econ last test

depreciation

-a decrease in the value of a currency as measured by the amount of foreign currency it can buy

Balance of Payments: Current Account

-a summary of all of a country's transactions with other countries. NX: exports of g/s - imports of g/s -exports create a credit to the balance of payments and imports create a debit to the balance of payments. Net Investment Income (interest, dividend, and profit income) -interest, divided, and profit income earned by Americans abroad minus the same income paid to foreigners Net Transfers -foreign aid, pensions, money sent back home. ex. mexican migrant workers sends money to family in Mexico.

purchasing power parity theory

-a theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries -based on a principle called the law of one price. this law asserts that a good must sell for the same price in all locations; otherwise, there would be opportunities for profit left unexploited. *the process of taking advantage of price differences fro the same item in different markets is called arbitrage...invisible hand would balance out prices. invisible hand could even balance on international scale. coffee example.

appreciation

-an increase in the value of a currency as measured by the amount of foreign currency it can buy. -if the exchange rate changes so that the dollar can buy more currency this is called an appreciation of the dollar.

capital control

-any measure taken by government, central bank to limit the flow of foreign capital in and out of the domestic economy. -include taxes, tariffs, outright legislation and volume restrictions, as well as market-based forces. -can affect foreign exchange trades -tight controls are most often found in developing economies, where the capital reserves are lower and more susceptible to volatility.

Balance of payments: capital/financial account

-foreign purchase of US real and financial assets -US purchase of foreign real and financial assets.

policies affect economy: government budget deficits

-gov. budget deficit is negative public saving so reduces national saving and reduces supply of loanable funds, raises interest rate, crowds out investment -increase in IR reduces NCO: because saving kept at home now earns higher rates of return, investing abroad is less attractive, and domestic residents buy fewer foreign assets. Higher IR attract foreign investors, who want to earn high rate of return. -because NCO fell, americans need less foreign currency to buy foreign assets, and therefore supply fewer dollars in the market for foreign-currency exchange. supply curve for dollars shifts leftward in foreign-exchange graph. reduces supply of dollars causes real exchange rate to appreciate, so dollar becomes more valuable in comparison to other currencies, which makes US goods more expensive so US exports fall and imports rise, so NX falls. -government budget deficits raise real interest rates, crowd out domestic investment, cause the currency to appreciate, and push the trade balance toward deficit.

debt service

-government's ability to meet its debt obligations

gains and losses of an importing country

-horizontal line at world price represents the rest of the world's supply of those textiles. -once trade is allows, the domestic price falls to equal the world price. the supply curve shows the amount produced domestically and the demand curve shows the amount consumed domestically. imports equal the difference between the domestic quantity demanded and domestic quantity supplied at the world price. buyers are better off while suppliers are worse off. *nations sometimes fail to enjoy the gains from trade because the losers from free trade are better organized than the winners. the losers may turn their cohesiveness into political clout and lobby fro trade restrictions such as tariffs or import quotas.

saving and investment

-if economy produces a large amount of new capital goods, then tomorrow it will have larger stock of capital and be able to produce more g&s -invest in more current resources in the production of capital -for society to invest more in capital, it must consume less and save more of its current income.

education

-investment in human capital, helpful with LR success -in US, each year of schooling has historically raised a person's wage by an average of about 10% -has an opportunity cost: when students are in school, can't be working to obtain a wage. -education has great externalities though: an educated person might generate new ideas about how best to produce stuff. if these ideas enter society's pool of knowledge then these ideas are an external benefit of education. -problem in some countries is brain drain: smartest people leave to study abroad in rich countries, may never return home...reduces poor countries human capital.

