Questions about course content for Econ 340, Winter 2018 Apr 24: There was this question in Midterm 2: 4. I travel to Mexico, give a lecture, and am paid a fee of 10,000 pesos in cash. Under which of the following circumstances will the United States current account not be affected? Why is the answer: d. I sell the pesos to a Mexican immigrant, working in Ann Arbor, who sends them to his family in Mexico City. I thought repatriation is considered a transfer. Shouldn't it be a debit to the current account? Also, what's wrong with option c? (c: I sell the pesos in the foreign exchange market to an American student who keeps them in his wallet for later use) A: Yes, repatriation is indeed a transfer and in the current account. My payment for the lecture is a payment to labor, and is also in the current account. So these two transactions offset each other, leaving the current account unchanged. Answer c is a capital flow which appears in the financial account, and therefore does not offset the wage payment in the current account. Apr 22: I do not understand why the answer to MCQ number 5 on the fall 2016 final is a. A: What's confusing here is that it mixes productivity (words a minute) for one activity with cost per unit output (10 minutes) for the other. But you can still use the numbers to see relative productivity and relative cost: Jack is half as good at typing as Janet (60/120=1/2) and less than one third as good at solving as Janet (3/10), so he has a comparative advantage in typing (1/2 > 1/3). Jack has an absolute advantage in both typing (60>40) and solving (10 < 20) compared to Jill, but he's twice as good at solving (20/10=2) and only 50% better at typing (60/40=1.5), so he has a comparative advantage in solving, not typing, compared to Jill. Jessica is better at typing than Jack (80>60) and worse at solving (15>10), so here each has an absolute advantage, and Jack's is in solving. Mar 26: I have two more questions as following: Based on the supply and demand model of the exchange rate, which of the following should cause the Philippine peso to appreciate? a. Concern abroad over the safety of Philippine toy exports. b. An increase in remittances from Philippine workers abroad to their families at home. c. Repayment by the Philippine government of its debt to the IMF. d. Increased imports by Philippine consumers of electronics made in Taiwan. e. An increase in Philippine savings that is used to purchase financial assets in Europe. Ans: b Why b is correct and other choices are wrong? Could you please help me to explain each choices? A: Answer b increases the demand for pesos (in order to pay the families) and thus the supply for foreign currency on the exchange market, shifting supply to the right. Answer a reduces demand for Philippine exports and thus for the peso; c requires that the government buy foreign currency in order to repay the debt; d increases the demand for foreign currency needed to buy the imports; and e increases demand for foreign currency to buy the foreign financial assets. Q: Short Answer#1 in study question lecture 15 The graph below shows the foreign exchange market from the perspective of the Japanese economy, with the U.S. dollar as its foreign currency. Suppose that a decline in investor expectations within Japan now causes aggregate demand there to fall, reducing output and prices. Based on this background, the answer says"...The decline in income also causes a fall in the Japanese interest rate", I don't understand why inerest rate falls. In the lecture slides, monetary contraction means Y falls, P falls and i rises, but why i falls in this question? A: Because this is a non-monetary contraction. Investors borrow less and the interest rate falls. You know this from Econ 102. Mar 25: I am sorry I have two more questions. The first one is question #1 in the study question of Lecture 12: Which of the following wouldbe included as contributing positively to the U.S. balance of merchandise trade? a. Purchase by a U.S. airline of an airplane made by the European firm, Airbus. b. Sale of a U.S. Treasury bill to a Japanese bank. c. Sale by a U.S. airline, to an Italian student, of a ticket from Rome to New York. d. Purchase by the Russian government of wheat from a U.S. grain firm. e. A capital export in the form of construction of a foreign factory by a U.S. firm. Ans: d Could I ask why b, c and e are wrong? Are they credit or debt? Are they in current account or financial account? And why? A: b is in the financial account. It's not trade. c is trade, but it is a service, not merchandise. e is in the financial account, FDI. It's not trade. Q: The second one is question #5 in the study question of Lecture 12: A surplus in the balance of trade or in the balance on current account (assume they’re the same for this question) implies that: Ans: The country is lending to foreigners more than foreigners are lending to it. I don't understand why a surplus in the balance of trade means the country is lending to foreigners more, I think if there is a surplus, exports should be greater than imports, which means that foreigners give us more money than we give foreigners. Why this means we lend more? I think there no lend or borrow occers in this question. A: You seem to have forgotten that, for several reasons discussed in class, the current account and the financial account must be equal and opposite. Go back and look at the slides about that. In this particular case, if we are exporting more than we are importing, then we are receiving payments in excess of what we are paying out. We have to do something with that excess, such as buying assets abroad. Mar 25: I would like to ask that is EU (Eurpoean Union), EMU (Economic and Monetary Union) and European Economic Community are exactly the same thing? If not, what's the difference between them? Also, what's the difference between EMU (Economic and Monetary Union) and EMS (European Monetary System)? I think the difference is that EMU has same currency but EMS not, is this correct? A: The European