Econ E202 Macro Econ

Define absolute advantage.

the ability of an individual or group to carry out a particular economic activity more efficiently than another individual or group.

Could political institutions be designed in a manner that would make political action more aligned with sound economic policies? How?

"yes." Such a design would include (1) checks on the powers of both the executive and simple legislative majorities; (2) constitutional protection of economic rights like ownership of property, freedom to trade and compete, and use of alternativecurrencies; and (3) political decentralization so that citizens can more easily escape from governmental units that fail to provide an attractive economic environment.

Mutual gains are enjoyed by countries because international trade allows citizens of each country to:

(1) specialize in the production of those things they do best and (2) import goods foreign producers are willing to supply at a lower cost than domestic producers.

Why will international trade be mutually beneficial?

, the trading partners will be able to produce a larger joint output and consume a larger, more diverse bundle of goods when they each specialize in areas where they have a comparative advantage.

What has been the trend in recent decades regarding international trade?

. In the United States, international trade (imports plus exports) summed to 29 percent of GDP in 2015, compared with 20 percent in 1980 and 9 percent in 1960.

What do several countries do with their currencies?

. Several countries link their currency to major currencies like the U.S. dollar or European euro.

What is NAFTA? What resulted?

. The 1994 North American Free Trade Agreement (NAFTA) estab- lished by the United States, Canada, and Mexico is an example. As a result of NAFTA, the tariffs of most goods moving among the three countries have been eliminated.

How likely is this to be implemented and maintained (see footnote)?

. They sought to limit federal actions to those areas of widespread agreement through the establishment of two legislative bodies based on different criteria; separation of powers among the executive, legislative, and judicial branches; and the listing of the specific powers of the central government

In what ways are quotas more harmful than tariffs?

. With a quota, foreign producers are prohibited from selling additional units regardless of how much lower their costs are relative to those of domestic producers.

What are the three general categories that make up the balance of payments?

1. Current-account transactions are dominated by the trade in goods and services. 2. Balance on current account The import-export balance of goods and services, plus net investment income earned abroad, plus net private and government transfers. 3. capital-account transactions focus on changes in the ownership of real and financial assets.

Open markets will also lead to gains from what 3 other sources? Explain.

1. More gains from large-scale production. International trade makes it possible for both domestic pro- ducers and consumers to derive larger gains from the lower per-unit costs that often accompany large-scale production, marketing, and distribution activities. 2. Gains from more competitive markets. International trade promotes com- petition and encourages production efficiency and innovation. 3. More pressure to adopt sound institutions. Not only do firms in open economies face more intense competition, so, too, do their governments.

What are two possible ways that exchange rate values may be determined?

the forces of supply and demand will determine the exchange rate value of currencies in the absence of government intervention.

List and describe 3 arguments for trade restrictions.

1.According to the national-defense argument, certain industries—aircraft, petroleum, and weapons, for example—are vital to a nation's defense. 2. Infant-industry advocates believe that new domestic industries should be protected from foreign competition for a period of time so that they will have a chance to develop. 3. THE ANTIDUMPING ARGUMENT Dumping involves the sale of goods by a foreign firm at a price below cost or below the price charged in the firm's home-base market.

Why are trade restriction arguments politically attractive? (Summarize the Murray Weidenbaum quote.)

: "Protection- ism is a politician's delight because it delivers visible benefits to the protected parties while imposing the costs as a hidden tax on the public."

What are the three major types of exchange rate regimes?

: (1) flexible rates; (2) fixed rate, uni- fied currency; and (3) pegged exchange rates.

What choices does a country have? What can it not do?

A country can either (1) follow an independent monetary policy and allow its exchange rate to fluctuate or (2) tie its monetary policy to maintain the fixed exchange rate.

When is a currency said to be strong? When is a currency said to be weak?

A currency is said to be strong when it has been appreciating in value, whereas a weak cur- rency is one that has been depreciating on the foreign exchange market.

What is a flexible exchange rate system? What is an alternative name for this?

A pure flexible exchange rate system is one in which market forces alone deter- mine the foreign exchange value of the currency.

Describe what a pure gold standard system is like.

