Economics for Educators

Save this PDF as:
Size: px
Start display at page:

Download "Economics for Educators"

Transcription

1 Economics for Educators Lesson 18 and 5E Model Revised Edition Robert F. Hodgin, Ph.D.

2 ii Economics for Educators, Revised Copyright 2012 All Rights Reserved

3 99 Economics for Educators, Revised Lesson 18: Gains from Trade Trade and the Law of One Price For millennia, people have voluntarily traded in goods because both parties to the transaction experience a gain from the exchange. In modern times, domestic producer interests and the national interest do not always coincide. Elected officials can pursue trade policies favoring political aims, despite the economic costs to citizens and businesses. Although most national leaders accept the law of comparative advantage as true, they rarely permit its full benefits to prevail in favor of policies supporting vested economic positions that curry political favor or punish political enemies. In a freely competitive world, identical tradable goods available in the US and a foreign country would sell for the same price as measured in each country s currency. A direct implication of this statement is that price changes for goods in one country get reflected in the value of that country s international currency. If a US citizen visited a foreign country and wished to buy a local Big Mac hamburger for $3.49 in the states, they should pay no more than the equivalent of that price at the foreign currency s value. That is how the law of one price operates in principal. Law of One Price A unit of any one currency say the US dollar buys the same quantity of identical goods in all countries, after the currency exchange. Reality gets in the way of this appealing law when we search for identical goods in each of two countries only to find that they may not be precisely the same, save the Big Mac, perhaps. Further, not all goods are mobile or easily tradable. Land, for instance, is not tradable in the usual sense of physical movement. Also, many goods produced domestically just are not traded internationally. Simple and appealing, the law of one price does serve as an interesting gauge against which to assess the relative accuracy of currency exchange rates. Comparative Advantage Theory Prior to 1850, thinkers in international trade theory believed that the ability to produce a product with fewer resources determined the basis for trade the so-called absolute advantage view. Absolute Advantage -One person or country can produce a good with fewer resources than another country. Classical economist David Ricardo established the correct efficiency logic for trade. He showed that neither the total volume of goods generated for trade nor the disparity between labor wage rates mattered. Rather, the comparative opportunity cost of the goods between the traders was paramount. One merely had to measure the cost of the next best foregone opportunity of producing

4 100 Economics for Educators, Revised a good in the home country compared to a potential trading partner s opportunity cost to see who should specialize and trade which good(s) to the benefit of both countries. Comparative Advantage -One person or country should specialize in producing those good(s) where they have the lower opportunity cost compared to another person or country producing the same good. To see how this law operates, inspect the data in the table below where Sidney and Francis as workers in two separate countries produce either fruit or sugar. For Sidney, one day s effort produces one unit of fruit; but she could have made two units of sugar. So, making 1 unit of fruit costs Sidney 2 foregone sugar units. For Francis, one day s effort can produce 3 units of fruit or 4 units of sugar, not both. So, 1 fruit unit (3/3 = 1) costs Frances 4/3 sugar units. Comparative Advantage Example Person Fruit In 1 Day Sugar Fruit s Cost Sugar s Cost Sidney 1 OR 2 1 costs 2 1 costs ½ Francis 3 OR 4 1 costs 4/3 1 costs ¾ As between the two, who produces fruit with the least real sacrifice? Francis. Her 4/3 (1 fruit costs 1 1/3 sugar units) is less than Sidney s 2 (1 fruit costs 2 sugar units). So, Francis should specialize in producing fruit. It is also true that Sidney should specialize in producing sugar because her cost is ½ units of fruit while Francis cost is ¾ units of fruit. After specialization, they can trade the goods between them, where total output would be greater than before and both goods get produced at a lower opportunity cost than before specialization. Any barrier to free trade erodes the comparative advantage one country may possess, reduces the quantity of goods available and increases their relative cost. There may be political arguments for limiting trade by imposing barriers but there always are economic costs in so doing. Barriers to Free Trade Tariffs a tax on imports or exports makes imported goods more expensive and erodes the opportunity cost advantage from comparative advantage. Quotas a quantity limit on imports or exports reduces the gains of comparative advantage by restricting the amount of a named good that can be traded. Embargos trade prohibition against a good eliminates the possibility of any gains from comparative advantage by preventing trade for the named good.

5 101 Economics for Educators, Revised Currency Markets and Exchange Rates Trade with other countries also contains a transaction complication that carries a cost. Each country legalizes its own currency for use within its borders. US currency legally circulates domestically but foreign goods sellers want payments made in their own currency s denomination. So for every trade of goods or services between countries, an exchange of currencies also must occur. Countries can only trade, buy and sell goods and services with another country, if they possess a sufficient volume of their trading partner s currency. They most easily acquire a stock of international currency by selling goods or services, directly or indirectly, to the country with whom they wish to trade. Without enough of the correctly denominated currency, exchange cannot easily take place between two countries. Dollar Exchange Rate How much of another country s currency one US dollar will buy. Sample US$ to Aussie$* Currency Exchange Rate Exchange Rate on Feb. 1, 2011 A$ Currency Depreciation US$ Currency Appreciation 1 Aussie$ buys US$ IF 1 A$ = 0.90 US$ (A$ Depreciated) IF 1 US$ = 1.1 A$ (US$ Appreciated) and simultaneously: then simultaneously: then simultaneously: 1 US$ buys Aussie$ 1 US$ = 1.11 A$ (US$ Appreciated) 1 A$ = 0.9 A$ (A$ Depreciated) Source: *Aussie$ is shorthand for the Australian Dollar Reciprocal supply and demand for goods (and, hence, currency supply and demand) between countries largely determine currency exchange rates for international trade. But currencies do not always exchange for price parity equivalent product value due to exchange market forces like different national inflation rates, exporter or importer currency price expectations or government intervention that shift currency supply and demand. US Currency appreciation when the international currency market requires fewer dollars in exchange for another currency OR the US dollar buys more of another currency, the US dollar has appreciated in value and, simultaneously, the other currency has depreciated in value against the dollar. The other country s goods become less expensive for US purchasers, increasing US imports and US goods become more expensive to the other country s purchasers, reducing US exports. US Currency depreciation when the international currency market requires more dollars in exchange for another currency OR the same US dollar buys less of another currency, the US dollar has depreciated in value and, simultaneously, the other currency has appreciated in value against the dollar.

