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CFA: Level 1 > Economics: Economics in a Global Context > Flashcards

Economics: Economics in a Global Context Flashcards

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1
Q

Int’l Trade/Cap Flows: GNP & GDP

A
  • 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
  • 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

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2
Q

Int’l Trade/Cap Flows: Benefits/Costs of International Trade

A

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

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3
Q

Int’l Trade/Cap Flows: Absolute vs. Comparative Advantage

A

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
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4
Q

Int’l Trade/Cap Flows: Absolute vs. Comparative Advantage - Example

A
  • 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
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5
Q

Int’l Trade/Cap Flows: Models of Trade

A

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
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6
Q

Int’l Trade/Cap Flows: Heckscher-Ohlin Model

A
  • 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
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7
Q

Int’l Trade/Cap Flows: Trade Restrictions

A
  • 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
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8
Q

Int’l Trade/Cap Flows: Effects of Tariffs and Quotas

A
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9
Q

Int’l Trade/Cap Flows: Reasons for Trade Restrictions

A

Two primary goals:

  1. Protecting domestic jobs
  2. 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
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10
Q

Int’l Trade/Cap Flows: Trade Restrictions

A
  • 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
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11
Q

Int’l Trade/Cap Flows: Capital Restrictions

A
  • 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
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12
Q

Int’l Trade/Cap Flows: Trading Blocs, Common Markets, and Economic Unions

A
  • 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
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13
Q

Int’l Trade/Cap Flows: Trading Blocs

A

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)
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14
Q

Int’l Trade/Cap Flows: BOP Accounts

A
  • 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.

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15
Q

Int’l Trade/Cap Flows: BOP Influences

A

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
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16
Q

Int’l Trade/Cap Flows: IMF and World Bank

A
  • International Monetary Fund (IMF)
    1. Monetary cooperation
    2. Growth of trade
    3. Exchange stability
    4. Multilateral system of payments
    5. Overcome temporary BOP difficulties
  • World Bank
    1. Fight poverty
    2. Development and assistance
  • World Trade Organization
    1. Enforce global rules of trade
    2. Ensure trade flows smoothly and freely
    3. Dispute settlement process
    4. Multilateral trading system – agreements
17
Q

Exchange Rates: ForEx Quotations

A
18
Q

Exchange Rates: Example: Real Exchange Rate

A
19
Q

Exchange Rates: Spot Market vs. Forward Market

A

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)

20
Q

Exchange Rates: Market Participants: Hedgers and Speculators

A

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

21
Q

Exchange Rates: Market Participants: Sell/ Buy Side

A

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)
22
Q

Exchange Rates: Currency Appreciation or Depreciation

A
23
Q

Exchange Rates: Cross Rates Example

A
24
Q

Exchange Rates: Forward Quotes - Point Basis

A
25
Q

Exchange Rates: Forward Quotes- Percentage Basis

A
26
Q

Exchange Rates: No-Arbitrage ForEx Rate

A
  • Follow the Numerator-Denominator rules: Given a quote A/B, use A’s interest rate in numerator and B’s interest rate in denomination
27
Q

Exchange Rates: No-Arbitrage Forward Rate - Example

A
28
Q

Exchange Rates: ForEx Rate - Problem

A
29
Q

Exchange Rates: Exchange Rate Regimes – No Sovereign Currency

A

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

30
Q

Exchange Rates: Exchange Rate Regimes - Sovereign Currency

A

Countries with sovereign currency

  1. Currency board: Commits to a fixed rate of exchange of domestic for a foreign currency
  2. Convential fixed peg: Maintain at pegged rate (+/- 1%( via direct intervential in the FX markets or indirectly via monetary policy changes
  3. Target zone: Gives inflexibility to maintain the exchange rate within a wider range (e.g. +/- 2%)
  4. Crawling peg: Allows exchange rate to move slowly with changes in fundamentals
    1. Active: Announced and implemented
    2. Passive: Managed but not market driven
  5. Managed floating: Does not have a target exchange rate; influences exchange rate through direct intervention or monetary policy
  6. Independently floating: Market determines
31
Q

Exchange Rates: Exchange Rates, Trade, and Capital

A

(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

32
Q

Exchange Rates: Exchange Rate and Trade Deficit

A
33
Q

Exchange Rates: Exchange Rate and Trade Deficit: J-Curve Effect

A

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
34
Q

Exchange Rates: Exchange Rate and Trade Deficit: Absorption Approach

A

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.
35
Q

Exchange Rates: Currency Depreciation Effect - Problem

A

CFA: Level 1 (18 decks)

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