Macro (Test 2) chapter 18 (Open Economy)
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cmcqueen40 on April 9, 2012
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1.The flow of goods:Exports, Imports, and Net Exports 2.The flow of financial resources:Net capital flow 3.The equity of Net Exports and Net Capital Outflow 4. Saving, Investment, and their Relationship to the International Flows 5. Nominal Exchange Rates 6. Real Exchange Rates 7. The basic logic of (see more)
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13 terms
Terms | Definitions |
|---|---|
 an open economy | an economy that interacts freely with other economies around the world |
| Net Exports | Net exports= Value of country's exports-Value of countries imports |
| The Flow of goods: exports,imports, and net exports | -Net exports tells us whether a country is, in total, a seller or a buyer in world markets for goods and services, net exports are also called the TRADE BALANCE -If net exports are positive, exports are greater than imports,indicating the country sells more goods and services abroad than it buys from other countries. This is a trade surplus -trade deficit- an excess of imports over exports -balanced trade=a situation in which exports equal imports |
| The Flow of Financial Resources: Net Capital Outflow | Net capital outflow=Purchase of foreign assets by domestic residents-purchase of domestic assets by foreigners -Mcds opening up in russia is foreign direct investment -american buys stock in a russian corporation= foreign portfolio investment *important variables that influence NCO 1.The Real Interest rates paid on foreign assets 2.The real Interest Rates paid on domestic assets 3. The perceived economic and political risks of holding assets abroad 4. The government policies that affect foreign ownership of domestic assets |
| The Equity of Net Exports and Net Capital Outflow | Net exports measure an imbalance between a country's exports and its imports. Net capital outflow measures an imbalance between the amount of foreign assets bought by domestic residents and the amount of domestic assets by foreigners ****NCO=NX ***When a nation is running a trade surplus (NX>0), it is selling more goods to foreigners. What its doing with the foreign currency it receives from the net sale of goods and services abroad? it must be using it to buy foreign assets. Capital is flowing out of the country (NCO>0) ***When a nation is running a trade deficit (NX<0), its buying more goods and services from foreigners than its selling to them. How is it financing the net purchase of these goods and services in world markets? It must be selling assets abroad. CApital is flowing into the country (NCO<0) |
| Saving, Investment, and their Relationship to International flows | A nations saving and investment are crucial for its long run economic growth Y=C+I+G+NX National Saving S=Y-C-G Y-C-G=I+NX S=I+NX NX=NCO S=I+NCO |
| Summary of trade | *****Trade Deficit -Exports<Imports -Net Exports<0 - Y<C+I+G -Saving<Investment NCO<0 *****Balanced Trade -Exports=imports -net exports=0 - Y=C+I+G -Saving= Investment -Net CApital Outflow=0 *****Trade Surplus -Exports>Imports -Net Exports>0 - Y>C+I+G -Saving>Investment NCO>0 |
| Nominal Exchange rates | The rate at which a person can trade the currency of one country for the currency of another apreciation-an increase in the value of a currency as measured by the amoun of foreign currency it can buy depreciation-a decrease in the value of currency as measured by the amount of foreign currency it can by |
| Real Exchange Rates | the rate at which a person can trade the goods and services of one country for the goods and services of another Real Exchange Rate=(Nominal Exchange Rate x Domestic Price) / Foreign Price -key determinant of how much a country exports and imports Real exchange rate=( e x P ) / P* P=US Basket P*=foreign basket e=nominal exchange rate between US dollar and foreign currency ****This real exchange rate measures the price of a basket of goods and services available domestically relative to a basket of goods and services available abroad -a depreciation(fall) in the US real excahnge rate means that US goods have become cheaper relative to foreign goods. This change encourages consumers both at home and abroad to buy more US goods and fewer goods from other countries. ****As a result US exports rise, US imports fall; both of these changes raise US net exports |
| Purchasing Power parity | a theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries |
| The basic logic of Purchasing Power parity | based on a principle called the law of one price. This law asserts that a good must sell for the same price in all location. Otherwise, there would be opportunities for profit left unexploited. process continues until eventually, the prices are the same in two markets the law of one price tells us that a dollar must buy the same amount of coffee in all countries |
| Implications of Purchasing Power parity | It tells us that nominal exchange rate between the currencies of two countries depends on the price levels in those countries **For the purchasing power of a dollar to be the same in two countries this must be the case **1/P=e/P with rearrangement it becomes **1=eP/P left side is constant and the right side is the real exchange rate so **** IF the purchasing power of the dollar is always the same at home and abroad, then real exchange rate-the relative price of domestic and foreign goods-cannot change -nominal exchange rates change when price level changes ***When the central bank prints large quantities of money, that money loses value both in terms of the goods and services it can buy and in terms of the amount of other currencies it can buy |
| limitations of Purchasing-Power Parity | first reason-many goods are not easily traded(haircut more expensive in Paris then New York) 2.Even tradable goods are not always perfect substitutes when they are produced in different countries. (German vs. US cars) -Thus, both because some goods are not tradable and because some tradable goods are not perfect substitutes with foreign counterparts, purchasing power parity is not a perfect theory of exchange rate determination. |
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