Unit 5/6 Introduction

https://www.youtube.com/watch?v=E81t3NTOCqU
https://www.youtube.com/watch?v=Qd1CiKVQ124

The Balance of Payments

• Measuring money of inflows and outflows between the United States and the rest of the world.

• Inflows are referred as Credits

• Outflows are referred to as Debits

• The balance of payments is divided into 3 accounts

-Current Account

-Capital/Financial Account

-Official Reserves Account

- Double Entry Bookkeeping

• Every transaction in the balance of payments is recorded twice in accordance with standard accounting prices.

- Current Account

• Balance of trade or Net Exports

 - Exports of goods and services-imports of goods and services

 - Exports create a credit to the balance of payments

 - Imports create a debit to the balance of payments

    -Net Foreign Income

       • Income earned by US owned foreign assets- income foreign held US Assets

- Capital/Financial Account

• The balance of capital ownership

• Includes the purchase of both real and financial assets

• Direct investment in the US is a credit tot he capital account

• Direct investment by US firms/individuals in foreign country are debits to the capital account

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

• Purchase of domestic financial assets by foreigners reprints a credit to the capital account. 

- Relationship between Current and Capital Account

• The current account and the capital account should zero each other out.

- Official Reserves

• The foreign currency holdings of the United States Federal Reserve System

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

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

- Active v. Passive Official Reserves

• The United States is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate.

• The People’s Republic of China is active in its use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate with the United States.

Foreign Exchange Market

• Foreign Exchange: the buying or selling of currency

• The Exchange adage is determined in the foreign currency markets.

      -Ex: The current exchange rate is approximately 77 Japanese Yen to 1 US dollar.

• Simply put the exchange rate is the price of a currency

• Do not try to calculate the exact exchange rate.

Tips

• Always change the D line on one currency graph, the S like on the other currency's graph

• Move the lines of the two currency graphs in the same direction (right or left) and you will have the correct answer.

• If D on one graph increases, S on the other will also increase.

• If D moves to the left, S will move got the left on the other graph.

- Changes in Exchange Rates

• Exchange rates (e) are a function of the supply and demand for currency.

   - An increase in the supply of a currency will make it cheaper to buy one unit of that currency.

   - A decrease in supply of a currency will make a more expensive to buy one unit of that currency.

   - An increase in demand for a currency will make it more expensive to buy one unit of that currency

    - A decrease in demand for a currency will make it cheaper to buy one unit of that currency

- Appreciation

• Appreciation of a currency occurs when the exchange rate of that currency increases

     -Ex: 100 Yen used to buy $1.

                             Now 200 Yen buy 1US dollar.

     - The dollar is "stronger" because one buys more Yen than it used to.

- Depreciation of a currency occurs when the exchange rate of that currency decreases

       -100 Yen used to buy one dollar. Now 50

         Yen buys one dollar.

      - The dollar is weaker because it takes fewer Yen to buy one dollar.

The Dollar

Dollar Appreciation:

• Each dollar gets you more of the other currency.

• This means is that US exports gets more expensive for foreigners.

• US imports gets cheaper for us

• Results: Exports decrease while imports increased

• $ is leaving the US

   -Xn and GDP decrease

   - Demand for the dollar increases

   - Supply of the dollar decreases

Dollar Depreciation:

• Each dollar gets you less of the other currency.

• Less of the foreign currency is needed.

• Exports are going to increase and imports are going to decrease.

• Money is entering the US

   - Net Exports increases

   - GDP increases

• Demand for the dollar decreases

• Supply of the dollar increase

- If it comes to supply of the dollar, we're making transferred payments to foreigners

- If it comes from supply of the dollar, foreigners are making transfer payments to us.

- Supply of the dollar: comes from US Citizens, banks and industries, wanting to purchase our goods, investments and assets.

Absolute Advantage vs. Comparative Advantage

•Absolute Advantage

-Individual: exists when a person can produce more of a certain good/service than someone else in the same amount of time.

-National: exists when a country can produce more of a good/service than another country can in the same time period.

•Comparative Advantage

-Individual/National: Exists when an individual or nation can produce a good/service at a lower opportunity cost than can another individual or nation.

- Absolute advantage is faster and more efficient while comparative has a lower opportunity cost.