Specialization 

• Individuals and countries can be made better off if they will produce in what they have a comparative advantage and then trade with others for whatever else they want/need.

Absolute Advantage

• The producer that can produce the most output OR requires the least amount of inputs (resources).

Comparative Advantage 

• The producer with the lowest opportunity cost.
• Countries should trade if they have a relatively low opportunity cost.

Input vs Output

• Output Problem: Presents the data as products produced given a set of resources. 

• Ex: Number of pens produced

• Input Problem: Presents the data as a number of resources needed to produce a fixed amount of output. 

• Ex: Number of labor hours to produce 1 bushel
• When identifying absolute advantage, input problems change the scenario from who can produce the most to two can produce a given product with the least amount of resources. 

Foreign Exchange

• The buying and selling of currency 
• Visiting Europe and exchanging dollars for Euros
• Any transaction that occurs in the Balance of Payments necessities foreign exchange
• The exchange rate (e) is determined in the foreign currency markets ---> (price of currency)

Changes in Exchange Rates

• Exchange rates are a function of the supply and demand for currency
• Increase in supply of currency = decrease in exchange rate of currency
• Increase in demand of currency = increase in exchange rate of currency

Appreciation and Depreciation

• Appreciation: When the exchange rate of currency increases
• Depreciation: When the exchange rate of that currency decreases

Exchange Rate Determinants

• Consumer Tastes
• Relative Income
• Relative Price Level

 

Balance of Payments

• Measure of money inflows and outflows between the United States and the Rest of the World (ROW)
• Inflows=Credit
• Outflow=Debit
• Divided into Three Accounts
• Current Account
• Capital/Financial Account
• Official Reserves Account 

Current Account

• Balance of Trade (Net Exports)
• Exports of goods and services/Imports of Goods and Services 
• Exports become credit to balance of payments
• Imputed become debit to balance of payments
• Net Foreign Income
• Income earned by US owned foreign assets- Income paid to foreign held to US assets
• Net Transfers 
• Foreign Aid ---> A debit to the current account 
• Ex: Mexican migrant workers send $ to family in Mexico

Capital/Financial Account

• The balance of capital ownership 
• Includes the purchase of both real and financial assets
• Direct investment in US is credit to capital account
• Ex: Toyota factory in San Antonio
• Direct investment by US firms/individuals in a foreign country and debits to the capital account 
• Ex: Intel factory in Costa Rica
• Purchase of foreign financial assets represents a debit to the capital account
• Ex: Warren buys stock in Petrochina
• Purchase of domestic financial assets by foreigners represents a credit to the capital account 
• Ex: The United Arab Emrite Sovereign wealth fund purchases a large stake in NASDQ

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 Official Reserves zero out the balance of payments