8 International Economies

Question 1

Closed economy

Answer 1

An economy that doesn’t interact with other economies

Question 2

Open economy

Answer 2

An economy that does interact with other economies

Question 3

Trade surplus

Answer 3

When exports> imports

Question 4

Trade deficit

Answer 4

When imports > exports

Question 5

Factors that influence trade

Answer 5

• tastes of consumers
• prices of goods at home and abroad
• exchange rates- people use domestic currency to buy foreign currencies
• incomes of consumers home and abroad
• transport costs
• government policies towards international trade

Question 6

Net capital outflow

Answer 6

Purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners

Question 7

Flow of capital takes two forms

Answer 7

Foreign direct investment

Foreign portfolio investment

Question 8

Factors that influence net capital outflow

Answer 8

• real interest rates paid on foreign assets
• real interest rates paid on domestic assets
• perceived economic and political risks of holding assets abroad
• government policies that effect foreign ownership of domestic assets

Question 9

What are net exports equal to?

Answer 9

Net exports= net capital outflow

Question 10

What is savings equal to?

Answer 10

S= Y-C-G

S=I+NCO

Question 11

Nominal exchange rate

Answer 11

Rate at which a person can trade currency of one country for currency of another

Question 12

Real exchange rate

Answer 12

The ratio at which a person can trade goods and services of one country for goods snd services of another

Question 13

Real exchange rate equation

Answer 13

Real exchange rate = nominal exchange rate x domestic price/ foreign price

Question 14

How does a depreciation in Pounds effect UK NX

Answer 14

Depreciation means UK goods are relatively cheap, consumers at home and abroad buy more UK goods, higher exports, lower imports, higher NX

Question 15

Purchasing power parity theory

Answer 15

It says a unit of any given currency should be able to buy the same quantity of goods in all countries and so the real exchange rate must be 1

Question 16

What does the nominal exchange rate between two countries reflect?

Answer 16

The price levels in those countries

Question 17

How does money supply affect exchange rate?

Answer 17

Increase in money supply leads to increase in prices. Increase in prices causes depreciation of exchange rate

Question 18

Limitations of PPP model

Answer 18

• in SR many other factors influence exchange rate
• real exchange rates aren’t constant over time
• many goods or services aren’t easily traded or aren’t perfect substitutes
• it says nothing about trade deficits or the currency market in the SR

Question 19

Assumptions of model about trade deficit

Answer 19

GDP is taken as given
The economy’s price level is taken for given
There are two markets
1. Supply and demand for loanable funds
2. Supply and demand for a foreign currency

Question 20

In the equation S=I+NCO what does S stand for?

Answer 20

Savings and the supply of loanable funds

Question 21

In the equation S=I+NCO what does I+NCO stand for?

Answer 21

Demand for loanable funds

Question 22

Is the supply curve S(r) increasing or decreasing

Answer 22

Increasing, a higher rate of interest encourages more saving

Question 23

Is the demand curve I(r)+NCO(r) decreasing or increasing

Answer 23

Decreasing, a higher r discourages investments and makes foreign assets less attractive

Question 24

What is demand for pounds equal to?

Answer 24

NX since NX is paid in pounds

Question 25

What is supply for pounds equal to?

Answer 25

NCO since people wanting to purchase foreign assets must sell pounds at the FX market to buy these

Question 26

Is demand for pounds increasing or decreasing with interest rates?

Answer 26

Decreasing as r increases. NX decreases when r rises because exports decrease and imports increase

Question 27

Is supply for pounds NCO increasing or decreasing?

Answer 27

It is fixed and is vertical

Question 28

What do exchange rates and interest rate determine?

Answer 28

• national saving
• domestic investment
• NCO
• net exports

Question 29

How do trade policies reducing imports influence net exports?

Answer 29

Reduced imports increases NX. This effect is offset by an increase in real exchange rate so NX doesn’t change

Question 30

What are the micro effects of a tariff on japanese car imports

Answer 30

UK car manufacturers will benefit, exporters will lose out due to appreciation of the pound

Question 31

Capital flight

Answer 31

A large and sudden reduction in the demand for assets located in a country

Question 32

What are the effects of capital flight?

Answer 32

^capital flight - ^NCO - ^loanable funds - ^interst rate - ^supply of pounds - ^depreciation of pounds

Question 33

How does an increase in interest rate caused by capital flight affect the economy?

Answer 33

Reduces domestic investment
Slows capital accumulation
Slow economic growth
Increases NX

Question 34

How do government budget deficits affect trade balances?

Answer 34

Budget deficit reduces supply of loanable funds - increases interest rate - reduces NCO - reduces supply of pounds - real exchange rate appreciates - NX decrease so this causes a trade deficit