Thursday, May 9, 2013

Unit 7

Unit 7
Balance of payments
  • measure of money inflows and outflows between the U.S. and the world
    • Inflows are referred to as credits
    • Outflows are referred to as debits
  • divided into:
    • Current account
    • capital / financial account
    • official reserve account
Double Entry Bookkeeping
  • every transaction in the balance of payments is recorded twice in accordance with standard accounting practice
    • Ex: U.S. manufacturer, John Deere, exports $50 million worth of farm equipment to Ireland
      • Credit of $50 million to current account
      • Debit of $50 million to capital/financial account
      • balances equal each other
Current Account (Net investments and transfers)
  • balance of trade or Xn (balance on goods and services)
    • exports(inflow/credit) - imports(outflow/debit)
  • Net Foreign Income
    • income earned by U.S. owned foreign assets - Income paid to foreign held U.S. assets
    • Ex: Interest payments on U.S. owned Brazilian bonds - Interest payments on German owned U.S. treasury bonds
  • Net transfers (tend to be unilateral)
    • foreign aid = a debit to the current account
    • Ex: Mexican immigrant workers send money to family in Mexico
Capital/ Financial Account (Stocks and bond, assets)
  • Balance of capital ownership
  • Includes purchase of real and financial assets
  • Direct investment in the U.S. us a credit to the capital account
    • Ex: Toyota factory in San Antonio
  • Direct investment by U.S. firms/ individuals in a foreign country are debits to the capital account
    • Ex: Intel factory in San Juan, Costa Rica
  • Purchase of foreign financial assets represents a debit to the capital account
    • Ex: Warren Buffet buys stock in Petrochina
  • Purchase of domestic financial assets by foreigner's represents a credit to the capital account
    • The United Arab Emirates sovereign wealth fund purchase a large stake in the NASDAQ
What causes Capital/Financial Flow?
  • Differences in rates of return on investment
  • Ceteris Paribus, savings will flow toward higher return

Relationship Between Current and Capital Account
  • The current account and capital account should zero each other
  • If current account has a negative balance(deficit), capital account should have a positive balance(surplus)
Official Reserves
  • foreign currency holding of U.S. Fed Reserve System
  • When there is a balance of payments surplus the Fed accumulates forgeign currency and debits the balance of paymetns
  • When there is a balance of payments defivit the Fed depletes its reserves of foreign currency and credits the balance of payments
  • The official reserves zero out balance of payments
Credits
  • additions to a nation's account
Debits
  • subtractions to a nation's account
How to calculate the following:
  1. Balance on trade: goods and service exports - goods and service imports
  2. Trade deficit occurs when the balance on trade is negative (imports > exports). Trade surplus occurs when the balance on trade is positive (Exports > Imports)
  3. Balance on current account: Balance on trade (Exports and Imports) + Net Investment Income + Transfer payments
  4. Official Reserves: Change in Current Account - Change in Capital Account + Change in Official Reserves = 0
Foreign Exchange
  • The buying and 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 rate(e) is determined in the foreign currency markets
    • Ex: The current exchange rate is approx. 77 Japanese Yen to 1 U.S. dollar
  • The exchange rate is the price of a currency
  • Do not try to calculate the exact exchange rate
Changes in Exchange Rates
  • Exchange rates(e) are a function of the supply and demand for currency
    • increase in supply of currency will decrease the exchange rate of currency
    • decrease in supply of currency will increase the exchange rate of currency
    • increase in demand of currency will increase the exchange rate of currency
    • decrease in demand of currency will decrease the exchange rate of currency
Appreciation and Depreciation
  • Appreciation of currency occurs when exchange rate of that currency increases
  • Depreciation of currency occurs when exchange rate of the currency decreases
Exchange rates determinates
  • Consumer tastes
  • Relative income
  • Relative price level
  • Speculation (expectation)

  • Demand $- exports and capital inflows. When the U.S. exports goods/services to other countries  they need our $ to complete the transaction. They demand our money. First they need to supply their.
  • Supply $- imports and capital outflows. When we import goods/services from other countries, we need their money to complete the transaction. So we demand their money. We need to supply our money.
Tips
  • Always change D line on one currency graph, the S line on the other currency 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 will increase on the other graph
  • If D moves left, S moves left on the opposite graph
Flexible exchange rate (floating)
  • Set by market forces with little or no government intervention
Fixed exchange rate
  • determined by government policies
Absolute Advantage v. Comparative Advantage
  • Absolute Advantage- faster, more, more efficient
  • Comparative Advantage- lower opportunity cost
  • Same country can have the same absolute advantage with two products
  • Only one country cane have a comparative advantage in one product






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