ECON2H Lecture Notes PDF

Employment Lecture 1 Economics: the study of solutions to the problem of infinite wants and the satisfaction of those wants with scarce resources Opportunity cost: the next best thing you could have done of chose Scarcity and Choice Scarcity: not enough resources to satisfy all the wants of the...

Employment Lecture 1 Economics: the study of solutions to the problem of infinite wants and the satisfaction of those wants with scarce resources Opportunity cost: the next best thing you could have done of chose Scarcity and Choice Scarcity: not enough resources to satisfy all the wants of the people: if something is scarce it will have a value Natural resources: land and law materials: limited in amounts Work resources: labor or human resources: limited in number or skill Capital Resources: machines all good manufactured Wants and Needs: humans being always wanting more things: their needs are infinite There are few resources which are sufficient most of the time and do not require more effort to produce more of them: they are therefore free most of the time( example: air) Choices: because most resources are not infinite, choices have t be made as part of economic activity: these choices always involve trade offs (opportunity costs) We cannot solve scarcity: but we can do different things with the resources we have Specializing in trade: doing the thing your best at, and trade with others Use tools/capitals: some cost today for benefit tomorrow Use knowhow and technology Macroeconomics: studies the processes in AGGREGATE ( usually whole countries at a time) Microeconomics: studies these processes at the individual level ( individual goods, service, people or firms) Macroeconomics Output What determines the size of a nation's outputs? Why does it sometimes grow? Why does it sometimes contract? Employment What causes unemployment? Why does everyone who wants a job sometimes not have one? Prices Absolute levels (total cost) and changes (inflation) ? Why do prices always seem to rise? Is this a good thing? Economic relationships with other countries Do these relationships affect the country? Individuals are assumed to be rational: they can compute and compare cost and benefits consistency and predictability and act to maximize benefits and minimize costs They operate on the basis that is the additional gain from an activity exceeds the additional cost then they will undertake that activity (marginal analysis) When considering cost, individuals consider opportunity cost Theories and Models: used to analyze how the economy functions and how it reacts to changes The Circular Flow of Goods and Incomes: consumer expenditure and wages and rent, etc. Positive statements: deal with issues that can be discussed using research and date, they can be true or false. Normative statements (an opinion based statement) : cannot be resolved no matter the state of research and data: they include “ought” and “should”. They are value judgements, and everyones is different Ceteris Paribus: relationship assuming nothing else has changed or impacted the graph Graphs: remember what we assume has stayed the same, in order to impact another Lecture 2 Gini Coefficients: the higher the number, the more inequality average= 2% Production Possibility Function (PPF): lists choices and their opportunity costs by summarizing what alternative outputs you can achieve with your given inputs The principle of increasing marginal opportunity cost: states that opportunity cost increase the more you concentrate on an activity Comparative advantage: explains why opportunity cost increases as the consumption of a good increases Society can produce more output, if Tech is improved Resources are discovered Capital is available Economic institutions get better at fulfilling out want or improving the function of market More potential output is represented by an outward shift in the ppf Lecture 3 Two hundred years ago: us had a comparative advantage. Now, countries with cheaper labor have comparative advantage in textiles Demand: we want something, and we have the ability to give something up to get it -​ It has to be exercisable -​ Total demand level: the number of potential consumers and income distribution also determines demand -​ What determines household demand? price , price of all other goods, households income and other social factors,and tastes -​ Price goes up and quantity goes down -​ Quantity demanded varies inversely with price Substitute: a rise in the price of a good leads you to buying another: you buy less in the short run Compliment: a rise in the price of a good, leads to you buying less Inferior goods: you don't really want the good, but you use/buy it Elastic: if you can make change Inelastic: if you cannot make change Supply: making a profit based on others demands -​ What determines the quantity supplied? The price of the good, the price of all other factors of production -​ The higher the price, the more the supplier wants to provide -​ Technology results in the ability to make a supplier more productive Market Equilibrium: Only one price that is equal that buyers want to pay, and sellers want to sell Disequilibrium: price that is not equal: surplus/shortage on goods and price must go down/up Expectations: 4 classic laws of Supply and Demand 1.