8 International Economies Flashcards
Closed economy
An economy that doesn’t interact with other economies
Open economy
An economy that does interact with other economies
Trade surplus
When exports> imports
Trade deficit
When imports > exports
Factors that influence trade
- 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
Net capital outflow
Purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners
Flow of capital takes two forms
Foreign direct investment
Foreign portfolio investment
Factors that influence net capital outflow
- 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
What are net exports equal to?
Net exports= net capital outflow
What is savings equal to?
S= Y-C-G
S=I+NCO
Nominal exchange rate
Rate at which a person can trade currency of one country for currency of another
Real exchange rate
The ratio at which a person can trade goods and services of one country for goods snd services of another
Real exchange rate equation
Real exchange rate = nominal exchange rate x domestic price/ foreign price
How does a depreciation in Pounds effect UK NX
Depreciation means UK goods are relatively cheap, consumers at home and abroad buy more UK goods, higher exports, lower imports, higher NX
Purchasing power parity theory
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
What does the nominal exchange rate between two countries reflect?
The price levels in those countries
How does money supply affect exchange rate?
Increase in money supply leads to increase in prices. Increase in prices causes depreciation of exchange rate
Limitations of PPP model
- 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
Assumptions of model about trade deficit
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
In the equation S=I+NCO what does S stand for?
Savings and the supply of loanable funds
In the equation S=I+NCO what does I+NCO stand for?
Demand for loanable funds
Is the supply curve S(r) increasing or decreasing
Increasing, a higher rate of interest encourages more saving
Is the demand curve I(r)+NCO(r) decreasing or increasing
Decreasing, a higher r discourages investments and makes foreign assets less attractive
What is demand for pounds equal to?
NX since NX is paid in pounds
What is supply for pounds equal to?
NCO since people wanting to purchase foreign assets must sell pounds at the FX market to buy these
Is demand for pounds increasing or decreasing with interest rates?
Decreasing as r increases. NX decreases when r rises because exports decrease and imports increase
Is supply for pounds NCO increasing or decreasing?
It is fixed and is vertical
What do exchange rates and interest rate determine?
- national saving
- domestic investment
- NCO
- net exports
How do trade policies reducing imports influence net exports?
Reduced imports increases NX. This effect is offset by an increase in real exchange rate so NX doesn’t change
What are the micro effects of a tariff on japanese car imports
UK car manufacturers will benefit, exporters will lose out due to appreciation of the pound
Capital flight
A large and sudden reduction in the demand for assets located in a country
What are the effects of capital flight?
^capital flight - ^NCO - ^loanable funds - ^interst rate - ^supply of pounds - ^depreciation of pounds
How does an increase in interest rate caused by capital flight affect the economy?
Reduces domestic investment
Slows capital accumulation
Slow economic growth
Increases NX
How do government budget deficits affect trade balances?
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
