CH12 - Open Economy

Question 1

Exports

Answer 1

the value of domestically-produced goods and services sold abroad
-> Or, foreigners’ purchases of domestically-produced goods and services (FPDG)

Question 2

Imports

Answer 2

the value of foreign-produced goods and services bought domestically
-> Or domestic residents’ purchases of foreign-produced goods and services (DPFG)

Question 3

Net exports (NX)

Answer 3

the value of a country’s trade in goods and services:
Exports - Imports
FPDG - DPFG

Question 4

trade surplus

Answer 4

positive balance of trade
NX > 0
exports > imports
FPDG > DPFG

Question 5

trade deficit

Answer 5

negative balance of trade
NX < 0
exports < imports
FPDG < DPFG

Question 6

values that affect net exports

Answer 6

-> Income of consumers at home and abroad
- Recessions affect incomes
-> Consumers’ preferences for foreign and domestic goods
- A “buy domestic” policy
-> Prices of goods at home and aboard
- A large rise in prices in Mexico
-> The exchange rate (a relative price) at which a foreign currency trades for a unit of domestic currency
- Changes in the money supply affect domestic prices which affect exchange rates (slide 33)
-> Transportation costs
-> Government policies such as tariffs and quotas

Question 7

2 types of foreign investment

Answer 7

Foreign Direct Investment

Foreign portfolio investment

Question 8

Foreign Direct Investment

Answer 8

domestic residents establish a long-term relationship with, and a significant degree of influence on the management of, the investment enterprise (at least 10% ownership of the voting power)
-> Active management or control of companies aboard

Question 9

Foreign portfolio investment

Answer 9

Domestic residents purchase foreign equity or debt securities, supplying “loanable funds” to foreign firms
-> These are characterized as passive (hands-off) investments

Question 10

Net Capital Outflow (NCO)

Answer 10

• a country’s trade in assets
• also called net foreign investment
  => Domestic residents’ purchases of foreign assets (DPFAs) minus foreigners’ purchases of domestic assets (FPDAs)
  => When NCO > 0, DPFAs > FPDAs: domestic purchases of foreign assets exceed foreign purchases of domestic assets

Question 11

• Variables that influence NCO

Answer 11

o Real interest rates paid on foreign vs domestic assets (NCO↓ if domestic rate ↑)
o Perceived risks of holding domestic vs. foreign assets (NCO↑ if domestic risk ↑)
o Government policies affecting the foreign ownership of domestic assets

Question 12

Some federal policies restricting foreign ownership

Answer 12

-> Bank Act
o No individual investor may hold more than 10% of the shares of a Schedule 1 bank
o Non-residents holding may not exceed 25% in aggregate
-> Insurance Companies Act
o Foreign ownership limited to 25% in aggregate and 10% for any individual non-resident
-> Broadcasting Act
o Broadcasting licenses may not be issues to non-Canadians or to companies that are effectively owned or controlled, directly or indirectly, by non-Canadian
-> Telecommunications Act
o Foreign ownership restricted to 20% for common carriers

Question 13

The balance of payments identity: NX = NCO

Answer 13

=> every transaction that affects NX also affects NCO by the same amount (and vice-versa) because every international transaction is “an exchange”

Question 14

Saving, investment and NCO identity

Answer 14

NCO = NS – I = (Y – C – G) - I = Exports – Imports = NX

Question 15

Appreciation versus depreciation

Answer 15

-> Appreciation (or “strengthening”)
- An increase in the value of a currency as measured by the amount of foreign currency it can buy
-> Depreciation (or “weakening”)
- A decrease in the value of a currency as measures by the amount of foreign currency it can buy

Question 16

The real exchange rate

Answer 16

the rate at which a country’s goods and services trade for the goods and services of another country

Question 17

Purchasing-power parity (PPP)

Answer 17

A theory of exchange rates that states that a unit of any currency should be able to buy the same quantity of goods in all countries in the long run

Question 18

why exchange rates do not always adjust to equalize prices across countries

Answer 18

1. Many good cannot be easily traded (haircuts, going to the movies)
   
   • Will you travel to another country for a burger?
2. Price differences on some goods cannot be arbitraged away
   
   • Foreign goods are not perfect substitutes for domestic goods; price differences reflect differences in tastes (or preferences)
   • Example: some Canadian consumers prefer Toyotas over Chevys (and vice-versa)