Chapter III
GDP, economic growth, and prosperity.

Wind: Wind is an example of a renewable natural resource. It occurs naturally in the environment and has the ability to replenish itself. It has also been used as a form of energy development through wind turbines.
Basic Economics of Natural Resources: Natural resource economics focuses on the supply, demand, and allocation of the Earth’s natural resources to create a more efficient economy.

As a field of academic research, natural resource economics addresses the connections and interdependence between human economies and natural ecosystems.

• By studying natural resources, economists learn how to develop more sustainable methods of managing resources to ensure that they are maintained for future generations.
• Natural resource economics is studied on an academic level, and the findings are used to shape and direct policy-making for environmental issues. These issues include resource extraction, depletion, protection, and management.
• Natural resource economics findings impact policies for environmental work including issues such as extraction, depletion, protection, and management.
• natural resource: Any source of wealth that occurs naturally, especially minerals, fossil fuels, timber, etc.
• sustainable: Able to be sustained for an indefinite period without damaging the environment, or without depleting a resource.

Natural resource economics focuses on the supply, demand, and allocation of the Earth’s natural resources. The main objective of natural resource economics is to gain a better understanding of the role of natural resources in the economy. By studying natural resources, economists learn how to develop more sustainable methods of managing resources to ensure that they are maintained for future generations. Economists study how economic and natural systems interact in order to develop an efficient economy. As a field of academic research, natural resource economics addresses the connections and interdependence between human economies and natural ecosystems. The focus is how to operate an economy within the ecological constraints of the earth’s natural resources.

Natural Resource Economics diagram also illustrates that society and the economy are subsets of the environment. It is not possible for social and economic systems to exist independently from the environment. Natural resource economics focuses on the demand, supply, and allocation of natural resources to increase sustainability. Economists study the commercial and recreational use and exploitation of resources. Traditionally, natural resource economics focused on fishery, forestry, and mineral models. However, in recent years many more topics have become increasingly important, including air, water, and the global climate. Natural resource economics is studied on an academic level, and the findings are used to shape and direct policy-making for environmental issues. Examples of areas of study in natural resource economics include:

• welfare theory
• pollution control
• resource exhaustibility
• environmental management
• resource extraction
• non-market valuation
• environmental policy

Research topics of natural resource economists can include topics such as the environmental impacts of agriculture, transportation and urbanization, land use in poor and industrialized countries, international trade and the environment, and climate change.

Impact of Natural Resource Economics: the findings of natural resource economists are used by governments and organizations to better understand how to efficiently use and sustain natural resources. The findings are used to gain insight into the following environmental areas:

• Extraction: the process of withdrawing resources from nature. Extractive industries are a basis for the primary sector of the economy. The extraction of natural resources substantially increases a country’s wealth. Economists study extraction rates to make sure that resources are not depleted. Also, if resources are extracted too quickly, the sudden inflow of money can cause inflation. Economists seek to maintain a sense of balance within extraction industries.
• Depletion: the using up of natural resources, which is considered to be a global sustainable development issue. Many governments and organizations have become increasingly involved in preserving natural resources. Economists provide data to determine how to balance the needs of societies now and preserve resources for the future.
• Protection: the preservation of natural resources for the future. The findings of economists help governments and organization develop measures of protection to sustain natural resources. Protection policies state the necessary actions internationally, nationally, and individually that must take place to control natural resource depletion that is a result of human activity.
• Management: the use of natural resources taking into account economic, environmental, and social concerns. This process deals with managing natural resources such as land, water, soil, plants, and animals. Particular focus is placed on how the preservation of natural resources impacts the quality of life now and for future generations.

Externalities and Impacts on Resource Allocation.

Production and use of resources can have a positive or negative effect on the allocation of the natural resources. Examine externalities and how they the impact resource allocation of natural resources.

• An externality is a cost or benefit that affects a party who did not choose to incur the cost or benefit.
• A negative externality, also called the external cost, imposes a negative effect on a third party.
• When external costs are present, the market equilibrium use of natural resources is inefficient because the social benefit is less than the social cost. In other words, society would have been better off if fewer natural resources had been used.
• Positive externalities, also referred to as external benefits, imposes a positive effect on a third party.
• Assuming that natural resources are used and also sustained, the external benefits of goods produced by natural resources impacts the majority of the public in a positive way.

Resource Allocation.

Resource allocation is division of goods for the use of production within the economy. The needs and wants of society as well as industries impact what is produced. Suppliers focus on producing the varieties of goods and services that will yield the greatest satisfaction to consumers. In the long run, externalities directly impact resource allocation. It must be determined whether the production, as well as the process of production, creates more benefits that costs for the producers, consumers, and society as a whole.

Externalities.

An externality (an impact, positive or negative, on any party not involved in a given economic transaction or act.) is a cost or benefit that affects a party who did not choose to incur the cost or benefit. In regards to natural resources, production and use of resources can have a positive or negative effect on the allocation of the resources.

External Costs.

A negative externality, also called the external cost, imposes a negative effect on a third party to an economic transaction. Many negative externalities impact natural resources negatively because of the environmental consequences of production and use. For example, air pollution from factories and vehicles can cause damage to crops. Likewise, water pollution has a negative impact of plants and animals.

Negative externality: Air pollution from vehicles is an example of a negative externality. It affects other than those who drive the vehicle and those who sell the gas. In the case of negative externalities, the marginal private cost of consuming a good is less than the marginal social or public cost. The marginal social benefit should equal the marginal social cost (i.e. production should only be increased when the marginal social benefit exceeds the marginal social cost). When external costs are present, the use of natural resources is inefficient because the social benefit is less than the social cost. In other words, society and the natural resources involved would have been better off if the natural resources had not been used at all. Developed countries use more natural resources and must enact sustainable development plan for the use of resources. Human needs must be met, but the environment and natural resources must be preserved. Examples of resource depletion include mining, petroleum extraction, fishing, forestry, and agriculture.

External Benefits.

Positive externalities, also referred to as external benefits, impose a positive effect on a third party. An example of a positive externality is when crops are pollinated by bees from a neighboring bee farm. In order to achieve the socially optimal equilibrium, the marginal social benefit should equal the marginal social cost (i.e. production should be increased as long as the marginal social benefit exceeds the marginal social cost). Assuming that natural resources are used and also sustained, the external benefits of goods produced by natural resources impacts the majority of the public in a positive way.

The Importance of Productivity.

Increasing productivity is a rare win-win, improving the standard of living from a governmental, commercial and consumer perspective.

Productivity is essentially the efficiency in which a company or economy can transform resources into goods, potentially creating more from less. Increased productivity means greater output from the same amount of input. This is a value-added process that can effectively raise living standards through decreasing the required monetary investment in everyday necessities (and luxuries), making consumers wealthier (in a relative sense) and businesses more profitable. From a broader perspective, increased productivity increases the power of an economy through driving economic growth and satisfying more human needs with the same resources. Increased gross domestic product (GDP) and overall economic outputs will drive economic growth, improving the economy and the participants within the economy. As a result, economies will benefit from a deeper pool of tax revenue to draw on in generating necessary social services such as health care, education, welfare, public transportation and funding for critical research, and managing our environment sustainably. The benefits of increasing productivity are extremely far-reaching, benefiting participants within the system alongside the system itself, and planet Earth.

