Balance of Payments

Balance of Payments

• Measures of money inflows and outflows between the United States and the rest of the world
• Inflows are referred to as credits
• Outflows are referred to as debits

Balance of Payment is divided into 3 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
• Foreign Aid- Debit to the current account
• Ex- migrant worker sending money to family

Capital/ Financial Account

• 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- Toyota company in San Antonio
• Direct Investment by United States in foreign countries are debits to the capital accounts
• Purchase of foreign financial assets represents a debit to the capital account
• Purchase of domestic financial assets by foreigners represents a credit to the capital account

Relationship between Current and Capital Account

• Current account and the capital account should zero each other out
• If current account has a negative balance (deficit) then capital account should then have a positive balance (surplus)

Official Reserves

• Foreign currency holding of the United States 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 vs. Passive Official Reserves

• United States is passive in its use of official reserves. 
• Does not seek to manipulate the dollar exchange rate
• People's Republic of China is aactive in its use of official reserve. 
• Actively buys and sells dollars in order to maintain a steady exchange rate w/ the United States

Formulas

• Balance of Trade
• Good exports + Goods Imports
• Balance on Goods & Services
• Good Exports + Services Exports + Good Imports + Service Imports
• Current Account
• Balance on Goods and Services + Net Investment + Net Transfers
• Capital Account
• Foreign Purchases + Domestic Purchases 

Unit 7: Foreign Exchange/ Flexible & Fixed Rates

Foreign Exchange

• Ex: In order to purchase souvenirs in France, it is first necessary for Americans to sell (Supply) their dollars and buy Euros. 
• Any transactions that occurs in the balance of payments necessitates foreign exchange.
• Exchange Rate is determined in the foreign currency markets.

Changes in the Exchange Rates

• Exchange Rates 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 the currency increases
• Depreciation of a currency occurs when the exchange rate of that currency decreases 
• The more you supply, the more the value depreciates. The more you demand, the more value appreciates

Exchange Rates Determinants

• Consumer Rates
• Relative Income
• Relative Price Level
• Speculation

Exports and Imports

• 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: 

• One supply line will change while the other demand line will also change
• They will move in the same direction
• One currency will appreciate while the other will depreciate

Flexible Rates

• Based on supply and demand of that currency versus the other currency
• Very sensitive to the business cycle and it provides options for investment

Fixed Rates

• Based on countries willingness to distribute currency and to control the amount

Unit 7: Absolute & Comparative Advantage

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 how they 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 that has a comparative advantage when it can produce the product at a lower domestic opportunity cost than a trading partner can. 

Examples of Output Problems:

• Words/Min
• MPG
• Tons/Acre
• Apples/Tree
• Televisions Produced Per Hour

Examples of Input Problems:

• # of hours to do a job
• # of acres to feed a horse 
• # of gallons of paint to paint a house

Specialization and Trade: 

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

Unit 5: Laffer Curve

Laffer Curve

• Depicts a theoretical relationship between tax rate and government revenue
• As tax rates increase from zero, government revenues increases from zero to a maximum level, and then decline

Criticsms of the Laffer Curve

• Research suggests that the impact of tax rates on incentives to work, save, and invest are small. 
• Tax cuts also increase demand which can fuel inflation, which causes demand to exceed supply
• Where the economy is actually located on the curve is difficult to determine

Unit 5: Supply Side Economics

Reaganomics

• Makes changes in AS but not AD and it determines the level of inflation, unemployment, and economic growth. 
• Lower marginal tax rate induce more work this AS increases.
• Makes leisure more expensive and make work more attractive. 

Supply Side Economics

• Support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transferred payment
• Ex. Unemployment compensation, 
• Welfare Programs that provided disincentives to work, invest, innovate and undertake entrepreneur inventions.

Incentive to save and invest

• High Marginal Tax Rate can reduce the rewards for savings and investments
• Consumption might increase, but investment depend upon savings
• Lower Marginal Tax Rates encourage saving and investment

Unit 5: Phillips Curve

The Long-Run Phillips Curve (LRPC)

• Long-Run Phillips curve exists off the natural rate of Unemployment (Un)
• Structural changes in the economy that affect Un will also cause the LRPC to shift.
• Increase in Un will shift LRPC to the right.
• Decrease in Un will shift LRPC to the left.

The Short-Run Philips Curve (SRPC)

• There is a trade off between inflation and unemployment. 
• As one increases, the other decreases and vice versa. 

LRPC

1. There is no trade off between inflation and unemployment. 
2. LRPC is represented by a vertical line.
3. The LRPC occurs at the natural rate of unemployment.
4. The LRPC only shifts if the LRAS shifts

NRU= Frictional + Structural + Seasonal Unemployment 

What changes LRPC?

The major LRPC assumption is that more worker benefits create a higher natural rate of unemployment and fewer worker benefit creates a lower natural rate

The Misery Index-

• It's a combination of inflation and unemployment in a given year. 
• Single digit misery is good
• Inflation: It is the general rise in the price level
• Deflation: A general decline in the price level
• Disinflation: Decrease in the rate of inflation over time
• Stagflation: Unemployment and inflation increasing at the same time 

Unit 5: Extending the Analysis of Aggregate Supply

SRAS

• This is the period in which wages and input prices remain fixed as price level decrease or increases. 

LRAS

• This is the period of time in which wages have become fully responsive to changes in prices level.

Effects Over the Short Run

• In the short run, price level changes to allow for companies to exceed Normal Outputs and hire more workers. 
• Prices are increasing while wages remain constant
• In long run, wages will adjust to the price level and previous output levels will adjust accordingly

Equilibrium in the Extended Model

• The extended model means the inclusion of both the short run and the AS curves. 
• The Long AS curve is represented with a vertical line at full employment level of real GDP.

Demand Pull Inflation in the AS Model

• Demand Pull: Prices increase based on increase in Aggregate Demand.
• In the short urn, demand pull will drive up prices and increase production. 
• In the long run, increase in aggregate demand will eventually return to previous levels.

Cost Push and Extended Models

Cost-push arises from factors that will increase per unit costs such as increase in the price of a key resources.

Dilemma for the Government

• In an effort to fight cost-push, the government can react in two different ways;
• Actions such as spending by the government could begin an inflationary spiral.
• No actions however could lead to recession.