A Complete Study Guide to Macroeconomics
A Complete Study Guide to Macroeconomics Econ 202
Cal State Fullerton
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This 37 page Study Guide was uploaded by Mario Giron on Thursday January 29, 2015. The Study Guide belongs to Econ 202 at a university taught by Dr. Dietz in Fall. Since its upload, it has received 572 views.
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Date Created: 01/29/15
Lecture 1 Tuesday August 26 2014 1016 AM The rule of seventy 70x X growth rate Lecture 2 Thursday August 28 2014 956 AM Capitalism 1 Limited government 2 Private property of factors of production 3 Selfinterest guides profits for producers wellbeing forconsumers 4 Markets and competition Lecture 3 Tuesday September 2 2014 949 AM GDP Gross Domestic Product Thus Market value of all final goods and services produced within the borders ofa country during some period of time 0 Market value is telling us these goods and services are traded in the market I Only final goods and services Sigma an Qn GDP Sigma Pn x Qn is a measure of the market value ofall new final production in a country over some period of time GDP is also a measure of total new income Y created in a country over some period oftime 0 Total income byY GDP is also equal to the total ofall Consumption spending C Investment spending I Government spending G and net exports NXexport earnings import spending on new final goods and services during some period of time GDP Sigma Pn x QnY CGNx Need to look at GDP per capita to compare countries and to look at GDP over time GDPPopulation Lecture 4 Thursday September 4 2014 958 AM GDP per capita often is used as a measure of the wellbeing of a country even though it is designed as a metric of production not of wellbeing For comparing GDP over time real GDP per capita must be used not nominal GDP per capita Nominal vs Real Nominal GDP Sigma Pcurrent yearX chrrent year 39 Real GDP Sigma Pbase yearX chrrent year 0 Choose a base year for prices to get real GDP Imperfections of GDP for looking at well being 0 Leaves out any own production and the addition to happiness of leisure time which has increased in the US over time and which surely makes people feel better off 0 Some quotbadsquot created in producing GDP particularly pollution and crime are not accounted forin the GDP measure 0 GDP per capita is a mean so it doesn39t39 tell us anything about the distribution of income and when income is unequally distributed it can give a distorted view of living standards Other Measures of Production and Income 1 Gross National ProductGN P all new income accruing to residents of country from new production of final goods and services regardless of where production took place 0 So it39s GDPincome of US citizens from production abroad minus income earned in the US by foreigners that is repatriated 0 Not all income created in the US belongs to US residents And not all the income that US residents receive comes from income created in the US Lecture 5 Tuesday September 9 2014 958 AM National income removes depreciation from the GDP measure sine it is not available as quotincomequot Personal incomezthis is really household income Retained corporate earnings are subtracted from national income and government transfer payments are added in Disposable personal income this is Personal income minus tax payments by household Key macroeconomic aggregates GDP and GDP per capita Unemployment rate Inflation rate 0 A person is counted as employed if she or he has worked at least 1 hourin the past week 0 A person is counted as unemployed if and only if that person has looked for work recently past4 weeks or was laid offand is waiting to return to work 0 Informal sectorunderground economy workers may report as unemployed or not in the labor force Discourage workers are not counted as unemployed because they have stopped looking forwork usually due to having been unsuccessful in finding work these individuals were counted as unemployed prior to dropping out of the laborforce due to their inability to find work but they are no longer counted as unemployed once they stop looking for work for more than 4 weeks Official Unemployment Rate unemployedlaborforce x 100 Involuntary parttime workers part time for economic reasons are those would prefer fulltime work but have taken parttime work because they could not find fulltime employment They are counted as employed but they do not have as much work as they wish In some sense they arepartially employed Labor force participation rate labor forceworking age population x 100 Three causes of unemployment Frictional people moving between jobs natural Structuralchanges in technology skills not in demand Cyclical business cycle Economists call the quotfull employment level ofunemploymentquotNatural unemployment rate it is when there is zero cyclical unemployment Lecture 6 Thursday September 11 2014 959 AM Inflation an increase in the average prices of goods and services overtime The inflation