6 102 Economics for Educators, Revised The other country s goods become more expensive for US purchasers, decreasing US imports and US goods become less expensive to the other country s purchasers, increasing US exports. Currency exchange rates between trading countries fluctuate based on the demand for and supply of a country s international currency for trading purposes. For example, if the US demand to purchase more goods from Germany increases, then more international dollars must be exchanged for German marks to facilitate the transaction. So US demand for German marks rises relative to the supply of German marks. As with any market, when demand rises against a fixed supply, the price of the good goes up. Here, the dollar cost of a German mark rises, which also means the US dollar has depreciated in value against the German mark. Currency exchanges complicate international trade transactions but organized international markets provide a relatively efficient mechanism to reduce transactions costs and uncertainty. Finally, barriers to trade, commonly predicated on political or power considerations, erode the economic opportunities revealed by the logic of comparative advantage. The Balance of Payments International transactions get recorded as a demand component of GDP called net exports (exports minus imports) where exports increase GDP but imports do not alter US GDP (because when US consumption rises, US imports rise by an identical but negative amount). All international transactions fall into one of two large categories plus a relatively minor third category: 1) current account, 2) capital account and 3) transfers, gifts and discrepancies. The current account tracks the flow of goods, services and income between countries. US Exports are sales to foreign countries and bring dollars into the US. US Imports are purchases from foreign countries and send dollars out of the US. If US exports exceed imports, then the current account balance is a surplus. If US imports exceed exports, the current account is in deficit. The capital account tracks investment flows, either direct real capital (machinery, land etc.) or financial capital (stocks, bonds). Exports are sales of US-owned real capital or US financial assets that bring dollars into the US. Imports are purchases of foreignowned real capital or foreign financial assets and that send dollars out of the US. Transfers and gifts are one-way flows between individuals in different countries or between governments, as foreign aid. Statistical discrepancies exist because international transactions are difficult to accurately track.

7 103 Economics for Educators, Revised US Current Account Balance Data, 2009 ($ Millions) Current Account Categories $ Amounts Exports of goods and services and income receipts 2,159,000 Imports of goods and services and income payments 2,412,489) Unilateral current transfers, net (124,943) Net Balance on Current Account $ (378,432) US Capital Account Balance Data, 2009 ($ Millions) Capital Account Categories $ Amounts U.S.-owned assets abroad (140,465) Foreign-owned assets in the United States 305,736 Net Financial Derivatives & Statistical Adjustment 213,301 Capital account transactions, net (140) Net Balance on Capital Account $378,432 Source: It is an accounting truism that for every current account transaction, there is an equal capital account transaction. One country always pays another through some financial instrument or money transaction. Current account transactions must equal capital account transactions (and are opposite in algebraic sign), including unilateral transfers, gifts and discrepancies. Trade between countries does not stop just because a country s trade balance is negative. Rather, the deficit country must offer some asset other than goods or services in return. Most commonly financial debt instruments from private companies or from the government are accepted, as long as the borrower s credit is good. The benefits to trade are large, continuing and within the grasp of any country that produces goods or services desired by another country s citizens. The law of comparative advantage shows that even developing countries may have an opportunity cost advantage in producing some good or goods and can trade them to their benefit.

8 104 Economics for Educators, Revised In Sum Law of one price in principle, the exchange rate between currencies should reflect equivalent values for identical tradable goods between the countries. Comparative advantage means that individuals and countries should specialize in producing those goods with the lowest opportunity cost compared to the opportunity costs of potential trading partners. With specialization: o More total goods will be available and at lower cost o The terms of trade the good-to-good exchange price between parties must fall between their comparative opportunity costs of production or there is no economic basis for trade. Any inhibition to free trade reduces the amount of goods available and raises the cost (price) of those goods o Tariffs a tax on imports o Quotas a limit on physical volume of imports o Embargos a prohibition on imports or exports Currency exchange rate the value of one country s currency expressed in units of another country s currency o Appreciation a country s currency buys more units of another country s currency o Depreciation a country s currency buys fewer units of another country s currency Balance of payments the means of accounting for all international transactions o Current account exchanges of goods and services o Capital account exchanges of real assets or financial assets o Current account transactions = capital account transactions after adjustments for transfers and omissions.

9 Engage Lesson 18: Gains From Trade, page 99 What is opportunity cost? Give an example of a recent decision you had to make and its opportunity cost. Page 57 An opportunity cost is the next best valued item you do not choose. It is your SECOND CHOICE. Answers will vary, but stress that it is the NEXT best choice the one that was sacrificed. Explore Divide the class into two regions: Greenland and Redland. Then write the opportunity cost table below on the board for all to see. Reinforce that for Greenland, per minute, each staple made costs one paperclip (and each paperclip made costs one staple!). Then reinforce that in Redland, per minute, each staple made costs ½ paperclip, and that each paperclip costs 2 staples!). Show the ratios. Define opportunity cost (again!) as the value of the next best option foregone when undertaking the chosen option. Each minute in: Staple(s) OR Paperclip(s) A. Greenland 1 OR 1 B. Redland 2 OR 1 Greenland: 1 staple = 1 paperclip and 1 paperclip = 1 staple Redland: 1 staple = ½ paperclip and 1 paperclip = 2 staples Compare to find whose opportunity cost is lower and then underline the lowest Allen Parkway * Houston, TX * (713) * Fax: (713) *

