BJ's Blog

End of Unit Test Reflection

Posted by bjyechan7 on February 8, 2011

I must make better use of the CRAMPSS and evaluate situations better. Also, I need to memorize definitions and concepts more because I got confused about what a trading bloc was. Thank you for the detailed comments Ms. Q!

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Yemen Information

Posted by bjyechan7 on February 1, 2011

GDP per capita – $2600

Life expectancy – 63.36 years

Population distribution –

0-14 years: 43.9% (male 5,108,423/female 4,925,523)
15-64 years: 53.5% (male 6,215,999/female 6,013,334)
65 years and over: 2.6% (male 285,752/female 309,207)
Exports – $7.462 billion
Commodities – crude oil, coffee, dried and salted fish, liquefied natural gas.
Imports – $8.35 billion
Commodities – food and live animals, machinery and equipment, chemicals.
Physicians per 1000 people – 0.3

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“Explain three factors that influence the value of a country’s exchange rate” and “evaluate government/central bank intervention in the foreign exchange market to reduce the value of the exchange rate.”

Posted by bjyechan7 on January 20, 2011

1. Question Demands

You have one hour for these two Paper 1 questions. You must choose three of the six factors that affects a nation’s exchange rate. You should identify the three factors your chose and then include definitions, a diagram, and a real world example. “Explain” requires a student to take the concept and make it clear to someone else, stating the steps involved in reaching this understanding.

2. Definitions

-An exchange rate is the price of one currency expressed in terms of another.

– An exchange rate system is the way in which the exchange rate is determined.

– An appreciation is an increase in the value of an asset. The term is most commonly used to refer to the appreciation of a currency which is where the value of one currency rises against another.

– A depreciation is when market forces in the foreign exhange market lower the value of one currency against another.

3. Triple A

Factors that affect exchange rate.

exchange rates will be affected by a number of factors. We will consider these in relation to Australian dollars (Aus $).

Trade flows

A surplus of exports over imports for Australia (a trade surplus) will cause an increase in demand for Aus $ (overseas buyers need the Aus $’s to pay for the goods) and will therefore exert an upward pressure on the exchange rate. This is illustrated in Figure 1 below.

Figure 1 Australian trade surplus – impact on exchange rate

However, a deficit situation in which Australia imports exceed exports (a trade deficit) will cause an increase in supply of Aus $’s (Australian importers will need to supply Aus $’s to obtain the foreign currency required to pay for the imports). This will exert a downward pressure on the exchange rate as shown in Figure 2 below.

Figure 2 Australian trade deficit – impact on exchange rate

Capital flows/interest rates changes/speculation

In reality, capital flows exert a more important influence on exchange rates than trade flows. This is because the fund managers of international financial organisations and multinational corporations, and rich individuals, such as oil sheikhs, move more money around the globe on a daily basis than is accounted for by trade alone. They do this to take advantage of differences in relative interest rates and changes in exchange rates, or may be speculating on future movements in such variables. For the average person / IB student, shifting funds from one commercial bank to another may yield some benefit in terms of higher returns, but it is unlikely that the sums involved would be very great. However, for large institutions, with millions/billions of $, yen, euro etc. at their disposal, even marginal differences in interest rate returns will generate substantial sums of money.

Thus, remaining with the Australian example (see above), if interest rates were to fall below those in other major world economies, or international speculators were pessimistic about the future of the Australian economy, or suspected a large future depreciation in the Australian $, they might decide to sell their holdings of Aus $ and convert them into yen. This would increase the demand for yen, while increasing the supply of Aus $’s and cause a depreciation of the currency. This can be seen in Figure 3 below.

Figure 3 Australian capital outflows – impact on exchange rate

A currency crisis is caused when large numbers of speculators decide to sell their holdings of a currency at the same time, causing its price to crash.

In the case of the opposite scenario, i.e. an increase in Australian interest rates relative to others or greater optimism about the future of the Australian economy, speculators / fund managers might decide to move funds currently being held in yen into Aus $’s. This would have the reverse effect. The yen would depreciate in value as its supply increased and the Aus $ would appreciate as the demand for it increased (denoted by a rightward shift of the demand curve for Aus $’s).

Inflation

A higher rate of inflation in Australia than in other competitor countries would make Australian exports less competitive and may lead to less exports being sold, depending on the price elasticity of demand for exports. If this resulted in a worsening of the current account, the exchange rate would depreciate. With less demand for exports and imports becoming relatively more price attractive, the demand for Aus $’s would fall while the supply would increase. This is shown in Figure 4 below.

Figure 4 Impact of higher inflation on the exchange rate

The opposite might be the case, i.e. an appreciation of the Aus $, if the rate of inflation in Australia fell below that in other countries.