Productivity identifies optimal inputs (and consequent outputs) to satisfy the needs of a given population via a particular production process. Factors of productivity are:

• Land/Natural Resources: Products of nature that have economic value, including metals/agriculture/livestock/land/etc.
• Capital: This is a broad term, capturing more than just financing and investment. Capital can also be fixed capital (i.e. machinery, equipment, buildings, computers, etc.) or working capital (i.e. goods, inventory and liquid assets). Concepts of human, intellectual and social capital is also highlighted, separate from the concept of labor below, which can affect the efficiency of a process.
• Labor: The human skills, time and efforts necessary to add value to the production process. This can range from highly tangible inputs (working hours, products assembled) to highly intangible inputs (entrepreneurship, experience, technology skills, etc.).

Impacts of Technological Change on Productivity.

Technological advances play a crucial role in improving productivity, and thus the standard of living in a system.

• Technological advances have driven productivity upwards, underlining the ongoing importance of focusing on technology as a primary change agent.
• Advances in energy systems, transportation, communication, logistics, and a variety of other technological trajectories have greatly enabled an increased standard of living through advancing productivity.
• Measuring the affects of technology on productivity is a difficult pursuit. It is generally approached through the Gross Domestic Product ( GDP ).

Monetary Transactions.

Aggregate demand (AD) is the total demand for final goods and services in the economy at a given time and price level. It is the sum of consumer spending, investments, government spending, and net exports within a given economic system (often written out as AD = C + I + G + nX).

The Creation of the Federal Reserve.

The Federal Reserve was created to promote financial stability, provide regulation and banking services, and conduct monetary policy.

• central bank: The principal monetary authority of a country or monetary union; it normally regulates the supply of money, issues currency and controls interest rates.
• reserve requirement: The minimum amount of deposits each commercial bank must hold (rather than lend out).

Commercial banks are required to hold a certain proportion of their deposits in reserves and not lend them out. This proportion is called the reserve requirement and is controlled by the Fed. By changing the reserve requirement, the Fed can impact the amount of money available for lending, and by extension, spending and investment.

Commercial banks are required to have a certain amount of reserves on hand at the end of each day. If they are going to come up short, they must borrow from other banks or the Fed. The Fed extends these loans through the discount window and charges what is called the discount rate. The discount rate is set by the Fed, and is important because it radiates throughout the economy: if it becomes more expensive to borrow at the discount window, interest rates will rise and borrowing will become more expensive economy-wide. In this way, the Fed can use the discount window to affect interest rates and the money supply.

The government borrows by issuing bonds. Recall that the interest rate that the government pays is determined by the price of the bond: the higher the price of the bond, the lower the interest rate. The Fed can affect the interest rate by conducting open-market operations (OMOs) in which it buys or sells bonds. Buying or selling bonds changes the demand or supply of the bonds, and therefore their price. By extension, OMOs change the interest rate, hopefully to achieve one of the Fed’s monetary goals.

While the demand of money involves the desired holding of financial assets, the money supply is the total amount of monetary assets available in an economy at a specific time. Data regarding money supply is recorded and published because it affects the price level, inflation, the exchange rate, and the business cycle. Monetary policy also impacts the money supply. Expansionary policy increases the total supply of money in the economy more rapidly than usual and contractionary policy expands the supply of money more slowly than normal. Expansionary policy is used to combat unemployment, while contractionary is used to slow inflation. In the United States, the Federal Reserve System controls the money supply. The reserves of money are kept in Federal Reserve accounts and U.S. banks. Reserves come from any source including the federal funds market, deposits by the public, and borrowing from the Fed itself. The Fed can attempt to change the money supply by affecting the reserve requirement and through other monetary policy tools.

The Federal Reserve has several tools at its disposal to reach its monetary policy objectives. These include the discount rate, the fed funds target rate, and the reserve requirement, and open market operations (OMOs). OMOs are considered to be the most flexible option for the Federal Reserve out of all of these. On a general level, OMO are the purchase and sale of securities in the open market by a central bank, as a means of controlling the money supply and the related prevailing interest rate. By buying and selling US Treasury bills on the open market, the Federal Reserve hopes to change their yields, which will then affect the interest rates in the broader market. In the United States, the Federal Reserve Bank of New York conducts open market operations. They are under the oversight of the Federal Reserve Open Market Committee (FOMC). The FOMC makes a plan for open market operations over the short term, and publicly announce it after their regularly scheduled meetings. Historically, the Federal Reserve has used OMOs to adjust the supply of reserve balances so as to keep the federal funds rate–the interest rate at which depository institutions lend reserve balances to other depository institutions overnight–around the target established by the FOMC.

The Federal Reserve (Fed) has an ability to directly influence economic growth and stability through the use of monetary policy. Though the central bank can directly influence the money supply the majority of its activities center around interest rates, the outcome of changes to the money supply.

Executing Expansionary Monetary Policy.

Central banks initiate expansionary policy during periods of economic slowing, increasing the money supply and reducing interest rates.

• In an expansionary policy regime, the Fed would reduce the reserve requirement, thereby effectively increasing the amount of loans that a bank can issue.
• Expansionary monetary policy will seek to reduce the fed funds target rate (a range).
• In an expansionary policy regime, the Fed purchases government securities via open market operations from a bank in exchange for cash; the Fed’s purchase increases the supply of reserves (money) to the banking system, and the federal funds rate ( interest rate ) falls.
• The interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis.
• open market operations: An activity by a central bank to buy or sell government bonds on the open market. A central bank uses them as the primary means of implementing monetary policy.
• reserve requirement: The minimum amount of deposits each commercial bank must hold (rather than lend out).

Monetary policy is based on the relationship between money supply and interest rates, where the interest rate is essentially the price of money. The two variables have an inverse relationship. As a result, as the money supply in an economy is increased, the interest rate will generally decrease and if the money supply is contracted, interest rates will generally increase. The money supply is a monetary policy mechanism available to a central bank as part of its mandate to promote economic growth and maintain full employment. Central banks use monetary policy to stabilize the economy; during periods of economic slowing central banks initiate expansionary policy, whereby the bank increases the money supply in order to lower prevailing interest rates. As the cost of money falls the demand for funds increases, thereby expanding consumer and investment spending and promoting economic growth.

The major tool the Fed uses to affect the supply of reserves in the banking system is open market operations—that is, the Fed buys and sells government securities on the open market. These operations are conducted by the Federal Reserve Bank of New York.

In a contractionary policy regime, the Fed sells government securities from a bank in exchange for cash. Payment for the bonds decreases the bank’s reserves, reducing the supply of funds that the bank has for loans. The Fed’s open market purchase decreases the supply of reserves (money) to the banking system, and the federal funds rate (interest rate) increases. In net, this reduces the financial resources available to stimulate growth and leads to a contraction in the economy.

The Balance of Payments (BOP).

The balance of payments is a record of all monetary transactions between a country and the rest of the world. This includes payments for the country’s exports and imports, the sale and purchase of assets, and financial transfers. The BOP is given for a specific period of time (usually a year) and in terms of the domestic currency.