10 Explain Ask which Region has the lower opportunity cost for STAPLES? Ask which Region has the lower opportunity cost for PAPERCLIPS. Redland! In the time it takes to make 1 staple just one-half a paperclip has been sacrificed; i.e. they can make 2 staples per minute (one every 30 seconds) but only 1 paperclip per minute. In contrast, for Greenland, in the one minute it takes to make 1 staple, 1 paperclip has been sacrificed. Page 58 Greenland! In the one minute it takes to make 1 paperclip just 1 staple is sacrificed. In contrast, for Redland for each paperclip made in one minute, 2 staples have been sacrificed. Extend If each region were to specialize and then trade with the other, which region should sell and which region should buy what product? And is there an advantage to them for trading? [Write down comments on the board for all to see and ponder.] Then note the correct explanation for the law of comparative advantage in trade. What determines the actual trading price for each good between the two regions? [Write student comments on the board.] Greenland has the (comparative) advantage in paperclips! So they could specialize in their production and sell some to Redland, the buyer (after Greenland citizens have bought all of them they want domestically). Redland has the (comparative) advantage in Staples! So they could specialize and sell some to Greenland, the buyer (after Redland citizens have bought all of them the want domestically) Allen Parkway * Houston, TX * (713) * Fax: (713) *

11 The region that produces a good for a lower opportunity cost than another region has an economic opportunity. If trade is permitted, there is an economic logic to support it. For Greenland, as long they can sell each Paperclip for MORE than 1 Staple, Greenlandians improve their position. For Redland, as long as they can buy each Paperclip for LESS than 2 Staples, Redlandians improve their position. For Redland, as long as they can sell each Staple for MORE than ½ Paperclip, Redlandians can improve their their position. For Greenland, as long as they can buy each Staple for LESS than 1 paperclip, Greenlandians can improve their position. Page 59 The delete actual economic answer is that the difference between the two region s opportunity costs in making each good determines the range of potential exchange prices. But the actual exchange price(s) depend on the relative negotiating power of each region. So the more productive a region is in making a good COMPARED to another region, the more there is a potential to gain from specialization and exchange. The trading price will be between the two opportunity costs not higher than the highest and not lower than the lowest. Remind them that no one is FORCED to sell or buy at an unfair price. Compare to a face to face negotiation on prices ex. Garage sale, flea market, Internet sites (Craig s list), etc. Evaluate Ask the class if the same logic above works for individuals inside the same country? Count the number of yes and no and uncertain votes. The answer is definitely YES! Indeed, it is the relative ability of each person in performing some task, compared to another, that makes him/her attractive to employers. And that comparative advantage can be improved through education and training! 1801 Allen Parkway * Houston, TX * (713) * Fax: (713) *

12 The (TCEE) thanks the Council for Economic Education and the Department of Education Office of Innovation and Improvement for awarding the Replication of Best Practices Program grant that allowed Economics for Educators, Revised Edition to be written and published. The also thanks six of its major partners whose support allows TCEE to provide the staff development that utilizes content and skills provided in Economics for Educators.

13 Helping young people learn to think & make better economic & financial choices in a global economy. economicstexas.org 1801 Allen Parkway Houston, Texas Telephone Fax

Big Concepts. Balance of Payments Accounts. Financing International Trade. Economics 202 Principles Of Macroeconomics. Lecture 12

Big Concepts. Balance of Payments Accounts. Financing International Trade. Economics 202 Principles Of Macroeconomics. Lecture 12 Economics 202 Principles Of Macroeconomics Professor Yamin Ahmad Big Concepts Balance of Payments Equilibrium The relationship between the current account, capital account and official settlements balance

More information

The Balance of Payments, the Exchange Rate, and Trade

The Balance of Payments, the Exchange Rate, and Trade Balance of Payments The Balance of Payments, the Exchange Rate, and Trade Policy The balance of payments is a country s record of all transactions between its residents and the residents of all foreign

More information

Chapter 12. National Income Accounting and the Balance of Payments. Slides prepared by Thomas Bishop

Chapter 12. National Income Accounting and the Balance of Payments. Slides prepared by Thomas Bishop Chapter 12 National Income Accounting and the Balance of Payments Slides prepared by Thomas Bishop Preview National income accounts measures of national income measures of value of production measures

More information

GOVERNMENT ECONOMIC OBJECTIVES AND POLICIES. Textbook, Chapter 26 [pg 317-328]

GOVERNMENT ECONOMIC OBJECTIVES AND POLICIES. Textbook, Chapter 26 [pg 317-328] GOVERNMENT ECONOMIC OBJECTIVES AND POLICIES Textbook, Chapter 26 [pg 317-328] Name: Class: Learning outcomes: Identify government economic objectives. Explain the main stages of the business cycle. Explain

More information

ECONOMIC GROWTH* Chapter. Key Concepts

ECONOMIC GROWTH* Chapter. Key Concepts Chapter 5 MEASURING GDP AND ECONOMIC GROWTH* Key Concepts Gross Domestic Product Gross domestic product, GDP, is the market value of all the final goods and services produced within in a country in a given

More information

MEASURING GDP AND ECONOMIC GROWTH CHAPTER

MEASURING GDP AND ECONOMIC GROWTH CHAPTER MEASURING GDP AND ECONOMIC GROWTH CHAPTER Objectives After studying this chapter, you will able to Define GDP and use the circular flow model to explain why GDP equals aggregate expenditure and aggregate

More information

Balance of Payments Accounting. (guidelines recommended by the IMF International Monetary Fund )

Balance of Payments Accounting. (guidelines recommended by the IMF International Monetary Fund ) Balance of Payments Accounting (guidelines recommended by the IMF International Monetary Fund ) To understand the factors that affect international trade and lending first requires basic knowledge of Balance

More information

Practice Problems on Current Account

Practice Problems on Current Account Practice Problems on Current Account 1- List de categories of credit items and debit items that appear in a country s current account. What is the current account balance? What is the relationship between

More information

FLEXIBLE EXCHANGE RATES

FLEXIBLE EXCHANGE RATES FLEXIBLE EXCHANGE RATES Along with globalization has come a high degree of interdependence. Central to this is a flexible exchange rate system, where exchange rates are determined each business day by

More information

What you will learn: UNIT 3. Traditional Flow Model. Determinants of the Exchange Rate

What you will learn: UNIT 3. Traditional Flow Model. Determinants of the Exchange Rate What you will learn: UNIT 3 Determinants of the Exchange Rate (1) Theories of how inflation, economic growth and interest rates affect the exchange rate (2) How trade patterns affect the exchange rate

More information

National Income Accounting and the Balance of Payments

National Income Accounting and the Balance of Payments National Income Accounting and the Balance of Payments Graciela L. Kaminsky Department of Economics George Washington University Lecture Notes 1 Questions The US current account deficit is about 7 percent

More information

International Economic Relations

International Economic Relations nternational conomic Relations Prof. Murphy Chapter 12 Krugman and Obstfeld 2. quation 2 can be written as CA = (S p ) + (T G). Higher U.S. barriers to imports may have little or no impact upon private

More information

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. Chatper 34 International Finance - Test Bank MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) The currency used to buy imported goods is A) the

More information

III. INTERNATIONAL TRADE

III. INTERNATIONAL TRADE III. INTERNATIONAL TRADE A. Gains from Trade -- a history of thought approach 1. The idea of mercantilism (15-175) argued that a country s well-being is directly tied to the accumulation of gold and silver.