rate is stated as a and is an increase in the average price level 0 A common way to look at inflation is via the Consumer Price Index CPI It is a measure of changes in the cost of living of a basket of goods and services forurban households How to calculate Inflation Rate CPI currentCPI previous CPI previous x 100 PriceCPI previous x CPI current to adjust for current prices PriceCPI x base year Real value nominalvalue in year ZCPI year Z x CPI year X Lecture 7 Tuesday September 16 2014 1000 AM The Real Interest Rate 0 The formula above for calculating real values from nominal values works for adjustingvalues ie variables expressed in dollars or yen or euros Real interest rate nominal interest rate inflation rate Inflation Deflation Disinflation The CPI is not the only measure of inflation and it may not be the best it certainly is controversial Getting the inflation rate right is important it affects all sorts of people with cost of living adjustment contracts or obligations Core Inflation PCE minusfood and energy the most volatile of prices The Importance ofeconomic growth 0 We care about economic growth defined as an increase in real GDP per capita because imperfect as it is real GDP per capita reflects something about improved well being 0 For real GDP per capita to increase over time it must be the case that 0 change real GDPgt change population gt change real GDPperson A dramatic increase in life expectancy More income led to better nutrition better diets more health care an improvement in the environment 0 Improved health and strength makes workers more productive so it is possible to have more GDP per person Feedback effect from income gt better health gt more income Compound Growth 0 Productivity enhanced by 0 Increased use of physical capital So investment by an economy in physical capital investment is critical It helps to shift upward the production curve 0 Larger quantities of human capital Investments in education health care on the job training are essential for economic growth Entrepreneurs in this category 0 Technological change so that more can be produced from the same inputs A functioning capitalist economy tends to generate a search for better technology as firms profit maximize o A supportive institutional environment A vibrant economy needs a system based on enforced laws well defined property rights sufficient physical infrastructure and a functioning financial system Financial System To provide funding to entrepreneursfirms wishing to expands They also providecollect information that would be costly for individuals to obtain Existing firms can expands their operations by 0 Using retained earnings Undistributed profits 0 Borrow in thefinancial markets either fromfinancial intermediaries like banks or in the bond markets issuing debt 0 Sell equity ownership shares in the stock market Remembering back GDP was defined as o The market value ofa new final goods and services o All new income created by the production ofa new final goods and services 0 Y A expenditures o All expenditures C G NX 39 YCG I Y C G Private savings Sprivate Y TR C T income transfer payments consumption taxes 0 By households private individuals Public savings Spublic T G R tax revenues government spending transfer payments 0 By government Total savings Sprivate Spublic o SYTRCT TG TRYCG I SYCG III Thus IS always 0 Whatever is saved not spend on goods and services by households or government becomes investment 0 Changesin inventory can be investment IfSpubnc T G TR gt 0 budget surplus Spublic T G TR 0 balanced budget Spublic T G TR lt 0 budget deficit Crowding out refers to the idea that if the federal government runs a budget deficit it will be forced to borrow funds which thus reduces the funds available for firms and other private investors thus crowding them out of the market 0 Depending on the state of the economy government deficits might actually result in crowding in as the private sector is stimulated by G thus leading to more investment especially if the economy is not operating at full employment and full capacity To overcome diminishing returns 0 Improved technology typically embedded in new physical capital so more physical capital is needed as that is one mechanism for how technology is transmitted but it is better physical capital not more of the same 0 This can lead to created destruction as new products appear driving out old ones and creating a web of interrelated new production and goods and services that multiply out over the economy Improvements in human capital training education learning by doing Government can provide protection and can stimulate the creation of knowledge via 0 Patents a 20 year monopoly right to produce Subsidize RampD via universities labs firms Subsidize education increases the pool ofthose with advanced skills and increases the likelihood ofserendipitous advances 0 Free riders I IILILALIL I4I I Ic LILI 3EL we also rememper that government neeas to develop ana emorce laws tnataeTInIte and protect