Economic Development Prepared by Chan Bonnivoit

MSc.
Chan Bonnivoit
Royal University of Agriculture
Chamcar Doung
ECONOMICS
DEVELOPMENT
1.Considerationonthefactorsofeconomic
development
1. Terminologicalterm
Development, Level of Development and Process of
Development
y Developmentdefinesas:
y Levelofdevelopment
y Processofdevelopment
y Levelofdevelopment
y Beingdevelopmentatcertaintime
y Processofdevelopment
y Beingatrendofthelevelofdevelopmentinaperiodoftime
1.Considerationonthefactorsofeconomic
development
y Thusitshouldbedeterminedthemeaningofthelevelof
development.
y Meaningofthelevelofdevelopment:
y Levelofwelfareortheleveloftheprosperityofthepeople
y Levelofwelfareisassumedasalivingstandard
y A living standard of the people can be measured by the
basic need. If the basic need is improved, it can be said
thatthelivingstandardofthepeopleisimproved.
I.Considerationonthefactorsofeconomic
development
y Meaningofthebasicneedformulatedbyscientist:
y To provide the people the existing of living conditions
oratleastofthehumanvaluewhichmeansthatshould
beprovidedphysic,psychologyandsocialofthehuman
tothepeople.
y MeaningofthebasicneeddefinedbyILO:
y Haveenoughfood,home,clothing,homesmaterials,
y Relating to social conditions, it should be provided
health, education, clean water, healthy and sanitation
andpublictransportation.
y It can be included improving of works conditions,
holiday and dialogue, social security and humanity
freedomaswellsomenotimportantthingsrequested.
development
y Throughthemeaningoftheleveloflivingstandard,it
canbeprovidedtounderstandthetermofdevelopment
relatingtothestaticanddynamicdevelopment.
y Therefore,itcanbesaid,thatthelevelofdevelopment
isunderstoodasalevelofthelivingstandardata
certaintime,and
y Theprocessofthedevelopmentisdeterminedwhatthe
capacityorthelevelofthedevelopmentwouldbe
changedinaperiodoftime.
development
y Buttofindoutthelevelofthelivingstandarditisverydifficult,
because it depends from the Country to the Country and from
the region to the region due to the economic, geographical and
cultural differentiation, the behavior and the livings style of
thosepeople.
y It means that it doesnt have the common value from the
Country to the Country and from the region to the region
regardingtothelevelofthelivingstandard.
y Therefore, it is very difficultly to have common value taking to
demonstrate in determining the Countries group in the world,
which are a group of LDC, Developing Country or Developed
Country.
y HowcanbedeterminedsuchCountries?
development
2. Indicatortomeasurethedevelopment
Definitionofdevelopmentsindicator
y Developmentindicatorsshouldhavetwocriterion:
y Theycanmeasurethelevelofdevelopment.
y Theyshouldhavethethresholdvaluewhichtakesto
determinethelevelofdevelopmentoftheCountries
whichcanbeclassifiedintothegroupoftheLeast
DevelopedCountries,theDevelopingCountriesorthe
DevelopedCountries.
y Suchdevelopmentindicatorscanmeasureorindicatethe
developmentlevelofeconomic,socialandpolitical
issues.
development
2. Indicatortomeasurethedevelopment(cont)
EconomicIndicators
PerCapita
Nationalincome/Population
Distributionindicator
LorenzCurve
Gini Coefficient
-e--e cu-cu--u-u:-
y .. ... . . .. :... . .. .. :.........
.....:.... ......
cu-cu--u-u:- - ::--u:-:--:u-:--
y . :.: . . ...... :... .. . .. :.... .
..:.......:.............. :....
. . ... . .... . ....:.......
. :.: . .... ... . (GDP)
cu-cu--u-u:- - ::--u:-:--:u-:--
y :.. . . :... =.. ... . = . :.:
y 370 - 220 = GDP = 150
PerCapita=Nationalincome/Population
GNP
GDP
NNP to
NNP to
y PerCapita=Nationalincome/Population
GNP
GDP
NNP to
NNP to
y GDP 9,299.2
y Plus:receiptsoffactorincomefromtherestoftheworld +305.9
y Less:paymentsoffactorincometotherestoftheworld 316.9
y Equals:GNP 9,288.2
y Less:Depreciation 1,161.0
y Equals:NetNationalProduct(NNP) 8,127.1
y Less:indirecttaxesminussubsidiesplusother 675.5
y Equals:NationalIncome 7,469.7
y Less:corporateprofitsminusdividends 485.7
y Less:socialinsurancepayments 662.1
y Plus:personalinterestincomereceivedfromthegovernmentand consumers +456.6
y Plus:transferpaymentstopersons +1,011.0
y Equals:PersonalIncome 7,789.6
y Less:personaltaxes 1,152.0
y Equals:DisposablePersonalIncome 6,637.7
THECOMPONENTSOFGDP
y WhatIsNotCountedinGDP?
y GDPexcludesmostitemsthatareproducedand
consumedathomeandthatneverenterthe
marketplace.
y Itexcludesitemsproducedandsoldillicitly,suchas
illegaldrugs.
THECOMPONENTSOFGDP
y GDP(Y)isthesumofthefollowing:
y Consumption(C)
y Investment(I)
y GovernmentPurchases(G)
y NetExports(NX)
GDP=Y=C+I+G+NX
THECOMPONENTSOFGDP
y Consumption(C):
y Thespendingbyhouseholdsongoodsandservices,
withtheexceptionofpurchasesofnewhousing.
y Investment(I):
y Thespendingoncapitalequipment,inventories,and
structures,includingnewhousing.
Business fixed investment includes the equipment and
structures that businesses buy to use in production.
Residential investment includes the new housing that
people buy to live in and that landlords buy to rent out.
Inventory investment includes those goods that businesses
put aside in storage, including materials and supplies, work
in progress, and finished goods.
THECOMPONENTSOFGDP
y GovernmentPurchases(G):
y Thespendingongoodsandservicesbylocal,provincial,
andcentralgovernments.
y Doesnot includetransferpayments(e.g.
unemploymentinsurancepayments),becausetheydo
notrepresentspendingongoodsandservicesorarenot
madeinexchangeforcurrentlyproducedgoodsor
services.
y NetExports(NX):
y Exportsminusimports.
GDPandItsComponents
Copyright2004 South-Western
GDPandItsComponents
(2001)
Consumption
69%
Government Purchases
18%
Net Exports
-3 %
Investment
16%
cu-cu--u-u:--:-:--:- --cu-cu--u:-u---
(Nominal GDP and Real GDP)
y GDP:. .. GDP :...:. (Current Price)
y Nominal GDP
t

y GDP .. .. GDP :...:. (Constant Price) :.....
y Real GDP
t

y ... . ........:..... .: ..
.. . . ..... . .. ... .
t
t
i
Qi P
t t
Qi Pi
0
RealandNominalGDP
RealandNominalGDP
RealandNominalGDP
development
y ProblemoftheCalculationofPerCapita
Deficitoftechnicalinfrastructuretocalculateper
capita
Notexcludedtheadvancepaymentofthehousehold
Marketpriceisaffectedeitherbythepowerof
suppliersorconsumer
Problemoftheregistrationofpopulation
Problemofconvertingpercapitaintoforeign
currency(US$)
Theoryofpurchasingpowerparity(PPP)
(P
cam,rice
=P
US,rice
S(R/US$))
BP=(X.P
R
E
no
.M.P
US$
)+(CM CX)
PurchasingPowerParity
inaPerfectCapitalMarket
y Purchasingpowerparity(PPP) isbuiltonthenotion
ofarbitrageacrossgoodsmarketsandtheLawofOne
Price.
y TheLawofOnePrice istheprinciplethatinaPCM
setting,homogeneousgoodswillsellforthesame
priceintwomarkets,takingintoaccountthe
exchangerate.
/ $ wheat UK, wheat US,
S P P =
I.Introduction
Imports(Debits)
CurrentAccount:(M)
Goodsandservices
Factor andassetsincome
Assets transfer (= transfer
account)
Aids, gifts etc. (= unilateral
transfer)
CapitalAccount:(CM)
Directinvestments
Securitypurchase
Bank claims, liabilities,
obligations,etc.
Governmentassetsabroad
Exports(Credits)
CurrentAccount:(X)
Goodsandservices
account)
Aids,giftsetc.(=unilateral
transfer)
CapitalAccount:(CX)
Directinvestments
Securitypurchase
obligations,etc.
development
y LorenzCurve
F
Q
development
y LorenzCurve(cont)
y Axislinepresentedthepercentageofpeoplegrouphaving
differentincome.
y Ordinatelinepresentedthepercentageoftheirincomein
relationtoGDP.
y OUisadiagonalline.
y IftheLorenzCurvehasatendencytoapproachthediagonal
line,itmeansthattheincomedistributionintheCountry
tendstoequally.
y IftheLorenzCurveisfarawayfromthediagonalline,it
meansthattheincomedistributionoftheCountrytendsto
unequally.
development
y Gini Coefficient
y Concentratingonlyonecoefficienttopresentthe
incomesdistributionoftheCountry
y Gini coefficient=SurfaceofLerenz Curve/(1/2
Quadrant)=[(F
i1
+F
i
)Q
i
] 1
y Gini coefficienthasatendencyto0,itmeansthat
theincomedistributionintheCountrytendsto
equally.
y Gini coefficienthasatendencyto1,itmeansthatthe
incomedistributionintheCountrytendsto
unequally.
Group of
People
(i)
Q
i
(Income %)
F
i
(Number of
people
interviewed
F
i-1
F
i-1
+F
i
(F
i-1
+F
i
)Q
i
Labor (1)
15% 20% (20) 0 20% 0.03
Farm (2)
12% 40% (20) 20% 60% 0.072
Businessman
(3)
35% 60% (20) 40% 100% 0.35
Official (4)
20% 80% (20) 60% 140% 0.28
Other (5)
18% 100% (20) 80% 180% 0.324
100% 100% 1.056

