MACRO PLAYLIST
Unit 1
Opportunity Cost
Every decision you make to do one thing
instead of another, to buy one thing instead of another involves a
trade-off. You give up one option for another. Whatever you give up
when you make one choice instead of the other is referred to as your
opportunity cost.
This concept is very important in
economics. For example, if a nation chooses to borrow money for
consumption instead of investment, the opportunity cost of consuming
now is slower economic growth and a lower standard of living in the
future because less productive capacity is being purchased so that
the nation can enjoy more consumption now.
The concept of opportunity cost is very
important in international trade. Nations engaged in trade should
always export (sell to other countries) the goods and services they
produce with the lowest opportunity cost and import (buy from other
countries) the goods for which they have the highest opportunity
cost.
Let's look at an example involving the
US and Korea. The US (Boeing) is great at making airplanes, and
Korea (Hyundai and Kia) is great at making cars. So if trade takes
place between the two, the US will export planes and Korea will
export cars.
Let's assume the two countries can
produce the following in one year (an output problem, because it is
how much each country can produce, not how many resources they use
for one unit of output): The US HAS an absolute advantage in both
cars and planes because they can produce more of both in one year.
Cars Planes
US 40 10
Korea 10 1
We can quantify this to illustrate the
difference in opportunity cost for planes. Suppose Korea has to give
up 10 cars to make one plane, while the United States only has to
give up 4 cars to make one plane. Korea's opportunity cost for one
plane is 10 cars/1 plane (10), while the US opportunity cost for
planes is 40 cars/10 plane (4). Since the US has the lower
opportunity cost for planes, the US should produce and export planes
and Korea should produce and export cars (which is exactly what
happens).
We can calculate the opportunity cost
for cars for both nations and we end up with the reciprocal of the
opportunity cost for planes. The opportunity cost for cars for Korea
is 1 plane/10 cars (1/10) while the opportunity cost for cars for the
US is 10 planes/40 cars (1/4). So the results are the same. Korea
has the lower opportunity cost for cars, they should export cars, and
the US should export planes since their opportunity cost for cars is
higher.
A country with a lower opportunity cost
is said to have a comparative advantage in that good.
Let's illustrate how to calculate an
output problem using the example from above.
The rule for an output problem is as
follows. Opportunity cost is always a country's internal cost, so we
always compare US productivity in cars to US productivity in planes,
and Korean productivity in cars to Korean productivity in planes.
When we calculate the opportunity cost for an OUTPUT problem, the
other value always goes over (OOO; Output Other Over). So for the US
we put 10/40 (cars) and 40/10 (planes). For Korea, we put 1/10
(cars) and 10/1 (planes). Our finished grid should look like this;
Cars Planes
US 40 (1/4) 10 (4)
Korea 10 (1/10) 1 (10)
Our final answer is determined as
follows;
The US has absolute advantage in both
cars and planes, since they can produce more of both in one year.
Korea has a comparative advantage in cars because their opportunity
cost is lower (1/10 vs. ¼ ) while the US has the comparative
advantage in planes (4 vs. 10).
Input problems (the amount of resource
inputs a country has to use to to produce one unit of output) are the
opposite of output problems. In this case, the smaller number
confers (gives, determines) absolute advantage, since it means that a
country has an advantage because they need to use fewer resources to
produce one unit of output.
For example, suppose it takes US
workers 2 hours to make a bushel of wheat and Russian workers 6 hours
to make a bushel of wheat. Also, it takes US workers 4 hours to make
a bushel of corn and Russian workers 8 hours to make a bushel of
corn. Since workers hours are a resource input, the US has an
absolute advantage in both wheat and corn since the US requires fewer
hours to produce both.
That brings us to point number one
about input problems. With an input problem, the smaller number is
always better and confers (gives to) a country absolute advantage
since they use less to produce more. The second key point regarding
input problems deals with their calculation. To calculate
opportunity cost for input problems, the other value always goes
under (Input Other Under (IOU)).