free trade

-inward-oriented policies: attempt to increase productivity and living standards within the country by avoiding interaction with the rest of the world-->stupid. domestic firms often advance "infant-industry argument" claiming they need protection form foreign competition to thrive as they get bigger/stronger-->stupid because if they are going to become successful, they shouldn't need the protection cuz the initial losses should be worth the eventual gain. -outward-oriented policies are better: with trade you can specialize, and in some ways it's type tech: can import stuff you don't have the means to create. countries on the ocean or by river have higher standard of living cuz more accessible to trade

implications of purchasing power parity

-it tells us that the nominal exchange rate between the currencies of 2 countries depends on the price levels in those countries. -the number of yen per dollar must reflect the prices of goods in the US and Japan. 1/P = e/P* 1=eP/P*, so if the purchasing power of the dollar is always the same at home and abroad, then the real exchange rate--the relative price of domestic and foreign goods cannot change. e=P*/P, nominal exchange rate equals the ratio of the foreign price level (measured in units of foreign currency) to the domestic price level (measured in units of the domestic currency). *according to the theory of purchasing-power parity, the nominal exchange rate between the currencies of 2 countries must reflect the price levels in those countries *a key implication of this theory is that nominal exchange rates change when price levels change. *when central bank prints large quantities of money, that money loses value both in terms of goods and services it can buy and in terms of the amount of other currencies it can buy

research and development

-primary reason that living standards are higher today than they were a century ago is that tech knowledge has advanced. -public good (knowledge): once one person discover an idea, the idea enters society pool of knowledge and other people can freely use it. gov. encourages research and development of new technologies. -NAsa, patent system.-->encouragement to engage in research

influences on NCO

-real IR paid on foreign assets -real IR paid on domestic assets -perceived economic and political risks of holding assets abroad -gov. policies that affect foreign ownership of domestic assets

how to raise productivity?

-saving and investment (investment tax credit) -invest in human capital -tax cuts -tech -increase labor force with immigration

population growth

-some say we are stretching our resources thin. as exponential growth in population occurs, we will run out of resources. Thomas Robert Malthus. others say large population reduces GDP per worker/productivty per worker. large school children population puts burden on educational system so educational attainment is low in countries with high population growth....rapid population growth makes it harder to provide workers the the tools and skills they need to achieve high levels of productivity....if more equality between genders, population would grow at lower rate because more women would want to work instead of raising kids at home. -otherside: larger number of people-->greater labor force, more opportunities for genius scientists and inventors. our ability to conserve and come up with new tech. to replace and conserve resources has made it so we won't ever run out.

market for foreign currency exchange

-supply is dollars that are supplies by US domestic residents who need foreign currencies to buy foreign goods, services, and assets. -upward sloping supply because US will supply more dollars if they can get more pesos for them. -demand for dollars: dollars are demanded in the foreign exchange market by foreigners who seek to purchase US goods, services, and assets. -because a depreciation of the real exchange rate increases NX, the demand curve for foreign-currency exchange slope downward. -x axis: Quantity of US Dollars (traded for pesos) -y axis: pesos per dollar -cause for shifts: what would make US citizens want to supply more dollars to get pesos?--> IR in Mex increased, risk/political instability-->you trust mexican assets more so you supply more dollars to exchange to pesos., increase in US real GDP-->more income-->increases people's purchasing power and shift right., preference of foreign goods -gov budget deficit-->supply of loanable funds goes left, IR increases, NCO decreases,-->americans need less foreign currency to buy foreign assets so they supply fewer dollars to the market for foreign currency exchange supply in foreign exchange market decreases. the reduced supply of dollars makes the dollar more valuable when compared to foreign currencies. their stuff is more expensive, US NX fall. -capital flight from Mexico increases Mexican interest rates and decreases the value of the Mexican peso in the market for foreign-currency exchange., trade surplus.

tariff

-tax on goods produced abroad and sold domestically; tax on imported goods -the tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade -domestic sellers are better off and domestic consumers are worse off, government raises revenue. -tariff causes dwl because 2 reasons 1) when tariff rates domestic price above world price it encourages domestic producers to increase their production even though the cost of making these incremental units exceeds the cost of buying them at world price. (left side) 2) tariff raises price that domestic consumers have to pay, so it encourages them to reduce consumption. (right side). even though domestic consumers value these incremental units at more than the world price, the tariff indices them to cut back their purchase. -most economics think tariffs > quotas because at least the government gets revenue. quotas are only equal if they are the ones companies can get with licenses and the gov can sell those.