GC = [(F
i-1
+ F
i
) Q
i
] 1 = 1.056 1 = 0.056
Calculation of Gini Coefficient (as e.g.)
development
y AnalysisofGini
F
Q
Case 1
Case 2
development
y AnalysisofGini
F
Q
development
2. Indicatortomeasurethedevelopment(cont)
SocialandpoliticalIndicators
IndicatorsdefinedbyEconomistsAdelman/Morris
QuantificationmethoddefinedbybothEconomists
Notuseablemethod,becauseof
BaseonownviewofScientistsorEconomist
Notcollectableforrelativevaluebetweentheindicators
development
3. GroupingtheCountryGroupintheReality
1. GroupingtheCountryGroupbyOECD
2. GroupingtheCountryGroupbyUN
IndustrialCountryGroup
TransitionEconomicGroup
DevelopingCountryGroup
LeastDevelopedCountry
MostSeriouslyAffectedCountry
NewIndustrialCountry
LandLockedCountry
- For the 2006 triennial review, the threshold for graduation was $900,
about 20 per cent above the $745 threshold for inclusion.
- Gross national income per capita
- Human Asset Index
- Economic Vulnerability Index
- There are two indicators of health and nutrition:
- the percentage of population undernourished and,
- the mortality rate for children aged five years or under
And, two for education:
- the gross secondary school enrolment ratio and,
- the adult literacy rate.
Figure 1: Composition of the economic vulnerability index (EVI)
II.TheoreticalInterpretationofEconomic
Development
1. NaturalResourcesandEco.Development
Limitationofsubstitutionofinputfactors
NaturalResources
Rawmaterials
Land
Weather
Environment
Second characteristic of production
function
L
K
0
Iso-quant
X
J
I L
1
K
2
K
1
L
2
MRS = L/K = MP
K
/MP
L
= R/W
MRS: Marginal rate of substitution
MP
L
: Marginal production of Labor
MP
K
: Marginal production of Capital
W: Wage
R: Rent
Iso-Cost
Development
a. RawmaterialsandEco.Development
SomeIndustrialCountrieslikeJapan,HongKong,
Singapore,Switzerlandetc.builttheirCountry
withoutrawmaterials,
TheCountrieshavespecialization(AdamSmith
Theory).
AdamSmith:Capitalaccumulationisaprerequisite
toextendthenationalspecializationandthe
allocationoftheresourceswhichareabasisto
improvethePerCapita
Development
a. RawmaterialsandEco.Development
Countriesobtainingrawmaterialstendtouse
thoseexportrevenueonlyforimportingthe
consumptiongoods,nottoimportthegoodsfor
buildingtheirindustrialinfrastructure.
Priceofrawmaterialsisalwayscheaper.The
reasonsarefollowing(seeslidesbelow):
Tariffpeaksandhightariffs
y GenerallyusedbyIOs:
y Nationalpeaks: 3timesthenational
average
y Internationalpeaks: >15%
y BUT,THEREISNOAGREEDWTO
DEFINITION
EC15:boundAVGperHSChap.
0
2
4
6
8
10
12
14
16
18
20
0
3
2
7
3
4
4
1
4
8
5
5
6
2
6
9
7
6
8
4
9
1
G
r
HS Chapter (Non Ag tariff lines only)
A
v
e
r
a
g
e

(
%
)
Bound Duty AV
I nt er n. Peak > 15%
Nat . AVG = 4%
Nat i on. Peak > 12%
3X
Nat .
AVG
Brazil:boundAVGperHSChap.
0
10
20
30
40
50
60
70
80
90
0
3
2
8
2
8
3
2
3
1
3
6
4
4
4
3
4
8
6
8
5
1
5
6
6
1
6
6
7
1
7
2
7
8
8
4
8
5
8
6
8
8
9
1
9
6
HS Chapter (Non AG tariff lines only)
A
v
e
r
a
g
e

