ap macro economics review
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AP Macro AP Macro Economics Economics
ReviewReview
AP Macro AP Macro Economics Economics
ReviewReviewPeggy Pride, PresenterPeggy Pride, Presenter
Production Possibility CurveProduction Possibility Curve
A
C
F
B
D
E
W
Capital Capital goods goods
Consumer goodsConsumer goods
B2
D
Capital Capital goods goods
Consumer goodsConsumer goods
D2
B
Market EquilibriumMarket EquilibriumMarket EquilibriumMarket Equilibrium
DemandDemand
SupplySupply
Pe
QeQuantity
Price
A change in Demand versus a change in A change in Demand versus a change in the Quantity Demandedthe Quantity Demanded
Change in DemandChange in Demand
√ √ Moves the curveMoves the curve
•IncomeIncome
•Future ExpectationsFuture Expectations
•# of Buyers# of Buyers
•Consumer InformationConsumer Information
•Taste and PreferenceTaste and Preference
•Substitues and ComplementsSubstitues and Complements
Change in Quantity Change in Quantity DemandedDemanded
√ √ Moves Along the Moves Along the SAMESAME curvecurve
• • Caused only by Price Caused only by Price change.change.
P
Qo
$5
4
3
2
1
P QD
$54321
1020355580
D
Price of Corn
Quantity of Corn
CORN
10 20 30 40 50 60 70 80
Price ChangePrice Change
P
Qo
$5
4
3
2
1
P QD
$54321
D
Price of Corn
Quantity of Corn
CORN
10 20 30 40 50 60 70 80
D’
Increase
in
Demand
Increase
in Quantity
Demanded1020355580
30406080 +
GRAPHING DEMAND
A change in Supply versus a change in A change in Supply versus a change in the Quantity Suppliedthe Quantity Supplied
Change in SupplyChange in Supply
√ √ Moves the curveMoves the curve
•Costs of ProductionCosts of Production
•Future ExpectationsFuture Expectations
•# of Sellers# of Sellers
•Taxes and SubsidiesTaxes and Subsidies
•Prices of goods using same resourcesPrices of goods using same resources
•Time period of productionTime period of production
Change in Quantity Change in Quantity SuppliedSupplied
√ √ Moves Along the Moves Along the SAMESAME curvecurve
• • Caused only by Price Caused only by Price change.change.
P
Qo
$5
4
3
2
1
P QD
$54321
1020355580
S
Price of Corn
Quantity of Corn
CORN
10 20 30 40 50 60 70 80
Price Change
SP
Qo
$5
4
3
2
1
10 20 30 40 50 60 70 80
Price of Corn
Quantity of Corn
$54321
60503520 5
P QS
CORN
8070604530
S’Increase
in
Supply
Increase
in Quantity
Supplied
GRAPHING SUPPLY
Verbal CluesVerbal Clues• Use a correctly labeled Use a correctly labeled grgraph and show…aph and show…• Analyze the effect…Analyze the effect…• Explain the mechanismExplain the mechanism……• Identify the area ofIdentify the area of……• Show the impactShow the impact……• Calculate (number and process)…Calculate (number and process)…• Show price and outputShow price and output……• Compare before and after…Compare before and after…• Two separate graphs correctly labeled graphTwo separate graphs correctly labeled graph• Side-by-sideSide-by-side• What is the relationship…What is the relationship…
Distinguish between:Distinguish between:
• Price and price level
• AS and S
• AD and D
o
PLPL
11
ASASsrsrASASlrlr
ADAD11
QQff
Pri
ce L
evel
Pri
ce L
evel
Real domestic outputReal domestic output
GROSS DOMESTIC PRODUCTGROSS DOMESTIC PRODUCTGROSS DOMESTIC PRODUCTGROSS DOMESTIC PRODUCT
Market ValueMarket Value of the of the total total
goods and servicesgoods and services produced produced
within the boundaries of the within the boundaries of the
USUS whether whether by Americans or by Americans or
foreignersforeigners in one year. in one year.