property rights This is called the quotRule of Lawquot Lecture 1 Tuesday September 30 2014 957 AM Not everyone agrees on howa capitalist economy reaches its equilibrium level ofGDP in unemployment Nor is there agreement among economists on how or even whether economic policy can equilibrium The classical perspective of macroeconomics Economists and policy makers with this viewpoint believe that capitalist markets work ef Economies reach equilibrium automatically and the level ofGDP attained is one where t employment f markets are not adversely affected by government policy 0 The classical economics view was the consensus theory until the Great Depression unemployment rate hit nearly 25 in 1933 doubt crept in The Keynesian View Out ofthe Great Depression came a new perspective This is known as Keynesian macroe John Keynes the famous British economist and politician Keynesians argue that left to themselves capitalist economies will reach an equilibrium economists argued However they disagree that the equilibrium will always be at full em classicals insisted Keynesians argued that a capitalist economy could be in equilibrium at any level ofGDP unemployment and it was not necessarily or even likely to be full employment all on its r Capitalists economics depend upon a sufficient level of spending mostlyfrom consumer that profits are sufficient to encourage private firms to produce and hire workers When spending is insufficient Keynesians argue then government spending must fill the gap tc economy toward a level of spending that can ensure a level of GDP consistent with full er laborforce The Keynesian view sees government as a regulator ofthe capitalist economy helping to spending and profitability so that private firms produce and employ workers at a sufficieI Government helps to keep the private sector vibrant and can help to reduce the ups and business cycle In this view government is a partner ofthe private sector Monetarist view of macroeconomics I a onand shapethe ficiently here is always full When the official economics after as the Classical Iployment as the and any level of own 5 and business so that level of qushthe nployment ofthe u ensure sufficient ntly high level downs ofthe 0 In the 196039s and 1970s the Monetarist perspective gained some traction particularly as hold in the US and Europe Monetarist have a lot in common with the classical economists but they believe the Fed39 money supply and the quantity of money money does not equal income Aggregate expenditures determine the level ofGDP and thus explain the business cycle 0 Aggregate expenditures C G NX 0 Consumption mostimportant 39 Consumption function C b aY where Y is total income 0 b is a fixed amount of consumption that is done independently of the level of y called au consumption 0 Autonomous consumption depends on otherfactors wealth prices future income These forces affect the level of C 0 a39 in the consumption function is the fraction of an extra dollar ofincome Y that is spen39 a39 is induced consumption a39 is the marginal propensity to consume MPC aMPC Change in C over Change in Y inflation took 5 control of the Itonomous Linterestrate t0ltalt1 Lecture 2 Thursday October 2 2014 1002 AM MPSMPC1 MPS Changein SChangein Y SY c At equilibriumGDP 1 All new final output produced is sold This will always be true if the economy is in equilibrium 2 All income Y is spend YC Consumption 3 No change in inventories at equilibrium GDP GDPYC CI change in inventory Lecture 3 Tuesday October 7 2014 1005 AM Change in inventories YAE AECG NX p planned investment amount of investment wants to do lA actual investment Ip change in inventory is the amount of investment that business ends up having The GDP multiplier The reason for this larger than expected increase in GDP and income from an inflow of new spending is to be found in the MPC With each extra dollar of income a new round of spending is generated And another and another 0 GDP spending multiplier 11MPC 0 Change in income or GDP 11M PC xChange in autonomous spending At equilibriumGDP 1 All new final output produced is sold This will always be true if the economyis in equilibrium 2 All income Y is spent Y C Ip No change in inventories at equilibrium GDP 4 Sa always but only at equilibrium does Slpla U Lecture 4 Thursday October 9 2014 1105 AM The paradox of thrift Remember that the GDP spending multiplier 11MPC 1M PS 0 Since CbMPCxY 0 When the MPS25 MPC75 0 And when MPS5 MPC5 And more saving out of income results in a lower level of AE and hence ofGDP This is the paradox ofthrift Ifconsumers begin to save more out oftheir income they are not spending That reduces AE everything else the same Of course everything else may not be the same More savings will most likely lower interest rates as banks have more deposits and more money to loan That could stimulate borrowing by businesses which increases Ip and increases AE Lecture 5 Tuesday October 14 2014 958 AM Keynes posited that in capitalist economies it was the level