Absolute Advantage v Comparative Advantage

Absolute advantage v comparative advantage 

• absolute advantage 

     - individual - persists when a person can produce more of a certain good/service than combine 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 time period

• comparative advantage

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

      - input problem vs output problem 

                 . Input problem - what can be produce using the least amount of resources. Land or time

                          - chosen item/ forgone item

                . Output problem - deals with production 

                         - what they give up/ what's produced

• absolute advantage 

     - faster, more, more efficient 

• comparative advantage 

     - lower opportunity cost 

Dollar Appreciation & Purchasing Power Parity

Dollar appreciation 

• each dollar gets you more of the other currency 

• more of the foreign currency is needed to buy each dollar 

• U.S. exports get more expensive for foreigners 

• U.S. imports gets cheaper for us 

• exports decrease 

• import increase

• GDP decrease 

• demand for the U.S. Dollar will increase 

• supply of the U.S. Dollar will decrease

Dollar depreciation 

• each dollar gets you less of the other currency 

• exports increase

• imports decrease 

• gdp increase 

• U.S. exports gets cheaper for foreigners to buy

• U.S. imports gets more expensive for the U.S. 

• demand for the U.S. Dollar will decrease

• supply for the U.S. Dollar will increase

Supply of the U.S. Dollar comes from:

• U.S. citizens 

• banks

• industries wanting to make foreign purchases

• investment 

• assets 

• and by making transfer payments to foreigners 

Demand of the U.S. Dollars comes from:

• foreigners

• banks

• industries wanting to purchase our goods

• investments

• assets

• make transfer payments to us 

purchasing power Parity

•When the currency rates are set by national markets, currency will be changed by the purchasing power parity

• markets will adjust quickly with floating rates, our pressure for change will change in currency change 

Why do we have exchange currency?

1. Sell exports and buy imports 

2. Invest in another's country's stocks and bonds

3. Build factories or stores in other countries 

4. Speculate on currency values 

5. To hold currencies in bank account for future exports, imports, and business loans 

6. To control excess imbalances

        -the fed controls the imbalances via the balance of payments 

Foreign Exchange

Foreign exchange (FOREX)

• the buying and selling of currency 

• the exchange rate (e) is determined in the foreign currency market 

       - ex. The current exchange rate is approximately 77 Japanese yens to 1$

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

• do not try to calculate the exact exchange rate 

Tip

• always change the D line on one currency graph, the S line on the other currency's graph

• move the lines of the two currency graphs on the same direction (left or right) and you will have the correct answer

• if D on one graph, S in the other will also increase 

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

Changes in Exchange Rates

• exchange rate (e) are a function of the supply and demand for currency 

       - an increase in the supply of a currency will make it cheaper to bye one unit of that currency 

       - a decrease in supply of a currency will make it more expensive to but one unit of that currency 

       - an increase in demand for a currency will make it more expensive to buy one unit of that currency 

        - 

Appreciation 

• appreciation of a currency occurs when the exchange rate of that currency increases (e^)

       - hypothetical: 100 yens used to buy 1$

Depreciation

• depreciation of a currency occurs when the exchange rate of that currency decreases (e down)

Exchange rate determinants

• consumer tastes

       - the increase in demand of the ten leads to the appreciation of the yen 

        - the increase in the supply of dollars 

• relative income. 

       - imports tend to be normal goods

       - this increases the demand for the dollar, causing the dollar to appreciate and the peso to depreciate 

• relative price level

• speculation

The Balance of Payments

• measure of money inflows and outflows between the United States and the rest of the world (ROW)

     - inflow = credit

     - outflow = debit

• balance of payments is divided to 3 parts 

       - current account

       - capital/financial account 

       - official reserves account 

Double entry bookkeeping 

• every transaction in the balance of payments is recorded twice in accordance with standard account practice

      - Ex. U.S. Manufacturer, John Deere, exports $50 million worth of farm equipment to Ireland

             . A credit of $50 mil. To the current account 

             . A debit of $50 mil to the capital/financial account l

      - notice that the two transactions offset

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 debut to the balance of payments 

• net foreign income 

       - income earned by U.S. Owned foreign assets - income paid to foreign held US assets

      - ex. Interest payments on US owned Brazilian bonds - interest payments in German owned US treasury bonds

• net transfers ( lend to be unilateral)

      - foreign aid -> a debut to the current account 

Capital/financial account 

• the balance of capital ownership

• includes the purchase of both real and financial assets 

• direct investments 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 

• 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 

Relationship between current and capital account 

• remember double entry bookkeeping?

