?

1. Increase in real GDP
2. Unemployment drops
3. Price level stays constant
4. Demand creates its own supply

So what are those ranges?

1. Classical Range - in the long run, the AS curve is vertical, because the only effects of an increase in AD is already when we are at full employment. Thus, you have an increase in price level, and supply creates its own law, (Say's Law).
2. Intermediate Range - AS is between classical and Keynesian range. When this occurs, AS shifts outward.
3. Keynesian Range -  The horizontal segment of the Keynesian aggregate supply curve that reflects rigid prices and wages. Shifts of the aggregate demand curve in this range lead to changes in the aggregate output, but not changes in price level. 

What determines the changes of AD or AS?

Investment Demand - this is the money spent or expenditures on:

1. New factories
2. Capital equipment
3. Technology
4. New homes
5. Inventories

Expected rates of return 

1. How does business make investment decisions? (Cost/benefit analysis)
2. How does business determine the benefits? (Expected rate of return)
3. How does business count the cost? (Interest costs)
4. How does business determine the amount of investment they undertake? (Compare expected rate of return to interest costs)

If the expected rate of return > interest costs, then invest.

If the expected rate of return < interest costs, then don't invest.

Real (r%) v. Nominal (i%)

So what's the difference?

1. Nominal is the observable rate of interest. 
2. Real subtracts out inflation (pi%) and is only ex post facto.

How do you know / compute real interest rate?

1. r% = i% - pi%

What then, determines the cost of an investment decision?

1. The real interest rate (r%).

Investment Demand Curve (ID)

1. What is the slope of the investment demand curve?

             - Downward sloping.

1. Why is it downward sloping? 

             - When interest rates are high, fewer investments are profitable; when interest rates are low, more    investments are profitable.

             - There are few investments that yield high rates of return, and many that yield low rates of return.

What shifts the investment demand curve?

1. Costs of production
2. Business taxes
3. Technological chance
4. Stock of capital
5. Expectations

Consumption and Savings

1. Disposable Income (DI) is the income after taxes or net income, (save or spend).
2. Consumption (C) consists of the amount of DI, and the propensity to save.
3. Do households consume if DI = 0? Autonomous consumption, dissaving.
4. Savings is the amount of DI, and the propensity to consume.
5. Do households save if DI = 0? No.
6. Some determinants: Wealth, expectations, household debt, taxes.

Average Propensity to Save (APS) and Average Propensity to Consume (APC)

APS + APC = 1.

1 - APC = APS.

1 - APS = APC.

If APC > 1, dissaving occurs. If APS is negative, dissaving occurs too.

Marginal Propensity to Consume (MPC) and Marginal Propensity to Save (MPS)

Change in Consumption / Change in Disposable Income

Change in Savings / Change in Disposable Income

The Spending Multiplier Effect - this is the initial change in spending, and causes a larger change in AS or AD.

Multiplier = Change in AD / Change in Spending

Why does it happen?

1. Expenditures and income flow continuously which sets off a spending increase in the economy.

Multiplier = 1 / MPS  or 1 / 1 - MPC (Spending Multiplier).

Calculating the Tax Multiplier - When the government taxes, the multiplier works in reverse. Why? Because money is leaving the circular flow.

The Tax Multiplier is negative:  -MPC / 1 - MPC    or  -MPC / MPS.

If there is a tax cut, then the multiplier is increasing, because there is now more money in the circular flow.

Fiscal Policy

What is fiscal policy? Fiscal policy is the changes in the expenditures or tax revenues of the government. There are 2 tools of fiscal policy:

1. Increase spending, decrease taxes
2. Decrease spending, increase taxes

Fiscal policy is enacted to promote our nation's economic goals: Full employment, price stability, economic growth.

Discretionary Fiscal Policy (action)

1. Expansionary fiscal policy - think deficit, recession
2. Contractionary fiscal policy - think surplus, inflation

Discretionary v. Automatic Fiscal Policies

Discretionary deals with increasing spending, decreasing taxes, and policy makers are responsible.

Automatic deals with social security, etc., and no policy makers are no included.

Contractionary Fiscal Policy

1. Policy designed to decrease spending, and increase taxes
2. Decreases AD, controlling inflation.

Expansionary Fiscal Policy

1. Increases AD
2. Strategy for increasing GDP, combatting a recession, reducing unemployment.

Progressive, Regressive / Proportional Tax System

1. Progressive: Average tax rate, (tax revenue / GDP), rises with GDP.
2. Proportional: Average tax rate remains constant as GDP changes.
3. Regressive: Average tax rate falls with GDP, the more progressive the tax system, the greater the economy is built-in stability.

