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What is economics and why should we study it? Global Economics Globalization is the process of integration of an economy into the world economy. This process involves output markets, labor markets, capital markets…. • • • • • • Immigration and Economic Development Technological Changes and Trade Outsourcing Foreign Investment and Currency Currency and Trade International Economic Shocks and Domestic Economics Stability » These are just some of the major venues through which world economy affects our economy Trade (% of GDP) 2003 World 47.84 Upper middle income 68.53 Middle income 61.98 High income 45.29 Lower middle income 57.10 Low income 44.61 Sub-Saharan Africa 64.28 South Asia 33.33 Middle East & North Africa 58.16 Latin America & Caribbean 45.53 European Monetary Union 68.25 East Asia & Pacific 74.17 United States 23.66 Definition: Trade is the sum of exports and imports of goods and services measured as a share of gross domestic product. For the US see BEA Income distribution in 2005: GDP per capita based on PPP Less than 1806.50 1806.50 – 4052.40 4052.40 – 7088.70 7088.70 – 19111.60 Greater than 19111.60 No Data Available World Economy in 2005 GDP (USD) population GDP per capita GDP per capita in millions of $ in millions Atlas method PPP method World 44645000 6438 6935 9529 High income 34687000 1011 34316 Upper middle income 3673800 600 Middle income 8553700 Lower middle income % of % of World Pop. World GDP 3.48 100 100 32725 2.66 77.70 15.70 6125 11174 5.52 8.23 9.32 3075 2782 7348 6.42 19.16 47.76 4879800 2475 1972 6442 7.03 10.93 38.44 Low income 1416200 2352 602 2499 8.04 3.17 36.54 Sub-Saharan Africa 621880 743 837 1994 5.69 1.39 11.54 South Asia 1016300 1470 691 3137 8.65 2.28 22.83 Middle East & North Africa 625310 306 2043 6126 4.26 1.40 4.75 Latin America & Caribbean 2461000 551 4468 8410 4.49 5.51 8.55 East Asia & Pacific 3040000 1886 1612 6052 8.95 6.81 29.29 European Monetary Union 9984100 314 31807 29162 1.30 22.36 4.88 United States 12417000 296 41891 41891 3.20 27.81 4.60 Source: WDI for 2007 GDP growth The planet Earth in the darkness of the night* * Image source: NASA (http://antwrp.gsfc.nasa.gov/apod/ap001127.html) 2003: Health expendit ures per capita (current USD) 2004: cases of TB per 100,000 2004: Internet Users per 1000 World 587.79 139.47 139.93 Upper middle income 279.96 112.15 Middle income 116.29 High income Mobile phone subscrib ers per 1000 Infant mortality rate per 1000 PCs per 1000 people 67.32 279.34 54.09 129.77 159.33 69.15 484.18 23.36 121.75 113.63 91.83 70.22 293.61 30.02 60.86 3449.40 17.11 544.93 78.74 771.72 6.12 574.14 Lower middle income 77.49 113.97 75.91 70.47 248.86 31.58 46.20 Low income 29.62 223.99 24.34 58.68 42.15 79.45 11.29 Sub-Saharan Africa 36.42 363.14 19.44 46.22 74.08 100.47 15.05 South Asia 23.78 177.21 26.14 63.41 41.31 66.41 12.14 Middle East & North Africa 92.41 53.91 58.00 69.35 128.61 44.09 48.55 Latin America & Caribbean 221.68 63.51 114.53 72.19 318.36 26.52 92.40 European Monetary Union 2552.10 13.00 443.22 79.38 904.19 4.11 420.84 64.11 137.75 73.79 70.28 243.47 29.16 38.19 5711.00 4.70 629.99 77.43 616.73 6.70 749.18 East Asia & Pacific United States Life expectan cy at birth Correlation between life expectancy and the standard of living as measured by the GDP per capita (PPP) is positive 0.63, see the stats table Health care expenditures per Life expetance at Physicians per 1000 capita (current USD) birth 2003 people, 2001 2002 % of population with improved water access 2002 Mexico Canada United States 73.64 79.34 77.41 1.71 2.10 379.00 2222.00 5274.00 91.00 100.00 100.00 France Germany Italy United Kingdom 79.26 78.33 79.83 77.63 3.29 3.62 6.07 2348.00 2631.00 1737.00 