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ECONOMIC MEASURES

1. Unemployment:

Due to changes in
demand for goods
Technological
advancement
Lack a particular
skill
Can be reduced
by retraining
progams

Caused by real
GDP less than
potential GDP
Recessions

Structural

Cyclical

Forced or
voluntarily change
jobs
New entrants
Temporarily
unemployed

Frictional
2. Inflation:

Rate of increase in the price of products usually measured on annual basis


i.

Hyperinflation: very high usually increasing inflation

ii.

Deflation: decrease in price levels

iii.

Price Index: measures the prices of a basket of products at a point in time in relation to prices
in a base period

Consumer Price Index (CPI): Prices that urban consumers pay

Producer Price Index (PPI): Prices of finished goods at wholesale level

The GDP deflator: Prices of net exports, investment, government expenditures and
consumer spending.

iv.

Causes:

Demand pull:

Agg. Spending > Normal full employment output capacity

Occurs at the peak

Real GDP > Potential GDP

Because labor is short, companies bid up the price leading to inflation

Cost Push:

Increase in cost of production

Decreases in agg output

Unemployment

3. Personal Disposable Income: Personal income personal taxes


4. Interest Rates
i.

Real: in terms of goods || adjusted for inflation

ii.

Nominal: in terms of nations currency

iii.

Difference between real and nominal is the inflation premium

5. Budget surplus/deficit:
In cases in which a budget deficit is identified, current expenses exceed the amount of income being
received through standard operations. In order to correct a budget deficit, a nation may need to cut
back on certain expenditures or increase revenue-generating activities, or employ a combination of
the two.
The counter to a budget deficit is called a budget surplus. When a surplus occurs, revenue exceeds
current expenditures and results in an excess of funds that can be allocated as desired. In situations in
which the inflows equal the outflows, the budget is said to be balanced.

6. Money:

Store of
value to
save
Medium of
Exchange

Common
denominato
r to
measure
prices

Purpos
es of
Money

M1 :
Currency
and Demand
deposits
Measur
es of
Money

M2 : M1

+ Savings
A/c and
Deposits <
$100,000

M3 :

M2
+ Large
time
Deposits

MONETARY POLICY
1. Reserve Requirements: Fed Reserve can influence the supply of money by changing the reserve
requirements for the banks and limiting lending.
2. Open market operations: Federal Open-Market Committee is involved with the sale and purchase
of government securities using the Fed Reserve Bank deposits.
a. Expansionary open-market operation: When Fed purchases govt. securities and increases
money supply.
b. Contractionary open-market operation: When Fed sells govt. securities and decreases money
supply.
3. The discount rate: Fed influences interest rates by setting the rate at which banks borrow funds from
the Fed (discount rate)
4. Economic analysis:
Interest rate=stimulate the economy
a.
b. Interest rate=slow the economy
c. The effects of monetary policy is based on the expectations.
5. Rational expectations

FISCAL POLICY
1. Fiscal Expansion: Increase in fiscal deficit due to increase in government spending or decrease in
taxes.
2. Fiscal contraction: Decrease in fiscal deficit due to increase in taxes.
3. Taxes: Levied based on 2 basic principles:
a. Ability to pay (eg. Progressive taxes)
b. Derived benefit (eg. Gas tax to pay for roads)
Types of taxes:

Income Tax
Value-added
Property
Wage
Sales T
Tax
ax
Tax
Tax

4. Monetary and fiscal policies take time to take effect as consumption based on personal disposable
income, investment and production based on changes in sales and spending based on interest rates
take time to adjust.
5. Fiscal policy has a large effect on the size of budget deficits.

ECONOMIC THEORIES

Market
equilibrium
will result
in full
employme
nt in the
long run

Economy
does not
result in
full
employme
nt on its
own

Classica
l

Keynesi
an

No govt.
interventio
n

Govt
interventio
n required

Does NOT
support
fiscal
policy ti
stimulate
economy

Focus on
use of
fiscal
policy to
stimulate
economy

Does not
support
fiscal
Monetar
policy

ist

Bolster
economy's
ability to
supply for
more
goods to
stimulate
growth
Supply-

Side

Combines
Keynesian
and
NeoMonetarist

Keynesi
an

Tax
decrease
results in
growth
Focus on
monetary
policy to
control
economic
growth

Laffer
curve

Combinatio
n of fiscal
and
monetary
policy to
stimulate
growth and
control
inflation

