Unit 7: Balance of Payments & Comparative and Absolute Advantages

Balance of Payments:

 the measure of money inflows and outflows between the United States and the Rest of the World. 

INFLOWS = CREDIT

OUTFLOWS = DEBIT 

Balance of Accounts (3 Parts)

Current Account

Capital Account

Official Reserves

Double Entry Bookkeeping

Every transaction in the balance of payment is recorded twice in accordance with standard accounting practice. EX: US MANUFACTURE, JOHN DEERE EXPORTS $50 MILLION WORTH OF FARM EQUIPMENT TO IRELAND. A credit of 50 million to current account (-50 million worth of farm equipment or physical assets). A debit of $50 million to the capital/financial account (+$50 mill of Euros or financial assets.)

2 transactions offset each other therefore balance payments should always equal 0. 

CURRENT ACCOUNT

Balance of Trade or net exports

- Exports of GOODS/SERVICES

- Exports create a credit to the Balance of Payments

- Imports create a debit to balance of Payments 

Net Foreign Income

Foreign Aid: a debit to the current account.

 (ex: Mexican migrant workers send money to family in Mexico)

Capital/Financial Account 

- The Balance of Capital ownership

- Includes the purchase of both real and financial assets

Here is a chart explain the break down of what comes from where: 

FORMULAS:

Balance of Trade: Goods and Services - Goods and Services 

Current Account: Balance of Trade + Net Investment + Net Transfers

Capital Account: Foreign Purchase of  US Assets + US purchases of assets abroad

Official Reserves: (Goods Exports + Service Exports) + (Goods Imports + Service Imports)

OFFICIAL RESERVES ARE THE FOREIGN CURRENCY HOLDINGS OF THE UNITED STATES. Official Reserves zero out the balance of payments. 

Active vs Passive Official Reserves

The US is passive in its use of official reserves. It does not seek to manipulate the dollar or exchange rate. The peoples republic of Chine is active in its use of official reserves. It actively buys and sells dollars in order to maintain a steady exchange rate with the Unite States. 

FOREIGN EXCHANGE

is the buying and selling of currency. 

The exchange rate (e) is determined in the foreign currency markets. 

Do not try to calculate exact change rate.

Markets will adjust quickly in floating rates or pressure will change in fixed rates.

Exchange rates are a function of the supply and demand for currency. An increase in the supply of currency will make it cheaper to buy one unit of that currency. A decrease do the opposite. 

COMPARATIVE ADVANTAGE

Absolute Advantage = Faster, more efficient.
Comparative Advantage = (Lower Opp. Cost)

Input Problem: Chosen Item/Forgone Item
Output Problem: What they give Up/What is produced