International Economics II Lecture Notes 5

Transcription

1 International Economics II Lecture Notes 5 Alper Duman April 5, 2012

2 Price Adjustments and Balance of Payments Disequilibrium Expenditure switching Price and income elasticities are important Price adjustment mechanisms differ for non-tradables

3 Market stability occurs when the characteristics of supply and demand are such that the market move back to the equilibrium. Backward-sloping supply curves can make markets instable. A country facing an inelastic foreign demand for its exports will experience a backward-sloping supply curve of foreign currency.

4 Exchange rate stability depends on export and import price elasticities MARSHALL-LERNER CONDITION states that X M η Dx + η Dm > 1 (1) where X is the expenditures on exports, M is the expenditures on imports, η Dm is the absolute value of the home-country price elasticity of demand for imports and η Dx is the absolute value of the price elasticity of demand for home-country exports. Find out the demand elasticities of exports and imports of TURKEY

5 Complete exchange rate pass-through requires that the change in the value of the home currency is totally reflected on domestic and foreign prices Short-term responses of consumers or firms to a depreciating currency would cause a J-CURVE in the long-run Depreciation in an economy with little or no excess capacity may do nothing more than stimulate domestic price increases. Why?

6 In GOLD STANDARD all currencies are pegged to gold, so effectively every country has fixed exchange rate regimes There is no restraint on the buying and selling of gold within countries, and gold moves freely between countries The money supply is allowed to change in response to the change in gold holdings in a country Prices and wages are assumed to be flexible upward and downward

7 The price adjustment mechanism in the gold standard works as a strong disciplinary force against inflation in a country because inflation leads to a deficit and loss of gold reserves Read about inter-war years and the causes of second-world war, i.e. Barry Eichengreen; Charles Kindelberger

8 Under a PEGGED RATE system governments fix the price of their currency and stand ready to support the fixed price in the foreign exchange market. RESERVES are the key in order to maintain the PEGGED target. Check out on IMF website to see which countries use which exchange rate systems

9 National Income and the Current Account In a Keynesian simple-open economy, desired aggregate expenditures (E), consist of consumption (C), investment (I), government spending (G), and export spending by foreign citizens on the country s exports (X). However, (M) domestic spending on imports should be extracted since the imports are expenditures on foreign countries goods and services. E = C +I +G +X M (2) Consumption depends on the disposable income of households: C = f(y d ) (3) where Y d = Y T

10 The general expression of the Keynesian Consumption Function is C = a+by d (4) a is the autonomous consumption spending; that may depend on population, cultural habits, wealth, interest rates b is known as the marginal propensity to consume, MPC MPC = C Y d (5) Consequently marginal propensity to save, MPS is defined as MPS = S Y d (6)

11 Logically, MPC +MPS = 1 Saving Function is derived from thre relation between the consumption and Income and Y d = C +S = a+by d +S (7) S = Y d (a+by d ) = a+(1 b)y d (8) or S = a+sy d where s = 1 b, is the marginal propensity to save, MPS

12 In the simple model investment is assumed to be independent of current income and written as I = I Government spending is also more dependent on government priorities such as national defense, education and health thus more or less independent of current income G = G The same is true for taxes, T = T Finally, exports are also determined by the income level of foreign countries, therefore is independent of the current income X = X

13 The import function on the other hand depends on the current income, the general form is M = f(y) and the specific form is M = M +my M represents the autonomous imports and the my represents the induced imports Marginal propensity to import, MPM is MPM = M Y and the average propensity to import, APM is M/Y The important term for the analysis is income elasticity of demand for imports, YEM (9) YEM = (% M % Y = MPM/APM (10)

14 If a country s MPM exceeds its APM, imports relative to income will rise as the country s income grows; YEM is elastic If MPM is less than APM, YEM is inelastic.

15 Determination of Equilibrium Level of National Income Aggregate Desired Spending should be equal to the national outpur or income Assume that C = Y d, Y d = Y T, T = 500, I = 180, G = 600, X = 140 and M = Y What is the equilbrium income? Remember that E = C +I +G +X M (11)

16 LEAKAGES are the items that reduce spending on domestic products; SAVING, IMPORTS and TAXES INJECTIONS arethe items that induce home production; INVESTMENT, GOVERNMENT SPENDING, and EXPORTS S +T +M = I +G +X and rearranging we get S +(T G) I = X M (12) In an open economy the difference between a country s total saving (private and goverment) and the country s investment equals to the current account balance