The Monetary System • The Fed was created in 1914 after a series of
bank failures convinced Congress that the United
THE MEANING OF MONEY
• Money is the set of assets in an economy that
people regularly use to buy goods and services
from other people.
The Functions of Money
• Money has three functions in the economy:
o Medium of exchange
o Unit of account
o Store of value
• Medium of Exchange
o A medium of exchange is an item that
buyers give to sellers when they want to
purchase goods and services.
o A medium of exchange is anything that is
readily acceptable as payment.
• Unit of Account
o A unit of account is the yardstick people
use to post prices and record debts.
• Store of Value
o A store of value is an item that people
can use to transfer purchasing power
from the present to the future.
• Liquidity
o Liquidity is the ease with which an asset
can be converted into the economy’s
medium of exchange.
The Kinds of Money
• Commodity money takes the form of a
commodity with intrinsic value.
o Examples: Gold, silver, cigarettes.
• Fiat money is used as money because of
government decree.
o It does not have intrinsic value.
o Examples: Coins, currency, check
deposits.
Money in the U.S. Economy
• Currency is the paper bills and coins in the hands
of the public.
• Demand deposits are balances in bank
accounts that depositors can access on demand
by writing a check.
CASE STUDY: Where Is All the Currency?
• In 2001 there was about $580 billion of U.S.
currency outstanding.
o That is $2,734 in currency per adult.
• Who is holding all this currency?
o Currency held abroad
o Currency held by illegal entities
THE FEDERAL RESERVE SYSTEM
• The Federal Reserve (Fed) serves as the nation’s
central bank.
o It is designed to oversee the banking system.
o It regulates the quantity of money in the
economy.
States needed a central bank to ensure the
health of the nation’s banking system.
• The Structure of the Federal Reserve System:
o The primary elements in the Federal
Reserve System are:
▪ 1) The Board of Governors
▪ 2) The Regional Federal
Reserve Banks
▪ 3) The Federal Open Market
Committee
The Fed’s Organization
• The Fed is run by a Board of Governors, which
has seven members appointed by the president
and confirmed by the Senate.
• Among the seven members, the most important
is the chairman.
o The chairman directs the Fed staff,
presides over board meetings, and
testifies about Fed policy in front of
Congressional Committees.
• The Board of Governors
o Seven members
o Appointed by the president
o Confirmed by the Senate
o Serve staggered 14-year terms so that
one comes vacant every two years.
o President appoints a member as
chairman to serve a four-year term.
• The Federal Reserve System is made up of the
Federal Reserve Board in Washington, D.C., and
twelve regional Federal Reserve Banks.
• The Federal Reserve Banks
o Twelve district banks
o Nine directors
▪ Three appointed by the Board of
Governors.
▪ Six are elected by the
commercial banks in the district.
o The directors appoint the district
president, which is approved by the
Board of Governors.
• The Federal Reserve Banks
o The New York Fed implements some of the
Fed’s most important policy decisions.
• The Federal Open Market Committee (FOMC)
o Serves as the main policy-making organ of
the Federal Reserve System.
o Meets approximately every six weeks to
review the economy.
• The Federal Open Market Committee (FOMC) is made
up of the following voting members:
o The chairman and the other six members of
the Board of Governors.
o The president of the Federal Reserve Bank of
New York.
o The presidents of the other regional Federal
Reserve banks (four vote on a yearly rotating
basis).
 • Monetary policy is conducted by the Federal
Open Market Committee.
o Monetary policy is the setting of the
money supply by policymakers in the
central bank
o The money supply refers to the quantity
of money available in the economy.
The Federal Open Market Committee
• Three Primary Functions of the Fed
o Regulates banks to ensure they follow
federal laws intended to promote safe
and sound banking practices.
o Acts as a banker’s bank, making loans
to banks and as a lender of last resort.
o Conducts monetary policy by
controlling the money supply.
• Open-Market Operations
o The money supply is the quantity of
money available in the economy.
o The primary way in which the Fed
changes the money supply is through
open-market operations.
▪ The Fed purchases and sells
U.S. government bonds.
• Open-Market Operations
o To increase the money supply, the Fed
buys government bonds from the public.
o To decrease the money supply, the Fed
sells government bonds to the public.
BANKS AND THE MONEY SUPPLY
• Banks can influence the quantity of demand
deposits in the economy and the money supply.
• Reserves are deposits that banks have received
but have not loaned out.
• In a fractional-reserve banking system, banks
hold a fraction of the money deposited as