​ Due to changes in tastes or a rise in the price of a substitute the demand curve shifts to the right 2.​ Price rises and the quantity consumed rises 3.​ Due to the changes in tastes or a rise on the price of a complement the demand shifts to the left 4.​ Prices fall and the quantity consumed falls Lecture 4 Price does not shift curve: everything else shifts Highly elastic: small change in price and big change in quantity Highly inelastic: big change in price and small change in quantity Market manipulation: price ceilings Price Ceiling ( Price Maximum) -​ Example: apartment rent Price Floor ( Price Minimum) -​ Example: minimum wage Taxes on Suppliers: shifts supply curve to the left Commodities: oil, iron, ore, steel,copper and corn The growth of major industries using these commodities as inputs will affect demand. Fast growing economies can boost demand for these, depending on their stage of development Supplies can be controlled by countries who dominate a source of supply for strategic or political reasons Supplies can be disrupted by wars of political disputes Labor Labor demand is derived. Workers are needed if there is a need for a final good or survive There are many labor markets, not all skill levels can be productive in all industries or in performing all tasks asked of a worker Supply shifts: supply change at every level -​ Left: people leave the market -​ Right: people join the market Demand shifts: demand change at every level -​ Left: technology increase demand for higher skill -​ Right: some technology increase demand for final product Labor market: disequilibria The labor market is subject to frictions It takes time to find another job Employers find some efficiency in keeping workers they don't fully need The labor market is regulated and manipulated by wage laws and law about working conditions and practices Financial Markets suppliers=savers:either individuals or companies ( national or global) demanders= borrowers price=interest rate (savers focus on the expected real) Interest rate: real=i (nominal) - (inflation) Multiple markets demanding savings (loans/bonds/equities). Shifts between them depending on expected risk and return. Change in risk expectation/perception in a market , shift in supply of savings to that market. Demand shifts if a change in return perception or change in risk of return Individuals save because: ​ To smooth expenditure over lifetime as earnings rise,then fall To protect against risk To leave for others Changes in circumstances can change saving behavior Changes in earnings and expectations of future earnings Changes in wealth Changes in risk perception and psychological factors Other things equal, higher real interest rate=more savings Firms save because To expand the business later To protect against risk Governments save if: The amount they raise in taxes is bigger than the amount they pay out in interest to private owners of its debt (bonds) and the transfer payments it makes for social security, other welfare payments, farm support plus what it buys for its needs demanders = firm Firms invest: to buy capital goods or housing if they think if will profit later They calculate profit versus cost, to help them decide if they should make the investment They set this percentage against the real interest rate, investment is inversely related to real interest rate Lecture 5A Government intervention: 1.​ Provide a stable institutional framework 2.​ Promote effective and workable competition 3.​ Correct for externalities : affecting a third party 4.​ Ensure economic stability and growth 5.​ Provide public goods 6.​ Assist where asymmetric information occurs 7.​ Adjust for undesired market results …so that the market can then decide what, how and for whom outputs are created to best address the problem of unlimited wants with limited resources Externality: cost experienced by someone who is not part of the original transaction Excludable goods: must pay or give something up for the good Nonexcludable goods : cannot be paid for: example: firework show asymmetric information: one parties knows more than the other example: telling someone that ice cream is healthy, even though it is not Demerit goods: things the government believes are bad for you, although you may like them Merit goods: things the government believes are good for you, although you may not like them Market failures: situations in which the market does not lead to a desired result Government failures: situations in which the government intervenes and makes things worse Regulating markets internationally -​ There is no central world government -​ Government are unable to come up with effective means of dealing with environmental issues Alternative Economic System Centrally planned/command economy: economic decisions are taken by central authorities Free market economy: all economic decisions are taken by individuals