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Welcome to Econ 414 International Economics

Study Guide

Week Eleven

Ending: Friday November 9

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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?

• No & Nob) Which country is the newest member of WTO?

• Tonga c) 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.” d) 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.

e) What was the size of the WTO’s budget last year?• 175million Swiss francs

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National Income Accounting and the Balance of Payments

CHAPTER 11CHAPTER 11

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• 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

What is national income accounting?

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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

What is excluded from GDP?

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• 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?

What is the difference between nominal and real GDP?

Real GDP in year t = (Nominal GDP in year t) * 100

(Price Index in year t)

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– Y = C + I + G + (X - M)Y = GDP (total production)= total incomeC = 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 governmentX = Exports of goods and servicesM = Imports of goods and services

What are the components of GDP?

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Ireland’s Real GDP in millions of € (source: Central Statistics Office- Ireland)

130,000135,000140,000

145,000150,000155,000160,000

165,000170,000175,000

2003 2004 2005 2006

Real GDP

http://www.cso.ie

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Are second hand sales in GDP?

• No

• GDP measures the value of newly produced goods and services only.

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Irish Nominal GDP components in 2006

(millions of €)(source: Central Statistics Office- Ireland)

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10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

G C I X-M

East

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Flow/Stock Variables

• Stock: Is measured at a given point in time

• Flow: Is measured per unit of time

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What are these variables, flow or stock?

• GDP

• Price index

• Exports

• Unemployment rate

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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)

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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?

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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.

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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?

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This means that in the future

• our domestic production will be less than our expenditures importing future consumption.

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• Trade imbalances denote a country’s preference for present versus future consumption

• Intertemporal Trade – Countries trading production for

consumption at different points in time.

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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

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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

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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?

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• 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

How could we reduce trade deficit?How could we reduce trade deficit?(X – M) = (T- G) + (S – I)(X – M) = (T- G) + (S – I)

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• 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

What is the balance of What is the balance of payments account?payments account?

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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

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1. Merchandise Balance Exports of goods – imports of goods

2. Balance on Goods & Services Merchandise Balance + export of

services – import of services

Goods & Services BalanceGoods & Services Balance

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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

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Ireland Current Account Balance (millions of €)

2005 2006

Merchandise +28,218 +25, 389

Goods and Services

+18,915 +17,970

Current Account Balance

-5,690 -7,276

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Note

• My discussion on Capital and Financial Accounts is different from your book

• Ask me questions, if you don’t get it.

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1. Irish resident buys shares of US stock (financial asset)

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)

Money enters the country foreign holdings of domestic assets goes up credit positive sign

3. Irish government sells dollars (official reserve)

Money (€) enters the country Domestic holding of foreign assets goes down credit positive sign

Examples of Capital Account Examples of Capital Account (financial assets, non-financial (financial assets, non-financial assets, official reserves) Itemsassets, official reserves) Items

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• Net increase in foreign holdings of domestic assets - Net increase in domestic holdings of foreign assets

The Capital Account BalanceThe Capital Account Balance

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• BOP = Current account balance+ capital account balance + statistical discrepancy = 0

• Why?

The Balance of The Balance of Payments (BOP) Payments (BOP)

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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

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Asst 6

• Due before 10 PM on Friday, November 9

• Has 10 points

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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 shoes2. A German tourist gets a hair cut in Galway

(€30)3. Ireland imports €100 worth of TVs4. Irish government sends €10 worth of aid to

Afghanistan5. A Japanese buys €90 Irish government bond6. An Irish tourist goes to movies in Germany

(€15)7. An Irish buys a €55 German bond.