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.