ofspending aggregate expenditures AE or total demand that determined the equilibrium level of GDP Ifcurrent GDP is less than potential GDP ie there is a recession or depression total spending is too low and what the economy needs is more spending And if the private sector can39t or won39t provide that extra spending the government can Two policy tools Monetary policy polices and decisions by the Fed on the money supply and interest rates designed to affect the level of GDP and inflation Fiscal policy Policies and decision by Congress and the President on federal government spending and taxes designed to affect the level of GDP and employment There is total government spending G 0 Federal government spending is split into two broad categories discretionary and automatic stabilizers Even in the 39discretionary39 category there is little room for making changes in spending Much of federal spendingis locked in 39 G about 14 of total GDP Automatic stabilizers federal income tax unemployment benefits other quotneedstestedquot transfer payments We can define the budget balance G T o fT G gt 0 budget surplus o fT G lt 0 budget deficit o fG T O balanced budget Ifthere is a deficit that adds to the national debt as the USTreasury must issue bonds to finance its spending that exceeds tax revenues The US federal government does not generally balance its budget Sometimes its revenues are higher than its expenditures but usually the reverse is true especially during wartime Fiscal policy has a multiplied effect on GDP 0 When G federal government spending increases say due to an increase in military spending then the usual spending multiplier we39ve been using comes into play 0 For change in g change in y GDP spending multiplier x change in G 0 Change in Y changein GDP 11M PC xchange in G 0 For change in T 0 Taxes do not directly affect spending It first affects income and then spending A change in T only indirectly affects spending The tax multiplier MPC1MPC 0 Change in y MPC1MPCxchange in T Balanced budget multiplier The balanced budget multiplier determines the multiplied effect on GDP when any increase in G is matched by an equal increase in T so no effect on the government budget balance or any decrease in T is matched by a decrease in G 0 Thus any change in G change in T Lecture 6 Thursday October 16 2014 1004 AM Differences in MPC The value ofthe MPC foreach individual differs based on 0 Current income 0 Wealth 0 Future income expectations Some problems with implementing discretionaryfiscal policy 0 There is a lag problem It may take Congress and the President a long time to react By then the problem may not be the same 0 Not much of the federal budget has room for increasing or decreasing G or T About 80 ofthe budget is mandated forSS or Medicare At best 20 ofthe budget is potentially discretionary Knowing what the target is can be an issue How do we arrive at value for potential GDP for Congress and the President to achieve Lecture 7 Tuesday October 21 2014 1002 AM Money banking and monetary policy What is money 0 Money is notthe same as income Money is something used in exchange for goods and services 0 Without money of some sort exchanges in the marketplace would be based on barter a most inefficient method to operate an economy 0 A barter economy would be a less productive economy because of the costs associated with the simple exchange of goods and services Moneyis anything That can be used a medium of exchange facilitates buying and selling That acts as a unit ofaccount way to measure and compare cost ofdifferent things That retains its value store of value over time 0 Money does not need to have an intrinsic value or to have a use on its own 0 Moneyin all modern economies is quotfiatquot money ie it has no intrinsic value other than acting as quotmoneyquot Money in the US Economy In the US and most modern economies there is a Central Bank that regulates the amount of money in the economy and determines interest rates The actual issuingprintingminting of coins and currency is done by the treasury The Central Bank is the bank forthe Federal government and it also serves as a bankto private bankinginstitutions In the US our Central Bank is the Federal Reserve System or simply the Fed Money in the US or what we will call the quotmoneysupplyquot is composed of o Coins and currency including traveler39s check outside of banks 39 Coins and currency held by bankinginstitutions as reserves is not part of the money supply 0 Checkable deposits 0 These are defined as M1 0 M2 is a broader definition ofthe money supply which includes M1 savings Interestingly about 23 of the currency held outside of banks is outside the US And a good portion of that maybe 80 is in 100 bills 0 The US dollar is a safe haven currency How banks create money supply 0 Banks create money in the form of checking deposits which are defined as part of the money supply above 0 Banks aren39t guarding yourdeposits They only need to legally hold on to a small fraction 10 or less