Economic Community was the name of the 6-country customs union formed in the 1950s. Over time it expanded with more countries and covering more than just tariffs. As it did so, at some point it changed its name, first to the European Community, and then (in 1992, I think) to the European Union. It now continues to be a customs union but covering also free movement of services, capital, and labor among the 28 countries that are now members (but which will likely fall to 27 as the UK leaves). The EMU, Economic and Monetary Union, is the subset of those countries that have adopted the euro as their common currency. It was preceded by the European Monetary System, in which the countries still had their own currencies but attempted to peg them together to a basket of currencies. Mar 25: Do you know why Question 3a of the Short Answer Section of the Pegging Exchange Rates Practice Test states that the Bundesbank is losing international reserves ? I thought it would make more sense if the answer was either: a) "Bundesbank is not changing its international reserves" at the moment (until it wants to revalue or devalue its currency) OR b)" Bundesbank is increasing international reserves", so that it can easily buy back its currency when it needs to. A: In the figure for question 3a, there is excess demand for dollars at the pegged exchange rate, so the German central bank must provide those extra dollars out of its reserves. (I suspect that you didn't look at the figure, thinking that it was not relevant to this first part of the question. But without the figure you would not know what rate they are pegging to, E-bar.) Mar 24: Hello, I am in econ 340 class and have one question in chapter 13 study question. In part 2 -1b, I don't understand how we can get the numbers on the answer sheet. The answers I got were 3.2, 66.6, and 213.33 according to the purchasing power theory, which says the real exchange rate should be constant. A: No, the PPP theory, as I told it to you, says that a currency should depreciate by the difference between its own inflation rate and the foreign one. If you calculate the percentage changes in the three prices that are reported there, take their difference, and apply that to the initial exchange rates, you should get the numbers that I posted as the answers. For example, US prices rise 20%, UK prices rise 15%, so the US dollar should depreciate by 20-15=5%. Thus the dollar price of the pound, initially 1.60, should rise by 5%, or .08, to 1.68. It's true that if PPP holds, the real exchange rate will be constant. But I don't find that a very easy fact to use in deriving the new exchange rate. Mar 24: Quick question, 5. If Canada were pegging the Canadian dollar to the U.S. dollar and also trying to sterilize the effects of its exchange market intervention, then when it buys U.S. dollars on the foreign exchange market, it should a.Sell Canadian government bonds. b.Buy Canadian government bonds c. Sell U.S. government bonds. d. Buy U.S. government bonds. e. Sell Canadian dollars. Why can't Canada's CB sell US government bonds as well? Wouldn't this put essentially do the same thing? When is it appropriate when sterilizing to sell or buy the foreign bonds vs. domestic bonds? A: It's true that in principle they could sell anything, as long as they sell things for Canadian dollars, so that those Canadian dollars will then get taken back out of Canada's money supply. But selling US government bonds would most naturally get them US dollars, not Canadian dollars. And if they were then to sell those US dollars on the exchange market, that would reverse the purchase of dollars that they needed to manage the exchange rate. In general, we define sterilization as use of open market operations to manage the money supply, and open market operations are normally done in the market for the country's own government bonds. Mar 19: If selling bonds means you're borrowing money, when the government sterilizes the money supply by selling bonds (or the intervention) does this mean the government is borrowing from people inside the country only? What will the government use that money for? If the money is spent, doesn't that just mean the money is circulated even more? (as in, how will selling bonds reduce the money supply if it is going to be circulated again?) A: Good question. It's not the government that is selling the bonds, but the central bank. Central banks, as a part of their job of managing the money supply, routinely buy bonds in whatever amounts are needed to manage the money supply. These are bonds that have been previously issued by the government and are now held by people in the private sector who had bought them when the government issued them to finance a deficit. So the central bank already has a lot of bonds on hand. When they sell bonds in order to sterilize the effects of having bought foreign currency, they just sell from that stockpile of bonds that they already have. It is really just an open market operation of the same sort that you learned about in Econ 102. Mar 19: I have a question on Lecture 13: Exchange Rates. Why is it that US imports are a source of demand for euros? Why should this not be thought of as a decrease in supply of euros? The reverse makes sense, I can understand why US exports would increase the supply of euros. A: Because in order to import, someone must buy euros: If the US buyer pays in euros, they must first buy euros. If the European seller accepts payments in dollars, then they will need to exchange those dollars for euros in order to pay their workers. So either way, the imports give rise to additional demand for euros. I don't know who you may be thinking of supplying euros who would then wish to supply less as a result of our imports. Mar 12: In The non-monetary expansion cause pegging the exchange rate to be easier. I can understand this for overvalued condition because you need to sell less currency to peg. But as for undervalued case, I don’t get it. On the graph it seems like the country have to buy more after