Inflation may also be a factor which currency speculators take into account when making decisions about buying/selling currencies. If a very high, uncontrollable rate of inflation was expected (a hyper-inflation), speculators might lose confidence in the currency and sell, causing a depreciation.

Use of foreign currency reserves

Exchange rates, whether fixed or floating, are usually influenced by the actions of governments. Thus, if the Australian government wished to exert an upward pressure on the Aus $ (perhaps as part of a monetary policy to lower the rate of inflation), they could buyAus $’s on the foreign exchange market using their reserves of foreign currency. This would increase the demand for Aus $’s, causing an appreciation, while increasing the supply of other currencies, exerting a downward pressure on them.

If the Australian government wishes to exert a downward pressure on the Aus $ (perhaps to make exports more price competitive, increase aggregate demand and the level of employment), they would sell Aus $’s and buy other currencies. This would increase the supply of Aus $’s, thus causing a depreciation, while increasing the demand for other currencies.

4. Slideshow of Diagram and Powerpoint Slides

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5. Evaluation Suggestions

The second question is an evaluation question. I would suggest using Pros and Cons, Causes and Consequences, and Stakeholders from CRAMPSS.

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Chinese Manipulation of Currency

Posted by bjyechan7 on January 18, 2011

China has been manipulating the currency to help its exports. China has been trying to lower the value of its currency, the Yuan, by increasing the value of the value of the currency of the United States of America. China has been buying U.S. dollars continuously to increase the demand for U.S. dollars, ultimately appreciating the U.S. currency. This makes U.S. firms have a more difficult time trying to compete with foreign producers. On the other hand, Chinese firms have easier times trying to export their goods because their currency has depreciated. The United States may be able to combat this by raising the value of Yuan by overly demanding for Chinese goods.

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International Economics Diagrams

Posted by bjyechan7 on January 18, 2011

Tariff:

By initiating free trade, China and U.S. markets will be able to get rid of the deadweight loss from the tariffs. Deadweight losses are costs that are caused by inefficient industries spending their resources inefficiently, and these costs are often passed on to the consumers. As China and U.S. initiate FTA, the prices of products will decrease from Pu.s. + tariff to Pu.s.. Subsequently, the deadweight losses caused by inefficient industries are eliminated, getting rid of the burden off the consumers’ hands.

Appreciation:

The U.S. is trying to appreciate the Chinese Yuan buy demanding more of Chinese products. China has been manipulating currency to keep the value of Yuan low, in order to make Chinese firms have an easier time against foreign competition. The appreciation of this Chinese currency will make U.S. firms have an easier time competing against Chinese firms.

Free Trade:

As EU and Korea get rid of the tariffs, there will be benefits for the consumers for several reasons. The Europeans will gain in chemicals, pharmaceutical, electronics, alcoholic beverages, and agricultural sectors. In other words, this means that the Europeans are efficient in these sectors and they have the ability to supply at the price of Pworld, which is way cheaper compared to how Korean industries are supplying at Pdomestic. Therefore, the Korean consumers benefit from a fall in price from Pdomestic to Pworld in these sectors. Also, the quantity demanded from the Korean consumers will increase from Q1 to Q2 due to its decreased price. So the consumers who could not buy the products from Q1 to Q2 now benefit from the EU-Korea FTA by the decrease in the price of the products. However, this will be especially bad for the Korean industries in these sectors. As it is illustrated in the diagram, their share of the market decreases from Qdomestic to Q1 due to the EU-Korea FTA.

Subsidy:

When the government gives a subsidy to domestic producers, the domestic supply curve shifts downwards from S1 to S2. S2 represents the domestic supply with the addition of the subsidy. The price to consumers remains the same but imports will fall while domestic production will increase. Though the overall quantity supplied does not increase in terms of world supply, the ratio of imports to domestic changes.

Aggregate Demand:

Aggregate demand could be increased by many factors. First of all, reduction in taxation could increase the consumption. Secondly, the reduction in interest rates will most likely shun away consumers to save their money but spend them. Also, due to the low interest rate, there will be less burden to borrow money. Therefore, this would both increase the consumption and the corporate investment. Thirdly, increase in government spending would increase the aggregate demand because it is one of the factors that comprises of the aggregate demand. The governmental spending boosts up the consumption in products and increases the earning/income in the sector. Finally, the improved competitiveness could also increase the aggregate demand as the opportunity cost in production would decrease. In addition, the increase in the competitiveness could also boost up the export, which also increases the aggregate demand.

