Macro Unit 5: Day 1

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Phillips Curve

Looking at an AS/AD curve you can see what happens when a change in AD occurs.  (You can also have changes in AS.)
 

The faster AD grows the faster inflation will grow.   

     As output increases unemployment decreases   

A slower growth in AD causes a slower growth in inflation and a  slower growth in unemployment.   

 If you put inflation and unemployment together you find that high inflation goes hand in hand with low unemployment and vice versa.  

If the AD curve shifts real far to the right, we have big time inflation.  This means big time increase in employment.  With this knowledge we can build a Phillips Curve.  

     It shows the inverse relationship between price level and unemployment rate. 

 The employees will be hired back but will see that they are not keeping up with inflation.  They will then ask for more money and the Aggregate Supply will shift back to its original location.  The net result is that prices go up but GDP (unemployment) stay the same.  This is the long run Phillips Curve.  

The economy will naturally gravitate to the natural rate of unemployment.  This is what makes the Phillips curve vertical in the long run.  

 Crowding Out Effect:

     Crowding out effect: One problem we encounter in Fiscal policy is the crowding out effect.  If the economy is in a recession and the government decides to expand what happens.  AD increases this will in turn increase output.  The problem is that it will also increase the interest rates because there is an increase in demand for money.  This increase in interest rates will then drive out investment spending.  

This can be shown in several ways:

In this example the government entered the money market and increased the demand for money.   This drove up interest rates.   The initial fiscal policy pushed AD from AD to AD'.   However, since the interest rates were driven up by the government borrowing, interest rate sensitive Investment and Consumption has been crowded out of the economy.   This means AD actually only increases to AD"

Here is another way of looking at Crowding Out Effect:

Here you are using the loanable funds market.  You get a decrease in Sm because the Government has entered the market and sucked the funds out of the market.   This drives up REAL interest rates, decreases I and hence causes AD to not shift out as far as the original fiscal policy would have wanted it to. 

Since the government is just another player in the loanable funds market, you can also show this effect from the demand side.

 Unit 5 Lesson 2  

*** Increases in GDP brought about by increases in aggregate demand  is not economic growth.   Economic growth involves the change in productive capacity.   This is an increase in potential GDP.  This involves a change in the long run aggregate supply curve (shift in the production possibilities curve).  An increase in investment over an beyond the replacement of  investment capital.  

Economic growth can be a percent change in real GDP or real GDP per capita.   

Productivity determines the amount of economic growth. 

Three sources of growth:
     1. Supply of labor (population)
     2. supply of capital (increases productivity)
     3. technology (increases productivity)

MACRO UNIT 6
LESSON 1: COMPARATIVE ADVANTAGE AND TRADE BARRIERS   

  International Trade is essential for the survival of all countries.   

  In the US alone we depend on other countries for things like bananas, cocoa, coffee, spices, tea, nickel, tin....      We in turn export thinks like wheat, cotton, tobacco and rice.  

  The US is a leader in trading volume.  

      International trade is the way that countries can specialize, increase the productivity of their resources, and realize a larger total output than otherwise.

       Countries like individuals are able to specialize in their production.

       The distribution of resources (human, natural and capital goods) and technologies leads to this specialization.

          Some countries can produce goods that are labor-intensive while others can produce goods that are capital-intensive.  Still others can produce goods that are land intensive.

       Comparative Advantage: The ability to produce a good or service at a lower opportunity cost compared to other producers.

       Absolute Advantage: The ability to produce more output from given inputs of resources than other producers can.      

 
You are an accountant that charges $50 an hour to do someone’s taxes.    A painter who makes $15 an hour is trying to decide if he should hire you to do his taxes.   He knows it will take him 10 hours to do the accounting.  He knows it will take you 2 hours.  Should he hire you?      Yes.

 Here is the logic behind it:  If the painter needs to do his accounting should he hire you. 

             10 x 15 = $150
             2 x 50 = $100.   He should hire the accountant.

     Each person has a comparative advantage in their specialty.  Even though both could do the work themselves it is to their advantage to hire someone else.

The same can be said for two countries. 

             In order to look at this we must assume.

     1) Just two countries and two products (coffee and wheat)

     2) Constant costs: This means that production possibility curves are straight.  (They are not really straight because as production increases the variable costs increase the cost of production.)

