Balance of Payments Problem Set

1. Which of the balance of payments accounts do the following events affect? a. Boeing, a U.S.-based company, sells a newly built airplane to China. The sale of the new airplane to China represents an export of a good to China and so enters the current account. b. Chinese investors buy stock in Boeing from Americans. The sale of Boeing stock to Chinese investors is a sale of a U.S. asset and so enters the financial account. c. A Chinese company buys a used airplane from American Airlines and ships it to China. Even though the plane already exists, when it is shipped to China it is an export of a good from the United States. So the sale of the plane enters the current account. d. A Chinese investor who owns property in the United States buys a corporate jet, which he will keep in the United States so he can travel around America. Because the plane stays in the United States, the Chinese investor is buying a U.S. asset. So this is identical to the answer to part (b): the sale of the jet enters the financial account

2. In the economy of Scottopia in 2008, exports equaled $400 billion of goods and $300 billion of services, imports equaled $500 billion of goods and $350 billion of services, and the rest of the world purchased $250 billion of Scottopia’s assets. What was the merchandise trade balance for Scottopia? What was the balance of payments on the current account in Scottopia? What as the balance of payments on financial account? What was the value of Scottopia’s purchases of assets from the rest of the world? In 2005, the merchandise trade balance was -$100 billion ($400 billion - $500 billion). The balance of payments on current account was -$150 billion [($400 billion + $300 billion) - ($500 billion + $350 billion)]. Since the balance of payments on financial account plus the balance of payments on current account must sum to zero, the balance of payments on financial account must have been +$150 billion. If the rest of the world bought $250 billion of Scottopia’s assets, Scottopia must have bought $100 billion of assets from the rest of the world.

1. What does the production possibilities curve (PPC) show? The PPC is a graphic representation of the trade-offs in the production of two goods.

2. What does it mean for one country to have an absolute advantage over another in trade? Absolute advantage means that one country can produce more of a good than another country.

3. What does it mean for one country to have a comparative advantage over another in trade? Comparative advantage means that one country can produce a good at a lower opportunity cost than another country. It may be producing less in absolute terms but still has an advantage in terms of lower opportunity cost.

4. The U.S. and England have the following production possibility curves.

Using the information on the graphs above: A. The opportunity cost of 1 unit of Fish in the U.S. is 1/2 chip per fish.

B. The opportunity cost of 1 unit of Chips in the U.S. is 2 fish per chip.

C. The opportunity cost of 1 unit of Fish in England is 1/4 chip per fish.

D. The opportunity cost of 1 unit of Chips in England is 4 fish per chip.

E. The U.S. has an absolute advantage in fish AND chips.

F. England has an absolute advantage in nothing.

G. The U.S. has a comparative advantage in chips (the U.S. gives up fewer fish per chip than England).

H. England has a comparative advantage in fish (England gives up fewer chips per fish than the U.S.).

5. Liam and Miley have two tasks they need to complete: mow the lawn and prepare meals for the day. They agree that trade is in their best interest, which is where they need your help. Using the information in the table below determine who should be responsible for the lawn and who should be working in the kitchen.

Mow Lawns Prepare Meals Liam 60 mins 120 mins Miley 120 mins 360 mins

A. Who has an absolute advantage in mowing lawns? Liam (it takes him less time to mow a lawn)

B. Who has an absolute advantage in preparing meals? Liam (it takes him less time to prepare a meal)

C. What is Liam’s opportunity cost associated with mowing 1 lawn? 1/2 meal per lawn

D. What is Miley’s opportunity cost associated with mowing 1 lawn? 1/3 meal per lawn

E. What is Liam’s opportunity cost associated with preparing 1 meal? 2 lawns per meal

F. What is Miley’s opportunity cost associated with preparing 1 meal? 3 lawns per meal

G. Who has a comparative advantage in mowing lawns? Miley because she gives up fewer meals per lawn

H. Who has a comparative advantage in preparing meals? Liam because he gives up fewer lawns per meal 6. The following figures represent the amount that can be produced with a fixed amount of factor inputs.

Country Shirts TVs China 400 200 India 120 30

A. Which country has an absolute advantage in producing shirts? China

B. Which country has an absolute advantage in producing TVs? China

C. What is China’s opportunity cost for producing one shirt? 1/2 TVs per shirt

D. What is India’s opportunity cost for producing one TV? 4 shirts per TV

E. Identify which country has a comparative advantage in shirts? India has the comparative advantage because its opportunity cost (1/4 TV per shirt) is less than China’s (1/2 TVs per shirt).

F. Which country has the comparative advantage in TV? China has the comparative advantage because its opportunity cost (2 TVs per shirt) is less than India’s (4 TVs per shirt).

G. Explain why these countries can benefit from trade. Both are able to increase their consumption of TVs and shirts due to trade.