So the US opportunity cost for wheat is
2 hours/4 hours (½ a bushel of corn), and the opportunity cost for
corn is 4 hours/2 hours (2 bushels of wheat). This is easy to see, in
that each two hours of labor can make one bushel of wheat, while it
takes twice as long (4 hours) to make one bushel of corn. So if a
worker in the US spends 4 hours making one bushel of corn, he is
giving up (his opportunity cost) 2 bushels of wheat.
Our calculation should look as follows
(remember, it's an input problem so the Other goes Under (Input Other
Under (IOU)).
Wheat Corn
US 2 (½) 4 (2)
Russia 6 (¾) 8 (4/3)
The answer to this problem is as
follows. The US has an absolute advantage in both wheat and corn
because it uses fewer resources to produce both. The US has a
comparative advantage in wheat because it has a lower opportunity
cost (½ vs ¾) than Russia, while Russia has a comparative advantage
in corn (4/3 vs 2). So the US should specialize in wheat and export
wheat while Russia should specialize in corn and export corn.
To calculate the opportunity cost of
any specific action, just figure out what you gave up and spent. If
Monica takes a day off work and gives up $64 in wages, and spends $50
dollars on a concert ticket, her opportunity cost of the concert is
$114 ($64 in lost wages plus $50 for the ticket).
If Ralph Lauren spends $100 million to
build a purse factory, and they could have invested the $100 million
in something else that would have earned them $10 million, their
opportunity cost for the factory is $110 million ($100 million in
direct expenditures (spending) and $10 million in lost income.
There is no opportunity cost for
necessities you would buy regardless of your choice. For example,
the opportunity cost of college includes tuition, books, and lost
income since you are not working, but doesn't include food and
clothes (you have to have those regardless of the choice you make).
Unit 2
Measuring the Economy
The total output of all goods and
services produced in one year by the economy is called Gross Domestic
Product (GDP). GDP is composed of four major components and is equal
to the sum of the four compnents, the equation being GDP= C+I+G+Xn.
C= Consumption spending (spending by
consumers). Sensitive to consumers incomes, confidence, savings
rates, and interest rates. When incomes and confidence are up,
consumers spend more. When interest rates fall and consumers are
saving less, spending also goes up. Spending falls when any of these
are reversed.
I = Investment spending, spending by
businesses on factories (plants) and machinery for production
(capital goods), and spending by consumers on homes. Investment
spending is very sensitive to interest rates (the cost of borrowing
money, which is the rate of interest a borrower pays on a loan). When
interest rates go down, I increases, and when interest rates go up, I
decreases.
G= Government expenditures on the
military, roads, bridges, dams, buildings, etc. It does not include
expenditures on social welfare payments that don't produce a good or
service (unemployment, food stamps, etc.).
Xn= Net exports (exports – imports).
The more we export, the more we produce domestically (within our own
country) and the greater our GDP.
Nominal and Real GDP
Nominal GDP is just the dollar value of
all goods and services produced in one year. Real GDP is nominal GDP
adjusted for inflation (the change in prices year over year). For
example, if nominal GDP increases by 10% but inflation was 5%, the
real change in output (the real increase in goods and services
produced) would only be 5%, since 5% of the nominal increase was only
a result of the change in prices.
GDP Deflator
The most accurate measure of inflation
or price increases since it adjusts the entire economy (GDP) for
inflation and gives us Real GDP (GDP adjusted for inflation, it
“deflates” or takes the inflation out). Formula is Nominal
GDP/GDP Deflator = Real GDP.
Consumer Price Index (CPI)
The Consumer Price Index (CPI) is the
sum of the prices of a “market basket” of specific goods and
services that the government calculates at the same time each year.
