Chapter 12 Open-Economy: basic concepts Flashcards
Closed economy
does not interact with other economies in the world
open economy
interacts freely with other economies around the world
Which of the following doesn’t happen in an open economy?
A: It buys and sells goods and services in world product markets.
B: It buys and sells capital assets in world financial markets.
C: It buys and sells foreign currency and capital goods for redistribution and domestic profit.
C: that doesn’t even make sense.
Exports
domestically-produced goods and services sold abroad
imports
foreign produced goods and services sold domestically
Net exports, aka the _____ ______
trade balance
Formula: Net exports (NX) =
value of exports - value of imports
What do you think would happen to Canadian net exports if:
The U.S. experiences a recession (falling incomes, rising unemployment)
canadian net exports would fall due to a fall in American consumer’ purchases of Canadian exports
What do you think would happen to Canadian net exports if:
Canadian consumers decide to be patriotic and buy more products “Made in Canada”
Net exports would rise due to a fall in imports
What do you think would happen to Canadian net exports if:
Prices of goods produced in Mexico rise faster than prices of goods produced in Canada.
This makes Canadian goods more attractive relative to mexico’s goods.
Exports to Mexico increase
Imports from mexico decrease
*** Net exports increase
Variables that Influence Net Exports: (6)
TTCPIG
Transportation costs
The exchange rates at which foreign currency trades for domestic currency
Consumers’ preferences for foreign and domestic goods.
Prices of goods at home and abroad
Incomes of consumers at home and abroad
Govt policies
Trade deficit
an excess of imports over exports
Trade surplus
an excess of exports over imports
balanced trade
when exports = imports
T or F: Trade deficit is always a bad
False
Define: domestic residents’ purchases of foreign assets MINUS foreigners’ purchases of domestic assets.
Net capital outflow (NCO)
NCO = ____ _____ _____
synonym
net foreign investment
When a Canadian resident buys stock in Telmex, the Mexican phone company, the purchase _____Canadian net capital outflow.
raises
When a Japanese resident buys a bond issued by the Canadian government, the purchase _______ Canadian net capital outflow.
reduces
The flow of capital abroad takes two forms:
foreign investment
Foreign direct investment
Foreign portfolio investment
Define: Domestic residents actively manage the foreign investment, e.g., Tim Hortons opens a fast food outlet in Russia
Foreign direct investment
Define: Domestic residents purchase foreign stocks or bonds, supplying “loanable funds” to a foreign firm.
foreign portfolio investment
Foreign direct investment
Foreign portfolio investment
Which of the above involves residents buying assets located in another country, and which increases net capital outflow?
Both
When NCO > 0 termed:
capital outflow
When NCO < 0
capital inflow
Domestic purchases of foreign assets exceed foreign purchases of domestic assets.
NCO >0 or NCO <0
capital is flowing out of the country
NCO >0
Foreign purchases of domestic assets exceed domestic purchases of foreign assets
NCO >0 or NCO <0
capital is flowing into the country
NCO <0
Variables that influence NCO
RRPG
Real interest rates paid on foreign assets
Real interest rates paid on domestic assets
Perceived risks of holding foreign assets
Govt policies affecting foreign ownership of domestic assets
T or F: real interest rate affects foreign investment
True
T or F: restrictions that affect trade, are never undermined
False; always undermined.
T or F: every transaction that affects NX also affects NCO by the same amount; but not the other way around.
false; same vice versa
When a foreigner purchases a good from Canada, Canadian exports and NX ______. NCO ______.
(increases or decreases)
increase; the foreigner pays with currency or assets, so the Canadian acquires some foreign assets, causing NCO to rise
Closed economy
does not interact with other economies in the world
open economy
interacts freely with other economies around the world
Which of the following doesn’t happen in an open economy?
A: It buys and sells goods and services in world product markets.
B: It buys and sells capital assets in world financial markets.
C: It buys and sells foreign currency and capital goods for redistribution and domestic profit.
C: that doesn’t even make sense.
Exports
domestically-produced goods and services sold abroad
imports
foreign produced goods and services sold domestically
Net exports, aka the _____ ______
trade balance
Formula: Net exports (NX) =
value of exports - value of imports
What do you think would happen to Canadian net exports if:
The U.S. experiences a recession (falling incomes, rising unemployment)
canadian net exports would fall due to a fall in American consumer’ purchases of Canadian exports
What do you think would happen to Canadian net exports if:
Canadian consumers decide to be patriotic and buy more products “Made in Canada”
Net exports would rise due to a fall in imports
What do you think would happen to Canadian net exports if:
Prices of goods produced in Mexico rise faster than prices of goods produced in Canada.