and private firms with no government intervention. System relies on market forces to solve the economic problem, the only government intervention is to create as system or private property rights within a rule of law Mixed economy: part free market economy part government decisions Advantages and Disadvantages Planned: -​ allows someone to take an overall view of resource allocation and avoid possible imbalances -​ Can achieve high growth by deciding to spend more on capital goods and less on consumption -​ Can allocate wealth more equally -​ Produce according to an agreed environmental policy -​ bureaucratic , loss of individual liberty, inefficiency Alternative Economic System Societal norms and systems: play a large role within economic problems and how they are solved Lecture 5B Major macroeconomic issues and goals The issue concerning output: economic growth -​ Governments try to achieve high and stable rates of economic growth over the long term The issue concerning employment: unemployment -​ Governments try to make unemployment as low as possible The issue concerning prices/purchasing power: inflation -​ Governments try to keep inflation low and stable The issue concerning economic relationships with other countries: balance of trade, payments and exchange rates -​ Governments try over the long term to avoid a balance of trade deficit ( a more complex statement required for the US) -​ Economic Growth: -​ The percentage increase in output over a 12 month period -​ The output we use is a real gross domestic product ( GDP) -​ GDP is the amount of final goods and services produced within the borders of a country in a specified period -​ The nominal GDP is all the stuff at current prices. To separate out the change from the previous period that was just a change in prices and the change that was a change stuff we need to do more math Unemployment -​ The number of people who are actively looking for work but are currently out of a job -​ Unemployment rate: number of unemployed expressed as a percentage of the labor force ( total employed plus total unemployed) Inflation -​ An upward change in the general price level. Inflation rate of the percentage change of prices over a 12 month period -​ Consider deflation as well Balance of Payments -​ A country's transactions with the rest of the world must balance -​ Receipts ( exports, investments by foreigners in the country, interest and dividends earned from abroad) -​ Payments (imports, investment abroad, interest and dividends paid abroad) -​ The current account ( flow before taking asset transactions taken into account) is the statistic we are most interest in initially Headline inflation: as reported through the consumer price index (CPI) released monthly by the bureau of labor statistics. The CPI calculates the cost to purchase a fixed basket of goods Core inflation: food and energy removed. Figures are focused on an “annualized basis” PCE ( personal consumption expenditures) : fed’s preferred inflation measure produced by BEA Implicit Price Deflator: the ratio of the current dollar value of a series, such as gross domestic product (GDP), to its corresponding chained dollar value , multiplied by 100 Lecture 5C Nominal: price sold for this year by quantity Nominal GDP/GDP deflator Intermediate variable examples -​ Interest rates -​ Money supply -​ Taxes -​ Government expenditure -​ Exchange rates Circular Flow of Income AD=C c= expenditure on goods and services Real GDP= change in quantity Nominal GDP= change in quantity and price nominal = prices times quantity Nominal GDP/GDP deflator= real GDP Key Items GDP: $ value of all good and services produced within the border of a country during a period of time Only count things once: either all the final products or the sum of all value added Only stuff produced: not money transferred between people or entities, and not second hand items Personal Consumption (“C”) : goods and services a.​ Durable (expected life of 3+ years) b.​ Non-durable goods (FFR then supply leaves the Fed Funds market. Even if the demand is small, falling supply raises the rate of Fed Funds until D=S b.​ lORB sets a “reservation price”  c.​ Not all banks and large nonbank financial institutions can open a reserve account at the FED: this could mean excess supply in the FF market and a separation of the lORB and FFR d.​ Reserve Repo Transaction: non eligible institutions may deposit excess funds in exchange for a security which matures in time Monetary Equilibrium a.​ Effects of changes in money supply on national income b.​ Effects on interest rates c.​ Effects of changes in interest rates on investments d.​ A bond pays interest for a fixed period (n) at a fixed rate C per period and then returns its principal amount P. it finds its value you discount the cash glows at the market rate r e.​ If interest rates rise, then r will rise and the value of V will fall. There is an inverse relationship between rates and price. ( inverse relationship) f.​ Interest rates up, value of bonds down g.​ Interest rates down, value of bonds up Monetary Policy: The FED and the Rate of interest a.