Inflation using the CPI is determined by taking the (CPI in year 2 -
CPI in year 1)/CPI year 1. The key word here is “market basket”
of goods and services that a household typically consumes which is
used as a measure of consumer inflation. It is not as accurate in
measuring overall inflation in the economy as the GDP Deflator since
it is not limited to a small number of goods and services.
Unemployment
To be unemployed you have to be looking
for a job. Unemployment is equal to the (number of people looking
for a job/the number of people in the labor force). The labor force
equals the number of people working + the number of people looking
for a job. It excludes children under 16, retired people, and people
in the military. REMEMBER THE RULE, I HAVE TO BE WORKING OR LOOKING
FOR WORK TO BE IN THE LABOR FORCE, AND IF I AM NOT LOOKING FOR A JOB
I CAN'T BE UNEMPLOYED.
Frictional Unemployment: People who
are between jobs for any reason (they moved, got fired, etc.) and are
looking for a job.
Structural Unemployment: My skills
become obsolete. An example would be a VCR repairman or an auto
worker replace by a robot.
Cyclical Unemployment: I get laid off
because of a downturn in the economy (a recession, which is a
contraction of the economy, GDP falls).
The Natural Rate of Unemployment is
equal to structural plus frictional unemployment.
Business Cycle
MACRO UNIT 3
Aggregate Demand and Aggregate Supply:
Aggregate (all) the demand and supply in the whole economy
Aggregate Demand (AD)
Any increase in the four main
components of GDP (C+I+G+Xn) will increase Aggregate Demand and cause
the AD curve to shift to the right (increase). Therefore, in its
simplest form, anything that increases consumer spending, business
and consumer investment (lower interest rates), government spending
(expansionary fiscal policy), and net exports (lower interest rates
and a decrease (depreciation) in the value of our currency which
makes our products cheaper) will increase AD. Anything that decreases
consumer spending, business and consumer investment (higher interest
rates), government spending (contractionary fiscal policy), and net
exports (higher interest rates and an increase (appreciation) in the
value of our currency which makes our products more expensive) will
decrease AD.
When AD shifts right (increases) the
quantity of Aggregate Supply increases and the price level increases.
When AD shifts left (decreases), the quantity of Aggregate Supply
decreases and the price level falls.
Aggregate Supply
Aggregate Supply is driven by costs of
production, Anything that lowers the cost of producing (lower wages,
lower natural resource costs, lower energy and shipping costs, lower
taxes, less government regulation, and subsidies (payments by the
government to encourage production) will shift AS right and increase
output while decreasing the price level. Anything that increases the
cost of producing (higher wages, higher natural resource costs,
higher energy and shipping costs, higher taxes, more government
regulation, and the removal of subsidies (payments by the government
to encourage production) will shift AS left and decrease output while
increasing the price level.
When AS shifts right (increases) the
quantity of Aggregate Demand increases and the price level falls.
When AS shifts left (decreases), the quantity of Aggregate Demand
decreases and the price level rises.
Long Run Aggregate Supply, Recession,
and Inflation.
Long Run Aggregate Supply (LRAS) is the
maximum sustainable output the economy can produce in the long run
independent of the price level (that is why the curve is vertical).
It results from the fact that the economy at any point in time only
has so many factors of production (workers, natural resources, level
of technology, number of factories, level of infrastructure (roads,
airports, bridges, trains, harbors) and education level and
productivity (output per worker) of the labor force, etc.) LRAS can
shift right if any of these factors of production increase or a
country engages in trade with other countries. However, if any of
these factors of production decrease or trade with other countries
decreases, LRAS will shift left.
Inflation is an increase in the price
level over a fixed period of time.
A Recessionary Gap results when the
intersection of AD and AS (equilibrium) is to the left of LRAS. In
this case the economy is operating below full employment with a
recession and policies to shift AD right (expansionary fiscal or
monetary policy) and/or AS right (lowering business taxes) should be
undertaken to move equilibrium towards LRAS (full employment) and
increase output and decrease unemployment.
