International economics, Apuntes de Administración de Empresas

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TOOLS in APPLIED ECONOMICS

Course: International Economics

Code: 102387- Group: 04

Universitat AutÚnoma de Barcelona

Rosella Nicolini

December 2011

Contents

Chapter 2

Some basic indicators

In this section we are introducing some basic indicators that are helpful in measuring eco- nomic activity. Serrano (2004) discusses the importance of measuring economic activity in order to be able to formulate some comments or provide interpretations of the trend and tendency of the evaluation of macroeconomics aggregates. The best way to address this issue is to focus on the changes that a few selected variables experiences over time.

2.1 Rate of change and index of variation

This index measures the relative change of the magnitude of a variable between two moments in time. It is often expressed as a percentage. Let us deÖne A 0 the value of a variable at time t = 0 and A 1 the value of a variable at time t = 1; the rate of change of the variable A passing from time 0 to time 1 is:

RC =

A 1 A 0

A 0

Therefore, if someone knows the rate of exchange and knows the initial value of variable A, it is easy to compute the value at time 1 by adopting the previous rule:

A 1 = A 0 (1 +

RC

As a simple extension of the rate of change, it is possible to compute the variation index (IV). This index represents the direct relationship between the magnitude of a variable at the current time and the value of the same variable at a precise moment in time that has been chosen as reference (and whose value is 100). Let us deÖne it by considering the previous variables A 0 and A 1 when we select as reference period t = 1 :

IV =

A 1

A 0

When we are referring to a change that takes place between two moments in time, it could be from one year to another year or one quarter versus another. We are talking about "year- on-year" changes when we are referring to two di§erent moments in time in two di§erent years. We are referring to "interannual" changes when we are comparing two periods (for instance, weeks or quarters) in a same year.^1

Example 1 (Serrano, 2004) Let us deÖne A 0 = 550 and A 1 = 500 and let us deÖne t=1 as the period of reference:

RC =

IV = (

2.2 Average cumulative rate

Another interesting exerecise is to compute the rate of variation of an economic variable for more than two periods. We may also want to compute a synthetic measure of this value to provide some economic interpretations of the general evolutionary trend. A very easy way to provide such an indicator is to compute a simple arithmetic average of the di§eren per-year variations, but this may be di¢ cult. Instead, the average cumulative rate indicator allows to achieve this result in a very direct way. The average cumulative rate basically smooths the annual di§erences in growth and provides a general results by taking into account the Örst and the last value of a series. The idea is to capture the average growth by focusing on the progressive increase (or decrease) of the magnitude of a variable as a results of the growth rate. However, this indicator has a major drawback: it has true economic meaning when the series of the variable we are referring to follow a monotonic evolution for the period we are considering. Again, let us consider A 0 as the initial magnitude of a variable An the Önal value of this variable after n time-periods (years, months, quarters....). The average cumulative rate (AVR) can be obtained as:

AV R =

An A 0

 (^1) n 1

knowing that:

An = A 0

AV R

n :

(^1) In this respect, an interesting glossary it is available on the OECD website at this URL:

http://stats.oecd.org/glossary/index.htm.

Chapter 3

Price index

We deÖne the price level as a weighted average of several di§erent prices.The reason for using di§erent weights is that some prices are more important than others for the economy. The price of oil, for example, is much more important than the price of apples. By using di§erent weights we allow for changes in some prices to have a larger e§ect on the price level than changes in other prices.Di§erent choices give rise to di§erent measures of the price level. To visualize the prices and weights that are included, we use the concept ìbasketîof goods and services. We may, for example, create a basket that contains all the goods sold by a particular store on a particular day. The price of this basket is then a price level - it will be a weighted average of the prices of the goods sold that day and the weights will be equal to the number of each good sold. Perhaps the basket contains 100 litres of regular milk but only one frozen cake. The price of regular milk will then have a weight of 100 while the price of frozen cake will have a weight of 1. Changes in the price of milk will then have a greater ináuence on the price level than changes in the price of frozen cake (Jochumzen, 2010). In economics we are not just interested in the value of price livels at a given moment in time: we are often interested in the percentage change in the price level between two points in time. We calculate the percentage change by Örst creating a basket of goods and services. At regular intervals (usually once a month on the Örst day of the month) we measure all the prices of the contents of the basket (typically as an average of the market) and calculate the price level. Exactly how much it would rise would depend on the weight of the changed price. Imagine that we have created a particular basket of goods and services. We calculate the price level at four di§erent points in time during 2008 without changing the content of the basket (the weights are unchanged). Suppose that we Önd the following time series for the price level (Jochumzen, 2010):