This makes Canadian goods more attractive relative to mexico’s goods.
Exports to Mexico increase
Imports from mexico decrease
*** Net exports increase
Variables that Influence Net Exports: (6)
TTCPIG
Transportation costs
The exchange rates at which foreign currency trades for domestic currency
Consumers’ preferences for foreign and domestic goods.
Prices of goods at home and abroad
Incomes of consumers at home and abroad
Govt policies
Trade deficit
an excess of imports over exports
Trade surplus
an excess of exports over imports
balanced trade
when exports = imports
T or F: Trade deficit is always a bad
False
Define: domestic residents’ purchases of foreign assets MINUS foreigners’ purchases of domestic assets.
Net capital outflow (NCO)
NCO = ____ _____ _____
synonym
net foreign investment
When a Canadian resident buys stock in Telmex, the Mexican phone company, the purchase _____Canadian net capital outflow.
raises
When a Japanese resident buys a bond issued by the Canadian government, the purchase _______ Canadian net capital outflow.
reduces
The flow of capital abroad takes two forms:
foreign investment
Foreign direct investment
Foreign portfolio investment
Define: Domestic residents actively manage the foreign investment, e.g., Tim Hortons opens a fast food outlet in Russia
Foreign direct investment
Define: Domestic residents purchase foreign stocks or bonds, supplying “loanable funds” to a foreign firm.
foreign portfolio investment
Foreign direct investment
Foreign portfolio investment
Which of the above involves residents buying assets located in another country, and which increases net capital outflow?
Both
When NCO > 0 termed:
capital outflow
When NCO < 0
capital inflow
Domestic purchases of foreign assets exceed foreign purchases of domestic assets.
NCO >0 or NCO <0
capital is flowing out of the country
NCO >0
Foreign purchases of domestic assets exceed domestic purchases of foreign assets
NCO >0 or NCO <0
capital is flowing into the country
NCO <0
Variables that influence NCO
RRPG
Real interest rates paid on foreign assets
Real interest rates paid on domestic assets
Perceived risks of holding foreign assets
Govt policies affecting foreign ownership of domestic assets
T or F: real interest rate affects foreign investment
True
T or F: restrictions that affect trade, are never undermined
False; always undermined.
T or F: every transaction that affects NX also affects NCO by the same amount; but not the other way around.
false; same vice versa
When a foreigner purchases a good from Canada, Canadian exports and NX ______. NCO ______.
(increases or decreases)
increase; the foreigner pays with currency or assets, so the Canadian acquires some foreign assets, causing NCO to rise
When a Canadian citizen buys foreign goods, Canadian imports ____, NX _____ (falls or rises)
rises; falls
the Canadian buyer pays with Canadian dollars or assets, so the other country acquires Canadian assets, causing Canadian NCO to fall.
T or F: Y = C + I + G + NX
True ; accounting identity
T or F: Y – C – G = I + NX
True
T or F: S=I+Y
False S=I+NCO
T or F: Y=I+NX
False; S=I+NX
When S>I , the excess loanable funds flow abroad in the form of _____________________.
positive net capital outflow
When Ss invenstent, and NCO ___ 0;
financing; <
3 types of International Flows of Goods and Capital :
- Trade Deficit
- Balanced Trade
- Trade Surplus
What type of international flow of goods and capital is this?
Exports < Imports
trade deficit
What type of international flow of goods and capital is this?
Net capital outflow = 0
Balanced Trade
What type of international flow of goods and capital is this?
Y= C+ I + G
balanced trade
What type of international flow of goods and capital is this?
Net exports >0
Trade Surplus
What type of international flow of goods and capital is this?
Y > C+ I + G
trade surplus
What type of international flow of goods and capital is this?
saving < investment
trade deficit
On a graph, if national saving rises above domestic investment, which would occur?
trade surplus
balanced trade
trade deficit
trade surplus
On a graph, if NCO fall below 0 (NCO < 0) the result is
Net capital inflow
International transactions are influenced by international _____.
prices
 The two most important international prices are the ______ _______ rate and the_____ ______ rate.
nominal exchange rate; real exchange rate
Nominal exchange rate:
the rate at which one country’s currency trades for another.
The two ways in which Nominal exchange rates can be expressed?
- in units of foregin currency per one Canadian dollar
2. in units of Canadian dollars per one unit of the foreign currency
Appreciation
(“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 measured by the amount of foreign currency it can buy
If the value of the Canadian dollar rises over time, it is Appreciating or depreciating?
appreciating
Real exchange rate
the rate at which goods and services of one country trade for the goods and services of another
Formula for real exchange rate?
