Notes Part I, Ejercicios de Administración de Empresas

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TOOLS in APPLIED ECONOMICS

Course: International Economics

Code: 102387- Group: 04 and 08

Universitat Autònoma de Barcelona

Rosella Nicolini

First edition: December 2011

This edition: July 2017

Contents

Chapter 1

Introduction

These notes cover the material discussed in class in the first part of the course. The material presented has been compiled by referring to books or other sources cited in the references. The purpose of the material is to provide support for the topics introduced in class and students are encouraged to refer to other official sources to complement their background. The contents of these notes are also useful for solving the assignment that students are expected to turn in according to the general schedule. This revised version includes more empirical evidence, some activities giving food for thoughts and two templates of exams (with solutions). I am grateful to Ana Larrea for re- viewing the previous edition and providing valuable suggestions. Once more, any suggestion is welcome to improve the content and make it ready to use. Of course, any error is my unique responsability.

First version: December 2011 Revised version: July 2017

Rosella Nicolini

°c All Rights reserved.

Chapter 2

Some basic indicators

In this section we are introducing some basic indicators that are helpful in measuring eco- nomic activity. Serrano Pérez (2004) and Serrano Pérez et al. (2009) discuss 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 define  0 the value of a variable at time  = 0 and  1 the value of a variable at time  = 1 the rate of change of the variable  passing from time 0 to time 1 is:

μ  1 −  0  0

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

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 define it by considering the previous variables  0 and  1 when we select as reference period  = 1 :

μ  1  0

It may also be the case that we interested in knowing how long a variable would take to achive a specific value. Rearranging the previous expression it is possible to obtain such a missing parameter:

ln

  0

ln

Exercise 2 (Serrano, 2004) The value of A in 1997 is 99,200. This variable records a positive AVR=2.729% per-year. What is the value A could achieve in 2005? NB: n=2005-1997=8.

μ 1 +

μ 1 +

Chapter 3

Price index

We define the price level as a weighted average of several different prices.The reason for using different 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 different weights we allow for changes in some prices to have a larger effect on the price level than changes in other prices.Different choices give rise to different measures of the price level. To visualize the prices and weights that are included, we use the concept “basket” of 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 influence 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 first creating a basket of goods and services. At regular intervals (usually once a month on the first 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 different points in time during 2008 without changing the content of the basket (the weights are unchanged). Suppose that we find 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 level 60770 62400 62850 62850

Figure 3.1: Consumer price index (2016). Source IMF

• Inflation is independent of which year we use as our base year for our price index.
• If the price index decreases between two points in time we say that the inflation is negative or that we have deflation.

The inflation rate is computed as any other rate of change being exactly the rate of change of prices (Jochumzen, 2010).

3.4 Empirical Evidence & Activity

International organizations as the International Monetary Fund (IMF) or the Wordbank (WB) made available interesting time-series statistics about the most relevant macro (and sometimes micro) indicators at country level or at world-regional level. Figure (3.1) picture of the spatial distribution of the consumer price index (CPI) in 2016 all around the world. Grey areas suffer from hypergrowth of the index. The ones painted in dark brown record sustained level of CPI growth whereas the light brown are the ones with the lowest rate of CPI growth. When turning to the evolution of the inflation rate, another interesting evidence appears. One of them is the Argentinian case: the country suffered from a progressive sustained inflation growth after the economic crisis in 2000 -Figure (3.2)-.

Instead, in the case of the EURO countries (above all, Germany) the inflation trend is much more under control (3.3). An interesting information one can deduce from Figure 3. is the timing mismatch of the economic recovery in Germany and the rest of the EURO countries. Germany acts as a frontrunner in the recovery path after 2008 crisis. German

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Inflation, GDP deflator (annual %)

Figure 3.2: Inflation trend in Argentina (Source WB)

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Inflation, GDP deflator (annual %)

Euro area Germany

Figure 3.3: Inflation rate in EURO countries (Source WB)

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 specific 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 firms, institutions or citizens is a credit,
• Each payment done to foreign firms, 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 inflow and outflows.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) inflows and outflows and all credit or debit leftovers for transactions that took place at a specific 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 Official Reserve Assets (R) corresponds to the entry or exit of official reserve assets as a consequence of a physical transactions.

• The Statistical discrepances (SD) is minor section including measurement errors in the definition of the value of each transaction due, for example, to the different values of the exchanges rates.

The Balance of Payments clears as follows:

The fulfilment 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 deficit of the CA has to correspond a surplus of K or FC, namely the debt of the current account section is financed by the inflow 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 inflow as donations from abroad National capital outflow as donations from abroa Foreign investments in lands and intangible assets Investment abroad in land and intangible assets Balance of the K: Credit - Debit

FA FDI Inflows FDI Outflows 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 flows, 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:

 =  ± remittances.

5.1 Real GDP

In order to be able to make reasonable comparisons of GDP over time, we must adjust for inflation. 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 effect of inflation we divide GDP by a price index and we define 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 deflator as a price index.

μ nominal GDP real GDP

The GDP deflator measures the price evolution of a basket whose composition is close to the composition of GDP. The difference between the CPI and the GDP deflator is fairly small however. In economic analysis, it is also quite common to approximate the the GDP deflator with the CPI: the CPI series are always available for any territorial unit while GDP deflator is more complicated to compute. This easy data availability makes of the CPI a good approximation of the GDP deflator (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 deflator 147 153 159

1. Determine the value of real GDP 2 Calculate the GDP deflator for 2001=100. Answers:
2. Real GDP: it is the ratio between nominal GDP and the GDP deflator

μ 590 147

μ 609 153

μ 646 159

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

μ 147 159

μ 153 159

μ 159 159

Finally, remind that GDP that is not adjusted for inflation 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 effects (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 fluctuate a lot because of the effect 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 7.1).

5.2 Economic growth

By (nominal) GDP-growth we mean the percentage change in (nominal) GDP over a specific period of time. Real GDP growth is defined as the percentage change in real GDP. The real growth tells us how much the economy has grown during a particular period when the effect of inflation 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.

Exercise 4 (Serrano, 2004) Let us consider the following data: 2000 2001 2002 GDP in current prices 609 646 697 GDP in constant prices 1997 510 521 536 Questions:

1. Determine the GDP deflator,
2. Inflation rate,
3. Real GDP growth rate in 2001 and 2002,
4. GDP 2002 at constant-2000 prices. Answers:
5. GDP deflator (1997=100):

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GDP growth (annual %)

Germany European Union Spain

Figure 5.1: Growth rate in the EU (2000-2016). Source WB.

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GDP growth (annual %)

China East Asia & Pacific

Figure 5.2: Growth rate in China and Asia (2000-2016). Source WB

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GDP growth (annual %)

North America United States Latin America & Caribbean Venezuela, RB

Figure 5.3: Growth rate in North and Latin America (2000-2016). Source WB

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GDP growth (annual %)

Middle East & North Africa Sub‐Saharan Africa Central African Republic

Figure 5.4: Growth rate in selected world regions (2000-2016). Source WB