​ Reserve repo b.​ Interest on reserve c.​ Discount rate d.​ Reserve ratio e.​ Open market operations f.​ Level of reserves and federal funds rate Monetary Policy a.​ Refers to the attempt to affect the 4 macroeconomic variables by changing the interest rate or money supply b.​ Dual mandate: afford economic growth, allow for it to happen and allow for reasonable employment opportunities and preserve the value of the currency c.​ Federal reserve: the bank for banks to deposit their money in d.​ Rates going up means that interest rates will also go up: in order to still turn a profit within the banking system The Effects of Interest Rates a.​ The Consumer Channel i.​ Lower interest rates: so you can borrow more cheaply ii.​ At a given level of appetite for debt, there is more consumption as people purchase more on credit iii.​ AD moves to the right, as the C term increases b.​ The Investment Channel i.​ Lower interest rates: so companies can borrow more at a cheaper rate ii.​ At a given level of appetite for debt, companies focus on future expectations, corporate taxes , more borrowing to make investments iii.​ AD moves to the right , as the I term increases: expansionary monetary policy c.​ The Trade Channel i.​ Lower interest rates: exports go UP and the AD curve shifts right ii.​ Lower exchange rates iii.​ The mechanism might be: 1.​ US bonds now yield less: foreign bond more attractive 2.​ People demand foreign bond this requires them to sell $ and buy foreign currency demand for $ down exchange rate down 3.​ May also encourage speculation against the $ iv.​ Exports more attractive as foreigners can buy more $ with the same amount of their own currency v.​ Imports more expensive as the $ buys less foreign currency needed to buy imports vi.​ Note: if import demand is inelastic then less volume of imports but more $ spent: example is oil, as it is needed and cannot be substituted vii.​ Note: supply side effects from imported inputs: negative effect on the SRAS d.​ The Wealth Channel & Others e.​ Seems logical that this would stimulate AD f.​ Lower interest rates g.​ Lower discount rates h.​ Higher share values= i.​ More wealth ii.​ More consumption iii.​ Lower cost for companies to raise financing vis shae issues i.​ This effect is difficult to find empirically Monetary Policy: Summary a.​ Monetary policy works by shifting AD b.​ Thus the dual mandate achieved by using interest rates to shift AD i.​ right : unemployment too high, inflation too low: via lower rates ii.​ left : unemployment too low, inflation to high: via higher rates c.​ How much higher or lower? i.​ We don't exactly know Monetary Policy: Criticism a.​ Recognition lags: same as for fiscal policy b.​ Operational lags: at least does not have to go through legislative process but still takes time for interest rate effects to wok through the channels c.​ Transmission problems i.​ What is lower rate of interest does not stimulate more: because lenders do not want to lend ii.​ What if they don't want to stimulate more C because people don't want to borrow iii.​ What is interest rates are already closer to zero The “FED” of Federal Reserve System a.​ Acts through the regional federal reserve banks b.​ Sets requirements for commercial banks and thrifts c.​ Acts at the “lender of last resort” to the commercial banks within the regional federal reserve banks d.​ Runs through the check clearing system e.​ Is the government fiscal agent: collecting taxes and paying bills f.​ Also sells and redeems government bonds g.​ Provides oversight and supervision for the commercial banks h.​ Manages the money supply The Keynesian Views of the effect of Money Supply a.​ A rise in the amount of money leads to people reducing their money balances b.​ Or the rate of reserves ( Lorb) is lowered, banks lend more, money supply increases, rates fall c.​ Investment rises, consumption rises and the exchange rate falls, stimulating exports d.​ X and I are injections therefore AD rises and unemployment falls  Step 1 is unreliable. As interest rates fall a small amount, suddenly people hold more speculative balances this increases demand and rates rise again. Step 1 is unstable because people change their speculative views all the time, who knows what a change in money supply will do to these views and therefore the demand for money. Step 2 is unreliable. Does investment really fall given a rise in interest rates? Perhaps the effect of business confidence is heavier than the effect of interest rates. If the economy is weak, firms may be reluctant to borrow if they are poor, even at lower rates The effect of interest rates on exchange rates is small compared to the speculation in the exchange markets Summary: the effects may be strong or weak, we cannot predict then in advance The Monetarist View of the Effect of Money Supply a.​ A rise in the amount of money leads to people reducing their money balances, they buy more bonds. The price of bonds rises and interest rates fall Supply Curve a.