Definition Aggregate Demand The total expenditure on the national output at different values of the price level over a given period of time. C onsumption or spending by households I nvestements = spending by firms on goods G overnment Spending X-M = Export minus Imports => net amount spent on economy’s output by rest of world Aggregate Supply Total output of goods and services, which all firms in the economy are willing and able to supply at different price levels over a period of time.
Reason for Shifts Aggregate Demand Reduction in income tax Consumption increase Reduction in interest rates Consumer spending and corporate investment increase Increase in government spending Boosting demand certain products, increasing earnings in sector Improved competitiveness performance Boosting export sales
Aggregate Demand Increase Price Level S P1 P D1 D 0 Output Q1 Q
Reasons for Shift Aggregate Supply Increase in short-run AS Reduction in Indirect Tax Reduction in Wage costs Reduction in raw material & import costs Favorable weather conditions Decrease in short-run AS Reverse of everything said.
Aggregate Demand Decrease Price Level S P1 P D1 D 0 Output Q1 Q
International Economics Reasons for Trade
Factor endowments Factors of production that a country has available to produce goods and services Australia has minerals
Specialization Exists where country specializes in production of goods and services where they have a comparative advantage in production. Trade to get goods and services in which they do not specialize.
Absolute Advantage Good exists where a country is able to produce more output than other countries using same inputs of factors of production.
Comparative Advantage A good exists where a country is able to produce a good at a lower opportunity cost of resources than another country.
Comparative Advantage between Japan and China Automobiles 100 Units 5 Japan 1 China 0 Apparel 5 20 Thousand units
Free Trade & Protectionism
Free Trade International trade takes place without any barriers, such as tariffs, quotas, and subsidies. Free trade in an economy Price SDomestic PEq Pworld Sworld D Qe 0 Q1 Quantity Q2
Tariff Duty that is placed upon imports to protect domestic industries from foreign competition and to raise revenue for government Tariff diagram Price SDomestic Deadweight Loss PEq STariff PTariff Pworld Sworld D Qe 0 Q3 Q1 Q4 Q2 Quantity
Quota Import barrier set upper limits on quantity or value of imports that may be imported into a country. Price SDomestic Loss Windfall gain by foreign producers PEq STariff PTariff Pworld Sworld D Qe 0 Q3 Q1 Q4 Q2 Quantity
Subsidy An amount of money paid by the government to a firm, per unit of output, to encourage output and to give firm an advantage over foreign competitors.
Voluntary Export Restraint Voluntary agreement between an exporting country and an importing country that limits volume of trade in particular product.
Infant Industry Argument Propose new industries should be protected from foreign competition until they are large enough to compete in international markets.
Dumping Selling of a good in another country at a price below its unit cost of production.
Anti-Dumping Legislation to protect an economy against import of a good at a price below its unit cost of production.
Economic Integration & WTO
Free Trade Area Exists when agreement is made between countries agree to trade freely among members of the group, but are able to trade with countries outside free trade area in whatever ways they wish.
Customs Union Agreement made between countries, where countries agree trade freely among themselves, and they also agree to adopt common external barriers against any country attempting to import into the customs union.
Common Market Customs union with common policies on product regulation, and free movement of goods, services, capital, and labor.
Trade creation A benefit of greater economic integration Entry of country into a customs union leads to the transfer of production from a high cost producer to a low cost producer
Trade Creation Before Trading Bloc A B Low Cost Producer C High cost Producer Tariffs B
Trade Creation After C High cost Producer A B Low cost Producer B
Trade Diversion A disadvantage of greater economic integration Entry of country into a customs union leads to the transfer of production from a low cost producer to a high cost producer
Trade Diversion Before D Low cost producer A C High cost Producer B
Trade Diversion After Trade Barriers D Low cost producer C High cost Producer A B
WTO World Trade Organization International body that sets rules for global trading and resolves disputes between its member countries. Also hosts negotiations concerning reduction of trade barriers between member nations.
Balance of Payments
Balance of Payments Record of value of all transactions between residents of a country with residents of all other countries over given time period.
Balance of Trade Measure of revenue received from exports of tangible goods minus expenditure on imports of tangible goods over a given time period.
Current Account Measure of flow of funds from trade in goods and services, plus net investment income flows (profit, interest, and dividends) and net transfers of money (foreign aid, grants, and remittances)
Capital Account Measure of buying & selling assets between countries. Assets are often separated to show assets that represent ownership and assets that represent lending.
Current Account Surplus Where revenue from exports of goods and services and income flows is greater than expenditure on import of goods and services and income flows over given time period.
Current Account Deficit Where revenue from export of goods & services & income flows is less than expenditure on import of goods & services & income flows over given time period.
Marshall-Lerner Condition Depreciation, or devaluation, of a currency will only lead to improvement in current account balance if elasticity of demand for exports plus elasticity of demand for imports is <1.
Exchange Rates and Terms of Trade
Exchange Rate Value of one currency expressed in terms of another.
Purchasing Power Parity Theory States that under floating exchange rate, exchange rates adjust to offset differential rates of inflation between countries that are trading partners in order to restore BoP equilibrium.
Terms of Trade Index that shows value of country’s average export prices relative to their average import prices.
Terms of Trade
Elasticity of Demand of Exports Measure of responsiveness of quantity demanded of exports when there is a change in relative price of exports. Increase in Demand for $ Price of $ in Yen S $20 $10 D1 D 0 Quantity of $
Elasticity of Demand for Imports Measure of responsiveness of quantity demanded of imports when change in relative price of imports. S Price of $ in Yen S1 $20 $10 D 0 Quantity of $