Unit 7 Notes

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.
• Input problems: this is where the country or individual can produce a set amount of something by using the least amount of resources, land, or time has the absolute advantage.
• Chosen item/forgone item

Output problems:

• What is given up/what is being produced

Balance of Payments

• Measure of money inflows and outflows between the United States and the Rest of the World (ROW)
• Inflows referred to as credits
• Outflows referred to as debits
• Divided into Three 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 practice
• John Deere exports $50 Million worth of farm equipment to Ireland
• Credit of $50 million to the current account
• (-$50 million worth of farm equipment or physical assets)
• Debit of $50 million to the capital/financial account (+$50 million worth of Euros or financial assets)

Current Account

• Balance of Trade or Net Exports
• Exports of goods/services - Import of goods/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 U.S. owned foreign assets - Income paid to foreign held U.S. assets
• Interest payments on U.S. owned Brazilian bonds - Interest payments on German owned U.S. Treasury bonds
• Net Transfers (tend to be unilateral)
• Foreign Aid is a debit to the current account
• Mexican migrant workers send money to family in Mexico
• Capital/Financial Account
• The balance of capital ownership
• Includes the purchase of both real and financial assets
• Direct investment in the Unites States is a credit to the capital account
• The Toyota Factory in San Antonio
• Direct Investment by U.S. firms/individuals in a foreign country are debits to the capital account
• Intel Factory in San Jose, Costa Rica
• Purchase of foreign financial assets represents a debit to the capital account
• Warren Buffet buys stock in Petrochina
• Purchase of domestic financial assets by foreigners represents a credit to the capital account
• The United Arab Emirates sovereign wealth fund purchases a large store in the NASDAQ
• Relationship between Current and Capital Account
• The Current Account and the Capital Account should zero each other out
• If the Current Account has a negative balance (deficit), then the Capital Account should then have a positive balance (surplus)
• 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 US 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 US.

Balance of Trade

• Goods & Services Exports - Goods & Services Imports
• Have Either Trade Deficit or Trade Surplus
• Deficit = Imports > Exports
• Surplus = Exports > Imports
• Current Account
• Balance on Trade + Net Investment + Net Transfers
• Capital Account
• Foreign Purchases of U.S. Assets + U.S. Purchases of Assets Abroad
• Official Reserves
• Current Account Balance + Capital Account Balance