An Inflationary Gap results when the
intersection of AD and AS (equilibrium) is to the right of LRAS. In
this case the economy is operating above full employment with
inflation and policies to shift AD left (contractionary fiscal or
monetary policy) should be undertaken to move equilibrium towards
LRAS (full employment) and decrease output and decrease the price
level.
The Phillips Curve
The Phillips Curve reflects the
trade-off between inflation and unemployment. When AD shifts right,
output goes up, the price level goes up, and unemployment goes down
since a larger number of workers are required to produce the
increased level of output. When AD shifts left, the opposite
happens. When output goes down, the price level goes down, and
unemployment goes up since a smaller number of workers are required
to produce the decreased level of output.
The rule to remember is this. When AD
shifts, we move along the Phillips curve opposite the shift in AD.
If AD shifts right, we move up and to the left along the Phillips
curve (higher inflation, lower unemployment). If AD shifts left, we
move down and to the right along the Phillips curve (lower inflation,
higher unemployment).
IF AS SHIFTS, THE WHOLE PHILLIPS CURVE
SHIFTS IN THE DIRECTION OPPOSITE TO THE SHIFT IN AS.
The Long Run Phillips Curve (LRPC) is
independent of the price level (like LRAS) because it represents the
natural rate of unemployment (NARU) when the economy is in long run
equilibrium (also called full employment output because we always
have structural and frictional unemployment).
Assuming no change in the labor force,
when LRAS shifts right or left, the Long Run Phillips Curve (LRPC)
shifts in the opposite direction.
AS: Keynesian vs Classical
The Keynesian curve assumes in a deep
recession we can have an increase in AD, an increase in output, and
no increase in prices because there is so much unused capacity
(slack). The Keynesian AS curve transitions from horizontal
(recession), upward sloping around full employment, and becomes
almost vertical (similar to LRAS) when we have a large inflationary
gap (high inflation).
The Classical AS curve (the one we use)
is upward sloping throughout its range.
Non-Discretionary vs. Discretionary
Fiscal Policy (Fiscal policy is government spending and taxes)
Non-Discretionary fiscal policy is
government spending over which the government has no control (no
discretion). Non-Discretionary fiscal policy expenditures (spending)
includes social security payments, unemployment, food stamps, housing
subsidies, other social welfare expenditures (spending), etc. These
programs are known as entitlements, which means that people
automatically qualify for them if they need them and don't have a
high enough level of income. The laws governing these expenditures
are already in place so the government has no discretion (choice) to
change them. For this reason, these non-discretionary expenditures
are also known as automatic stabilizers, meaning they help stabilize
the economy when we go into a recession by providing financial
support to individuals in need which causes AD to fall less than it
would without these supplemental sources of income.
Discretionary fiscal policy includes
changing the levels of government spending and/or tax policy to
achieve desired macroeconomic outcomes. For example, if we are in a
deep recession, the government might increase spending and cut income
taxes to increase AD (shift AD right), and decrease business taxes to
increase AS (shift AS right). With inflation, the government might
decrease spending and raise income taxes in an effort to decrease AD
and reduce inflationary pressures.
The Spending Multiplier
All spending is multiplied throughout
the economy. For example, if Ajahn buys something from Teresa's
store, Teresa's employees earn wages, and they buy from Monica's
store, and Monica's employees buy from Amber's store, etc., etc.,etc.
The formula governing the value of the multiplier is 1/MPS (The
Marginal Propensity to Save, the fraction of people's income they
save instead of spend). For example if MPS=0.2, the spending
multiplier = 1/0.2=5. If MPS falls to 0.1, the multiplier becomes
1/0.1=10. This makes sense. If people are saving less, they are
spending more.
People's willingness to spend, or the
fraction of their income they spend instead of save, is known as the
Marginal Propensity to Consume (MPC). The sum of MPC+MPS always is
equal to 1, since you only have two options with each dollar of
income, spend it or save it. Therefore, 1-MPC=MPS, and 1-MPS=MPC.
