Unit Seven: Comparative and Absolute Advantage

Comparative and Absolute Advantage

Notes 5/9/16

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

Output Problems: Tons/ acre, MPG, Words Per Minute, Apples Per Tree, Televisions produced per Hour

Input Problems: Number of hours to do a job, Number of acres to feed a horse, Number of gallons to paint a house

Specialization and Trade

-Gains from trade are based on comparative advantage, not absolute advantage

-Companies should trade if they have a relatively lower opportunity cost

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Unit Seven: Mechanics of Foreign Exchange

Mechanics of Foreign Exchange (FOREX)

Notes from 5/3/16

FOREX- The buying and selling of currency

-Any transaction that occurs in the balance of payments necessitates foreign exchange

-The exchange rate (e) is determined in the foreign currency

Change in e 

-e are a function of the supply and demand for currency

-An increase in the supply of a currency ---> Decrease in e

-A decrease in the supply of a currency ---> Increase in e

-An increase in the demand of a currency ---> Increase in e

-A decrease in the demand for a currency ---> Decrease in e

Appreciation v. Depreciation

+ Appreciation- Occurs when the e of that currency increases

+ Depreciation- Occurs when the e of that currency decreases

Exchange Rate Determinants

1. Consumer's Tastes

2. Relative Income

3. Relative Price Level

4. Speculation

Exports and Imports

-The e 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 increasing imports

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Unit Seven: The Balance of Payments

The Balance of Payments

Notes from 4/27/16

Balance of Payments- Measure of money inflows and outflows between the United States and the rest of the worlds

-Inflows---> CREDITS

-Outflows---> DEBITS

Balance of Payments is divided into 3 accounts

1. Current Account

2. Capital/ Financial Account

3. Official Reserves Account

Current Account

Balance of Trade or Net Exports

-Exports of Goods/Services - Imports of Goods/Services

-Exports create a credit

-Imports create a debit

Net Foreign Income

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

-Example: Interest payments on the U.S. owned Brazilian bonds - Interest payments on German owned U.S. Treasury bonds

Net Transfers (tend to be unilateral)

-Other states sending money to other states

-Foreign aid is a debit to the current account

-Example: Mexican immigrant workers send money to family in Mexico

Capital/ Financial Account- Balance of capital ownership

-Includes purchase of both real and financial assets

-Direct investment in the U.S. is a credit to the capital account

-Direct investment by U.S. firms/ individuals in a foreign country are debits to the capital account

-Purchase of foreign financial assets represent a debit to the capital account

-Purchase of domestic financial assets by foreign represents a credit to the capital account

Relationship Between Current and Capital Accounts

-Current and Capital accounts should ZERO each other out

-If current account has a negative balance (deficit), then the capital account should have a positive balance

Official Reserves

-The foreign currency holdings  of the U.S. Federal Reserve 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

-SHOULD ZERO OUT 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

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Unit Five: Reaganomics/ Supply Side Economics

Reagonomics/ Supply Side Economics

Notes from 4/13/16

Reagonomics- Change in AS (not AD) which determines the level of inflation, employment rates, and economic growth

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, invest, innovate, and undertake entrepreneurial ventures 

BASICALLY- "What can you do in your work time?"

-Lower marginal tax rates induce more work and AS increases and also makes leisure more expensive and more more attractive

-Higher opportunity cost not to work

-Postpone retirement and increase hours may have lower unemployment rates

Incentives to Save and Invest

1. High marginal tax rates reduce the rewards for savings and investments

2. Consumption might increase, but investments depend on savings

3. A lower marginal tax rate encourages savings and investment

Laffer Curve

-Depicts a theoretical relationship between tax rates and government revenues

-As tax rates increase from 0, government revenues increase from 0 to some maximum level, then decline 

3 Criticisms of the Laffer Curve

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

2. Tax cuts increase demand, which can fuel inflation and demand may exceed supply

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

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Unit Five: Phillips Curve

Phillips Curve

Notes from 4/8/16

Long Run Phillips Curve

LRPC

-Because the LRPC exists at the NRU, structural changes in the economy that effect NRU will also cause the LRPC to shift