the shifting. Isn’t that mean it’s harder instead of easier? A: I agree that this case is less obvious than the other. My thinking is that, by causing the central bank to acquire reserves more rapidly, it is building up larger reserves that will make it easier to defend its peg later on if the situation changes. It is true, as you say, that it must do more, not less. But using its own money to buy foreign currency is not hard, since as the central bank it can create its own money needed to make the purchase. Mar 12: I don’t understand why one currency depreciate and then domestic AD shift right from the lecture PDF. Because the exports will grow and I think it should be the case where SRAS will shift right. A: No, exports are one of the components of aggregate demand, not aggregate supply. Mar 6: 1) Real Exchange Rates: Why can't we just calculate it by dividing the cost of 1 consumption basket in one country by the cost of 1 consumption basket in another country? Say if in the UK it costs 200 pounds to buy 1 basket there and in the US it's $400, then isn't it easy to say 1 pound= $2? I mean, 1 pound in the UK should buy the same things as $2 in the US right? A: Good question. In its absolute version, if purchasing power parity held perfectly, then consumption baskets would cost the same in the two countries at the prevailing exchange rate. Your calculation of the ratio of the two basket prices would yield the nominal exchange rate that would prevail if that were true, and the real exchange rate as we define it would then be one. If the nominal exchange rate does not equal that ratio, then the real exchanger rate is different than one, and that's why we use both the nominal rate and the two prices to calculate it. Q: 2) You said government interferes more in determining spot exchange rates more than forward ones? Wouldn't they be more influential in the forward market though? A: The forward and spot rates are tied together sufficiently (by arbitrage) that it wouldn't matter which one they intervened in to influence. I'm not sure what the advantage would be of using the forward rate. Mar 3: I am in your Econ340 class and wanted to hear your opinion on the recent tariffs that are supposed to be enacted next week. There clearly isn't many benefits if any that outweigh the potential costs that will be passed onto the consumers, and I haven't found a single article that supports the tariffs. With that said, I am more interested in the bigger picture of the things and how a shift in policy can change the international system. A: You are right that almost all economists and most people in business oppose these tariffs, which by the way are not at all certain to happen as of now. Trump merely announced them, but has done nothing yet to put them in place, although he has the power to do that. He's getting lots of pressure from both at home and abroad against doing so, so I expect that the actual policy will be weaker than what he announced, in some fashion. The economic benefits of the tariffs would be solely to the US producers of steel and aluminum, and the costs to those who use these metals as inputs. As always, the costs are larger but spread across a much larger part of the population of producers that use the metals and consumers of their products. For consumers, the costs will be positive but small. For producers of things like cars, the costs will be larger and hurt their ability to compete with producers abroad. So one expects employment gains in steel and aluminum and employment losses, eventually, in the using industries. I wouldn't be surprised if the employment losses are bigger than the gains, but I don't know that. None of which is really relevant to why Trump wants the tariffs. The claimed reason is national security -- reluctance to rely on imports for defense-necessary products. Since we import more from Canada than anyone else, that can't be serious. Trump would point to our trade deficit, and he probably believes that, but his economics is mistaken. What he is mainly doing is trying to satisfy his base, which fears trade more generally, and on that he's right. Q: I am very interested in the dollars role in the international system, trade deficits, current account deficits and how and if the US can shift its policies to help balance these deficits. I understand the entire system is dependent on the US to export their deficit and dollars abroad however, infinite debt limits is impossible and we have already started to see these risks arise recently as demand for dollars and US government debt are decreasing, all while the Fed normalizes its balance sheet. A: As we discussed in the last lecture before break, the US deficit and mounting debt is indeed a problem, since it means that we are benefitting at the expense of other countries, including ones much poorer than us. But they get in return an increasing amount of US debt on which they'll earn interest on, probably very safely, for the foreseeable future. I don't see any sign that they will not continue to be willing to add to these holdings, but if they change their view, the exchange rate will change in a way that will correct the problem. When and if that happens, we will be worse off, as our imports will have to decline. But it shouldn't provoke a crisis. Q: My point is, is it feasible that if a larger scale policy shift, like what is happening, help cure America's biggest problem of increasing deficits and a growing debt burden? A: If by policy shift you mean Trump's tariffs, no. That won't change our trade deficit, and our other policies like the tax cut will increase our deficit. Feb 16: On question 3 of the study questions, the question is "When a large country levies a tariff on imports..." and the correct answer is "E", all the above. This includes "D" which states "The domestic price rises by less than the tariff." However, on page 16 of Lecture 5, the bullet point reads "Domestic price rises (by full amount of tariff)". This is very confusing. Which will be correct during the exam? Attached