2031.00 100.00 100.00 100.00 100.00 Ukraine Russian Federation Belarus 68.29 65.71 68.17 2.97 4.17 4.50 40.00 150.00 93.00 98.00 96.00 100.00 Kenya Nigeria Tanzania Zimbabwe 45.41 44.91 42.67 38.53 19.00 19.00 13.00 118.00 62.00 60.00 73.00 83.00 Electric power consumption (KWH per capita) 2002 Internet users per 1000 people 2002 Television sets per 1000 people 2001 Mexico Canada United States 1659.70 15613.00 12183.00 98.48 512.83 551.38 281.96 690.63 937.51 France Germany Italy United Kingdom 6606.40 6046.00 4901.20 5618.00 313.83 436.17 352.44 423.10 631.92 637.41 Ukraine Russian Federation Belarus 2229.20 4291.20 2656.60 18.75 81.57 361.77 Kenya Nigeria Tanzania Zimbabwe 120.31 68.17 62.14 831.40 12.70 3.50 2.32 42.98 25.98 102.63 44.65 55.62 950.48 Economic development = quality of life Correlation with GDP per capita based on PPP Life expectancy at birth Child mortality rate Healthcare expenditures per capita % of population with improved water access Internet users per 1000 people 0.61554089 -0.597142331 0.898003539 0.542805766 0.87013155 Evaluating Economic Activity Output – production, the process of income creation •GDP - the total market value of all final goods and services produced by factors of production located within a nation’s borders over a period of time •GNP - the total market value of all final goods and services produced by factors of production owned by a nation over a period of time Relation of Gross Domestic Product and Gross National Product [Billions of dollars] www.bea.gov 1994 Gross domestic product 2000 2001 2002 2003 2004 7,072.20 9,817.00 10,128.00 10,469.60 10,971.20 11,734.30 Plus: Income receipts from the rest of the world 186.4 382.7 322.4 305.7 343.7 415.4 Less: Income payments to the rest of the world 160.2 343.7 278.8 275 275.6 361.7 7,098.40 9,855.90 10,171.60 10,500.20 11,039.30 11,788.00 Equals: Gross national product Output and Income GDP and GNI •GDP is a measure of production, and production represents economic activity. Note that the sale of output is simply a transfer of ownership (or wealth), while the production of output is the process of generating wealth. The production generates incomes to the factors of production, which are then distributed to the inputs: -pay wages to employees -pay interest to lenders -pay profit to capital owners etc. •Therefore total value of output is equal to total income. In what we can consume we are limited by what we produce. •Therefore GDP per capita (GDP/population) is a measure of average income in a country. Understanding GDP • How should the following count? – Purchase of MSFT shares through e-trade broker – Purchase of a previously owned house – Purchase of a new house from a construction company – Purchase of a used car from a private individual – Purchase of a used car from a used car dealer – Purchase of a class at GSU – Build up of dealer inventories? – Cooking your own meal? – Going out to a restaurant? Understanding the GDP II • How should the following count? – Purchase by Ford Comp. of new tires from a tire supplier? – Purchase by me (private car owner) of new tires from a tire supplier – Purchase of oil by an American oil company from another American oil company (oil is domestically extracted) – Purchase of oil by an American oil company form a foreign supplier of oil – Receipt of dividends by a US resident from a Russian company – Production of new Nissan Altima cars by a US based Nissan Facility – Production of new VW Jetta cars by a Mexico-based VW facility Comparing Incomes Across Countries Real PPP GDP per capita as a measure of the standard of living. Standard of living: Income/Prices • Read GDP as a measure of income • Adjustment for the cost of living: difference in prices Purchasing Price