     -Increases in the NRU wil shift LRPC --->

     -Decreases in the NRU will shift the LRPC <---

SRPC

-There is a tradeoff between inflation and unemployment

-One increases, then the other decreases and vice versa

-Determinants are same as AS: Productivity, Input Costs, Legal Institutions

LRPC

-There is NO tradeoff between inflation and unemployment

-Always vertical at the natural rate of unemployment (NRU)

-Will only shift if LRAS shifts

*NRU= Frictional + Structural + Seasonal Unemployment

MAJOR LRPC ASSUMPTION

That more worker benefits create higher NR's and fewer worker benefits create lower NR's 

Supply Shocks

-Rapid and significant increases in resource costs which cause the SRAS curve to shift

-Outcome: SRAS will shift downward, SRPC will shift outward

Misery Index

-The combination of inflation and unemployment in any given year

-Single digit misery is GOOD

-Used to determine what is up with the economy

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Unit Five: Extending the Analysis of Aggregate Supply

Extending the Analysis of Aggregate Supply

Notes from 4/7/16

Short Run Aggregate Supply- Period in which wages remain fixed as price level increases or decreases

Effects over Short Run

-In Short Run (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 (LR), wages will adjust to the price level and previous output levels will adjust accordingly

Equilibrium in the Extended Model

Extended Model- The inclusion of both the short run and long run aggregate supply curves

-The LRAS curve is represented with a vertical line at full employment

Demand Pull Inflation- Prices increase based on increase in AD

-In SR, demand pull will drive up prices and increase production

-In LR, increases in AD will eventually return to previous levels

Cost Push- Arises from factors that will increase per unit costs such as increase in the price of a key source

Dilemma for the Government

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

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

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

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Unit Four: Countercyclical Polices

Fiscal Policy v. Monetary Policy

Notes from 3/29/16

1. In the early 21st century, here in the USA:

An efficient, "full employment" economy  will probably have:

-An annual unemployment rate of 4-5%.

-An annual inflation rate of 2-3%.

2. If the economy goes into recession:

-The real GDP decrease for at least 6 months.

-The unemployment rate will go to 6% or more.

-The inflation rate will probably go to 2% or less.

3. If Congress enacts Keynesian Fiscal Policies to attempt to slow/stop the recession, then:

- The policy will try to improve C or G (parts of AD)

-Congress will cut federal taxes.

-Congress will increase job and spending programs.

-The federal budget will probably create a deficit.

-Due to changes in Money Demand, interest rates will increase.

(Crowding Out may occur)

4. If the Federal Reserve employs Monetary Policy options to slow/stop the recession, then:

-The policy will target improvement in Ig (part of AD).

-The Fed will target a lower federal funds rate.

-The Fed can decrease the discount rate.

-The Fed can buy bonds.

-The Fed can lower the reserve requirement.

-The Fed policies will decrease the interest rates through changes in the Money Supply.

-These options should increase Ig.

5. If the economy suffers from too much demand-pull inflation or cost-push inflation, then:

-The unemployment rate will go to 4% or less.

-The inflation rate will probably go to 4% or more.

6. If Congress enacts Keynesian Fiscal Policies to attempt slow/stop the inflation problems, then:

-The policy will try to decrease C or G (parts of AD)

-Congress will increase federal taxes.

-Congress will decrease job and spending programs.

-The federal budget will probably create a surplus.

-Due to changes in Money Demand, interest rates will decrease.

7. If the Federal Reserve employs Monetary Policy options to slow/stop the inflation problems, then:

-The policy will target decreases in Ig (part of AD).

-The Fed will target a higher federal funds rate.

-The Fed increase discount rate.

-The Fed can sell bonds.

-The Fed can raise the reserve requirement, but probably won't because it is too complex for the banks. 

-The Fed policies will increase the interest rates through changes in the Money Supply.

-These options should decrease Ig. 

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