reserves and lend out the rest.
• Reserve Ratio
o The reserve ratio is the fraction of
deposits that banks hold as reserves.
Money Creation with Fractional-Reserve Banking
• When a bank makes a loan from its reserves, the
money supply increases.
• The money supply is affected by the amount
deposited in banks and the amount that banks
loan.
o Deposits into a bank are recorded as
both assets and liabilities.
o The fraction of total deposits that a bank
has to keep as reserves is called the
reserve ratio.
o Loans become an asset to the bank.
• When one bank loans money, that money is generally
deposited into another bank.
• This creates more deposits and more reserves to be
lent out.
• When a bank makes a loan from its reserves, the
money supply increases.
The Money Multiplier
• How much money is eventually created in this
economy?
• The money multiplier is the amount of money
the banking system generates with each dollar of
reserves.
• The money multiplier is the reciprocal of the
reserve ratio:
M = 1/R
• With a reserve requirement, R = 20% or 1/5,
• The multiplier is 5.
The Fed’s Tools of Monetary Control
• The Fed has three tools in its monetary toolbox:
o Open-market operations
o Changing the reserve requirement
o Changing the discount rate
• Open-Market Operations
o The Fed conducts open-market
operations when it buys government
bonds from or sells government bonds to
the public:
▪ When the Fed buys government
bonds, the money supply
increases.
▪ The money supply decreases
when the Fed sells government
bonds.
• Reserve Requirements
o The Fed also influences the money supply
with reserve requirements.
o Reserve requirements are regulations on the
minimum amount of reserves that banks must
hold against deposits.
• Changing the Reserve Requirement
o The reserve requirement is the amount (%)
of a bank’s total reserves that may not be
loaned out.
▪ Increasing the reserve requirement
decreases the money supply.
▪ Decreasing the reserve requirement
increases the money supply.
• Changing the Discount Rate
o The discount rate is the interest rate the Fed
charges banks for loans.
▪ Increasing the discount rate
decreases the money supply.
▪ Decreasing the discount rate
increases the money supply.
Problems in Controlling the Money Supply
• The Fed’s control of the money supply is not precise.
• The Fed must wrestle with two problems that arise due
to fractional-reserve banking.
o The Fed does not control the amount of
money that households choose to hold as
deposits in banks.
o The Fed does not control the amount of
money that bankers choose to lend.
• The term money refers to assets that people
regularly use to buy goods and services.
 • Money serves three functions in an economy: as
a medium of exchange, a unit of account, and a
store of value.
• Commodity money is money that has intrinsic
value.
• Fiat money is money without intrinsic value.
SUMMARY
• The Federal Reserve, the central bank of the
United States, regulates the U.S. monetary
system.
• It controls the money supply through open-
market operations or by changing reserve
requirements or the discount rate.
• When banks loan out their deposits, they
increase the quantity of money in the economy.
• Because the Fed cannot control the amount
bankers choose to lend or the amount
households choose to deposit in banks, the Fed’s
control of the money supply is imperfect.
INTERNATIONAL MONETARY SYSTEM
Definition Of International Monetary System
IMS (International Monetary System) defined as the
institutional framework within which international
payments are made, movements of capital are
accommodated and exchange rates among currencies
are determined.
The rules and regulations set by the international
monetary system to regulate and control the exchange
value of the currencies are agreed upon by the respective
governments of the nations. Thus, the government’s
stand may affect the decision making of the international
monetary system.
Purpose Of International Monetary System
• To facilitate the exchange of goods, services and
capital among countries
• To contribute to stable and high global growth
while currently fostering price and financial
stability
• Regulates the balance of payments, which is an
accounting device that records all international
transactions between a country and the rest of the
world for a given period
Elements Of International Monetary System
• Exchange arrangements/rates
• International payments and transfers relating to
current international transactions
• International reserves
• International capital movements
Evolution Of International Monetary System
▪ BIMETALLISM: Before 1875 Classical Gold
Standard: 1875-1914 Interwar Period: 1015-
1944
Bimetallism: Before 1875
It is a monetary system where the value of the
money is based on two different metals. Usually, these
two metals are gold and silver. Bimetallism became an
alternative to the gold standard where the value of money
was based on how much gold a country had in its reserves