Parity – adjustment for the cost of living. Prices differ across countries creating differences in purchasing power of money. For instance, 1000 USD buys more (today, probably less) in Moscow than in Atlanta. Constructing a cost of living index • Fixing a market basket • Tracking that market basket through different locations GNI per capita in 2001, PPP method (current international $) World Bank Development Indicators for 2003 Less than 1710 1710-3560 3560-6250 6250-15110 Over 15110 No data available Income distribution in 2004 Lower income group: GNI per capita PPP< $1878 Lower middle income: GNI per capita PPP < $4244 Middle income group: GNI per capita PPP <7515 Upper middle income group: GNI per capita PPP < $18589 High income group: GNI per capita PPP > $18589 Real GDP growth rate in 2000 World Bank Development Indicators 2003 Less than –0.6 -0.6 < . < 0.8 0.8 < / <2.1 2.1 < . < 4.2 Over 4.2 No data available Real GDP growth rate in 2001 World Bank Development Indicators 2003 Less than –0.6 -0.6 < . < 0.8 0.8 < / <2.1 2.1 < . < 4.2 Over 4.2 No data available Evaluating economic activity - Inflation • Inflation – the rate of growth in the average of all prices • Measuring inflation: – Price Index • CPI • PPI • Core Index • Real versus Nominal measures • US statistics: www.bls.gov Real versus Nominal i N GDP i 1 PiQi Nominal GDP growth rate = output growth rate + price level growth rate Growth in Nominal vs Real GDP Nominal GDP USA Real GDP 8.0 7.0 6.0 level of growth 5.0 4.0 3.0 2.0 1.0 0.0 1995 1996 1997 1998 1999 2000 year 2001 2002 2003 2004 Characteristics of Recent US inflation • Low level • Non-uniform • Impact of dollar exchange rate/weaknesses in foreign economies in the 1990’s; a characteristic of globalization in the output markets • Recent impact of the price of Oil Impact of Inflation • • • • Menu costs Redistribution of wealth Instability of relative prices Currency value – the law of one price for internationally traded goods • Increased costs associated with forward looking financial arraignments Sources of Inflation • Tight labor market – Overheated economy: US in the late 1990’s • Strong Monetary Expansion – Germany in the 1920’s; Russia in the early 1990’s • Rapid increases in input costs (other than labor) – US economy today and the price of Oil • Currency depreciation – Recent dollar depreciation, particularly against the currency of China Short international comparison Inflation, consumer prices (annual %) 2000, selected high income countries, source: World Bank Australia Austria Belgium Canada Denmark Finland France Germany Greece Iceland Ireland Italy 4.48 2.35 2.55 2.75 2.92 3.37 1.7 1.95 3.15 5.16 5.56 2.54 Japan Korea, Rep. Luxembourg Netherlands New Zealand Norway Portugal Spain Sweden Switzerland United Kingdom United States -0.67 2.25 3.15 2.52 2.62 3.09 2.87 3.43 1 1.58 2.93 3.38 Aruba Bahamas, The Bahrain Cyprus Hong Kong, China Israel Kuwait Netherlands Antilles Qatar Singapore Slovenia 4.04 1.61 -0.7 4.14 -3.75 1.12 1.81 5.82 1.68 1.36 10.85 Evaluating economic activity Unemployment • Defining labor force, unemployment, labor force participation rate • Measuring unemployment • US unemployment statistics: www.bls.gov • Structural and cyclical unemployment Labor Market Conditions in a few selected economies in 2001 (Unemployment Rate is for 2000) (Females as % of Unemployment Labor Force (mil) Labor Force Rate United States 146.711 46.1 4.1 United Kingdom 29.418 44.21 5.3 Switzerland 3.893 40.64 2.7 Russian Federation 77.616 49.22 11.4 Pakistan 53.482 29.05 5.9 India 460.533 32.39 .. France 26.849 45.2 10 Mexico 41.319 33.48 .. European Monetary Union 142.162 41.341 9.763 In 2001 EMU included Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxemburg, The