BOP = Current Account + Financial Account + Capital Account + Balancing Item

The current account records the flow of income from one country to another. It includes the balance of trade (net earnings on exports minus payments for imports), factor income (earnings on foreign investments minus payments made to foreign investors), and cash transfers.The financial account records the flow of assets from one country to another. It is composed of foreign direct investment, portfolio investment, other investment, and reserve account flows.The capital account is typically much smaller than the other two and includes miscellaneous transfers that do not affect national income. Debt forgiveness would affect the capital account, as would the purchase of non-financial and non-produced assets such as the rights to natural resources or patents.The balancing item is simply an amount that accounts for any statistical errors and ensures that the total balance of payments is zero. Whenever a country receives funds from a foreign source, a credit is recorded on the balance of payments. Sources of funds include exports, the receipt of loans or investment, and income from foreign assets. Whenever a country has an outflow of funds, such as when the country imports goods and services or when it invests in foreign assets, it is recorded as a debit on the balance of payments.When all components of the BOP accounts are included they must sum to zero with no overall surplus or deficit. For example, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counterbalanced in other ways – such as by funds earned from its foreign investments, by running down central bank reserves, or by receiving loans from other countries.

The Current Account.

The current account represents the sum of the balance of trade (net earnings on exports minus payments for imports), factor income (earnings on foreign investments minus payments made to foreign investors), and cash transfers. The balance of trade is the difference between a nation’s exports of goods and services and its imports of goods and services. A nation has a trade deficit if its imports exceed its exports.

Calculating the Current Account.

Normally, the current account is calculated by adding up the 4 components of current account: goods, services, income and cash transfers. Goods are traded by countries all over the world. When ownership of a good is transferred from a local country to a foreign country, this is called an export. When a good’s ownership is transferred from a foreign country to a local country, this is called an import. In calculating the current account, exports are marked as a credit (inflow of money) and imports are marked as a debit (outflow of money). Services can also be traded by countries. This happens frequently in the case of tourism. When a tourist from a local country visits a foreign country, the local country is consuming the foreign services and this is counted as an import. Likewise, when a foreign tourist comes and enjoys the services of a local country, this is counted as an export. Other services can also be transferred between countries, such as when a financial adviser in one country assists clients in another. Because the USA has been at war for so long and in so many countries, private military advisers, consultants, and mercinaries are also counted as an import.

When the USA military is invading or declaring war to an other nation and destroy this other nation, then it owns it, and the reconstruction of the other nation should be an import. The rebuilding includes infrastructure, socail and housing habitats, health care, and countless activities to make this other nation (s) a sustainable place to live in. When the USA helps another nation militarily (such as Israel, Saudi Arabia) and those other nations destroy other nations using the military USA hardware and other services, then the costs of those expenses should be condidered as imports. The costs of rebuilding those other nations destroyed by friendly or allies nations are also the USA costs and should also be imports.

A credit of income happens when a domestic individual or company receives money from a foreign individual or company. This would typically take place when a domestic investor receives dividends from an investment made in a foreign country, or when a worker abroad sends remittances back to the local country. Likewise, a debit in the income account takes place when a foreign entity receives money from an investment in the local economy.Finally, a credit in the cash transfers column would be a gift of aid from a foreign country to the domestic country. Similarly, a debit in the cash transfers column might be the provision of official assistance by the local economy to a foreign economy.Thus, a country’s current account can by calculated by the following formula:

CA = (X-M)+NY+NCT

Where CA is the current account, X and M and the export and import of goods and services respectively, NY is net income from abroad, and NCT is the net current transfers. When the sum of these four components is positive, the current account has a surplus.

The Financial Account (also known as the Capital Account). When Americans are buying properties and services in an other nation such as those private military advisers and oil and gas corporations doing business in an other nation, then the money spent should be part of the America financial deficit.

The financial account (also known as the capital account under some balance of payments systems) measures the net change in ownership of national assets. When financial account has a positive balance, we say that there is a financial account surplus. A financial account surplus means that the net ownership of a country’s assets is flowing out of a country – that is, foreign buyers are purchasing more domestic assets than domestic buyers are purchasing of assets from the rest of the world. Likewise, we say that there is a financial account deficit when the financial account has a negative balance. This occurs when domestic buyers are purchasing more foreign assets than foreign buyers are purchasing of domestic assets. For example, a financial accounts deficit would exist when Country A’s citizens buy $200 million worth of real estate overseas, while overseas investors purchase only $100 million worth of real estate within Country A. When Americans are buying properties and services in an other nation such as those private military advisers and oil and gas corporations doing business in an other nation, then the money spent should be part of the America financial deficit.

Calculating the Financial Account. (This should include all the money spent by private military advisers and businesses while America is invading an other nation.)

The financial account has four components: foreign direct investment, portfolio investment, other investment, and reserve account flows. Foreign direct investment (FDI) refers to long term capital investment such as the purchase or construction of machinery, buildings, or even whole manufacturing plants. If foreigners are investing in a country, that is an inbound flow and counts as a surplus item on the financial account. If a nation’s citizens are investing in foreign countries, there is an outbound flow that will count as a deficit.

After the initial investment, any yearly profits not re-invested will flow in the opposite direction, but will be recorded in the current account rather than the financial account. Portfolio investment refers to the purchase of shares and bonds. It is sometimes grouped together with “other” as short term investment. As with FDI, the income derived from these assets is recorded in the current account; the financial account entry will just be for any buying or selling of the portfolio assets in the international financial markets.

Other investment includes capital flows into bank accounts or provided as loans. Large short term flows between accounts in different nations are commonly seen when the market is able to take advantage of fluctuations in interest rates and/or the exchange rate between currencies. Sometimes this category can include the reserve account.The reserve account is operated by a nation’s central bank to buy and sell foreign currencies; it can be a source of large capital flows to counteract those originating from the market. Inbound capital flows (from sales of the account’s foreign currency), especially when combined with a current account surplus, can cause a rise in value (appreciation) of a nation’s currency, while outbound flows can cause a fall in value (depreciation). If a government (or, if authorized to operate independently in this area, the central bank itself) does not consider the market-driven change to its currency value to be in the nation’s best interests, it can intervene. Such intervention affects the financial account. Purchases of foreign currencies, for example, will increase the deficit and vis versa.To calculate the total surplus or deficit in the financial account, sum the net change in FDI, portfolio investment, other investment, and the reserve account.

Interest Rates and the Financial Account.

The outflow or inflow of assets in the financial account depends in large part on the domestic interest rate and how it compares to interest rates in other countries. A higher central bank interest rate will tend to increase the interest rate on all domestic financial assets, such as bonds, loans, and government securities. In general, if interest rates are higher in one country than another, an investor would prefer to purchase financial assets in the country with the higher interest rate. An increase in the domestic interest rate will therefore cause foreign investors to purchase more domestic assets, creating a financial account surplus. Likewise, a fall in the domestic interest rate will cause domestic investors to purchase foreign assets in place of domestic assets, and will cause a financial account deficit.

The Capital Account.

The capital account acts as a sort of miscellaneous account, measuring non-produced and non-financial assets, as well as capital transfers.There are two common definitions of the capital account in economics. The first is a broad interpretation that reflects the net change in ownership of national assets. Under the International Monetary Fund (IMF) definition, however, most of these asset flows are captured in the financial account. Instead, the capital account acts as a sort of miscellaneous account, measuring non-produced and non-financial assets, as well as capital transfers. The capital account is normally much smaller than the financial and current accounts. Like the financial account, a deficit in the capital account means that money is flowing out of a country and the country is accumulating foreign assets. Likewise, a surplus in the capital account means that a money is flowing into a country and the country is selling (or otherwise disposing of) non-produced, non-financial assets.

Calculating the Capital Account. (When the USA builds a new military base (already over a thousand bases al over the world) in an other nation, then that is creating a capital account deficit.)