A pure gold standard system, in which each country agrees to exchange units of its domestic currency for gold at a designated price and fully backs its domestic money sup- ply with gold, is also a fixed rate, unified system.

What is a tariff?

A tariff is a tax on imports from foreign countries.

What differs across countries which influences the costs at which various goods and services can be produced?

Absolute exchange, where one can produce more of a good than another nation

According to the title page quote, what is an exchange rate?

An exchange rate is the price of one currency in terms of another.

What is an import quota?

An import quota, like a tariff, is designed to restrict foreign goods and protect domes- tic industries from foreign competition.

Will democratic political frameworks tend to implement sound economic policies? Why or why not?

And there is no assurance that the gains of the winners will be greater than the costs imposed on the losers.

What does it mean if the U.S. dollar appreciates? If it does, what happens to the foreign currency?

Appreciation An increase in the value of a currency relative to foreign currencies. An appreciation increases the purchasing power of the currency over foreign goods.

In the Foreign Exchange Market, for what two main reasons would foreigners supply a foreign currency (in exchange for the U.S. dollar)?

As the dollar depreciates (movement up the vertical axis), foreigners buy more from Americans and supply more foreign currency in exchange for dollars. The supply curve for foreign currency therefore slopes upward to the right.

Of what is the "current account" comprised?

Balance on current account The import-export balance of goods and services, plus net investment income earned abroad, plus net private and government transfers.

Is the U.S. running a capital account deficit, balance or surplus?

Because the capital inflow exceeded the outflow, the United States ran a $490.4 billion capital-account surplus in 2015.

Between 1944 and 1971, what type of system did most of the world operate under? Explain. How was it maintained?

Between 1944 and 1971, most of the world operated under a system of fixed exchange rates, where each nation fixed the price of its currency relative to others. maintained by reserves with the International Monetary Fund (IMF), which could be drawn on when payments to foreigners exceeded receipts from them.

What is meant by "managed"?

But the system is also "managed" because the major industrial nations have from time to time attempted to alter supply and demand in the foreign exchange market by buying and selling various currencies.

What factors will cause a nation's currency to appreciate?

CHANGES IN INCOME DIFFERENCES IN RATES OF INFLATION CHANGES IN INTEREST RATES - Thus, increases in real interest rates relative to a nation's trading partners will tend to cause that nation's currency to appreciate. CHANGES IN THE BUSINESS AND INVESTMENT CLIMATE

Of what is the "capital account" comprised?

Capital account The record of transactions with foreigners that involve either (1) the exchange of ownership rights to real or financial assets or (2) the extension of loans.

What are some key import categories for the U.S.?

Capital goods like automobiles, computers, semiconductors, telecommunications equipment, and industrial machines are bought and sold in worldwide markets.

Which countries are the leading trading partners of the U.S.?

China, Canada, Mexico, and Japan are the four largest trading partners of Americans.

In what way does the balance of payments have to balance?

Current-Account Balance 1 Capital-Account Balance 1 Official Reserve-Account Balance 5 0

What does it mean if the U.S. dollar depreciates? If it does, what happens to the foreign currency?

Depreciation A reduction in the value of a currency relative to foreign currencies. A depreciation reduces the purchasing power of the currency over foreign goods.

What has been the history of tariffs in the U.S. since 1890?

During the past 80 years, however, tariff rates in the United States have declined substan- tially. In 2015, the average tariff rate on imported goods was only 4.9 percent.

"Economic Freedom" is a method of organizing economic activity characterized by what factors?

Economic freedom Method of organizing economic activity characterized by (1) personal choice, (2) voluntary exchange coordinated by markets, (3) freedom to enter and compete in markets, and (4) protection of people and their property from aggression by others

Why do fallacies about international trade persist?

Failure to consider the secondary effects of international trade is part of the answer. Key elements of international trade are closely linked; you cannot change one element without changing the other.

Is institutional change possible? What are three reasons given for why positive institutional change can be possible?

First, the colonial era is over, they can now make their own institutional and policy choices.Second, the collapse of communism has also expanded the opportunity for institutional change. Third, and perhaps most important, substantial reductions in transportation and communication costs have increased the importance of institutions and policies.