Aggregate Supply:

Increase in the aggregate supply from AS1 to AS2 increases real output from Q1 to Q2 but decrease the price level from P1 to P2. This is desirable as the price level is decrease and the real output has increased. Increase in the aggregate supply could be caused by many factors. First of all, reduction in indirect taxation could lead to increase in the aggregate supply. As the taxation is reduced from the price of the product, the producer could manufacture products at much lower opportunity cost and gain price advantage. Secondly, the reduction in wages of the employees would lead to cut in the production cost and therefore gain price competitiveness. This way, the manufacturer could sell more products at much cheaper price, increasing the aggregate supply. Thirdly, the reduction in price of raw material also leads to the increase in the aggregate supply due to the cut in the production cost. Finally, favorable weather conditions could help industries that depend on the weather to produce more. Therefore, this would also increase the aggregate supply.

Comparative Advantage:

Japan and China are in a comparative advantage to each other. Japan produces more automobiles at QA2 than what China’s producing at QA1. However, China produces more break pads at QB2 than what Japan is producing at QB1. In conclusion, Japan has a comparative advantage in automobiles over China, however, China has a comparative advantage in break pad over Japan. In these countries were to initiate FTA, they would both have loss and gains.

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International Economics Definitions

Posted by bjyechan7 on January 18, 2011

Free trade – international trade that takes place without any barriers such as tariffs, quotas, or subsidies.

Tariff – duty (tax) that is placed upon import to protect domestic industries from foreign competition and to raise revenue for the government. For example, China placed a  tariff on chicken from the United States.

Quota – an import barrier that sets upper limits on the quantity or value of imports that may be imported into a country.

Subsidy – an amount of money paid by the government to a firm, per unit of output, to encourage output and to give the firms an advantage over foreign competitors. For example, the Bolivian government subsidized petroleum products due to the complaints of the high prices.

Voluntary Export Restraint (VER) – a voluntary agreement between an exporting country and an importing country that limits the volume of trade in a particular product (or products).

Infant Industry argument – an argument that proposes that new industries should be protected from foreign competition until they are large enough to compete in international markets.

Dumping – the selling of a good in another country at a price below its unit cost of production.

Anti-dumping – the legislation to protect an economy against the imports of a good at a price below its unit cost of production.

Free trade area (FTA) – what exists when an agreement is made between countries, where the countries agree to trade freely among the members of the group, but are able to trade with countries outside the free trade area in whatever ways they wish, for example, the North American Free Trade Agreement between the United States, Canada, and Mexico.

Customs union – an agreement made between countries, where the countries agree to trade freely among themselves, and they also agree to adopt common external barriers against any country attempting to import into the customs union, for example, the Switzerland-Liechtenstein customs union.

Trade creation – what occurs when the entry of a country into a trading bloc leads to the production of a good moving from a high cost producer to a low cost producer. if, for example, a country joins the EU, its car producers are no longer subject to the EU common external tariff and it can export more cars to EU member countries.

Trade diversion – what occurs when the entry of a country into a customs union leads to the production of a good moving from a low cost producer to a high cost producer. When the United Kingdom, for example, joined the EU it had to impose a common external tariff on butter from the low cost producer New Zealand, and start to import butter from high cost EU producers.

World Trade Organization (WTO) – an international body that sets the rules for global trading and resolves disputes between its member countries. It also hosts negotiations concerning the reduction of trade barriers between its member nations.

Balance of payments – accounts measure the international trade performance of an economy and show how well it is managing to match imports and exports of goods and services and the flows of investment in and out of the country.

Current account – records imports and exports of goods (sometimes known as the ‘balance of trade’ or ‘visible trade’) and imports and exports of services (sometimes known as ‘invisible trade’).

Capital account – the balance of payments records the flows of money into and out of a country for investment and other purposes. There will be inflows of money (credits) and outflows of money from a country (debits).

The capital account breaks down into a number of sub-sections:

(a) Direct and portfolio investment – direct investment is productive investment. In other words it is investment in plant, equipment, machinery or factories – investment that will help with the process of wealth creation. Portfolio investment on the other hand is investment in paper assets like shares. There may be both inflows and outflows of portfolio investment.

(b) Other financial flows – this heading can cover a range of short-term monetary flows like bank deposits from overseas residents, loans into a country from abroad and so on. These short-term flows often arise to take advantage of changes in interest rates between countries and are sometimes called ‘hot-money flows’. These flows are often of a purely speculative nature.

(c) Flows to and from reserves – all countries hold reserves of foreign currency and this section measures any changes in these reserves. If the government were trying to influence the exchange rate, e.g. trying to create an appreciation in the rate, then they may sell some of their foreign currency reserves and buy their own currency instead.