THE GLOBAL ECONOMY AND INTERNATIONAL TRADE


Economic globalization
Single world market due to:
o FDI
o Reduction in trade barriers
o Modernization of developing economies
Absolute advantage: Incentive to produce more than needed to export to countries with higher
production costs.
Comparative advantage: Country has no alternate uses of its resources that would involve a higher
return (i.e. Opportunity costs are less)
Michael Porters Diamond of National Advantage
o Factor conditions
o Demand conditions
o Related and supporting industries
o Firm strategy, structure and rivalry

Michael Porter introduced a model that allows analyzing why some nations are more competitive than others
are, and why some industries within nations are more competitive than others, in his book Competitive
Advantage of Nations. This model of determining factors of national advantage has become known as Porters
Diamond. It suggests that the national home base of an organization plays an important role in shaping the
extent to which it is likely to achieve advantage on a global scale. This home base provides basic factors,
which support or hinder organizations from building advantages in global competition. Porter distinguishes
four determinants:

Firm Strategy, Structure, and Rivalry


The conditions in a country that determine how companies are established, are organized and are managed,
and that determine the characteristics of domestic competition
Here, cultural aspects play an important role. In different nations, factors like management structures,
working morale, or interactions between companies are shaped differently. This will provide advantages and
disadvantages for particular industries.
Typical corporate objectives in relation to patterns of commitment among workforce are of special
importance. They are heavily influenced by structures of ownership and control. Family-business based
industries that are dominated by owner-managers will behave differently than publicly quoted companies.
Porter argues that domestic rivalry and the search for competitive advantage within a nation can help provide
organizations with bases for achieving such advantage on a more global scale.

Factor Conditions
The situation in a country regarding production factors, like skilled labor, infrastructure, etc., which are
relevant for competition in particular industries.
These factors can be grouped into human resources (qualification level, cost of labor, commitment etc.),
material resources (natural resources, vegetation, space etc.), knowledge resources, capital resources, and
infrastructure. They also include factors like quality of research on universities, deregulation of labor
markets, or liquidity of national stock markets.
These national factors often provide initial advantages, which are subsequently built upon. Each country has
its own particular set of factor conditions; hence, in each country will develop those industries for which the
particular set of factor conditions is optimal. This explains the existence of so-called low-cost-countries (low
costs of labor), agricultural countries (large countries with fertile soil), or the start-up culture in the United
States (well developed venture capital market).
Porter points out that these factors are not necessarily nature-made or inherited. They may develop and
change. Political initiatives, technological progress or socio-cultural changes, for instance, may shape
national factor conditions. A good example is the discussion on the ethics of genetic engineering and cloning
that will influence knowledge capital in this field in North America and Europe.
Demand Conditions
Describes the state of home demand for products and services produced in a country.
Home demand conditions influence the shaping of particular factor conditions. They have impact on the pace
and direction of innovation and product development. According to Porter, home demand is determined by
three major characteristics: their mixture (the mix of customers needs and wants), their scope and growth
rate, and the mechanisms that transmit domestic preferences to foreign markets.
Porter states that a country can achieve national advantages in an industry or market segment, if home
demand provides clearer and earlier signals of demand trends to domestic suppliers than to foreign
competitors. Normally, home markets have a much higher influence on an organizations ability to recognize
customers needs than foreign markets do.
Related and Supporting Industries
The existence or non-existence of internationally competitive supplying industries and supporting industries.

One internationally successful industry may lead to advantages in other related or supporting industries.
Competitive supplying industries will reinforce innovation and internationalization in industries at later
stages in the value system. Besides suppliers, related industries are of importance. These are industries that
can use and coordinate particular activities in the value chain together, or that are concerned with
complementary products (e.g. hardware and software).
A typical example is the shoe and leather industry in Italy. Italy is not only successful with shoes and leather,
but with related products and services such as leather working machinery, design, etc.

1. Obstacles to free trade


a. Protectionism to restrict free trade
b. Import
i. Import tariff to discourage consumption and raise revenue
ii. Trigger price duty on all products below trigger price (restrictions for cheap imports)
iii. Import Quota restriction on amount of goods imported during a period
iv. Embargo total ban
c. Voluntary export restriction limit quality of goods exported to appease importing countries
and keep them from imposing stiffer restrictions
d. Foreign exchange control
2. Dumping
a. Predatory pricing in which a countrys manufacturer exports at a price lower than the price
charged in the home market or below companys cost of production
b. Under WTO dumping is condemned
c. Anti-dumping petition
3. Export subsidies
a. Payments by government to encourage production and export
b. Countervailing duties imposed by importers country to nullify effect of export subsidies
4. WTO
a. Supervise and liberalize international trade
b. Facilitates trade agreements
c. Resolve disputes and enforce agreements
5. NAFTA Free trade agreement between USA, Mexico and Canada in 1993
a. Advantages
i. Lower labor cost of Mexico
ii. Opening of new markets for USA goods that have comparative advantage such as
technology
b. Disadvantages
i. Firms in USA hurt due to availability of cheap products from Mexico
ii. Lower labor cost of Mexico hurts certain firms in USA
6. Balance of Payments Account summary of a nations transactions with other nations. It has three
major sectors:
a. Current A/c flow of goods and services
i. Balance of Trade=Total goods exportedTotal goods imported
ii. Trade surplus/deficit
b. Capital A/c flow of investments in fixed and financial assets
c. Surplus/Deficit Amount that nets the capital and current accounts
d. Official Reserve A/c shows the changes in the nations reserves (gold and foreign currency)
7. G-20
a. Group of finance ministers and central bank governors of the EU and 19 countries
b. Studies and reviews global financial stability and addresses issues
8. EU
a. Economic and political union of 27 countries
b. Single market