The capital account can be split into two categories: non-produced and non-financial assets, and capital transfers. Non-produced and non-financial assets include things like drilling rights, patents, and trademarks. For example, if a domestic company acquires the rights to mineral resources in a foreign country, there is an outflow of money and the domestic country acquires an asset, creating a capital account deficit. If a U.S. company sold its rights to drill for natural gas off the southern coast of the U.S., it would be recorded as a credit in the capital account..

Capital transfers include debt forgiveness, the transfer of goods and financial assets by migrants leaving or entering a country, the transfer of ownership on fixed assets, the transfer of funds received to the sale or acquisition of fixed assets, gift and inheritance taxes, death levies, and uninsured damage to fixed asset. For example, if the domestic country forgives a loan made to a foreign country, this transfer creates a deficit in the capital account.Thus, the balance of the capital account is calculated as the sum of the surpluses or deficits of net non-produced, non-financial assets, and net capital transfers.

Reason for a Zero Balance.

Equilibrium in the market for a country’s currency implies that the balance of payments is equal to zero.

Capital Flows. (When Russia and China purchased bonds from the USA, they became part of the world demand for the 'dollars'. And recently, Russia sold the bonds it had purchased from the USA. Now Russia is using its own currency to make transactions in the world. China will eventually follow.)

Trade within a country differs in one important way from trade between countries: unless the two nations share a common currency, any trade requires that countries go through the foreign exchange market to trade currency, in addition to trading goods and services. For example, imagine that buyers in France purchase oranges produced in Chile. The French buyers use the euro in order to make the purchase but the Chilean orange producers must be paid with the Chilean peso. This exchange between France and Chile requires that the firms exchange euros for pesos. In general, there are two reasons for demanding a country’s currency: to purchase assets within the country and to purchase a country’s exports – that is, the goods and services produced within that country. The country’s currency is supplied when it is used to purchase foreign currencies. This also happens for two reasons: to purchase assets in other countries and to import goods or services from other countries.

Imaging that we are analyzing Italy’s economy and its currency transactions with the rest of the world. If an American buyer wishes to purchase bonds issued by an Italian corporation, she becomes part of the world demand for euros to buy Italian assets. Adding the demand for exports to the demand for assets outside of a country, we get the total demand for a country’s currency. Likewise, a country’s currency is supplied when it is used to purchase currencies in the rest of the world. Italian euros, for example, are supplied when Italian consumers or firms import goods and services from the rest of the world. Italian euros are also supplied when Italian purchasers acquire assets from other countries.

Equilibrium and Zero Balance. (Russia selling USA bonds and now getting rid of the dollar to do business has had the effect of diminishing the equilibrium.)

When a country’s balance of payments is equal to zero, there is equilibrium in the market for that country’s currency. Equilibrium occurs when: Quantity of currency demanded = quantity of currency supplied.

We have already seen that the quantity of currency demanded is equal to the demand for exports and demand for domestic assets. The quantity of currency supplied is equal to the demand for imports and the domestic demand for foreign assets. Thus, we can rewrite the relationship:

Exports + (foreign purchases of domestic assets) = imports + (domestic purchases of foreign assets)

Finally, we can rearrange the above formula as:

Exports – imports = domestic purchases of foreign assets – foreign purchases of domestic assets. (When Russia sold the USA bonds, the foreign purchase of USA domestic assets diminished a lot and diminished the USA financial account. When China sells its USA assets the effect will create a complete shut down of the USA economy and diminish the 'dollar' as a currency to be used in the world.)

The left-hand term is net exports – the difference between the amount of goods and services a country exports and the amount that it imports. We refer to this difference as the current account. When a country exports more goods than it imports, this number is positive and we say that the country has a current accounts surplus. When a country imports more than it exports this number is negative and we say that the country has a current accounts deficit.The right-hand term is the difference between the foreign assets that people within the country purchase and the domestic assets that are purchased by foreigners. This is called the financial account. These assets include the reserve account (the foreign exchange market operations of a nation’s central bank ), along with loans and investments between the country and the rest of world (but not the future regular repayments/dividends that the loans and investments yield; those are earnings and will be recorded in the current account). The financial account is also sometimes used in a narrower sense that excludes the foreign exchange operation of the central bank. When a country buys more foreign assets that other countries buy of its assets, this balance is positive and there is a financial account surplus. If the above equation holds true, then any current account surplus must be matched by a financial account deficit, and vice versa. This holds true when a country’s currency market is in equilibrium and there are no external currency controls.

Exchange Rates. (During boom times when the economy is doing well, people earn more income and this translates to higher tax revenues for the government, lowering the budget deficit, at least that is what the Republican leadership should be doing instead of giving more tax breaks to rich corporations.)

Exchange rates are constantly fluctuating to ensure that the quantity of currency supplied equals the quantity demanded. Because of this, the inflows and outflows of money are equal, creating a balance of payments equal to zero.

When the country takes an economic downturn, more people become unemployed. As a result more people file for unemployment and other welfare measures, which increases government spending and aggregate demand. The unemployed also pay less in taxes because they are not earning a wage, which in turn decreases government revenue. The result is an increase in the federal deficit without Congress having to pass any specific law or act. Similarly, the budget deficit tends to decrease during booms, which pulls back on aggregate demand. Because more people are earning wages during booms, the government can collect more taxes. Also, because fewer individuals need social services support during a boom, government spending also decreases. As spending decreases, aggregate demand decreases. The increased funds received from the government by citizens allows them to increase their consumption. As a result, producers must increase their production, which requires firms to hire more workers. Because of the increased purchases and lower unemployment, people have more money to spend and increase their consumption. This consumption-production-consumption cycle leads to an overall increase in national income greater than the initial incremental amount of spending.

The Role of the Federal Budget.

The federal budget dictates how much money the government plans to raise and how it plans to spend it in the upcoming year.

• Congressional decisions are governed by rules and legislation regarding the federal budget process. Budget committees set spending limits for the House and Senate committees. Appropriations subcommittees then approve individual appropriations bills to allocate funding to various federal programs.
• If Congress fails to pass an annual budget, a series of appropriations bills must be passed as “stop gap” measures.
• The budget is a method of conducting fiscal policy and reflect government intervention in markets.
• appropriations bill: A legislative motion that authorizes the government to spend money.

The USA Federal Budget is the roadmap for how the national government plans to spend its money of the course of the upcoming year. It dictates which programs will receive funding and how much money the government will spend on each. The federal budget is meant to provide the larger American economy with a sense of direction regarding where the Federal government is going to go and what they are going to do. The Federal budget discloses how much the government plans to tax and how it plans to spend its money. Individuals and businesses can then adjust their actions to accommodate what they’ll have to pay in taxes and what resources will be available to them in the government. The federal budget also is one mechanism for conducting fiscal policy. The government can choose to expand or contract the budget to conduct expansionary or fiscal policy. The specific items in the budget also have important policy implications: social welfare, social insurance, and government intervention in markets may all be reflected in the budget.

Arguments for and against Balancing the Budget. (Knowing that the USA financial account which measures the net change in ownership of national assets which used to be flowing out of the USA when Russia and China where buying USA assets to help the nation to keep going even though it had an out of control high national debt and an increasingly high annual deficit, but now that Russia is selling the USA and China will be doing the same soon, the USA Congress should reflect in getting its House in order and produce a budget, if any, to at least admit its failure of governing with care.)

Balanced budgets, and the associated topic of budget deficits, are a contentious point within both academic economics and politics.

