Questions and Answers

Balance of payments surplus
    Q: Why must payments balance?

    A: The answer depends on what you mean by balance of payments. Under some definitions, payments do not need to balance, especialliy under a pegged exchange rate if the payments do not include official reserves transactions. However, if all payments both into and out of a country are included, then payments must balance because all transactions have two parts, giving rise either to equal debits and credits, or to two offsetting debits or two offsetting credits. This is easiest to see in terms of currency exchange, where any international transaction requires both a buyer and a seller of the country's currency (else neither could transact), whose actions are recorded as the offsetting payments. For example, in order for me to import a car for 20,000 euros, I must find someone willing to sell me those euros in exchange for dollars, and whatever they do with those dollars (including holding them) will be the payment that offsets my import.

Heckscher-Ohlin and comparative advantage
    Q: I would like to know if the Heckscher-Ohlin Theorem is linked with the principle of comparative advantage.

    A: Yes, the Heckscher-Ohlin Theorem is, in a sense, all about comparative advantage. What it does is to identify an important source of comparative advantage: relative factor abundance interacting with relative factor intensity. I thank you for your question and I will revise my entry to make this clearer.

Capital Flows in IS-LM
    Q: You mention that an exogenous capital inflow has no impact on the IS or LM curves because the Central Bank is sterilizing the inflows. What if the Central Bank does not sterilize? For instance, to take a real world situation, suppose China (Fixed Exchange Rates, Moderate Capital Mobility)receives Foreign Direct Investment from (say) General Motors. Since any such investment is likely to generate employment, why would the Central Bank not print more local currency? And if it does and GM invests the money, wouldn't both, the IS and LM curves shift out? Wouldn't there be an increase in output following such a shift in both the IS and LM curves?

    A: What I state about the effects of capital flows is, I hope, correct for financial flows that are sterilized. If they are not sterilized, then yes, that means by definition that the capital inflow causes an increase in the money supply and a rightward shift of the LM curve. That is, as the central bank buys the foreign currency it puts its own currency into circulation, expanding the money supply.

    As for the IS curve, that depends on whether the FDI entails an increase in domestic investment. If it does, then you are also correct that the IS curve shifts to the right as well. But not all FDI involves such investment, as for example if GM simply buys an existing factory in China.

Offer curves with more than two goods
    Q: Contrary to your statement that offer curves work only for a 2-good & 2-consumer market, I have employed 3-good(criteria) offer surfaces in an Edgeworth cube to find general competitive equilibrium points that solve 3-criteria(goods)design engineering problems. I came across your website in my quest to find out more about offer curves...specifically, I > am interested in finding one or more actual examples of offer curves in welfare ecomonics. The offer curves (surfaces) that I employ are in fact the Pareto fronts resulting from a multi-criteria design optimization of an engineering artifact. Such Pareto fronts are theoretically formed by an infinite number of designs, and I use the welfare economics techniques noted in the foregoing to identify those very few that lie at the interesecting points of the offer curves (surfaces) for 2(3)-designers (consumers)i.e.points of acceptable mutually beneficial trade where all 2 (or 3) MRS are equal.

    A: The problem, I think, is that while the line from the origin to a point on the two-dimensional offer curve uniquely defines the relative prices that generate the offer, this is not the case in three dimensions. Likewise, with three goods in three dimensions, what one has is offer surfaces, not offer curves, and two of these surfaces will intersect along a curve, not at a single point. So, as I think your comment suggests, an additional condition will be needed to identify the equilibrium, not just the offer surfaces alone. I agree that these may be useful for some purposes, and you have apparently found one. But for the main purpose for which offer curves are used in international economics, which is exposition, I don't think they are helpful beyond the two-good case.

Terms of trade - currency and prices
    Q: I was looking at your 'terms of trade' definition, and --- maybe this reflects approaching senility --- it seemed to me you should clarify that Px/Pm is denominated in 'dollars', not local currencies. Is this too obvious to mention? Does everybody know this? Or am I wrong?

    A: Since the terms of trade is a ratio, it doesn't matter what currency the prices are measured in, as long as they are measured in the same currency. The units of the terms of trade are: import goods per export good. However, it is true that both of these prices should be world prices (in whatever currency), not domestic prices within the country, since the latter may be different due to tariffs or other trade policies. That is an important qualification and I am changing my definition to include that. Thanks.

Terms of trade - relative
    Q: About the terms of trade, I'm quite unclear on what this is when you say "relative." Do you mean all of a nations exports compared with all of a nation imports or do you mean a certain quantity? e.g if a nation imported 1 car but exported 1000000 computers would the terms of trade be below 100, since that 1 car costs more than 1 computer?

    A: Relative, in this case, means that it is a ratio. That is, it is the ratio of the price of the country's exports to the price of its imports. Since countries export and import many goods, each of these prices is a price index, so the terms of trade is equal to the index of export prices divided by the index of import prices. Like all things based on indices, this means nothing by itself, but only has meaning in comparison to the value of the ratio at another time or situation. For example, if the ratio is 1.1, this means that the relative price of exports has risen 10% in comparison to the base period for the price indices.

    The terms of trade is defined as a ratio of prices, not of quantities. However, if trade is balanced (as it is in many trade models although seldom in the real world), then PxX=PmM (where X and M are the quantities of exports and imports and Px and Pm their prices), so Px/Pm = M/X and the terms of trade is also the ratio of the quantity of imports to the quantity of exports. That is, it measures how much of the imported good the country is able to buy per unit of what it exports. This is the only connection between the terms of trade and the quantities of trade that I know of, and it is not very useful since it works only with balanced trade. And even then it would be hard to interpret if there were lots of goods.