Macroeconomics Exchange Rates and Balance of Payments

For Ireland, the ratio of GDP/GNP is greater than 1. This means that Ireland's gross domestic product (GDP) is larger than its gross national product (GNP).

The real exchange rate reflects the relative prices of goods and services between two countries. It helps us understand the purchasing power of a currency.

The real exchange rate is calculated using the nominal exchange rate and the prices of a common basket of goods in both countries. A real exchange rate greater than one means that goods and services are cheaper in the country whose currency is in the denominator.

The balance of payments (BoP) records all economic transactions between a country and the rest of the world. It includes payments for goods, services, investments, and financial transfers.

The balance of payments is always balanced, meaning that the sum of all transactions must equal zero. There are no net leakages or injections of funds in the global economy.

The exchange rate between two currencies determines how much of one currency you need to buy a certain amount of the other currency. It can be expressed as the price of one currency in terms of another.

The real exchange rate is an important determinant of net exports. A stronger real exchange rate (higher value of domestic goods) makes domestic goods more expensive for foreigners, potentially decreasing net exports.

GDP measures the total value of goods and services produced within a country's borders, while GNP measures the total income earned by a country's citizens, regardless of their location.

Mercantilism argues that a country should aim for a trade surplus. However, not all countries can have a trade surplus at the same time - if one country has a surplus, another must have a deficit. This creates a paradox as it implies that not all countries can be successful according to mercantilist principles.

A country has a comparative advantage in producing a good if it can produce that good at a lower opportunity cost than another country.

This theory says that countries will export goods that use relatively more of their abundant factors of production and import goods that use relatively more of their scarce factors.

This model explains international trade based on differences in labor productivity across countries. Countries specialize in producing goods where they have a comparative advantage and trade to benefit from this specialization.

This model explains trade based on imperfect competition, product differentiation, and economies of scale. Firms in each country specialize in producing a variety of differentiated goods and trade to access a wider range of products.

A market structure where firms have some market power, but face competition from other firms selling similar but not identical products.

Firms in the Krugman model maximize their profits by producing where their marginal revenue equals their marginal cost.

In the Krugman model, the industry reaches equilibrium when the price of the good equals the average cost of production, leading to zero economic profits for each firm.

International trade can lead to gains for all participating countries, but it's not always guaranteed. Some individuals or industries may lose out due to increased competition.

A country has an absolute advantage in producing a good if it can produce it using fewer resources than another country.

A trade balance surplus occurs when a country exports more goods and services than it imports

When a currency becomes stronger relative to another currency, meaning you need more of the other currency to buy one unit of the appreciating currency.

A trade balance deficit occurs when a country imports more goods and services than it exports

The opportunity cost of producing a good is the value of the next best alternative use of resources.

When a currency becomes weaker relative to another currency, meaning you need less of the other currency to buy one unit of the depreciating currency.

A situation where the forward exchange rate (future price) of a currency is higher than the spot exchange rate (current price).

Products that are similar but not identical, often with different features or branding.

A situation where the forward exchange rate (future price) of a currency is lower than the spot exchange rate (current price).

A condition where the return on an investment in a foreign currency is equal to the return on a domestic investment, after accounting for the exchange rate changes.

A theory that suggests the difference in interest rates between two countries should be equal to the expected change in the exchange rate between their currencies.

A theoretical model that explains the relationship between interest rate differentials and the exchange rate. It's represented by two curves, Home Return (HR) and Foreign Return (FR), and demonstrates the equilibrium exchange rate.

A curve in the UIP model that represents the return on an investment in the domestic currency, factoring in the expected change in the exchange rate.

A curve in the UIP model that represents the return on an investment in a foreign currency, factoring in the expected change in the exchange rate.

The point where the Home Return (HR) curve and Foreign Return (FR) curve intersect in the UIP model. It represents the equilibrium exchange rate under the UIP conditions.

Profit earned by taking advantage of price differences between two or more markets. In the context of foreign exchange, it involves exploiting differences in interest rates and exchange rates.

Empirical analysis to determine whether the uncovered interest rate parity condition holds true in real-world data. This involves running regressions to see if the relationship between interest rate differentials and exchange rate changes supports the UIP theory.

A statistical measure that quantifies the relationship between interest rate differentials and the exchange rate in the UIP model. It represents how much the exchange rate changes in response to a change in the interest rate differential.