(
%
)
Bound duty AV
Nat . AVG = 30%
3X
Nat .
AVG
0
5
10
15
20
25
30
35
40
45
Raw material Semi-manufactured Finished product
Tariff
(%)
Tariffescalation:textilesandclothing
Tariff Peaks:
Japan
minimum tariff 0% maximum tariff 958%
Tariff Escalation:
cocoa imports into the EC
cocoa beans milk chocolate
0% 18.7%
Forms:
Specific duties and ad valorem duties
Seasonal duties
Matrix tariffs
Tariff only but problems still exist
Development
b. LandandEco.Development
y Notefficientusingofland,becauseof
ProblemofownershipofLand
Lackofcropmanagement
Lackoflandmanagement
Lackofirrigationsystem
Lackoftechnologyandknowhow
Lackofpublicandprivateinvestment
Lackofcredit
andsoon
Development
b. LandandEco.Development(cont)
y Inefficientofusinglandcanbeimproved
through:
Publicandprivateinvestmentinirrigation
system,fertilizerandotherinfrastructure
Legalandinstitutionalreform,including
creditreformandbureaucracyreform
Setuplocalfarmcommunityorassociation
inordertoprovidenewtechnologyknow
howandinformationrelatingtomarket,
etc.
Development
c. WeatherandEco.Development
MostdevelopedCountrieslocatedinthezonewherehavea
themoderatedweather,namelyfourseasonsinayear.
DevelopingCountriesmostlylocateintheinadequatezone
oftheworld.
Theinadequateweathercanbenegativelyeffectedonthe
humanhealthaswelltheproductivity,becauseitcancreate
abestconditionsforthegrowthoforganism,virus,bacteria
etc.tospreadtheiractivitieswhichcanhastyhazardthe
humanandanimalhealth.
ButCountrieslikeSingaporeandMalaysialocatealsointhe
inadequateweatherzone,buttheCountriescanbe
developedtheireconomicsbecauseofimprovingthehealth
system,sanitarymeasuresandworkconditionsfortheir
people.
Development
d. EnvironmentandEconomicDevelopment
Urbanization,gaspollution,waster,migrationintothe
City,woodcuttingetc.canrigorousdamagethe
environment.
Buttousetheenvironmentinreproductionable
mannerfordevelopingtheeconomicsinthecountry
cannotdevastatetheenvironment.
Currently,mostcountries,includingthedeveloping
countriesandleastdevelopedcountriesintheworld
aretakingintoaccounttousetheenvironmentinthe
sustainablemanner.
Development
e. Conclusion
HavingnaturalresourcesmeansthattheCountryhas
thecapacitytodeveloptheeconomicoftheCountry.
Butitdoesntmeansthatitcandeterminethelevelof
economicdevelopmentoftheCountry.
TheeconomicdevelopmentoftheCountrydepends
muchmoreonthemanagementandtheknowledgeto
usethesenaturalresources.
Development
2. CapitalandDevelopment(cont)
EffectsoftheCapitalontheEco.Development
CapitalistheMotor.
AdamSmith:Capitalaccumulationisaprerequisiteto
extendthenationalspecializationandtheallocationof
theresourceswhichareabasistoimprovethePer
Capita.
ProductionelasticityoftheDevelopedCountriesis
larger2timeor3timethantheproductionelasticityof
theDevelopingCountries.
Development
RelationshipbetweenMaterialCapitalandHR
Materialcapitalcanbeequipment,building,goodsin
store,inventory,etc.
HRcannotbeusedasamaterialcapital,althoughHR
isdefinedasaskilledCapital.
BaseonEconomistDenisonHRinvolvedinthe
productionprovidestheshareoftheoutputfrom50%
to70%incomparingtothematerialcapitalproviding
onlyfrom30%to50%.
Development
Basictheorytobuildupthecapital
Development
ReasonsoftheinsufficiencyofCapital
Tobeinsufficientinsavings
Tobeinsufficientininvestments
Tobeinsufficientinfinancialinstitutions(1)
Lackoncapitalequipmentsofsubpopulation
Capitalflowintoabroad
Development
Low Output
Low Per Capita
Low Saving
Low Capital
Investment
Low Capital
Equipments
Low Productivities
Reasonsofdeficitofsaving
Itcanhaveadeficiencyofcapacitytosavelikeavicious
circlebelow.
Development
Reasonsofdeficitofsaving(cont)
Lackonwillingnesstosave,becauseof:
Fluctuatinginterestratethatcannotbe
predicable
Consideringmetaeconomicwhichaffects
onthecomparisonbetweenthevalueof
currentandfutureusingoftheircapital.
Development
Reasonsofdeficitofinvestments
Deficitofcapacitytoinvest:Itcanbedeficiencyof
investmentclimateswhicharefollowing:
Economic
Economicpolicy(Fiscalandmonetarypolicy)
Economicconditions(Governmentbudgetdeficit/surplus,
balancepayment,interestrate,inflation,productivity,
economicgrowth,speculativesentiments)
Politicalsituation
MarketPsychologyorconsumerconfidence
Investment meanseverykindofasset,ownedorcontrolled,byaninvestor,
includingbutnotlimitedtothefollowing:
y (i) movableandimmovablepropertyandotherpropertyrightssuchas
mortgages,liensorpledges;
y (ii) shares,stocks,bondsanddebenturesandanyotherformsofparticipation
inajuridicalpersonandrightsorinterestderivedtherefrom;
y (iii) intellectualpropertyrightswhichareconferredpursuanttothe lawsand
regulationsofeachMemberState;
y (iv) claimstomoneyortoanycontractualperformancerelatedtoabusiness
andhavingfinancialvalue;
y (v) rightsundercontracts,includingturnkey,construction,management,
productionorrevenuesharingcontracts;and
y (vi) businessconcessionsrequiredtoconducteconomicactivitiesand having
financialvalueconferredbylaworunderacontract,includinganyconcessions
tosearch,cultivate,extractorexploitnaturalresources.
y Theterminvestment alsoincludesamountsyieldedbyinvestments,in
particular,profits,interest,capitalgains,dividend,royaltiesandfees.Any
alterationoftheforminwhichassetsareinvestedorreinvestedshallnotaffect
theirclassificationasinvestment;
Development
Development
Low Output
Low Per Capita
Low Domestic
Demand
Low Capital
Investment
Low Capital
Equipments
Low Productivities
Reasonsofdeficitofinvestments
Itcanhaveadeficitofwillingnesstoinvest
Development
Reasonsofinsufficiencyoffinancialinstitutions
insufficiencyofsomefinancialinstitutionslike:
FinancialMarket
StockMarketandBondsMarket
FinancialIntermediaries
CentralBank
CommercialBank
SpecializedBank
MutualFund
OtherFinancialMarket
MicroFinancesInstitutions
LoanandCreditAssociations
InsurancesandPensionFunds
Development
Reasonsoflackonfinancialinstitutions(cont)
Itcanbeadeficiencyofqualityoffinancialinstitutions:
Sufficiencyofliquidity
Currentratios
AcidTest
SourceofCapital
Insufficiencyofprofitability
Development
Net worth is a company's total assets minus total liabilities.
Development
Development
Development
Debit
Debit
Credit
Credit
-
-
Consumption
Consumption
-
-
Investments :
Investments :
-
-
Capacity Building
Capacity Building
-
-
Assets
Assets
-
-
GNP
GNP
-
-
Income from Assets
Income from Assets
-
-
Income from Working
Income from Working
Deficitofcapitalequipmentsofsubpopulation
Balancesheetofhouseholdincome
Development
Deficitofcapitalequipmentsofsub
population(cont)
Theeffectsoftheirhouseholdincomeare:
Beinglowskilllabor,becauseofdeficitofcapitalto
investonthecapacitybuilding.
Havingsmallland
Usingonlytraditionalequipmentsfortheir
productions
Deficitofruralcreditsandinvestments
Development
Deficitofcapitalequipmentsofsubpopulation
(cont)
Bythesideofthedevelopmentpolicythere
distributionincomepolicy whichoftenisusedbymost
Countriesaresuccessfullyinstrumenttodiminishthe
deficitofcapitalequipmentsofsubpopulation.
PriceandIncomePolicy(directpolicy)
FiscalPolicy(indirectpolicy)
AdamSmith: Thenationalspecializationandthe
allocationoftheresourcesareabasistoimprovetheper
capita.
Development
Thereasonofdeficitofcapitalisalsothe
capitalflowintoabroad:
y Repatriationofforeignincomeandprofit.
y Repaymentofthecreditandpaymentof
interestrate.
y Localpeoplesavetheirmoneyinabroad.
y Highskilledlaborsmovetoworkinabroad.
Development
Cambodianinvestmentprotection:Theinvestmentlawand
subdecreecontainsanumberofimportantguaranteesforthe
investors:
Equaltreatmentofallinvestors
Nonationalizationadverselyaffectingthepropertyof
investors
Nopricecontrolsonproductsorservices
Norestrictiononforeignequityparticipation
Norestrictiononforeignconvertibility
Remittanceofforeigncurrenciesabroad.
Development
3.Socialandpoliticalconditionsandeco.
Development
Problemofthereligion
Familystructure(clan)
Problemofethnic
Deficitofmobilizationorproblemof
marginalizationofthedifferentgroupof
people
Development
4.DevelopmentandinternationalEconomic
Internationaleconomicsmeansall
economicaltransactionsbetween
households,privatesandpublicofone
Countryandhousehold,privatesand
publicofanotherCountries
Imports(Debits)
CurrentAccount:(M)
Goodsandservices
account)
Aids, gifts etc. (= unilateral
transfer)
CapitalAccount:(CM)
Directinvestments
Securitypurchase
obligations,etc.
Exports(Credits)
CurrentAccount:(X)
Goodsandservices
account)
Aids,giftsetc.(=unilateral
transfer)
CapitalAccount:(CX)
Directinvestments
Securitypurchase
obligations,etc.
Development
88
TheU.S.BalanceofPayments,2005(MillionsofDollars)
International Transactions: Data
Development
Balancesheetofbalancepayment
X+CM=M+CX
=>M X=CM CX
ifM>X=>CM>CX,itmeanstradedeficit.InthiscasetheCountry
shouldtakethecreditfromtheabroadtocompensatethedeficit
inordertomaintainthecurrentvalueofexchangerate.
ifM<X=>CM<CX,itmeanstradesurplus.InthiscasetheCountry
canusethesurplusforpublicinvestmentorincreasingthesalary.
BalanceofPaymentsandtheExchange
Rate
Q
P
Exchange rate $
Credits Debits
Current Account
1 Exports
$1,418.64
2 Imports
($1,809.18)
3 Unilateral Transfers $10.24 ($64.39)
Balance on Current Account
($444.69)
Capital Account
4 Direct Investment $287.68 ($152.44)
5 Portfolio Investment $474.39 ($124.94)
6 Other Investments $262.64 ($303.27)
Balance on Capital Account
$444.26
7 Statistical Discrepancies
Overall Balance
$0.30
Official Reserve Account
($0.30)
0.73
S
D
Q
P
As U.S. citizens import, they supply dollars to the FOREX market.
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
($444.69)
Capital Account
$444.26
Overall Balance
$0.30
($0.30)
0.73
Exchange rate $
S
D
Rate
Q
P
As U.S. citizens export, others demand dollars in the FOREX market.
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
($444.69)
Capital Account
$444.26
Overall Balance
$0.30
($0.30)
0.73
Exchange rate $
S
D
Rate
Q
P S
D
As the U.S. government sells dollars, the supply of dollars increases.
S
1
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
($444.69)
Capital Account
$444.26
Overall Balance
$0.30
($0.30)
0.73
Exchange rate $
Rate
WhatDoestheTradeBalance
Really Mean?
y Soinspiteofitsname,anditsdefinition,the
tradebalance
y Isnotreallyabouttrade,whichisjustthesymptom
y Itis aboutwhetherwearelivingwithinourmeans
y Whenisatradedeficitgood?
y Whenthecountry(likeayoungperson)isinvesting
forthefuture(likeasuccessfuldevelopingcountry)
y Notwhenitisgoingintodebtjusttofinancecurrent
consumption(liketheUS)
What i s t he gover nment debt
and t he annual budget def i ci t ?
Annual Deficit (2002)
The government debt
is an accumulation
of all past annual
deficits. In 2001, the
debt of the U.S. federal
government was $3.2
trillion.
When a government spends more than it collects in taxes, it borrows
from the private sector to finance the budget deficit.
ConditionofinternationalTrade
Absolutepriceadvantage
P
1
CountryA<P
1
ofCountryB,inthiscaseAexportsgood1
toB.(onlywiththestableexchangerate)
Comparativepriceadvantage
P
1
/P
2
of Country A < P
1
/P
2
of Country B, in this case A
exports good 1 to B, and B exports good 2 to A (only with
thestableexchangerate)
Exchangerateandinflation(interestrate)
The rates varied occur the change of the price of goods
trading and can change the direction of trade. (One
example : if S($/pound) = 1, the good (price in England 20
pound und in USA 30 US$) is exported to US, but if the
S($/pound)=2,thencanthetradechangethedirection)
Development
Factors that Shift R
F
and R
D
It present only
return, not relating
to exchange rate
presented in the
ordinal axe
Factors that Shift R
F
and R
D
Conditionsofinternationaltrade(cont)
Domesticdemandfortheproduct.
LocationofexportCountry
Productiondiversifyingindifferentareascanprovidethe
differencefactorallocationaswellsalary.
Profitandcostvariation
It depends on variation of production condition like
production factor, technology, salary, state policy (tax
andexpenditureforinfrastructure)andmoneysupply.
Tariffsandnontariffbarriers
Advalorem,specifictax,compoundtariff,MFNandGSP.
Quota, voluntary export restriction, dumping price,
subsidies, SPS, TBT, safeguard and government
procurement.
Development
e
Income, Output, Y
LM*
IS*
e
Income, Output, Y
LM*
IS*
IS*'
LM*'
When income rises in a small open economy, due to
the fiscal expansion, the interest rate tries to rise but
capital inflows from abroad put downward pressure
on the interest rate.This inflow causes an increase in
the demand for the currency pushing up its value
and thus making domestic goods more expensive
to foreigners (causing a NX). The NX offsets
the expansionary fiscal policy and the effect on Y.
When the increase in the money supply puts downward
pressure on the domestic interest rate, capital flows out
as investors seek a higher return elsewhere. The capital
outflow prevents the interest rate from falling. The
outflow also causes the exchange rate to depreciate
making domestic goods less expensive relative to
foreign goods, and stimulates NX. Hence, monetary
policy influences the e rather than r.
+G, or T
+e, no Y
+G, or T
+e, no Y
+M
-e, +Y
+M
-e, +Y
The Mundel l -Fl emi ng Model
Under Fl oat i ng Exchange Rat es
The quantity equation is an identity: the definitions of the four
variables make it true. If one variable changes, one or more of the
others must also change to maintain the identity. The quantity equation
we will use from now on is the money supply (M) times the velocity of
money (V) which equals price (P) times output (Y):
Money Velocity = Price Output
M V = P Y
Because Y is also total income, V in the quantity equations is called the
income velocity of money. This tells us the number of times a dollar
bill changes hands in a given period of time.
TheTariff
Ad valorem tariff: a trade tax is equally to a given
percentageofsellingprice.
Ex:13%forimportedknitcottonheadwearinUS$.
Specifictariff:atradetaxisequallytoafixedamountof
moneyperunitsold.
Ex:14centsoneachpoundofimportedfertilizer.
Compound tariff: a trade tax that has both a specific
andanadvalorem.
Ex: 19 cents per pound plus 18.5 percent ad valorem on
importedcashmeresweaters.
TheTariff(cont)
MFN(mostfavorednation):
IfanyotherCountrygrantsanotherCountryMFNstatus,
itagreestochargetariffsagainstthatCountrysgoodthat
arenohigherthanthoseimposedagainstthegoodsofany
otherCountry.
GSP(generalsystemofpreference)
Which was instituted by the United States in the early
1970.
OtherindustrializedCountries,includingCanada,ECand
JapanhavetheirownGSPprograms.
The idea behind the GSP is that by charging lower tariffs
ongoodsfromDevelopingCountries
Tariffs
IA
Tariff Rate Quota
IB
Agricultural Products
Section I
Non-Agricultural products
Section II
Part I
Part II
Part III
Part IV
Most Favored Nation Tariff
Preferential Tariffs
Non-tariff Concessions
Agricultural products:
Commitments limiting subsidization
D
O
H
A