• A balanced budget is a budget where revenues equal expenditures. A balanced budget can also refer to a budget where revenues are greater than expenditures.
• Most economists have also agreed that a balanced budget would decrease interest rates, increase savings and investment, shrink trade deficits and help the economy grow faster over a longer period of time.

A balanced budget, particularly a government budget, is a budget with revenues equal to expenditures. There is neither a budget deficit nor a budget surplus; in other words, “the accounts balance. ” More generally, it refers to a budget with no deficit, but possibly with a surplus. A cyclically balanced budget is a budget that is not necessarily balanced year-to-year, but is balanced over the economic cycle, running a surplus in boom years and running a deficit in lean years, with these offsetting over time. Balanced budgets, and the associated topic of budget deficits, are a contentious point within academic economics and within politics.

Long-Run Implications of Fiscal Policy. (But today the USA has started an economic war with the rest of the world and no one wants to buy USA bonds anymore and thus give value to the USA dollar currency.)

Expansionary fiscal policy can lead to decreased private investment, decreased net imports, and increased inflation.

• Fiscal policy is the use of government revenue collection (taxation) and expenditure (spending) to influence the economy.
• When government borrowing increases interest rates, it can attract foreign capital from foreign investors, which can increases demand for that country’s currency and raise it’s value. This increase in the currency’s value increases export the price of exports.
• When governments fund a deficit with the issuing of government bonds, interest rates can increase across the market, because government borrowing creates higher demand for credit in the financial markets. This causes a lower aggregate demand for goods and services.
• In theory, fiscal stimulus does not cause inflation when it uses resources that would have otherwise been idle.
• inflation: An increase in the general level of prices or in the cost of living.

Fiscal policy is the use of government revenue collection (taxation) and expenditure (spending) to influence the economy. The two main instruments of fiscal policy are changes in the level and composition of taxation and government spending in various sectors. It is important to underline that fiscal policy is heavily debated, and that expected outcomes are not achieved with complete certainty. That being said, these changes in fiscal policy can affect the following economic variables in an economy:

• Aggregate demand and the level of economic activity;
• The distribution of income;
• The pattern of resource allocation within the government sector and relative to the private sector.

When the government runs a budget deficit, which it does today and has been doing for decades, funds will need to come from public borrowing (the issue of government bonds), overseas borrowing, or monetizing the debt. When governments fund a deficit with the issuing of government bonds, interest rates can increase across the market, because government borrowing creates higher demand for credit in the financial markets. This causes a lower aggregate demand for goods and services, contrary to the objective of a fiscal stimulus.

When government borrowing increases interest rates it attracts foreign capital from foreign investors. This is because, all other things being equal, the bonds issued from a country executing fiscal policy now offer a higher rate of return. In other words, companies wanting to finance projects must compete with their government for capital so they offer higher rates of return. To purchase bonds originating from a certain country, foreign investors must obtain that country’s currency. Therefore, when foreign capital flows into the country undergoing fiscal expansion, demand for that country’s currency increases. The increased demand causes that country’s currency to appreciate. Once the currency appreciates, goods originating from that country now cost more to foreigners than they did before and foreign goods now cost less than they did before. Consequently, exports decrease and imports increase.

Other possible problems with fiscal stimulus include inflationary effects driven by increased demand. Simply put, increasing the capital in a given system will eventually devalue the currency itself if there is an increase in money supply in circulation. Similarly, if stimulus capital is invested in creating jobs, the overall spending in a given economy will increase (that is, if jobs are actually created). This spending increase will shift demand to potentially increase price points. Whenever fiscal policy decisions are made, modeling the likelihood of inflation is a critical consideration.

Government debt limits future government actions and can be hard to pay off because Congressmen are unwilling to do what is necessary to pay down the debt. (To sell the State of Texas to China including all its natural resources and assets should be almost enough for the USA to solve its debt problem, but that is assuming China would even consider the deal.)

• To raise the necessary funds to pay down debt, governments will ultimately have to lower costs and/or raise taxes. Because cutting spending and raising taxes is unpopular, Congressmen may be hesitant to take those actions because it might prevent them from being re-elected.
• To pay off the debt, the government must maintain a certain level of income. This could limit the government’s ability to pursue fiscal policies to address future recessions.
• If the government chooses to delay paying down the debt, the compounding interest will lead to more debt which will lead to a higher annual interest expense that future generations will have to pay.

Capital, also referred to as capital goods, real capital, or capital assets.

Capital references non-financial assets used in the production of goods and services. Capital is important because it is a significant factor in the creation of wealth.

Classifications of Capital.

In a broad sense, capital can be divided into two categories:

• Physical Capital: capital that must be produced by human labor before it can become a factor of production (also referred to as manufactured capital). Examples include machinery and buildings.
• Natural Capital: a factor of production that occurs naturally in the environment; for example, land or minerals.

Fundamentally, capital is any product that is produced and has the ability to enhance a person’s power to perform work that is economically useful. For example, roads are capital for individuals who live in a city. Capital is directly impacted by both interest and profit. Interest is a fee that is paid by a borrower of assets. It is a form of compensation for the use of the assets. Commonly, it is the price that is paid for the use of borrowed money. Profit is the accumulation of capital, which is the driving force behind economic activity. Interest allows capital to be obtained, while profit is the accumulation of the capital.

There are detailed classifications of capital which include the following types:

• Financial Capital is capital that is liquidated as money for trade, and owned by legal entities. It is a form of capital assets that is traded in financial markets. The value of financial capital is based on the market perception of expected revenues and risk.
• Natural Capital is capital that occurs naturally in the environment and is protected because it supports human life. Examples of natural capital include land and water.
• Social Capital is capital that is captured as goodwill or brand value. It is the general concept of inter-relationships between humans have money-like value that motivates actions.
• Instructional Capital is capital that is defines as the aspect of teaching knowledge and transferring knowledge that is not inherent in individual or social relationships.
• Human Capital is capital that includes social, instructional, and individual human talent combined together. As a term, it is used to define balanced growth where the goal is to improve human capital and economic capital equally.

Fiscal Policy is the use of government spending and taxation to influence the economy.

• The government has two levers when setting fiscal policy: it can change the levels of taxation and/or it can change its level of spending.
• There are three types of fiscal policy: neutral policy, expansionary policy, and contractionary policy.
• In expansionary fiscal policy, the government spends more money than it collects through taxes. This type of policy is used during recessions to build a foundation for strong economic growth and nudge the economy toward full employment.
• In contractionary fiscal policy, the government collects more money through taxes than it spends. This policy works best in times of economic booms. It slows the pace of strong economic growth and puts a check on inflation.

Fiscal policy is the use of government spending and taxation to influence the economy, the level of aggregate demand in the economy, in an effort to achieve the economic objectives of price stability, full employment, and economic growth.

For example, suppose the government spends $1 million to build a plant. The money does not disappear, but rather becomes wages to builders, revenue to suppliers, etc. The builders then will have more disposable income, and consumption may rise, so that aggregate demand will also rise. Suppose further that recipients of the new spending by the builder in turn spend their new income, raising demand and possibly consumption further, and so on. The increase in the GDP is the sum of the increases in net income of everyone affected. If the builder receives $1 million and pays out $800,000 to sub contractors, he has a net income of $200,000 and a corresponding increase in disposable income (the amount remaining after taxes). This process proceeds down the line through subcontractors and their employees, each experiencing an increase in disposable income to the degree the new work they perform does not displace other work they are already performing. Each participant who experiences an increase in disposable income then spends some portion of it on final (consumer) goods, according to his or her marginal propensity to consume, which causes the cycle to repeat an arbitrary number of times, limited only by the spare capacity available.

