Download Macroeconomics Module 9 - Kellogg Community College

Macroeconomics
Unit 17
Global Macroeconomic Issues
Introduction
This unit exposes you to the basic macro economic issues of
world trade. What are the advantages and disadvantages of
world trade?
The marginal propensity to import is discussed as a new
leakage to the circular flow.
A continuing discussion of specialization and comparative
advantage occurs as we examine the positive and negative
aspects of world trade on individual economies.
The Global View
The U.S. economy is not immune or isolated from other
economies in the world.
As international trade increases, our economy, along with other
economies, become more dependent upon each other.
Economic policy decisions in other countries can impact U.S.
exports and imports.
International Trade
If an economy does not have any foreign trade
(imports/exports) it is called a closed economy.
GDP in a closed economy = Consumption + Investment +
Government Spending (C + I + G).
In a closed economy there are no leakages from the circular
flow from imports.
In a closed economy there are no injections into the circular
flow from exports.
International Trade
In an open economy, exports (X) and imports (IM) affect the
circular flow.
GDP or Y = C + I + G + (X-IM). Often this equation is restated
as: C + I + G + X = Y + IM.
The restated equation illustrates the effects of imports and
exports.
In an open economy, total spending may not equal total output
because of the effect of imports and exports.
International Trade
Changes in income will affect the amount of spending in our
economy.
A portion of any increase in income will be spent on imports
which results in a leakage to the circular flow of the economy.
The marginal propensity to import (MPM) is used to
determine the fraction of each additional dollar in income that is
spent on imports. MPM reduces the economic impact of
changes in income to an economy.
International Trade
MPM also reduces the size of the
multiplier. Remember the multiplier =
1/(1-MPC) or 1/MPS.
In a closed economy, the value of the
multiplier is not affected by imports. In
an open economy, the value of the
multiplier is affected by MPM.
Open economy multiplier =
1 / (MPS + MPM)
International Trade
The open economy multiplier includes the leakages associated
with savings and imports. Since the amount of leakages is
greater in an open economy, any fiscal stimulus package will
be reduced by the amount of savings (MPS) and the amount
spent on imports (MPM).
Simply stated the total effect of the multiplier is reduced when a
portion of all income is spent on imports. If consumers receive
an additional dollar in income, a portion of that dollar is spent
on imports which does not help the domestic economy.
International Trade
Action
Closed Econ.
Open Econ.
Gov’t spends $10 + $10 billion
billion more
+ $10 billion
Consumer:
MPC = .9
MPS = .1
MPM = .1
Save $1 billion
Save $1 billion,
spend $1 billion on
imports
Multiplier
1/MPS = 10
1/(MPS + MPM) = 5
Total Change
$100 billion increase
$50 billion increase
International Trade
The preceding table points out the difference between a closed
economy and an open economy where imports occur.
Spending on imports reduced the multiplier from 10 to 5, and
reduced the economic impact of an increase in government
spending from $100 billion to $50 billion.
The effect the MPM has on an economy is based upon its
value. As its value increases, more spending is occurring on
imports which can significantly reduce the value of the multiplier
and any fiscal policy decision to increase economic activity.
International Trade
Changes in income within the U.S. do not have an impact on
exports.
Exports are dependent upon foreign income and spending
patterns.
A change in the demand for exports will cause aggregate
demand to shift. If more exports are demanded AD will shift to
the right. Once again, exports are dependent upon economic
conditions in other countries.
Trade Imbalances
The difference between what we export and import is called net
exports (X-IM).
If exports exceed imports, we have a trade surplus.
If imports exceed exports, we have a trade deficit.
A trade deficit indicates that we are consuming more than we
produce. Currently, the United States has a trade deficit.
Trade Imbalances
Trade deficits tend to lessen the chance for inflation. Imported
products and services are usually less expensive than
domestically produced products and services.
Trade deficits can make it more difficult to achieve full
employment as domestic companies must compete against
possibly lower priced products being imported.
Any fiscal stimulus program designed to boost domestic
spending will make trade deficits worse as consumers continue
to spend additional income on imports.
