Absolute and Comparative Advantage

Absolute Advantage 

• individual - exists when a person can produce more of a certain good or service than someone else in the same amount of time
• national - exists when a country can produce more of a goods or service than another country can in the same time period
• faster and more efficient ( time-wise )

Comparative Advantage 

• individual / national - exists when an individual or nation can produce a goods or service at a lower opportunity cost than can another individual or nation
• lower opportunity cost
• production

- lower opportunity cost is GOOD

Purchasing Power Parity

• when currency rates are set by international markets, changes will be based on neutral purchasing power of currencies
• U.S. $ to European Euro is 1.5 : 1
• each $1.50 will buy 1euro, however if an item in the U.S. cost $1.50 and then cost more / less than 1euro, the parity is lost
• markets will adjust quickly in floating rates, or pressure for change will occur in fixed rates

Reasons we Exchange Currencies

1. to sell export and buy imports
2. to invest in another country's stocks and bonds
3. build stories or factories in another country
4. speculate on currency values
5. to hold currencies in bank accounts for future exports / imports/ business loans
6. control excessive imbalances

Foreign Exchange ( FOREX )

• buying / selling of currency
• ex : in order to purchase souvenirs in France, 1st recession for American to sell ( supply ) their dollar and buy ( demand ) Euros
• exchange rate is determined in the foreign currency markets
• ex : currency exchange rate is approximately 77 yen to 1 U.S. dollar
• simply put, exchange rate is price of currency
• do not try to calculate exact exchange rate
• ALWAYS change the demand line on one currency graph, the supply line on the other economy's graph
• MOVE the lines on the two currency graphs in the same direction ( R or L ) and you will have the correct answer
• IF demand on the other graph increases, supply on the other will also increase
• IF demand moves to the L, supply will move to the L on the other graph

Changes in Exchange Rates

• exchange rates are a function of the supply and demand for currency
• increase in supply of currency will make it cheaper to buy one unit of the currency
• decrease in supply of currency will make it more expensive to buy one unit of that currency
• increase in the demand of currency will make it more expensive to buy one unit of that currency
• decrease in the demand of currency will make it cheaper to buy one unit of that currency

Appreciation

• appreciation of a currency occurs when the exchange rate of that currency increases
• hypothetically : 100 Yen used to buy $1, now 200 Yen to buy $1
•  dollar is "stronger" because one buys more Yen than it used to

Depreciation

• depreciation of currency occurs when the exchange rate of that currency decreases
• hypothetically : 100 Yen used to buy $1, now 50 Yen buys $1
• dollar is weaker because it takes fewer Yen to buy $1

- extra -

• Supply of money : comes from U.S. citizens, banks, and industries wanting to purchase government investments and assets
• making transfer payments to foreigners
• Demand of money : comes from foreigners making transfer payments to the U.S.

Dollar Appreciation :

• each dollar gets you more of the other currency
• U.S. exports gets more expensive for foreigners
• U.S. imports gets cheaper for us
• dollar leaving U.S.
• exports decrease
• imports increase
• Net exports decrease
• GDP decreases
• demand of dollar increases
• supply of dollar decreases

Dollar Depreciation :

• each dollar gets you less of the other currency
• less of foreign currency is needed to get dollar
• exports increase
• imports decrease
• money either enters U.S. :
• Net exports increase
• GDP increase
• Demand of dollar decreases
• Supply of dollar increases

On the Graph, it is inverse between demand and supply, but they move in the same direction between increase or decrease.

