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show the relationship b/w net foreign investment and t

 

Sub C&G from both sides we get Y-C-G=I+NX As Y-C-G=NATIONAL SAVINGS WE SAY IT AS "S" now we have S=I+NX Subtract I from both sides we get S-I=NX This is the form of national account identity also it shows that the net export must always equal to the difference b/w its savings and its investmentrade balance using Y=C+I+G+NX

 

Hyperinflation is double digit inflation. It is the extreme form of inflation. Hyperinflation is when the prices of commodities and services skyrocket, usually more than or equal to 50% a month

 

 

THE CLASSICAL THEORY OF INFLATION

INFLATION

In economics, inflation is a rise in the general level of prices of goods and services in an

economy over a period of time. The term "inflation" is also defined as the increases in the

money supply (monetary inflation) which causes increases in the price level.

.

 

 The basic measure of price inflation is the inflation rate, which is the percentage change in a price index over time.

  • · “Classical” -- assumes prices are flexible & markets clear.
  • · This applies to the long run.

 

MONEY

Money is the stock of assets that can be readily used to make transactions.

MONEY: FUNCTIONS

  • · Medium of exchange: we use it to buy stuff.
  • · Unit of account: the common unit by which everyone measures prices and values.
  • · Store of value: transfers purchasing power from the present to the future.

LIQUIDITY

The ease with which money is converted into other things-- goods and services-- is sometimes

called money’s liquidity.

MONEY: TYPES

  • · Fiat money: has no intrinsic value, example: the paper currency we use.
  • · Commodity money: has intrinsic value, examples: gold coins.

 

The money supply is the quantity of money available in the economy. Monetary policy is the

control over the money supply.

Monetary policy is generally referred to as either being an expansionary

policy, or a contractionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply.

 

 

 

State Bank controls the money supply in three ways.

  • · Open Market Operations (buying and selling Treasury bills).
  • · Δ Reserve requirements.
  • · Δ Discount rate which commercial banks pay to borrow from the State Bank.

 

 

 

SYMBOL ASSETS INCLUDED

 C       Currency

M1     C + demand deposits, travelers’ checks, other checkable deposits

M2      M1 small time deposits, savings deposits, money market mutual funds,

          money market deposit accounts

M3      M2 + large time deposits, repurchase agreements, institutional money

          Market mutual fund balances

 

SEIGNIORAGE

To spend more without raising taxes or selling bonds, the govt. can print money. The

“revenue” raised from printing money is called seigniorage

(pronounced SEEN-your-age).

The inflation tax:

Printing money to raise revenue causes inflation. Inflation is like a tax on people who hold

money.

INFLATION AND INTEREST RATES

Nominal interest rate, i is not adjusted for inflation. Real interest rate, r is adjusted for inflation:

r = i - p

THE FISHER EFFECT

The Fisher equation: i = r + p

S = I determines r. Hence, an increase in p causes an equal increase in i. This one-for-one

relationship is called the Fisher effect.

 

TWO REAL INTEREST RATES

p = actual inflation rate (not known until after it has occurred).

pe = expected inflation rate

  • · i – pe = ex ante real interest rate: what people expect at the time they buy a bond or

take out a loan

  • · i – p = ex post real interest rate: what people actually end up earning on their bond or

paying on their loan

 

ADDITIONAL COST OF UNEXPECTED INFLATION:

Arbitrary redistributions of purchasing power. Many long-term contracts not indexed, but based

on pe. If p turns out different from pe, then some gain at others’ expense.

For example, borrowers & lenders, If p > pe, then (r-p) < (r-pe)

then purchasing power is transferred from lenders to borrowers. If p < pe, then purchasing

power is transferred from borrowers to lenders.

 

 

ONE BENEFIT OF INFLATION

Nominal wages are rarely reduced, even when the equilibrium real wage falls. Inflation allows

the real wages to reach equilibrium levels without nominal wage cuts. Therefore, moderate

inflation improves the functioning of labor markets.

 

 

WHAT CAUSES HYPERINFLATION?

Hyperinflation is caused by excessive money supply growth. When the central bank prints

money, the price level rises. If it prints money rapidly enough, the result is hyperinflation.

 

Real variables are measured in physical units: quantities and relative prices, e.g. Quantity of

output produced, real wage: output earned per hour of work, real interest rate: output earned

in the future by lending one unit of output today

Nominal variables are measured in money units: e.g. nominal wage: dollars per hour of

work, nominal interest rate, dollars earned in future

by lending one dollar today,

 

 

INTERNATIONAL CAPITAL FLOWS

Net capital outflows

=S – I =net outflow of “loanable funds” =net purchases of foreign assets

Net capital outflows

The country’s purchases of foreign assets minus foreign purchases of domestic assets. When

S > I, country is a net lender, when S < I, country is a net borrower. An open-economy version

of the loanable funds model includes many of the same elements.

 

SAVING AND INVESTMENT IN A SMALL OPEN ECONOMY

NATIONAL SAVING: THE SUPPLY OF LOANABLE FUNDS

ASSUMPTIONS: CAPITAL FLOWS

 

  • · Domestic & foreign bonds are perfect substitutes.
  • · Perfect capital mobility: no restrictions on international trade in assets,
  • · Economy is small: cannot affect the world interest rate, denoted r*.

= C + I + G + E X - ( C f + I f + G f )

= C + I + G + E X - I M

= C + I + G + N X

 

production function: Y =Y = F (K ,L)

consumption function: C = C (Y -T )

investment function: I = I (r )

exogenous policy variables: G = G , T =T

 

 

ASSUMPTIONS: CAPITAL FLOWS

  • · Domestic & foreign bonds are perfect substitutes.
  • · Perfect capital mobility: no restrictions on international trade in assets,
  • · Economy is small: cannot affect the world interest rate, denoted r*.