​ As prices rose and in the short run wage and other factor costs did not rise. Then firms would supply more as their profits would rise. Even at full employment they would find a way to use more factors of production, they might pay overtime or find a way to seek out and train the structurally unemployed. ( not totally unrealistic because people are employed under fixed term contracts) b.​ As pries fall and in the short run wage and other factor costs did not fall, then firms would supply less as their profits would fall ( not totally unrealistic because people are employed under fixed term contracts) Implications a.​ Cost push inflation will, in the long run be reserved by fall in the price of factors of production but: b.​ Until the reversal takes place in the long run, the short term effects will be declining economic growth and rising unemployment c.​ Any increases in output and employment created by demand side policies will if used at the point of full employment create only rises in prices in the long term but in the short term temporary rises in output  d.​ The demand side policies will only create the same long term effects that would have happened “automatically” in the long term. The only differences is that demand side policies will restore equilibrium at higher prices Example: Election of New Government a.​ Short run: Demand curve shifts to the right: by expanding the C and I term, as people are feeling more inspired and better due to the new government b.​ Falling unemployment and more economic growth, and some inflation c.​ Long run: SRAS moves back after a while: with inflation but in the exact same spot Phillips Curve: relationship between high inflation and low unemployment: during the 1930’s-1970’s The Economy in the Long Term a.​ Supply side change: the PPF and therefore the LRAS shifts outward b.​ Left alone in the long run, the economy has an excess of resources ( underemployed resources), prices of factor fall and the SRAS moves to the right c.​ The new output level reaches equilibrium, and the new full employment level for the economy and the price level falls d.​ This causes the government to fear deflation and they employ demand side policies e.​ Economy's resources are overemployed: prices rise and the SRAS moves: now full employment equilibrium is stored, now with some inflation f.​ In the long run we should always be trying to move the LRAS to the right, and moving the PPF outward Supply Side Policy The use of supply side policies a.​ To reduce equilibrium unemployment b.​ To reduce inflation c.​ To increase economic growth Two Types a.​ Market Oriented: the government stays out of it, and the market takes charge in order to find equilibrium b.​ Interventionist: the government steps in and makes changes Market Oriented: Supply Side Policies a.​ Reducing Government Expenditure i.​ Although this may seem to be against growth, in fact some government consider government spending itself to be against growth because it is inefficient ii.​ If the resources were taken away from the government and put into the private sector, more could be produced with less b.​ Tax Cuts i.​ Cutting taxes where you think it will create efficiency ii.​ No longer need to include international affairs: everything would be more domestic iii.​ Cut business taxes so they are more globally competitive c.​ Reducing the power of labor i.​ Less power for unions: cannot be formed or under legal constraints d.​ Reducing welfare i.​ Welfare for poor people ii.​ Increases the workforce by forcing people from NILF to Employed e.​ Policies to encourage competition i.​ Privatization: regulation of a private monopoly ii.​ Deregulation: getting rid of regulation that get in the way of a business iii.​ Introducing market relationships into the public sector: not wanted as markets want to dominate iv.​ Free trade and capital movements: allows for everyone to have comparative advantage The Wrapper Around the 2X8 Matrix a.​ Consider the effects of the supply side policies b.​ Wrapper: the wrapper around moving the PPF outward i.​ Effective and efficient rule of law ii.​ Level of corruption/level of transparency Background to Interventionist Policy a.​ Some people have said that reducing regulation and letting the market increase productivity and growth is not enough and that the government should intervene. Interventionist Supply Side Policy  a.​ Help to firms i.​ Rationalization: encouraging mergers and rationalization in industries that need it ii.​ Advice and persuasion iii.​ Information iv.​ Finance for research and development v.​ Assistance to small firms b.​ Infrastructure development: helps for more infrastructure and buildings as a whole c.​ Training and education: further education and help d.​ Welfare to work: gives incentive and help for those looking for a job e.​ Healthcare policy f.​ education policy g.​ Cultural factors: helps us understand more people and make more relationships Taxation as a Supply Side Policy a.​ If you believe that taxation reduces productivity by reducing incentives, then a rise in taxation will shift the LRAS to the left. Output will fall and tax revenues will actually fall. b.