Defining…Defining…
+
+
+
++
++
GROSS DOMESTIC PRODUCTGROSS DOMESTIC PRODUCTGROSS DOMESTIC PRODUCTGROSS DOMESTIC PRODUCT
ConsumptionConsumptionby Householdsby Households
InvestmentInvestmentby Businessesby Businesses
GovernmentGovernmentPurchasesPurchases
ExpendituresExpendituresby Foreignersby Foreigners
Expenditures ApproachExpenditures Approach Income ApproachIncome ApproachWagesWages
RentsRents
InterestInterest
ProfitsProfits
StatisticalStatisticalAdjustmentsAdjustments
= =GDP
NOMINAL GDP vs. REAL GDPNOMINAL GDP vs. REAL GDPNominal GDPNominal GDP … … reflects the current price level of goods and services and reflects the current price level of goods and services and ignores the effect of inflation on the growth of GDP. ignores the effect of inflation on the growth of GDP. … … this measure is called Current Dollar GDP. this measure is called Current Dollar GDP.
Real GDP Real GDP … … measures the value of goods and services adjusted for measures the value of goods and services adjusted for change in the price level. It will reflect the real change in change in the price level. It will reflect the real change in output.output. … … This measure is called the Constant Dollar GDP. This measure is called the Constant Dollar GDP. … … indicates what the GDP would be if the purchasing power of indicates what the GDP would be if the purchasing power of the dollar has not changed from what it was in a base year. The the dollar has not changed from what it was in a base year. The government currently uses 2000 as its base year for Real GDP government currently uses 2000 as its base year for Real GDP measurement. measurement.
GDP Price IndexGDP Price Index
Price IndexPrice Indexin a givenin a given
yearyear==
Price of market basketPrice of market basketin specific yearin specific year
Price of same marketPrice of same marketbasket in base yearbasket in base year
x 100x 100
Real GDPReal GDP ==Nominal GDPNominal GDP
Price IndexPrice Index(in hundredths)(in hundredths)
Disposable IncomeDisposable Income
By subtracting from Personal Income, By subtracting from Personal Income, the dollars lost to taxes, we have the the dollars lost to taxes, we have the Disposable Income. Disposable Income. This is the “bottom” This is the “bottom” line of national income accounting.line of national income accounting.
Disposable Income = C + SDisposable Income = C + S
Unemployment Rate = Unemployment Rate = UnemployedUnemployedLabor ForceLabor Force
FrictionalFrictional – “temporary”, “transitional”, – “temporary”, “transitional”, “short-term” (“between jobs” or “search” “short-term” (“between jobs” or “search” unemployment) (seasonal work)unemployment) (seasonal work)Structural Structural – “technological” or “long term”. – “technological” or “long term”. basic changes in the “structure” of the labor basic changes in the “structure” of the labor force which make certain “skills obsolete”.force which make certain “skills obsolete”.Cyclical Cyclical – “economic downturns” in the – “economic downturns” in the business cycle.business cycle.
The Full employment rate of The Full employment rate of unemployment or the unemployment or the Natural Natural
Rate of Unemployment (NRURate of Unemployment (NRU) is ) is present when the economy is present when the economy is
producing its potential output.producing its potential output.
The Natural Rate of Unemployment The Natural Rate of Unemployment exists when the cyclical unemployment exists when the cyclical unemployment
is zero.is zero.
Inflation A rising of the general level of prices
=
Price of the same marketbasket in 2000
x 100CPIPrice of the market basket in the particular year
Producer Price Index (PPI)Producer Price Index (PPI) Prices at the wholesale or production level which are early indicators of inflation.