Netherlands, Spain, Portugal Supply - Demand • Market – Product definition – Geographical boundaries • Demand: Q = F (P, all other relevant factors) – Law of demand: as Price increases quantity demanded decreases – Relevant factors • Income – Normal: Income increases demand increases – Inferior: income increases demand decreases • Related in consumption goods – substitutes: Px increases demand for Y increases » MARTA and GSU parking – Complements: Px increases demand for Y decreases » GSU parking and gasoline use • And many other factors… – Interesting demand functions: • Vertical demand: no price sensitivity – Gasoline demand in the short-run – Your demand for this class if you are one class away from graduation Supply - Demand • Supply: Q = F (P, all other relevant factors) – Law of supply: as Price increases quantity supplied increases – Relevant factors • Cost of production – Cost of factors of production » Wages, interest rate – Production technology » Productivity and cost of production • Related in production goods – Substitutes in production » Same resources can be used to produce either good » Condos versus single family homes – Complements in production Market equilibrium (private goods with no externalities) • Quantity demanded = quantity supplied – Market clearing • No excess supply or shortage • Properties of the Market Equilibrium – Stability – Efficiency: • Welfare to society – Consumer surplus – Producer surplus ForEx Average Daily Volume of Bank Foreign-Exchange Market Activity (Source: Basel: Bank for International Settlements, September 2004) billions of dollars percentage share Spot 621 35 Swaps 944 53 Forwards 208 12 Total 1773 100 Defining the Market: Institutions facilitating the market: Major Private Banks Central Banks Market Participants: Banks, Central Banks, Corporations, Investors, even consumers. Brief History of the International Monetary System Gold Standard: 1880 - 1914 Dates of adoption of a gold standard •1695: United Kingdom at £1 to 113 grains (7.32g) of gold. •1818: Netherlands at 1 guilder to 0.60561g gold •1854: Portugal at 1000 reis to 1.62585g gold •1871: Germany at 2790 Goldmarks to 1kg gold •1873: Latin Monetary Union (Belgium, Italy, Switzerland, France) at 31 francs to 9g gold •1873: United States de facto at 20.67 dollars to 1troy oz •1875: Scandinavian monetary union: (Denmark, Norway and Sweden) at 2480 kroner to 1kg gold •1876: France internally •1876: Spain at 31 pesetas to 9g gold •1878: Finland at 31 marks to 9g gold •1879: Austria 1893: Russia at 31 Roubles to 24g gold •1897: Japan at 1 yen to 1.5g gold Price Stability Simplified conversion No Future markets 1918-1939 • Great Depression and lack of international cooperation • 1925 -1931 UK operates on Gold Standard • US remains on Gold Standard till 1933 • Fixed exchange system Post WWII era • Bretton Woods – IMF and the Gold Exchange Standard • Gold Exchange Standard – – – – – – Fixed system with limited (1% allowable adjustments) Dollar is convertible into gold at 35 USD per 1 Oz Very few monetary reforms are undertaken by member states 1950’s – 1960’s August of 1971 USD is no longer a convertible currency The Smithsonian Conference of December of 1971 • 38.02 USD = 1 oz • Dollar remains inconvertible • Increased allowable adjustment to 2.25% • March of 1973 FLOAT begins Spot market • http://www.federalreserve.gov/releases/h10/Update/default.htm • Ask and Bid prices and the spread – – – – • Ask – Bank’s asking (bank’s sales price) Bid – Bank’s purchase price Spread – return to the market maker, in this case the bank Consider the following rouble quote: Ask Price: $0.0425; Bid Price: $0.0420 Alignment of exchange rates – Arbitrage • • • – Simple setting (2 or more currencies): – Consider two banks