net capital outflow

-the purchase of foreign asset by domestic residents minus the purchase of domestic assets by foreigners. -foreign direct investment or foreign portfolio investment. if Us opens fast food outlet in Russia: foreign direct investment. if American buys stock in Russian corporation, this is foreign portfolio investment. -->in both cases, US residents are buying assets locate din another country, so both purchases increase US net capital outflow. -when NCO is negative (domestic residents are buying less foreign assets than foreigners are buying domestic assets), capital is flowing out of the country and the country is experiencing a capital inflow. -also called net foreign investment. two forms: 1) Foreign direct investment: domestic residents actively manage the foreign investment. ex. McDonalds opens a fast-food outlet in Moscow. 2) Foreign portfolio investment: domestic residents purchase foreign stocks or bonds, supplying "loanable funds" to a foreign firm.

nominal exchange rates

-the rate at which a person can trade the currency of one country for the currency of another -can be expressed 2 ways. yen per dollar or dollar per yen.

real exchange rate

-the rate at which person can trade the goods and services of one country for the goods and services of another (nominal exchange rate) (domestic price)/(foreign price) real exchange rate = (e x P)/P* e= nominal exchange rate between US dollar and foreign currencies P=price index for US basket P*= price index for foreign basket -a depreciation (fall) in the US real exchange rate means that US goods have become cheaper relative to foreign goods, and then NX increases.

debt ratio/bank failtures

-total debt/total assets. -the proportion of a company's assets that are financed by debt -the higher the ratio, the more leveraged the company is, implying greater financial risk. -banks borrowed/lended money excessively to finance investment and wasn't paid back

health and nutrition

-type of human capital -expenditures that lead to a healthier population-->healthier worker are more productive. -nutriton makes you better worker -causal link between health and wealth -virtuous circle: policies that lead to more rapid economic growth would naturally improve health outcomes, which in turn would promote economic growth

arguments for restricting trade

1) "destroys domestic jobs", it creates jobs at same time it destroys them because when it imports textiles from other countries, those countries obtain resources to buy other goods from Island country....it just shifts industries that have a lot of jobs. 2) "when an industry is threatened tim competition from other countries, people argue that the industry is vital to national security" -->we must not rely on another country for steel because what if a war breaks out and we can't produce weapons to defend ourself. problem is that countries exaggerate their industry's role in national defense and if world price of steel is cheaper than domestic production Isolandia can benefit from accumulating a stockpile of weapons before a war at a cheaper cost 3) "infant industry argument"-->new industries argue for temporary trade restrictions to help them get started. after a period of protection, these industries will mature and be able to compete with foreign firms. older industries argue they need temp. protection to adjust to new conditions...it's hard for gov. to determine which industries will eventually be profitable and if the firms are so sure they'll become profitable they should be okay with the temporarily losses. often protection is rewarded to powerful industries and it ends up never being removed. 4) unfair-competition argument: firms in dif. countries are subject to different laws then its unfair to expect the firms to compete in international market place. ex. japan gives subsidy to textile industry and they can make a lot. USA wants protection from japan textile companies because they're prices are so much lower....USA producers would suffer but our consumers benefit at the lower price. the losers will be the taxpayers in Japan. 5) protection-as-a-bargaining-chip: threat of a trade restriction can help remove a trade restriction that's already imposed by a foreign government....threat doesn't always work and can lead to either more trade restrictions or embarrassing yourself

benefits of national trade

1)increased variety of goods 2)lower costs through economies of scale: some goods can be produced at low cost only if they're produced in large quantities. domestic market is too small to take advantage of this. 3)increased competition: a company shielded from foreign competitors is more likely to have market power which gives it the ability to raise prices above competitive levels (type of market failure). 4)enhanced flow of ideas: transfer of technological advances around the world is often thought to be linked to the trading of the goods that embody those advances.

variables that affect NX

1. tastes of consumers 2. prices of goods at home and abroad 3.government policies toward international trade 4. cost of transporting goods form one country to another. 5. exchange rates 6. the incomes of consumers at home and abroad

equality of Net Exports and Net Capital Flow

NCO = NX. US sells computer to Japan for 100 yen. Exports increase by 100. if you keep the 100 yen in your mattress: you are using some of your income to invest in Japanese economy:you acquired a foreign asset (japanese currency). the US increase in NX is matched by US increase in NCO. or you will buy japanese bond or stock in japanese corporation-->same result of a domestic citizen buying foreign asset. -when a nation is running a trade surplus (NX > 0), it is selling more g&s to foreigners than it is buying from them. with the foreign currency it receives, it is buying foreign assets (NCO>0). -when nation is running trade deficit (NX < 0), it must be selling assets abroad to finance the net purchases of the goods and services in the world markets. capital is flowing into the country (NCO < 0).