Balance of Payments ( 2 )

Assets or CREDITS ( + ) , Demand for $ , "Inflows"

• Current Accounts :
• Balance on Goods and Services
• Net Exports ( Xn )
• Balance of Trade
• Exports ; tourism Here ( ex : Disney World )
• Net Investments
• interest / dividend payments foreigners paid to U.S. for the use of exported capital
• Net Transfers
1. Aid to U.S.
2. Transfer back to U.S.
3. Royal ties 
• ex : wrote a song, but other people use it ( copyright )
• Capital / Financial Accounts :
1. Capital / Inflows
2. Direct investment in the U.S. by foreigners
3. Purchase of stocks and bonds by foreigners

• Official Reserves
1. Currencies
2. IMF ( international monetary funds ) Holdings
3. Gold

Liabilities or DEBITS ( - ) , Supply of $ , "Outflows"

• Current Accounts :
• Balance on Goods and Services
• Net Exports ( Xn )
• Balance of Trade
• Imports ; tourism There ( ex : Paris )
• Net Investments
• interest / dividend payments the U.S. made for the use of foreign capital invested in the U.S.
• Net Transfers
1. Aid to Them
2. Remittance from the U.S.
3. Their Royalties
• Capital / Financial Accounts :
1. Capital / Outflows
2. Direct investment in the U.S. over There
3. Purchase of stocks and bonds by the U.S.

• Official Reserves
1. Currencies
2. IMF ( international monetary funds ) Holdings
3. Gold

Balance Trade :

• goods and service EXPORT - goods and service IMPORT

Trade Deficit when balance on trade is negative :

• more import than export

Trade surplus occurs when balance of trade is positive :

• more export than import

Current Account :

• balance of trade + net investment + net transfer

Capital Account :

• foreign purchase of you country's asset + your country's purchase of assets abroad

Official Reserves ( ALWAYS POSITIVE )

• Current Account + Capital Account

Balance of Goods and Service :

• goods import + services import

Balance of Trade :

• goods export + goods import

Balance of Payments

• measure of money inflows and outflows between U.S. and Rest of the World ( ROW )
• system of accounting used for international trade
• credit ( in ) and debit ( out )
• inflow ( adding ) and outflow ( subtracting ) from account

3 Accounts

1. Current Account
2. Capital / Financial Account
3. Official Reserves Account

Double Entry Bookkeeping

• every transaction in the balance of pavements is recorded twice in accordance with standard accounting practice
• ex : always = 0 ; offset each other and should = 0 ( theoretically )
• ex : John Deere export $ 50 million
• credit $ 50 million to current account
• debit $ 50 million to capital / financial account

Current Account

• balance of trade or net exports
• exports of goods and services - imports of goods and services
• exports create a credit to balance of payments
• imports create a debit to balance of payments
• Net Foreign Income
• income earned by U.S. owned foreign assets - income paid to foreign held U.S. assets
• ex : interest payment to U.S. owned Brazilian bonds - interest payment to German owned U.S. Treasury bonds
• Net Transfer ( tend to be unilateral )
• foreign aid → a debit to the current account
• ex : Mexican migrant workers send money to family in Mexico

Capital / Financial Account

• balance of capital ownership
• includes purchase of both real and financial assets
• direct investment in U.S. is 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 Jose, Costa Rica
• Purchase of Foreign financial assets represent debit of capital account
• ex : Warren Buffet buys stocks in Petrochina
• Purchase of domestic financial assets by foreigners represent a credit to the capital account
• ex : United Arab Emirates Sovereign Wealth Fund purchases a large stake in NASDAQ

Relationship between Current and Capital Account?

• Current and Capital Account MUST = 0 ( or cancel each other out )
• if the current account has a negative balance ( deficit ) , then the capital account should then have a positive balance ( surplus )
• ex : the constant net inflow of foreign financial capital to the U.S. ( capital account surplus ) is what enables us to import more than when we export ( current account deficit )

Official Reserves ( encompassing gold and reserves )

• foreign currency holdings of the U.S. Federal Reserves System
• when there is a balance of payments surplus the FED accumulates foreign currency and debits the balance of payments
• when there is balance of payments deficit the FED depletes its reserves of foreign currency and credits the balance of payments

Active v.s. Passive Official Reserves

• U.S. is passive in its use of official reserves
• it does not seek to manipulate the dollar exchange rate
• the People's Republic of China is active in its use of official reserves
• it actively buys and sells dollars in order to maintain a steady exchange rate with the U.S.