Comparative Advantage: (The math I am using here is from Act 49)

  Input method: looks at the amount of inputs (usually time) necessary to do an activity. 

  To look at this problem from an input method you take x and put y under it.   The one with the least opportunity cost COMPARED TO OTHER PRODUCERS is the one you  choose. You then compare x for USA to x for Japan.  Since 10/5 is less than 14/4 this means the opportunity cost for x is less for USA so USA needs to produce x.  

Output method: looks at the amount of output over a given time.

    To look at this problem from an output method you take A and put B over it.  You then compare A for Germany to A for England.  Since 2/4 is less than 15/12 this means the opportunity cost for A is less for England so England needs to produce A.  

             Each should specialize where it has the comparative advantage.

In this case they each have separate cost curves.  That is why the production possibility curves are shaped as they are. 

     The US can exchange 30 ton of wheat for 30 ton of coffee.  1W = 1C
     Brazil has to give up 20C for 10W.         1W = 2C.

      Look at the possible points of production.  US might choose 18W and 12C while Brazil might choose 8W and 4C.  (THIS SHOWS WHAT EACH NATION CHOOSES TO CONSUME)

      In our example the US has a comparative advantage in wheat.  It can produce 1 wheat at the cost of only 1 C.  The world economy would not be helped if Brazil produced W when the US can produce it cheaper.

     Brazil has the comparative advantage in C.  It must only give up 1/2 a ton of C for one ton of Wheat.  It would be bad for the world economy for the US to produce C. 

      If each country produces the maximum amount of their good the world actually has more of that good.  The US can produce 30 wheat and Brazil can produce 20 coffee (base on production possibility curve.)

      Now that each country has specialized in its production it must now trade in order to get what it needs. 

      The US knows that if it produced 1C it would have to give up 1W.  It must therefore get more than 1C for its 1W.

      Brazil knows that it can produce 1W for its 2C.  It must therefore get 1W for less than 2C

  Terms of Trade

      Each country wants to export as little as it can in order to get as much as it can.  The actual exchange rate is based on this idea. 

     No matter what the US would want to get more than one C for each wheat.  The reason being is that it can get one by itself.  

     No matter what Brazil will want to get more than one wheat for 2 coffee.  It can get that by itself.

     Suppose it came out to be 1W = 1 1/2C.  Each nation can then go in and make a Trading possibility curve base on 1W = 1 1/2C.

     Trading Possibilities Curve:  By trading, each country can reach a point beyond their production possibility curve.  (Both get more of each product (or have to give up less to get more)).

     The net result of all this is that the world produces more if the countries specialize.  This is evident on Graph 37-2.  Point A' is superior to A and point B' is superior to B.

     When you remove the assumption of fixed production costs you will find that the initial ratio will be less.  It may actually work out that as the US produces more W it would need 1 1/2 coffee and this same ratio may be found for Brazil. 

In the end the increasing costs may make specialization less efficient at some point. 

Trade Barriers:

      How do the following trade barriers affect the economy?

      1) Revenue Tariffs: taxes on imported goods to get money for the federal government.  These are usually on goods that can not be produced in the US.  

    2) Protective Tariffs: taxes on imported goods to put them at a disadvantage to domestic goods.  This is usually done for on fledgling industries or industries that could prove vital to national defense (cars...)

   3) Import Quotas: limits on amounts that can be imported.

       *** Trade barriers only serve to reduce the comparative advantage.   

       If a country imposes a barrier against its imports, what is likely to happen to the amount imported and the price of the imported goods?  (Amount imported falls and prices rise.)

       If the price of imported goods rises when a barrier is erected, what is likely to happen to the output of domestic firms that produce goods which can be substituted for imports?  (output rises and profits of these firms increase.

       Is anyone made worse off as a result of import barriers? 
             (1) Foreign producers 
             (2) domestic consumers who must pay higher prices. 
             (3) domestic producers who produce goods that complement the imported goods.)

       Who gains and who loses from subsidies to our export industries? (Export producers gain; taxpayers who must provide the subsidy lose through paying higher taxes.

Q is the equilibrium quantity

  Pd is the equilibrium price (domestic)  

Now assume a foreign producer brings in a product.   They have the absolute advantage in producing this item and can do it at a lower price.