saving, investment, and their relationship to the international flows

Saving = Y - C -G. Y-C-G=I+NX S = I + NCO Saving = domestic investment + net capital outflow -an open economy has 2 uses for saving: domestic investment and net capital outflow trade surplus: savings > Investment NCO > 0. balanced trade: saving = investment NCO = 0. * when S>I, the excess loanable funds flow abroad in the form of positive NCO *when S<I, foreigners are financing some of the country's investment and NCO <0.

Production Function

Y=AF(L, K, H, N) Y=quantity of output, L=quantity of labor, K= quantity of physical capital, H= quantity of human, N=quality of natural resources. A is a variable that reflects the available production technology. as A rises, the economy produces more output from any given combo of inputs. Y/L=AF(1, K/L, H/L, N/L).... Y/L is output per worker, which is measured by productivity... this equation says that labor productivity depends on physical capital per worker, human capital per worker, and natural resources per worker. also depends on the state of tech as reflected by A. -we won't run out of resources because our ability to conserve these resources is growing more rapidly than their supplies are dwindling

political instability and capital flight

capital flight: large and sudden reduction in the demand for assets located in a country -politiical instability worries people, so they decide to pull their assets out of Mexico and move these funds to the US or "safe havens." -when investors sell their Mexican assets and use the proceeds to buy US assets, this increases Mexican NCO. -when NCO increases, there's greater demand for loanable funds to finance the purchases of capital assets abroad, so demand curve for loanable funds shifts right....also because NCO is higher for any IR, the NCO curve shifts right. (IR is higher) -The rise in IR makes Mex assets more attractive, but this barely offsets the impact of capital flight on NCO. -increase in NCO raises the supply of pesos in the market for foreign currency exchange....that is, as people try to get out of Mexican assets, there's a large supply of pesos to be converted into dollars....this increase in supply causes the peso to depreciate. *capital flight form Mexico increase Mexican interest rates and decreases the value of the Mexican peso in the market for foreign-currency exchange. -the depreciation of currency , makes exports cheaper and imports more expensive, so trade balance is pushed towards surplus. -increase in IR reduces domestic investment, which slows capital accumulation and economic growth. -at same time, there'd be a fall in US NCO, US dollar would appreciate in value, US IR would fall.

hot money

currency that moves regularly and quickly between financial markets so investors ensure they are getting the highest short-term interest rates available. continuously shifts from countries with low IR to those with high IR.

diminishing returns and the catch-up effect

diminishing returns: the property whereby the benefit from an extra unit of an input declines as the quantity of the input increases -with the nation saving more, fewer resources are needed to make consumption goods, and more resources are available to make capital goods....as a result, capital stock increases, leading to rising productivity and more rapid growth in GDP. -because of diminishing returns, an increase in savings are leads to higher growth only for a while...benefits from additional capital become smaller overt time -in LR, higher saving rate leads to higher level of productivtivity and income but not higher growth in these variables. catch up effect: property whereby countries that start off poor tend to grow more rapidly than countries that start off rich....poor countries can increase producvtity faster.

exchange rate regime options

fixed exchange rate: an exchange rate where a currency's value is matched (or pegged) to the value of another single currency, a basket of currencies, or to another measurable value...if the value of US currency is increased due to too much demand, the gov. can fix this by selling their own currency on foreign exchange market which would result in increase in their reserves of foreign currencies. floating exchange rate: exchange rate regime where the value of a currency is allowed to be determined solely by the demand for and supply of the currency on the foreign exchange market banded: when one or both governments allow the currency to trade or float between an upper and lower limit. outside these limits, the exchange rate is fixed. central banks attempt to influence their countries' exchange rates by buying and selling currencies...known as dirty float.

