Welcome to Econ 414 International Economics Study Guide

Welcome to Econ 414 International Economics Study Guide Week Eleven Ending: Friday November 9 1

Assignment 5 (20 points) Key to Question 1 Visit the WTO’s web page at wto. org to answer the following questions: a) Is Iran a member of WTO? How about Iraq? • b) No & No Which country is the newest member of WTO? • c) Tonga Is the following statement true or false? Explain. “WTO is for free trade at any cost. ” • d) False; “It’s really a question of what countries are willing to bargain with each other, of give and take, request and offer. ” Is the following statement true or false? Explain. “The voting power of a nation that is a member of WTO depends on its GDP. ” • e) False; each member has one vote. What was the size of the WTO’s budget last year? • 175 million Swiss francs 2

CHAPTER 11 National Income Accounting and the Balance of Payments 3

What is national income accounting? • The process used to keep track of GDP and its components. • What does GDP measure? – A country’s total output per a unit of time – A country’s total income per a unit of time • Total output measured in country’s currency with goods/services measured at market prices 4

What is excluded from GDP? 1. Intermediate goods • Only final goods/services are included. Why? – To avoid multiple counting 2. Non-reported market transactions and activities • • Informal economy Shadow economy – Mostly to avoid paying taxes or following other regulations • • Illegal goods GDP is understated and provides a conservative estimate of country’s total economic activity 5

What is the difference between nominal and real GDP? • Nominal GDP – The value of GDP in current prices. • Real GDP – The value of GDP in base year prices. • How do they relate to each other? Real GDP in year t = (Nominal GDP in year t) * 100 (Price Index in year t) 6

What are the components of GDP? – Y = C + I + G + (X - M) Y = GDP (total production)= total income C = Public’s consumption of goods and services I = private business firms’ investment in equipment, software, structures, and changes in business inventories, and residential investment G = The purchase of goods and services (even investment goods) by government X = Exports of goods and services M = Imports of goods and services 7

Ireland’s Real GDP in millions of € (source: Central Statistics Office- Ireland) http: //www. cso. ie 8

Are second hand sales in GDP? • No • GDP measures the value of newly produced goods and services only. 9

Irish Nominal GDP components in 2006 (millions of €) (source: Central Statistics Office- Ireland) 10

Flow/Stock Variables • Stock: Is measured at a given point in time • Flow: Is measured per unit of time 11

What are these variables, flow or stock? • • GDP Price index Exports Unemployment rate 12

What is X-M equal to? • X-M is net exports or the trade balance = exports of goods and services minus imports of goods and services • Y + C + G + I + (X-M) • X-M = Y – (C + I + G) • Trade Balance = domestic production (supply) – domestic expenditures (demand) 13

If Y< (C+I+G) X<M Trade deficit • Our income (production, supply) is less than our expenditures (demand) or we produce less than we consume domestically • We are borrowing from foreigners – flow or stock? • Our international indebtedness increases – flow or stock? 14

This means that in the future • Deficits must be paid by producing more than consuming (exporting future consumption). • Trade deficit is the process of importing present consumption and exporting future consumption. 15

If Y> (C+I+G) X>M Trade surplus • Our income (production) is more than our expenditures or we produce more than we consume domestically • We are lending to foreigners – flow or stock? • Our international indebtedness decreases – flow or stock? 16

This means that in the future • our domestic production will be less than our expenditures importing future consumption. 17

• Trade imbalances denote a country’s preference for present versus future consumption • Intertemporal Trade – Countries trading production for consumption at different points in time. 18

Production and Income • We know that – GDP = C + I + G + (X-M) = Y • We also know that –Y=T+C+S • This means that –C+I+G+X-M=T+C+S –I+G+X–M=T+S –I+G+X=T+S+M 19

Injections and leakages • I+G+X=T+S+M • The left side items are all expenditures on domestic output create income in the country injections in the income stream • The right side items are all monies not spent on domestic output don’t create income in the country leakages from the income stream 20

Trade balance, private saving, government saving and business investment • I+G+X=T+S+M • (X – M) = (T- G) + (S – I) • Trade balance = government saving + (private saving – business investment) • What causes the trade deficit? – Budget deficit? – Low amount of saving relative to investment? 21

How could we reduce trade deficit? (X – M) = (T- G) + (S – I) • 4 strategies to reduce trade imbalance: 1) Increasing the level of savings to reduce the trade deficit 2) Reduce the level of investment 3) Increase taxes 4) Reduce government spending 22

What is the balance of payments account? • • A summary of all the international transactions of a country’s residents with the rest of the world during a year. Composed of different accounts 23

In general • Any transaction resulting in money (€) flowing into a country is a credit and has a positive sign • Any transaction resulting in money (€) flowing out of the country is a debit and has a negative sign 24

Goods & Services Balance 1. Merchandise Balance n Exports of goods – imports of goods 2. Balance on Goods & Services n Merchandise Balance + export of services – import of services 25

Current Account Balance • Balance on goods and services + income received from investments abroad – income paid to foreigners on their investments in the country + unilateral transfers received – unilateral transfers sent abroad. • Unilateral Transfers: – Grants or gifts extended to or received from other countries 26

Ireland Current Account Balance (millions of €) 2005 2006 Merchandise +28, 218 +25, 389 Goods and Services Current Account Balance +18, 915 +17, 970 -5, 690 -7, 276 27

Note • My discussion on Capital and Financial Accounts is different from your book • Ask me questions, if you don’t get it. 28

Examples of Capital Account (financial assets, non-financial assets, official reserves) Items 1. Irish resident buys shares of US stock (financial asset) n Money leaves country domestic holdings of foreign assets goes up debit negative sign 2. American buys a right to produce something in Ireland (franchise, non financial asset) n 3. Money enters the country foreign holdings of domestic assets goes up credit positive sign Irish government sells dollars (official reserve) n Money (€) enters the country Domestic holding of foreign assets goes down credit positive sign 29

The Capital Account Balance • Net increase in foreign holdings of domestic assets - Net increase in domestic holdings of foreign assets 30

The Balance of Payments (BOP) • • BOP = Current account balance+ capital account balance + statistical discrepancy = 0 Why? 31

Why is the balance of payments zero? • Example – – 2 countries: US & Ireland US has no €; Ireland has no $ US buys Irish sweater for $1000 US Current account balance = ? • -$1000 – US pays $1000 to Irish exporter or US gives and IOU (a $1000 bond) to Irish Exporter – Is this a capital inflow or capital outflow? • Inflow – US Capital account balance = ? • +$1000 32

Asst 6 • Due before 10 PM on Friday, November 9 • Has 10 points 33

Given the following information, find Ireland’s (1) merchandise balance, (2) goods and services balance, (3) current account balance, (4) capital account balance and (5) statistical discrepancy. 1. Ireland exports € 50 worth of shoes 2. A German tourist gets a hair cut in Galway (€ 30) 3. Ireland imports € 100 worth of TVs 4. Irish government sends € 10 worth of aid to Afghanistan 5. A Japanese buys € 90 Irish government bond 6. An Irish tourist goes to movies in Germany (€ 15) 34 7. An Irish buys a € 55 German bond.