What is the WTO? What resulted?

Following 1993, GATT was given a new name: the World Trade Organization (WTO). This organization of 162 countries is now responsible for monitoring and enforc- ing the trade agreements developed through GATT.

What are some notable observations from the list of EFW Index ratings given in the text?

It also must keep taxes low, refrain from creating barriers to both domestic and international trade, and rely more fully on markets rather than governments to allocate goods and resources.

What is the foreign exchange market?

Foreign exchange market The market in which the currencies of different countries are bought and sol

What is GATT? What resulted?

General Agreement on Tariffs and Trade (GATT) An organization formed after World War II to set the rules for the conduct of international trade and reduce trade barriers among nations.

What is the expected impact of this trend in the U.S.?

If the United States continues to follow policies restrictive of economic freedom, it can expect to grow at a slower rate in the years ahead.

During 1800-1980, what was occurring among countries?

In 1800, the wealthy nations of the world had income levels five or six times those of poor countries, but by 1980, the income levels in the world's richest countries were 30 or 40 times those present in the less- developed world. Thus, during 1800-1980, worldwide income inequality increased decade after decade.

What happened in 1997-1998 in Brazil, Thailand and Indonesia?

In 1997-1998, much the same thing happened in Brazil, Thailand, and Indonesia. Like Mexico, these countries sought to maintain fixed exchange rates (or rates within a narrow band), while following monetary and fiscal policies that were inconsistent with the fixed rate.

Is the U.S. running a current account deficit, balance or surplus?

In 2015, the United States ran a current-account deficit of $484.1 billion.

The demand for a foreign currency originates from what?

In our two-country world, the demand for pounds in the exchange rate market originates from the purchases by Americans of British goods, services, and assets (both real and financial).

Do the countries in a unified currency regime with the U.S. dollar conduct their own monetary policy?

Instead, they merely accept the monetary policy of the nation to which their currency is tied

What happened in Mexico during 1989-1994?

Mexico during 1989-1994. Mexico promised to exchange the peso for the dollar at a pegged rate, but it also expanded its domestic money supply much more rapidly than the United States. I

How is it that the U.S. has a unified currency regime with some other countries?

Obviously, the 50 states of the United States have a unified currency, the dollar. In addition, the U.S. dollar has been the official currency of Panama for more than a century. Ecuador adopted the U.S. dollar as its official currency in 2000, and El Salvador did so in 2001.

What is the official reserve account?

Official reserve account The record of transactions among central banks.

What method do economists generally prefer to use to compare incomes across countries?

Purchasing power parity (PPP) method Method in which the relative purchasing power of each currency is determined by comparing the amount of each currency required to purchase a common bundle of goods and services in the domestic market. This information is then used to convert the GDP of each nation to a common monetary unit like the U.S. dollar

What has the Chinese economy experienced since 1980? Explain.

Since 1980, China has been the world's fastest-growing economy.

What has been the trend since 1980?

Since 1980, the trend toward inequality has reversed. Worldwide, income inequality is now declining.

How can a country use exchange rate controls as a trade restriction?

Some countries fix the exchange rate value of their currency above the market rate and impose restrictions on exchange rate transactions.

Cost reductions in what areas have spurred increases in international trade?

Spurred by cost reductions in transportation and communications, the volume of international trade has grown rapidly in recent decades.

According to the book "Why Nations Fail", what do successful nations do? Why do nations fail?

Successful nations adopt institutions and policies that limit the power of political leaders, provide secure property rights, and permit open markets—all of which encourage trade, innovation, and entrepreneurship. In contrast, nations fail when their institutions and policies are "extractive," when they allow the politi- cally powerful to take resources and income from others.

Use an exchange rate to determine the price of a foreign good in terms of a domestic currency.

Suppose the exchange rate is $1.50 = 1 pound and that you decide to buy 200 pairs of athletic shoes from the British manufacturer at 30 pounds ($45) per pair. You will need 6,000 pounds in order to pay the British manufacturer.

What are the three most commonly used trade restriction devices?

Tariffs, quotas, and exchange rate controls are the most commonly used trade-restricting devices.

What are some examples of currencies?