• Expansionary monetary policy: Traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding.
• Discretionary: Available at one’s discretion; able to be used as one chooses; left to or regulated by one’s own discretion or judgment.

Monetary policy is referred to as either being expansionary or contractionary. Expansionary policy seeks to accelerate economic growth, while contractionary policy seeks to restrict it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. This is done by increasing the money supply available in the economy. Expansionary policy attempts to promote aggregate demand growth. Aggregate demand is the sum of private consumption, investment, government spending and imports. Monetary policy focuses on the first two elements. By increasing the amount of money in the economy, the central bank encourages private consumption. Increasing the money supply also decreases the interest rate, which encourages lending and investment. The increase in consumption and investment leads to a higher aggregate demand. It is important for policymakers to make credible announcements. If private agents (consumers and firms) believe that policymakers are committed to growing the economy, the agents will anticipate future prices to be higher than they would be otherwise. The private agents will then adjust their long-term plans accordingly, such as by taking out loans to invest in their business. But if the agents believe that the central bank’s actions are short-term, they will not alter their actions and the effect of the expansionary policy will be minimized.

The Basic Mechanics of Expansionary Monetary Policy.

The primary means a central bank uses to implement an expansionary monetary policy is through open market operations. Commonly, the central bank will purchase government bonds, which puts downward pressure on interest rates. The purchases not only increase the money supply, but also, through their effect on interest rates, promote investment. Because the banks and institutions that sold the central bank the debt have more cash, it is easier for them to make loans to its customers. As a result, the interest rate for loans decrease. Businesses then, presumably, use the money it borrowed to expand its operations. This leads to an increase in jobs to build the new facilities and to staff the new positions. The increase in the money supply is inflationary, though it is important to note that, in practice, different monetary policy tools have different effects on the level of inflation.

A central bank can enact a contractionary monetary policy several ways. The primary means a central bank uses to implement an expansionary monetary policy is through open market operations. The central bank can issue debt in exchange for cash. This results in less cash being in the economy. Because the banks and institutions that purchased the debt from the central bank have less cash, it is harder for them to make loans to its customers. As a result, the interest rate for loans increase. Businesses then, presumably, have less money to use to expand its operations or even maintain its current levels. This could lead to an increase in unemployment. The higher interest rates also can slow inflation. Consumption and investment are discouraged, and market actors will choose to save instead of circulating their money in the economy. Effectively, the money supply is smaller, and there is reduced upward pressure on prices since demand for consumption goods and services has dropped.

Expansionary fiscal policies are usually implemented during recessions because they attempt to increase economic demand, and as a result, increase economic output which is reduced during a recession. Expansionary fiscal policies involve reducing taxes or increasing government expenditure. Remember that government revenue is based on collected taxes. When taxes exceed government spending, the government is characterized as having a surplus. When taxes equal government expenditures, the government has a balanced budget. When the government spends more than the revenue it collects, it has a deficit.

Increasing government spending, creating a budget deficit, and financing the shortfall through debt issuance are typical policy actions in an expansionary fiscal policy scenario.

When the government runs a budget deficit, funds will need to come from public or foreign borrowing. As a result, the government issues bonds. This raises interest rates across the economy because government borrowing increases demand for credit in the financial markets. This may in turn reduce aggregate demand for goods and services, which defeats the purpose of a fiscal stimulus. Fiscal stimulus is implemented with the view that tax relief through a reduction in tax rate and or direct government spending through investment (infrastructure, repair, construction) will provide stimulus to increase economic growth by directly influencing consumption or the government expenditure component of GDP.

• inflation: An increase in the general level of prices or in the cost of living.
• central bank: The principal monetary authority of a country or monetary union; it normally regulates the supply of money, issues currency and controls interest rates.
• financial crisis: A period of serious economic slowdown characterized by devaluing of financial institutions often due to reckless and unsustainable money lending, debt and deficit.

Contractionary monetary policy decreases the money supply in an economy. The decrease in the money supply is mirrored by an equal decrease in the nominal output, otherwise known as Gross Domestic Product (GDP). In addition, the decrease in the money supply will lead to a decrease in consumer spending. This reduction in money supply reduces price levels and real output, as there is less capital available in the economic system. Expansionary monetary policy increases the money supply in an economy. The increase in the money supply is mirrored by an equal increase in nominal output, or Gross Domestic Product (GDP). In addition, the increase in the money supply will lead to an increase in consumer spending. This would lead to a higher prices and more potential real output.

Under the policy, investors know what the central bank considers the target inflation rate to be and therefore may more easily factor in likely interest rate changes in their investment choices. This is viewed by inflation targeters as leading to increased economic stability. The United States Federal Reserve, the country’s central bank, practices a version of inflation targeting. Instead of setting a specific number, the Fed sets a target range.

• open market operations: An activity by a central bank to buy or sell government bonds on the open market. A central bank uses them as the primary means of implementing monetary policy.
• discount rate: An interest rate that a central bank charges to depository institutions that borrow reserves from it.
• fed funds rate: Short for Federal Funds rate. The interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis.

One of the main tools of central banks is the interest rate that it charges banks to hold their money overnight. This rate is ultimately passed on to the bank’s depositors. Depositors, in turn, adjust their levels of savings and investment based on that rate. Take, for example, a high interest rate. At a high interest rate, it is very expensive to borrow money: investors will not want to invest because they have to pay a lot of interest on their loans. Savers, on the other hand, love high interest rates: they earn a lot simply by keeping their cash in the bank. High interest rates encourage savings and discourage investment. The precise opposite is true for low interest rates. When rates are low, investors know they can borrow money to finance investments cheaply. At the same time, savers aren’t earning much by keeping their money in the bank. Low interest rates encourage investment and discourage savings. Much of a central bank’s actions are focused on adjusting how much people save and invest.

The government can also incentivize savings and investment in a number of ways. The most common way of doing so is by adjusting tax rates. Governments offer individuals and firms who take the action it desires. For example, a government can offer a tax break to companies that are investing in a desirable area (e.g. medicine). It can also encourage savings through tax breaks. Roth IRAs are an instrument for saving for retirement that the US has made tax exempt (under certain conditions). In the first example, the government uses tax reductions to encourage investment for companies. In the second, the government encourages saving by helping savers earn more of the interest they earn over time in the savings vehicle.

Inflation can result from increased aggregate demand, but can also be caused by expansionary monetary policy or supply shocks that cause large price changes.

Inflation targeting occurs when a central bank attempts to steer inflation towards a set number using monetary tools. Consumer price index: A statistical estimate of the level of prices of goods and services bought for consumption purposes by households. Inflation targeting is an economic policy in which a central bank estimates and makes public a projected, or “target”, inflation rate and then attempts to steer actual inflation towards the target through the use of interest rate changes and other monetary tools. The United States Federal Reserve uses a form of inflation targeting when coordinating its monetary policy. Because interest rates and the inflation rate tend to be inversely related, the likely moves of the central bank to raise or lower interest rates become more transparent under the policy of inflation targeting. Examples include:

• if inflation appears to be above the target, the bank is likely to raise interest rates. This usually has the effect over time of cooling the economy and bringing down inflation;
• if inflation appears to be below the target, the bank is likely to lower interest rates. This usually has the effect over time of accelerating the economy and raising inflation.