More information

3) The excess supply curve of a product we (H) import from foreign countries (F) increases as B) excess demand of country F increases.

3) The excess supply curve of a product we (H) import from foreign countries (F) increases as B) excess demand of country F increases. International Economics, 8e (Krugman) Chapter 8 The Instruments of Trade Policy 8.1 Basic Tariff Analysis 1) Specific tariffs are A) import taxes stated in specific legal statutes. B) import taxes calculated

More information

Chapter 11. International Economics II: International Finance

Chapter 11. International Economics II: International Finance Chapter 11 International Economics II: International Finance The other major branch of international economics is international monetary economics, also known as international finance. Issues in international

More information

1. Planning - Establishing organizational goals and deciding how to accomplish them

1. Planning - Establishing organizational goals and deciding how to accomplish them 1 : Understanding the Management Process Basic Management Functions 1. Planning - Establishing organizational goals and deciding how to accomplish them SWOT analysis - The identification and evaluation

More information

Knowledge Enrichment Seminar for Senior Secondary Economics Curriculum. Macroeconomics Series (3): Extension of trade theory

Knowledge Enrichment Seminar for Senior Secondary Economics Curriculum. Macroeconomics Series (3): Extension of trade theory Knowledge Enrichment Seminar for Senior Secondary Economics Curriculum Macroeconomics Series (3): Extension of trade theory by Dr. Charles Kwong School of Arts and Social Sciences The Open University of

More information

Agenda. Saving and Investment in the Open Economy. Balance of Payments Accounts. Balance of Payments Accounting. Balance of Payments Accounting.

Agenda. Saving and Investment in the Open Economy. Balance of Payments Accounts. Balance of Payments Accounting. Balance of Payments Accounting. Agenda. Saving and Investment in the Open Economy Goods Market Equilibrium in an Open Economy. Saving and Investment in a Small Open Economy. Saving and Investment in a Large Open Economy. 7-1 7-2 Balance

More information

Commentary: What Do Budget Deficits Do?

Commentary: What Do Budget Deficits Do? Commentary: What Do Budget Deficits Do? Allan H. Meltzer The title of Ball and Mankiw s paper asks: What Do Budget Deficits Do? One answer to that question is a restatement on the pure theory of debt-financed

More information

Thank You for Attention

Thank You for Attention Thank You for Attention Explain how the foreign exchange market works. Examine the forces that determine exchange rates. Consider whether it is possible to predict future rates movements. Map the business

More information

Chapter 4. Money, Interest Rates, and Exchange Rates

Chapter 4. Money, Interest Rates, and Exchange Rates Chapter 4 Money, Interest Rates, and Exchange Rates Preview What is money? Control of the supply of money The willingness to hold monetary assets A model of real monetary assets and interest rates A model

More information

Reading the balance of payments accounts

Reading the balance of payments accounts Reading the balance of payments accounts The balance of payments refers to both: All the various payments between a country and the rest of the world The particular system of accounting we use to keep

More information

Chapter 14. Preview. What Is Money? Money, Interest Rates, and Exchange Rates

Chapter 14. Preview. What Is Money? Money, Interest Rates, and Exchange Rates Chapter 14 Money, Interest Rates, and Exchange Rates Slides prepared by Thomas Bishop Copyright 2009 Pearson Addison-Wesley. All rights reserved. Preview What is money? Control of the supply of money The

More information

Balance of Payments. BoP Account Definitions. Tracking International Flows Of Goods and Services. Balance of Payments

Balance of Payments. BoP Account Definitions. Tracking International Flows Of Goods and Services. Balance of Payments Balance of Payments Tracking International Flows Of Goods and Services Balance of Payments The Balance of Payments (BoP) details the flow of all international transactions in and out of the country. It

More information

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. ECON 4110: Sample Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Economists define risk as A) the difference between the return on common

More information

MGEC61 International Economics: Finance

MGEC61 International Economics: Finance MGEC61 International Economics: Finance Introduction International finance is a study of problems and policies of an open economy. International finance studies the issues like unemployment, savings, trade

More information

GEORGIA PERFORMANCE STANDARDS International Domain [Type the author name]

GEORGIA PERFORMANCE STANDARDS International Domain [Type the author name] GEORGIA PERFORMANCE STANDARDS International Domain [Type the author name] GEORGIA PERFORMANCE STANDARDS INTERNATIONAL ECONOMICS Fundamental Economic Concepts SSEF3 The student will explain how specialization

More information

University of Lethbridge Department of Economics ECON 1012 Introduction to Macroeconomics Instructor: Michael G. Lanyi

University of Lethbridge Department of Economics ECON 1012 Introduction to Macroeconomics Instructor: Michael G. Lanyi University of Lethbridge Department of Economics ECON 1012 Introduction to Macroeconomics Instructor: Michael G. Lanyi CH 25 Exch Rate & BofP 1) Foreign currency is A) the market for foreign exchange.

