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.
- 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.
·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
