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Net Exports and International Finance
Read Chapter 15 pages 310-326
I The International Sector: An Introduction
A) The Case for Trade
1) A country has a comparative advantage in
the production of a good if it can produce
it at a lower opportunity cost than other
countries. If countries specialize in
production of what they do best then
global production will be increased which
can result in more consumption for
everyone.
2) Types of restrictions on trade.
a) A tariff is a tax imposed on imported
goods or services.
b) A quota is a ceiling on the quantity of
specific goods and services that can be
imported.
3) If one were to argue against free trade one
would have to argue on normative grounds
such as valuing,
a) certain sectors of the economy or
b) the environment to a greater extent.
B) The Rising Importance of International
Trade.
1) In the U.S. international trade has risen
from 3.7 % of GDP in 1960 to 11.7% of
GDP in 1999.
2) Trade has risen as:
a) Costs associated with transportation and
communication have fallen;
b) Trade barriers have fallen.
C) Net Exports and the Economy
1) Determinants of Net Exports.
a) Income – higher incomes in the world
means people will buy more goods and
services.
b) Relative prices – a higher price level
within a country makes one countries goods
more expensive and thus reduces its
exports.
c) An increase in the exchange rate means
that more foreign currency is required to
obtain domestic currency (i.e. currency is
more expensive) thus reducing exports.
d) Trade policies can potentially limit exports
or imports.
e) Preferences and technology.
2) Net exports affect both the slope and
position of aggregate demand.
a) Slope is impacted by the international trade
effect.
b) Other factors change the position.
II International Finance
A) International Finance is that field that
examines the macroeconomic consequences of
the financial flows associated with
international trade.
B) The balance between spending flowing into
a country and spending flowing out is called
the balance of payments.
C) We will look at the balance of payments
with two simplifications, 1) ignore transfer
payments, 2) used GNP measurements rather
than GDP.
D) Currency demand comes from two
sources.
1) Exports.
2) Purchases by foreigners of domestic
assets.
E) The supply of currency comes from two
sources.
1) Imports.
2) Domestic purchases of foreign assets.
F) Currency market equilibrium
Exports + (demand by foreigners of domestic
assets) = Imports + (domestic demand for
foreign assets.)
G) Accounting for International Payments.
1) Exports – imports = (domestic demand for
foreign assets)- (demand by foreigners of
domestic assets). [Note there is a typo in
formula (3) on page 317.]
2) The current account is an accounting
statement that includes all spending flows
across a nation’s borders except those that
represent purchases of assets.
3) The balance of current account equals
spending flowing into an economy from the
rest of the world on current account less
spending flowing from the nation to the rest
of the world on current account. (This
equals net exports.)
4) When the balance on current account is
positive, the country runs a current account
surplus.
5) When the balance on current account is
negative, the economy is in a current
account deficit.
6) A country’s capital account is an
accounting statement of spending flows into
and out of the country during a particular
period for purchases of assets.
7) If more foreign money flows into a country
for the purchase of domestic assets than
flows out for the purchase of foreign assets
then there is a capital account surplus.
8) If less foreign money flows into a country
for the purchase of domestic assets than
flows out for the purchase of foreign assets
then there is a capital account deficit.
9) Current account balance= -(capital account
balance)
H) Deficits and Surpluses: Good or Bad?
The U.S. has run current account deficits and
capital account surpluses for the last two
decades. Is this good or bad?
Common arguments that it is bad:
1) Trade deficits mean a lose of jobs.
This is untrue as can be noting that the last
twenty years has resulted in increased U.S. job
creation.
2) Foreigners now own parts of the U.S. Nothing
wrong with this. If anything, it keeps the capital
in the U.S. supporting our own jobs.
III Exchange Rate Systems
1) In a free-floating exchange rate system,
governments and central banks do not
participate in the market for foreign
exchange.
2) Government or central bank participation
in a floating exchange rate system is
called a managed float.
3) A fixed exchange rate system is one in
which the exchange rate between two
currencies is set by the government.
4) Types of Fixed exchange rate systems.
a) In a commodity standard system,
countries fix the value of their respective
currencies relative to a certain commodity
or group of commodities. (e.g. gold)
b) Currency board arrangements are systems
that fix the exchange rate to a specified
foreign currency with a legislative
commitment to ensure that this rate will
hold up.
c) Fixed exchange rate through intervention.
Some reminders.
Homework #3 due Wednesday.
Midterm #3 is Friday. The exam will cover
chapters 10-15. The format will be the
same as before with 30 multiple choice
questions.
There is a sample exam as well as powerpoint
printouts in Eisenhower.
On Wednesday we will review as much as
possible.