quoting the rouble: » Bank I: $0.0425 - $0.0430. » Bank II: $0.0435 - $0.0440 Price difference falling within the spread Setting 2: implied exchange rate (3 or more currencies): – Consider tw banks providing the following quotes: » Bank I: Between Rouble and Dollar: R1 = $0.0425 Between Rouble and Euro: R1 = EUR 0.030 Implied USD/EUR rate is: USD1 = 0.7059 » Bank II Between Rouble and Dollar: R1 = $0.0425 Between Rouble and Euro: R1 = EUR 0.031 Implied USD/EUR rate is: USD1 = EUR0.7294 Are profits from arbitrage possible? Currency Index: USD Index by the FED Economy Euro area Canada China Japan Mexico United Kingdom Korea Taiwan Hong Kong Malaysia Singapore Brazil Switzerland Thailand Australia Sweden India Philippines Israel Indonesia Russia Saudi Arabia Chile Argentina Colombia Venezuela Total weight in percentage 1997 2003 17.49 16.92 6.58 14.27 8.5 5.73 3.68 3.77 2.65 2.25 2.87 1.82 1.43 1.59 1.31 1.22 0.88 1.18 0.84 1.25 0.78 0.8 0.53 0.61 0.49 0.58 100 18.8 16.43 11.35 10.58 10.04 5.17 3.86 2.87 2.33 2.24 2.12 1.79 1.44 1.43 1.25 1.16 1.14 1.06 1 0.95 0.74 0.61 0.49 0.44 0.41 0.3 100 change 1.31 - .49 4.77 - 3.69 1.55 - .56 0.18 - .90 - .32 - .01 - .75 - .03 0.01 - .16 - .06 - .06 0.26 - .12 0.16 - .30 - .04 - .19 - .05 - .18 - .08 - .27 0 USD weights Source: FED Source: FED Recent performance of the USD 1.8 $/Euro 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 Source: FederalReserve.gov: http://www.federalreserve.gov/releases/h10/Hist/ 1/3/2008 7/3/2007 1/3/2007 7/3/2006 1/3/2006 7/3/2005 1/3/2005 7/3/2004 1/3/2004 7/3/2003 1/3/2003 7/3/2002 1/3/2002 7/3/2001 1/3/2001 7/3/2000 1/3/2000 0 USD exhcnage rate against the Canadian Dollar Source: FRB, NY 1/2/2006 1/2/2005 1/2/2004 1/2/2003 1/2/2002 1/2/2001 1/2/2000 1/2/1999 1/2/1998 1/2/1997 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 Role of the exchange rate in the price of oil USD Price of Oil $/Euro Euro Price of Oil 3-Mar-08 102.42 1.521 67.34 5-Mar-07 60.05 1.3094 45.86 6-Mar-06 62.46 1.2002 52.04 7-Mar-05 53.9 1.3203 40.82 8-Mar-04 36.53 1.2371 29.53 3-Mar-03 36.1 1.0835 33.32 4-Mar-02 22.55 0.8652 26.06 change in the price 79.87 % change (inflation) 354.1906874 41.27 75.7975 Source for historical oil price data – US Dept. of Energy, http://tonto.eia.doe.gov/dnav/pet/pet_pri_spt_s1_d.htm 158.36 The ForEx Market • Supply of the USD – Imports to the US • Goods (trade) • Services (tourism) – US investment abroad • Foreign Financial Markets • Direct investment abroad – Central Banks – Speculation • Demand for the USD – US Exports • Goods • Services (tourism) – Foreign Investment into US • US Financial markets • Direct investment – Central Banks – Speculation The Interesting 90’s • 1991-92: Collapse of the USSR Block, beginning of the Transitional Recession in Eastern Europe • 1994 Mexican Currency Crisis • 1991(2)-95 The Balkan Wars • 1998 Recession in Japan • 1997 (July) Beginning of the Asian Financial Crisis • 1998 major Rouble Crisis US ECONOMY average % rates 19922000 20012004 Real GDP 3.7 2.5 Gross Domestic Private Investment 8.7 1.8 Non-Residential Investment 9.1 0.2 The market for USD in the 90’s P of USD Influx of investment stimulated Demand D S Increase in imports stimulated Supply Demand Effect Dominated (thus positively effecting consumers’ standard of living) The post 90’s era • United Europe – 10 New Countries Entered the Union on May 1st of 2004, bringing the total number of member states to 25, with combined population of over 430 million (US population is 293 million). • Growth in Russia and China nearing double digits • Emerging Economies of Brazil and India • Threat of Terrorism to the US • Continuous Growth in US Trade Deficit The market for USD in the post 90’s era P of USD D S Supply effect appears to be