Trade policies can shift aggregate demand. Protectionism, for example, is a policy that interferes with the free workings of the international marketplace. By implementing protectionism policies such as tariffs and quotas, a government can make foreign goods relatively more expensive and domestic goods relatively cheaper, increasing net exports and therefore aggregate demand. Since the world demands more goods produced in the home country, the demand for the domestic currency increases and the exchange rate rises.

Capital flight occurs when assets or money rapidly flow out of a country due to an event of economic consequence. Such events could be an increase in taxes on capital or capital holders, or the government of the country defaulting on its debt that disturbs investors and causes them to lower their valuation of the assets in that country, or otherwise to lose confidence in its economic strength. This leads to an increase in the supply of the local currency and is usually accompanied by a sharp drop in the exchange rate of the affected country. This leads to dramatic decreases in the purchasing power of the country’s assets and makes it increasingly expensive to import goods. Net exports rise as a component of aggregate demand.

• Inflation targeting is an economic policy in which a central bank publicly determines a target inflation rate and then attempts to steer actual inflation towards the target.
• Inflation targeting has often been successful in keeping inflation levels low and avoiding many of its negative effects.
• inflation: An increase in the general level of prices or in the cost of living.
• central bank: The principal monetary authority of a country or monetary union; it normally regulates the supply of money, issues currency and controls interest rates.

International trade agreements are trade agreements across national borders intended to reduce or eliminate trade barriers to promote economic exchange. International trade encounters a variety of obstacles, some of which pertain to the protectionism identified in other atoms, which reduce trade incentives. This is usually through tariffs, quotas, taxes, and other trade restrictions. It is also useful to create standards and norms across different countries, particularly for things like intellectual property law recognition, which enables businesses to operate across borders. There are quite a few international trade agreements, some of which are more formal than others. The trade agreements below provide a fairly comprehensive overview of the current international trade environment:

World Trade Organization (WTO).

The WTO is the largest international trade organization, replacing the General Agreement on Tariffs and Trade (GATT) in 1995, designed to enable international trade while reducing unfair practices. In many ways, the WTO is more complex than other international trade agreements because it incorporates a variety of smaller agreements into a larger framework. The WTO includes upwards of 60 different agreements alongside 159 official members and 25 observers. underlines how effective and universal international trade agreements are becoming. The WTO performs several objective functions as well if trade disputes arise, acting as a framework for assessing appropriate international trade practices. WTO Members: The World Trade Organization (WTO) is an organization designed to oversee and enable international trade. This map shows how successful this has been on a global scale. The core of the WTO is the most-favored nation (MFN) rule, which states that each WTO member must be charged the lowest tariffs that an importer places on any country. For example, if the US charges Brazil a 5% tariff on imported clothes, and this is the lowest tariff it has placed on any country in the WTO, all other WTO members must also be charged a 5% tariff. Every WTO member gets charged the lowest tariff that an importer charges any other member.

North American Free Trade Agreement (NAFTA), now being replaced by the USMCA.

Unlike the WTO, which is an entirely global approach, most international agreements stem from geographic proximity. NAFTA is a trilateral agreement between the United States, Canada and Mexico designed to minimize any trade or investment barriers between any of these countries (primarily in the form of tariffs). Generally speaking, the United States demonstrates a trade deficit with these countries relative to goods and a surplus relative to services. The United States also demonstrates high and fast-growing foreign direct investment (FDI) in both regions. NAFTA Participants: This map outlines each of the countries involved in the North American Free Trade Agreement, an international trade agreement focused on a geographic proximity. There has been a great deal of controversy surrounding this trade agreement. Agriculture is not included in this agreement, and is often a tough point of discussion for the WTO as well. Mexico is also a point tension due to the fact that it is developing economically (compared to the U.S. and Canada who are considered already developed). Finally, Canadians have often objected to the NAFTA agreements due to the way in which the United States FDI employs hostile takeovers. These agreements demonstrate some of the validity behind trade protectionism and isolationism (as discussed in other atoms in this chapter).

Asia-Pacific Economic Cooperation (APEC).

The APEC forum is particularly interesting in the context of the above agreements, as it is slightly less formal than the above two (it is referred to as a ‘forum’). The APEC forum is a cooperative discussion between 21 countries in the Pacific Rim region promoting free trade, with a focus on newly industrialized economies (NIE). Developing nations gaining access to capital investment and export agreements is the central outcome of APEC, driving economic growth through controlled global expansion. This region represents over half of the world’s GDP and 40% of the overall world population, making this a critical region of the world economy. APEC Participants: The Asia-Pacific Economic Cooperation (APEC) is a forum of 21 countries in the Pacific Rim region, focusing on free trade and economic cooperation.

BRICS: Brazil, Russia, India, China and South Africa.

BRICS is the acronym coined by British Economist Jim O’Neill meant for an association of five major emerging national economies: Brazil, Russia, India, China and South Africa. As of 2018, these five nations have a combined nominal GDP of US$18.6 trillion, about 23.2% of the gross world product, combined GDP (PPP) of around US$40.55 trillion (32% of World's GDP PPP) and an estimated US$4.46 trillion in combined foreign reserves. Overall the BRICS are forecasted to expand 4.6% in 2016, from an estimated growth of 3.9% in 2015. The World Bank expected BRICS growth to increase to 5.3% in 2017. The BRICS have received both praise and criticism from numerous commentators. Bilateral relations among BRICS nations have mainly been conducted on the basis of non-interference, equality, and mutual benefit.

Quotas are limitations on imported goods, come in an absolute or tariff-rate varieties, and affect supply in the domestic economy.

• Justifications for the use of quotas include protection for domestic employment and infant industries, protection against unfair foreign trade practices, and protection of national security.
• Quotas often hurt domestic consumers and benefit domestic producers. Quotas may also provide incentives for administrative corruption and smuggling.
• absolute quota: A limitation of the quantity of certain goods that may enter commerce during a specific period.
• quota: A restriction on the import of something to a specific quantity.
• tariff-rate quota: Allows a specified quantity of imported goods to be entered at a reduced rate of duty during the quota period, with quantities entered in excess of the quota limit subject to a higher duty rate.

Consequences of Quotas.

Like other trade barriers, quotas restrict international trade, and thus, have consequences for the domestic market. In particular, quotas restrict competition for domestic commodities, which raises prices and reduces selection. This hurts the domestic consumer, who experiences a loss in consumer surplus. On the other hand, this very action benefits the domestic producer, who sees an increase in producer surplus. Often, the increase in producer surplus is not enough to offset the loss in consumer surplus, so the economy experiences a loss in total surplus. Quotas may also foster negative economic activities. Import quotas may promote administrative corruption, especially in countries where import quotas are given to selected importers. There are incentives to give the quotas to importers who can provide the most favors or the largest bribes to officials. Quotas may also encourage smuggling. As quotas raise the price of domestic goods, it becomes profitable to try and circumvent the quota by bringing in goods illegally, or in excess of the quota.

Other Barriers. Barriers to trade include specific limitations to trade, customs procedures, governmental participation, and technical barriers to trade.

