Economics: Economics in a Global Context Flashcards
Int’l Trade/Cap Flows: GNP & GDP
- Gross Domestic Product (GDP): Value of goods and servies produced in a country
- Gross National Product (GNP): Value of good and servies produced by a country’s citizens
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Differences:
- Income of citizens working abroad, non-citizens working in country
- Income to capital owned by foreigners, foreign capital owned by citizens
GDP is better for measuring domestic activity
Int’l Trade/Cap Flows: Benefits/Costs of International Trade
Benefits:
- Lower cost to consumers of imports
- Higher employment, wages, and profits in export industries
Costs:
Displacement of workers and lost profit in industries competing with imported goods
Economists: Benefits outweigh costs
Int’l Trade/Cap Flows: Absolute vs. Comparative Advantage
Absolute advantage refers to lower cost in terms of resources used
Comparative advantage refers to lower opportunity cost to produce a product
Law of comparative advantage:
- Trade makes all countries better off
- Each country specializes in goods they produce most efficiently and trades for other goods
- Outcome: Increased worldwide output and wealth with no country being worse off
Int’l Trade/Cap Flows: Absolute vs. Comparative Advantage - Example
- Portugal has absolute advantage in both wine and cloth
- England has comparative advantage in cloth, opportunity cost of 100/110 in terms of wind compared to 90/80 opportunity cost in Portugal
- Portugal has comparative advantage in wine, opportunity cost of 80/90 units of cloth compared to 110/100 of cloth in England
- If Portugal specialized in wine production and England specializes in cloth production, both can be better off
- Trade can also product benefits from economies of scale and efficiences resulting from cross-border competition
Int’l Trade/Cap Flows: Models of Trade
Ricardian model
- Labor is the only factor of production
- Comparative advantage depends on relative labor productivity for different goods
Heckscher-Ohlin model
- Two factors of production: capital and labor
- Comparative advantage depends on relative amount of each factor possessed by a country
Int’l Trade/Cap Flows: Heckscher-Ohlin Model
- Under Heckscher-Ohlin model, there is a redistributio of wealth between two factors of production due to international trade
- The price of more abundant resource will increase
- Results in a wealth transfer within a country from scarce resource to abundant resource
Int’l Trade/Cap Flows: Trade Restrictions
- Tariff is a tax impossed on imported goods
- Quota is a limitation on the quantity of goods imported
- Export subsidies are payments by government to domestic exporters
- Minimum domestic content specifies required proportion of product content to be sourced domesticaly
- Voluntary Export restraints (VERs) are agreements by exporting countries to limit the quantity of goods they will export to an importing country
Int’l Trade/Cap Flows: Effects of Tariffs and Quotas
Int’l Trade/Cap Flows: Reasons for Trade Restrictions
Two primary goals:
- Protecting domestic jobs
- Protecting domestic producers
- Other reasons include countering foreign trade restrictions and export subsidies, anti-dumping, and revenues from tariff for domestic government
- A large country could actually decrease the world price by imposing a quota or tariff
Int’l Trade/Cap Flows: Trade Restrictions
- In case of quota, the distribution of gains between the domestic goverment and foreign exporter depends on the amount of quota rent collected by the domestic government
Int’l Trade/Cap Flows: Capital Restrictions
- Restrictions on flow of financial capital
- Outright prohibition
- Punitive taxation
- Restrictions on repatriation
- Restrictions decrease economic welfare
- Short-term benefit for developing countries: reducing volatile capital inflows and outflows
- Long-term costs of isolation from global capital markets
Int’l Trade/Cap Flows: Trading Blocs, Common Markets, and Economic Unions
- Economic welfare is improved by reducing trade restrictions
- Gains from reducing trade restrictions between member countries are offset by losses if bloc increases restriction on non-member countries
Int’l Trade/Cap Flows: Trading Blocs
Free trade area (FTA)
- Removes all barriers of trade between member countries
- Example: NAFTA
Customs Union (CU):
- FTA + common trade restricitons on non-members
Common Market (CM)
- CU + removes barriers to movement of labor and capital among members
Economic Union
- CM + members establish common institutions and economic policiy
Monetary Union
- Economic union + members adopt a common currency (e.g., European Union)
Int’l Trade/Cap Flows: BOP Accounts
- Current account
Merchandise/services purchases, foreign dividends and interest, and unilateral transfers
- Capital Account
Sales/purchases of physical assets, natural resources, intangible assets, debt forgiveness, death duties, and taxes
- Financial Account
Domestic-owned financial assets abroad (official reserve, government, private) and foreign-owned domestic financial assets.