More information

CHAPTER 32 EXCHANGE RATES, BALANCE OF PAYMENTS, AND INTERNATIONAL DEBT

CHAPTER 32 EXCHANGE RATES, BALANCE OF PAYMENTS, AND INTERNATIONAL DEBT CHAPTER 32 EXCHANGE RATES, BALANCE OF PAYMENTS, AND INTERNATIONAL DEBT Chapter in a Nutshell Along with the flows of goods and services being traded between countries, there are corresponding flows of

More information

CHAPTER 14 BALANCE-OF-PAYMENTS ADJUSTMENTS UNDER FIXED EXCHANGE RATES

CHAPTER 14 BALANCE-OF-PAYMENTS ADJUSTMENTS UNDER FIXED EXCHANGE RATES CHAPTER 14 BALANCE-OF-PAYMENTS ADJUSTMENTS UNDER FIXED EXCHANGE RATES MULTIPLE-CHOICE QUESTIONS 1. Which of the following does not represent an automatic adjustment in balance-of-payments disequilibrium?

More information

What Is the Balance of Payments?

What Is the Balance of Payments? What Is the Balance of Payments? Norman S. Fieleke Vice President and Economist Federal Reserve Bank of Boston Federal Reserve Bank of Boston July 1976 Revised August 1985 and October 1996 Hypothetical

More information

Theories of Exchange rate determination

Theories of Exchange rate determination Theories of Exchange rate determination INTRODUCTION By definition, the Foreign Exchange Market is a market 1 in which different currencies can be exchanged at a specific rate called the foreign exchange

More information

MGE#12 The Balance of Payments

MGE#12 The Balance of Payments MGE#12 The Balance of Payments The Current Account, the Capital Account and the Balance of Payments Introduction to the Foreign Exchange Market Savings, Investment and the Current Account 1 From last session

More information

International Economic Relations

International Economic Relations nswers to Problem Set #5 International conomic Relations Prof. Murphy Chapter 5 Krugman and Obstfeld. Relative PPP predicts that inflation differentials are matched by changes in the exchange rate. Under

More information

13. If Y = AK 0.5 L 0.5 and A, K, and L are all 100, the marginal product of capital is: A) 50. B) 100. C) 200. D) 1,000.

13. If Y = AK 0.5 L 0.5 and A, K, and L are all 100, the marginal product of capital is: A) 50. B) 100. C) 200. D) 1,000. Name: Date: 1. In the long run, the level of national income in an economy is determined by its: A) factors of production and production function. B) real and nominal interest rate. C) government budget

More information

A guide to managing foreign exchange risk

A guide to managing foreign exchange risk A guide to managing foreign exchange risk CPA Australia Ltd ( CPA Australia ) is one of the world s largest accounting bodies with more than 122,000 members of the financial, accounting and business profession

More information

D) surplus; negative. 9. The law of one price is enforced by: A) governments. B) producers. C) consumers. D) arbitrageurs.

D) surplus; negative. 9. The law of one price is enforced by: A) governments. B) producers. C) consumers. D) arbitrageurs. 1. An open economy is one in which: A) the level of output is fixed. B) government spending exceeds revenues. C) the national interest rate equals the world interest rate. D) there is trade in goods and

More information

Econ 202 Section 2 Final Exam

Econ 202 Section 2 Final Exam Douglas, Fall 2009 December 17, 2009 A: Special Code 0000 PLEDGE: I have neither given nor received unauthorized help on this exam. SIGNED: PRINT NAME: Econ 202 Section 2 Final Exam 1. The present value

More information

Chapter 14 Foreign Exchange Markets and Exchange Rates

Chapter 14 Foreign Exchange Markets and Exchange Rates Chapter 14 Foreign Exchange Markets and Exchange Rates International transactions have one common element that distinguishes them from domestic transactions: one of the participants must deal in a foreign

More information

Ch. 38 Practice MC 1. In international financial transactions, what are the only two things that individuals and firms can exchange? A.

Ch. 38 Practice MC 1. In international financial transactions, what are the only two things that individuals and firms can exchange? A. Ch. 38 Practice MC 1. In international financial transactions, what are the only two things that individuals and firms can exchange? A. Currency and real assets. B. Services and manufactured goods. C.

More information

CHAPTER 5: MEASURING GDP AND ECONOMIC GROWTH

CHAPTER 5: MEASURING GDP AND ECONOMIC GROWTH CHAPTER 5: MEASURING GDP AND ECONOMIC GROWTH Learning Goals for this Chapter: To know what we mean by GDP and to use the circular flow model to explain why GDP equals aggregate expenditure and aggregate

More information

Cosumnes River College Principles of Macroeconomics Problem Set 11 Will Not Be Collected

Cosumnes River College Principles of Macroeconomics Problem Set 11 Will Not Be Collected Name: Solutions Cosumnes River College Principles of Macroeconomics Problem Set 11 Will Not Be Collected Fall 2015 Prof. Dowell Instructions: This problem set will not be collected. You should still work

More information

PRACTICE- Unit 6 AP Economics

PRACTICE- Unit 6 AP Economics PRACTICE- Unit 6 AP Economics Multiple Choice Identify the choice that best completes the statement or answers the question. 1. The term liquid asset means: A. that the asset is used in a barter exchange.

More information

Refer to Figure 17-1

Refer to Figure 17-1 Chapter 17 1. Inflation can be measured by the a. change in the consumer price index. b. percentage change in the consumer price index. c. percentage change in the price of a specific commodity. d. change

More information

Monetary Policy Bank of Canada

Monetary Policy Bank of Canada Bank of Canada The objective of monetary policy may be gleaned from to preamble to the Bank of Canada Act of 1935 which says, regulate credit and currency in the best interests of the economic life of

More information

Chapter 13 International Trade: Does it Jeopardize American Jobs

Chapter 13 International Trade: Does it Jeopardize American Jobs Chapter 13 International Trade: Does it Jeopardize American Jobs Multiple Choice Questions 1. In 2006, trade made up percent of the U.S. economy. a. 1.3 b. 5.0 C. 11.5 d. 22.7 2. In 2005, the U.S. experienced

More information

2 0 0 0 E D I T I O N CLEP O F F I C I A L S T U D Y G U I D E. The College Board. College Level Examination Program

2 0 0 0 E D I T I O N CLEP O F F I C I A L S T U D Y G U I D E. The College Board. College Level Examination Program 2 0 0 0 E D I T I O N CLEP O F F I C I A L S T U D Y G U I D E College Level Examination Program The College Board Principles of Macroeconomics Description of the Examination The Subject Examination in

More information

Economics 380: International Economics Fall 2000 Exam #2 100 Points

Economics 380: International Economics Fall 2000 Exam #2 100 Points Economics 380: International Economics Fall 2000 Exam #2 100 Points Name (ID) YOU SHOULD HAVE 7 PAGES FOR THIS EXAM. EXAM WILL END AT 1:50. MAKE SURE YOUR NAME IS ON THE FIRST AND LAST PAGE OF THE EXAM.