Real exchange rate = e x P / P*
RER = nominal exchange rate (foreign/domestic cur) x domestic price / forign price (in foreign currency)
A Big Mac costs $2.50 but 400 yen in Japan
e=120 yen per $
Compute the real exchange rate:
0.75 Japanese Big Macs per CDA Big Mac
a real exchange rate of Big macs of 0.75 :
T or F; a Japanese citizen literally exchanges Japanese burgers for Canadian ones.
False; This does not mean a Japanese citizen literally exchanges Japanese burgers for Canadian ones
Correct: To buy a Big Mac in Canada,
a Japanese citizen must sacrifice an amount that could purchase 0.75 Big Macs in Japan.
T or F: Big Mac is the same everywhere in the world and makes it easy to determine real exchange rate T or F:
true
Define: the notion that a good should sell for the same price in all markets
Law of one price
arbitrage
making a quick profit by buying coffee in some place and selling in a place of more worth.
T or F: Example: Arbitrage drives up the price in placeA and drives down the price in placeB, until the two prices are equal.
True
Purchasing Power Parity (PPP)
a theory of exchange rates whereby a unit of any currency should be able to buy the same quantity of goods in all countries
T or F: Purchasing-Power Parity (PPP) is based on the law of one price
True
T or F: PPP implies that the nominal exchange rate between two countries should equal the ratio of price levels.
True
If inflation is higher in Mexico than in Canada., then P* _____ faster than P, so e ______ –
the dollar _________ against the peso.
rises; rises; appreciates
If inflation is higher in the Canada than in Japan, then P _____ faster than P*, so e _____ –
the dollar _______ against the yen.
rises; falls; depreciates
Limitations of PPP Theory
Two reasons why exchange rates do not always adjust to equalize prices across countries:
Many goods cannot easily be traded
Foreign domestic goods not perfect substitutes
During the German Hyperinflation: what happened to money supply? and what happend to the exchange rate?
money supply rose; exchange rate fell
- Which of the following statements about a country with a trade deficit is not true?
A. Exports < imports
B. Net capital outflow < 0 C. Investment < saving D. Y < C + I + G
C
A trade deficit means NX < 0. Since NX = S – I,
a trade deficit implies I > S.
A Ford Escape SUV sells for $24,000 in Canada and 720,000 rubles in Russia.
If purchasing-power parity holds, what is the
nominal exchange rate (rubles per dollar)?
e = P*/P = 720000/24000 = 30 rubles per dollar
Canada is an economy with perfect capital mobility because (2 reasons)
- Canadians have full access to world financial markets
2. the rest of the world has full access to the Canadian financial market
T or F:canada’s perfect capital mobility doesn’t mean that the real interest rate in Canada should equal the real interest rate prevailing in
the world: r = rw
False ; *it does mean
interest rate parity
The theory that the real interest rate in Canada should equal that in the rest of the world is known as interest rate parity
Real interest rate in Canada is not always equal to the real interest rate in the rest of the world for two reasons:
Financial assets carry with them the possibility of default
Financial assets offered for sale in different
T or F: Net exports equal exports minus imports.
True
T or F: Net capital outflow equals domestic residents’ purchases of foreign assets minus foreigners’ purchases of domestic assets.
True
T or F: Not every international transaction involves the exchange of an asset for a good or service, so net exports equal net capital outflow.
False; Every international transaction involves the exchange of an asset for a good or service, so net exports equal net capital outflow.
T or F: saving equals domestic investment plus net capital outflow.
True
Saving can be used to finance domestic _______ or to buy ________ abroad.
investment; assets
The ________ exchange rate is the relative price of the currency of two countries.
nominal
The _________ exchange rate is the relative price of the goods and services of the two countries.
real
T or F: According to the theory of purchasing-power parity, a unit of any country’s currency should be able to buy a different quantity of goods in different countries.
false; According to the theory of purchasing-power parity, a unit of any country’s currency should be able to buy the same quantity of goods in all countries.
T or F: Theory of PPP implies that the nominal exchange rate between two countries should equal the ratio of the price levels in the two countries.
True
T or F: Theory of PPP also implies that countries with high inflation should have depreciating currencies.
true
With perfect capital mobility for small open economy is that the nominal exchange rate in Canada should equal the Net Capital outflow prevailing in world financial markets.
False; With perfect capital mobility for small open economy is that the real exchange rate in Canada should equal the real interest rate prevailing in world financial markets.