Point in time Jan 1, 2008 Feb 1, 2008 March 1, 2008 April 1, 2008 Price index 60 770 62 400 62 850 62 850

3.1 Price index

Since we are only interested in the percentage change of the price level and not the particular value, we can divide each price level by a given constant so that the numbers are easier to deal with. When we divide a series of price levels by a constant we end up with what is called a time series of price indexes. Using the same basket as above, if we divide the entire series by 607.70 we get the following time series of price indexes:

Point in time Jan 1, 2008 Feb 1, 2008 March 1, 2008 April 1, 2008 Price index 100 102.68 103.42 103. The reason for choosing 60770 is that we want the index to be equal to 100 for the Örst point in time. The advantage of having an index that starts with 100 is that we will have a clearer picture of the evolution of prices. We may, for example, immediately conclude that prices rose by 2.68% on average in January and by 3.42% during the three months fromJanuary to March. Note that the percentage change of the original price level and the percentage change of the price index is the same. The percentage change will not depend on which point in time we select as our ìbaseî (giving the price index a value of 100). Using the price index, the percentage change during January is (62400 - 60770)/60770 = 2,68% which is exactly the same as the percentage change of the price index (Jochumzen, 2010).

3.2 Consumer Price Index (CPI)

CPI is a price index of a particular basket called the CPI-basket. The CPI-basket contains basically all the goods and services consumed in a country - food, gas, medicine, haircuts, transportation, house rent and so on. The composition of the CPI basket is determined by the value of what is consumed in the country - the larger the value of total consumption of a good or service, the larger the weight in the basket. For example, if we spend twice as much on apples as on pears, apples will have twice the weight in the basket. The exact details of the composition of the basket and how the CPI is calculated are complicated and vary somewhat between countries (Jochumzen, 2010).

3.3 Ináation rate

The ináation between two points in time is deÖned as the percentage increase of the price index between these two points in time. It is very important to pay attention to the following aspects:

 Price index is calculated at a particular point in time, ináation over a time period, typically one year

 Ináation may just as well be deÖned as the percentage change in the price level.

Chapter 4

The Balance of Payments

The Balance of Payments records all the economic transactions of a country with the rest of the world during a speciÖc period (usually one year but it can be also one month or one quarter). As in the standard account practice:

 Each payment received from foreign Örms, institutions or citizens is a credit,

 Each payment done to foreign Örms, institutions or citizens is a debt.

A complete balance of payments is composed by three sections:

 The Current Account (CA) records all transactions from and to foreign countries. These transactions principally include imports and exports of goods and services, pay- ment of interests rate (on dividends) on some investments,rents, insurances, transport costs/incomes, and commissions paid for services. In this chapter we also include immigrant remittances and pensions.

 The Capital Account (K) records short and long term capital ináow and outáows.In particular, it includes institutional donations for development and transactions asso- ciated to assets as lands or other resources. We also include in this section all bank deposits held by foreign residents in the country and by citizens abroad.

 The Financial Account (FA) records operations such as foreign direct investment (FDI) ináows and outáows and all credit or debit leftovers for transactions that took place at a speciÖc moment during the period we are considering, but without being completed with the entire monetary compensation. Investment in foreign treasury bonds (or other assets that guarantee a return) are recorded as well.

 Variation of O¢ cial Reserve Assets (R) corresponds to the entry or exit of o¢ cial reserve assets as a consequence of a physical transactions.

