Unit 7

I'm so glad that everything is done with and we are finally able to move on with our lives because this has been the most stressful month for me because of senior legacy, ap testing, and just keeping up with all these work and projects in order to keep the grades I've been having all year to graduate and get exempt. I hope everything turns out well!

Balance of Payments

·                     Measures of money inflows and outflows between the U.S. and the rest of the world

• Inflow = credit
• Outflow = debit

·                     Divided into 3 accounts

• Current Account
• Capital/Financial Account
• Official/Reserve Account

Double Entry Bookkeeping

·                     Every transaction in the balance of payments is recorded twice with standard accounting practive

Current Account

·                     Balance of trade/Net exports

• Exports of goods/services - import of goods/services
• Exports = credit
• Import = debit

·                     Net Foreign Income

• Income earned by U.S. owned foreign assets - income paid to foreign held U.S. assets

·                     Net Transfers

• Foreign aid  - debit to the current account

Capital/Financial Account

·                     Balance of capital ownership

·                     Includes the purchase of both real and financial assets

·                     Direct investment in the U.S. is a credit to the capital account

·                     Direct investment by U.S. firms/individuals in a foreign country are debits to the capital account

·                     Purchase of foreign financial assets represents a debit to the capital account

·                     Purchase of domestic financial assets by foreigner represents a credit

·                     What causes these flows?

• Differences in rates of return on investment
• Ceteris Paribus, savings will flow toward higher returns

Relationship between Capital and Current Account

·                     Double entry bookkeeping

·                     Zero each other out

Official Reserves

·                     Foreign currency holding of the U.S. Fed

·                     When there is a balance of payments surplus the Fed accumulates foreign currency and debits the balance of payments

·                     When there is a balance of payments deficit there is a balance of payments deficit the Fed depletes its reserves of foreign currency and credits the balance of payments

Credit vs. Debit

·                     Credit - addition to a nation's account

·                     Debit - subtractions to a nation's account

How to Calculate

1.             Balance on trade

• Merchandise and service exports - merchandise and service imports

2.             Trade deficit occurs when the balance on trade is negative

• imports > exports

3.             Trade surplus when bot is positive

• exports > imports

4.             Balance on current account

• Balance on trade + net investment income + transfer payments

5.             Official Reserves

• Nationally change in CA + change in FA + change in official reserves = non zero

Foreign Exchange (FOREX)

·                     Buying and selling of currency

·                     The exchange rate is determined in the foreign currency markets

·                     Exchange rate is price of currency

Changes in Exchange Rates

·                     Exchange rates are a function of the supply and demand for currency

• An increase in the supply of a currency will decrease the exchange rate of a currency
• Decrease in supply of currency will increase exchange rate
• Increase in demand for currency, increase in e
• Decrease in demand for currency, decrease in e

Appreciation and Depreciation

·                     Appreciation - when e of currency increases

·                     Depreciation - when e of currency decreases

Exchange Rate Determinants

·                     Consumer's Taste

·                     Relative Income

·                     Relative Price level

·                     Speculation

Flexible Exchange Rate

·                     Set by market forces with little or no government intervention

Fixed Exchange Rate

·                     Determined by government policies

Absolute Advantage - Faster, more efficient

• Producing a good using less resources

Comparative Advantage - Lower opportunity cost

·                     Same country can have absolute advantage in 2 products

·                     Can only have one comparative advantage in 1

• Producing a good at a smaller opportunity cost