• the current account and 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 account (surplus)

Official reserves 

• the foreign currency holding of the United States federal reserve system

• when there is a balance of payments surplus. Des 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 balances of payments 

• the official reserves should zero out the balance of payments 

Active v passive official reserves 

• the United States is passive in its use of official reserves. It does not seek to manipulate the dollars 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 with the United States 

•Goods and service exports - goods and services imports

• unofficial way of trade: good exports + goods imports 

• informal: Goods imports + service imports 

• Current account = balance of trade + net investments + net transfers 

• capital account = foreign purchases of U.S. Assets + US purchases of assets abroad 

• official reserves = Capitol account balance + current account balance

Unit 5 and 6 - Philips curve & supply side economics

Phillips curve

•Represents the relationship of unemployment and inflation

• LRPC: 

      - occurs on the natural rate of unemployment

      - represented by a vertical line 

      - not trade between unemployment and inflation in the long run. Means economy produces at the full employment level

     - long run Phillips curve will only shift if the LRAS shifts

     - the major LRPC assumption is that more worker benefits create higher natural rates and fewer benefits lower natural rates.

•SRPC:

     - a trade of with inflation and unemployment in the short run

               . inverse relationship

     - has relevance with okun's law

     - since wages are sticky, inflation changes move the points on the SRPC

    - if inflation persist and the expected rate of inflation rises, then the entire SRPC moved upward which causes the situation called stagflation 

    - if inflation expectation drop due to new technology or economic growth then the SRPC moves downward

Aggregate supply shocks

   - causes both the rate of inflation and rate of unemployment to increase

   - is a rapid and significant increase in resource cost 

Misery index

• a combination of inflation and unemployment in any given year

• single digit misery is good 

Long run Phillips curve (LRPC)

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

• increases in Un, will shift LRPC ->

• decrease in Un will shift LRPC <-

Supplied side economics 

• it is the belief that the AS curve will determine will determine the levels of inflation, unemployment, and economic growth. 

• to increase the economy, shift AS curve to the right ->

• supply side economists focus on the marginal tax rate

      - marginal tax rate: the amount paid on the last dollar earned or on each additional dollar earned

• they believe lower taxes are incentive for a business to invest in the economy

• also believe lower taxes are an incentive for workers to work hard there by becoming more productive

• lower taxes are incentives for people to increase savings and therefore create lower interest rates, which causes an increase in business investment

1. Supply side economist 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 provides disincentives to work, invest, innovate, and undertake entrepreneur ventures. 

• also called Reaganomics 

     - lowered the marginal tax rates to get the US out of recession. -> deficit 

Laffer Curve

• it is used to support the supply side argument

• as race rates increase from 0 tax revenues increase from 0 to maximum number than decline

Criticism 

1. Research suggest that the impact of tax rates on incentives on work save and are small

2. Tax cuts also increase demand, which can fuel inflation. Thus creating a situations where demand exceeds supply

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

Types of money

• commodity money

• representative money

•fiat money

   - not backed by legal money

   - backed by govt word

Functions of money

•medium of exchange 

    - through money you exchange

•Store of value

• unit of account

     -P = worth (quality)

Time to short, for wages to adjust to the price level

• rational: workers may not be aware of changes in their real wages due to inflation and have adjusted labor supply decisions in wage demands accordingly. 

Nominal wages 

• is the amount of money received per hour, per day, or per year

sticky wages

• nominal wage level that is set according to an initial price level and does not vary 

•Keynesian range

     - price level: fixed

     - wage level: fixed

     - unemployment is flexible

     - implications: output depends upon change in employment 

• intermediate 

     - price level: flexible

     - wage level: fixed

     - unemployment level: flexible

     - implications: output depends upon changes in price level and employment 

• classical range

     - price level: flexible

     - wage level: fixed

     - unemployment level: fixed 

     - implications: output depends upon change in price level

LRAS

Time long enough for wages to adjust to the price level

Assumptions

1. Price 

2. Changes in wage and price level offset each other 

Video Summaries

Video 1:
In the video, it discusses that there is three types of money. They are commodity money, representative money, and fiat money. Commodity money is allowing goods to be accepted as money. Then representative money is currency that is backed up by something, usually its metal like gold and silver. Lastly, fiat money is currency that isn’t backed up by metal but it is backed up by the government by giving it a value. There is also functions of money, they were medium of exchange, store of value, and unit of account. Medium of exchange is “through money that exchange happens” and store of value is money that is saved in the bank and people thinking that it will have the same value as before.

