Unit 7

»»»Balance of payments

Measure of money inflows and outflows between the United states and the rest of the world (ROW)
    -inflows are referred to 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

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»»Double entry bookkeeping

-every transaction in the balance of payments is recorded twice in accordance with standard accounting practice
    - EX. US manufacturer, John Deere, exports $50 million worth of fan equipment to Ireland
    A credit of $50 to the current account ($50 million worth of farm equipment or physical assets)
    A debt of $50 to the capital/financial account (+$ 50million worth of euros or financial assets)
**the two transactions offset each other. Theoretically, the balance payments would always equal zero... Theoretically

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» current account-Balance of trade or net exports
    -Exports of goods/services - imports of goods/services
    -Exports create a credit to the balance of payments
      -Imports create a debt to the balance of payments

-Net foreign income
    -Income earned by US owned foreign assets -income paid to foreign held US assets
    -EX interest payments on US owned Brazilian bonds- interest payments on German owned US treasury bonds

-Net transfers (tend to be unilateral)
    -foreign aid > a debit to the current account
    - EX Mexican migrant workers send money to family in Mexico

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» capital/financial account

-the balance of capital ownership
-includes the purchase of both real and financial assets
- direct investment in the United States is a credit to the capital account
    -EX the Toyota factory in San Antonio
-Direct investment by US firms/individuals in a foreign country are debits to the capital account
    - EX the Intel factory in San Jose, Costa Rica
-purchase of foreign financial assets represents a debit to the capital account
    EX Warren buffet buys stocks in petrochina
- purchase of domestic financial assets by foreigners represents a credit to the capital account
    - the United Arab Emirates sovereign wealth funds purchases a large stake in the NASDAQ

What causes capital/financial flows?
- differences in rates of return on investment
- ceteris Paribas, savings will flow toward higher returns

Relationship between current and capital account
- remember double entry bookkeeping?
- the current account and the capital account should be zero each other out
-that is... if the current account has a negative balance (deficit), then the capital account should then have a positive balance (surplus)

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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
-the officials reserves zero out the balance of payments

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Credit vs debits

Credit: additions to a nation's account
Debits: subtraction to a nation's account

How to calculate the following:
1. Balance on trade
    - (merchandise and service exports) - (merchandise on service imports)
2. Trade deficit occurs when the balance on trade is negative (imports > exports)
    Trade surplus occurs when the balance on trade is positive ( exports > imports)
3. Balance on current account:
    Balance on trade (exports & imports) + net investment income + transfer payments
4. Official reserves
    -nationally
          (change^) in CA [current capital] + (change^) in FA [capital amount] + (change^) in official reserves = 0

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»» foreign exchange (FOREX)

- the buying and selling of currency
    EX in order to purchase souvenirs from France, it is first necessary for Americans to sell (supply) they dollars and but (demand) euros
- the exchange rate (e) 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 calculate the exact exchange rate

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» 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 decrease the exchange rate of the currency
    - a decrease of the supply of a currency will increase the exchange rate of the currency
    -an increase in demand of a currency will increase the exchange rate of the currency
    -a decrease in the demand of a currency will decrease the exchange rate of a currency

»» Appreciation and depreciation (supply of dollars)

-Appreciation of a currency occurs when the exchange rate of that currency increases (e^)
-Depreciation of a currency occurs when the exchange rate of that currency decreases (ev)
EX: if German tourists flock to America to go shopping, then the supply of euros will increase and demand for dollars will increase. This will cause the euro to depreciate
and the dollar to appreciate

» exchange rate determinants

-consumer tastes
-relative income
-relative price level
-speculation

» demand $ - exports and capital inflows
When the US exports goods/services to other countries, they need our dollar to compete the transaction.
    -they demand our money, they need to supply theirs

» supply $ - imports and capital outflows
When we import goods/services from other countries, we need their money to complete the transaction
    - we demand their money, we need to supply ours

EXAMPLE GRAPH

***TIPS 
- always change the D line on one currency graph, the S life on the other currency's graph
- move the lines of the two currency graph in the same direction (right or left) and you will have the correct answer
- if D in one graph increases, S on the other will also increase
- if D moves to the left, S will move to the left on the other graph 

Fixed exchange rates
It is determined by government policies

flexible (floating) exchange rates
It is set by market forces with little or no government intervention


»» Absolute advantage v. Comparative advantage
» absolute advantage : faster, more effective
» comparative advantage: lower opportunity cost

» the same country can have an absolute advantage in two products
» only one country can have a comparative advantage at one product

Comparative output (item A):
Opposite product/product you're looking for (B/A)