 The Statistical discrepances (SD) is minor section including measurement errors in the deÖnition of the value of each transaction due, for example, to the di§erent values of the exchanges rates.

The Balance of Payments clears as follows:

CA + K + F A R  SD = 0:

The fulÖlment of this conditions implies that the results of each sections can be positive or negative, but the total value has to sum up to zero. For instance, it may occur that our economy gets negative values of the CA because of more imports than exports. The condition of the parity of the balance of payments implies that to a deÖcit of the CA has to correspond a surplus of K or FC, namely the debt of the current account section is Önanced by the ináow of foreign capital in our country.

The best way to elaborate the Balance of Payments of a country is to represent each single section as shown in the following table:

Credit Debit CA Export of goods and services Import of goods and services Investment returns from abroad Investment returns to abroad Remittances, pensions etc..from abroad Remittances and pensions to abroad Balance of the CA: Credit - Debit

K Foreign capital ináow as donations from abroad National capital outáow as donations from abroad Investment abroad in land and intangible assets Foreign investments in lands and intangible assets Balance of the K: Credit - Debit

FA FDI Ináows FDI Outáows Credits grant by foreign institutions Credits grants to foreign institutions Balance of the K: Credit - Debit

R Increase of the reserves Decrease of the reserves of foreign currencies of foreign currencies

SD

Remark: The Balance of Payments is based on the notion of double-entry book keeping.

In addition, in countries with large immigration and emigration áows, the GDP is not the best measure of the true income produced by "citizens". In this case the GNP (Gross National Product) is a more suitable measure of the income of those countries. For instance, in countries like the United States statistics about GNP are the most referred to in statistics for measuring the annual "income" of the country.The GNP is obtained as:

GN P = GDP  remittances.

5.1 Real GDP

In order to be able to make reasonable comparisons of GDP over time, we must adjust for ináation. For example, if prices are doubled over one year, then GDP will double even though exactly the same goods and services are produced as the year before. To eliminate the e§ect of ináation we divide GDP by a price index and we deÖne real GDP as GDP divided by a price index. It is not very common to use CPI in the construction of real GDP. The reason is that CPI measures the price evolution of consumer goods while GDP includes investment goods as well as consumer goods. Instead, it is common to use a GDP deáator as a price index.

GDP def lator =

nominal GDP real GDP

The GDP deáator measures the price evolution of a basket whose composition is close to the composition of GDP. The di§erence between the CPI and the GDP deáator is fairly small however. In economic analysis, it is also quite common to approximate the the GDP deáator with the CPI: the CPI series are always available for any territorial unit while GDP deáator is more complicated to compute. This easy data availability makes of the CPI a good approximation of the GDP deáator (Jochumzen, 2010 and Burda, 2005).

Example 3 (Serrano, 2004). Let us consider the following values of GDP: 1999 2000 2001 Nominal GDP 590 609 646 GDP deáator 147 153 159

1. Determine the value of real GDP
2. Calculate the GDP series at prices 2000 by assuming that the GDP di§erences are purely due to the e§ect of changes in prices and not in quantities. 3 Calculate the GDP deáator for 2001=100. Answers:
3. Real GDP: it is the ratio between nominal GDP and the GDP deáator

2. In order to compute the GDP series at prices 2000, we consider that the nominal value of GDP in 2000 is the reference. Therefore:

3. In order to calculate the GDP deáator taking as a reference 2001, we need to compute a variation index:

Finally, remind that GDP that is not adjusted for ináation is often called nominal GDP. It is also very important to pay special attention when making international comparisons to assess the level of income of a country (or any other territorial units). First, when comparing GDP across countries to state their level of income, it is very important to get rid of any size e§ects (namely, the total Chinese GDP is orders of magnitude larger than total Swedish GDP, but this does not mean that the Swedish income is lower than the Chinese one). In order to overcome this problem we must compare GDP per capita between countries. Since the GDP value is a nominal one, it may happens that the value of the comparisons may áuctuate a lot because of the e§ect of a high volatile exchange rate. Once more, we have to control for this volatility. A way of avoiding dependence on the exchange rate is to compute the GDP per capital at country level by using the purchasing power indicators (refer subsection 5.1).

