Global economics guide, Summaries of Economics

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R. C. Allen,

Global economics

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Competency 1 Business Decision Making in the Global Environment (15 points) TOPIC: GLOBALIZATION (6 points) Chapter 1 (Global Business) (PENG) Globalization: close integration of countries and people throughout the world International Business: action of doing business abroad Global Business: Business around the globe Multinational Enterprise: A firm that engages in Foreign Direct Investment (FDI) FDI: investing in controlling and managing value added activities in other countries What determines the success and failures of firms around the globe:

• Resource based view: All control and blame are on the firm and it indicates that the success and failure depend on themselves
• Institution based view: Believes that the success and failures of the firm lies in formal (laws/rules) and informal institution (customs/traditions/culture) 3 Views of globalization
• New force: globalization is something new, started 1950s in western countries
• Long-run historical evolution: globalization has been with humanity since the inception
• Pendulum: globalization is not new and not one particular way but swings back and forth between extremes Chapter 5 (Peng) Theories of International Trade Classic Mercantilism (antiquated theory) The wealth of the world is fixed (measured in gold/silver). A nation that exports more than imports captures a net inflow of wealth and thus become richer. International trade is viewed as a ‘zero-sum’ game. Winner and loser. Those that win, gain; and those that lose, lose; thus having a balance of the two and a zero sum game.

Can help countries connect ‘research’ to industry outcomes Chapter 6 (Investing Abroad Directly) (PENG) Foreign Direct Investment- investing in controlling interest and managing value added activities in other countries. Has controlling interest. Foreign portfolio investment-investment in stocks/bonds in foreign countries without a controlling interest. Does not have controlling interest. Horizontal and Vertical FDI Horizontal: produce the same good in host country as at home. GM produces car in US and Mexico Vertical: upstream and downstream; GM produces a car in US but doesn’t produce car in Mexico, they only sell it. Not doing the same thing in both countries MNE vs Non-MNE Multi-national enterprise: Engages in FDI Non-multi-national enterprise: Does not engage in FDI Why engage in FDI Ownership-gives you control Location-gives you some ties to that place Internalization-replaces exporting and importing Political views on FDI Radical view-very hostile; doesn’t like FDI Free market view-like FDI; want less government intervention Pragmatic nationalism-each gov will weigh cost and benefit of FDI, if the benefits outweigh the cost, then the gov will allow it. Benefits and Costs of FDI Benefits: capital inflow, job creation, learn new technology. Costs: loss of sovereignty, competition, capital outflow Chapter 11 (Making Alliances & Acquisitions Work) (Peng) Alliances and Acquisitions Alliances-voluntary cooperation/agreement between firms Acquisitions-transfer of the control of operations and management from one firm to another

Resources and Alliances: Use the resources we have and build it into our alliances. VRIO gives a firm a competitive advantage (not comparative advantage). Company has rare resources, management style that is difficult to imitate, or organizational setting that is an advantage. Value, Rarity, Imitability, Organization Resources Similarity-extent to which a given a competitor possesses strategic endowment comparable to those in competition. Market Commonality-overlap between two rival markets. Commonality is low, competition is high and vice versa. TOPIC: INTERNATIONAL TRADE AND FOREIGN EXCHANGE MARKET (9 points) Repeat of Chapter 5 (Peng) Chapter 7 (Peng) Determinants of Foreign Exchange Supply/Demand factors Relative price differences & PPP (purchasing power parity) Interest rates and money supply Productivity and balance of payments Exchange rate policies Investor psychology Productivity and Balance of payments Balance of payments: A country’s international transaction statement, which includes merchandise trade, service trade, and capital movement (balance sheet of imports vs exports) Current Account Balance Current account=balance of trade + net factor income from abroad + net unilateral transfer from abroad Exchange Rate Policies Floating (flexible) exchange rate policy: Willingness of a gov to let supply and demand conditions determine exchange rate Clean (Free) float: Pure market solution to determine exchange rate Dirty (Managed) float: using selective gov intervention to determine exchange rate