Int’l Trade/Cap Flows: BOP Influences
X - M = private savings + government savings - investment
*X - M is exports minus imports
- An increase (decrease) in private or government savings would improve (worsen) the balance of trade
- A trade deficit due to a decrease in private or government savings is less desirable than trade deficit due to high domestic investment
Int’l Trade/Cap Flows: IMF and World Bank
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International Monetary Fund (IMF)
- Monetary cooperation
- Growth of trade
- Exchange stability
- Multilateral system of payments
- Overcome temporary BOP difficulties
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World Bank
- Fight poverty
- Development and assistance
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World Trade Organization
- Enforce global rules of trade
- Ensure trade flows smoothly and freely
- Dispute settlement process
- Multilateral trading system – agreements
Exchange Rates: ForEx Quotations
Exchange Rates: Example: Real Exchange Rate
Exchange Rates: Spot Market vs. Forward Market
Spot exchange rates: Exchange rates for immediate delivery
Forward contract: An agreement to buy or sell a specific amount of a foreign currency at a future date at the quotes _forward exchange rate _(e.g. 30, 60, 90 days in the future)
Exchange Rates: Market Participants: Hedgers and Speculators
Hedgers
Have an existing FC risk that they want to reduce/eliminate with forward FX contracts
Speculators
Have no existing FX risk
They take on FX risk with forward contracts with the expectation of earning profit
Exchange Rates: Market Participants: Sell/ Buy Side
Sell side
Market makers: Large multinational banks
Buy side
- Corporations
- Investment accounts: Real money and leveraged
- Governments, sovereign wealth funds, pension plans, central bans
- Retail market: Househols (e.g., tourism)
Exchange Rates: Currency Appreciation or Depreciation
Exchange Rates: Cross Rates Example
Exchange Rates: Forward Quotes - Point Basis
Exchange Rates: Forward Quotes- Percentage Basis
Exchange Rates: No-Arbitrage ForEx Rate
- Follow the Numerator-Denominator rules: Given a quote A/B, use A’s interest rate in numerator and B’s interest rate in denomination
Exchange Rates: No-Arbitrage Forward Rate - Example
Exchange Rates: ForEx Rate - Problem
Exchange Rates: Exchange Rate Regimes – No Sovereign Currency
Countries without sovereign currency
Formal dollarization: Uses other country’s currency
**Monetary union: **Several countries use a common currency
Country cannot have its own monetary policy
Exchange Rates: Exchange Rate Regimes - Sovereign Currency
Countries with sovereign currency
- Currency board: Commits to a fixed rate of exchange of domestic for a foreign currency
- Convential fixed peg: Maintain at pegged rate (+/- 1%( via direct intervential in the FX markets or indirectly via monetary policy changes
- **Target zone: **Gives inflexibility to maintain the exchange rate within a wider range (e.g. +/- 2%)
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Crawling peg: Allows exchange rate to move slowly with changes in fundamentals
- Active: Announced and implemented
- Passive: Managed but not market driven
- Managed floating: Does not have a target exchange rate; influences exchange rate through direct intervention or monetary policy
- Independently floating: Market determines
Exchange Rates: Exchange Rates, Trade, and Capital
(X - M) = (Private saving - investment) + (tax revenue - government spenging)
(X - M) > 0, trade surplus when private savings + government surplus exceeds domestic investment
(X - M) < 0, trade deficit when private saving - domestic investmnt is less than budget deficit
Exchange Rates: Exchange Rate and Trade Deficit
Exchange Rates: Exchange Rate and Trade Deficit: J-Curve Effect
J-Curve Effect
In the short run, due to existing contracts, export and import demand are relatively inelastic
- Currency depreciation initially leads to larger trade deficity
In the long run, elasticities increase
- Currency depreciation leads to a reduction in the trade deficit
Exchange Rates: Exchange Rate and Trade Deficit: Absorption Approach
The absorption approach includes the effect of currency depreciation on capital flows as well as trade flows
Exports - Imports = National Income - Expenditures
For depreciation to improve the balance of trade:
- National income must incease relative to expenditures
- National saving (private + government) must increase relative to domestic investment in physical capital.
Exchange Rates: Currency Depreciation Effect - Problem