​ The opposite would then be true, reducing taxes and productivity rises. LRAS shifts to the right, output rises and the amount collected in taxes actually rises. c.​ With the slightly counter-intuitive result that budget deficit are not created by tax returns ( enhanced by the thought that people avoid taxes less if the rates are low) d.​ The argument also goes that investment shifts the LRAS to the right by improving productivity and that high taxes reduce the incentive to invest and therefore shift the LRAS to the left for this reason also Supply Side Policy a.​ To reduce equilibrium unemployment b.​ To reduce inflation c.​ To increase economic growth Benefits of Growth in Productive Potential a.​ Can relive poverty b.​ Provide the extras resources to house people and give them health and education c.​ Higher real income per head allow people to buy more of the thing they want d.​ By allowing people to produce more of what they want inflation can be reduced e.​ Produces resources that can be put back into helping the environment Cost of Growth in Productive Potential a.​ Does not necessarily make people happier b.​ Benefits may be shared very unequally c.​ The environment may be destroyed d.​ To grow we need to invest, this may actually mean less consumption now e.​ More goods may actually make people more consumerist and less satisfied with what they have f.​ Fast growth means fast change in society. This dislocates people and makes them feel insecure Taxes and Economic Activity a.​ Taxes UP and GDP UP caution unlikely to run from tax to GDP, more likely vice versa Motivation Measurable Effect Comment Managing economy by Difficult, so many other counteracting other influences things going on like changes Paying for more “G” or in C and I financing less “t” Addressing an inherited A tax rise of 1% of GDP In this case fall in Y from a budget deficit lowers the real GDP -2.3% rise in “t” in part offset by enhanced business confidence (more “I”) and lower rates of interest Supply side policy Exam Review Monetary Policy and Employment Expansionary monetary policy: interest rate goes down: C and I go up: E goes up I goes down: and exchange rate goes down If demand goes down on the supply side: this will lead to less unemployment, however the opposite goes for if demand goes up, such as when interest rates go down: therefore there will be more employment. Interest on reserves: the money the bank receives from the fed when putting money into the reserves Exchange rate: the price of one currency against another: to compare the price across different country which is a driven of imports and exports When exchange rates weaken, imports go down: however, exports from the US could go up due to demand in different countries who want such items. For example: buying a vehicle from japan vs usa :and the different currencies which are used Tax cuts: causes the country to be more productive Restrictive monetary policy: a.​ Increase in interest rate b.​ Demand for bonds by foreigners increase c.​ Demand for dollars increase d.​ Exchange rate goes up e.​ Exports go down an imports go up Bonds and interest rates move inversely: a.​ when interest rates are down: bonds are up b.​ When interest rates are up: bonds are down Dollar strengthens: exports goes up and imports go down Dollars weakens: exports go down and imports go up Loan deposit pairs: to give someone a loan someone also must have a deposit to give that person that money Lecture 13: Notes for Final Exam Beginning Trade, Capital Flows and Exchange Rates a.​ refer back to pakistan and belgium example: lecture 3 b.​ Countries can trade with others: and also trade with themselves after if the need more of one good, or less of another The Gains From Trade a.​ Specialization as the basis for trade i.​ Countries can benefit if they specialize and produce goods at which they can exploit the skills they have, the resources they have and where volume production brings them economies of scale. They gain if they produce more of those goods than they need domestically, then they export the surplus and import goods where they have less of an advantage b.​ Absolute advantage i.​ In some situations a country may be able to produce a particular good using less resources than another country. It is said to have an absolute advantage. If two countries each have an absolute advantage producing one of two goods, France in A and the UK in B,then france should produce a and the uk should produce b, and they should trade to meet the demands they have c.​ The limitations to specialization and trade i.​ Increasing opportunity costs from increasing specialization ii.​ Diminishing marginal productivity of factors iii.​ Mobility of factors of production : example industries in different areas iv.​ Decreasing costs 1.​ Countries which are small mayim prove their comparative advantage if they trade because of economies of scale v.​ Differences in demand 1.​ Differences in satisfaction of production and goods we may like more vi.​ Increased competition 1.​ Foreign firms may introduce more competition, benefiting consumers, breaking domestic monopolies, providing choice vii.