UNIT 7

UNIT 7 PRACTICE

AP Macroeconomics Unit 7 - Part 1

Unit 7

• Absolute Advantage

-Individual- exists when a person can produce more of a certain good/ service than someone else in the same amount of time (or can produce a good using the least amount of resources.)
-National-exists when a country can produce more o a good/ service than another county can in the same time period.

• Comparative Advantage

-A person or a nation has a comparative advantage in the production of a product when it can produce the product at a lower domestic opportunity cost than can a trading partner.

• Examples of output problem:

-word per minute

-miles per gallon

-tons per acre

-apple per tree

-television produced per hour

• Examples of Input problems:

-number of hours to do a job

-number of acres to feed a horse

-number of gallon of paint to paint a house

• Specialization and trade

-Gains from trade are based on comparative advantage, not absolute advantage

(who can d what in a certain amount of time)

IMPORTANT (Smallest number is who has opportunity cost)

Unit 7

Exchanges

• Foreign Exchange (FOREX)

- the buying and selling of currency

      Example: in order to purchase souvenirs in France, it is first necessary for Americans to sell their dollars and buy Euros

- any transactions that occurs in the balance of payments necessitates foreign exchange

-Exchange Rate (e) is determined in foreign currency markets

• Changes in Exchange Rates

-exchange rates (e) are a function of supply and demand for currency

•        an increase in the supply of a currency

•        a decrease in supply of a currency will increase the exchange  rate of currency

•        increase in demand for currency will increase the exchange rate of currency

•        decrease in demand for a currency will decrease the exchange rate of currency

• Appreciation and Depreciation

-appreciation of currency occurs when exchange rate of that currency increases (e^)

-depreciation of a currency occurs when the exchange rate of that currency decreases

• Exchange Rate Determinants

-consumer tastes

-relative income

-relative price level

-speculation

• Exports and Imports

-exchange rate is a determinant of both exports and imports

-appreciation of the dollar causes american goods to be relatively more expensive and foreign goods to be relatively cheaper, thus reducing exports and increasing imports

-depreciation of the dollar causes american goods to be relatively cheaper and foreign goods to be relatively more expensive thus increasing exports and reducing imports

Unit 7

Balance of payments

• measure of money inflows and outflows between the US and the Rest of the World (ROW)

     *Inflows are referred to as CREDITS

     *out flows are referred to as DEBITS

• the balance of payments is divided by 3 accounts

      - current account
      - capital/ financial accounts
      - official reserves accounts

Current Accounts

- balance of trade or net exports

-net foreign income

-net transfers (tend to be unilateral)

Capital/ Financial Accounts

- the balance of capital ownership

-includes the purchase of both real and financial assets

-direct investment in the US is a credit to the capital account

-direct investment by US Firms/ individuals in foreign country are debits to capital accounts

-purchase of foreign financial assets represents a debit to a capital account

-purchase of domestic financial assets by foreigners represents a credit to the capital accounts

          Important Info:the current account and the capital account should zero each other out***

Official Reserves 

-foreign currency holdings of US Federal Reserve System

-when there is a balance of payments surplus the FED accumulates foreign currency and debits balance of payments

-when there is a balance of payments deficit FED depletes its reserves of foreign currency and credits balance of payments

Active US passive official reserves

-the US is passive in its use of official reserves

unit 6

Economic Growth Defined

•Sustained increase in Real GDP over time.

•Sustained increase in Real GDP per Capital over time.

Why Grow?

•Growth leads to greater prosperity for society.

•Lessens the burden of scarcity.

•Increases the general level of well-being.

Conditions for Growth

•Rule of Law

•Sound Legal and Economic Institutions

•Economic Freedom

•Respect for Private Property

•Political & Economic Stability

–Low Inflationary Expectations

•Willingness to sacrifice current consumption in order to grow

•Saving

•Trade

Physical Capital

•Tools, machinery, factories, infrastructure

•Physical Capital is the product of Investment.

•Investment is sensitive to interest rates and expected rates of return.

•It takes capital to make capital.

•Capital must be maintained.

Technology & Productivity

•Research and development, innovation and invention yield increases in available technology.

•More technology in the hands of workers increases productivity.

•Productivity is output per worker.

•More Productivity = Economic Growth.

Human Capital

•People are a country’s most important resource. Therefore human capital must be developed.

•Education

•Economic Freedom

•The right to acquire private property

•Incentives

•Clean Water

•Stable Food Supply

•Access to technology

Hindrances to Growth

•Economic and Political Instability

–High inflationary expectations

•Absence of the rule of law

•Diminished Private Property Rights

•Negative Incentives

–The welfare state

•Lack of Savings

•Excess current consumption

•Failure to maintain existing capital

•Crowding Out of Investment

–Government deficits & debt increasing long term interest rates!

•Increased income inequality à Populist policies

•Restrictions on Free International Trade