investment from abroad

foreign direct investment: a capital investment that is owned and operated by a foreign entity is called foreign direct investment. ex. Ford motor company builds a car factory in mexico. foreign portfolio investment: investment that is financed with foreign money but operated by domestic residents. ex. American buys stock in Mexican corporation. the mexican company can use the proceeds to build a new factory....in both these cases American saving is being used to finance Mexican investment. when ford opens car factory in Mexico, some of the income the factory generates goes to people who don't live in Mexico...as a result, foreign investment raises income of Mexicans (measured by GNP) by less than it raises production in Mexico (measured by GDP). GNP=gross national product--the income earned by residents of a country both home and abroad -investment from abroad can help a country grow. it increases their economy's stock of capital, leading to higher productivity and wages, and one way for poor countries to learn new technologies

moral hazard

if you protect someone too well against unwanted outcome, they will behave recklessly. setting a bad precedent by bailing out a country who has dug itself into debt.

main factors to allow a country's economy to grow

labor force and productivity

gains and losses of exporting country

once trade is allowed, domestic price rises to equal the world price. supply curve shows quantity of textiles produced domestically, while demand curve shows quantity consumed domestically. exports equal the difference between the domestic quantity supplied and the domestic quantity demanded at the world price. sellers are better off and buyers are worse off. overall surplus increases. -horzontal line at the world price represents the world' demand for textiles

how productivity is determined

physical capital: the stock of equipment and structures that are used to produce g&s. the inputs used to produce g&s are factors of production, a important feature of capital is that it is a produced factor of production human capital: the knowledge and skills that workers acquire through education, training, and experience. requires inputs from teachers and libraries. natural resources: the inputs into the production of g&s that are provided by nature, such as land, rivers, and mineral deposits. forms: renewable-forest will always be there. nonrenewable--oil cuz limited supply...not necessary for a an economy in a country to be productive in producing stuff. tech knowledge: society's understanding of the best ways to produce g&s. some is common knowledge: ex. assembly-line production. propriety--known only by the creators like Coca-Cola recipe. some things are patented. *tech knowledge refers to society's understanding about how the world works. human capital refers to the resources expended transmitting this understanding to the labor force. tech knowledge is the quality of society's textbooks, while human capital is the amount of time that the population has spent reading them.

property rights and political stability

property rights: refers to the ability of people to exercise authority over the resources they own. a mining company will not make the effort to mine ore if it expects it to be stolen. the company only mines it if they expect to benefit from its subsequent sale....courts are important because they enforce property rights. and criminal justice system discourages theft and civil justice system ensures that buyers and sellers live up to their contracts. -in some countries, corruption and bad legal system and lack of property rights screw things up -revolutions and coups are common, there's doubt whether property rights will be respected in future, if people are scared their gov. will confiscate their business capital, they have less incentive to save, invest, and start new businesses. and foreigners have less incentive to invest in country.

productivity

quantity of goods and services produced from each unit of labor input living standard is tied to productivity productivity determines living standards -the amount of goods and services produced for each hour of a worker's time

devaluation

reduction in the official value of a currency in relation to tother currencies

Foreign reserves

reserve assets held by a central bank in foreign currencies, used to back liabilities on their own currency as well as to influence monetary policy. -gives the central gov. flexibility and resilience; should one or more currencies crash or become rapidly devalued, the central banking apparatus has holdings in other currencies to help them withstand such market shocks.

trade policy

tariff: tax on imported goods import quota: limit on quantity of good produces abroad that can be sold domestically. -US imposes quota on number of cars that can be imported from Japan. reduces imports, so NX rises. because foreigners need dollars to buy US net exports, there is an increased demand for dollars in market for foreign-currency exchange....causes real exchange rate to appreciate (value of a dollar)-->domestic goods become more expensive relative to foreign goods, and this appreciation encourages imports and discourages exports to other countries. these changes work to offset the direct increase in NX due to the import quota. in end, import quota reduces both imports and exports, but NX is unchanged. *trade policies don't affect the trade balance because they don't alter national saving or domestic investment...trade policy can only alter trade for specific firms.

market for loanable funds

the supply comes from saving. demand comes from domestic investment (I) and net capital outflow (NCO). -because NCO can either be positive or negative it can either add to or subtract from the demand for loanable funds that arises from domestic investment. when NCO>0-->country is experiencing a net outflow of capital and the net purchase of capital overseas adds to the demand fro domestically generated loanable funds. -high IR reduces the Q of loanable funds demanded. in increase in US IR encourages foreigners to buy US assets.