Summary
Summary Terms work for International Trade and Finance Eco3023f
- Course
- Eco3024f
- Institution
- University Of Cape Town (UCT)
This is a comprehensive summary of the terms work done.
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ECO3024F Term 1 SummariesWeek 1:
• Chapter 13
Week 2:
• Chapter 14
Week 3:
• Chapter 15
Week 4:
• Chapter 16
Week 5:
• Chapter 17
Week 6:
• Chapter 18 & 21
,WEEK 1: Chapter 13
• National income accounting – records all the expenditures that contribute to a country’s
income & output.
• Balance of payments accounting – keeps track of both changes in a country’s
indebtedness to foreigners and the fortunes of its export & import-competing industries.
National Product and National Income:
Gross National Product (GNP) = the value of all final G&S produced by the country’s FOPs and
sold on the market in a given time period.
GNP consists of 4 types of expenditure:
- Consumption (the amount consumed by private domestic residents) +
- Investment (amount put aside by firms to build equipment for future production) +
- Government purchases (the amount used by the government) +
- Current account balance (the amount of net exports of G&S to foreigners).
à The term national income accounts, rather than national output accounts, is used to
describe this 4-fold classification bc a country’s income = its output. National income is
the income earned in a given period by its FOPs.
Bc we have defined GNP and national income so that they are necessarily equal, their equality
is really an identity. However, 2 adjustments to the definition of GNP must be made before
the identification of GNP and national income is entirely correct in practice:
1. Capital Depreciation: GNP doesn’t take into account the economic loss due to the
tendency of machinery and structures to wear out as they are used. This loss
(depreciation) reduces the income of capital owners. Therefore, to calculate national
income over a given period, we must subtract the depreciation of capital over the period
from GNP: Net National Product (NNP) = GNP – depreciation.
2. International Transfers (unilateral transfers): A country’s income may include gifts from
residents of foreign countries, called unilateral transfers of income – E.g., payments to
retired citizens living abroad; reparation payments; foreign aid such as relief funds
donated to drought-stricken nations. Net unilateral transfers are part of a country’s
income but are not part of its product, and they must be added to NNP in calculations of
national income.
∴ National Income (NNP) = GNP – Depreciation + Net Unilateral transfers.
Gross Domestic Product (GDP):
GDP is supposed to measure the volume of production within a country’s borders.
GDP = GNP – net receipts of factor income from the RoW.
= GNP – (factor payments from RoW) + (factor payments to the RoW).
GNP = GDP + net receipts of factor income from the RoW.
For the US, net receipts of factor income from the RoW comprise primarily of the income
domestic (US) residents earn on wealth they hold in other countries minus the payments
domestic (US) residents make to foreign owners of wealth that is located in the domestic (US)
country. Unlike GNP, GDP does not correct for the portion of countries’ production carried
out using services provided by foreign-owned capital & labour.
§ Example: The profits of a Spanish factory with British owners are counted in Spain’s GDP,
but are part of Britain’s GNP. The services British capital provided in Spain are a service
export from Britain, therefore they are added to British GDP in calculating British GNP. At
, the same time, to calculate Spain’s GNP, we must subtract from its GDP the corresponding
service import from Britain.
Movements in GDP and GNP usually do not differ greatly. However, our focus is on GNP, bc it
tracks national income more closely than GDP does, and national welfare depends more
directly on national income than on domestic product.
National Income Accounts for an Open Economy:
GNP in a Closed economy: Y = C + I + G
GNP in an Open economy: Y = C + I + G + EX – IM (Equation 13-1)
• In an open economy, saving & investment are not necessarily equal like they are in a
closed economy. This is bc countries can save in the form of foreign wealth by exporting
more than they import, and they can dissave (i.e., reduce their foreign wealth) by
exporting less than they import.
• NOTE: Investment spending (I) may be viewed as the portion of GNP used to increase the nation’s stock
of capital – E.g., Steel & bricks used to build a factory; services provided by a technician who builds
business computers; firms’ purchases of inventories. “investment” is often used to describe
households’ purchases of stocks, bonds, or real estate…but do not confuse this everyday meaning with
the economic definition of investment as a part of GNP – E.g., When you buy a share of Microsoft stock,
you are buying neither a good nor a service, so your purchase does not show up in GNP.
Current Account and Foreign Indebtedness
CA = EX – IM
• CA deficit: EX < IM ⇒ Net borrower
• CA surplus: EX > IM ⇒ Net lender
The CA is important for several reasons:
– Since the RHS of the GNP identity (13-1) gives total spending on domestic output, changes
in the CA can be associated with changes in output and, thus, employment.