  This will drop the price to Pw (World Price).  At this price d will be sold.

  The difference between d and a is the amount that the foreign producer sells.  

Qa: Qs (domestic) with no tariff

Qb: Qs (domestic) with tarriff

Quantity demanded decreases and price increases. 

 Furthermore, the domestic producers are now getting more for their goods.   They get Pt instead of Pw.   They will also move up their supply curve (from Oa to Ob.)   This means they are getting more money and increase sales.  

The US government will get the amount equal to the difference between Pt and Pw.  (Orange section)  (Price of tariff (Pw - Pt) times the number of foreign goods (bc)  

From all of this we get:

      1. A decline in consumption in the United States.  (Because of higher prices.) This means US consumers are hurt.

      2. An increase in Domestic Production (over the amount prior to the tariff.)   They will move up the  supply curve.

       3. A decline in imports.  (It costs more to sell to us now.)

      4. An increase in Tariff revenue for the government. (orange rectangle.)  This is in effect a transfer of money from the consumers to the government.

       5. Fewer dollars in the foreign country means they can now buy less American goods.

       6. US companies now are operating (using resources) in a less efficient manner.  

  Why Have Protectionism:

     1. Self-sufficient Military: 
             Can you name any industry that does not contribute either directly or indirectly to national security.  (The war effort)  

     2. Increase domestic employment- preserve jobs. 
             While it does cause local manufactures to increase production (thus creating jobs) it also causes us to lose jobs.  Some people are involved in importing the goods.   Someone has to sell the foreign goods.

      3. Level the playing field:
             protect the American workers from foreign labor.  If they can produce at a cheaper rate than us we would be better off using our resources in other areas.

     4. Help infant industries:
          Do these industries really need protecting in order to be competitive on a global market?  
          Perhaps a subsidy would be in better order. 

       5. Diversify the economy:
             We are already very diversified.  We do not depend on one industry.

       6. Protect against dumping:
          Dumping goods in the American market to drive down the price and therefore drive out American producers is very rare.   When it does happen the American consumer gains in the short run.

             Other issues not discussed:
     1. The other nations may retaliate.  If they stop importing American goods we are hurt.
     2. Inefficient use of resources leads to higher prices.
     3. Foreign nations need to sell goods to us in order to afford our goods.  (use our money.)  
 

Unit 6: Lesson 3  

  When dealing with international trade one of the things you have to deal with is the difference in the currencies.  Each country wants to be paid in its currency.  This means they must go through the foreign exchange market. 

     When we buy things overseas we pay them in their currency (yen).  We get these yen from a major bank.  We give dollars for yen.  They then have to buy the Yen from a Japanese bank.

             1. In so doing we have created a demand for Yen.  This gives the Japanese access to American dollars.

            2. When we deposit our dollars in a bank in exchange for Yen that bank must hold those dollars for later exchanges.  They have lost Yen.  This represents a leakage from the money supply.  If we do not export to Japan to get back those dollars our money supply is decreased.  

Exchange Rates (Unit 6 Lesson 4)  

      Fixed Exchange Rate: when a government artificially fixes the exchange rate.

      Free Floating Exchange Rates:  This is all determined by Supply and Demand of that foreign money.

     Managed (dirty float) exchange rates: when countries buy and sell currency to attempt to control exchange rate.  

The Supply curve is upward sloping because as the price of the dollar in terms of pound falls the British will be more willing to buy our goods.    

When the dollar value goes from 1$ for 1 pound to $2 dollars for one pound the value of the dollar has depreciated.  It means it takes more dollars to buy one pound.  (Notice that the pound has appreciated).  

Strong and Weak dollar only applies when comparing to foreign currency.  It has nothing to do with the value of the dollar domestically.

A strong dollar is one that exchanges for large amounts of foreign currency.

       Importers want strong dollars while exporters want weak dollars.

       Example:

             Year One: $1 = four Euros
             Year Two: $1 = five Euros

       a. has the dollar appreciated or depreciated. 

       b. has the Euro appreciated or depreciated?    

      c. What is the price of one Euro in year one?

       d. What is the price of one Euro in Year two?

       e. If a good was made for $1 in Year One, what would it sell for in France?