Economic Growth
Economic Growth is an increase in Real
(inflation adjusted) GDP (output), represented by a rightward shift
in LRAS. The best measure of economic growth is an increase in real
(inflation adjusted) per capita (per person) GDP, which means that
the standard of living has increased for the average person.
Things that shift LRAS right include
more workers (a larger labor force), greater natural resources, a
higher level of technology, a larger number of factories, an improved
level of infrastructure (roads, airports, bridges, trains,
harbors),higher education levels and productivity (output per
worker), foreign trade, and lower interest rates which increase
investment in productive capacity.
INTEREST RATES
The interest rate is a rate expressed
as a percentage that a borrower has to pay for a loan. When interest
rates are low, businesses are more likely to borrow to expand their
productive capacity (investment), and consumers are more likely to
borrow to buy houses (investment) and cars (consumption). Therefore,
low interest rates stimulate economic activity by increasing I and C,
and therefore, AD in the short run and LRAS in the long run (as a
result of increased investment in productive capacity). Borrowers
like low interest rates. When interest rates are high, the reverse
happens, and businesses and consumers borrow less, which has a
negative impact on output in both the short and long run.
Real interest rates are the nominal
(given) rate minus the inflation rate. So if I have a 6% loan and the
inflation rate is 3%, my real cost of borrowing is 3% and the bank's
real earnings are 3% (6%-3%=3%).
Savers (lenders) are just the opposite
of borrowers. They like high interest rates, or a greater return on
their savings (remember, when you save, or put money in the bank, you
are loaning money to the bank to lend to lend to others, that is why
the bank pays you interest on your savings). Therefore, when
interest rates increase, the quantity of money supplied also
increases, and when interest rates decrease, the quantity of money
supplied decreases.
Interest rates impact the value of a
country's currency (money) as a result of the behavior of lenders
(savers). If Japan has a higher real (inflation adjusted) interest
rate than the US, people will take their money out of US banks and
put it into Japanese banks to earn a higher real rate of return. To
do this, they have to buy Japanese Yen in the foreign exchange market
to deposit in Japanese banks. This increased demand for Yen causes
the Yen to go up in value (appreciate). This transaction also causes
the dollar to fall in value, because the increase in the supply of
dollars in the foreign exchange market causes the dollar to go down
in value (depreciate). So the rule is, higher relative real interest
rates will cause a country's currency (money) to appreciate, while
lower relative real interest rates will cause a country's currency to
depreciate.
Monetary Policy
Monetary Policy is control of a
nation's supply of money, and therefore interest rates, foreign
exchange
rates, and inflation rates by a
nation's central bank. The three tools a central bank usually uses
are buying and selling government bonds (securities) from commercial
banks, changing the rate at which the central bank charges commercial
banks for a loan (the discount rate), and changing the reserve
requirement (the amount of deposits banks are not allowed to lend).
When the central bank buys bonds from
commercial banks, it is sending cash to the banks in exchange for the
bonds (securities), so the banks now have more money to lend,
increasing the supply of money and decreasing interest rates, which
increases investment and consumption since businesses and consumers
can borrow money at a lower cost. Bond prices also increase since
the demand for bonds increases, which also causes interest rates to
fall.\
When the central bank sells bonds
(securities) to commercial banks, it is receiving cash from the banks
in exchange for the bonds (securities), so the banks now have less
money to lend, decreasing the supply of money and increasing interest
rates, which decreases investment and consumption since businesses
and consumers now have to pay more for borrowed money. Bond prices
also decrease since the supply of bonds increases, which causes
interest rates to rise.
Another tool to control the money
supply is use of the discount rate, the rate the central bank charges
commercial banks for a loan. If the discount rate is lowered, banks
can borrow more inexpensively, they charge less for loans to their
customers (lower interest rates), which increases investment and
consumption since businesses and consumers can borrow money at a
lower cost.