More information

Assignment 3 Answer Key (Maximum Points: 100) Multiple-Choice Questions Each question is worth 3 points. Explanation is not required.

Assignment 3 Answer Key (Maximum Points: 100) Multiple-Choice Questions Each question is worth 3 points. Explanation is not required. Econ 4401 International Economics University of Minnesota Deniz Cicek Fall 2009 Assignment 3 Answer Key (Maximum Points: 100) Multiple-Choice Questions Each question is worth 3 points. Explanation is not

More information

ASSIGNMENT 1 ST SEMESTER : MACROECONOMICS (MAC) ECONOMICS 1 (ECO101) STUDY UNITS COVERED : STUDY UNITS 1 AND 2. DUE DATE : 3:00 p.m.

ASSIGNMENT 1 ST SEMESTER : MACROECONOMICS (MAC) ECONOMICS 1 (ECO101) STUDY UNITS COVERED : STUDY UNITS 1 AND 2. DUE DATE : 3:00 p.m. Page 1 of 13 ASSIGNMENT 1 ST SEMESTER : MACROECONOMICS (MAC) ECONOMICS 1 (ECO101) STUDY UNITS COVERED : STUDY UNITS 1 AND 2 DUE DATE : 3:00 p.m. 19 MARCH 2013 TOTAL MARKS : 100 INSTRUCTIONS TO CANDIDATES

More information

Measuring GDP and Economic Growth

Measuring GDP and Economic Growth 20 Measuring GDP and Economic Growth After studying this chapter you will be able to Define GDP and explain why GDP equals aggregate expenditure and aggregate income Explain how Statistics Canada measures

More information

Chapter 14. Money, Interest Rates, and Exchange Rates. Slides prepared by Thomas Bishop

Chapter 14. Money, Interest Rates, and Exchange Rates. Slides prepared by Thomas Bishop Chapter 14 Money, Interest Rates, and Exchange Rates Slides prepared by Thomas Bishop Preview What is money? Control of the supply of money The demand for money A model of real money balances and interest

More information

Key elements of Monetary Policy

Key elements of Monetary Policy Key elements of Monetary Policy Part II Economic Policy Course for Civil Society June 2004 World Bank Institute Structure of the Presentation Introduction Current account Balance of Payments Debt Current

More information

Econ 202 Section 4 Final Exam

Econ 202 Section 4 Final Exam Douglas, Fall 2009 December 15, 2009 A: Special Code 00004 PLEDGE: I have neither given nor received unauthorized help on this exam. SIGNED: PRINT NAME: Econ 202 Section 4 Final Exam 1. Oceania buys $40

More information

1 Multiple Choice - 50 Points

1 Multiple Choice - 50 Points Econ 201 Final Winter 2008 SOLUTIONS 1 Multiple Choice - 50 Points (In this section each question is worth 1 point) 1. Suppose a waiter deposits his cash tips into his savings account. As a result of only

More information

Lecture 10-1. The Twin Deficits

Lecture 10-1. The Twin Deficits Lecture 10-1 The Twin Deficits The IS-LM model of the previous lectures endogenised the interest rate while assuming that the portion (NX 0 ) of net exports not dependent on income was exogenously fixed.

More information

Statement by Dean Baker, Co-Director of the Center for Economic and Policy Research (www.cepr.net)

Statement by Dean Baker, Co-Director of the Center for Economic and Policy Research (www.cepr.net) Statement by Dean Baker, Co-Director of the Center for Economic and Policy Research (www.cepr.net) Before the U.S.-China Economic and Security Review Commission, hearing on China and the Future of Globalization.

More information

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. Suvey of Macroeconomics, MBA 641 Fall 2006, Final Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Modern macroeconomics emerged from

More information

The risks and benefits of shares

The risks and benefits of shares Course 3 The risks and benefits of shares Topic 1: The risks of shares... 3 The risks of shares... 3 The risk of capital loss... 3 Volatility risk... 4 The risk of poor quality advice... 4 Time for your

More information

A Primer on Exchange Rates and Exporting WASHINGTON STATE UNIVERSITY EXTENSION EM041E

A Primer on Exchange Rates and Exporting WASHINGTON STATE UNIVERSITY EXTENSION EM041E A Primer on Exchange Rates and Exporting WASHINGTON STATE UNIVERSITY EXTENSION EM041E A Primer on Exchange Rates and Exporting By Andrew J. Cassey and Pavan Dhanireddy Abstract Opportunities to begin exporting

More information

Learning Objectives. Chapter 17. Trading Currencies in Foreign Exchange Markets. Trading Currencies in Foreign Exchange Markets (cont.

Learning Objectives. Chapter 17. Trading Currencies in Foreign Exchange Markets. Trading Currencies in Foreign Exchange Markets (cont. Chapter 17 Financing World Trade Learning Objectives Explain how foreign exchange rates are determined. Differentiate between floating and fixed exchange rate systems. Contrast the balance of trade and

More information

Chapter 13. Aggregate Demand and Aggregate Supply Analysis

Chapter 13. Aggregate Demand and Aggregate Supply Analysis Chapter 13. Aggregate Demand and Aggregate Supply Analysis Instructor: JINKOOK LEE Department of Economics / Texas A&M University ECON 203 502 Principles of Macroeconomics In the short run, real GDP and

More information

Chapter 7. Comparative Advantage and the Gains from International Trade

Chapter 7. Comparative Advantage and the Gains from International Trade Chapter 7. Comparative Advantage and the Gains from International Trade Instructor: JINKOOK LEE Department of Economics / Texas A&M University ECON 203 502 Principles of Macroeconomics International Trade