– The CA measures the size & direction of international borrowing. When a country imports
more than it exports, it is buying more from foreigners than it sells to them and must
somehow finance this CA deficit. To pay for additional imports once it has spent its export
earnings, the country must borrow the difference from foreigners. Thus, a country with a
CA deficit must be increasing its net foreign debts by the amount of the deficit. Similarly,
a country with a CA surplus is earning more from its exports than it spends on imports.
This country finances the current account deficit of its trading partners by lending to them.
The foreign wealth of a surplus country rises bc foreigners pay for any imports not covered
by their exports by issuing IOUs that they will eventually have to redeem. This all shows
that a country’s CA balance equals the change in its net foreign wealth.
We know that: CA = EX – IM. Equation (13-1) says that the CA is also equal to the difference
between national income and domestic residents’ total spending C + I + G:
CA = Y – (C + I + G)
It is only by borrowing abroad that a country can have a CA deficit and use more output than
it is currently producing. If it uses less than its output, it has a CA surplus and is lending the
surplus to foreigners. Intertemporal trade:
– A country with a CA deficit is importing present consump. and exporting future consump.
– A country with a CA surplus is exporting present consump. and importing future consump.
, Savings and the Current Account:
National saving = the portion of output (Y) that is not devoted to household consumption (C),
or government purchases (G).
• In a closed economy, national savings = investment (therefore, a closed economy as a
whole can only increase its wealth by accumulating new capital). Thus, our definition tells
us that: S = Y – C – G. Since the closed-economy GNP identity, Y = C + I + G, may also be
written as I = Y – C – G, then, S = I.
• In an open economy, however, saving and investment can differ. Since S = Y – C – G and
CA = EX – IM, we can re-write the GNP identity (Equation 13-1) as:
S = I + CA
CA = S – I
à This equation highlights an important difference between open and closed economies: An
open economy can save either by building up its capital stock or by acquiring foreign wealth,
but a closed economy can save only by building up its capital stock.
Unlike a closed economy, an open economy with profitable investment opportunities doesn’t
have to increase its saving in order to exploit them. The expression shows that it is possible
simultaneously to raise investment and foreign borrowing without changing saving.
§ E.g., if SA decides to build a new power plant, it can import the materials it needs from the US and
borrow US funds to pay for them. This transaction raises SA’s domestic investment bc the imported
materials contribute to expanding its capital stock. It also raises SA’s CA deficit by an amount equal to
the increase in investment. SA’s saving doesn’t have to change, even though investment rises. But, for
this to be possible, US residents must be willing to save more so that the resources needed to build
the plant are freed for SA’s use. The result is another example of intertemporal trade, where SA imports
present output (when it borrows from the US) and exports future output (when it pays off the loan).
Bc one country’s savings can be borrowed by a second country in order to increase the second
country’s stock of capital, a country’s CA surplus is often referred to as its net foreign
investment. Of course, when one country lends to another to finance investment, part of the
income generated by the investment in future years must be used to pay back the lender.
Domestic investment and foreign investment are two different ways in which a country can
use current savings to increase its future income.
Private and Government Saving:
• Private savings = the part of disposable income (Y – T) that is saved rather than consumed.
Thus: 𝑆 ! = 𝑌 − 𝑇 − 𝐶.
• Government savings = the part of gov. income that is saved rather than consumed. The
gov’s income tax revenue (T) and its consump. is gov. purchases (G). Thus: 𝑆" = 𝑇 − 𝐺.
National saving = private saving + government saving. We previously defined national saving
as: S = Y – C – G. Therefore:
𝑆 = 𝑌 − 𝐶 − 𝐺 = (𝑌 − 𝑇 − 𝐶) + (𝑇 − 𝐺) = 𝑆 ! + 𝑆"
In an open economy, because 𝑆 = 𝑆 ! + 𝑆" = 𝐼 + 𝐶𝐴,
𝑺𝒑 = 𝐼 + 𝐶𝐴 − 𝑆" = 𝐼 + 𝐶𝐴 − (𝑇 − 𝐺) = 𝑰 + 𝑪𝑨 + (𝑮 − 𝑻) (Equation 13-2)
à Equ (13-2) relates private saving to: domestic investment, the CA surplus, and government
saving. To interpret Equ (13-2), we define the government budget deficit as G – T, that is, as
government saving preceded by a minus sign. The gov. budget deficit measures the extent to
which the government is borrowing to finance its expenditures. Equ (13-2) then states that a
country’s 𝑆 ! can take 3 forms: investment on domestic capital (I), purchases of wealth from
foreigners (CA), and purchases of the domestic government’s newly issued debt (G – T).
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