trade off in outputs can’t have advantage in everything. All countries will have advantage at some point.
Absolute Advantage – same amount of output with less input. Can have advantage in everything. You should understand and
describe the underlying concept.
You should also be able to calculate production and consumption in a two-country, two-
commodity economy, with and without trade.
Exchange Rate Systems
; Free floating, managed (or dirty) float, fixed rates. – most
currencies freely float, including the majors: US, Yen, Pound, Euro, Swiss Franc, Australian, Brazilian, Peso. Dirty Float – market
forces set rates unless excess volatility occurs. Then central bank determines rate. System tries to smooth out excess volatility, but
central governments may not recognize fundamental shifts in value. Examples of dirty float include Indian Rupee, Russian Ruble,
Argentina $. Fixed Rate System – rate determination- central bank (govt maintains target rates, if rates are threatened, central banks
buy/sell currency. Monetary policies coordinated. Requires central bank to maintain adequate reserves. Examples are CFA Franc
(Euro), Saudi Arabia). Currency boards (no central bank) – govt holds interest bearing notes of pegged currency. The money supply
is determined by market demand for the currency (Hong Kong, Bosnia, Bulgaria).
Balance of payments
- BCA – Balance of
Current Account (more sellers of $’s than buyers, credits – exports goods, exports services, debits – import goods, imports
services), BKA – Balance of Capital Account (more buyers of $’s than sellers, credits – foreign investment in the domestic
economy, statistical discrepancy, debit – domestic investments in foreign economies), BRA – Balance of Reserve Account (if it is
negative, it is growing), BCA + BKA + BRA = 0 ----
BCA = -BKA. National income (consumption and savings), national
spending (Consumption and Investment), National Income – National Spending = Savings – Investment (amount needed for BKA).
current and capital accounts, and the reserve balance.
You should understand the balance of payments relative to fixed versus
floating exchange rate systems.
– involves contracting today for the future purchase or sale of foreign exchange.
The forward price may be the same as the spot price, but usually it is higher (at a premium) or lower (at a discount) than the spot
PPP – Purchasing Power Parity
– when the law of one price is applied internationally to a standard commodity basket. The
exchange rate between currencies of two countries should be equal to the ratio of the countries’ price levels.
FPPP – “forward
purchasing power parity”
– the forward premium/discount is equal to the expected inflation differential.
FE – Fisher Effect
implies that the interest rate differential should be equal to the expected inflation differential. Holds that an increase (decrease) in
the expected inflation rate in a country will cause a proportionate increase (decrease) in the interest rate in the country. 1+ Nominal