chap 12 Flashcards
open vs closed economy
open economy - interacts freely w other world economies
closed economy - doesn’t interact w other economies
trade balance
same as net exports (exports - imports)
trade surplus vs deficit
trade surplus: exports > imports, NX > 0
trade deficit: im > ex, NX < 0
balanced trade
ex = im, NX = 0
net capital outflow (NCO)
purchase of foreign assets by domestic ppl MINUS purchase of domestic assets by foreigners
kind of like imports - exports
foreign direct investment
capital investment owned and operated by foreign entity
foreign portfolio investment
financed by foreign money, operated by domestic residents
NX = NCO
when net exports = net capital outflow
when (exports - imports) = (imports - exports)
they’re equal bcs every transaction is an exchange
value of g/s sold by a country (NX) = net value of assets acquired (NCO)
NX > 0 , NC0 > 0
when NX > 0, country sells more g/s than buys
- receives foreign currency
- have funds to buy assets
capital flowing OUT OF country (buying from other countries)
NX < 0, NCO < 0
NX<0, buying more g/s than selling
to finance purchases, must sell abroad
capital flowing INTO country (gain from selling to other countries)
savings relationship to NCO
S = I + NCO
NCO is interchangeable w NX
when S > I, NCO is positive
- means country is using savings to buy assets abroad
foreign exchange market
market where diff currencies are bought/sold
nominal exchange rate
of units of foreign currency that can be bought w 1 unit of domestic currency
i.e. CAD –> USD
appreciation
inc in value of a currency
depreciation
exchange rate dec, lowered value of currency
CERI
CAD effective exchange rate
weighted avg of exchange rates b/w CAD and other currencies
what happens if CAD appreciates
imports inc
inc supply CAD, shift right (money supply)
exports dec, demand dec, shift left
real exchange rate
of units of foreign GOODS can be purchased w 1 domestic GOOD
(enom x P)/ P*
enom = nominal exchange rate
P = domestic price lvl
P* = foreign price lvl
purchasing power parity
the theory that similar foreign and domestic g/s should have same price when in same currency
based on:
law of one price (LOP) - a good must be same price in all locations
purchasing power parity and inflation
e depends on price lvl, is impacted by WORTH
if money supply inc and price lvl inc, currency depreciates
overvalued
nominal exchange rate (actual) is less than the PPP exchange rate (predicted)
small open economy
buys/sells g/s from other economies but has little effect on world prices and interest rates
perfect capital mobility
canadians have full access to world financial markets and v.v.
canada’s real IR must equal world’s IR
r = r^w
what happens if r and r^w not equal
if r^w is higher, canadians buy foreign assets bcs gain more
they sell canadian assets, capital outflow
foreigners buy from canadians, who MUST offer the same IR as r^w
interest rate parity
theory that real IR on financial assets should be same in all economies w access to world financial markets
limitations of interest rate parity
why r may not equal r^w
- financial assets have risk of default (not paying) and buyers have risk
- assets offered in diff countries are NOT perfect substitutes and have diff tax returns
