Post on 22-Jan-2015
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Macroeconomic Diagrams
Definition• Aggregate Demand
• The total expenditure on the national output at different values of the price level over a given period of time.
• C onsumption or spending by households• I nvestements = spending by firms on goods• G overnment Spending• X-M = Export minus Imports => net amount spent on economy’s
output by rest of world• Aggregate Supply
• Total output of goods and services, which all firms in the economy are willing and able to supply at different price levels over a period of time.
Reason for Shifts• Aggregate Demand
• Reduction in income tax• Consumption increase
• Reduction in interest rates• Consumer spending and corporate investment increase
• Increase in government spending• Boosting demand certain products, increasing earnings in sector
• Improved competitiveness performance• Boosting export sales
0
Aggregate Demand Increase
Output
Pric
e Le
vel
D
D1
S
P
P1
Q Q1
Reasons for Shift• Aggregate Supply
• Increase in short-run AS• Reduction in Indirect Tax• Reduction in Wage costs• Reduction in raw material & import costs• Favorable weather conditions
• Decrease in short-run AS• Reverse of everything said.
0
Aggregate Demand Decrease
Output
Pric
e Le
vel
D
D1
S
P
P1
Q Q1
International EconomicsReasons for Trade
Factor endowments• Factors of production that a country has available to produce
goods and services • Australia has minerals
Specialization• Exists where country specializes in production of goods and services
where they have a comparative advantage in production. Trade to get goods and services in which they do not specialize.
Absolute Advantage• Good exists where a country is able to produce more output than
other countries using same inputs of factors of production.
Comparative Advantage• A good exists where a country is able to produce a good at a
lower opportunity cost of resources than another country.
Automobiles Comparative Advantage between Japan and China
Apparel
Thousand units
100
Uni
ts
5
5 20
1
0
Japan
China
Free Trade & Protectionism
Free Trade • International trade takes place without any barriers, such as tariffs,
quotas, and subsidies.
0
Free trade in an economy
Price
Quantity
Sworld
SDomestic
D
Pworld
PEq
QeQ1 Q2
Tariff• Duty that is placed upon imports to protect domestic industries
from foreign competition and to raise revenue for government
Sworld
SDomestic
D
PEq
0
Price
Pworld
QeQ1 Q2 Quantity
Tariff diagram
STariffPTariff
Q3 Q4
Deadweight Loss
Quota• Import barrier set upper limits on quantity or value of imports that
may be imported into a country.
Sworld
SDomestic
D
PEq
0
Price
Pworld
QeQ1 Q2
STariffPTariff
Q3 Q4
Windfall gain by foreign producersLoss
Quantity
Subsidy• An amount of money paid by the government to a firm, per unit of
output, to encourage output and to give firm an advantage over foreign competitors.
Voluntary Export Restraint• Voluntary agreement between an exporting country and an
importing country that limits volume of trade in particular product.
Infant Industry Argument• Propose new industries should be protected from foreign
competition until they are large enough to compete in international markets.
Dumping • Selling of a good in another country at a price below its unit cost
of production.
Anti-Dumping• Legislation to protect an economy against import of a good at a
price below its unit cost of production.
Economic Integration & WTO
Free Trade Area• Exists when agreement is made between countries agree to trade
freely among members of the group, but are able to trade with countries outside free trade area in whatever ways they wish.
Customs Union• Agreement made between countries, where countries agree trade
freely among themselves, and they also agree to adopt common external barriers against any country attempting to import into the customs union.
Common Market• Customs union with common policies on product regulation, and
free movement of goods, services, capital, and labor.
Trade creation• A benefit of greater economic integration• Entry of country into a customs union leads to the
transfer of production from a high cost producer to a low cost producer
Trade Creation
A
B
C High cost Producer
BLow Cost Producer
Tariffs
Trading Bloc
Before
Trade Creation
A
B
C High cost Producer
BLow cost Producer
After
Trade Diversion• A disadvantage of greater economic integration• Entry of country into a customs union leads to the
transfer of production from a low cost producer to a high cost producer
Trade Diversion
AC
High cost Producer
B
DLow cost producer
Before
Trade Diversion
A
C High cost Producer
B
Trade Barriers
DLow cost producer
After
WTO• World Trade Organization
• International body that sets rules for global trading and resolves disputes between its member countries. Also hosts negotiations concerning reduction of trade barriers between member nations.