ofwhat you deposit and the remainder they can loan out 0 That39s how banks earn profit By loaning out yourdeposits at a higher rate of interest than they pay you 0 Required reserve ratio RRR of deposits that must be held by a bank in their vault or on deposit at the Fed Simple deposit multiplier the money multiplier 1RRR Change in checking money Change in reserves x 1RRR This is the maximum value of the money multiplier any leakages from the banking system into cash or of banks holding excess reserves above the RRR will make this smaller and that is likely to happen and did soon a huge scale since the 2007 recession 0 Banks did not believe there were good loans to be made so they refused to lend out reserves despite the federal funds rate being maintained at zero This is known as a liquidity trap the Fed was unable to push rates any lower to encourage investment The Fed Chairperson and the Board of Governors 7 total appointed by the President of the US 0 12 Regional Federal Reserve Banks 0 Federal Open Market Committee FOMC 12 members 0 The Fed39s goals often called the dual mandate are to achieve stable prices and full employment 0 Stable prices means keeping the inflation rate low Note the goal is not zero inflation but low inflation Currently that target is 2 or less Maximum employment means attaining the maximum sustainable growth rate of potential GDP keeping real GDP close to potential GDP and the unemployment rate close to the natural unemployment rate Currently that target is in the mid 5 range To carry out its monetary policy the Fed has 3 tools 0 Required reserve ratios changed infrequently Discount rate This is the rate ofinterest at which banks can borrow from the Fed This is typically set for some period oftime Open market operations this is virtually daytoday Guided by the FOMC decisions Fed buys or sells US government treasury bonds in the open market ie not directly from the Treasury These tools are designed to affect the amount that banks can loan Fed policy affects GDP and employment only indirectly via interest rates and borrowing Not directly as fiscal policy does Carrying out Monetary Policy FOMC Actions to Avert Recession AntiRecessionary policy Expand the money supply so as to reduce interest rates and encourage borrowing This would be the policy if the economy was in a recession How can the Fed expand the money supply so as to try to shift the Ae curve upward if more borrowing takes place Lowering the discount rate would be one step 0 But most of the action will be via open market operations In this case to expand the money supply and reduce interest rates the Fed would buy shortterm government bonds the debt ofthe US in the bond market that increases someone39s amount of cash as they exchange their bonds one asset for money a different asset Some or all ofthat money will get deposited in a bank and then the money multiplier will kick in increasing the money supply When the Fed increases the money supply the shortterm interest rate must fall until it reaches a level at which households and firms are willing to hold the additional money 0 Although it does not directly set the federal funds rate through open market operations the Fed can control it quite well a A nn39l39on39l39ial nrnhlom Ali39l39h an39l39Lroroccinnaru mnnn39l39aru nnliru ic fha39l39 i39l39 ran ho alzin I PULCIILIUI HIUUICIII VVILII UIILI ICUCJJIUIIUI y IIIUIICLUI y HUIIby I LIIUL IL ball RIC UIIII to pushing on a string If borrowers are reluctant to borrow lower interest rates may be a weak incentive to entice them to incur new debt 0 It was determined that to get the economy to full employment not only would low interest rates be needed but they would have to be negative That would mean banks paying customers to borrow Fed followed a new policy known as Quantitative Easing This involved massive purchases of long term government securities normal open market operations involve purchases of shortterm government bonds and for the first time ever purchases of mortgagebacked securities in an attempt to propupthe housing market by driving mortgage interest rate down Lecture 8 Tuesday October 28 2014 1000 AM Review of Fed policy tools 0 The Fed attempts to carry out its dual mandate of stable prices and maximum employment by influencing bank reserves so as to affect interest rates and then and only then borrowing and spending Stepsin Fed impact on GDP 0 Conduct open market operations buy or sell federal government billsbonds in the bond market 0 This will have an impact on bank reserves and interest rates 0 If borrowing takes place the money supply increases there is more spending and the AE curve shifts upward 1 Expansionary monetary policy fthe Fed is interested in attempting to stimulate the economy because it is in a recession and current GDP is less than potential GDP the Fed can pursue a loose money policy ie reduce interest rates and stimulate borrowing and spendingto increase GDP and employment Policytools used 0 Reduce the discount rate 0 