Welcome to Econ 414 International Economics

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

2. Assignment 5 (20 points)Key to Question 1 Visit the WTO’s web page at wto.org to answer the following questions: • Is Iran a member of WTO? How about Iraq? • No & No • Which country is the newest member of WTO? • Tonga • Is the following statement true or false? Explain. “WTO is for free trade at any cost.” • 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.” • False; each member has one vote. • What was the size of the WTO’s budget last year? • 175million Swiss francs

3. CHAPTER 11 National Income Accounting and the Balance of Payments

4. 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

5. What is excluded from GDP? • Intermediate goods • Only final goods/services are included. Why? • To avoid multiple counting • 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

6. 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)

7. 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

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

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

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

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

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

13. 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)

14. 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?

15. 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.

16. 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?

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

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

19. 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

20. 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

21. 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?

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

23. 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

24. 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

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

26. 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

27. Ireland Current Account Balance (millions of €)

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

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

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

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

32. 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

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

34. 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. • Ireland exports €50 worth of shoes • A German tourist gets a hair cut in Galway (€30) • Ireland imports €100 worth of TVs • Irish government sends €10 worth of aid to Afghanistan • A Japanese buys €90 Irish government bond • An Irish tourist goes to movies in Germany (€15) • An Irish buys a €55 German bond.