More information

FOREIGN EXCHANGE RISK MANAGEMENT

FOREIGN EXCHANGE RISK MANAGEMENT CHAPTER - VII CHAPTER - VII FOREIGN EXCHANGE RISK MANAGEMENT INTRODUCTION DEFINITION & MEANING EXPOSURE IN FOREIGN EXCHANGE > TRANSACTION EXPOSURES > TRANSLATION EXPOSURES > OPERATING EXPOSURES MANAGING

More information

Wells Fargo Hands on Banking & CEE National Content Standards Alignment

Wells Fargo Hands on Banking & CEE National Content Standards Alignment Standard 1: Scarcity Productive resources are limited. Therefore, people can not have all the goods and services they want; as a result, they must choose some things and give up others. Section 1 Savings

More information

Econ 202 Final Exam. Table 3-1 Labor Hours Needed to Make 1 Pound of: Meat Potatoes Farmer 8 2 Rancher 4 5

Econ 202 Final Exam. Table 3-1 Labor Hours Needed to Make 1 Pound of: Meat Potatoes Farmer 8 2 Rancher 4 5 Econ 202 Final Exam 1. If inflation expectations rise, the short-run Phillips curve shifts a. right, so that at any inflation rate unemployment is higher. b. left, so that at any inflation rate unemployment

More information

UNIT I NATIONAL INCOME AND MACROECONOMICS

UNIT I NATIONAL INCOME AND MACROECONOMICS UNIT I NATIONAL INCOME AND MACROECONOMICS 1 National Income National Income is defined as the sum total of all the goods and services produced in a country, in a particular period of time. Normally this

More information

Economics 152 Solution to Sample Midterm 2

Economics 152 Solution to Sample Midterm 2 Economics 152 Solution to Sample Midterm 2 N. Das PART 1 (84 POINTS): Answer the following 28 multiple choice questions on the scan sheet. Each question is worth 3 points. 1. If Congress passes legislation

More information

Test 4 Created: 3:05:28 PM CDT 1. The buyer of a call option has the choice to exercise, but the writer of the call option has: A.

Test 4 Created: 3:05:28 PM CDT 1. The buyer of a call option has the choice to exercise, but the writer of the call option has: A. Test 4 Created: 3:05:28 PM CDT 1. The buyer of a call option has the choice to exercise, but the writer of the call option has: A. The choice to offset with a put option B. The obligation to deliver the

More information

Chapter 6 Foreign Currency Translation. The objective of a currency is to provide a standard of value, a medium of

Chapter 6 Foreign Currency Translation. The objective of a currency is to provide a standard of value, a medium of Introduction and Background Chapter 6 Foreign Currency Translation Foreign Exchange Concepts and Definitions The objective of a currency is to provide a standard of value, a medium of exchange, and a unit

More information

Chapter 17 review. Multiple Choice Identify the letter of the choice that best completes the statement or answers the question.

Chapter 17 review. Multiple Choice Identify the letter of the choice that best completes the statement or answers the question. Chapter 17 review Multiple Choice Identify the letter of the choice that best completes the statement or answers the question. 1. Which of the following resulted in a retaliation by the United States of

More information

Currency Futures trade on the JSE s Currency Derivatives Trading Platform

Currency Futures trade on the JSE s Currency Derivatives Trading Platform Currency Futures trade on the JSE s Currency Derivatives Trading Platform DERIVATIVE MARKET Currency Derivatives Currency Futures www.jse.co.za Johannesburg Stock Exchange Currency Futures & Options trade

More information

International Finance Prof. A. K. Misra Department of Management Indian Institute of Technology, Kharagpur

International Finance Prof. A. K. Misra Department of Management Indian Institute of Technology, Kharagpur International Finance Prof. A. K. Misra Department of Management Indian Institute of Technology, Kharagpur Lecture - 7 Features of Foreign Exchange Market Good morning, today we will discuss features of

More information

Macroeconomics, 10e, Global Edition (Parkin) Chapter 26 The Exchange Rate and the Balance of Payments

Macroeconomics, 10e, Global Edition (Parkin) Chapter 26 The Exchange Rate and the Balance of Payments Macroeconomics, 10e, Global Edition (Parkin) Chapter 26 The Exchange Rate and the Balance of Payments 1 The Foreign Exchange Market 1) The term "foreign currency" refers to foreign I. coins II. notes III.

More information

Chapter 12. Aggregate Expenditure and Output in the Short Run

Chapter 12. Aggregate Expenditure and Output in the Short Run Chapter 12. Aggregate Expenditure and Output in the Short Run Instructor: JINKOOK LEE Department of Economics / Texas A&M University ECON 203 502 Principles of Macroeconomics Aggregate Expenditure (AE)

More information

Why a Floating Exchange Rate Regime Makes Sense for Canada

Why a Floating Exchange Rate Regime Makes Sense for Canada Remarks by Gordon Thiessen Governor of the Bank of Canada to the Chambre de commerce du Montréal métropolitain Montreal, Quebec 4 December 2000 Why a Floating Exchange Rate Regime Makes Sense for Canada

More information

Chapter 3.1. Capital and Trade Flow Drive Currency Values

Chapter 3.1. Capital and Trade Flow Drive Currency Values Chapter 3.1 Capital and Trade Flow Drive Currency Values 0 CAPITAL AND TRADE FLOW DRIVE CURRENCY VALUES Supply and demand are the simple concepts behind all price movement in the forex market, and no two

More information

The U.S. current account deficit has grown steadily since 1991,

The U.S. current account deficit has grown steadily since 1991, Is The Large U.S. Current Account Deficit Sustainable? By Jill A. Holman The U.S. current account deficit has grown steadily since 1991, hitting record levels of 3.6 percent of GDP in 1999 and 4.4 percent

More information

Review Question - Chapter 7. MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

Review Question - Chapter 7. MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. Review Question - Chapter 7 MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) International trade arises from A) the advantage of execution. B) absolute

More information

Homework Assignment #3: Answer Sheet

Homework Assignment #3: Answer Sheet Econ 434 Professor Ickes Homework Assignment #3: Answer Sheet Fall 2009 This assignment is due on Thursday, December 10, 2009, at the beginning of class (or sooner). 1. Consider the graphical model of