If the discount rate is raised, bank
borrowing costs increase, they charge more for loans to their
customers (higher interest rates), which decreases investment and
consumption since businesses and consumers now have higher borrowing
costs.
The third tool of monetary policy a
central bank can use is the reserve requirement. The reserve
requirement, usually stated as a percentage, is the amount of a
customer's deposit that banks must keep in reserve (how much of a
deposit they are not allowed to lend). If the reserve requirement is
decreased, banks can now lend a higher percentage of their deposits,
so the supply of funds available to be lent would increase,
decreasing interest rates. If the reserve requirement is increased,
the supply of funds available to be lent would decrease, increasing
interest rates.
The US central bank is the Federal
Reserve Bank, which is usually called the “Fed”.
Money Multiplier
Money lent by banks is multiplied
throughout the banking system in the same way that spending is
multiplied throughout the economy. If Monica gets a loan and buys
construction material from Victor, Victor deposits the money Monica
spent in his bank. His bank then loans the money to Victoria, who
spends it at Jackie's business. Jackie then deposits it in her bank,
who lends it to Mariela, etc., etc., etc.
The amount of new money created by any
new deposit is related to the reserve requirement (RR), the amount of
any new deposit banks are required to hold in reserve (the amount
they can't lend). Therefore, the lower the reserve requirement (RR),
the more banks can lend and the larger the money multiplier.
The formula for the money multiplier is
1/RR. To calculate the total new money that can be created by a
deposit, we do the following. If the deposit is $1000 and RR=0.2,
the total increase in the money supply is equal to $1000 times 5
because (1/.2 = 5), which equals $5000, but then we have to subtract
out the original $1000 (since it was already in the money supply), so
the total potential increase in the money supply is $4000. We called
it the potential increase in the money supply because banks don't
always lend all their excess reserves (the reserves that they are not
required to keep, which are the reserves available for lending).
When the Federal Reserve buys bonds,
sending cash to the bank for the bonds, the bank can lend all of the
money it received since it is their money (not a depositors) and they
are not required to hold any of it in reserve. If the Fed buys $1000
in bonds from Wells Fargo and the reserve requirement(RR) is 0.1, the
total new money creation is $1000(10)=$10,000.
The rule to remember is banks can
always lend ALL THEIR EXCESS RESERVES, and cash at the Federal
Reserve is not considered to be a part of the money supply.
When calculating problems dealing with
a withdrawal by depositors or the Fed selling bonds, the math is
exactly the same, except it is now a decrease in the potential money
supply, so it is preceded by a negative sign (we put a minus in front
of it).
Loanable Funds Market
The loanable funds market differs from
the money market (which is controlled by central bank actions) in
three ways. First, it represents the total supply and demand for
money in the economy and can be affected by the behavior of borrowers
(demand for money) and savers and lenders (supply of money) outside
control of the central bank. Second, it does not have the vertical
supply curve like the money market, it's supply curve is upward
sloping characteristic of a normal market. Finally, it uses real
interest rates as a price signal as opposed to nominal interest rates
used in the money market.
Budget Deficits and “Crowding Out”
of private investment
When the government runs a budget
deficit (when the government spends more than it takes in in taxes),
the government is forced to borrow money in the loanable funds market
to cover the shortfall in revenue. This increased demand for money
by the government causes the demand for money curve to shift up and
to the right, increasing real interest rates, which decreases
investment. The government, in essence, has “crowded out” private
investment since it's demand for money causes real interest rates to
rise.
The rule for us is this. If we see the
word “budget deficit”, we think “crowding out”, with the
increased interest rates decresing investment and shifting AD left.
“Crowding in” would reverse the
process, lower government borrowing from a surplus (more tax revenue
than spending) resulting in less demand for money, lower interest
rates, and more investment. However, “crowding in” is uncommon
and we will most likely not see it on the test.