S
C
H
E
D
U
L
E
St at e A
Schedules of Concession on Goods
4. Tariff
(Schedules of concessions for WTO Members)
4. Tariff
(Schedules of concessions for WTO Members)
Schedule VI SRI LANKA
This Schedule is authentic only in the English language
PART I MOST-FAVOURED NATION TARIFF
SECTION II Other Products
Tariff item
number
Description of products Base rate of duty
(U/B)
Bound rate of duty Initial negotiating
right
Other duties and
charges
1 2 6 4 5 6
0301 LIVE FISH
030110 - ornamental fish 66% (U) 50%
030191 -- trout (salmo trutta, salmo gairdneri, salmo
clarki, salmo agua bonita, salmo gilae)
66% (U) 50%
030192 -- eels (anguilla spp.) 66% (U) 50%
030193 -- carp 66% (U) 50%
030199 -- other: 66% (U) 50%
0302 FISH, FRESH OR CHILLED,
EXCLUDING FISH FILLETS AND
OTHER FISH MEAT OF HEADING NO.
0304
030211 -- trout (salmo trutta, salmo gairdneri, salmo
clarki, salmo agua bonita, salmo gilae)
66% (U) 50%
030212 -- pacific salmon (oncorhynus spp.), atlantic
salmon (salmo salar) and danube salmon
(hucho hucho)
66% (U) 50%
4. Tariff (Schedules of concessions for WTO Members)
4. Tariff (Schedules of concessions for WTO Members)
Bound and Applied MFN Tariffs
0.0%
20.0%
40.0%
60.0%
80.0%
100.0%
120.0%
140.0%
160.0%
180.0%
200.0%
2006 2006 2005 2006 2006 2006 2006 2006 2006 2006 2006 2006 2006
Bangladesh Norway India Korea Indonesia Brazil Philippines Japan Malaysia China EC United
States
Australia
Bound Tariff Applied Tariff
Bound Duty
Applied Duty
Source) World Trade Report 2004
13
Philippines
0.0
10.0
20.0
30.0
40.0
Wood, pulp, paper and
furniture
Textiles and clothing
Leather, rubber,
footwear
and travel goods
Metals
Chemicals and
photographic
supplies
Transport equipment
Non-electric machinery
Electric machinery
Mineral products
and precious stones
and precious metals
Manufactured
articles not
elsewhere
specified
Fish and
fish products
Petroleum
Binding coverage : 61.8%
Average of bound dut ies : 23.4%
Average of applied dut ies : 4.3%
Bound Rates and Applied Rates by Sector
China
0.0
10.0
20.0
30.0
40.0
furniture
Leather, rubber,
footwear
and travel goods
Metals
Chemicals and
photographic
supplies
Transport equipment
Electric machinery
Mineral products
and precious stones
and precious metals
Manufactured
articles not
elsewhere
specified
Fish and
fish products
Petroleum
Bound Duty
Applied Duty
Source) World Trade Report 2004
18
US
0.0
10.0
20.0
30.0
40.0
furniture
Leather, rubber,
footwear
and travel goods
Metals
Chemicals and
photographic
supplies
Transport equipment
Electric machinery
Mineral products
and precious stones
and precious metals
Manufactured
articles not
elsewhere
specified
Fish and
fish products
Petroleum
EU
0.0
10.0
20.0
30.0
40.0
furniture
Leather, rubber,
footwear
and travel goods
Metals
Chemicals and
photographic
supplies
Transport equipment
Electric machinery
Mineral products
and precious stones
and precious metals
Manufactured
articles not
elsewhere
specified
Fish and
fish products
Petroleum
Nontariffbarriersandargumentfor
protection
Quota:
Government imposed the limitation on the volume or
valueofinternationaltrade.
Quota rent: Profit that come about, because a quota has
artificiallyraisedthepriceofimportedproducts.
Quotaoccurs thelossoftheconsumers
Tariff Quotas or Tariff Rate Quotas
Imports (MT)
Imports (MT)
Quota volume
Quota volume
Applied duty %
Applied duty %
Out-of-quota
tariff
In-quota
tariff
Tariff Quotas or Tariff Rate Quotas
protection
Embargo:
Embargo is a complete ban on trade in product or
products.
Voluntaryexportrestraint (VER)
Agreement between imported and exported Countries
whereby the export agree to limit the amount of their
export.
Through this agreement these foreign industries are able
toraisetheirprices.
Inthecase,theimportedCountrylosstherevenueC=C+
C
2
(seenfigurebelow).
Financialcontributionsandkindsofcontributionby
GovernmentasExamples
Subsidies
y Grants
y Loans
y Loanguarantees
y Taxcredits
y Taxexemptions
y Importdutyexemptions
oncapitalequipmentused
y Provisionofgoodsor
servicesotherthangeneral
infrastructure
y Purchaseofgoods
y Incomeorpricesupports
y Govt entrustsordirects
privatebodytocarryout
abovefunctions
protection
Exportsubsidy:
A payment by a government to an industry that leads to
anexpansionofexportsbythatindustry.
ExportsubsidiesPolicycoverage Article9.1(WTO)
(a)directsubsidiescontingent on
exportperformance
(b)saleordisposalforexportby
govt atpricebelowdomestic
market
(c)paymentsonexportsfinanced
bygovt action
(d)marketingsubsidies,including
handling,upgrading,transport,
freight
(e)favourableinternaltransport
andfreightchargesforexports
(f)subsidiesonagr.Products
contingentonincorporationin
exportedproducts
OtherNontariffbarriersandargument
forprotection
Pi l l ar s of t he Agr eement on Agr i cul t ur e
Mar ket
Access
Domest i c
Suppor t
Expor t
Compet i t i on
Tar i f f i cat i on
Bi ndi ngs
Reduct i ons
Mar ket Access
Tar i f f Rat e Quot as
Speci al
Saf eguar d
Amber Box
AMS Reduct i on
Bl ue Box
Pr oduct i on Li mi t i ng
Pr ogr ammes
Gr een Box
Non Tr ade
Di st or t i ng
Vol ume
Reduct i on
Val ue Reduct i on
Rol l -over
Amber box
Cal cul at i ng t he Cur r ent Tot al AMS
Annexes 3 and 4
Product -speci f i c
support
z Market pri ce support
z Compensat ory payment s
z Product -speci f i c
subsi di es
+
= Cur r ent Tot al AMS
Non-product speci f i c
support
z Fert i l i zers
z Irri gat i on, drai nage
z El ect ri ci t y
z Subsi di zed credi t s
Countervailingduty:
A tax imposed by importing Country designed to offset
artificially lowpriceschargedbyexporters.
This measures is to impose the tax in order to offset the
subsidizedexportgoods.
Governmentprocurementpolicies:
Directpurchasingagentsofstateandlocalgovernmentto
purchase American product unless comparable foreign
goodaresubstantiallycheaper.
Othernontariffbarriersandargument
forprotection
Dumping:
DefinedasellingaproductinaforeignCountryataprice
that is lower than the price charged by the same firm in
itshomemarketoratapricebelowcostofproduction.
Manyreasonsfordumping:
Maybepredatorypricingpolicy
Mayberesultofcustomproduction
Maybe unintentional /technicaldumping
May be conscious economic decision relating to profits from
increasedmarginalproduction.
forprotection
Definition of Dumping base on WTO agreement
Dumping=whenaproductissoldforexport toanother
countryatlessthanitsnormalvalue.
NormalValue is
thepriceinthehomemarketwhenthegoodissoldata
priceabovethecostofproduction
thepricechargedforthegoodwhensoldatapriceabove
costinthirdcountrymarkets
constructednormalvalue calculatedasthetotalcostsof
producingtheproductplusareasonableamountfor
selling,generalandadministrativeexpensesandprofit.
forprotection
Antidumping law:
Dumping margin: The difference between the normal
valueofaproductanditsdumpedprice.
Injury test: Investigation to determine the cause of the
foreigntradepracticeto harmadomesticproducer.
forprotection
INJURYFACTORS(Article3.4)
Include:
y Actual and potential decline in:
Sales - Productivity
Profits - Return on investment
Output - Utilisation of capacity
Market share
y Actual and potential negative effects on:
Cash flow - Growth
Inventories - Ability to raise capital
Employment - Ability to raise investment
Wages
y Factors affecting domestic prices
y The magnitude of the margin of dumping
Safeguard:
A measure trade law that allows for temporary
protection (5 years) against fairly trade foreign
import.
Reasonforusingthismeasureistradeadjustment in
thedomesticproducers.
But for using this measure it should be investigated
the injury of the domestic industry through the
foreignproducts.
forprotection
SAFEGUARDS(WTO):BASICREQUIREMENTS
Adeterminationthat,
As a result of (i) unforeseen developments and (ii) the
effectofaMembersobligationsunderGATT1994
Aproductisbeingimportedinsuchincreasedquantities
Astocauseorthreatentocause
Seriousinjury tothedomesticindustry
Producing like products or directly competitive
products
forprotection
seriousinjury
(threatof)
=significantoverallimpairmentinthepositionof
adomesticindustry
y Relevantfactors:
y Increasedimports(valueandvolume)
y Marketpenetrationofimports
y Changesinsales
y Production
y Productivity
y Capacityutilization
y Profits/losses
y Employment
RuleofOrigin(ASEANcase):
Agricultureproducts(chapter0124)and
agriculturalproductscommittoWTO,such
ascottonchapter52,silkchapter50.
Nonagriculturalproducts
forprotection
RuleofOrigin(ASEANCase)(cont):
AgriculturalProducts
Applytheruleofwhollyproducedorobtainedapplicablefor
goodswhicharemadewhollyfromdomesticrawmaterial.
Thevalueofrawmaterialsfromexportingcountryand
ASEANCountryisnotlessthan60%oftotalproductioncost.
forprotection
RuleofOrigin(ASEANCase)(cont):
NonagriculturalProducts
Applytheruleofwhollyproducedorobtained
applicableforgoodswhicharemadewholly
fromdomesticrawmaterial.
Thevalueofrawmaterialsfromexporting
countryandASEANCoutry isnotlessthan40%
oftotalproductioncost.
forprotection
y ThelocalASEANcontentcanbecumulative,that
is,thevalueofinputsfromvariousASEAN
memberscanbecombinedtomeetthe60%or40%
requirement.Thefollowingformulaisapplied:
y (Rawmaterialcost+Directlaborcost+Direct
overheadcost+Profit+Inlandtransportcost)x
100/FOBvalue
forprotection
TheformulaforcalculatingtheRCVshallbe:
A BuildUpMethod
RVC=(VOM/FOB)x100%
B BuildDownMethod
RVC=[(FOB VNM)/FOB]x100%
RVC:RegionalValueContent
VOM:Valueoforiginatingmaterialsusedbytheproducerin
theproductionofgood
VNM:Valueofnonoriginatingmaterialsusedbythe
producerintheproductionofgood
forprotection
Protectintellectualpropertyright:
Patent allows inventors the opportunity to recover their
investment and the cost of creating and marketing
inventions.
Copyright give authors control over the reproduction,
disseminationandpublicperformanceoftheirwork.
Trademark assures consumers about the product
characteristicssuchasquality.
forprotection
Protectintellectualpropertyright(cont):
GeographicalIndication isanygeo. sign(wordorsymbol)
used to indicate that a product originates in a given
country/region/place and its quality, reputation or other
characteristic are essentially due to its geographical
origin.
Industrialdesignisaesthetic shape(ex.Modelofshirt)of
massproducedproducts.
Neigbouring right is Performers, Phonogram Producers
andBroadcastingOrganizations
forprotection
Nontariffbarriers
Nontariffbarriers
Fields Protected:
Literary Works
Musical Works
Artistic Works
Photographic Works
Cinematographic Works
Maps
Computer Programs
Works of Applied Art
Copyright
Disclosure
DEFINITION
Patentable subject matter
Industrial applicability
Novelty
Inventive Step
Patents
NO if dictated purely by the function
NO if contrary to public order and morality
Industrial
New (Worldwide)
Main Characteristics of Industrial
Design
r i sks ar i si ng f r om addi t i ves,
cont ami nant s, t oxi ns or di sease-causi ng
or gani sms
damage caused by t he ent r y,
est abl i shment or spr ead of pest s
a count r y
human l i f e
di seases car r i ed by ani mal s or pl ant s
human or ani mal
l i f e
pest s, di seases or di sease-causi ng
or gani sms
ani mal or pl ant
l i f e
To prot ect :
f rom :
DefinitionofanSPSMeasure
y productcriteria
y quarantinetreatments
y productionmethods
y certificationandapproval
y inspection
y samplingprocedures
y packagingandlabelling
directlyrelatedtofood
safety
Al l t ypes of measur es wi t h SPS obj ect i ves,
i ncl udi ng :
Whattypeofmeasures?
TheTBTAgreement.
Tostart:somedefinitions
TechnicalRegulation
y "Documentwhichlaysdownproductcharacteristicsortheir
relatedprocessesandproductionmethods...withwhich
complianceismandatory.
Standard
y Document,approvedbyarecognizedbody thatprovides,forcommon
andrepeateduse,rules,guidelinesorcharacteristicsforproductsor
relatedprocessesandproductionmethods,withwhichcomplianceis
notmandatory
Conformityassessmentprocedure
y Anyprocedureused,directlyorindirectly,todeterminethatrelevant
requirementsintechnicalregulationsorstandardsarefulfilled
Development
Effectsoftheunequallypowersharein
internationaltrade
Perroux theorysaidthatthelargeCountrieshas:
y Dominanttoimplementthetradepolicy
y Havingpowertoinfluencetheimportingpriceand
exportingprice
y Usingtherevenuefromtheexportfordomesticgoods
y Dominanttoimplementthemonetarypolicy,in
particulartheinterestratepolicyforcreditsintothe
foreignmarket
ThewelfarelostofthetariffsimposedbysmallCountry
P
P
W
X
a
0
S
P
W+T
D
Tariff (T)
Q
3
Q
4
Q
2
b c d
The welfare lost of a tariff imposed by a small Country
baseontheabovefigure.
Changeinconsumersurplus: a$ b$ c$ d$
Changeinproducersurplus:+a$
Changeingovernmentrevenue:+c$
Netwelfarechange: b$ d$
ThewelfarelostofthetariffsimposedbylargeCountry
P
P
W
X
0
S
P= P
W+T
D
Tariff (T)
Q
3
Q
4
Q
2
P
ThewelfarelostofthetariffsbythelargeCountry
P
A
P
W
P
B
X
W
X
A
X
B
Country A: Market large
Country
Country B: Market small
Country
World Market
D
A
S
B
D
A
D
B
S
A
S
B
P
W
P
S
B
+ Tariff
Tariff
L
0
L
1
a
c
e
b d
P
W
P
W
P
The welfare lost of a tariff imposed by a large Country