Real and Nominal IncomeReal and Nominal IncomeNominal incomeNominal income … is the number of dollars … is the number of dollars
earned as rent, wages, interest or profitearned as rent, wages, interest or profitReal incomeReal income… measures the amount of … measures the amount of
goods and services nominal income can buy.goods and services nominal income can buy.
√√ If nominal income rises If nominal income rises faster than price faster than price levellevel, real income will rise. , real income will rise.
√√ If the price level increases If the price level increases faster than faster than nominal incomenominal income, then real income will fall., then real income will fall. √ √ Your real income falls only when nominal Your real income falls only when nominal income fails to keep up with inflation.income fails to keep up with inflation.
o
PLPL11
ASASsrsrASASlrlr
ADAD11
QQff
Pri
ce L
evel
Pri
ce L
evel
Real domestic outputReal domestic output
Long Run EquilibriumLong Run EquilibriumIn the extended In the extended AD-AS model, AD-AS model,
equilibrium equilibrium occurs at the occurs at the
intersection of intersection of AD and the ASAD and the ASlrlr
and the ASand the ASsrsr. .
QQf f is the amount is the amount
of Real GDP at of Real GDP at full employment.full employment.
DEMAND-PULL INFLATION DEMAND-PULL INFLATION and Self-Correctionand Self-Correction
DEMAND-PULL INFLATION DEMAND-PULL INFLATION and Self-Correctionand Self-Correction
Long Run Long Run Nominal Wages Nominal Wages
rise and ASrise and AS22srsr
moves left. moves left. RGDP returns RGDP returns
to previous to previous level on Aslevel on Aslrlr
But…PL rises But…PL rises even more to even more to
PLPL33!!o
PLPL11[2%][2%]
ASASsrsr
ASlr
ADAD11
a
QQf f
Pri
ce L
evel
Pri
ce L
evel
Real domestic outputReal domestic output
bPLPL22[5%][5%]
ADAD22
YY22
c
ASAS22srsr
PLPL33[7%][7%]
Short Run—Short Run—Increase in AD Increase in AD shows shows point bpoint b
COST-PUSH INFLATION COST-PUSH INFLATION with government action with government action
COST-PUSH INFLATION COST-PUSH INFLATION with government action with government action
If government If government stimulates AD to stimulates AD to dotted line, an dotted line, an inflationary spiral inflationary spiral will occur…PLwill occur…PL33 at at
QQf.f. We have Full We have Full
Employment but at Employment but at a higher price level.a higher price level.
o
PLPL11[[22%]%]
ASASsrsr
ASlr
ADAD11
a
QQff
Pri
ce L
evel
Pri
ce L
evel
Real domestic outputReal domestic output
b
ASAS22srsr
PLPL22[[33%]%]
YY22
ADAD22
cPLPL33[[55%]%]
COST-PUSH INFLATION COST-PUSH INFLATION with NO government action with NO government action COST-PUSH INFLATION COST-PUSH INFLATION with NO government action with NO government action
o
PLPL11[[22%]%]
ASASsrsr
ASlr
ADAD11
a
QQff
Pri
ce L
evel
Pri
ce L
evel
Real domestic outputReal domestic output
ASAS22srsr If government lets If government lets
the recession take the recession take its course, nominal its course, nominal wages will fall in wages will fall in the long run and the long run and return to point a…return to point a…PLPL11 at Q at Qf.f.
cPLPL33[[55%]%]
o
PLPL33[[22%]%]
ASAS22srsr
ASlr
ADAD22
a
QQff
Pri
ce L
evel
Pri
ce L
evel
Real domestic outputReal domestic output
bPLPL22[[33%]%]
ADAD11
YY22
c
ASAS11srsr
PLPL11[[55%]%]
Recession Recession Recession Recession This decline in This decline in the price level the price level will eventually will eventually shift the ASshift the AS11
srsr to to
ASAS22sr. sr. Price level Price level
declines to PLdeclines to PL33
at Qat Qf . f . Shown at Shown at
point c.point c.
