Chapter 12 - Open Economy

Question 1

Closed vs open economy

Answer 1

Closed - economy does not interact with other economies in the world (North Korea)
Open - economy that interacts freely with other economies around the world

Question 2

2 ways an open economy interacts with other economies

Answer 2

1. Buys and sells g/s in the world
2. It buys and sells capital assets such as stocks and bonds in world financial markets

Question 3

Trade balance, trade surplus, trade deficit, and balanced trade

Answer 3

1. The value of nation;s exports minus imports, same as net exports
2. Excess of exports over imports
3. Excess of imports over exports
4. Situation which exports equal imports

Question 4

Net capital outflow (NCO)

Answer 4

The purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners (difference between what we buy abroad which is money leaving our economy and what foreigners buy of our assets which is money coming into our economy)

Question 5

Variables that influence NCO

Answer 5

• real interest rates being paid on foreign assets (if you can make more $ investing abroad, you will)
• real interest rates being paid in domestic assets (if high here, you’ll buy here)
• economic and political risks of holding assets abroad
  4. Govt policies that affect foreign ownership of domestic assets

Question 6

Relations between net capital outflow and net exports

Answer 6

They are always equal

Question 7

Equation using NCO

Answer 7

S = I + NCO
Savings = domestic investment + net capital outflow

Question 8

Nominal exchange rate vs real exchange rate

Answer 8

N - rate at which a person can trade the currency of one country for the currency of another
R - the rate at which a person can trade the g/s of one country for the g/s of another

Question 9

Real exchange rate formula

Answer 9

Real x rate = (nominal x rate x domestic price) / foreign price

Question 10

Appreciation vs depreciation

Answer 10

A - increase in value of a currency measured by amount of foreign currency it can buy ( need fewer of your dollars for foreign dollar)
D - decrease in value of a currency as measured by amount of foreign dollars it can buy ( need more of your dollars for foreign dollars; would increase exports)

Question 11

Purchasing power parity (ppp)

Answer 11

Theory of exchange rates that a unit of any given currency should be able to buy the same quantity of goods in all countries. Based on the law of one price (good must sell for same price in all locations)

Question 12

PPP equation

Answer 12

e =P* / P
Exchange rate = foreign price/domestic price
This will be equal if the purchasing power of a dollar is the same in both countries