Unit 7; Balance of Payments, Foreign Exchange, Comparative and Absolute Advantage

Topic 1- Balance of Payment 

Balance Payment

• measure of money inflows and outflows between the United States and the rest of the world. 
• Inflows: Credits
• Outflows: Debits
• The Balance of Payments is divided into three accounts:

1. Current Account
2. Capital/Financial Account
3. Official Reserves

• Every transaction in the Balance of Payment is recorded twice. 
• current account has to equal to capital account

Current Account

• net exports 
• known as balance of trades
• exports - imports
• net foreign factor payment
• income earned by US earned foreign assets
• net transfers
• tend to be unilateral (one-way)
• what do we give to other countries/what do they give to us
• es. foreign aid 

Capital/Financial Account

• 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
• ex. Toyota factory in San Antonio
• direct investment by US firms/individuals in a foreign country are debits to the capital account.
• ex. dell computer factory in Costa Rica
• the purchase of foreign financial assets represents a debit to the capital account
• ex. bill gates buying stocks in petro china
• purchase of domestic financial assets by foreigners represents a credit to the capital account.
• ex. cuba purchases a large stake in mcdonalds
• capital and current account, when added together, must zero each other out. 

Official Reserves

• the foreign currency holdings of the United States Federal Reserve System. 
• the official reserves zero out the balance of payments 

Formulas for Balance of Payments

• Balance of Trade= goods export + goods imports
• Balance on Goods and Services= goods exports + services exports - goods imports + services imports
• Balance of Current Amount= net exports + net foreign factor payment + net transfer
• Capital amount= foreign ourchases of assets + US purchases of foreign assets

↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔↔

Topic 2- Foreign Exchange

Foreign Exchange Market- The buying and selling of currency

appreciation: the increase of value of a countries currency with respect to a foreign countries currency 

• a dollar is set to be stronger
• less unit of dollars that are needed to buy a single unit of the other currency
• trade deflict 

depreciation: the loss of value of a countries currency with respect to a foreign currency

• the dollar is consider weak
• more units of dollar is needed to buy a single unit of the other currency

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Topic 3- Comparative and Absolute Advantage

Absolute Advantage- the producer can produce the most output or requires the least amount of input (resources)

• Ex. Papa Johns produces 12 pizzas while McDonald produces 3  

Comparative Advantage- the producer with the lowest opportunity cost

• Lowest number when you do the calculations. 
• Lowest opportunity cost

Input vs. Output 

Input- certain amount of input to get a given product (time)

Output- certain amount of product out of a given input (production)