This decline in This decline in the price level the price level will eventually will eventually shift the ASshift the AS11
srsr to to
ASAS22sr. sr. Price level Price level
declines to PLdeclines to PL33
at Qat Qf . f . Shown at Shown at
point c.point c.
An
nu
al r
ate
of in
flat
ion
An
nu
al r
ate
of in
flat
ion
Unemployment rate (percent)Unemployment rate (percent)
7
6
5
4
3
2
1
01 2 3 4 5 6 7
As inflation declines...As inflation declines...
The Phillips Curve ConceptThe Phillips Curve ConceptThe Phillips Curve ConceptThe Phillips Curve Concept
UnemploymentUnemploymentincreasesincreases
PCPC
√ √ In the long run, there is not a stable relationship In the long run, there is not a stable relationship
between unemployment and inflation.between unemployment and inflation.
√ √ The long-run Phillips curve is the vertical line at the The long-run Phillips curve is the vertical line at the
natural rate of unemployment.natural rate of unemployment.
The Phillips CurveThe Phillips CurveSummarySummary
The short run Phillips Curve is downward sloping.The short run Phillips Curve is downward sloping.
Aggregate Demand changes move along the same Aggregate Demand changes move along the same short run Phillips curve.short run Phillips curve.
Aggregate Supply changes create new short run Aggregate Supply changes create new short run Phillips curves.Phillips curves.
Expansionary Fiscal PolicyExpansionary Fiscal Policy
√ √ Increase Government SpendingIncrease Government Spending√ √ Decrease Tax RatesDecrease Tax Rates
……Or Combination of the TwoOr Combination of the Two
Goal: To Reduce Unemployment and Effects of Recession…
Contractionary Fiscal PolicyContractionary Fiscal Policy
√ √ Decrease Government SpendingDecrease Government Spending√ √ Increase Tax RatesIncrease Tax Rates
……Or Combination of the TwoOr Combination of the Two
Goal: To Reduce Demand—Pull Inflation…
Pri
ce le
vel
Real GDP (billions)
EXPANSIONARY FISCAL POLICYEXPANSIONARY FISCAL POLICY
$60 billion$60 billionincrease in increase in AggregateAggregateDemandDemand
ADAD11ADAD22
$20 billion decrease in tax rates; $15 billion in $20 billion decrease in tax rates; $15 billion in new consumption spendingnew consumption spending
the multiplier at work...the multiplier at work...
P1
$550 $550
AS
$490$490
P2
MPS = .25MPS = .25
Pri
ce le
vel
Real GDP (billions)
CONTRACTIONARY FISCAL POLICYCONTRACTIONARY FISCAL POLICY
$60 billion$60 billiondecrease in decrease in AggregateAggregateDemandDemand
ADAD44
ADAD33
$20 billion increase in tax rates; $15 billion lost $20 billion increase in tax rates; $15 billion lost in consumption spendingin consumption spending
the multiplier at work...the multiplier at work...
P1
$550$550
AS
$490$490
P2
MPS = .25MPS = .25
Crowding —Out EffectCrowding —Out EffectCrowding —Out EffectCrowding —Out EffectR
eal I
nte
rest
Rat
e, (
per
cen
t)R
eal I
nte
rest
Rat
e, (
per
cen
t)
Quantity of Loanable FundsQuantity of Loanable Funds
i%i%
D
LF0
SIncreased Increased demand for demand for loanable funds loanable funds by government by government raises the raises the interest rate.interest rate.
D2
i%i%
LF1
MIMI• Checkable depositsCheckable deposits• Travelers checksTravelers checks• CurrencyCurrency
• Money market accountsMoney market accounts• Savings depositsSavings deposits• Small time depositsSmall time deposits
• Large time depositsLarge time deposits
M2M2
M3M3++
++
MM
OO
NN
EE
YY
MM
EE
AA
SS
UU
RR
EE
SS
i%
$$ demanded
Dm
i%1
Sm
The Money MarketThe Money MarketThe Money MarketThe Money MarketSupply of Supply of money is a money is a vertical line vertical line since monetary since monetary authorities authorities (FED) and (FED) and financial financial institutions institutions have provided have provided the economy the economy with a certain with a certain stock of money. stock of money.