More information

The National Accounts and the Public Sector by Casey B. Mulligan Fall 2010

The National Accounts and the Public Sector by Casey B. Mulligan Fall 2010 The National Accounts and the Public Sector by Casey B. Mulligan Fall 2010 Factors of production help interpret the national accounts. The factors are broadly classified as labor or (real) capital. The

More information

FOREIGN EXCHANGE AND CURRENCY

FOREIGN EXCHANGE AND CURRENCY Exchange rates represent the linkage between one country and its partners in the global economy. They affect the relative price of goods being traded (exports and imports), the valuation of assets, and

More information

7. Which of the following is not an important stock exchange in the United States? a. New York Stock Exchange

7. Which of the following is not an important stock exchange in the United States? a. New York Stock Exchange Econ 20B- Additional Problem Set 4 I. MULTIPLE CHOICES. Choose the one alternative that best completes the statement to answer the question. 1. Institutions in the economy that help to match one person's

More information

Part A: Use the income identities to find what U.S. private business investment, I, was in 2004. Show your work.

Part A: Use the income identities to find what U.S. private business investment, I, was in 2004. Show your work. Exercise 1 Due: Preliminary figures (in billions of dollars) for 2004 taken from the 2005 Economic Report of the President showed that: Y = 11,728.0, C = 8,231.1, EX = 1,170.2, IM = 1,779.6, G = 2,183.8

More information

Econ 202 Final Exam. Douglas, Fall 2007 Version A Special Codes 00000. PLEDGE: I have neither given nor received unauthorized help on this exam.

Econ 202 Final Exam. Douglas, Fall 2007 Version A Special Codes 00000. PLEDGE: I have neither given nor received unauthorized help on this exam. , Fall 2007 Version A Special Codes 00000 PLEDGE: I have neither given nor received unauthorized help on this exam. SIGNED: PRINT NAME: Econ 202 Final Exam 1. On average over the past 50 years, the U.S.

More information

This chapter seeks to explain the factors that underlie currency movements. These factors include market fundamentals and market expectations.

This chapter seeks to explain the factors that underlie currency movements. These factors include market fundamentals and market expectations. EXCHANGE-RATE DETERMINATION LECTURE NOTES & EXERCISES based on Carbaugh Chapter 13 CHAPTER OVERVIEW This chapter seeks to explain the factors that underlie currency movements. These factors include market

More information

The relationship between exchange rates, interest rates. In this lecture we will learn how exchange rates accommodate equilibrium in

The relationship between exchange rates, interest rates. In this lecture we will learn how exchange rates accommodate equilibrium in The relationship between exchange rates, interest rates In this lecture we will learn how exchange rates accommodate equilibrium in financial markets. For this purpose we examine the relationship between

More information

Grain Marketing Terms

Grain Marketing Terms Grain Marketing Terms File A2-05 January 2010 www.extension.iastate.edu/agdm Actuals - The physical commodities that are being traded. Arbitrage - The simultaneous purchase of commodities in one market

More information

INTRODUCTION TO MACROECONOMICS MIDTERM- SAMPLE QUESTIONS

INTRODUCTION TO MACROECONOMICS MIDTERM- SAMPLE QUESTIONS INTRODUCTION TO MACROECONOMICS MIDTERM- SAMPLE QUESTIONS MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) In May 2009, Ford Motor Company's sales

More information

Economic Systems. 1. MARKET ECONOMY in comparison to 2. PLANNED ECONOMY

Economic Systems. 1. MARKET ECONOMY in comparison to 2. PLANNED ECONOMY Economic Systems The way a country s resources are owned and the way that country takes decisions as to what to produce, how much to produce and how to distribute what has been produced determine the type

More information

FISCAL POLICY* Chapter. Key Concepts

FISCAL POLICY* Chapter. Key Concepts Chapter 11 FISCAL POLICY* Key Concepts The Federal Budget The federal budget is an annual statement of the government s expenditures and tax revenues. Using the federal budget to achieve macroeconomic

More information

CHAPTER 3 BALANCE OF PAYMENTS SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS

CHAPTER 3 BALANCE OF PAYMENTS SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS CHAPTER 3 BALANCE OF PAYMENTS SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS QUESTIONS 1. Define the balance of payments. Answer: The balance of payments (BOP) can be defined

More information

Lecture 2. Output, interest rates and exchange rates: the Mundell Fleming model.

Lecture 2. Output, interest rates and exchange rates: the Mundell Fleming model. Lecture 2. Output, interest rates and exchange rates: the Mundell Fleming model. Carlos Llano (P) & Nuria Gallego (TA) References: these slides have been developed based on the ones provided by Beatriz

More information

The Return of Saving

The Return of Saving Martin Feldstein the u.s. savings rate and the global economy The savings rate of American households has been declining for more than a decade and recently turned negative. This decrease has dramatically

More information

What Determines Exchange Rates? In the Short Run In the Long Run

What Determines Exchange Rates? In the Short Run In the Long Run What Determines Exchange Rates? In the Short Run In the Long Run Selected Exchange Rates Selected Exchange Rates Determinants of the Exchange Rate in the Short Run In the short run, movements of currency

More information

ARE YOU TAKING THE WRONG FX RISK? Focusing on transaction risks may be a mistake. Structural and portfolio risks require more than hedging

ARE YOU TAKING THE WRONG FX RISK? Focusing on transaction risks may be a mistake. Structural and portfolio risks require more than hedging ARE YOU TAKING THE WRONG FX RISK? Focusing on transaction risks may be a mistake Structural and portfolio risks require more than hedging Companies need to understand not just correlate the relationship

More information

Determinants of FX Rates: Chapter 2. Chapter Objectives & Lecture Notes FINA 5500

Determinants of FX Rates: Chapter 2. Chapter Objectives & Lecture Notes FINA 5500 Determinants of FX Rates: Chapter 2 Chapter Objectives & Lecture Notes FINA 5500 Chapter Objectives: FINA 5500 Chapter 2 / Determinants of Exchange Rates 1. To be able to explain in your own words why

More information