• Specific limitations to trade barriers include local content requirements and embargoes. This category of barriers comes from trade regulations.
• Customs and administrative procedure barriers include bureaucratic red tape and anti- dumping practices. This category of barriers comes from government procedures.
• Governmental participation barriers include government procurement programs, export subsidies, and countervailing duties. This category of barriers involves the direct participation of government in trade.
• Technical barriers to trade include sanitary regulations, measurement and labeling standards, and ingredient standards. This category of barriers involves health, safety, and measurement standards.
• Dumping: Selling goods at less than their normal price, especially in the export market.
• countervailing duty: A tax levied on an imported article to offset the unfair price advantage it holds due to a subsidy paid to producers or exporters by the government of the exporting country if such imports cause or threaten injury to a domestic industry.
• embargo: A ban on trade with another country.

Defining Health Care.

Health care is a significant concern for patients, insurance companies, governments, businesses, health care providers, researchers, and non-profits. It is a vast economic system with many internal players and externalities. Understanding the basic factors involved, both logistically and economically, will provide useful context in defining health care and the medical care services.

Healthcare has many inputs and a wide variety of interested parties profiteering. Understanding what drives the need for health care (and what prevents it), what is included in the cost, and the overall accessibility of this essential service is critical to understanding economics issues in healthcare. A dollar spent on health care can find it’s way to insurance providers, medical service providers, pharmaceutical companies, governments, administrative bodies (managing these businesses), and laboratories. Understanding what individuals pay for and why, alongside what is available, is important data for navigating this market.

Where the Money Goes? While a percentage breakdown of who procures the largest capital gains from health care is difficult to ascertain across such a complex system, it is safe to say that quite a few players contribute to the constantly rising price of even simple procedures and doctor’s visits.

A breakdown of the critical players illuminates this further:

• Health Care Providers: On the surface, this is who a beneficiary feels like they are paying. This is their doctors, nurses, psychologists, dietitians, technologists, chiropractors, surgeons, and a wide range of other hands on and customer facing roles. These individuals are further differentiated by the fact that they often act as references as opposed to direct suppliers, making them both a direct to consumer provider and a third party provider.
• Pharmaceutical Companies: Drugs are playing an increasingly large role in health care, and likely will continue to do so in the future. The constant development of new drugs, alongside the distribution of established medications, is an enormous part of the market.
• Insurance Providers: There is a divider between most medical service consumers and their providers, and this is the insurance company. For those who are covered by their full-time jobs (or dependents of these individuals), this is largely a matter of who their business purchases from. For others not covered, insurance issues are a complex and highly expensive issue, and getting coverage is quite difficult (this is being addressed in the U.S. by new legislation, and is not an issue in most other developed nations). The insurance companies command a huge profit and represent a substantial part of the medical price tag.
• Government: The role of government in health care is fiercely debated in the United States, but in most of the developed world the government is essentially the provider of health care plans (using social services models to consolidate tax revenues to be allocated for this service). In the U.S., this is only done for medicaid and medicare. The government also takes tax revenues from involved parties in this industry, driving prices up further.
• Administration: This is the hospital itself, or the doctors office, where the management team attempts to run a largely profitable business in the medical industry. Administration pays the health care providers and the government, taking income from direct consumers, the government, and the insurance companies to cover the cost of business (and often turn substantial profits).

With these group of incumbents in mind, it becomes quite clear why the costs are rising exponentially and are so unsustainable. The constant struggle between these large and powerful players coupled with an essentially infinite demand has left the consumer as an extremely weak player in the market. Indeed, with this in mind, the graph displays the trajectory of health care spending due to excess costs in the long term.

Health Care Costs: have become in of danger of continuing down path of using the excessively high cost-structure U.S. health care incumbents have dictated in the context of spending as a % of GDP. One of the most discussed topics in health care is accessibility. Due to the fact that health care represents the ability for an individual to maintain a healthy and happy life, it seems intuitive that accessibility must as unlimited as possible. Of course, in a capitalistic system, this will not be the case. Economics dictates that price points will be determined based on supply and demand, and the demand in this industry is often essentially infinite. As a result, accessibility and profitability do not always align from an economic perspective. The U.S. employs medicaid and medicare to provide for low-income and elderly citizens that would otherwise be excluded from the market, while other countries have healthcare systems with more government intervention to address market failure. One of the larger issues in accessibility is nations without the infrastructure required to support health care industries. Developing nations often do not have access to the skills or suppliers required to run modern hospitals and doctors offices, nor the ability to act preventatively (i.e. eating healthy, getting exercise, check ups, etc.). This creates enormous inefficiency in the system and reduces the economic viability of operating in these countries for insurance providers. Addressing this concern is one of the central issues for the United Nations (UN) and other nongovernmental organizations.

Externalities in the Health Care Market. An externality is any impact, be it positive or negative, on individuals or groups not involved in a given economic transaction. That is to say, an externality is something that affects other people outside of the particular parties involved in an exchange. A classic example of externalities is the automobile. Cars consistently produce air pollution whenever they are driven, slowly eroding the health of our ecosystem. This cost is shouldered not only by the driver of the vehicle, but also by every living thing on the planet. This is an example of parties not involved in the transaction (selling or buying the vehicle) being impacted, in this case negatively. Environmental Degradation: Health care produces a great deal of chemical waste, requires a great deal of emissions (ambulances, etc.) and alters the natural ecological environment of bacteria.

Health care can impact people beyond the person receiving and the person providing the care, causing positive and negative externalities.

• An externality is any impact, be it positive or negative, on individuals or groups not involved in a given economic transaction.
• Negative externalities include tax costs, infectious disease, anti-biotic resistance and environmental degradation. The negative components impact others despite their participation in the system.
• Positive externalities include increases in wealth due to increased health, vaccinations to limit disease exposures and increases in technology and knowledge.
• Positive externalities include increases in wealth due to increased health, vaccinations to limit disease exposures and increases in technology and knowledge.

In health care, the critical externality in most systems is the care provided to others. You benefit from others being healthy because it reduces the likelihood of you catching their illness (assuming it’s contagious). You benefit from a positive externality of others receiving health care. Your health care costs are also affected by others choosing to purchase health care. The healthy pay more to the insurance company than they receive in treatment, while the opposite is true for the sick. Insurance fundamentally operates by taking the money from healthy people to pay for the procedures required by sick people. Taxpayers should also be concerned with the state of the healthcare system not only because they pay for Medicare and Medicaid, but also because healthcare is a huge part of the US economy. In 2011, the US spent 17.2% of GDP on healthcare, more than any other country. Reducing the cost of health care can clearly increase the amount that the US can consume or invest.

Other negative externalities include:

• Infectious Disease: One of the largest reasons why health care is so critical is the fact that disease are infectious. Untreated disease will result higher population vulnerability to that disease due to increased exposure.
• Antibiotic Resistance: An interesting byproduct of the newer solutions to medical dilemmas is the slowly growing resistance of antibiotics in bacteria. Due to the way in which the health care industry has been operating, bacteria are dramatically altering to resist our solutions.

Positive externalities include:

• Health Affects Wealth: Healthy workers are absent from work less and are more productive workers. A health care market that effectively helps workers can lead to positive economic gains.
• Technology and Information: The study of health care, and the research involved in generating new solutions, has dramatically increased the knowledge and technological capacity of society in general. This has affected other industries, as research and development in health care affects the technological efficacy in other markets.
• Vaccinations: An interesting new development in health care is the advent of vaccines. Vaccination results in herd immunity, or essentially the fact that many individuals will become immune and thus reduce the likelihood that everyone in the population will contract certain diseases.