Unit 7 - Comparative & Absolute Advantage

Absolute Advantage

• looks at who can produce more with the same resources or who can produce the same output with less resources
• ex: Papa John's producing 20 pizzas while McDonald's produces 4

Comparative Advantage

• who can produce with the least opportunity cost

Input vs. Output

• Input
• Examples:
• # of hours to do a job
• # of gallons of paint to paint a house
• # of acres to feed a horse
• Output
• Examples:
• miles per gallon
• tons per acre
• words per minute
• apples per tree
• computers produced per hour

Unit 7 - Foreign Exchange Market

• buying and selling of currency
• Appreciation - value of currency is strong, the dollar buys more of another currency which results in less expensive imports and more expensive exports
• imports increase because they are cheaper and creates a trade deficit
• Depreciation - weak dollar, the dollar buys less of another currency and results in more expensive imports and less expensive exports

Unit 7 - Balance of Payments

Balance of Payments

• it is a measure of money inflations and outflows between the U.S. and the rest of the world
• inflations are referred to as credits
• outflows are referred to as debits
• the balance of payments is divided into 3 accounts:
1. current account
2. capital/financial account
3. official reserves
• Current Account
1. balance of trade/net exports
• export = credit or asset
• import = debit or liability
2. net foreign income/net investment
• income earned by U.S. owned foreign assets
• encompasses income paid to foreign held U.S. assets
3. net transfers
• foreign aid (ex: U.S. gives money to other country for disaster)
• tends to be unilatteral
• Capital/Financial Account
• balance of capital ownership
• includes purchase of both real and financial assets
• real assets = real estates
• financial assets = stocks and bonds
• direct investment in U.S. is a credit to the capital account (ex: Toyota factory in U.S.)
• direct investment by U.S. firms/individuals in a foreign country are debits to the capital account (ex: Dell computer factory in Costa Rica)
• the purchase of foreign financial assets represents a debit to the capital account (ex: Bill Gates buys stock in Petrol China)
• purchase of domestic financial assets by foreigners represents a credit to the capital account (ex: Venezuela buys stock in McDonalds)
• Official Reserves
• the foreign currency holdings of the U.S> Federal Reserve System
• the official reserves should zero out the balance of payments
• the capital and current account must zero each other out

Formulas

• Balance of Traders = goods exports + goods imports
• Balance on Goods & Services = (goods exports + service exports) - (goods imports + service imports)
• Balance on Current Account = balance of traders + net investment + net transfers
• Balance on Capital Accounts = foreign purchase of assets + U.S. purchase of assets abroad

Unit 5

Phillips Curve

• represents the relationship between unemployment and inflation
• there is a trade-off between inflation and unemployment in the short term
• in the short run, inflation increases as the economy expands
• during a recession, unemployment increases because the economy slows down
• Long Run  Phillips Curve (LRPC)
• occurs at the natural rate of unemployment
• represented by a vertical line
• there is no trade-off between unemployment and inflation in the long run
• the economy produces at full employment output level
• LRPC will only shift if LRAS shofts
• Supply Shocks
• a rapid and significant increase in resource cost
• Stagflation
• where inflation and unemployment increase at the same time
• shifts of the Phillips Curve
• if AD changes, we will move points on the SRPC
• if SRAS changes, we will move the SRPC
• LRPC is equivalent to the natural rate of unemployment
• natural rate of unemployment = frictional, seasonal, and structural unemployment
• Misery Index
• a combination of inflation and unemployment in a given year
• single-digit misery is good
• Disinflation
• a reduction in the inflation rate from year to year, which can be seen in the long-run Phillips Curve
• this also occurs when aggregate demand declines
• Deflation - a general decline in the price level
• Hyperinflation - when an economy experiences a high and unusual rates of inflation, which can decrease the value of the local currency

Supply-Side Economics

• changes in AS, not AD
• to determine the level of inflation, unemployment rate, and economic growth
• a.k.a. Reaganomics
• supply-side economists support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payments (unemployment compensations and welfare programs) provide disincentives to work, invest, and underline entrepreneurial ventures

Laffer Curve

• depicts a fear radical relationship between tax rates and government revenue
• as tax rates increase from zero, tax revenues increase from zero to some maximum level and then declines
• 3 criticisms of Laffer Curve
1. empirical evidence suggests that the impact of tax rates on incentives to work, save, and invest are small
2. tax cuts also increase demand which can fuel inflation
3. where the economy is actually located on the Laffer Curve is difficult to determine