Slide 2 After Exam 1

Distribution of Exam 1 Score

A Lecture From Mr. Romney xg xg

US Trade Balance (Deficit if Negative)

Facts Data from trade/statistics/historical/# trade/statistics/historical/# US had no trade deficit before 1980 China joined world trade organization in December 2001 Hot issue: is Chinese currency the main reason for US trade deficit?

Hint 1 Before 2000, US had trade deficit mainly with Japan and Germany Both countries use floating exchange rates

Hint 2

Hint 3 In eco 201 you learn that it is demand and supply that determine the price, not vice versa Mr Romney just looks at the demand curve, and he forgets supply curve

Three Questions How to explain the rising trade deficit in early 1980? How to explain the rising trade deficit in early 1990? How to explain the falling trade deficit in late 2000?

Review We apply classical dichotomy to open economy We first find net export, then real exchange rate, and finally nominal exchange rate

Long Run Model for Exchange Rate

Discuss What may cause law of one price or purchasing power parity to fail? If inflation in England was higher than Germany in 1992, then British Pound was expected to ______________ against German Mark

Short Run Model The nominal exchange rate is the price for currency Suppose home is China, and foreign country is US The exchange rate for Chinese currency yuan is denoted by $/¥. Yuan appreciates when the exchange rate goes_______

Warm Up As yuan appreciates, the Chinese good becomes (more expensive or cheaper), and this will (increase or decrease) the demand for Chinese good

Demand and Supply The demand for yuan comes from China’s export The demand curve is downward sloping since China’s export falls as yuan appreciates. The supply for yuan comes from China’s import The supply curve is ______ sloping since China’s import ________ as yuan appreciates

Application How to explain that there are more and more Chinese students coming to US when yuan appreciates?

Graph Time The demand-and-supply diagram for yuan is

Critical Thinking Draw the demand and supply curve for Yuan, but now the exchange rate is ¥/$

Story Time In order to help China’s export, the Chinese government want to keep the value of yuan (low or high) That means, thanks to Chinese government’s intervention on the FX market, there will be (shortage or surplus) of yuan, and China will have trade (deficit or surplus)

How To Intervene Chinse government needs to constantly sell yuan and buy dollars on the FX market That means supply curve of yuan shifts to (right or left), and Chinese dollar reserve (rises or fall)

US Foreign Debt

There is no free lunch Undervalued Yuan helps Chinese export Undervalued Yuan may lead to inflation in China (How?)

Application: Quantitative Easing China exports good, and US exports inflation (to a country whose currency is pegged to US dollar)

China can control exchange rate, but only the nominal one, and only in short run In long run, price level in China will rise, and this will cause yuan to appreciate in real term, even though the nominal rate is fixed (how?)

In long run, the winner is

Currency Crisis George Soros vs Bank of England Before September 1992, Pound was pegged to Mark Soros thought Pound is ________ because inflation in England was higher than Germany To keep Pound from depreciating, Bank of England had to ____ Pound and _____ Mark The foreign reserve of England went ______ Crisis happened when __________ Soros tried again, in 1997, at HongKong, but this time….

Do not mess with Texas Because they are big!

Why do economists hate budget deficit? Rising government expenditure crowds out investment and export Investment is crucial for growth

Production Function

Solow Model Dynamic Model Proposed by Robert Solow, a Nobel winner It shows how the income grows over time The key concept is steady state (dynamic equilibrium)

Per Worker Terms

Fundamental Equation

Exercise

Critical Thinking What if Increasing Marginal Product

Discuss What is the effect of rising saving rate on growth?

Steady State

Solow Model Without Population Growth

Dynamics

A Dilemma

Golden Rule

Optimal Saving Rate

Policy Implication

Solow Model with Population Growth

Fundamental Equation

Proof (Optional)

Application How does the one-child policy of China affect its long run living standard?

Solow Model with Population Growth

Exercise

Summarize Saving can increase future living standard Population growth can increase GDP Population growth can reduce future living standard How about technology? Read chapter 8 (optional)