baseontheabovefigure.
Changeinconsumersurplus: a$ b$ c$ d$
Changeinproducersurplus:+a$
Changeingovernmentrevenue:+c$+e$
Netwelfarechange: b$ d$+e$
Tariffescalation
y Tariffsescalatewhentheyincreasewiththelevelof
processing
y Attheaggregatelevel,thepictureisdiverse
y thetariffstructuresofCanada,Australia,NewZealand,
TurkeyandNorwayexhibitescalation
y thetariffstructuresofseveralcountriesexhibitpartial
escalation
y Attheproductlevel,tariffescalationispresentevenin
countrieswhereoverallstructureexhibitslittleorno
escalation
Tariffdistribution:tariffpeaks
y Tariffsthatexceedaselectedreferencelevel
y Nationalpeaksaremorefrequentwhereaverage
tariffislow
y Developedcountries:NewZealand,Australiaand
Icelandhavemanypeaks,EUhasfew
y LatinAmerica:oftenalltariffsabove15%
y Otherdevelopingcountries:alsohighshareoftariffs
above15%
Tariffpeaksandhightariffs
y GenerallyusedbyIOs:
y Nationalpeaks: 3timesthenational
average
y Internationalpeaks: >15%
y BUT,THEREISNOAGREEDWTO
DEFINITION
EC15:boundAVGperHSChap.
0
2
4
6
8
10
12
14
16
18
20
0
3
2
7
3
4
4
1
4
8
5
5
6
2
6
9
7
6
8
4
9
1
G
r
HS Chapter (Non Ag tariff lines only)
A
v
e
r
a
g
e

(
%
)
Bound Duty AV
Nat . AVG = 4%
3X
Nat .
AVG
Brazil:boundAVGperHSChap.
0
10
20
30
40
50
60
70
80
90
0
3
2
8
2
8
3
2
3
1
3
6
4
4
4
3
4
8
6
8
5
1
5
6
6
1
6
6
7
1
7
2
7
8
8
4
8
5
8
6
8
8
9
1
9
6
HS Chapter (Non AG tariff lines only)
A
v
e
r
a
g
e

(
%
)
Bound duty AV
Nat . AVG = 30%
3X
Nat .
AVG
0
5
10
15
20
25
30
35
40
45
Raw material Semi-manufactured Finished product
Tariff
(%)
Tariffescalation:textilesandclothing
Tariff Peaks:
Japan
minimum tariff 0% maximum tariff 958%
Tariff Escalation:
cocoa imports into the EC
cocoa beans milk chocolate
0% 18.7%
Forms:
Specific duties and ad valorem duties
Seasonal duties
Matrix tariffs
Tariff only but problems still exist
Development
BackwasheffectsofMyrdall
Myrdall theoryarguedthattheinternationaltrade
has
thebackwasheffects:
y FlowofHumanResourcesintothelarge
Country.
y ContinualflowofCapitalintothelargeCountry,
becauseofitseconomicboom.
y LargeCountryhastradingpricesadvantageand
exportsadvantage.
Development
Underdevelopedastheeffectsofdeclining
termoftrade(ToT)?
y ItisthetheoryofPrebish andSinger
y DefinitionofToT =P
X
/P
M
y P
X
isexportingpriceindex
y P
M
isimportingpriceindex
y ToT meanshowmanyunitsofimportinggoods
willbeexchangedwithoneunitofexporting
goodsoftheCountry.
Development
Underdevelopedastheeffectsofdeclining
termoftrade(TOT)?(cont)
y Priceindexformula:
y Laspeyres priceindex= P
i
t
.Q
i
t0
/ P
i
t0
.Q
i
t0
y Paashe priceindex(GDPDeflator)= P
i
t
.Q
i
t
/ P
i
t0
.
Q
i
t
y P=Price
y Q=Quantity
y t=time
y i=kindoftheproducts
( ) t
i
t
i
t
i
t
i
p
Q P
Q P
o
P
=
( )
u-u-:- (Price Index)
o o
o
t
i
t
i
t
i
t
i
p
Q P
Q P
L

