Basic Economic Concepts

Introduction to GNP,BOP & Foreign Exchange : 

Introduction to GNP,BOP & Foreign Exchange

Topics & Structure of Lesson : 

Topics & Structure of Lesson International Institutions,BOP & Exchange Rate: GDP & GNP BOP – it’s accounts,it’s implications & how to rectify a deficit BOP Exchange Rate – factors influencing it,Pegged Exchange Rate,Exchange Control Currency Appreciation & Government Interventions

Learning Outcomes : 

Learning Outcomes At the end of this chapter, you should: Understand the impacts on a country when changes take place in GNP, GDP, Balance of Payment ,Foreign Exchange.

KEYWORDS : 

KEYWORDS Gross National Product (GNP) & Gross Domestic Product (GDP) Deficit / Surplus Balance of Payment Exchange Rates Pegged Exchange Rate Exchange Controls Currency Appreciation / Depreciation Government Interventions

GDP & GNP : 

GDP & GNP Gross Domestic Product (GDP) – is the value of output produced within a country’s borders. Gross National Product (GNP) – is the value of output produced using resources owned by a particular country wherever these resources are located.

GDP & GNP : 

GDP & GNP Would a decline in GDP result in higher or lesser economic growth?

BOP : 

BOP BOP is defined as statistical “accounting” record of a country’s international trade transactions (purchase / selling of a good or services) and capital transactions (acquisition / disposal of assets / liabilities ).

BOP - accounts : 

BOP - accounts 3 accounts: Current account – trade in goods,trade in services,investment,transfer ( visible trade[export and import of goods] & invisible trade[mainly the sale and purchase of services] ) Capital account – summaries transactions involving fixed assets Financial account- acquisition/ disposal of financial assets ( bonds, shares, securities)

Surplus / Deficit BOP : 

Surplus / Deficit BOP Surplus BOP – investment and add to official reserves Deficit BOP – borrow money from abroad, sell bought assets

Deficit BOP - Effects : 

Deficit BOP - Effects Effects when deficit of Balance of Payment takes place: Import tariffs Import quotas Total ban or embargo on imports

Rectify a Deficit : 

Rectify a Deficit How to rectify a deficit? Devaluation (within a controlled exchange rate system) Direct measures Reduce aggregate (restrict imports by imposing tariffs and quotas) demand (C+I+G+X)

Rectify a Deficit : 

Rectify a Deficit Administrative burdens on importers (safety standards) Exchange control regulations (difficult to obtain foreign currency) Providing export subsidies

Exchange Rate : 

Exchange Rate Exchange Rate Changes in the exchange rate = implications to BOP (either surplus / deficit) For example : UK (exporter) and US (importer ) trade, US must buy sterling pounds using US dollars.

Factors influencing ER : 

Factors influencing ER Factors influencing the Exchange rate for a currency: Rate of inflation Interest rate Balance of Payment Speculation Government policy ( Price Pegging)

Pegged Exchange Rates : 

Pegged Exchange Rates Pegged exchange rates – a rate is fixed and then guaranteed by the government. (for example, our Malaysian Ringgit is pegged against the US dollars (US Dollar 1 = MR3.80)

Exchange Controls : 

Exchange Controls Exchange control – refers to restrictions placed upon the ability of citizens to exchange foreign currency freely (example Malaysian government restricts Malaysian to convert only RM5,000 into foreign currency for holidays abroad.)

Fixed Exchange Rates : 

Fixed Exchange Rates Fixed Exchange Rates - give certainty to international trade and investors reduce speculation imposes discipline on domestic economic policies (in times of adverse BOP)

Fixed Exchange Rates : 

Fixed Exchange Rates -Expensive as requires a large reserves of foreign reserves - Costly and damaging to the domestic economy

Currency Appreciation : 

Currency Appreciation Effects of currency appreciation: Reflects lower inflation period Stocks build up ( output increases) Short time working and labour redundancies Investment – deferred / cancelled Imports will become cheaper

Government Interventions : 

Government Interventions Government interventions: Sell own currency for foreign currency – keep down the exchange rate Buy own currency with foreign currencies (reserve) when exchange rate is increased. Change in interest rate (foreign investment)

References : 

References Sloman J. & Sutcliffe M.(2001) Economics for Business, Prentice Hall

Question for Discussion : 

Question for Discussion Explain how a firm will be affected by the change in the exchange rates. Outline the potential advantages and disadvantages to a Malaysian company of negotiating its contract in US dollars.