dominating The demand effect The BIG picture • • • • Rise in Imports Increase in Supply Depreciation Rise in Exports Increase in Demand Appreciation Influx of Investment Increase in Demand Appreciation Outflow of Investment Increase in Supply Depreciation Modern Economic Systems • A modern Mixed Economy: Capitalism with elements of Socialism • An economic system – Capitalism – Socialism – Communism • An economic system and economic efficiency – What? How? For Whom? – Market Economy versus Command Economy General government final consumption expenditure (% of GDP) 30.00 26.91 25.00 23.40 21.27 21.52 20.00 16.67 15.00 14.23 General government final consumption expenditure (% of GDP) 10.00 5.00 0.00 United States Sw eden Russian Federation Data for 2001, source: World Bank Norw ay Finland France Market Economy Prices play two roles: signaling mechanism and distribution mechanism Consumer and producer surpluses: Welfare economics Income effect on the demand Consumer sovereignty (voting with dollars) Price controls and lack of adjustment on the part of the market Market efficiency Presence of government in the production process Competition Versus Monopoly Mixed industry: GSU versus Emory Can GSU be viewed as a competitive firm? Large presence of the government in an industry: Primary education Government Monopoly: Provision of some public utilities in certain areas, such as water services in Fulton county Soft Budget Constraint Command Economy Command Economies of Eastern Europe and USSR • History: 1917, 1945, 1985, 1989-1991 50’s 60’s 70-75 75-80 80-85 GNP growth 5.7 5.2 3.7 2.6 2.0 Productivity Growth 1.6 (1.4) 1.5 (0.9) 0 (1.5) -0.4 (-0.8) -0.5 (-1.2) • Structure of command economy: – – – – – – – Central planning versus price mechanism State ownership versus private entities State monopoly versus competition Quality versus quantity Pricing of raw materials (USSR and the Eastern Block) Emphasis on industrialization (USSR) Principal-Agent problem Industry value added as % of GDP 60.000 50.000 40.000 Poland Romania Russian Federation 30.000 Ukraine France Germany 20.000 10.000 0.000 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Source: World Bank Economies in Transition: Real GDP growth rates 10.00 5.00 0.00 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Poland -5.00 Romania Russian Federat ion Ukraine Unit ed St at es -10.00 France Germany -15.00 -20.00 -25.00 Reforms in Transitional Economies planning is great if you have the opportunity to do it • Privatization • What’s the value of state enterprises? • How should the shares of those enterprises be allocated? – Poland (intermediate funds), Czech Republic (vouchers), Yugoslavia (worker-control), Russia (combination of vouchers, management control…) – Effect of the scheme on the scope of restructuring - income distribution - government budget - differences between the economies of the USSR and those of Eastern Europe • Price liberalization • Shock therapy versus gradual approach - Poland (January 1, 1990) versus Hungary and the experience of Russia • Sequence of reforms (political and economic) and income inequality • Financial Stability and exchange rate Principles of Trade • Absolute Advantage: total cost • Comparative Advantage: relative (opportunity) cost Consider two economies (A, B), each endowed with 200 worker-hours. Consider that there are only two goods being produced (X, Y). Consider that in country A the hourly wage is $A10, while in country B it is $B20, for simplicity assume that $A=$B. Table below shows costs in each country: A B X 1 ($A10) 1 ($B20) Y 3 ($A30) 2 ($B40) What can be said about the absolute and comparative advantage principles in this case? Productivity and trade (education, physical capital…) Currency and Trade