=
y ...:
y .: Passch . .:.. ...... GDP deflator :
y .: Laspeyres . .:.. .... .. CPI PPI .
Development
ProductionPossibilityFrontier(PPF)andTOT
Development
Underdevelopedastheeffectsofdecliningtermof
trade(TOT)?(cont)
y TOTdeclinesthatmeanseco.development
wouldbegonedown,becausetheimporting
pricewouldbeincreasedor/andtheexporting
pricewouldbereduced.
y TOTincreasesthatmeanseco.development
wouldbegrownup,becausetheimportingprice
wouldbereducedor/andtheexportingprice
wouldbeincreased.
Development
trade(TOT)?(cont)
y TOTofsomeDevelopingCountriesandleastdeveloped
Countriesisgenerallyterrible.
y ThereasonsoffailingTOTofsuchCountriesare:
y Priceoftheirimportinggoodsdependsonincome
elasticity.
y Priceoftheirexportinggoodsdependsonpriceelasticity.
y Monopolizingofimportinggoodsfromindustrial
Countries.
y ExportinggoodsandthosepriceofDevelopingCountries
facedsomeconstraintsregardingtopotential
implementingofcommercialpolicybythelargeCountries.
Development
trade(TOT)?(cont)
y InthecasethattheTOTdeclinesorisworse,theeffectson
eco.developmentoftheDevelopingCountriesare
following:
Reducingtheimportinggoodswhichareaffectedonthe
developmentoftheCountries.
Exportingsectorcannotbeimprovedintermoftechnology
andproductivity.
Employmentofexportingsectorcanbedeclined.
Development
trade(TOT)?(cont)
y CriticonthetheoryofPrebish andSinger:
y FormulaofpriceindextooktocalculatetheTOTisnotso
correct,ifthetimetooktocalculatethepriceindexissofar
fromthebasictimeintheformula.
y Thereasonisthattheproductscanbealreadychangedthe
physicalattitudeorquality,althoughthosenameisnot
changing.
Development
trade(TOT)?(cont)
y CriticonthetheoryofPrebish andSinger(cont):
y DreadfulTOTdependsnotonlyexternalissueslike
mentionedabove.
y Itcandependsontheinternalissueslikeincreasingincome
andtechnologyintheDevelopingCountrywhichare
causingtoincreasetheimportingpriceandtoreducethe
exportingprice.
Development
trade(TOT)?(cont)
y CriticonthetheoryofPrebish andSinger(cont):
y Thus,dreadfulTOTcanbeconsideredasfinefor
developmentofthedevelopingCountryiftheinternal
effectscomparestoexternaleffectspositive.
y Thus,shockingTOTcanbeconsideredasterriblefor
developmentofthedevelopingCountryiftheexternal
effectsisstronglythantheinternaleffects.
Development
Effectsofinstabilityofexportrevenue
y Instabilityofexportrevenuedependsonthe
fluctuationofexportingprice.
y ItcanseriouslyaffectontheCountrywhichhas:
y smallGDP,
y largeshareofexportinGDP,
y exportingonlysingleproductorsectorand
y theirdomesticdevelopmentdependingmostlyon
importinggoods.
y Itcanexplaintheseeffectsbelow.
Development
Effectsofinstabilityofexportrevenue(cont)
y Incaseexportingpricegoingdowntheexportrevenuewill
bereduced.
y Thus,theGDPwillbereducediftheCountrydoesnthave
otherexportrevenueofanotherproductsinorderto
compensate.
y Finally,thedevelopmentoftheCountrywillbestagnateor
gonedown.
y Itcanseeinthemathematicalformulationbelow.
Development
y Y=C+I+G+X Mor
y Y=C
D
+C
M
+I
D
+I
M
+X Mor
y Y=C
D
+I
D
+G
D
+X+(C
M
+I
M
+G
M
M)
Y=GDP
C=Consumption
I=GrossInvestments
X=Export
M=Import
D=Domestic
Development
y Baseonaboveformulaitcanwritefollowing
y C
M
+I
M
+G
D
M=0
y =>Y=C
D
+I
D
+G
D
+X
y IfXreducedand,C
D
,I
D
andG
D
arestable,itwillbeseen
thatYorGDPwillbereducedaccordingly.
y Also,GDP=Y=C
D
+I
D
+G
D
+Xisgonedown.
Development
y Otherwiseiftheexportrevenuehasreduced,itcanhappenlike
belowrelatingtoimportingoftheCountry:
y BaseonaboveformulaithasX=M,and
y C
M
+I
M
M=0whichcanbewrittenasC
M
+I
M
=M
y IfXreduced,itwillbeseenthatMwillalsoreduce
accordingly,
y ReducingMmeansC
M
aswellI
M
canbereduced,butC
M
as
dailyconsumptioncannotdecreaseforallcases.
y Therefore,onlyI
M
willbedecreasedandthosereducings effect
canbringtodiminishtheeco.developmentoftheCountry.
Development
y Incaseincreasingoftheexportingprice
y SincesomeDevelopingCountriesandLDChasalimitation
ofHRandmaterialcapital,itcandelaytheproductions
planforexportinginthetimethattheexportingpriceis
increasing.
y Thus,theCountriescannotusesuchopportunityto
improvetheexportrevenuewhichcaneffectontheGDP
andthedevelopmentoftheCountry.
Development
Underdevelopmentastheeffectsofinternational
capitalstransaction?
y CategorizingtheforeigndirectInvestments
(FDI)infollowing:
y FDIs investtoexploitthenaturalresources
y FDIs investtosupplyinthedomesticmarket
y FDIs investtosupplyintheirCountriesandother
thirdCountries.
Development
Underdevelopmentastheeffectsofinternationalcapitals
transaction?(cont)
y AdvantagesanddisadvantagesofFDIinvestingtoexploitthe
naturalresources
y Itcanbemonocultureproductionwhichcanbringtofoods
insecurity
y LossofpotentialdevelopmentoftheCountryifthey(FDIs)think
thattheCountrydoesntinvestsomemoneytoobtainitsraw
material
y Relativelysmallcapitalinvestmentsinthissector
y TheCountrycangainlowtechnologybythisinvestment
y Lowsalaryforthelaborinwhichthosesalarycannotpushto
buildupthedomesticindustries,becauseitcanbuyonlythe
traditionalproducts.
Development
transaction?(cont)
y AdvantagesanddisadvantagesofFDIinvestingtosupplyin
thedomesticmarket
y Advantages
y IncreasingthevolumeofGDP.
y FlowthecapitalintotheCountrywhichcaneffectoncapital
accumulationfortheCountry.
y Reducingorcuttingupimportinggoodswhichwillbe
producedbysuchFDI.
y Savingcapital,whichuseforimportingsuchgoods,inorder
toinvestforothersectorsoftheCountry.
y Improvingdomestictechnology
y Creatingjobsfordomesticlabor
y Buildingupcapacityofhumanresourceandtraining
institution
Development
Underdevelopmentastheeffectsofinternational
capitalstransaction?(cont)
y AdvantagesanddisadvantagesofFDIinvestingtosupplyin
thedomesticmarket
y Disadvantage
y FlowouttheincomeandprofitintotheCountryofFDI
y Domesticproducerscandisappearfromthedomesticmarket,
becauseofweakcompetition.
y Increasingunemploymentasdisappearingofdomestic
companies
Development
transaction?(cont)
y AdvantagesofFDIinvestingtosupplyintheirCountryorthethird
Countries
y IncreasingthevolumeofGDP.
y FlowthecapitalintotheCountrywhichcaneffectoncapitalaccumulation
fortheCountry.
y Reducingorcuttingupimportinggoodswhichwillbeproducedby such
FDI.
y Savingcapital,whichuseforimportingsuchgoods,inordertoinvestfor
othersectorsoftheCountry.
y Increasingcapitalreserve
y Improvingdomestictechnology
y Creatingjobsfordomesticlabor
y Buildingupcapacityofhumanresourceandtraininginstitutions
y Repatriateoftheirprofitcanbenotcarriedoutifthetaxpolicyoftheir
Countryisinconvenient.
Development
5.PopulationGrowthandtheEco.Development
Basictheoryofproductionfunction
y X=f(L,C,R)
y x=Output
y f=Function
y L=Labor
y C=Capital
y R=Naturalresources
y P=Population
y Productionfunctionintherelationtothepopulation
y X/P=f(L/P,C/P,R/P)
Development
Effectspopulationgrowthonthelaborfactor
y Populationgrowthwilloccurincreasingthepotentialof
labor
y Butincreasingoflabordependsonthemortalityrate
y TheEffectsonGDPbythepopulationgrowthdependon
theproductivityofthosepeople
y Ifthoseproductivityis0,itmeansthatGDPwillbestable
andthepercapitawillbereduced.
y Ifthoseproductivityisnot0,itmeansthatGDPwill
increaseandthusthepercapitawillalsoincrease.
Development
EffectspopulationgrowthontheCapital
y Capitalcomingfromstateandhouseholdisneededto
providethefood,educationandtraining
y Reducingcapitalwhichplanedtoinvestotherproductive
sector
y Asdeficiencyofcapitaltobuildupthecapacityofthe
younggenerationitcanappearinthefuturethattheycan
notbeefficientlyusedfortheCountrysproduction,
becauseofunemploymentsissues,deficitmoraland
understandingoftheethnic,andthemortalityetc.
y Buildingupofcapitalorcapitalaccumulationwillbe
reducedaccordingly
y Finally,GDPorpercapitawillbereduced
Development
Effectspopulationgrowthonnaturalresources
y PopulationgrowthinDevelopingCountrydidnotmean
thatintherealitythenaturalresourcewillbegrownup.
y Oft,populationgrowthinthisCountrycausesinupgrading
thenaturalresources.
y Thereasonsofupgradingnaturalresourcebythe
populationgrowthareincreasingtouseenergy,forest,
land,waterandothermaterialequipment.
y Increasingtheaboveusingwillbringthenaturaldisaster
likelanderosion,flooding,dryingetc.
Development
Effectspopulationgrowthoninternationaltrade
y Itcanbepositiveaswellnegativeeffectsonthe
internationaltrade.
y Positiveeffectscanexist,iftillnowthedomestic
productionsfortheexportintheCountryseemto
intensivelyneedthelabor.
y Negativeeffectswillexist,becausedemandoftheCountry
willbeincreasedwhichcancausestoreducetheexportof
thosegoodsaswelltheexportrevenuefortheCountry.
Development
Conclusionofeffectsofthepopulationgrowthfor
theeco.development
y Negativeeffectonusingcapitalandnaturalresources
y Positiveeffectregardingthelabor
y ButEconomistnamedClarkcriticizedthatitcannotbelieve
themyth thatsaidthepopulationgrowthcanbringthe
negativelyaffectsontheeco.development.
y Clark foundforhisempiricalresearchwhichdidntfindthe
correlationbetweenthepopulationgrowthandincreasing
percapita.
y ThefindingofhisresearchwasnotfoundanyCountrywith
thelowpopulationgrowththathasincreasingpercapita.
1. Exchange Rates
y Therateatwhichonecurrencycanbeexchangedfor
anothere.g.
y 1=$1.90
y 1=1.50
y Importantintrade
III.Politicalmacroglobalpolicy
1. Exchange Rates
Convertingcurrencies:
y Toconvert into(e.g.)$ Multiplythesterling
amountbythe$rate
y Toconvert$into dividebythe$rate:e.g.
y Toconvert5.70to$atarateof1=$1.90,
multiply5.70x1.90=$10.83
y Toconvert$3.45to atthesamerate,divide3.45by1.90
=1.82
1. Exchange Rates
Appreciationoftheexchangerate:
y Ariseinthevalueof inrelationtoother
currencies each buysmoreoftheother
currencye.g.
y 1=$1.851=$1.91
y UKexportsappeartobemoreexpensive
(Xp)
y ImportstotheUKappeartobecheaper
(Mp)
1. Exchange Rates
DepreciationoftheExchangeRate
y Afallinthevalueofthe inrelationtoother
currencies each buyslessoftheforeign
currencye.g.
y 1= 1.501= 1.45
y UKexportsappeartobecheaper
(Xp)
y ImportstotheUKappearmoreexpensive
(Mp)
1. Exchange Rates
DeterminantsofExchangeRates:
y Exchangeratesaredeterminedbythedemandfor
andthesupplyofcurrenciesontheforeign
exchangemarket
y Thedemandandsupplyofcurrenciesisinturn
determinedby:
Government intervention & factors
influenced
y Supply and demand for any given currency, and
thus its value, are not influenced by any single
element, but rather by several. These elements
generally fall into three categories:
y Economic factors,
y Political conditions and
y Market psychology.
Economic factors
These include:
1. Economic policy comprises:
Government fiscal policy (budget/spending practices) and
monetary policy (the means by which a government's
central bank influences the supply and "cost" of money,
which is reflected by the level of interest rates).
2. Economic conditions include:
Government budget deficits or surpluses
Relative interest rates
Changes in relative inflation rates
The demand for imports
The demand for exports
Investment opportunities
Speculative sentiments
Global trading patterns
The Effect of a Government Budget Deficit
Loanable Funds
(in billions of dollars)
0
Interest
Rate
3. . . . and reduces the equilibrium
quantity of loanable funds.
S
2
2. . . . which
raises the
equilibrium
interest rate . . .
Supply, S
1
Demand
$1,200
5%
$800
6%
1. A budget deficit
decreases the
supply of loanable
funds . . .
e
Income, Output, Y
LM*
IS*
e
Income, Output, Y
LM*
IS*
IS*'
LM*'
+G, or T
+e, no Y
+G, or T
+e, no Y
+M
-e, +Y
+M
-e, +Y
The Mundel l -Fl emi ng Model
Under Fl oat i ng Exchange Rat es
Political conditions
Internal, regional, and international political conditions and events can
have a profound effect on currency markets.
All exchange rates are susceptible to political instability and
anticipations about the new ruling party. Political turmoil and
instability can have a negative impact on a nation's economy. For
example, destabilization of coalition governments in Pakistan and
Thailand can negatively affect the value of their currencies.
Similarly, in a country experiencing financial difficulties, the rise of a
political faction that is seeming to be fiscally responsible can have the
opposite effect.
Also, events in one country in a region may spur positive or negative
interest in a neighbouring country and, in the process, affect its
currency.
Market psychology
Market psychology and trader perceptions influence the
foreign exchange market in a variety of ways:
Flights to quality
Long-term trends
"Buy the rumor, sell the fact"
Economic numbers
Technical trading considerations
1. Exchange Rates
y Relativeinterestrates
y Changesinrelativeinflationrates
y Thedemandforimports
y Thedemandforexports
y Investmentopportunities
y Speculativesentiments
y Globaltradingpatterns
1. Exchange Rates
y Adepreciationinexchangerateshouldleadtoa
riseindemandforexports,afallindemandfor
imports the balanceofpayments should
improve
y Anappreciationoftheexchangerateshouldlead
toafallindemandforexportsandarisein
demandforimports thebalanceofpayments
shouldgetworse BUT
197
TheU.S.BalanceofPayments,2005(MillionsofDollars)
International Transactions: Data
Q
P
As U.S. citizens import, they supply dollars to the FOREX market.
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
($444.69)
Capital Account
$444.26
Overall Balance
$0.30
($0.30)
0.73
Exchange rate $
S
D
Rate
Q
P
As U.S. citizens export, others demand dollars in the FOREX market.
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
($444.69)
Capital Account
$444.26
Overall Balance
$0.30
($0.30)
0.73
Exchange rate $
S
D
Rate
Q
P S
D
As the U.S. government sells dollars, the supply of dollars increases.
S
1
Credits Debits
Current Account
1 Exports $1,418.64
2 Imports ($1,809.18)
($444.69)
Capital Account
$444.26
Overall Balance
$0.30
($0.30)
0.73
Exchange rate $
Rate
1. Exchange Rates
y FloatingExchangeRates:
y Pricedeterminedonlybydemandandsupplyofthe
currency nogovernmentintervention
y FixedExchangeRates:
y Thevalueofacurrencyfixedinrelationtoan
anchorcurrency notallowedtofluctuate
y DirtyFloatingorManagedExchangeRate:
rateinfluencedbygovernmentviacentralbank
aroundapreferredrate
Pro&ConsforFloatingExchangeRate
y Argumentsinfavorofflexibleexchangerates:
y Easierexternaladjustments.
y Nationalpolicyautonomy.
y Argumentsagainstflexibleexchangerates:
y Exchangerateuncertaintymayhamper
internationaltrade.
y Nosafeguardstopreventcrises.
1.ExchangeRates
Fixed vs Flexible Exchange Rate
Regimes
y Supposetheexchangerateis$1.40/ today.
y Inthenextslide,weseethatdemandforBritish
poundsfarexceedsupplyatthisexchangerate.
y TheU.S.experiencestradedeficits.
Regimes
S D
Q of
D
o
l
l
a
r