and how much that gold was worth.
Issues About Bimetallism System
For bimetallism to work effectively, there needed to be
some sort of international cooperation.
Political cartoon depicting the battle between the gold
standard and bimetallism
Classical Gold Standard
The gold standard is a monetary system where a
country’s currency or paper money has a value directly
linked to gold. With this system, countries agreed to
convert paper into a fixed amount of gold.
Interwar Period
After WW1, the world powers tried to return to the
gold standard at prewar parities (i.e., at the previous
exchange rates), but the attempt to restore gold
convertibility did not succeed, except momentarily. The
1920s30s were characterized by recessions, banking
crises, the Great Depression and the rise of fascism.
Exchange rates were mostly floating and protectionism
increased.
Flexible Exchange Rate Regime
Flexible exchange rates can be defined as
exchange rates determined by global supply and demand
of currency. In other words, they are prices of foreign
exchange determined by the market, that can rapidly
change due to supply and demand, and are not pegged
nor controlled by central banks.
Evolution Of International Monetary System
Jamaica Agreement
▪ Flexible exchange rate was declared acceptable to the
IMF members and central banks were allowed to
intervene in the exchange markets to iron out
unwarranted volatilities
▪ Gold was officially abandoned (demonetized) as an
international reserve asset. Half of the IMF’s gold
holdings were returned to the members and the other
half were sold, with the proceeds to be used to help
poor nations.
▪ Non-oil –exporting countries and less developed
countries were given greater access to IMF Funds.
Types Of Exchange Rate System
➢ Managed Float System of Exchange
Rate
➢ Free Floating Exchange Rate System
Managed Float System
A system where exchange rates are allowed
fluctuate from day to day within a range before the central
bank will intervene to adjust it.
Free Floating Exchange Rate System
Sometimes referred to as clean or pure float, is a
flexible exchange rate system solely determined by
market forces of demand and supply of foreign and
domestic currency, and where government intervention is
totally inexistent.
The Strategy of International Business
What Is Strategy?
• A firm’s strategy refers to the actions that
managers take to attain the goals of the firm
• Firms need to pursue strategies that increase
profitability and profit growth
o Profitability is the rate of return the firm
makes on its invested capital
o Profit growth is the percentage increase
in net profits over time
What Is Strategy?
• To increase profitability and profit growth, firms
can
o add value
o lower costs
o sell more in existing markets
o expand internationally
How Is Value Created?
• To increase profitability, firms need to create
more value
• The firm’s value creation is the difference
between V (the price that the firm can charge for
that product given competitive pressures) and C
(the costs of producing that product)
o a firm has high profits when it creates
more value for its customers and does so
at a lower cost
How Is Value Created?
• Profits can be increased by
1. Using a differentiation strategy
o adding value to a product so that
customers are willing to pay more for it
2. Using a low-cost strategy
o lowering costs
Why Is Strategic Positioning Important?
• Michael Porter argues that firms need to choose
either differentiation or low cost, and then
configure internal operations to support the
choice
• So, to maximize long run return on invested
capital, firms must
o pick a viable position on the efficiency
frontier
o configure internal operations to support
that position
o have the right organization structure in
place to execute the strategy
How Are a Firm’s Operations Configured?
• A firm’s operations are like a value chain
composed of a series of distinct value creation
activities:
o production, marketing, materials
management, R&D, human resources,
information systems, and the firm
infrastructure
• All of these activities must be managed
effectively and be consistent with firm strategy
Are A Firm’s Operations Configured?
• Value creation activities can be categorized as
1. Primary activities
o R&D
o Production
o marketing and sales
o customer service
2. Support activities
o information systems
o logistics
o human resources
How Can Firms Increase Profits Through International
Expansion?
• International firms can
1. Expand their market
o sell in international markets
2. Realize location economies
o disperse value creation activities to locations
where they can be performed most efficiently
and effectively
3. Realize greater cost economies from experience
effects
o serve an expanded global market from a
central location
4. Earn a greater return
o leverage skills developed in foreign
operations and transfer them elsewhere in the
firm
