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Welcome to Econ 414
International Economics
Study Guide
Week Eleven
Ending: Friday November 9
1
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?
•
b)
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.”
c)
•
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.”
d)
•
False; each member has one vote.
What was the size of the WTO’s budget last year?
e)
•
175million Swiss francs
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CHAPTER 11
National Income Accounting and
the Balance of Payments
3
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
4
What is excluded from GDP?
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
5
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)
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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
7
Ireland’s Real GDP in millions of €
(source: Central Statistics Office- Ireland)
175,000
170,000
165,000
160,000
155,000
150,000
145,000
140,000
135,000
130,000
Real GDP
http://www.cso.ie
2003
2004
2005
2006
8
Are second hand sales in GDP?
• No
• GDP measures the value of newly
produced goods and services only.
9
Irish Nominal GDP components in
2006
(millions of €)
(source: Central Statistics Office- Ireland)
90,000
80,000
70,000
60,000
50,000
40,000
30,000
20,000
10,000
0
East
G
C
I
X-M
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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
12
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?
14
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.
15
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?
16
This means that in the future
• our domestic production will be less than
our expenditures  importing future
consumption.
17
• 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?
21
How could we reduce trade deficit?
(X – M) = (T- G) + (S – I)
•
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
22
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
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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
24
Goods & Services Balance
1. Merchandise Balance

2.
Exports of goods – imports of goods
Balance on Goods & Services
 Merchandise Balance + export of
services – import of services
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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
26
Ireland Current Account
Balance (millions of €)
2005
2006
+28,218
+25, 389
Goods and
+18,915
Services
Current Account -5,690
Balance
+17,970
Merchandise
-7,276
27
Note
• My discussion on Capital and Financial
Accounts is different from your book
• Ask me questions, if you don’t get it.
28
Examples of Capital Account
(financial assets, non-financial
assets, official reserves) Items
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)

3.
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
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The Capital Account Balance
•
Net increase in foreign holdings
of domestic assets - Net increase
in domestic holdings of foreign
assets
30
The Balance of
Payments (BOP)
•
•
BOP = Current account balance+
capital account balance + statistical
discrepancy = 0
Why?
31
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
32
Asst 6
• Due before 10 PM on Friday, November 9
• Has 10 points
33
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 shoes
2. A German tourist gets a hair cut in Galway
(€30)
3. Ireland imports €100 worth of TVs
4. Irish government sends €10 worth of aid to
Afghanistan
5. A Japanese buys €90 Irish government bond
6. An Irish tourist goes to movies in Germany
(€15)
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7. An Irish buys a €55 German bond.