The British use pounds; the Japanese, yen; the Mexi- cans, pesos; nineteen European countries, the euro; and so on.

Explain the political realities of trade restrictions.

The U.S. tariff code itself is a reflection of the politics of trade restrictions. It is both lengthy (the schedule fills 3,151 pages) and highly complex.

What are some goods that the U.S. currently imposes a quota on?

The United States imposes quotas on several products, including brooms, shoes, sugar, dairy products, and peanuts.

What does the balance of payments summarize?

The balance of payments summarizes the transactions of the country's citizens, businesses, and governments with foreigners.

What is a unified currency regime? What is its distinguishing characteristic?

The distinguishing characteristic of a fixed rate, unified currency regime is the presence of only one central bank with the power to expand and contract the supply of money.

Why do people engage in international trade?

The expectation of gain provides the answer. If both parties did not expect to gain, they would not agree to the exchange.

What is the relationship of current account movements and net capital inflow movements?

The link between the inflow of capital and the current-account deficit is clearly visible. As the middle and lower panels illustrate, the two are mirror images. When the inflow of capital increases, the current-account (trade) balance shifts toward a deficit.

Is a trade deficit necessarily bad? Is a net inflow of capital a good or bad thing? Explain.

Trade deficits are not necessarily bad. Countries that grow rap- idly and follow policies that investors find attractive will tend to experience an inflow of capital and a trade deficit.

What has been the general trend throughout the world during recent decades?

The world is starting to have a higher econmic freedom of the world rating

In the Foreign Exchange Market, for what two main reasons would Americans demand a foreign currency?

This will make it cheaper for Americans to purchase things from foreigners. Thus, we say that the dollar has appreciated, meaning that it will now buy more foreign goods than it previously could.

Summarize some real-world considerations.

To keep things simple, we ignored the potential importance of transportation costs, which, of course, reduce the potential gains from trade. Sometimes transportation and other trans- action costs, both real and artificially imposed, exceed the potential for mutual gain. In this case, exchange does not occur.

What complicates trade across national boundaries?

Trade across national boundaries is complicated by the fact that nations generally use different currencies to buy and sell goods in their respective domestic markets.

What are the clear implications of the law of comparative advantage?

Trade between nations will lead to an expansion in total output and mutual gain for each trading partner when each country specializes in the production of goods it can produce at a relatively low cost and uses the proceeds to buy goods that it could produce only at a high cost.

Define a trade deficit. Typically, a trade deficit will be associated with what flow of capital?

Trade deficit The situation when a country's imports of goods and services are greater than its exports.

Define a trade surplus. Typically, a trade surplus will be associated with what flow of capital?

Trade surplus The situation when a country's exports of goods and services are greater than its imports.

What challenges arose that led to the demise of the system?

Under this fixed exchange rate regime, nations often imposed tariffs, quotas, and other trade barriers in an effort to keep their payments and receipts in balance at the fixed rate. Various restrictions on the convertibility of currencies were also common. These problems eventually led to the demise of the system.

What has been happening in Venezuela since 2003? What is resulting?

Venezuelans need foreign currency to purchase goods and services from foreigners, and when they are unable to obtain it because of the controls, they often turn to the black market

Trade deficits (current account deficits) are associated with what condition of the capital account?

When foreigners are making more "investments" in a country than the residents of the country are making abroad, a capital account surplus will occur. In turn, the capital account surplus generally leads to a trade (and current account) deficit. In essence, trade (and current-account) deficits are the flip side of capital inflows.

Why is international trade a key to economic prosperity?

When people are permitted to engage freely in international trade, they are able to achieve higher income levels and living standards than would otherwise be possible.

Are all rich countries getting richer and all poor countries getting poorer by comparison?

When you think about it, the rapid growth of LDCs with a low initial income should not be surprising. When low-income countries establish sound institutions and policies, they actually have an advantage. The low-income economies can copy or emulate ideas and technologies that have been successful in the high-income countries.

Does free trade with low-wage countries like Mexico and China reduce the wages of Americans? Explain.

Workers in the United States generally are well educated, possess high skill levels, and work with large amounts of capital equipment. These factors contribute to their high productivity, which is the source of their high wages.