Video 2:
This video was about the Money Market Graph. The women draws out the graph and labels them. The y axis is the interest rate (i) and the x-axis is quantity of money (QM). She also tells us why the demand of money slopes downward. When the price is high, the demand is low but when the price is low then the demand is high and the interest rate people borrow more. Then the supply of money is fixed and set by the Fed. It does not change by the interest rate.

Video 3:
In video three, it talks about the tools of the monetary policy. During expansionary the reserve requirement is lowered so they can have more excess loans to lend out and for contractionary it is being raised. The discount rate is increased to stop the amount of borrowing. Then the federal fund rate is rates that are charged to other banks when they receive overnight loans.

video 4:
This video talks about the loanable fund rate and how that when there is more money saved then more money will be lend out. The women also talked about how the interest rate is affected by the Money Market and the Loanable fund market. The interest rate is hurt in the money market when is low and its vice versa in the loanable fund market.

video 5:
The video talks about how there is two ways to create money. One way is through the money multiplier and the other is the multiple deposit expansion. However money is always created by making loans.

video 6:
In video 6, the women shoes the graphs of the money market, the loanable fund market, and the AD-AS graph. She explains how if the government is in a deficit, then they borrow money to run the deficit. When they are borrowing money, it is from the public. The women also explains that when MV is increasing so is PQ because MV has to equal PQ.

Loanable Fund Market

• the market where saver and borrowers exchange funds (Qlf) at the real rate of interest (r%)

• the demand for loanable funds, or borrowing comes from households, firms, govt, and the foreign sector. The damns for loanable funds is in fact the supply of bonds

• the supply of loanable funds, or saving comes from households, firms, govt, and the foreign sector. The supply of loanable funds is also the demand for bonds

Changes in the demand for loanable funds

• remember that demand for loanable funds = borrowing (supply bonds)

• more borrowing = more demand for loanable funds ->

• less borrowing = less demand for loanable funds (<-)

• example 

     - government deficit spending = more borrowing = more demand for loanable funds 

    -Dlf -> r%^

    -less investment demand = less borrowing = less demand for loanable funds 

Changes in the supply of loanable funds

• remember that supply of loanable funds = savings ( demand for bonds)

• more saving = more supply of loanable funds ->

• less saving = less supply of loanable funds <-

• examples 

     - government budget surplus = more saving = more supply of loanable funds

     - Slf -> r%^

     -  decrease in consumers' MPS = less Savings = less supply of loanable funds

Final thoughts of loanable funds 

• when the government does fiscal policy it will affect the loanable funds 

• changes in the real interest rate (r%) will affect gross private investment 

Tools of Monetary Policy

Fiscal policy 

• Congress and president 
• Tax or spend  

Monetary policy 

• The fed  
• Omo 
• Discount rate  
• Federal found rate 
• Reserve requirement 

Expansionary  

• Easy money 
• Recession 
• Open markets operation buy bonds  
• Icrease money supply 
• Decrease dicount rare 
• Decrease reserve requirements  

Contractionary 

• Tight money 
• Inflation 
• Open market operations sells bonds 
• Increase discount rate 
• Increase reserve requirement  

Discount rate: interest rate that the fed charges commercial banks for borrowing money 

Federal fund rate: Interest rates that commercial banks charge one another for an over night loan 

• Inderect relationship of the two 

Prime rate: interest rate that banks charge their most credit worthy customers

Key Principles

Key principles:

• a single bank can create money (through loans) by the amount of ER

• the banking system as a whole can create money by a multiple (deposit on money multiplier) of initial ER

Initial deposit

• cash

     -Existing money

     - increase bank reserves 

     - no immediate change in ms because the composition, is in circulation 

     - change in the banking system

• FED purchase of a bond from public

     - new money

     - increase bank reserves 

     - yes immediate change in ms because money coming from the FED, puts new money in circulation

     - deposit change in the banking system

• bank purchase of a bond from public

     - new money

     - increase

     - yes because money coming from actual reserves puts new money in circulation

     - deposit change in the banking system 

Factors the weaken the effectiveness of the deposit multipliers

1. If banks fail to loan out all their ER 

2. If bank customers take their loans in cash rather than in new checking account deposits, it's creates a cash or currency drain