5.2 Economic growth

By (nominal) GDP-growth we mean the percentage change in (nominal) GDP over a speciÖc period of time. Real GDP growth is deÖned as the percentage change in real GDP. The real growth tells us how much the economy has grown during a particular period when the e§ect of ináation is removed. The measure of real growth is the most common indicators adopted to draw insights about the economic perspective of a country or any other territory.

the box Örms). Firms are compensated for the goods and this compensation is equal to GDP.

 Consumers receive goods from the goods market where prices are determined through supply and demand.

 In order to pay for the goods, the consumers deliver factors of production (labor and capital) to the factor markets.

 Firms buy factors of production using the income they receive from the goods market.

Note that the áow of money from Örms to the factor markets is exactly the same as the áow of money from the goods market to the Örms. If this was not the case, Örms as a group would make a proÖt or a loss. But since all Örms are owned by individuals (directly or indirectly through pension funds and other funds), all proÖts or losses must eventually fall on the consumers (Jochumzen, 2010).

5.3.1 GDP from the supply side

A Örm in our model is a unit which adds value to products. These products may be raw material, semi-manufactured goods, Önal goods and services. By adding value, we mean that the Örm acquires the good, adds value to it and then sells it. Firms add value by using factors of production (mostly various forms of labor and capital). We deÖne value added (va) as the di§erence between the revenue and the cost of the goods. If a supermarket buys a Ösh for 4 euro and sells it for 5 euro, it has added 1 euro of value to the Ösh. Since the value added in each Örm is equal to the return to the factors of production, the total return to the factor market must be equal to the sum of value added from all Örms, which is equal to the GDP (Jochumzen, 2010). The total return to the factor market =

Sum of all value added=

X^ n

i=

vai + T AX = GDP;

with n the total numer of sectors and T AX the net taxes on the production (and products). TAX is obtained as the di§erence between the taxes less and subsidies or transfers to the production (and products).

5.3.2 GDP from the demand side

Since the private sector receives the entire return from the factors of production, the national income is equal to the GDP and we can use the symbol Y for national income as well. The private sector pays taxes to the government. Here we must include all taxes, income taxes,

value added taxes, selective purchase taxes and payroll taxes (which are ultimately paid by the private sector since it owns the Örms). Part of these taxes will be returned to the private sector in the form of pensions, child allowances, sickness beneÖt, unemployment beneÖts and so on (Jochumzen, 2010). All these are examples of transfers from the government. We denote government expenditure by G. Total consumption by the private sector is denoted by C. Consumption needs not be equal to disposable income as the private sector can save and borrow. We deÖne the private sectors savings as SH = YDisp - C (H for household). If C

YDisp then SH < 0, which implies that the private sector (in the aggregate) is borrowing money. The total value of all exports to the rest of the world is denoted by X, while the total value of all imports from the rest of the world is denoted by M. If M > X then the value of all goods and services received from the rest of the world is larger than the value of goods and services that we send to them. The di§erence, SR = M - X is rest of the world savings and this is also the amount we borrow from the rest of the world, which must eventually be paid back by exporting more than we import. Finally, we have to take into account investments. When we use the word investment, we typically mean ìgross investmentî. Basically, gross investment consists of all Önished goods that we have produced but not consumed. The gross investment (I) is composed by gross Öxed investment and changes in inventories. Gross Öxed investment is the total amount of investment in Öxed capital. If a Örm produces more than it sells in a particular period of time, its inventory will increase. This will be counted as a positive investment. In the same way, we will have a negative inventory investment whenever inventories decrease (Jochumzen, 2010). By correctly summing up properly the previous components we get to the expression of the total nominal GDP (at current prices) from the demand side as follows:

GDP = Y = C + I + G + X M

Example 5 Let us consider the following values: Private consumption (C): 1 283 Gross investment (I): 456 Public consumption (G): Import (M): 1 093 Export (X):1 299 GDP= 1283+456+728+1299-1093= 2673