How do firms respond to foreign exchange movements? Primary strategies *Currency hedging: transaction that protects traders and investors from exposure to the fluctuations of the spot rate Spread out your currency investment to multiple countries. Akin to diversifying your stock portfolio. *Strategic hedging: Spreading out activities in a number of countries in different currency zones to offset any currency losses in one region through gains in another region. Why? For fear of war or tariffs. Strong vs Weak Dollar Strong=appreciate Advantages Consumers benefit US firms find it easier to acquire foreign targets Lower prices on foreign goods Disadvantages Businesses are hurt US exporters have a hard time competing abroad US firms have a hard time competing with low-cost imports Foreign tourists find it more expensive visiting the US Weak= depreciate Advantages US exporters find it easier to compete on price abroad US firms face less competitive pressure to keep prices low Foreign tourist enjoys lower prices in the US Foreign firms find it easier to acquire US targets Disadvantages US consumers face higher prices on imports High priced imports contribute to higher price level/inflation in US IMF (International Monetary Fund): An international organization established to promote international monetary cooperation, exchange stability, and orderly exchange arrangements. Chapter 10 (Peng)

Overcoming the Liability of Foreignness Liability of Foreignness: inherent disadvantage foreign firms experience in host countries because of their non-native status (culture, religion, customs) Resource based view: foreign firms need to deploy overwhelming resources and capabilities to offset the liability of foreignness. Where to enter? Location specific advantages: benefits that a firm reaps from the features specific to a place Agglomeration: location specific advantages that arise from the clustering of economic activities in certain locations (Ex Silicon Valley for technology) Natural resource seeking: possession of natural resources and related transport and communication infrastructure (Ex oil in the middle east) Market seeking: abundance of strong market demand and customers willing to pay (Ex GM in China) Efficiency Seeking: economies of scale and abundance of low-cost factors Innovation seeking: abundance of innovative individuals, firms, and universities (Ex telecom in Dallas) When to enter? *First mover advantages: Benefits that accrue to firms that enter the market first and those later entrants do not enjoy. more risk, more reward. Don’t confuse with the word ‘early’. *Late mover advantages: Benefits that accrue to firms that enter the market later and those early entrants do no enjoy. Don’t confuse with the word ‘last’. Lower risk, lower reward How to enter? *Scale of entry: amount of resources committed to entering a foreign market *Mode of entry: method used to enter a foreign market *Nonequity: entering foreign markets through exports or contractual agreements that tends to reflect relatively smaller commitments to overseas markets. Easier to back out of. Dipping your toe in the water so to speak. *Equity: entering foreign markets through Joint Venture or wholly owned subsidiaries that indicates a relatively larger, harder-to-reverse commitment. Jumping in head first. Harder to back out of this. Competency 2: Political and Economic Forces (10 points)

System where citizens elect representatives to govern the country on their behalf. Citizens have freedom to express themselves and organize themselves Totalitarianism Dictatorship. Political system where one person/party exercises absolute political control over the population. Ex. Communist, Right wing, Theocratic, Tribal Political Risk Totalitarianism is not good for business. Risk of wars, riots, chaos, protests Legal systems How a country’s laws are enacted and enforced Civil Law (France, Brazil, China) Derived from Roman Law Oldest, most influential, and most widely used Common Law (US, Canada, Australia) Shaped by precedents and traditions from previous judicial decisions English Speaking countries Theocratic Law (Iran, Saudi Arabia, UAE) Based on religious teachings Jewish law/Islamic law Property rights: the most fundamental economic function that a legal system serves to protect. Think of land usage and its resources. The right to use a resource and derive income from it Intellectual property rights is the intangible property that is a result of intellectual activity Books, Videos, Websites, music *Patents (legal rights to investors) *Copyrights (legal rights to authors/publishers) *Trademarks (legal rights to use names, brand, and design) Economic systems How a country is governed economically Market ------------------------  Command Market (open; as in open to trade) Invisible Hand (Adam Smith, 1776) The equilibrium between supply and demand; which then determines price Laissez-Faire (hand off approach) Factors of production are privately owned Government intervention is limited Mixed Elements of both market and command economy Command (closed; as in closed to trade/centrally planned)

Government steps in on either price or quantity (quota) Government takes a ‘commanding height’ Factors of production government owned Supply, demand and price planned by government No country has ever completely been Market or Command, each is on a spectrum…but most countries consider themselves a market economy Drivers of Economic development Culture (1600-1960) Rich countries have smarter and harder-working people driven by a stronger motivation for economic success Geography (1960-Now)