Economic Growth and Productivity ( 2 )

• Economic Growth Defined
• sustained increase in real GDP over time
• sustained increase in real GDP per capita over time
• Why Grow?
• growth leads to greater prosperity for society
• lessens the burden of scarcity
• increases the general level of welbeing
• Conditions for Growth
• Rule of Law
• Sound Legal and Economics Institutions
• Economic Freedom
• Respect for Private Property
• Political and Economic Stability
• low inflationary expectations
• Willingness to sacrifice current consumption in order to grow
• Saving
• Trade
• Physical Capital
• tools, machinery, factories, infrastructure
• physical capital is the product of investment
• investment is sensitive to interest rates and expected rates of return
• it takes capital to make capital
• capital must be maintained
• Technology and Productivity
• research and development, innovation and invention yield increases in available technology
• more technology in the hands of the workers increases productivity
• productivity is out per worker
• more productivity = economic growth
• Human Capital
• people are a country's most important resource, therefore human capital must be developed
• education
• economic freedom
• the right to acquire private property
• incentives
• clean water
• stable food supply
• access to technology
• Hindrances to Growth
• Economic and Political Instability
• high inflationary expectations
• abscence of the Rule of Law
• diminished private property rights
• negative incentives
• welfare state
• lack of savings
• excess current consumption
• failure to maintain existing capital
• Crowding Out of Investment
• government deficits and debt increasing long term interest rates
• increased income inequality
• Populist policies
• restrictions on Free International Trade

Supply - Side Economics

• Supply - Side Economists tend to believe that the AS curve will determine levels of inflation, unemployment, and economic growth
• to increases economy, you take actions to  shift the AS curve to the right, always benefiting the company first
• focus on marginal tax rates
• Marginal Tax Rates - the amount paid on the last dollar earned or on each additional dollar
• believe that if reduce marginal tax rate, it would encourage more people to work longer in which they would forgo their leisure time for extra income
• lower taxes are incentives for businesses to invest in our economy
• lower taxes are incentives for people to increase savings and therefore create lower interest rats for increases in business investment
• Reaganomics ( another name for Supply - Side Economics )

Laffer Curve - trade - off between tax rates and government revenue

• used to support Supply - Side argument
• tax revenue increases from 0 to some max level then declines as tax rates increase from 0 then.... ( it's a cycle )
• opportunity cost, choose best option to go for

1. research suggest that the impact of tax rates on incentives to work, save, and invest are small
2. tax cuts also increase demand, which can fuel inflation, which will cause demand to exceed supply
3. where the economy is actually located on the curve is difficult to determine

Reaganomics - used to get out of recession

• lower marginal tax rates to get U.S. out of a recession led to a deficit
• Clinton raised marginal tax rate, led to surplus

Phillips Curve

- relationship between unemployment and inflation
- tradeoff only occurs in the short run ( time too short to adjust to price level )

• Long Run PC ( Phillips Curve )
• occurs at natural rate of unemployment
• represented by a vertical line
• no trade off between unemployment and inflation
• only shifts if LRAS curve shift
• major assumptions is that more worker benefits creates more natural rate and lower worker benefits creates natural rate

3 Types of Natural Unemployment ( FE)

1. Structural, need update
2. Frictional, in between jobs
3. Cyclical, only available at certain seasons

-Cyclical NOT because the economy fluctuates, not natural

Short Run PC

• relevance to Okun's Law
• inverse relationship between unemployment and inflation rate
• inflation ↓ unemployment ↑
• inflation ↑ unemployment ↓
• high inflation = low unemployment
• low inflation = high unemployment
• aggregate supply shocks can cause both rate of inflation and unemployment to increase

Supply Shocks

• rapid and significant increase in resource cost, which will cause SRPC to shift
• wages are stick, inflation changes, moves points on SRPC
• if inflation persists and expected rate of inflation rises, then entire SRPC moves upward, which creates a situation called stagflation
• if inflation expectations drops due to new technology, then SRPC will move downward