p
r
i
c
e

p
e
r

(
e
x
c
h
a
n
g
e

r
a
t
e
)
$1.40
Trade deficit
Demand
(D)
Supply
(S)
Flexible Exchange Rate
Regimes
y Underaflexibleexchangerateregime,thedollarwill
simplydepreciateto$1.60/,thepriceatwhichsupply
equalsdemandandthetradedeficitdisappears.
Regimes
Supply
(S)
Demand
(D)
Demand (D*)
D = S
Dollar depreciates
(flexible regime)
Q of
D
o
l
l
a
r

p
r
i
c
e

p
e
r

(
e
x
c
h
a
n
g
e

r
a
t
e
)
$1.60
$1.40
Regimes
y Instead,supposetheexchangerateisfixed at
$1.40/,andthustheimbalancebetweensupplyand
demandcannotbeeliminatedbyapricechange.
y Thegovernmentwouldhavetoshiftthedemand
curvefromDtoD*
y Inthisexamplethiscorrespondstocontractionary
monetaryandfiscalpolicies.
Regimes
Supply
(S)
Demand
(D)
Demand (D*)
D* = S
Contractionary
policies
(fixed regime)
Q of
D
o
l
l
a
r

p
r
i
c
e

p
e
r

(
e
x
c
h
a
n
g
e

r
a
t
e
)
$1.40
2.Monetarypolicy
Instrumentstoimprovefinancial
institutions
- Improvingfinancialinstitutioncanbringthe
savingoftheprivatehouseholdintothe
financialinstitutionsandcapitalflowfrom
abroadintotheCountry.
- Improvingfinancialinstitutioncanmove
forwardthecurrentsubsistencesector.
TheFinancialSystem
y Thefinancialsystemconsistsofthegroupof
institutionsintheeconomythathelptomatchone
personssavingwithanotherpersonsinvestment.
y Itmovestheeconomysscarceresourcesfromsavers
toborrowers.
FINANCIALINSTITUTIONS
y FinancialMarkets
y StockMarket
y BondMarket
y FinancialIntermediaries
y Banks
y MutualFunds
y Financialintermediariesarefinancialinstitutions
throughwhichsaverscanindirectlyprovidefundsto
borrowers.
y Banks
y takedepositsfrompeoplewhowanttosaveandusethe
depositstomakeloanstopeoplewhowanttoborrow.
y paydepositorsinterestontheirdepositsandcharge
borrowersslightlyhigherinterestontheirloans.
y Banks
y Bankshelpcreateamediumofexchange byallowing
peopletowritechecksagainsttheirdeposits.
y Amediumofexchangesisanitemthatpeoplecaneasilyuse
toengageintransactions.
y Thisfacilitatesthepurchasesofgoodsandservices.
y MutualFunds
y Amutualfundisaninstitutionthatsellssharestothe
publicandusestheproceedstobuyaportfolio,of
varioustypesofstocks,bonds,orboth.
y Theyallowpeoplewithsmallamountsofmoneytoeasily
diversify.(LinkstoText)
y OtherFinancialInstitutions
y Creditunions
y Pensionfunds
y Insurancecompanies
y Loansharks
institutions(cont)
- Improvingfinancialinstitutionsshould
betookintoaccountthatitdontbring
intothesituationas demand
following orsupplyleading ofthose
financialinstitutions.
institutions(cont)
y Demandfollowing meansthatthefinancial
institutionsfollowtherequestofthecreditors.
y Inthiscasethefinancialinstitutionsplayapassive
rolefortheeco.development.
y Iftheycannotfulfillordelaytherequestofthe
creditors,itcancausethenegativeeffectsonthe
eco.DevelopmentoftheCountry.
institutions(cont)
y Supplyleading meansthatthedevelopmentof
financialsectorgoesonwardthantheproduction
sector.
y Thefinancialsectorincreasestheircapitalaccording
toincreasingsavingandplayssignificantroleforthe
capitalorcreditmarket.
y Inthiscasetheyplayaactiverolefortheinvestors
andtheeco.development.
Instrumenttoimprovefinancialinstitution
(cont)
y Buttheeco.Developmentdoesntdependonlythefinancial
sector.Increasingofsavingcanrelativelyreducethe
revenueofthefinancialsectorregardingtodeclinethecost
ofcredits
y Growthoffinancialsectorcanbeincurredtostockupina
periodoftimesomeEco.Factorswhichcanactively
improvethecurrentEco.DevelopmentoftheCountry.
y Thus,thefinancialsectorplayasignificantroleto
acceleratetheEco.Development,butitdoesntmeanthat
thesectorisonlyonesectortopushEco.Development.
ImportanceofMonetaryPolicy
ImportanceofMonetaryPolicy
Gross National Product (GNP) = C + I + G + X
Where: C = Private Consumption expenditure
I = Private Investment Expenditure
G = Government Expenditure
X = Net Exports
C, I, X can be influenced by the monetary policy which can also influence
the private consumption and investment spending and exports and
imports.
The Government and the Central Bank (i.e., RBI) make use of various
fiscal and monetary weapons respectively to achieve stability and growth
by influencing and regulating the behavior of the various classes of
spenders as savers, consumers and investors.
These policies can influence the aggregate supply and demand and the
associated level of employment, wages, interest, rent, price and profit.
MonetaryPolicy
MonetaryPolicy
Monetary Policy refers to the use of instrument within the control of
the Central Bank to the influence the level of aggregate demand for the
goods and services or to influence in certain sector of the economy.
Monetary policy operates through varying the cost and availability of
credit.
The modern economy is regarded as a credit economy in sense that
credit forms the basis of most of the economic activities in such an
economy.
The level and nature of economic activities such an economy are
influenced by the cost and availability of the credit.
IS*: Y=C(Y-T) + I(r*) + G + NX(e)
LM*: M/P=L (r*,Y)
Recall the two equations of the Mundell-Fleming model:
e
Income, Output,Y
LM*
IS*
LM*'
P
Income, Output,Y
AD
When the price level falls the LM*
curve shifts to the right. The
equilibrium level of income rises.
The second graph displays the
negative relationship between P and
Y, which is summarized by the
aggregate demand curve.
When the price level falls the LM*
curve shifts to the right. The
equilibrium level of income rises.
The second graph displays the
negative relationship between P and
Y, which is summarized by the
aggregate demand curve.
MeasuresofMoneyStock
MeasuresofMoneyStock
Reserve Bank of India employs FOUR measures of money stock, namely M1,
M2, M3, M4
M1 : The measure of money stock designed by M1 is usually described as the
money supply. The components of money supply are currency with the public
(i.e., notes in circulation, circulation of rupee coins and circulation of small
coins) and deposits (demand deposits with banks and other deposits with the
RBI).
M2 : M2 is M1 + Post Office Savings Bank Deposits.
M3 : M3 is M1 + Time Deposits with the banks. In other words, M3 is money
supply plus fixed deposits with the banks. M3 is usually referred to as
aggregate monetary resources.
M4 : M4 is M3 plus the total Post Office Deposits.
InstrumentsofMonetary
InstrumentsofMonetary
Policy
Policy
Instrumentsofmonetarypolicyare
dividedinto:
1. GeneralMethods
2. SelectiveMethods
GeneralCreditControl
GeneralCreditControl
y Thegeneralmethodsaffectthetotalquantityofcredit
andaffecttheeconomygenerally.
y Therearethreegeneralorquantitativeinstrumentsof
creditcontrol.
1.TheBankRate
2.OpenMarketOperations
3.VariableReserveRequirements
y Theuseofoneinstrumentratherthananotheratany
point of time is determined by the nature of the
situationandtherangeofinfluence.
BankRatePolicy
BankRatePolicy
y TheBankrate,alsoknownastheDiscountRate.
y TheBankRatePolicyseekstoaffectboththecost and
availabilityofcredit.
y An increase in the Bank Rate implies an increase in
the cost of credit and viceversa. The demand for
credit usually varies with the variation in the cost of
credit.
y Thecentralbankhascontroltobringacontractionin
the money supply by raising Bank Rate and an
expansioninthemoneysupplybyloweringit.
BankRatePolicy(
BankRatePolicy(
Contd
Contd
)
)
y TheTheoryofBankRatestates,anincreaseinthe
BankRatereducestheextentofborrowings.
ReductionintheDiscountratehastheopposite
effects.
y Ex:HighinflationleadstoincreaseinBankRateand
reducetheinflation.
OpenMarketOperations.
OpenMarketOperations.
y Itsreferbroadlytothepurchaseandsaleby
theCentralBankofavarietyofassets, suchas
foreignexchange,gold,governmentsecurities
andevencompanyshares.Ex.InIndia,they
arelimitedtothepurchaseandsaleof
Governmentsecurities.
y Toincreasethemoneysupply,thecentral
bankbuyssecuritiesfromcommercialbanks
andpublic.
VariableReserveRatios
VariableReserveRatios
y Commercialbanksineverycountrymaintain,either
bytherequirementoflawby orcustom,acertain
percentageoftheirdepositsintheformofbalances
withthecentralbank.
y Thecentralbankhasthepowertovarythisreserve
requirementandthevariationinthereserve
requirementsaffectthecreditcreatingcapacityof
commercialbanks.
y Ex:Ifthereserverequirementis10%,themaximum
amountthebankcanlendisequivalentto90%ofthe
totalreserves.Ifthereserveratioisraisedto20%,the
bankcannotlendmorethan80%ofthetotalreserves.
SelectiveCreditRegulation
y SelectiveorQualitativecreditcontrolrefersto
regulationofcreditforspecificpurposeorbranchesof
economicactivity.
y Theaimofselectivecontrolsistodiscouragesuch
formsofactivityasareconsideredtoberelatively
inessentialorlessdesirable.
y Creditcontrolsareconsideredtobeuseful
supplementtogeneralcreditregulations
y Ex.inIndia,suchcontrolshavebeenusedtoprevent
speculativehoardingofcommoditieslikefoodgrains
andessentialrawmaterialtocheckanunderrisein
theirprices.
Monetarypolicytosupporttheinvestment
Interestratepolicy
BaseonnatureofinvestorstheyinvestintheCountryif
theirinternalinterestrate(r
P
),whichcanbecalculated
fromthecapitalvalue(capitalinvestmentformulatobe
puttingequal0)isexceededthemarketinterestrate(i