MaximumMaximumDemand-Demand-DepositDepositcreationcreation
== ExcessExcessreservesreserves
xx MoneyMoneyMultiplierMultiplier
MoneyMoneyMultiplierMultiplier Required reserve ratioRequired reserve ratio
11==The Money MultiplierThe Money Multiplier
√ √ One bank can loan One bank can loan only its excess reservesonly its excess reserves and is and is limited by those reserves in creating money.limited by those reserves in creating money.
√ √ The banking system creates a “multiplied” The banking system creates a “multiplied” amount.amount.
Currency drain and no creditable customers will Currency drain and no creditable customers will decrease the amount multiplied.decrease the amount multiplied.
MS i% IMS i% Inn C AD PL RGDP C AD PL RGDP
EASY MONEY EASY MONEY Goal: Cheap, available credit; Goal: Cheap, available credit; increase the money supplyincrease the money supply
Actions • FED willbuygovernmentbonds frombanks andthe public
• FED will lower thelegal reserve ratio
• FED will lowerthe discount ratecharged to memberbanks
Results ¦ Increasethe bankexcessreserves, andbanks canmake moreloans.
An increase in themoney supply willlower the interest rate,causing Investment toincrease andequilibrium GDP torise.
The amount of thechange will bedependent on thesize of the IncomeMultiplier (1/MPS)
Easy money is Easy money is reinforcedreinforced by the Net Export Effect by the Net Export Effect
Real domestic output, GDP
DDmm
InvestmentInvestmentDemandDemand
Rea
l rat
e of
inte
rest
, i
10
8
6
0Quantity of money demanded and supplied Amount of investment, i
SSm1m1
ASAS
ADAD11(I=$15)(I=$15)
PLPL11
10
8
6
0
SSm2m2
ADAD33(I=$25)(I=$25)PLPL22
If the Money SupplyIf the Money SupplyIncreases to StimulateIncreases to Stimulatethe Economy…the Economy…
Interest Rate DecreasesInterest Rate DecreasesInvestment IncreasesInvestment IncreasesAD & GDP IncreasesAD & GDP Increases with slight inflationwith slight inflation
Pri
ce le
vel
ADAD22(I=$20)(I=$20)
PLPL33
SSm3m3
Increasing money supplyIncreasing money supply continues the growth –continues the growth – but, watch Price Level.but, watch Price Level.
Easy Monetary Policy And Equilibrium GDPEasy Monetary Policy And Equilibrium GDP
MS i% IMS i% Inn C AD PL RGDP C AD PL RGDP
Tight Money Tight Money Goal: Restrict credit; decrease the Goal: Restrict credit; decrease the money supplymoney supply
Actions • FED willsellgovernmentbonds tobanks andthe public
• FED will raise thelegal reserve ratio
• FED will raisethe discount ratecharged tomember banks
Results ¦ Decreasethe bankexcessreserves, andbanks willissue fewerloans
An decrease in themoney supply will raisethe interest rate,causing Investment toincrease andequilibrium GDP tofall.
The amount of thechange will bedependent on thesize of the IncomeMultiplier (1/MPS)
Tight money is Tight money is reinforcedreinforced by the Net Export Effect by the Net Export Effect
Real domestic output, GDP
Dm
InvestmentInvestmentDemandDemand
Rea
l rat
e of
inte
rest
, i
10
8
6
0Quantity of money demanded and supplied Amount of investment, i
SSm3m3
ASAS
ADAD33(I=$15)(I=$15)
PLPL33
10
8
6
0
SSm2m2
ADAD11(I=$25)(I=$25)PLPL22
If the Money SupplyIf the Money SupplyDecreases to “cool”Decreases to “cool”the Economy…the Economy…
Interest Rate IncreasesInterest Rate IncreasesInvestment DecreasesInvestment DecreasesAD & GDP DecreasesAD & GDP Decreases with lower PLwith lower PL
Pri
ce le
vel
ADAD22(I=$20)(I=$20)
PLPL11
SSm1m1
Decreasing money supplyDecreasing money supply continues the “cooling” –continues the “cooling” – as Price Level falls.as Price Level falls.