• Rich countries have natural resources
• Landlocked; because they have to travel through other countries before they can get to the sea.
• North/south (of the tropic of cancer/Capricorn); therefore, there are four seasons. Less tropical diseases in these areas. Institutions (1970-Current)
• Provide the incentive structure of a society
• Political, legal, economic systems impact development by affecting incentives and the cost of doing business Gains from trade Specialization Property Rights Is a democracy conducive to economic growth? In general, YES….Except for China: The fastest growing major economy in the last three decades remains totalitarian 1980: 60 countries practicing democracy 2000: 117 countries practicing democracy Private vs State Ownership State owned: reward manager and workers equally. Extra work doesn’t equal extra pay. Little incentive to improve quality and efficiency Washington Consensus is spearheaded by: International Monetary Fund (IMF) World Bank Beijing Consensus Centers on state ownership is superior to private ownership

Combinations of two goods that person can purchase given her income and the prices of the goods. The trade-off of two goods. The opportunity cost of the two products. (price of banana/price of apple). Income/price of product; plot this. Income/price of other product; plot this. Connect the two lines. Everything under the line is attainable (can have any combination of products within this area). Unobtainable is above the line. Indifference Curve Analysis: shows combination of two goods that make people equally happy. This shows consumer preference. The slope of the indifference curve at any point is the consumer’s marginal rate of substitution. Marginal rate of substitution resembles the demand curve; downward sloping and convex The higher the indifference curve the better-this means we can consume more of the good we can consume and the happier we will be. Where the budget line and the indifference curve=equilibrium point. Effects of Increased Income As income increases, consumers will buy more normal goods and less inferior goods As income decreases, consumers will buy more inferior goods and less normal goods TOPIC: FIRM BEHAVIOR UNDER DIFFERENT MARKET STRUCTURES (10 points) Chapter 13 Cost of Production (Mankiw) Economic Costs (Opportunity cost) Explicit cost + implicit cost Explicit cost=monetary payment (material cost, wages, interest) Implicit cost=income you would have earned (time, value of next best opportunity). Includes depreciation and lost income (ex going to college instead of working) Profit Accounting profit Total revenue – explicit cost Economic profit Total revenue – economic cost (opportunity cost; EC-IC)

Law of Diminishing Returns (production) Add a variable resource to a fixed resource Output will increase by a smaller and smaller amount Short and Long Run Costs Short Run Resources are fixed Long Run Resources are variable Fixed costs-costs don’t vary with output (ex factory) Variable costs-costs change with the amount of output (ex material/labor) Total cost=Fixed + variable cost Average Fixed cost=Total fixed cost/quantity Average total cost (ATC) curve is U-shaped At very low levels of output, ATC is high because fixed cost is spread over only a few units ATC declines as output increases ATC starts rising because AVC rises substantially as output continues rising If MC<ATC then ATC is decreasing (where MC is marginal cost) If MC>ATC then ATC is increasing Long Run ATC Economies of Scale (downward sloping) A firm produces more and long run average total cost goes down Labor specialization-workers are more efficient Diseconomies of Scale (upward sloping) A firm produces more and long run average total cost increases Problem of communication and cooperation Constant Returns to Scale (horizontal line) A firm produces more and long run average total cost remains the same Chapter 14 (Mankiw) Four Market Models Perfect/pure competition (competitive markets) Monopolistic competition Oligopoly competition Pure monopoly Perfect competition Number of firms-large

In the short-run, firms in competition and monopolistic competition can make economic profits Produce where MC=MR Chapter 15 (Mankiw) Chapter 16 (Mankiw) Demand curve Downward sloping Highly elastic (there are many firms under this competition) Produce where MR=MC Short run profit or loss Entry and exit Long run zero economic profit Heavy use of advertising. Try to decrease their average total cost Chapter 17 (Mankiw) Competency 4: Microeconomic and Macroeconomic (8 points) TOPIC: MACROECONOMIC PRINCIPLES (3 points) Chapter 29/34 (Mankiw) Money Fiat:

1. Store of value a. Durable b. Keeps it value c. Inflation attacks this aspect
2. Medium of exchange a. Has to be accepted in consumer interactions b. Widely accepted
3. Unit of account a. Easily divisible b. Make change and compare different amounts Currency whose value is set by the gov or the market and not an actual valuable commodity Commodity Currency: Currency with is made of a valuable commodity (gold/silver) M1: (can spend right now) Demand deposits Travelers checks Other checkable deposits

Currency M2: (M1+ M2 (can’t spend directly)) Savings deposits Small time deposits Money market/mutual funds Everything included in M Money is an asset Credit card is a debt Quantity of M1/M2 is the total value of the money supply Money supply (M1 + M2) line and a downward sloping money demand curve. Where they meet is the equilibrium interest rate. Opportunity cost for holding money. If you are holding money (not bonds) then the opportunity cost is the money you could’ve been earning from holding bonds and earning interest Chart: Vertical line representing money supply, downward sloping line is money demand; equilibrium interest rate vertical axis, quantity of money horizontal axis.Any change in money supply or money demand changes the price of money (interest rate) The Federal Reserve system Changes in monetary supply is called monetary policy It is controlled by the Federal Reserve Federal Reserve doesn’t have to ask the president or congress for permission Three tools of the Federal Reserve

1. Reserve requirement ratio a. How much the bank must keep on as ‘reserves’ at the Federal Reserve b. Where your bank does their banking
2. Open Market Operations a. Buying/selling of US Gov Treasuries (Bonds)
3. Discount Window Rate a. Rate of interest the Federal Reserve charges banks when banks borrow from the Fed b. The interest rate that the Fed charges banks for loaning them money Increase the Money Supply Open Market purchase (fed buys bonds, pay with currency) Decrease the discount window rate (cost of borrowing for banks falls; lend more) Decrease reserve requirement ratio (banks have more money to lend)

Market Demand: the combination of multiple individual buyers and sellers Competition: many buyers and sellers. No one seller or buyer has market power. No single buyer or seller controls the market. Consumer demand Utility: a measure of happiness Utility Maximization: we all make choices that make ourselves the happiest we can be. Constrained Utility Maximization: my budget (or something else) may prevent me from getting what I think would make me the happiest Preferences: what I like the most Diminishing marginal utility: the more you consume of a good the less additional happiness you get from it How much of a good will you consume? Until the marginal benefit =the marginal cost (Ex the more ice cream you eat the less you are willing to pay for it). *Demand curves are always downward sloping *Law of Demand: as price increases quantity demanded falls Change in quantity demanded: a movement along the demand curve Change in demand: a shift of the entire demand curve Change in quantity supplied: a movement along the supply curve Change in supply: a shift of the entire supply curve Supply curve: relationship between the quantity supplied and the price. Represents the marginal cost of production to the firm *Law of Supply: as price increases the quantity supplied increases. Always is upward sloping Equilibrium: the point where the marginal cost of production (supply) equals the marginal cost of consumption (demand). Markets cause rational behavior, where supply equals demand If price is too high then we have a surplus of the product If price is too low then the result is a shortage Graph: right shift=increase; left shift=decrease. Upward sloping supply; downward sloping demand. Price on the vertical; quantity on the horizontal What can shift demand curve? Change in prices of related goods Changes in tastes and preferences

Change in consumers income Change in number of buyers Change in expectations of price What can shift supply curve? Change in cost of inputs Change in technology Change in number of suppliers Expectations of future Increase in income: Rightward shift for normal goods Left shift for inferior goods Decrease in income: Leftward shift for normal goods Right ward shift for inferior goods Increase in buyers: Demand shifts right; price increases, quantity increases Elasticity: measure how responsive demand is to something *Price elasticity of demand=% change in quantity demand/# change price Income elasticity of demand=% change quantity demand/% change income Cross price elasticity of demand=% change in quantity demand of good #1/% change in price of good # Elastic goods has a price elasticity of demand > Inelastic goods has a price elasticity of demand <1 (milk, gas, diapers) Chapter 5 (Mankiw) Competency 5: Assessing Global Economic Performance and International Trade (6 points) TOPIC: INTERNATIONAL TRADE (2 points) Chapter 9 (Mankiw) TOPIC: MEASURING ECONOMIC PERFORMANCE (4 points) Chapter 7 (Mankiw) Chapter 23 (Mankiw)