Trade Imbalances
A trade surplus may cause an increase in inflation. Policies
designed to reduce inflation domestically may not affect foreign
purchases.
A trade surplus may exist only because of a reduction in
domestic spending. If spending increases, the surplus may
disappear.
Currently the U.S. has a trade deficit, not a trade surplus.
When a country has a trade deficit, other countries must have a
trade surplus.
International Finance
Money moves from country to country in exchange for goods
and services.
When U.S. exports are purchased, or investments are made in
the U.S. stock or bond markets by foreign investors, capital
inflows of money increase.
Money that is spent on imports, or U.S. citizens or companies
investing in foreign markets, produce capital outflows of money.
Capital Imbalances
Similar to trade deficits and surpluses, capital inflows and
outflows may not be in balance.
A capital deficit exists when the capital outflow exceeds the
capital inflow in a given time period. Funds are being invested
in other countries at a greater rate then domestic investment.
A capital surplus exists when the capital inflow exceeds the
capital outflow in a given time period. Funds are being invested
domestically at a higher rate than foreign investment.
Capital Imbalances
Capital imbalances are directly related to trade imbalances.
A trade deficit indicates that more money is being sent
overseas. Foreign investors, eager to invest in the U.S. return
the money into our economy. This creates a capital surplus.
A trade surplus indicates greater foreign purchases of exports
than imports.
More foreign money is being used to purchases goods and
services compared to U.S. dollars being spent overseas on
products. This creates a capital deficit.
Capital Imbalances
One factor that has an impact on capital flows is the exchange
rate.
The exchange rate is the price of one country’s currency
expressed in terms of another country’s currency.
For example, the U.S. dollar may be worth 2 Canadian dollars;
the Canadian dollar may be worth $0.50 US.
Capital Imbalances
If the value of the U.S. dollar rises, it indicates that the dollar is
worth more relative to another country’s currency.
A higher valued U.S. dollar enables you to purchase more
foreign goods and services.
A higher valued dollar also makes our exports more expensive
in world markets.
Exchange rates change daily in response to fiscal and
monetary policy changes.
Productivity and Competitiveness
Many of the items we import could be
produced here in the U.S. Oil, coffee, toys,
etc. could all be produced here.
Some of these items would be costly to
produce here, or may have a negative
impact on the environment.
As a result we import items that other
countries can produce at a lower cost or
more efficiently.
Productivity and Competitiveness
When a country is able to produce and good or service for a
lower opportunity cost, that country has a comparative
advantage.
Specialization occurs when countries produce goods and
services more efficiently and for lower opportunity costs than
other countries.
Foreign trade ensures competing domestic producers remain
efficient. The competition from foreign imports increases
domestic productivity and efficiency.
Productivity and Competitiveness
Improvements in productivity (output per
unit of input) are necessary in order to
compete against lower international labor
costs.
U.S. companies have higher labor costs
than most foreign competitors. To remain
competitive, U.S. companies must have
higher levels of productivity than their
competing foreign companies.
International Organizations
The International Monetary Fund (IMF) is essentially a bank
that assists countries in economic trouble.
Its primary function is to lend funds obtained from member
countries to assist other countries with economic stabilization.
The loans help a country’s currency become more stable and
assists with economic development and growth.
International Organizations
The European Union (EU) was originally a group of 11 (and
rising) European countries who joined together to establish a
common currency, financial system and eliminate trade
barriers.
A common currency enables easier trading between member
countries. Each country adopts a common monetary policy in
terms of interest rates and the supply of money.
The governments continue to operate as separate entities.
Summary
•
•
•
•
•
•
•
•
•
•
•
Closed economy and an open economy.
Marginal propensity to import.
Impact of imports on fiscal stimulus.
Trade surplus, trade deficit.
Impact of a trade deficit on the economy.
Capital deficit, capital surplus.
Exchange rate.
Effect of exchange rates on imports and exports.
Specialization, comparative advantage.
International Money Fund.
European Union.