ECONOMICS

FISCAL POLICY

1. MODULE 17.1: INTERNATIONAL TRADE

2. Tariff: tax on imports; raises domestic price, cuts imports, raises domestic output; producers gain, consumers lose; government gets revenue; foreigners lose. Example: Donald Trump put tariffs on Chinese steel; US steel prices rose, US mills benefited, US buyers paid more, Treasury collected tariff cash, Chinese exporters absorbed losses.
3. Quota: hard cap on import quantity; raises domestic price and output; producers gain, consumers lose; no automatic government revenue; scarcity creates rents. Example: Trump-era steel quotas would limit tons entering the US; price jumps not from tax but from artificial shortage.
4. Quota with auctioned licenses: government sells import licenses; outcome ≈ tariff; same higher price and lower imports, but now government captures quota rents instead of tariff revenue. Example: if Trump had auctioned steel import permits, US government not the firms would pocket the scarcity value.
5. Quota makes the good scarce in the domestic market, the price there rises above the world price; foreign exporters who hold the free import licenses can sell the limited quantity at this higher domestic price, pay no tax or fee to the government, and keep the entire price gap as extra profit — that gap is the quota rent.
6. In the case of a quota, if the domestic government collects the full value of the import licenses, the result is the same as for a tariff.
7. Under VER, the importing country pressures exporters to limit supply (think drug dealing by Pablo Escobar); scarcity pushes prices up; consumers lose; domestic producers gain; foreign exporters keep the price markup as profit; government gains nothing.
8. Because a VER raises domestic prices like a quota but gives all the quota rents to foreign exporters, while the importing country gets no tariff revenue, no license revenue, and still suffers consumer losses and efficiency distortions.
9. Marshall–Lerner condition: a currency depreciation improves a country's trade balance iff the sum of the absolute price elasticities of demand for exports and imports is greater than 1. Why: depreciation makes exports cheaper to foreigners and imports costlier to locals; trade balance improves only if quantities respond strongly enough to offset the price effect.
10. Stolper–Samuelson theorem: in a two-good, two-factor trade model, an increase in the relative price of a good raises the real return of the factor used intensively in producing that good and lowers the real return of the other factor. Why: higher output price raises demand for its intensive factor; factor prices adjust economy-wide, not just in that sector
11. In a Free Trade Area (FTA), member countries remove trade barriers among themselves but maintain independent trade policies toward non-members.
12. A Customs Union extends an FTA by adopting a common external trade policy against non-members.
13. Under the WTO's 'Most Favored Nation' (MFN) principle, a country must apply the same tariff rates to all WTO members.
14. Regional Trading Agreements (RTAs) like the EU or USMCA are permitted exceptions to the MFN principle.

MODULE 18.1: THE FOREIGN EXCHANGE MARKET

1. When you buy a forward contract, you agree to BUY an underlying at a agreed price at a future date. If I buy a Euro / Rupee forward from you at 1 EUR = 100 INR, I am obliged to buy 1 EUR @ 100 INR, no matter whatever is the price. I have hedged my risk.
2. Real P/B Exchange Rate = Nominal P/B � (CPI Base / CPI Price) You multiply nominal by how pricier base is with respect to price currency.
3. At a base period, the CPIs of the United States and United Kingdom are both 100, and the exchange rate is $1.70/�. Three years later, the exchange rate is $1.60/�, and the CPI has risen to 110 in the United States and 112 in the United Kingdom. What is the real exchange rate at the end of the three-year period. Here Nominal P/B = $1.6/�, CPI Base = 112, CPI Price = 110. Real P/B = 1.6 � (112/110) = 1.632
4. Suppose in January 1 EUR = 100 INR. In December 1 EUR = 120 INR. INR depreciated by 20%. To calculate EUR appreciation: 1 INR = 0.01 EUR in Jan and 1 INR = 0.0083 EUR in Dec. So EUR appreciated by (0.01-0.0083) / 0.01 = 16.99%

MODULE 19.1: FOREIGN EXCHANGE RATES

1. A cross rate is a rate which is quoted using a third currency as a base. This is useful when there is no direct market between currencies in question.

1. We have domestic rate as \(r_d\), foreign rate as \(r_f\).
   • Suppose we borrow spot(d/f) and lend to foreign.
   • Here, cost of carry of spot = spot(d/f) \(\times\) \(r_d\)
   • Here, benefits from investing spot into foreign country = forward(d/f) \(\times\) \(r_f\) . Why forward(d/f)? Because I will take back my money after one time period and will lock in forward rate today itself.
   • Now using Spot + Cost of Carry - Benefits = Forward. This gives spot(d/f) \(\times\) \((1+r_d)\) - forward(d/f) \(\times\) \(r_f\) = forward(d/f)
   • spot(d/f)\((1+r_d)\) = forward(d/f)\((1+r_f)\) is no-arbitrage relationship.

1. How to make free money (arbitrage)? Suppose Forward(INR/USD) is 92.5 > 91.99. Let us now borrow INR 9.01 Million from HDFC Bank @ 6.65% and convert it to USD. I have 100,000 USD which I lend to JP Morgan at 4.2%. Also I do a Forward(INR/USD) and lock in the price at 92.5. After 1 year: - JP Morgan pays me 100,000 (1.042) = 104,200, and I close the forward by selling 104,200 @ 92.5 which gives me INR 9.638 million. - I pay back HDFC: 9.01 (1.0665) = USD 9.609 Million - I make free money = 9.638 - 9.601 = INR 0.028 Million ~ INR 28k.

1. Forward rates are quoted as points, not prices: points are the difference from spot, measured in the last decimal of the spot quote (e.g., with 4 decimals, 1 point = 0.0001). INR/USD future is trading at 198 bips, which makes forward rate = 90.01 + 1.98 = 91.99.
2. For INR, Forward > Spot, hence INR is trading at forward premium

MODULE 9.1: TESTS FOR INDEPENDENCE