Stagflation, high unemployment AND high inflation simultaneously

• BIG PROBLEM

Misery Index

• combination of inflation and unemployment in a given year
• single digit misery is good

Inflation = 2 - 3 %

Unemployment = 4 - 5 %

- these are good percentages

Long Run Phillips Curve ( LRPC )

• because LRPC exists at the natural rate of unemployment, structural changes in the economy that affect unemployment, will also cause LRPC to shjift
• increase in natural unemployment, shift →
• decrease in natural unemployment, shift ←

Phillips Curve relating to AD / AS

• changes in AD / AS can also be seen in Phillips Curve
• easy way to understand how changes in AD / AS affect Phillips Curve is to think of the two sets of graphs as mirror images
• 2 models are not equivalent, AD / AS model is static, but Phillips Curve includes changes over time whereas AD / AS shows one time changes in price level as inflation / deflation
• Phillips Curve illustrates continuous change in price level as either increase inflation / deflation

Increase AD = up / left movement SRPC

Stagflation - situation where you have high inflation and high unemployment at the same time

Disinflation - reducing in inflation value from year to year, which is usually displayed in LRPC

- decrease in inflation rate

- occurs when AD declines

- in SRPC, profits fall and unemployment rate increases

Deflation - actual drop in the price level

SRPC meet with LRPC at NRU ( natural rate of unemployment )

• graph relates inflation with unemployment = Phillips Curve
• disinflation = inflation decrease ( ex : 8 , 4 , 2 )
• cost - push inflation
• high inflation with high unemployment = stagflation
• economists call the knowledge and skills that make the workers productive = Human Capital

Economic Growth and Productivity

• Long - Run Economic Growth, Phillips Curve, and Laffer Curve
• focus on real GDP per capita
• last 50 years real GDP grew by about 3.5 % per year
• last 50 years real GDP per capita grew by about 2.3 % per year
• Sources of Long - Run Growth
• Productivity, output per unit of input
• Labor Productivity, output per worker
• What leads to higher productivity?
• Stock of Physical Capital - buildings, machines, robots, etc.
• Human Capital - knowledge, sills, education, etc.
• Technology - technical means for producing goods and services
• Improved Resources Allocation - trade allows us to shift labor services from low - productive jobs to high productive jobs
• Economics Of Scale - reduction in per - unit cost that results from increases in size of markets and firms
• Production Possibilities Curves and LRAS :
• Economic Growth : shift in PPC outward
• Economic Growth : shift in LRAS Curve to the RIGHT
• Why Growth Rates Differ Among Countries :
• Rates of Savings
• Foreign Investment
• Education
• Infrastructure : roads, power lines, ports, and informative networks, etc.
• Research and Development
• Political Stability
• Protection of Property Rights
• Economic Freedom v.s. Excessive Government Intervention
• The Phillips Curves - Short and Long Run
• tradeoof between inflation and unemployment
• stagflation leads to shifts in the SRPC
• Aggregate Supply Shocks :
• Oil Embargo
• Major Agriculture Shortfalls
• Depreciating U.S. Dollar
• Wage Hikes
• Inflationary Expectations
• Long - Run Phillips Curve (  LRPC )
• vertical line at the natural rate of unemployment

• Supply - side Economics and the Laffer Curve
• stress that changes in the Aggregate Supply are an active force in determining the levels of inflation, employment, and economic growth
• concentrate on tax levels
• lower taxes are an incentive for business to invest in our economy
• lower taxes are an incentive for workers to work more and harder, thereby becoming more productive
• lower taxes are incentives for people to increase savings and therefore create lower interest rates for increases in business investment
• focus on marginal tax rates
• The Laffer Curve
• relationship between tax rates and tax revenues
• used to support the supply - side arguement
• Reaganomics = Supply - Side Economics
• Ideas = government could lower tax rates and actually increase tax revenues
• has been severely criticized