 

 

Nominal exchange Rate:

THE nominal exchange rate is simply the price of one currency in terms of the number of units of some other currency. The nominal exchange rate E is defined as the number of units of the domestic currency that can purchase a unit of a given foreign currency.

Formula:

The nominal exchange rate e is the price in domestic currency of one unit of aforeign currency.

where P* is the foreign price.  

 e = EP*/P.

Real Exchange Rate:

The relative price of domestic goods in terms of foreign goods.

the ratio of the price level abroad and the domestic price level, where the foreign price level is converted into domestic currency units via the current nominal exchange rate

Formula:

effective price of domestic goods for foreigners is eP, where P is the domestic price and e is the nominal exchange rate. So

E = eP/P*

 

FISCAL POLICY AT HOME A fiscal expansion reduces national saving, net capital outflows, and the supply of dollars in the foreign exchange market causing the real exchange rate to rise and NX to fall.

 

FISCAL POLICY ABROAD

An increase in r* reduces investment increasing net capital outflows and the supply of dollars

in the foreign exchange market causing the real exchange rate to fall and NX to rise.

 

An increase in investment reduces net capital outflows and the supply of dollars in the foreign

exchange market causing the real exchange rate to rise and NX to fall.

 

DOES PPP HOLD IN THE REAL WORLD?

PPP does not hold in the real world for two reasons:

1. International arbitrage not possible.

  • · Non traded goods
  • · Transportation costs

2. Goods of different countries not perfect substitutes.

Nonetheless, PPP is a useful theory:

  • · It’s simple & intuitive
  • · In the real world, nominal exchange rates have a tendency toward their PPP values

over the long run.

PURCHASING POWER PARITY (PPP)

A doctrine that states that goods must sell at the same (currency-adjusted) price in all

countries is known as PPP. In PPP, the nominal exchange rate adjusts to equalize the cost of

a basket of goods across countries. The reason for PPP is arbitrage, the law of one price.

PPP: e x P = P*

 

ISSUES IN UNEMPLOYMENT

NATURAL RATE OF UNEMPLOYMENT

Natural rate of unemployment is the average rate of unemployment around which the

economy fluctuates. In a recession, the actual unemployment rate rises above the natural rate.

In a boom, the actual unemployment rate falls below the natural rate.

 

NATURAL RATE OF UNEMPLOYMENT

Natural rate of unemployment is the average rate of unemployment around which the

economy fluctuates. In a recession, the actual unemployment rate rises above the natural rate.

In a boom, the actual unemployment rate falls below the natural rate.

 

BREAK-EVEN INVESTMENT

(d + n) k = break-even investment, the amount of investment necessary to keep k constant.

  • · Break-even investment includes:
  • · dk to replace capital as it wears out.
  • · nk to equip new workers with capital. (Otherwise, k would fall as the existing capital

stock would be spread more thinly over a larger population of workers).

 

THE EQUATION OF MOTION FOR k

With population growth, the equation of motion for k is Dk = s f (k) - (d + n) k. Where S f (k)

= actual investment, (d + n) k = breakeven investment.

 

STARTING WITH TOO MUCH CAPITAL

Then increasing c* requires a fall in s. In the transition to the Golden Rule, consumption is

higher at all points in time.

 

STARTING WITH TOO LITTLE CAPITAL

Then increasing c* requires an increase in s. Future generations enjoy higher consumption,

but the current one experiences an initial drop in consumption.

 

THE GOLDEN RULE LEVEL OF CAPITAL STOCK

K*gold = the Golden Rule level of capital, the steady state value of k that maximizes

consumption. To find it, first express c* in terms of k*:

c* = y* - i*

= f (k*) - i*

= f (k*) - k*

In general: i = Dk + k, in the steady state: i* = k* because Dk

 

 

What happen to export & import, if exchange rate change in domestic country:

If  real exchange rate increase then

↑ε ⇒ US goods become more expensive relative to foreign goods ⇒ ↓EX, ↑IM⇒ ↓NX

Export of domestic country decrease and Import Increase :

A higher currency makes a country's exports more expensive and imports cheaper.

If real exchange rate decreas then :

 increase exports and decrease imports:

A lower exchange rate would increase  Export and decrease imports :

 

Actions of non-profit organization will effect a lot on domestic investors and on overall macroeconomic indicators as they purchase all the equipments like rickshaws and sewing machines from domestic market then it will increase the supply of material. So, demand will be increase. Domestic investor will willing to invest more and they will try to work more efficiently so GDP rate will increase. An increase in demand deposits will indicate expectations that inflation will rise, resulting in a decrease in bank lending and an increase in savings.

INLFATION RATE

As there are so many domestic investors which will invest in the market because their concern is with profit and company is purchasing all the equipments from domestic area so competition will increase then inflation rate will get decrease so purchasing power of people will increase.

TAX RATE;

AS production will increase then tax on things will also increase.so tax rate will also increase.

CPI:

This action of nonprofit organization will change the economic growth , price of goods will change so consumer spending pattern will also change. Competition will be high so price will decrease of goods and then consumer will spend more

UNEMPLOYMENT:

It will decrease the unemployment as, it will change the business cycle because consumer expectations can indicate future consumer spending. As unemployment will decrease then well being of society will increase.

INTEREST RATE:

As the company is purchasing all equipments from domestic market so investors will invest more because it is nonprofit organization and investor’s concern is just with return, this thing will attract them more to invest.

 

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