Conduct open market operations in this case the purchase of US government securities from the bond market 0 When the Fed buys US government securities the Fed receives the bond and holds it 2 Contractionary monetary policy fthe Fed wishes to slow down the economy then a tight money policy can be applied Raise the discount rate Fed Open market operations would be to sell US government securities to the public so as to increase the federal funds rates and then all other interest rates so as to discourage borrowing and spending What the Fed is doing in carrying out any monetary policy Affect bank reserves Affect quantity of loans banks can make 0 Changes in the quantity of loans banks can make affects the money supply Limits to the Fed39s efforts 0 The Fed can more predictably slow down the economy by reducing bank reserves and increasing the federal funds rate than it can stimulate the economy via a lower federal funds rate and lower interest rates Stopping consumers and businesses from borrowing by raising the cost of borrowing will reduce AEThis always works Encouraging consumers and businesses to borrow in a recession when they are reluctant to do so means even very low interest rates may not increase AE This is quotpushing on a stringquot problem 0 In recessionary periods fiscal policy may be the best tool forstimulating the economy with monetary policy as weak secondary player in the band Monetary policy and the inflation fear 0 There is a fear that recent Fed policy has put the economy at risk of future inflation Monetarists are proponents ofthe Quantity Theory ofMoney It is a very simple theory based on the following equation of exchange MxVPxY M is the money supply M1 or M2 V is the velocity of money how many times in a year each unit ofthe money supply is exchanged P is the average price level Y is the physical quantity of final goods and services It says that the money supply multiplied by the velocity of circulation of money nominal GDP Px Y But to the monetarists if you make a couple of assumptions you have a theory of inflation Assumptions 0 The economy is at full employment so Y is a constant ie the quantity of stuff produced is at its maximum 0 The velocity of money is a constant Then the equation of exchange becomes M X Vconstant P X Yconstant From this it39s clear that if the money supply increases by 5 then P must also increase by 5 to keep the equation of exchange equal since V and Y do not change In fact the monetarists are a little more sophisticated than that They do realize that Y the production of final goods and services in the economy changes over time With little economic growth Y might grow say 3 per year M X Vconstant P X Y If M the money supply also grows by 3 then with V constant prices do not change M XVconstant P X Y Lecture 1 Tuesday November 4 2014 1012 AM How the great recession started 0 Typically rents and housing prices evolve fairly closely over time Rents are a measure of the value of home services Housing prices dramatically diverged Higher prices for homes led to a burst of construction to cashin on the gains 0 New home sales were 60 20002005 and 80 20052010 Unemployment in the construction industry durable goods Manyjust walked away from their homes as they were upside down and al the foreclosures led to a furtherdrop in prices as the supply of unsold homes on the market grew What set us up for the bubble The US financial sector had been deregulated in the 1980psThetraditional differences between banks credit unions investment banks etc were blurred and they became more alike Mortgagebacked securities allowed banks and other lenders to sell offtheir existing mortgages and get new cash forlending without having to depend on deposits for loans And then the banking system was threatened It39s one thing to have falling GDP and rising unemployment It39s another problem altogether if the banking system starts to disintegrate Or the manufacturing sector Lehman Bros declared bankruptcy in September 2008 because its highly leveraged mortgagebacked securities had lost so much value that it had negative assets 0 The Fed began to buy mortgagebacked securities on the secondary market to prop up their values 0 Fannie Mae and Freddie Mac were made notjust government agencies but were absorbed by the federal government TARP Troubled Asset Relief Program to temporality make the US government a partial owner of problem banks until the loans could be paid off provided needed liquidity to the banking system Moral hazard dilemma o The above actions were crisis mode steps The federal government acted in ways that were far beyond normal activities But there were more normal fiscal and monetary policy actions that came into play too Though these became an order of magnitude greater than seen before The Fed39s policies 2007 onward We have seen that the Fed reduced the discount rate and has taken steps to keep the federal funds rate in the OO25 range But this did not do much Lecture 2 Thursday November 6 2014 1002 AM