are screenshots. A: Page 16 of Lecture 5 says at the top that it is for the small country. The study question says "large country." Feb 14: I found the article that was asked about in lecture today. In the “How Costly is Protectionism” article, it discussed a case involving Harley Davidson in which tariffs were placed on some of its Japanese competitors who were producing in the US. It also brought up the issue of deciding whether certain cars should be treated as domestic or imported. This came from pages 170 and 171. I was also wondering how this relates to what we learned about why firms choose FDI today. A: Thanks for sharing this. As I've now (re)read the relevant paragraph, I see that this was a special case of firms producing in a "Foreign Trade Zone" within the US. This is not something we've discussed in class, but from what this says, the idea of the FTZ is to let producers import inputs without paying a tariff as long as they then export the resulting product. And if instead they sell the good within the US, they must pay either the tariff on the input or the tariff on the output. I presume that there is some provision within the GATT/WTO that permits such an arrangement, since it is commonly used in many countries. What was special here was that in the Harley Davidson case, such firms were required to pay the increased safeguard tariff on sales in the US, as though they has exported from abroad. I do suspect that this was probably not legal under the GATT, but apparently nobody complained. Feb 14: I have one more question about Study Question. According to those who are in favor of anti-dumping laws, which of the following is not an example of “trade distorting practices” that contribute to unfair trade? a.Tariffs b.Anti-dumping duties c.Cartels d.NTBs e.Subsidies Ans:b I don't understand what is the meaning of “trade distorting practices”? Why Anti-dumping duties is not a trade-distorting practices? A: I don't actually recall what reading this question comes from, and perhaps it was one that I no longer assign. But that shouldn't matter for the answer. Since the question says "According to those who are in favor of anti-dumping laws," such people couldn't possibly think that anti-dumping duties contribute to unfair trade. They presumably think that AD duties do distort trade, but in a way that offsets the distorting effects of the other things listed. Feb 13: I'm a bit confused on Study Questions for Lecture 9 (WTO), question #7: the answer indicates that the "G20" is "a group of developing countries that insisted on the elimination of export subsidies on agricultural products." I'm confused because the G-20 seems to be mostly developed countries? Are there different definitions of G-20? A: Yes, there are indeed two different G-20's. This one is only developing countries, while the other is, as you say, mostly developed countries. See slides 58-60 of those posted for Lecture 9 and slides 15-17 of those posted for Lecture 2. The developing country group got its name at the Cancun Ministerial in 2003, while the developed/developing country group was formed later, at least for its summit meetings, in 2008. It is indeed confusing. Jan 31: Another question about today’s lecture is that, in the Patriotism Argument, you said that buying own goods will will incur cost for company and generate benefit for consumer. But the firms also receive revenue and the firms will be better off, right? So why this argument is misleading? A: You are right that the firms from whom we buy locally do benefit. When I said the "sellers incur the cost of production," I meant the selling country. Buy buying from a domestic firm when we could have gotten the good cheaper as an import, our country is incurring a higher cost than it needs to for providing the good to consumers. Had we not done that, the resources used by the firm to produce the good could have been used for something else more valuable. Jan 31: I have a question about the paper: Why are Trade Barriers so Low? In the article, writer claimed that: “These efficiency costs from tariffs, however, are quite small, particularly at low levels of protection, while the gains to a protected industry from tariffs can be enormous.” Later on he tried to explain why the barrier is relatively lower compared to how it should be. But he did not mention the biggest reason which is the consumer losses. I think the consumer losses are the reason why there DWL, which he mentioned as following: “In a small country, the loss to consumers from tariffs always outweighs the gains to producers and the government, so there is a net welfare loss from protection.” So, I don’t understand that why he found that the overall economy within a country has some DWL which means benefits outweigh gains of supplier. But do not mentioned it for the explanation in the low barrier part. A: I'm not sure I understand your question. Are you asking why Magee does not list the loss to consumers as one of the reasons for low tariffs? If so, I suppose the reason is that the loss to consumers does not, by itself, motivate policy makers, since consumers don't play much of a role in influencing policy. Thus the policy makers, to the extent that they consider the loss to consumers, do it along with the gains for producers and tariff revenue, so that only the net effect of all three -- the dead weight loss -- enters their calculation. Jan 22: This is the question for Jan 17 class. When two counrties open to trade. The price doesn’t has to be in the half. I remember there is a Cliker question that shows the exporter gains more than the importer or something. So, what determines the price? Because, the slide on the website doesn’t contains the questions. Thank you. A: The answer is on slide 11 of the PowerPoints posted after the class: the price is determined by the two horizontal distances between supply and demand being equal. That is, price is the only price at which the quantity that one country wants to export equals the quantity that the other country wants to import.