chap 12

Question 1

open vs closed economy

Answer 1

open economy - interacts freely w other world economies

closed economy - doesn’t interact w other economies

Question 2

trade balance

Answer 2

same as net exports (exports - imports)

Question 3

trade surplus vs deficit

Answer 3

trade surplus: exports > imports, NX > 0

trade deficit: im > ex, NX < 0

Question 4

balanced trade

Answer 4

ex = im, NX = 0

Question 5

net capital outflow (NCO)

Answer 5

purchase of foreign assets by domestic ppl MINUS purchase of domestic assets by foreigners

kind of like imports - exports

Question 6

foreign direct investment

Answer 6

capital investment owned and operated by foreign entity

Question 7

foreign portfolio investment

Answer 7

financed by foreign money, operated by domestic residents

Question 8

NX = NCO

when net exports = net capital outflow

when (exports - imports) = (imports - exports)

Answer 8

they’re equal bcs every transaction is an exchange

value of g/s sold by a country (NX) = net value of assets acquired (NCO)

Question 9

NX > 0 , NC0 > 0

Answer 9

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)

Question 10

NX < 0, NCO < 0

Answer 10

NX<0, buying more g/s than selling

to finance purchases, must sell abroad

capital flowing INTO country (gain from selling to other countries)

Question 11

savings relationship to NCO

Answer 11

S = I + NCO

NCO is interchangeable w NX

when S > I, NCO is positive
- means country is using savings to buy assets abroad

Question 12

foreign exchange market

Answer 12

market where diff currencies are bought/sold

Question 13

nominal exchange rate

Answer 13

of units of foreign currency that can be bought w 1 unit of domestic currency

i.e. CAD –> USD

Question 14

appreciation

Answer 14

inc in value of a currency

Question 15

depreciation

Answer 15

exchange rate dec, lowered value of currency

Question 16

CERI

Answer 16

CAD effective exchange rate

weighted avg of exchange rates b/w CAD and other currencies

Question 17

what happens if CAD appreciates

Answer 17

imports inc

inc supply CAD, shift right (money supply)

exports dec, demand dec, shift left

Question 18

real exchange rate

Answer 18

of units of foreign GOODS can be purchased w 1 domestic GOOD

Question 19

(enom x P)/ P*

Answer 19

enom = nominal exchange rate

P = domestic price lvl

P* = foreign price lvl

Question 20

purchasing power parity

Answer 20

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

Question 21

purchasing power parity and inflation

Answer 21

e depends on price lvl, is impacted by WORTH

if money supply inc and price lvl inc, currency depreciates

Question 22

overvalued

Answer 22

nominal exchange rate (actual) is less than the PPP exchange rate (predicted)

Question 23

small open economy

Answer 23

buys/sells g/s from other economies but has little effect on world prices and interest rates

Question 24

perfect capital mobility

Answer 24

canadians have full access to world financial markets and v.v.

canada’s real IR must equal world’s IR

r = r^w

Question 25

what happens if r and r^w not equal

Answer 25

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

Question 26

interest rate parity

Answer 26

theory that real IR on financial assets should be same in all economies w access to world financial markets

Question 27

limitations of interest rate parity

why r may not equal r^w

Answer 27

1. financial assets have risk of default (not paying) and buyers have risk
2. assets offered in diff countries are NOT perfect substitutes and have diff tax returns