7. Aggeragate supply, balance of payments and exchange rates Flashcards
what factors influence short run classical aggeragate supply?
- changes in costs of raw materials and energy
- chages in exhange rates
- changes in tax rates
what factors influence long run classical aggeragate supply ?
- technological advancements
- changes in productivity
- changes in education and skills
- migration / population changes
- changes in government regulations
- competition policy
explain the SRAS and LRAS classical curve diagrams
SRAS looks like a supply curve but more elastic and LRAS is a vertical line
what are the main differences between the Keynesian and Classical perspectives on the macroeconomy?
Keynesian:
- markets can fail
- wages are sticky downwards
- gov spending rises AD and causes growth
Classical:
- markets always clear
- wages adjust smoothly
- gov spending causes inflation and no growth
what does a rise in aggeragate demand mean in the classical model
pure inflation and no economic growth :
AD increases to AD2 but real output stays the same because LRAS is vertical (inelastic) , there is just pure inflation from P1 to P2 because SRAS increased to SRAS2
what is the definition of the balance of payments ?
all the flows of money between the residents of that country and the rest of the world
what are the 3 accounts in the balance of payments ?
- current account (X-M)
- capital account = debt forgiveness, sale/transfer of patents
- financial account = short term capital (hotmoney), investment (shares), FDI
what is an exhange rate?
exchange rate is the value of one currency in comparison to the value of another. The rate at which one countries currency can be exchanged for another.
what is a depreciation ?
a fall in the value of a currency in terms of other currencies due to market forces
what is appreciation ?
a rise in the value of a currency in terms of another currency due to market forces
What is devaluation?
a fall in the value of currency in terms of other currencies due to the policy of a government or central bank e.g. Managed exchange rate
what is revaluation?
a rise in the value of a currency in terms of other currencies due to the policy of a government or central bank e.g. managed exhange rate
Inflows into the balance of payments cause what ?
an increase in the demand for a currency = appreciation
outflows from the balance of payments cause what?
a decrease in demand for a currency = depreciation
how does international trade effect exchange rate?
a rise in exports will cause a rise in demand for the domestic currency because foreign currencies must be exchanged to pay for exports. Vice versa
a rise in imports will cause a decrease in supply of the domestic currency because our currency must be exchanged for foreign currency. Vice versa
how does inward and outward investment effect ER?
inward investment increases demand for domestic currency = appreciation
outward investment caused a decreased supply of domestic currency = depreciation
how do interest rates effect exchange rates ?
- higher interest means savers get more returns, so demand for domestic currency increases. This is called ‘hot money’
how does speculation effect exchange rate?
if speculators believe that the value of a currency is likely to rise in the future they are likely to buy the domestic currency and sell foreign currency = appreciation . VICE VERSA
what would be the effect if the UK have a higher inflation than the rest of the world on exchange rate?
the ER would fall because the currency price would increase and demand would fall.
what deos the acronym SPICED stand for ?
Strong
Pound
Imports
Cheaper
Exports
Dearer
what is the marshal learner condition ?
depreciation will lead to an improvement in the current account so long as the combined PED of X and M is elastic (greater than 1)
what is the J curve effect ?
the short term depreciation is likely to lead to a deterioration in the current account before it starts to improve, if the marshal learner condition is met
in the short run why is the PED for exports and imports inelastic?
firms have agreed contracts so will continue to purchance at the new price. They may also not have substitutes = deterioration in current account
in the long run why is the PED for exports and imports more elastic ?
Imports :
- firms adapt by increasing domestic production and sourcing of products.
- consumers purchase domestic substitutes and change their behavior
Exports :
- exports now appear cheaper in overseas markets causing greater volume of exports and hense the overall total value of exports rises
.
Hence in the long run the total value of exports rise due to proportionally greater volume exports and the total value of imports falls this leads to an improvement in current account