c. 17 countries use Euro


d. ECB establishes monetary policy
9. Global financial institutions
a. World Bank objective of promoting world wide economic development
b. IMF objective of maintaining international monetary system
10. Reduction in trade and investment barriers
a. GATT
b. FDI
11. Technology advances

FOREIGN EXCHANGE RATES


1. Factors influencing exchange rate:
Deflates currency value
Holding reduces purchasing power

Inflation

Higher interest rates will attract more FDI


More demand for currency

Interest Rates

deficit or surplus determines the demand for


currency

Balance of Payments

Government
Intervention
political and economic stability
stock market
demand for major exports

Other factors

2. Exchange rate regime


Central bank
controls deviation
within bank value

Floatin
g

Fixed
Tied to value of
another currency

3. Spot rates and forward rates:

Pegge
d

Market Factors

Manag
ed
Central bank

controls movement
of currency value

a. Spot Rate: rate for immediate delivery


b. Forward Rate: rate for future delivery
c. Discount/Premium: difference between spot and forward rate
4. Forward premium/discount:

5. FOREX risk:
a. Translation/Accounting Risk: MNCs converting financials in foreign currency
b. Transaction Risk: Possibility of gains/losses from income transactions
6. Hedging:
a. Options: right to buy or sell standard commodity at a specified price, specified time
(American option) and specified date (European option)
b. Forwards: Negotiated contract to buy or sell a specific commodity at a specified price at the
origination of the contract at a future date;
c. Futures: Forward based standardized contracts
d. Currency swaps: Forward based contract in which two parties agree to exchange an obligation
to pay cash flows in one currency for an obligation to pay in another currency.
e. Money market hedge:
Foreign exchange risk can arise either due to transaction exposure - i.e. due to receivables
expected or payments due in foreign currency - or translation exposure, which occurs because
assets or liabilities are denominated in a foreign currency. Translation exposure is a much
bigger issue for large corporations than it is for small business and retail investors. The money
market hedge is not the optimal way to hedge translation exposure - since it is more
complicated to set up than using an outright forward or option - but it can be effectively used
for hedging transaction exposure.
If a foreign currency receivable is expected after a defined period of time and currency risk is
desired to be hedged via the money market, this would necessitate the following steps:

Borrow the foreign currency in an amount equivalent to the present value of the receivable. Why
the present value? Because the foreign currency loan plus the interest on it should be exactly
equal to the amount of the receivable.
Convert the foreign currency into domestic currency at the spot exchange rate.
Place the domestic currency on deposit at the prevailing interest rate.
When the foreign currency receivable comes in, repay the foreign currency loan (from step 1) plus
interest.
Similarly, if a foreign currency payment has to be made after a defined period of time, the
following steps have to be taken to hedge currency risk via the money market:
Borrow the domestic currency in an amount equivalent to the present value of the payment.
Convert the domestic currency into the foreign currency at the spot rate.
Place this foreign currency amount on deposit.
When the foreign currency deposit matures, make the payment.
Note that although the entity who is devising a money market hedge may already possess the
funds shown in step 1 above and may not need to borrow them, there is an opportunity cost
involved in using these funds. The money market hedge takes this cost into consideration, thereby
enabling an apples-to-apples comparison to be made with forward rates, which as noted earlier are
based on interest rate differentials.

FOREIGN INVESTMENT
1. FDI:
a. Involves political risks
b. Strategies to reduce risks:
i. Joint venture with local firm
ii. Financing with local-country capital
iii. Insurance
2. Transfer Pricing
a. Price at which goods are exchanged across international borders between related parties.
b. Minimize tax burden by minimizing net income in heavy taxing countries
c. Methods used for transfer pricing:
i. The cost method: price is determined based on cost of production
ii. The market price method: price is determined based on external market for the item
iii. The negotiated price method: price is determined based on negotiated agreement