Chapter 12 - OPEN ECONOMY MACROECONOMICS

Question 1

What is Trade Balance?

Answer 1

The value of a nation’s export - the value of its imports = Net exports

Question 2

Trade surplus?

Answer 2

Export > Imports

Question 3

Trade deficit?

Answer 3

Imports > Exports

Question 4

Balanced trade?

Answer 4

Exports = Imports

Question 5

What is Net Capital Outflow (NCO) ?

Answer 5

The purchase of foreign assets by domestic residents – Purchase of domestic assets by foreigners.

Question 6

What variables can influence the NCO?

Answer 6

• Real interest rates being paid on foreign assets.
• Real interest rate being paid on domestic assets.
• Perceived economic and political risks of holding assets abroad.
• Government policies that affect foreign ownership of domestic assets.

Question 7

What is Nominal Exchange Rate?

Answer 7

The rate at which a person can trade the currency of one country for the currency of another.

Question 8

What is Appreciation?

Answer 8

The increase in the value of a currency as measured by the amount of foreign currency it can buy. Om nominal exchange rate = 60 sek / $1 CAD och sedan går den upp till 65 sek /$1 CAD då är det appreciation.

Question 9

What is Depreciation?

Answer 9

The decrease in the value of a currency as measured by the amount of foreign currency it can buy.

Question 10

What is Real Exchange Rate?

Answer 10

The rate at which a person can trade the goods and services of one country for the goods and services of another.

Question 11

Why does the Real Exchange Rate matter?

Answer 11

It matters because it is a key determinant of how much a country exports and imports.

Question 12

What is the formula for Real exchange rate?

Answer 12

Nominal x-rate X Domestic Price / (Foreign price) = e X P/P*?

Question 13

What is the Purchasing -Power Parity theory of?

Answer 13

The theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries.

Question 14

What are the implications of purchasing-power parity?

Answer 14

-The nominal exchange rate between the currencies of two countries depends on the price levels in those countries.

-If a dollar buys the same quantity of goods in Canada (where prices are measured in dollars) as in Japan (where prices are measured in yen), then the number of yen per dollar must relect the prices of goods in Canada and Japan.

Question 15

What are the limitations of purchasing-power parity?

Answer 15

PPP provides a simple model of how exchange rates are determined.

Exchange rates do not, however, always move to ensure that a dollar has the same real value in all countries all the time.
- Many goods are not easily traded.
- Tradable goods are not always perfect substitutes.

Question 16

Why can international trade make anyone better off?

Answer 16

International trading can raise living standards in all countries by allowing each country to specialize in producing those goods and services in which it has a comparative advantage.

Question 17

Why can you not have a different interest rate in your country if you are an open economy compared to the rest of the world?

Answer 17

Because if the rest of the world has a higher interest rate, people will invest in rest of the world.

Question 18

What are some variables that influence the net capital outflow?

Answer 18

-The real interest rate paid on foreign assets
-The real interest rate paid on domestic assets
-The perceived economic and political risks of holding assets abroad
-The government policies that affect foreign ownership of domestic assets

Question 19

Why must NCO = NX hold?

Answer 19

NCO = NX holds because every transaction that effects one side of this equation affects the other side by exactly the same amount.

Question 20

Suppose that a bushel of American rice sells for $100 and a bushel of Japanese rice sells for 16,000 yen. What is the real exchange rate between American and Japanese rice? If the nominal exchange rate is 80 yen per
dollar, then a price for American rice of $100 per bushel is equivalent to 8,000 yen
per bushel.

Answer 20

1) Convert the the prices into a common currency.

2) The real exchange is 1/2
bushel of Japanese rice per bushel of American rice.

3) Real exchange rate = Nominal Exchange rate * Domestic Price / Foreign price

4) Real exchange rate = (80 yen/dollar)*($100/bushel of American Rice)/ 16000 yen/bushel of Japanese rice

= 1/2 bushel of Japanese rice/bushel of American rice.

Question 21

What is perfect capital mobility?

Answer 21

means Canadians have full access to world financial markets.The implication of perfect capital mobility for a small open economy like Canada’s is that the real interest rate in Canada should equal the real interest rate prevailing in world financial markets.
r=r^w

Question 22

What is Interest rate parity?

Answer 22

Interest rate parity is a theory of interest rate determination whereby the real interest rate on comparable financial assets should be the same in all economies with full access to world financial markets.