Balance of Payments
Balance of Payments• Record of value of all transactions between residents of a country
with residents of all other countries over given time period.
Balance of Trade• Measure of revenue received from exports of tangible goods minus
expenditure on imports of tangible goods over a given time period.
Current Account• Measure of flow of funds from trade in goods and services, plus net
investment income flows (profit, interest, and dividends) and net transfers of money (foreign aid, grants, and remittances)
Visible TradeImports and Exports of
Goods
Invisible TradeImports and Exports of Services
Net Transfers
Current Account
Capital Account• Measure of buying & selling assets between countries. Assets are
often separated to show assets that represent ownership and assets that represent lending.
Net Transfers of Capital
Net Investme
nt and loans
Changes in
National Reserves
Capital Account
(Financial Account)
Current Account Surplus• Where revenue from exports of goods and services and income
flows is greater than expenditure on import of goods and services and income flows over given time period.
ProsForeign investments made overseas will generate interest and profit
National Saving for future consumption
ConsPolitical tension (one country’s surplus is another’s deficit)
Tax loss as overseas investments taxed by foreign governments
Resources are being diverted abroad
Investment aboard and not at home
Current Account Deficit
• Where revenue from export of goods & services & income flows is less than expenditure on import of goods & services & income flows over given time period.
Pros
Foreign Investment increases output
Cons
Long term loss of confidence
Foreign ownership of assets
Foreign exchange reserves depleted
Correcting a Current Account Deficit
Short Term Strategies
Manipulate Exchange RateDevalue currency
Expenditure-switching policies Less expenditure on imports through Protectionism & Devaluation
Expenditure-reducing policiesReduce AD through deflationary fiscal and monetary policies
Long Term Strategies
Supply-side policies Increase LRAS to increase productivity
Correcting a Current Account Surplus
Manipulate Exchange Rate Appreciate currency
Expenditure-switching policies More expenditure on imports through removal of Protectionism
Expenditure-increasing policiesIncrease AD through inflationary fiscal and monetary policies
Marshall-Lerner Condition• Depreciation, or devaluation, of a currency will only lead to
improvement in current account balance if elasticity of demand for exports plus elasticity of demand for imports is <1.
J-Curve
Exchange Rates and Terms of Trade
Exchange Rate• Value of one currency expressed in terms of another.
Fixed Exchange Rate System
Government intervention to maintain a fixed exchange rate
Floating (Flexible) Exchange Rate
System
Supply and Demand determine the exchange rate
Managed Exchange Rate
System
Exchange rate generally allowed to
float but governments intervene to avoid
sudden fluctuations
Appreciation/Depreciation
Appreciation Increase in value of one currency in terms of another currency in afloating exchange rate system
DepreciationFall in value of one currency in terms of another currency in floating exchange rate system
Revaluation/Devaluation
RevaluationIncrease in value of currency in a Fixed Exchange rate system.
DevaluationDecrease in value of currency in a Fixed Exchange rate systemRevaluation
Purchasing Power Parity Theory
• States that under floating exchange rate, exchange rates adjust to offset differential rates of inflation between countries that are trading partners in order to restore BoP equilibrium.
Terms of Trade• Index that shows value of country’s average export prices relative to
their average import prices.
Improving TOTExport prices rise more relative to Import prices or if Export prices fall relatively less than Import prices
Deteriorating TOTImport Prices Rise more relative to Export prices or if Import Prices fall relatively less than Export prices.
Terms of Trade
Improving TOTRise in Standard of Living but International Competitiveness can be jeopardized (Your exports are more expensive)
Deteriorating TOT Fall in Standard of Living but International Competiveness improves (Your exports are cheaper)
Elasticity of Demand of Exports• Measure of responsiveness of quantity demanded of exports when
there is a change in relative price of exports.
Increase in Demand for $
0Quantity of $
Pric
e of
$ in
Yen
$10
$20
S
D
D1
Elasticity of Demand for Imports• Measure of responsiveness of quantity demanded of imports when
change in relative price of imports.
0
Pric
e of
$ in
Yen
$10
$20
S1
D
S
Quantity of $