​ Trade as an “engine of growth” 1.​ Allows for growth within both countries that are trading  viii.​ Knowledge drives 1.​ Allows for us to learn more and grow more ix.​ Non economic factors x.​ Such as politics xi.​ No transport costs xii.​ No economies/diseconomies of scale xiii.​ Factors of production assumed perfectly mobile xiv.​ No tarrifts or trade barriers xv.​ There is perfect knowledge so buyers can be found for the goods anywhere and new producers know more Arguments for Restricting Trade methods a.​ Tariffs: effective if demand is reasonable elastic b.​ Quotas c.​ Administrative barriers d.​ Other: i.​ Import licenses ii.​ Embargoes: law against bringing stuff into the country ​ Subsidies to domestic producers iii.​ Government procurement processes that favor domestic producers iv.​ Exchange controls ( locals may not buy foreign current to pay for imports) a.​ Infant industry argument i.​ Small companies that haven't been able to grow yet due to trade b.​ Changing comparative advantage c.​ To prevent dumping i.​ Selling a product for less than the factors of production that went into it d.​ To prevent other trade that is going on using unfair practices i.​ Trading with people that we do not like or take part in unethical practices e.​ To create self sufficient and not be at total supply risk from a trading partner i.​ Example: cars could not be delivered due to missing a chip that came form a trading partner f.​ To prevent the cost of structural unemployment g.​ To prevent establishment of a foreign based monopoly h.​ To spread risks  i.​Countries that specialize in certain goods become income elastic, therefore they are at risk altogether i.​ Externalities j.​ Pursuing national interests k.​ Non-economic arguments Problems with Protection a.​ Protection as second best b.​ World multiplier effects i.​ Restrictions within different exports; leads to unemployed and retaliates with tariffs: both countries are worse off c.​ Retalization d.​ Illegality e.​ Cushions inefficiency i.​ Example: us car industry ii.​ Tariffs lead to a sense of inefficiency and costs a lot to keep in place f.​ Bureaucracy Trade Effects a.​ Industries are always changing due to comparative advantage: change in what we are good at leads to differences in trading across the world Balance of Payments Accounts a.​ Meaning of the balance of payments b.​ The sum of all transactions between residents of a country and all foreign nations c.​ B.O.P has three accounts: current account and financial account d.​ The current account e.​ Trade in goods and services f.​ Balance of trade in goods and services g.​ Income flows : interest and dividend income h.​ Current transfers: money: public and private remittances: such as giving money to ukraine to keep the economy going  i.​ Balance on current account Example: Current Account Trade in goods Exports 125m Imports 135m Trade in services Exported services 20m ( Finish later ) The Capital Account a.​ Payments in and out for past investments b.​ Forgiveness of debt The Financial Account a.​ Investment: direct and portfolio: examples b.​ Purchases of US treasury securities by foreigners c.​ Investments in us subsidiaries by foreign companies d.​ Shares bought in overseas companies by us residents e.​ Flow to and from reserves of the central bank In the end all account must balance a.​ Apart from statistical errors and emissions Y=C+1+G+X-M and Y=C+S+T Rearranged: S+ (M-X)= I + (G-T) If the budget deficit (G-T) grows, then other things equal, the trade deficit (M-X) will grow. In another case, if domestic investment (I) grows and is not financed by domestic private saving from individuals or companies (S) or the government (T rises or G falls) then it must cause the trade deficit to rise and foreign capital to flow in The Rate of Exchange a.​ Individuals rates of exchange  b.​ The rate at which one currency trades for another c.​ A floating exchange rate: rate determined by the market forces: supply and demand Determination of Exchange Rates a.​ The equilibrium exchange rate b.​ The equilibrium is determined where demand equals supply c.​ The demand for $ by foreigners will be downward sloping, the higher the price of $ ( expressed in their currency) the less they will demand d.​ The supply by the US will be the opposite. The higher the price of $ the more the US will supply a.​ When the dollar strengthens: this is bad news for exporters, as products look more expensive in foreign markets b.​ what affects one side effects the other: both the demand and supply are impacted by the exchange rate c.​ When the demand for one country is up, the supply is less: which makes it more appealing at a smaller price 1.​ Differences in Interest Rates a.​ If us rates fall, there will a shift inward in the $ demand curve as $ rate falls b.​ Foreigners will want to invest in the US less, thus the demand for $ falls( shifts to left) c.​ At the same time more US residents want to invest abroad. Their supply of $ abroad rises 2.​ Differences in Inflation Rates a.