Tight Monetary Policy And Equilibrium GDPTight Monetary Policy And Equilibrium GDP
Nominal Rate = Nominal Rate = Real Interest rate + expected rate Real Interest rate + expected rate of inflationof inflation
Real Interest Rate =Real Interest Rate =Nominal rate—expected rate of Nominal rate—expected rate of inflation inflation
Nominal Rate = Nominal Rate = Real Interest rate + expected rate Real Interest rate + expected rate of inflationof inflation
Real Interest Rate =Real Interest Rate =Nominal rate—expected rate of Nominal rate—expected rate of inflation inflation
NominalInterest
Rate
RealInterest
Rate
InflationPremium
=11%
5%
6%+
ANTICIPATED INFLATIONANTICIPATED INFLATION
SSmmii%%
Q of $$ demanded
Dm
The supply of money is The supply of money is vertical no matter what vertical no matter what the interest rate is on the interest rate is on the vertical axis. The the vertical axis. The FED controls the FED controls the supply of money.supply of money.
The demand for The demand for money is money is composed of the composed of the transaction transaction demand and demand and asset demand.asset demand.
Money Market Money Market Graph—Graph—Nominal Nominal Interest RateInterest Rate
Money Market Money Market Graph—Graph—Nominal Nominal Interest RateInterest Rate
QQee
i%i%ee
rr
rree
Q of LF Q of LF QQee
SSLFLF
DDLFLF
Loanable Funds Market—Real Loanable Funds Market—Real Interest RateInterest Rate
Changes in the real interest rate caused by Changes in the real interest rate caused by movements of demand (from borrowers) and supply movements of demand (from borrowers) and supply (from savers).(from savers).
Demand is:Demand is:
• • Business for investmentBusiness for investment
• • Consumer for spendingConsumer for spending
• • Government for Deficit Government for Deficit spendingspending
Supply is mostly from Supply is mostly from private savingsprivate savings
Classical View:Classical View:
√ √ AS is vertical and AS is vertical and
determines the output at determines the output at
QQff
√ √ AD is stable and AD is stable and
determines the price determines the price
level as long as money level as long as money
supply is stable. supply is stable.
√ √ If AD is unstable, If AD is unstable,
prices and wages adjust. prices and wages adjust.
P1
Qf
ASAS
ADAD11
Pri
ce L
evel
Real Domestic OutputA shift to ADA shift to AD22 shows shows that the price level that the price level declines. declines.
ADAD22
P2
Keynesian ViewKeynesian View::
√ √ Product prices and Product prices and wages are downward wages are downward inflexible inflexible √ √ AS is horizontal up to AS is horizontal up to Qf then becomesQf then becomes verticalvertical √ √ If AD is unstable, If AD is unstable, changes in AD have no changes in AD have no effect on PL but affect effect on PL but affect RGDP.RGDP. Movement from ADMovement from AD11 to AD to AD22
reduces the Real GDP but reduces the Real GDP but the PL remains constant.the PL remains constant.
