Chapter 12 Flashcards
OPEN-ECONOMY MACROECONOMICS: BASIC CONCEPTS
So far, our study of macroeconomics has largely ignored the economy’s interaction with other economies around the world.
One of the ten principles of economics is that trade can make everyone better off.
The study of an open economy raises new issues.
OPEN-ECONOMY MACROECONOMICS: Open vs. Closed Economy
Closed economy is an economy that does not interact with other economies in the world.
Open economy is an economy that interacts freely with other economies around the world.
THE INTERNATIONAL FLOWS OF GOODS AND CAPITAL
The Flow of Goods:
Exports, Imports, and Net Exports
An open economy interacts with other economies in two ways:
* It buys and sells goods and services in world product markets.
* It buys and sells capital assets such as stocks and bonds in world financial markets.
These two activities, as well as the close relationship between them, are discussed here.
THE INTERNATIONAL FLOWS OF GOODS AND CAPITAL Part 2
Exports are goods and services that are produced domestically and sold abroad.
Imports are goods and services that are produced abroad and sold domestically.
Net exports (or trade balance) is the value of a nation’s exports minus the value of its imports.
THE INTERNATIONAL FLOWS OF GOODS AND CAPITAL: Trade Balance, Surplus, Deficit
Trade balance is the value of a nation’s exports minus the value of its imports; also called net exports.
Trade surplus is an excess of exports over imports.
Trade deficit is an excess of imports over exports.
Balanced trade is a situation in which exports equal imports.
FIGURE 12.1 The Internationalization of the Canadian Economy
This figure shows the value of Canada’s exports and imports as a percentage of GDP since 1960.
It shows the value of exports and imports to the whole world and the value of exports and imports to the United States, Canada’s largest trading partner.
The substantial increase over time shows the increasing importance of international trade, particularly with the United States.
The dramatic increase in trade following the signing of the Canada–U.S. Free Trade Agreement in 1989 is especially noteworthy.
A recession in 2009 and the COVID-19 pandemic starting in 2020 are both evident in the sharp falls in international trade that they caused.
(Instructor’s Note)
An important change in the Canadian economy since 1960 has been the increasing importance of international trade and finance.
The Flow of Financial Resources: Net Capital Outflow
Net capital outflow (NCO) is the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners.
Some of the variables that influence NCO:
- Real interest rates being paid on foreign assets
- Real interest rates being paid on domestic assets
- Perceived economic and political risks of holding assets abroad
- Government policies that affect foreign ownership of domestic assets
The Equality of Net Exports and Net Capital Outflow
Net exports measure an imbalance between a country’s exports and its imports.
Net capital outflow measures an imbalance between the amount of foreign assets bought by domestic residents and the amount of domestic assets bought by foreigners.
NCO always equals NX:
NCO = NX
The Equality of NX and NCO Part 2: NX > 0
When NX > 0, the country is selling more goods and services to foreigners than it is buying from them.
What is it doing with the foreign currency it receives from the net sale of goods and services abroad?
It must be using it to buy foreign assets.
Capital is flowing out of the country (i.e., NCO > 0).
The Equality of NX and NCO Part 3: NX < 0
When NX < 0, the country is buying more goods and services from foreigners than it is selling to them.
How is it financing the net purchase of these goods and services in world markets?
It must be selling assets abroad.
Capital is flowing into the country (i.e., NCO < 0).
Saving, Investment, and Their Relationship
to the International Flows
Closed Economy: NCO = 0, S = I
Y = C + I + G + XN
Y - C - G = I + XN
S = I + XN
s = I + NCO
Saving, Investment, and Their Relationship
to the International Flows (cont’d)
Savings = Domestic Investment + Net Capital Outflow
Because net exports (NX) also equal NCO, we can write the equation as shown.
TABLE 12.1 International Flows of Goods and Capital: Summary
This table shows the three possible outcomes for an open economy.