​ If the US has a rise in prices exports become less competitive, imports become more attractive to US residents b.​ Demand for $ shifts to the left foreigners demand less $ become relatively more expensive c.​ Supply of $ shifts to the right as US residents seek imported goods which now look relatively cheaper 3.​ Rise in domestic incomes relative to those abroad: change in aggregate demand a.​ Demand for imports rises within incomes and the supply of dollars will increase  4.​ Relative investment prospects abroad improve a.​ Demand for investment abroad by US residents increase the supply of $ b.​ If foreigners also recognize this trend, they will demand less US investments and the demand for dollars will shift to the left 5.​ Speculation: largest impact compared to the others a.​ If businesses think the $ is about to fall they will attempt to sell $ early, its supply will rise b.​ Those who need $ will attempt to delay their needs and delay purchasing $ because they think that if they wait for the dollar will become cheaper, demand for $ shifts to the left Exchange Rates and The Balance of Payments: no government intervention a.​ If supply and demand for a currency are determined entirely in a free market, then the price of the currency will be determined by the demand and supply of that currency. The exchange rate is said to float freely b.​ There will be automatic balancing of overall balance of payments c.​ Current, capital and financial accounts might not separately balance but together they must Exchange Rates and The Balance of Payments: government intervention a.​ Governments may decide movements in exchange rates are bad for business i.​ Constant short term fluctuations 1.​ Create uncertainty and a poor investment climate 2.​ Make long term trade agreements difficult to manage b.​ Reducing short term fluctuations i.​ Using reserves shifts the $ demand curve to the right by selling foreign currency reserves to buy $ ii.​ Borrowing from abroad in FX and then using the foreign currency borrowed to buy $ again shifting the D curve to the right n iii.​ Change in interest rates: raise US interest rates this shifting the $ supply curve to the left and right demand curve to the right c.​ Maintaining a fixed rate of exchange over the longer term: deflation /reflation d.​ If the government wants the $ to rise in value it can shift the dollar supply curve to the left by reducing AD ( fiscal or monetary policy) this cuts important e.​ Directly as AD falls and import demand falls  f.​ Indirectly as prices fall and inflation falls thus making important goods seem more expensive g.​ Using supply side policies h.​ Actual legal controls important or foreign exchanging dealing Exchange Rates and The Balance of Payments a.​ Advantages of maintain a FIXED rate of exchange over the longer term i.​ Certainty helps investment and long term trade deals ii.​ With a fixed rate there is not volatility from speculation iii.​ Takes away a method for the government to behave irresponsibly. If they create inflation about the level of countries with whom they trade, the current account will fall, and the country's reserves will fall. There's no way to get out of the problem using a fall in the value of the currency b.​ Disadvantages of maintain a FIXED rate of exchange over the longer term c.​ To control the flow of currencies and keep a fixed exchange rate the government may have to use interest rate policy. Therefore interest rate ( monerary) policy cannot be used to manage domestic goals, only fiscal policy can be used. d.​ To reduce inflation to keep the flows in line with the fixed rate the government may have to reduce its own growth by using fiscal and monetary policies, other counties may try to compete by lowering their inflation e.​ If there are sudden shocks the country may have to abandon its domestic policies to keep the rate at a fixed level f.​ If speculators do not believe a country has the reserves to keep its currency fixed, they may attack it and force the currency down. Floating Systems Advantages: a.​ Automatic adjustment to a free floating price equilibrium b.​ No cruises as reserves fall c.​ Automatic adjustment to external shocks d.​ Government can use its policies ( fiscal and monetary) to control the domestic economic variables Disadvantages a.​ the currency is volatile creating uncertainty which may hurt trade and investment b.​ Speculators may drive the currency to great highs and lows Purchasing Power Parity Theory  a.​ Implies that the nominal exchange rate between two countries will come to rest when the price of a basket of everything, costs the same in both countries when translate at the nominal exchange rate b.​ Also that if a country has higher relative inflation, it's currency will depreciate c.​ Called the “ big mac index” i.​ Take the local price of a big mac in each of 2 countries this should give the PPP exchange rate as the products are the same Sample questions on section 3: PAGE 49 AND 50 Also do questions on page 91 and 85 4 key macroeconomic policies: Low and stable inflation High and stable economic growth Low rates of unemployment Balance of trade