How Can Firms Leverage Their Products and
Competencies?
• Firms can increase growth by selling goods or
services developed at home internationally
• The success of firms that expand internationally
depends on
o the goods or services sold
o the firm’s core competencies
How Can Firms Leverage Their Products and
Competencies?
• Core competencies - skills within the firm that
competitors cannot easily match or imitate
o can exist in any value creation activity
• Core competencies allow firms to reduce the
costs of value creation and/or to create perceived
value so that premium pricing is possible
Why Are Location Economies Important?
• Location economies are economies that arise
from performing a value creation activity in the
optimal location for that activity, wherever in the
world that might be
• By achieving location economies, firms can
o lower the costs of value creation and
achieve a low-cost position
o differentiate their product offering
Why Are Location Economies Important?
• Firms that take advantage of location economies
in different parts of the world, create a global web
of value creation activities
o different stages of the value chain are
dispersed to locations where perceived
value is maximized or where the costs of
value creation are minimized
Why Are Experience Effects Important?
• The experience curve refers to the systematic
reductions in production costs that occur over the
life of a product
o by moving down the experience curve,
firms reduce the cost of creating value
o to gets down the experience curve
quickly, firms can use a single plant to
serve global markets
• Learning effects are cost savings that come
from learning by doing
• When labor productivity increases
o individuals learn the most efficient ways
to perform particular tasks
o managers learn how to manage the new
operation more efficiently
Why Are Experience Effects Important?
• Economies of scale - the reductions in unit cost
achieved by producing a large volume of a product
• Sources of economies of scale include
o spreading fixed costs over a large volume
o utilizing production facilities more intensively
o increasing bargaining power with suppliers
How Can Managers Leverage Subsidiary Skills?
• Managers should
1. Recognize that valuable skills that could
be applied elsewhere in the firm can arise
anywhere within the firm’s global network - not
just at the corporate center
2. Establish an incentive system that
encourages local employees to acquire new
skills
3. Have a process for identifying when
valuable new skills have been created in a
subsidiary 4. Act as facilitators to help transfer
skills within the firm
What Types of Competitive Pressures Exist in The Global
Marketplace?
• Firms that compete in the global marketplace
face two conflicting types of competitive
pressures
o the pressures limit the ability of firms to
realize location economies and
experience effects, leverage products,
and transfer skills within the firm
• Dealing with both pressures is challenging
What Types of Competitive Pressures Exist In The Global
Marketplace?
• Two competitive pressures:
1. Pressures for cost reductions
o force the firm to lower unit costs
2. Pressures to be locally responsive
o require the firm to adapt its product to
meet local demands in each market
▪ but this strategy can raise costs
When Are Pressures for Cost Reductions Greatest?
• Pressures for cost reductions are greatest
1. In industries producing commodity type
products that fill universal needs (needs that
exist when the tastes and preferences of
consumers in different nations are similar if not
identical) where price is the main competitive
weapon
2. When major competitors are based in low-cost
locations
3. Where there is persistent excess capacity
4. Where consumers are powerful and face low
switching costs
When Are Pressures for Local Responsiveness
Greatest?
• Pressures for local responsiveness arise from
1. Differences in consumer tastes and
preferences
o strong pressure emerges when
consumer tastes and preferences differ
significantly between countries
2. Differences in traditional practices and
infrastructure
o strong pressure emerges when there are
significant differences in infrastructure
and/or traditional practices between
countries
3. Differences in distribution channels
o need to be responsive to differences in
distribution channels between countries
4. Host government demands
o economic and political demands imposed
by host country governments may
require local responsiveness
Which Strategy Should a Firm Choose?
• There are four basic strategies to compete in
international markets
o the appropriateness of each strategy
depends on the pressures for cost
reduction and local responsiveness in the
industry
Which Strategy Should a Firm Choose?
1. Global standardization - increase profitability and
profit growth by reaping the cost reductions from
economies of scale, learning effects, and location
economies
• goal is to pursue a low-cost strategy on a global