P
).
Theequilibriumoftheinvestmentcanbereachedonlywith
internalinterestrateequalthemarketinterestrate(r
P
=i
P
).
BaseonKeynes thesocialinterestrater
S
isabovethe
commoninterestratedeterminedbytheCentralBankin
theDevelopingCountryandLeastDevelopedCountry
accordingthescarcityoftheCapitalintheCountry.
Interest rate policy
Keynes Theory
Keynes Theory
CS
Tax on Expenditure
Keynes Theory
Keynes Theory
Monetarypolicytosupporttheinvestment
MoneySupplyPolicy
MoneySupplyPolicy
MoneySupplyPolicy
Keynes Theory
CS
Money Supply
MoneySupplyPolicy
MoneySupplyPolicy
InflationaffectedbyMoneySupplyPolicy
NominalandrealIncomeaffectedbyMoneySupplyPolicy
Monetarypolicytosupportsaving
Keynes Theory
i for saaving
2.MonetaryPolicy
THEFED
y FederalReserveBank
y Bankofthegovt oftheUS
y Cancontrol$supply&interestrates
y (theoretically)maycontrolinflationrate.
FedChairman:
BenBernake
HowtheFedEffectsEconomy
y Loans$toallotherbanksinUS
y Establishesinterestrates(thediscountrate)thosebanksmustpaytothe
Fed
y Banksthenraiseorlowerinterestratesonloanstoyou,meand businesses
y Banksborrowmorewheninterestratesarelow thushavemore$tolend
y Banksborrowlesswheninterestratesarehigh thushaveless$tolend
y Sellbonds(likeanIOUwithinterest)tobanksinexchangefor$.
y Bankshaveless$onhandsocannotloanasmuch$ discouragesborrowing
y Buybondsbackfrombanks
y Banksgain$socanloanmore$toyouandme encouragesborrowing
y Canrequirebankstokeepmoreorless$inreserveandnotavailableto
loanout
Fedraisesinterestratestobanks MasterCard(ownedbyBankof
America)thenraisesITSinterest
ratetoyou.
Youthenspendless.
(less$incirculation)
Thislowers
prices
Lessdemand
TheFedatwork(intheory)
whichhelpsfightinflation
FiscalPolicyandBudget
FiscalPolicyMeaning
y Thewordfisc meansstatetreasury andfiscalpolicyrefers
topolicyconcerningtheuseofstatetreasury orthegovt.
financestoachievethemacroeconomicgoals.
y anydecisiontochangethelevel,compositionortimingof
govt.expenditure ortovarytheburden,thestructureor
frequencyofthetaxpayment isfiscalpolicy.
G.K.Shaw
G.K.Shaw
ObjectivesofFiscalPolicy
y Ithas2majorobjectives:
i. GENERALobj.aimedatachievingmacroeconomic
goals
ii. SPECIFICobj.relatingtoanytypicalproblemsof
aneconomy
FiscalPolicyAnd
MacroeconomicGoals
y EconomicGrowth:Bycreatingconditionsforincreaseinsavings&
investment.
y Employment:Byencouragingtheuseoflabourabsorbing
technology
y Stabilization:fightwithdepressionary trendsandbooming
(overheating)indicationsintheeconomy
y EconomicEquality:Byreducingtheincomeandwealthgaps
betweentherichandpoor.
y Pricestability:employedtocontaininflationaryanddeflationary
tendenciesintheeconomy.
InstrumentsofFiscalPolicy
y Budgetarysurplusanddeficit
y Governmentexpenditure
y Taxation directandindirect
y Publicdebt
y Deficitfinancing
Budgetarysurplusanddeficit
y Abudgetisadetailedplanofoperationsforsomespecific
futureperiod
y Keepingbudgetbalanced(R=E)ordeficit(R<E)orsurplus
(R>E)asamatterofpolicyisitselfafiscalinstrument.
y Anaccumulateddeficitoverseveralyears(orcenturies)is
referredtoasthegovernmentdebt
y Adeficitisaflow.Andadebtisastock.Debtisessentially
anaccumulatedflowofdeficits
GovernmentExpenditure
Itincludes:
y Governmentspendingonthepurchaseofgoods&
services.
y Paymentofwagesandsalariesofgovernmentservants
y Publicinvestment
y Transferpayments
Taxation
y Meaning:Nonquidproquotransferofprivate
incometopubliccoffersbymeansoftaxes.
y Classifiedinto
1.Directtaxes Corporatetax,Div.DistributionTax,
PersonalIncomeTax,Benefittaxes,BankingCash
TransactionTax
2.Indirecttaxes CentralSalesTax,Customs,ServiceTax,
exciseduty.
Publicdebt
y Internalborrowings
1. Borrowingsfromthepublicbymeansof
treasurybillsandgovt.bonds
2. Borrowingsfromthecentralbank(monetized
deficitfinancing)
y Externalborrowings
1. foreigninvestments
2. internationalorganizationslikeWorldBank&
IMF
3. marketborrowings
BUDGET
y Abudgetisadetailedplanofoperationsforsome
specificfutureperiod
y Itisanestimatepreparedinadvanceoftheperiodto
whichitapplies.
COMPONENTSOFBUDGET
y Revenuereceipts
y Capitalreceipts
y Revenueexpenditure
y Capitalexpenditure
WhereThe$$ComesFrom
service & other taxes
7%
excise
17%
customs
12%
income tax
13%
corporation tax
21%
borrowings
19%
non-debt capital reciepts
1%
non-tax revenue
10%
WhereDoesThe$$GoesTo
state's share of taxes
& duties
18%
non plan assistance
to states
5%
planned state
assistance
7%
central plan
20%
interest
20%
defence
12%
subsidies
7%
other non plan exp.
11%
FISCALPOLICYCHOICES
1. Expansionary fiscal policy: used to combat a
recession.
2. Contractionary fiscal policy: used to combat
demandpullinflation,duetoexcessspending.
EXPANSIONARYFISCALPOLICY
Expansionary Policy needed: a decline in investment has
decreasedAD,sorealGDPhasfallen,andalsoemploymenthas
declined.Apossiblefiscalsolutionmaybe:
a.Anincreaseingovernmentspending,whichshiftsADtothe
rightbymorethanthechangeinG,duetothemultiplier.
b.Adecreaseintaxes(raisesincome,andconsumptionrisesby
MPC times the change in income). AD shifts to the right by a
multipleofthechangeinconsumption.
c.AcombinationofincreasedGspendingandreducedtaxes.
d. If the budget was initially balanced, expansionary fiscal
policycreatesabudgetdeficit.
CONTRACTIONARYFISCALPOLICY
Contractionary Policy needed: When demandpull inflation
occurs,ashiftofADtotherightintheverticalrangeofAS,then
contractionary policyistheremedy.
a. A decrease in G spending shifts AD back left, once the
multiplier process is complete. Here price level returns to its
preinflationary level, but GDP remains at fullemployment
level.
b. An increase in taxes will reduce income, and then
consumptionatfirstbytheMPCtimesthedecreaseinincome,
and then the multiplier process leads AD to shift leftward still
further.
c.AcombinedGspendingdecreaseandtaxincreasecouldhave
thesameeffectwiththerightcombination.
d. If the budget was initially balanced, a contractionary fiscal
policycreatesabudgetsurplus.
FINANCINGDEFICITS
The method used to finance deficits or dispose of surpluses
influencesfiscalpolicy:
A. Financingdeficitscanbedone2ways:
1. Borrowing: (crowding out effect) The government
competes with private borrowers for funds, and could drive
up interest rates; the government may crowd out private
borrowing,andthisoffsetsthegovernmentexpansion.
2.MoneyCreation: When the Federal Reserve loans
directlytothegovernmentbybuyingbonds,theexpansionary
effect is greater since private investors are not buying bonds.
(Monetarists argue that this is monetary, not fiscal, policy
thatishavingtheexpansionaryeffectinthissituation).
DISPOSINGOFSURPLUSES
B.Disposingofsurplusescanbedonein2ways:
1. Debt reduction is good, but may cause interest
ratestofallandstimulatespending,whichcouldthen
beinflationary.
2. Impounding or hiring the surplus funds remain
idlewouldhavegreaterantiinflationaryimpact.The
government holds surplus tax revenues which keeps
thesefundsfrombeingspent.
POLICYOPTIONS:GORT?
y Economists have mixed views aboutwhether to use
government spending or tax changes to promote
stability, depending on their view of the
government:
1. If economists are concerned about unmet social
needs or infrastructure, they tend to favor higher
government spending during recessions and higher
taxesduringinflationarytimes.
2. When economists think that government is too
largeorinefficient,theytendtofavorlowertaxesfor
recessions and lower government spending during
inflationaryperiods.
Classicalvs KeynesianEcon
y ClassicalEcontheory
y Pricesrise webuyless(demandgoesdown) surpluses
pricesdrop webuymore.
y Whenwebuyless,businesseslayoffworkers lesspeople
withjobs lessbuying recessionordepression.
y Eventually,businessesdroppricestopointwherepeoplebuy
stuff businessesmake$ businesseshiremoreworkers
workers spend$ Depressionover
ClassicalSystem,
y Governmenthadnoroleinmanagementoftheeconomy
Laissezfaire ordonothing
y Iftheeconomyfacesaninflationarygap(equilibriumata
levelhigherthanfullemployment),Governmentmust
reducedemandbyspendingless;raisetaxes;increase
interestrates;reducingwelfare
KeynesianEconomics:
DemandSideEconomics
y JohnMaynardKeynes(early1900s)
y Economiesareunstableandalwayschanging
y InflationcausedbyDEMAND Toomany$tryingto
buytoofewgoods
y EconomieswillNOTbalancethemselvesoutina
timelymanner
y Toomanypeoplewillgethurtwaitingfortheeconomytoadjustto
imbalanceinSupply&Demand
y Governmentmuststepintocorrecttheinherent
instabilityoftheeconomy
FiscalPolicy(Keynesview)
y Inarecession(notenoughspending)Governmentmustincrease
demandbyspendingmore;loweringtaxes;loweringinterestrates;
increasingwelfare
y Examples:FDRsNewDealprograms,Bush/Obamas StimulusPackage
y DeficitSpending isgood
y Whenindebt,govt shouldSPENDmoneyandtaxlessto
getoutofdebt
y Explainhowthisworks.
SupplySideEconomics
y Believesinflationcausedbylackofsupply
y TaxlessAND cut GovernmentSpending
y TrickleDownEconomics
y E.g.RonaldReaganin1980s(Reaganomics)
u-a:-
THANKSYOU

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The welfare lost of a tariff imposed by a large Country

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