FOREIGN EXCHANGE AND TRADE
Currency Appreciation: When a
country's currency appreciates (goes up in value), it costs less to
buy another country's currency, making it less expensive to buy
foreign products. However, it now costs more in the foreign currency
to buy the appreciating currency, causing exports to fall since
products denominated (priced) in the appreciating currency are now
more expensive.
Currency Depreciation: When a
country's currency depreciates (goes down in value), it costs more to
buy another country's currency, making it more expensive to buy
foreign products. However, it now costs less in the foreign currency
to buy the depreciating currency, causing exports to rise since
products denominated (priced) in the depreciating currency are now
less expensive
The value of a nation's currency has a
direct effect on AD and output. When a nation's currency
depreciates, it's products become less expensive for foreign buyers,
it's exports will increase, it's imports will fall (since foreign
products become more expensive with the depreciation of the
currency), causing the value of it's net exports to increase,
increasing AD and output.
The reverse happens when a country's
currency appreciates. When a nation's currency appreciates, it's
products become more expensive for foreign buyers, it's exports will
decrease, it's imports will increase (since foreign products become
less expensive with the appreciation of the currency), causing the
value of it's net exports to decrease, decreasing AD and output.
The value of a nation's currency is
strongly influenced by the supply of it's currency both in the
domestic (home) market and the foreign exchange market.
If the money supply is increased in the
domestic market, nominal and real interest rates fall, and foreign
demand for the home currency will decrease due to the lower real rate
of return for foreign investors, and the currency will depreciate.
At the same time, investors in the home country will want to move
money into other countries to earn the higher real rates of return,
increasing the supply of the home currency, resulting in a decrease
in the value of the currency (depreciation). Therefore, expansionary
monetary policy also results in a depreciation of the domestic (home)
currency.
If the money supply is decreased in the
domestic market, nominal and real interest rates rise, and foreign
demand for the home currency will increase due to the higher real
rate of return for foreign investors, and the currency will
appreciate. At the same time, investors in the home country will
want to move money back into the home country to earn the higher real
rates of return, decreasing the supply of the home currency,
resulting in an increase in the value of the currency (appreciation).
Therefore, contractionary monetary policy results in an appreciation
of the domestic (home) currency.
Demand changes for a nation's currency
will impact it's value. If demand for the home currency increases in
the foreign exchange market, the currency will appreciate, exports
will fall, imports will rise, and output will decline as a result of
a decrease in net exports.
If demand for the home currency
decreases in the foreign exchange market, the currency will
depreciate, exports will rise, imports will fall, and output will
increase as a result of an increase in net exports.
Supply changes for a nation's currency
will impact it's value. If supply of the home currency increases in
the foreign exchange market, the currency will depreciate, exports
will rise, imports will fall, and output will increase as a result of
an increase in net exports.
If supply of the home currency
decreases in the foreign exchange market, the currency will
appreciate, exports will fall, imports will rise, and output will
decline as a result of a decrease in net exports.
The keys to remember in the foreign
exchange market and analysis are these.
Depreciating currency, more net
exports, increased AD and output. If the country is dependent on
foreign resource inputs, the depreciating currency can have a
negative impact however, by decreasing AS (shifting it up to the
left).
Appreciating currency, less net
exports, decreased AD and output. If the country is dependent on
foreign resource inputs, the appreciating currency can have a
positive impact however, by increasing AS (shifting it down to the
right).
The domestic (home) currency is
always priced with the number of foreign currency units needed to
buy one unit of the home currency. For example, in the dollar
market the dollar is priced in Japanese Yen/1$ (you can't price
dollars in dollars). On the flip side, in the Yen market the
price signal is always US$/1 Yen.
Balance of Payments
A nation's current account balance
(balance of trade) is really just a reflection of it's net exports.
If net exports to the rest of the world are positive, a nation has a
current account surplus. If net exports to the rest of the world are
negative, a nation has a current account deficit.
The sum of the current account + the
financial (capital) account is always 0.
Graph Review
Course Review