Deficits, Surpluses and Debt

Balanced budget - revenues = expenditures.

Budget deficit = revenues < expenditures.

Budget surplus = revenues > expenditures.

Government debt = sum of all debt - sum of all surpluses.

Unemployment

What is unemployment? Who is considered to be unemployed?

Unemployment - basically this refers to the "failure" to use available resources.

What are the types of unemployment?

1. Frictional

    - these are people that are temporary, transitional, short-term, or in between jobs, or searching for jobs.

    - this also includes graduates (high school and college)

    - people that get fired or quit.

2. Cyclical

     - caused by recession face of business cycle.

3. Structural

     - this type of unemployment is caused by technology, long-term technological effects, such  as replacement of people with robots.

4. Seasonal

     - unemployment caused by lack of jobs due to difference in season, (example would be summer jobs, or jobs during the xmas time).

Who is unemployed?

     - Homeworkers, students, retirees, disabled people, discouraged workers, people that are in prison or mental institutions, the ones that have lost their job, been fired, quit their job, the ones that are layed off, entrance and reatrance.

Is there a formula for unemployment?

Unemployment = (#of unemployed) / (total labor force)

The total labor force = #of unemployed + #of employed.

Inflation - Unit 2

UNIT II (Inflation)

What is inflation? What are the types of inflation?

Inflation - this is the rise in general price level.

Deflation - the decline in general price level.

Disinflation - this occurs when inflation rate declines or is declining.

Hyperinflation - occurs when a country experiences very high, accelerating, and perceptibly "unstoppable" rates of inflation.

How do you solve inflation problems?

Rule of 70 - calculates how many years will it take for the inflation rate to double.

Formula: (70 / inflation rate). The inflation rate is a percentage.

Inflation rate = (current year price index - previous year's price index) / (previous year's price index).

Interest rate - real wages, what comes in. 

Real interest rate - cost of borrowing or lending money that is adjusted for inflation.

Nominal interest rate - unadjusted cost of borrowing or lending money.

Formula for interest rate: (Nominal interest rate - Inflation).

What are the causes of inflation? How many are there? 
There are two types of inflation:

1. Demand-pull: Caused by excess of demand over output that pulls prices upward.
         1. Increases in government purchases
         2. Excessive increases in money supply, which creates a situation of hyperinflation.

2. Cost-push (supply-side economics): Caused by a rise in per unit production costs due to increasing resource costs.
         1. Supply shocks - dramatic rise in energy or raw material prices.
         2. Price-wage spiral - workers seek higher wages to offset rising consumer prices.

If you're still confused about inflation, you can watch this video, which outlines every important aspect of it in a broad perspective.

Unit II: Economic systems, GDP..

Unit II

Types of economic systems:

1. Command
2. Traditional
3. Mixed
4. Free Market

1. Command
1. the government decides production (owns land, capital, controls labor); example: Cuba.

1. Traditional
   1. based on rituals, habits and customs. Most decisions are made by the elders, example: tribes.

1. Free Market
1. people and firms act in their own best interest. It allows buyers and sellers to exchange goods and services. Only free market: Hong Kong.

1. Mixed Economy
1. government regulating business to protect the public's interest. examples: US, Canada, Mexico.

Product market - buyer is usually consumer, and seller is a firm.

Factor market - factors of production. Most important: labor. The buyer is usually the firm, and the seller is the factor owner.

Gross Domestic Product - total value of all the final goods and services produced within the country's borders within a given year. It includes all production or income earned within the US by US and foreign producers. It excludes production outside of the US, even by Americans.

Gross National Product - it is the total value of all the final goods and services produced by Americans in a year. It includes production or income earned by Americans anywhere in the world. It excludes productions by non-Americans, even in the US.

Formula for GDP:

GDP = C + Ig + G + Xn, where:

             C = Personal consumption,

             Ig = Gross Private Domestic Investment (factory equipment, maintenance...)

             G = Government purchases of goods and services

             Xn = Net Exports (Exports - Imports)

Real GDP vs. Nominal GDP explainded:

Net national product (NNP) = GNP - Depreciation.

Net domestic product (NDP) = GDP - Depreciation.

National income - income earned by American owned resources, whether here or abroad.

Formula for national income: 

NNP - Indirect Business Taxes (IBT) or,

CE + RI + II + CP + PI, where:

CE = Compensation of employees,

RI = Rental income, 

II = Interest income, 

CP = Corporation profits, 

PI = Proprietors income, or

GDP - IBT - Depreciation - Net Foreign factor payments

Disposable personal income - after tax income available for household consumption (DPI).

Formula for disposable personal income:

NI - HT + GT, where

NI = National income,

HT = Household taxes,

GT = Government taxes