The money market 

• demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded 

     -money demand ^ interest v

Functions of the FED

Function of the FED

• it issues paper currency

• sets reserve requirements and hold reserves of banks

• it lends money to banks and charges then interest 

• they are a check clearing service for banks

• it acts as personal bank for the government 

• supervises member banks

• controls the money supply in the economy 

Three types of multiple deposit expansion 

1. Calculate the initial change in excess reserves 

    - xaka the Amount a single bank can loan from the initial deposit 

2. Calculate the change in loans in the banking system 

3. Calculate the change in the money supply

   - sometimes type 2 and type 3 will the same result (I.e. No Fed involvement)

4. Calculate the change in demand deposits 

Creating a bank 

• transaction #4

• depositing reserves in a federal reserve bank

   - required reserves 

   - reserve ratio 

• reserve ratio = commercial banks required reserves/ commercial banks Checkable-deposit liabilities

Reserve requirements

• excess reserves 

    - actual reserves - required reserves

• required reserves 

    -checkable deposits x reserve ratio

How banks work

• assets 

    - reserves:

         . Required reserves (rr) - % required by fed to keep on hand to meet demand 

         . Excess reserves (er) - % reserves over and above the amount needed to staidly the minimum reserve ratio set by fed

   - loans to firms, consumers and other banks (earns interest)

   - loans to govt. = treasury securities 

   - bank property - (if blank fails, you could liquidate the building/property)

• liabilities + equity 

    - demand deposits ($ put into bank)

    - timed deposit (CD's)

    - loans from: federal reserve and other banks 

    - shareholders equity - (to set up a bank, you must invest your own money in it to have a stake in the banks success or failure) 

•Bonds are loans are I o u that represent debt that the government or corporation must repay to an investor

• they are literally low risk investments 

3 components

• coupon rate - it is the interest rate that a bond issuer is to pay to a bond holder

• maturity - the time at which payment to a bond holder is due 

• par value - it is the amount that an investor pays to purchase a bond that will be repaid to an investor at maturity 

Time value of money

• is a dollar today worth more than a dollar tomorrow?

    - yes

• why? 

    - inflation and opportunity cost 

    - this is the reason for charging and paying interest 

• let v = future value of $

       p = present value of $

       r = real interest rate (nominal rate - inflation rate) expressed as a decimal

      n = years 

      k = number of times interest is credited per year 

• simple interest formula 

    v = (1 + r)^n x p

• the compound interest formula 

    v = (1 + r/k)^nk x p

Fiscal Policy

Fiscal Policy

·     Changes in the expenditures or tax revenues of the federal government.

o  2 tools of fiscal policy: controlled by congress

§  Taxes – government can increase or decrease taxes

§  Spending – government can increase or decrease spending

Deficit, Surpluses, and Debt

·       Balanced budget

o   Revenues = Expenditures

·       Budget deficit

o   Revenues < Expenditures

·       Budget Surplus

o   Revenues >Expenditures

·       Government Debt

o   Sum of all deficits – sum of all surpluses

·       Government Borrows money when it runs a budget deficit from:

o   Individuals

o   Corporations

o   Financial Institutions

o   Foreign entities or foreign governments

Discretionary Fiscal Policy (action)

·       Expansionary fiscal policy – think deficit

·       Contractionary fiscal policy – think surplus

Non –Discretionary Fiscal Policy (no action)

Discretionary vs. Automatic

·     Discretionary

o  Increasing or decreasing government spending and/or taxes in order to return economy to pull full employment.

o  Involves policy makers doing fiscal policy in response to an economic problem

·     Automatic

o  Unemployment compensation and marginal tax rates are examples of automatic policies that help mitigate effects of a recession and inflation

o  Automatic fiscal policy takes places without policy makers

Contractionary Fiscal Policy – policy designed to decrease aggregate demand

·     Strategy for controlling inflation

·     Inflation is countered

o  Government spending decrease

o  Taxes increase

   Expansionary Fiscal policy – policy designed to increase aggregate demand

·       Strategy for GDP combating recession and reducing unemployment

·       Recession is countered with expansionary policy

o   Government spending increases

o   Taxes decreases

Automatic or Built in stabilizers

·       Anything that increases the government’s budget deficit during a recession and increases its budget surplus inflation without requiring explicit action by policymakers

Automatic Stabilizers

1.   Transfer Payments

a.   Welfare Checks

b.   Food Stamps

c.   Unemployment Checks

d.   Corporate Dividends

e.   Social Security

f.     Veteran’s benefits

2.   Progressive income taxes

a.   Automatic stabilizers take 33-50% out

   Progress Tax System

·       Average tax rate (tax revenue/ GDP) rises with GDP

   Proportional Tax System

·       Average tax rate (remains constant as GDP changes)

    Regressive tax System

·       Average tax rate fall with GDP