5.3.3 GDP from the income side

As the sum of all returns from the factor markets, the total GDP can be also obtained as the sum of wages, return on capital and so on. In this respect, the value of the GDP includes wages of the employees, rents (for land or real estates), interests and other returns on Önancial activites, taxes (on production, consumption and import) minus subsidies or public transfer to the production or trade activity. Therefore, the nominal GDP at current prices can be obtained as:

• 1 Introduction
• 2 Some basic indicators
  • 2.1 Rate of change and index of variation
  • 2.2 Average cumulative rate
• 3 Price index
  • 3.1 Price index
  • 3.2 Consumer Price Index (CPI)
  • 3.3 Ináation rate
• 4 The Balance of Payments
• 5 Gross Domestic Product (GDP)
  • 5.1 Real GDP
  • 5.2 Economic growth
  • 5.3 The components of GDP
    • 5.3.1 GDP from the supply side
    • 5.3.2 GDP from the demand side
    • 5.3.3 GDP from the income side
• 6 Indicators of competitiveness
  • 6.1 Prices and trade
  • 6.2 Other indicators of trade competitiveness
    • Exports 64. Exercise 6 These are data refer to the Catalan GDP in 2007 (mill. e)
    • Gross investment (capital formation) 58.
    • Final consumption (families 135.
    • Imports 78.
    • Wages of employees 97.
    • Value added agriculture 1.
    • Value added energy 3.
    • Value added industry 36.
    • Value added construction 20.
    • Other incomes and revenues 89.
    • Public expenditure 28.
    • Value added market services 107.
    • Value added no market services 18.
    • Net taxes on production 20.
    • Net taxes on production and imports 21.
• Export 64. a. 1) GDP: demand side
• Gross investment (capital formation) 58.
• Private consumption 135.
• Import - 78.
• Public expenditure 28.
  • GDP 2007 market prices (€) 208.
• VA Agriculture 1. a.2) PIB: supply side
• VA Energy 3.
• VA Industry 36.
• VA Construction 20.
• VA Market Services 107.
• VA No market services 18.
• Net taxes on production 20.
  • GDP 2007 market prices (€) 208.
• Wages 97. a.3) GDP: revenue and income side
• Others incomes and revenues 89.
• Net taxes on production and import 21.
  • GDP 2007 market prices (€) 208.

Chapter 6

Indicators of competitiveness

The information we compile to compute the GDP from the demand side allows for getting some complementaty insights about the evolution of the competitiveness of a country. The most natural (and intuitive) indicator refers to the trade account, namely the di§er- ence between exports and imports (X-M). A positive trade accounts implies that a country is particular competitive in the international markets. This situation entails some positive beneÖts: the GDP (hence the available income) increases and the exchange rate of the coun- try is expected to apreciate. Another easy way to check the status of competitivenes is by looking at the terms of trade of a country. The terms of trade is the ratio between the prices of exports and the price of imports. It measures the quantity of foreign goods can be purchased with one unit of domestic output (Burda, 2005). On the trading side, the competitiveness of a country identiÖes with the share of export in in the international countries.

6.1 Prices and trade

The level of prices across countries a§ects the trade directions. A country usually records high export áows when the price of the good and services it o§ers on the international markets is lower than that of the direct competitors. When talking about prices in the international markets, we are not only referring to the nominal value of a good (or service) but also the exchange rate that allows it to pass from a currency or another. The relationship between prices, exchange rates and international trade is quite complex. A country whose currency is particularly depreciated on the international markets can enjoy some technical beneÖts to be able to export at quite constant rates even if the internal prices (namely ináation) are increasing. Of course, the same country would be in serious trouble on the import side given that the price of imported goods and services is progressively increasing too. In economics, one usually refers to the concept of purchasing power parity when asserting that the real exchange rate is constant. This idea implies that the price level of a same good (in di§erent) countries is equalized across these countries when converted into the same currency. Let us consider the price of a worldwide good (the BIG-MAC, for instance);