What type of regime will not? Why?

a pegged exchange rate regime is something like a time bomb. Pushed by political considerations, monetary policy makers in most countries are unable to follow a course consistent with the maintenance of pegged rates.

What does maintaining a pegged rate do to monetary policy options?

adopting the pegged exchange rate continue to conduct mon- etary policy. Thus, an excess of purchases from foreigners relative to sales to them does not automatically force the country to reduce its domestic money supply.

What types of regimes will work reasonably well?

ains from trade, and retard economic progress. Both economic theory and real-world experience indicate that either a purely flexible exchange rate regime or a fixed rate, unified regime with a single central bank will work reasonably well.

When domestic producers can supply a good more cheaply than foreign competitors, do exports or imports result?

exports

How does it differ from the currency board approach?

countries adopting the pegged exchange rate continue to conduct mon- etary policy. T

What point is made about countries' histories during the colonial era?

during the colonial era exerted a major impact on the evolution of its institutions. Researchers have found that countries with colonial settlers who planned on staying were likely to develop sound institutions and policies.

How else (than tariffs or quotas) can governments restrain foreign competition?

governments sometimes use regulations and political pressure to restrain foreign competition.

According to the title page quote, what has the massive increase in international trade fostered?

has fostered markedly higher standards of living for almost all countries who have participated in cross-border trade.

When domestic producers are more expensive than foreign competitors at supplying a good, do exports or

imports

In order to achieve a high Economic Freedom of the World (EFW) Index rating, what must a country do?

in order to achieve a high EFW rating, a country must provide secure protection of privately owned property, evenhanded enforcement of contracts, and a stable monetary environment.

What types of groups can gain from specialization and exchange?

individuals, regions, or nations

Do economies that are more open perform better? (Applications in Economics) Explain.

more detailed statistical analysis indicates that even after the differences in other factors such as legal system, geography, climate, inflation, and initial income level are taken into account, trade openness continues to have a strong positive impact on both per capita GDP and growth rates.

What is another system described in the text that has a unified currency regime?

neteen countries of the European Union—Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, and Spain—have also established a unified cur- rency regime. The official currency in each of these countries is the euro.

What factors will cause a nation's currency to depreciate?

opposite of appreciating

The supply of a foreign currency originates from what?

orrespondingly, the supply of foreign exchange (pounds in our two-country case) originates from sales by Americans to foreigners.

What is a pegged exchange rate system?

pegged exchange rate system is one in which a country commits itself to the maintenance of a specific exchange rate (or exchange-rate range) relative to another cur- rency (like the U.S. dollar) or a bundle of currencies.

How often do exchange rates change relative to the U.S. dollar?

the exchange rate between currencies changes from day to day and even from hour to hour.

Define comparative advantage.

the ability of an individual or group to carry out a particular economic activity (such as making a specific product) more efficiently than another activity.

What has been the direction of economic freedom in the United States in recent years?

the summary EFW rating of the United States fell from 8.7 in 2000 to 7.7 in 2013, a reduction of one full unit. By 2013, the U.S. ranking had fallen to sixteenth, down from the third place position it occupied in 2000. Several factors contrib- uted to the decline in the U.S. rating. Government spending on both consumption and trans- fer payments was higher in 2013 than in 2000, pushing the ratings for these components down. The rating in the legal system and protection of property rights area also declined sub- stantially during the past decade. Non-tariff trade barriers, perhaps the result of increasing cost of meeting heightened security standards, have risen in recent years.

Do trade restrictions that limit imports save jobs and expand employment? Explain.

they are likely to foster employment in the industries shielded from competition. But this is only half of the story: Simultaneously, jobs in other domestic sectors will be destroyed. Here's how: When trade barriers reduce the amount of goods Americans buy from foreigners, sales to foreigners will also fall.

What has happened to the volume of U.S. imports and exports as a % of GDP in recent decades?

tor of the United States has grown rapidly during the last several decades. In 1960, total exports of goods and services accounted for 5.0 percent of the U.S. economy, whereas imports summed to 4.2 percent.

According to Henry George, what are trade restraints?

trade restraints act like blockades.