Using statistical methods to test the hypothesis that the regression coefficient for the difference between domestic and foreign interest rates is equal to 1 in the UIP model.

Cost advantages that arise within a firm as it increases its scale of production. This means that the average cost of producing each unit decreases as the firm produces more.

A tax imposed on imported goods. This raises the price of imported goods, making domestic goods relatively cheaper.

The difference between what consumers are willing to pay for a good and what they actually pay. It represents the benefit that consumers derive from buying a good.

The difference between the price producers receive for a good and the minimum price they are willing to accept. It represents the benefit that producers derive from selling a good.

Income received by the government. In the context of tariffs, this revenue comes from the tax collected on imported goods.

The overall well-being of individuals and society. It is often measured by factors like income, health, and education.

An economy that is small relative to the world economy and is open to international trade. This means it cannot influence world prices.

An economy that is large enough to influence world prices. This means that their actions, like imposing tariffs, can affect prices in the global market.

Actions undertaken by a central bank to manage the money supply and interest rates. This can be used to stimulate or restrain economic activity.

A monetary policy aimed at increasing the money supply and lowering interest rates. This is often used to stimulate economic growth.

Actions undertaken by the government to influence the economy through spending and taxation. It can be used to stimulate or restrain economic activity.

The price of one currency in terms of another. A higher exchange rate means the currency is more valuable.

A variable whose value is determined within a model or system. Its value is dependent on other variables in the model.

A variable whose value is determined outside a model or system. Its value is independent of other variables in the model.

A system where the value of a currency is determined by market forces, meaning it can fluctuate freely against other currencies.

When households want to hold more money, usually due to decreased trust in the banking system or increased desire for saving.

An economy operating at its maximum potential, unable to produce more output in the short term.

The part of money demand that is independent of income and interest rates.

When the central bank reduces the amount of money circulating in the economy.

When a currency becomes stronger relative to other currencies, meaning you need more of the foreign currency to buy the same amount of the domestic currency.

When the government reduces its spending on goods, services, and projects.

A macroeconomic model that combines the IS-LM model with the ZZ curve, showing the equilibrium of output, interest rates, and exchange rates.

A situation where a significant percentage of the labor force is unemployed, indicating a weak economy.

The LoP states that identical goods should sell for the same price in different markets, adjusted for exchange rates. It implies that arbitrage opportunities should be eliminated quickly.

Absolute PPP suggests that the exchange rate between two currencies should equal the ratio of the price levels of a common basket of goods in those two countries.

Relative PPP focuses on the changes in exchange rates over time and relates them to the difference in inflation rates between two countries.

Arbitrage occurs when an investor exploits price differences in different markets to profit. It involves buying a good in one market and selling it in another market where the price is higher. This process can lead to exchange rate adjustments that eliminate the price difference.

A confidence interval provides a range of plausible values for an unknown parameter, such as the intercept or slope in a regression model. It is based on the estimated value and its standard error, and reflects the uncertainty surrounding the estimate.

Hypothesis testing in regression helps us assess the statistical significance of the estimated coefficients. We compare the observed values with the expected values under the null hypothesis, and decide whether to reject or fail to reject the null hypothesis based on the p-value or t-statistic.

The t-statistic measures the number of standard errors the estimated coefficient is away from zero. It helps determine the significance of the coefficient, indicating whether it is likely to be different from zero.

Endogenous variables in an economic model are those whose values are determined within the model itself. Their values are influenced by the interaction of other variables in the model.

Exogenous variables in an economic model are those whose values are determined outside the model. Their values are assumed to be given and are not influenced by the model's internal relationships.

In an economy with fixed output, the government's spending increases without affecting the overall production level. It doesn't cause an increase in output because the economy is at full capacity. This can lead to crowding out, a reduction in private investment due to higher interest rates.

Crowding out occurs when government spending increases interest rates, reducing private investment. This happens because government borrowing puts upward pressure on interest rates, making it more expensive for private firms to borrow.

Monetary policy in a floating exchange rate system focuses primarily on managing inflation, output, and interest rates. Central banks can adjust the money supply or interest rates to stabilize the economy.

Helicopter money refers to a direct injection of money into the economy, much like a central bank dropping money from a helicopter. This increases the money supply, leading to expansionary monetary policy.