Absolute Advantage v. 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. 

-National: exists when a country can produce more of a good/service than another country can in the same time period. 

•Comparative Advantage 

-Individual/National: Exists when an individual or nation can produce a good/service at a lower opportunity cost than can another individual or nation. 

•Absolute Advantage 

   -Faster, more, more efficient 

•Comparative Advantage 

    -lower opportunity cost 

Dollar Appreciation

Dollar Appreciation: 

•Each dollar gets you more of the other currency.

• this means is that US exports gets more expensive for foreigners. 

•US imports gets cheaper for us

•Results: Exports decrease while imports increased 

• $ is leaving the US 

   -Xn and GDP decrease

   - Demand for the dollar increases

   - Supply of the dollar decreases 

Dollar Depreciation:

• Each dollar gets you less of the other currency. 

• Less of the foreign currency is needed. 

•Exports are going to increase and imports are going to decrease. 

•money is entering the US 

   - Xn increases

   - GDP increases 

•Demand for the dollar decreases 

•Supply of the dollar increase 

*if it comes to supply of the dollar, we're making transfered payments to foreigners 

*If it comes from supply of the dollar, foreigners are making transfer payments to us. 

* Supply of the dollar: comes from US Citizens, banks and industries, wanting to purchase our goods, investments and assets. 

     

Foreign Exchange Market

•Foreign Exchange: the buying or selling of currency

    -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 adage is determined in the foreign currency markets. 

      -Ex: The current exchange rate is approximately 77 Japanese Yen to 1 US dollar. 

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

•Do not try to calculate the exact exchange rate.

TIPS

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

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

•If D on one graph increases, S on the other will also increase. 

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

-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 make it cheaper to buy one unit of that currency. 

   - A decrease in supply of a currency will make a more expensive to buy one unit of that currency.

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

    - A decrease in demand for a currency will make it cheaper to buy one unit of that currency 

-Appreciation 

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

     -Hypothetical: 100 Yen used to buy $1. 

                             Now 200 Yen buy 1US$.

     - The dollar is "stronger" because one   buys more Yen than it used to. 

-Depreciation of a currency occurs when the exchange rate of that currency decreases 

       -100 Yen used to buy one dollar. Now 50 

         Yen buys one dollar. 

      - The dollar is weaker because it takes 

         Fewer Yen to buy one dollar. 

The Balance of Payments

•Measuring money of inflows and outflows between the United States and the Rest of the World (ROW)

•Inflows are referred as CREDITS 

•Outflows are referred to as DEBITS

• The balance of Payments is divided into 3 accounts 

-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 accounting prices. 

   -Ex: US Manufacturer John Deere exports $50 million worth of farm equipment to Ireland. 

     • A credit of 50 million to the current account 

      *(- 50 million worth of farm equipment or physical assets) 

-Current Account 

• Balance of trade or Net Exports 

  *   Exports of goods and services-imports of goods and 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 US owned foreign assets- income foreign held US Assets 

    Ex: Interest payments on US owned Brazilian bonds - interest payments on German owned US treasury bonds 

    -Net Transfers (tend to be unilateral) 

        • Foreign Aid: a debit to the current account 

     Ex: Mexican migrant workers send money to family in Mexico 

-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 tot he capital account 

    *Ex: the Toyota Factory in San Antonio 

• Direct investment by US firms/individuals in foreign country are debits to the capital account 

    *Ex: The Intel Factory in San Jose, Costa Rica 

•Purchase of foreign financial assets represents a debit to the capital account. 

   *Ex: a Warren Buffet buys stock in Petrochina. 

•Purchase of domestic financial assets by foreigners reprints a credit to the capital account.  

   *Ex: The United Arab Emirates sovereign wealth fund purchases a late stake in the NASDAQ. 

-Relationship between Current and Capital Account 

•Remember double entry bookkeeping? 

• The current account and the capital account should zero each other out. 

-Official Reserves 

•The foreign currency holdings of the United Staes 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 Fev depletes its reserves of foreign currency and credits 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 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 with the United States. 

Supply Side Economics

-Supply Side Economics (Reaganomics)

• Supply side economists tend to believe the ASA curve will determine levels of inflation, unemployment, and economic growth.
• To increase the economy, you take actions to shift the AS curve to the right. 
• Always benefitting the company first. 
• They focus on marginal tax rates, which is the amount paid on the last dollar earned or on each additional dollar.
• Lowered taxes are an incentive for businesses to invest in our economy. 
• Lowered taxes are incentives for people to increase savings and therefore create lower interest rates for increases and business investment. 
• They only believe in AS. 

• The laffer curve is a trade off between tax rates and government revenue 
• It is used to support the supply side argument 
• As tax rates increase from zero, tax revenues increase from zero to some maximum level and then decline. 

-Criticisms of the Laffer Curve: 

-Research suggest that the impact of tax rates of incentives to work save and invest are small.

-Tax cuts also create demand. Which will cause demand to exceed supply. 

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

-Reaganomics:

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

Long Run Phillips Curve

-The Long Run Phillips Curve (LRPC) 

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

•increases in unemployment will shift LRPC>

•decreases in unemployment will shift LRPC< 

•Changes in the AS/AD model can also be seen in the Phillips curves 

•an easy way to understand how changes in the AS/AD model affect the Phillips curve is to think of the two sets of graphs as mirror images 

•NOTE: the 2 models are not equivalent. The AS/AD model is static, but the Phillips curve includes change over time. Whereas AS/AD shows one time changes in the price level as inflation or deflation, the Phillips curve illustrates continuous change in the price level as either increased inflation or disinflation. 

Periods of Stagflation:

•civil rights movement 

•women's movement 

•baby boom error

•Vietnam ended 

• all embargo (1973 and 1979)

•Disinflation: reduction in the inflation rate from year to year. 

•This also occurs when aggregate demand declines.

•In the short run, profits fall and the unemployment rate increases.

•Deflation: an actual drop in the price level. 

Phillips Curve

Phillips Curve: Relationship between unemployment and inflation.

The trade off between unemployment and inflation is on the short run. 

SHORT RUN PHILLIPS CURVE:

•It has relevance to Okun's law. For every 1% percent of unemployment, there is a 2% 

•There is an inverse relationship between unemployment rates and inflation rates. 

• Since wages are sticky, inflation changes. Move the points on the SRPC. 

•If inflation persists and the expected rate of inflation rises, then the entire SRPC moves upward. Which creates a situation called "stagflation".

•STAGFLATION: You have high unemployment plus high inflation simultaneously. 

•If inflation expectations stop due to new technology, then the SRPC will move downward. 

LONG RUN PHILLIPS CURVE: 

•It occurs at the natural rate of unemployment.

• It is represented by a vertical line. 

•There is no trade off between unemployment and inflation in the long run. •It only shifts if the LRAS curve shifts. 

• The major LRPC assumption is that more worker benefits create higher natural rates and fewer worker benefit create lower natural rates. 

•If LRAS is stable, so is LRPC.

Natural Rate of Unemployment: Seasonal, structural, and Frictional. Cyclical does not count because 

•Aggregate supply shocks can cause the rate of inflation and the rate of unemployment to increase. 

-What are Supply Shocks? 

•They are rapid and significant increases in resource cost which will cause the SRAS curve to shift. 

-The Misery Index: 

•A combination of inflation and unemployment in a given year.

• Single digit misery is good.