The Phillips Curve and the SR and LR trade off facing the fed Monetary policies We have seen that the Fed reduced the discount rate and has taken steps to keep the federal funds rate in the OO25 range in an effort to stimulate borrowing and spending so that AE and GDP would grow 0 This did not do much to get borrowing going Remember that banks have been holding excess reserves and not making loans like would be expected This is because the demandjust hasn39t been there for borrowing even at 0 The Fed implemented a program of Quantitative Easing the purchase of long term federal securities in the secondary market and of mortgagebacked securities at preannounced planned and large increments Fiscal policy In terms of fiscal policy the most important discretionary spending program the federal government implemented was the ARRA The Phillips Curve With QE 1 2 3 and the flooding of the economy with liquidity via massive expansions in the bank reserves the major target was to stimulate GDP by increasing spending so as to reduce unemployment Inflation was a concern of the Fed and they always keep an eye on It and mention it but it has not emerged as a problem as the rate of inflation has remained very low Lecture 3 Thursday November 13 2014 1006 AM How does international trade affect the domestic economy NX X M SoYCGXM Bretton Woods Agreement 0 1944 0 UN 0 World bank aid for poorcountries International monetary fund balance of payments funding and exchanging rates WTO GATT eventually reduction of tariffs and other barriers to trade 0 The 1973 oil crisis and its aftermath OPEC Why do countries trade 1 Some goods or services are not or cannot be produced in some countries 2 Comparative advantage means some countries are better at producing some goods and services than others When a country has comparative advantage it means it is a relatively lowcost producer compared to other countries The Logic of Trade Restrictions The fact that imports hurt GDP and exports help GDP and that imports hurt some groups in an importing country can result in countries attempting to manipulate the market so that they are not hurt so much by international trade 0 The most blunt instrument is a tariff o Protects USindustries Trade Restrictions Barriers to trade 0 Tariffs o Quotas imposed or voluntary VER o Other nontariffquota barriers 0 Under the rules of the WTO developed nations cannot use tariffs to improve their own economic conditions Non Tariff Barriers What can be and are used more often because they are much less transparent are a range of qualitative rules that inhibit trade Health safety and other regulatory rules red tape Traditional Argument favoring protection 0 There are some broader arguments in favor of protectionism that are not related to protecting particular economic interests 0 National security agriculture autotrucks watch making 0 Infantindustry protection tariffs to protect new industries in less developed economies to allow them time to be competitive o Dumpinnghis is when an exporter sells its goods or services at a price below the cost of production 0 This may be a predatory action by a particular firm or it may be that the action is financed by a foreign government In either case WTO rules allow compensatory import tariffs to be placed on such goods to neutralize this quotillegalquot activity The Other arguments for restricting trade 0 A means to save US jobs This is what typically lies behind the plea for tariffs or quotas by special interests that we examined above Promotefair trade o It is sometimes argued that US workers cannot compete with lowpaid foreign workers This depends on productivity notjust the wage rate however It is an empirical question 0 Differences in regulations laborlaws environment regulations attitudes and practices related to corruption exchange rate manipulation by governments etc that reduce costs in other countries visavis the US creating a quotnon level playing fieldquot This can be a very legitimate concern Balance of payments 0 But countries are also connected to each other via trade in services investment flows transfers among nations and individuals Lecture 4 Tuesday December 2 2014 1036 AM Exchange Rates 0 There is a demand to hold Us dollars outside of the USThis demand is from those living outside the US Foreigners demand dollars to use to buy US exports including travel in the US for speculation purposes and for safety reasons The Big Mac Theory of Exchange Rates 0 Exchange Rate Regimes Most economies had fixed rates ofone sort of another until the 1970sThen the pressures ofthe oil crisis and forthe US the costs ofthe Vietnam war led to more marketdriven exchange rates 0 Actually this should be called the purchasing powerparity theory of exchange rates 0 The idea behind purchasing power parity is thatS1or1 euro should be able to purchasethe same quantity of goods in any country at the same price 0 If not then there is the possibility ofarbitrage
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