Capital account deficit – what exists where the revenue from the export of goods and services and income flows is greater than the expenditure on the import of goods and services and income flows over a given time period.

Current account deficit – what exists where revenue from the export of goods and services and income flows is less than the expenditure on the import of goods and services and income flows over a given time period. For example, the UK is facing a current account deficit for their imports are rocketing.

Exchange rate – the price of one currency expressed in terms of another.

Fixed exchange rate – an exchange rate system where one currency is fixed in value against another. It involves the government working to keep the parity via intervention on the currency markets. These give certainty but can cost vast sums of foreign exchange from national reserves.

Floating exchange rate – an exchange rate which accepts that market forces will determine rates based on how they view a country’s trade performance and its economic and political stability. These systems cost less to maintain but can result in vast swings and changes in currency values. This can seriously affect trade performance and confidence.

Managed exchange rate – where the rate is floating but between upper and lower limits that the domestic government keeps it to. It brings more stability but at less cost to the national reserves.

Depreciation – a fall in the value of one currency in terms of another currency in a floating exchange rate system. The Chinese Yuan is depreciating relative to the U.S. dollar because

Appreciation – an increase in the value of one currency in terms of another currency in a floating exchange rate system. The U.S. dollar is appreciating because China continued to purchase U.S. dollars.

Devaluation – a decrease in the value of a currency in a fixed exchange system. China has been devaluing its currency in order to make exporting easier.

Revaluation – an increase in the value of one currency in a fixed exchange system. The U.S. is attempting to revaluate the Yuan because China has been manipulating the currency.

Deteriorating terms of trade – what exist where the average price of exports falls relative to the average price of imports.

Elasticity of demand for exports – a measure of the responsiveness of the quantity demanded of exports when there is a change in the relative price of exports.

Elasticity of demand for imports – a measure of the responsiveness of the quantity demanded of imports when there is a change in the relative price of imports.

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Australia’s current account deficit

Posted by bjyechan7 on December 14, 2010

Australia has been stuck in a current account deficit and this has been the country’s largest economic problem. Current account deficit is the country’s trade deficit and interest payments on what the country borrows from foreigners to finance the trade deficit. According to a recent article, “As high as $16 billion in the March quarter, Australia’s current account deficit shrank to $5.6 billion in the June quarter. That is just 1.7 per cent of gross domestic product, the third-lowest result in 30 years and the lowest in about 10 years.” Exports rose by 12 percent, showing that Australia is on the rising part of the J-curve, meaning that they are moving towards zero, then a current account surplus.

Click to view the recent article.

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Spain Stuck in Eurozone

Posted by bjyechan7 on December 9, 2010

The Euro was first introduced in 1999 and Spain was one of the first European nations to use the Euro. In the beginning, there were lots of investments from all over Europe, allowing the Spanish economy to experience a rapid growth. Back then, Spain was facing a current account surplus which is an imbalance in a nation’s balance of payments current account in which payments received by the country for selling domestic exports are greater than payments made by the country for purchasing imports. In the present day, Spain is facing a current account deficit which is when a country’s total imports of goods, services and transfers is greater than the country’s total export of goods, services and transfers. By leaving the Eurozone, Spain would be able to use protectionism, which are government actions and policies that restrict or restrain international trade, often done with the intent of protecting local businesses and jobs from foreign competition to lower imports. This could be done with tariffs, quotas, or subsidies, but they are trapped in the Eurozone because if they left, many small firms would suffer and run out of business.

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Hope might be in sight for the UK: The Marshall-Lerner Condition and the J-Curve

Posted by bjyechan7 on December 7, 2010

The diagram above represents the J curve, which is what the article “UK trade gap widens unexpectedly as imports rocket” was about. The J curve is a model that represents the worsening and bettering of the economy. As shown by the diagram above, a nation that is in a current account deficit will have an even larger increase in deficit and then at some point, turn around and start to rise toward zero, meaning there is no surplus or deficit. Once this point is reached, the point will keep moving higher into a current account surplus. This article explained that the UK was in a current account deficit and told us that they are still moving down the J curve for they said that “Britain’s trade gap widened more than expected in March as imports shot up five times faster than exports.” This shows that the deficit will increase, but economists have predicted that things will get better for the UK, meaning the turning point of the J curve will be soon.

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DBQ Reflection (via Kotaro’s Econ Blog)

Posted by bjyechan7 on December 6, 2010

Kotaro is an excellent economics student and people should read his reflections.

I thought I did pretty good on this DBQ. I left out minor details about trade disputes in the evaluation in which I lost points. I could have gained a point in one of the diagram sections if I had only talked about price in the tariff diagram. Overall my score was 18/20, 95%. … Read More

via Kotaro's Econ Blog

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