scale
This strategy makes sense when
o there are strong pressures for cost reductions
and demands for local responsiveness are
minimal
2. Localization - increase profitability by customizing
goods or services so that they match tastes and
preferences in different national markets
This strategy makes sense when
• there are substantial differences across nations
with regard to consumer tastes and preferences
and cost pressures are not too intense
3. Transnational - tries to simultaneously achieve low
costs through location economies, economies of scale,
and learning effects
• firms differentiate their product across geographic
markets to account for local differences and
foster a multidirectional flow of skills between
different subsidiaries in the firm’s global network
of operations
This strategy makes sense when
both cost pressures and pressures for local
responsiveness are intense
4. International – take products first produced for the
domestic market and sell them internationally with only
minimal local customization
This strategy makes sense when
• there are low-cost pressures and low pressures
for local responsiveness
How Does Strategy Evolve?
• An international strategy may not be viable in the
long term
o to survive, firms may need to shift to a
global standardization strategy or a
transnational strategy in advance of
competitors
• Localization may give a firm a competitive edge,
but if the firm is simultaneously facing aggressive
competitors, the company will also have to
reduce its cost structures
o would require a shift toward a
transnational strategy
INTERNATIONAL BUSINESS OPERATIONS
IMPORTING, EXPORTING and COUNTERTRADE
TRADE
• A basic economic principle that deals with buying
or selling of goods and services, and or the
exchange of goods or services between two or
more parties.
WHY TRADE?
• No single country possesses all the natural
resources and manpower to fully exploit it
IMPORTING VS. EXPORTING
EXPORTING
• The act of purchasing goods and services from
other countries the bringing them homebound for
consumption or as a raw material to produce a
final product.
 EXPORTING
• Selling of goods and services to foreign nations.
ADVANTAGES OF IMPORTING AND EXPORTING
• Importing and Exporting are the most simple and
practical means or routes of entering into the
global trade. This also means lesser risk for both
countries once the partnership is established.
• It provides job opportunities for countries (ex.
China)
• Since nations cannot be ultimately self-sufficient,
import and export serves as an opportunity for
both countries to continually function and grow
• Importing gives poor countries access to the best
and latest technologies available in the world.
DISADVANTAGES OF IMPORTING AND EXPORTING
• It can incur a lot of costs for countries as a lot of
factors would have to be considered
• Domestic businesses can be more accessible for
businesses in times of urgent need.
• Any quality issues borne by the product may have
a direct impact on the reputation of the country,
moreover, their trading and foreign policies.
• Political and other domestic issues can cause
inevitable delays, or worse, closure of trade
transactions.
5. Switch trading
o The use of specialized third-party trading
house in a countertrade arrangement
What are the Pros of Countertrade?
Countertrade is attractive because
• it gives a firm a way to finance an export deal
when other means are not available
• it gives a firm a competitive edge over a firm that
is unwilling to enter a countertrade agreement
• Countertrade arrangements may be required by
the government of a country to which a firm is
exporting goods or services
What are the Cons of Countertrade?
Countertrade is unattractive because
• it may involve the exchange of unusable or poor-
quality goods that the firm cannot dispose of
profitably
• it requires the firm to establish an in-house trading
department to handle countertrade deals
• Countertrade is most attractive to large, diverse
multinational enterprises that can use their
worldwide network of contacts to dispose of
goods acquired in countertrade deals

COUNTERTRADE

• A range of barter-like agreements that facilitate

the trade of goods and services for other goods
and services when they cannot be traded for
money

What are the forms of Countertrade?

There are five distinct versions of countertrade:

1. BARTER
o A direct exchange of goods and/or
services between two parties without a
cash transaction
2. Counter-purchase

A reciprocal buying agreement

o Occurs when a firm agrees to purchase a

certain amount of materials back from a
country to which a sale is made
3. Offset
o Similar to counter-purchase- one party
agrees to purchase goods and services
with a specified percentage of the
proceeds from the original sale
4. Buyback
o Occurs when a firm builds a plant in a
country or supplies technology,
equipment, training, or other services to
the country