P1
Qf
ASAS
ADAD11
Pri
ce L
evel
Real Domestic Output
ADAD22
Q2
NEW CLASSICAL VIEW OF SELF-CORRECTIONNEW CLASSICAL VIEW OF SELF-CORRECTIONNEW CLASSICAL VIEW OF SELF-CORRECTIONNEW CLASSICAL VIEW OF SELF-CORRECTION
P2
Q1
Pri
ce L
evel
Real Domestic Output
AD2
AD1
ASLR
P1
AS1
AS2
P3
Self-CorrectionSelf-Correction
a
bc
AD increases moves economy from a to b.Price level rises Price level rises (P(P22) and then ) and then
self-correction self-correction to c by shifting to c by shifting left to ASleft to AS2 2 as as
Nominal Wages Nominal Wages rise.rise.
The The National or Public DebtNational or Public Debt is the is the accumulated deficits and surpluses of the accumulated deficits and surpluses of the government over time.government over time.
The The National or Public DebtNational or Public Debt is the is the accumulated deficits and surpluses of the accumulated deficits and surpluses of the government over time.government over time.
Deficits, Surpluses and DebtDeficits, Surpluses and DebtDeficits, Surpluses and DebtDeficits, Surpluses and DebtA A budget deficitbudget deficit is the amount by which the is the amount by which the government expenditure exceeds the government expenditure exceeds the government revenue in a particular year. government revenue in a particular year.
A A budget deficitbudget deficit is the amount by which the is the amount by which the government expenditure exceeds the government expenditure exceeds the government revenue in a particular year. government revenue in a particular year. A A budget surplusbudget surplus is the amount by which is the amount by which the government revenue exceeds the the government revenue exceeds the government expenditure in a particular government expenditure in a particular year. year.
A A budget surplusbudget surplus is the amount by which is the amount by which the government revenue exceeds the the government revenue exceeds the government expenditure in a particular government expenditure in a particular year. year.
√√ Comparative AdvantageComparative Advantage …is the ability to …is the ability to produce an item at a lower opportunity cost. Resources produce an item at a lower opportunity cost. Resources are scarce, so that one can only produce more of one are scarce, so that one can only produce more of one product by taking the resources away from another. It product by taking the resources away from another. It means that total world output will be greatest when each means that total world output will be greatest when each good is produced by the nation which has the lowest good is produced by the nation which has the lowest domestic opportunity cost.domestic opportunity cost.
√√ As a result of trade, countries that trade products based As a result of trade, countries that trade products based on their own specialization will have more of BOTH on their own specialization will have more of BOTH products (produced and traded for).products (produced and traded for).
√√ Terms of Trade…the exchange ratio between goods Terms of Trade…the exchange ratio between goods traded. This ratio explains how the gains from traded. This ratio explains how the gains from international specialization and trade are divided international specialization and trade are divided among the trading nations; it depends on the world among the trading nations; it depends on the world supply and demand for the two products. supply and demand for the two products.
SS
DD
$ Price of$ Price ofForeign Foreign
Currency Currency
Quantity of Foreign CurrencyQuantity of Foreign Currency
The intersection The intersection will be the will be the
exchange rate.exchange rate.
Flexible exchange ratesFlexible exchange rates
QQfcfc
$$fcfc
A nation’s A nation’s Balance of PaymentsBalance of Payments records all the transactions that take records all the transactions that take place between its residents and the place between its residents and the
residents of a foreign nation.residents of a foreign nation.
Current AccountCurrent Account
Mdse. TradeMdse. Trade
Services TradeServices Trade
Net Investment Net Investment IncomeIncome
Net TransfersNet Transfers
Capital AccountCapital Account
Real InvestmentReal Investment
Financial InvestmentsFinancial Investments
Official Reserves AccountOfficial Reserves Account
+ to balance a deficit+ to balance a deficit
——to balance a surplusto balance a surplus
=
Changes in tastesChanges in tastes
Changes in relative incomesChanges in relative incomes
Changes in relative pricesChanges in relative prices
Changes in relative interest ratesChanges in relative interest rates
Speculation in currenciesSpeculation in currencies
Determinants of exchange rates:Determinants of exchange rates:Determinants of exchange rates:Determinants of exchange rates:
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