Chapter 12 - Open Economy Macroeconomics

Question 1

Net Exports (also called _____) =

Answer 1

value of exports - value of imports

-also called trade balance

Question 2

Variables for Net Exports are… (6)

Answer 2

1. Consumer preferences (foreign + domestic); 2. Prices;
2. Incomes; 4. Exchange rates; 5. Government Policies;
3. Transportation Costs

Question 3

Trade deficit is…

Answer 3

imports > exports

Question 4

Trade Surplus is…

Answer 4

imports < exports

Question 5

Net Capital Outflow is…

-also called_____

Answer 5

domestic purchase of foreign minus foreign purchase of domestic
-also called net foreign investment

Question 6

Flow of Capital Abroad is in 2 forms:

Answer 6

1. Foreign Direct Investment (own + operate foreign investment)
2. Foreign Portfolio Investment (stock/bond purchase to incr LF Supply in foreign)

Question 7

Capital Outflow…

Answer 7

NCO>0

Question 8

Capital Inflow

Answer 8

NCO<0

Question 9

Variables for NCO (3)

Answer 9

1. Real interest rate paid (f+d)
2. perceived risk in foreign country
3. gov’t policy on foreign domestic purchase

Question 10

Accounting Identity…

Answer 10

every transaction that affects NX also affects NCO by same amount (+ vice versa)

Question 11

Formula: S=I+NCO

• when S>I…
• when S<I…

Answer 11

• excess L funds abroad (so +’ve NCO)

- foreigners finance domestic investment (so -‘ve NCO)

Question 12

Nominal Exchange Rate is…

Answer 12

one country’s currency exchanging for another’s

-eg. Canadian $/peso

Question 13

Appreciation…

Answer 13

incr in value of domestic currency compared to how much foreign currency it can buy

Question 14

Depreciation…

Answer 14

decreased value of domestic money compared to amount of foreign money it can buy.

Question 15

Real Exchange Rate is…

-formula =

Answer 15

G/S trading in one country for G/S trading in another.

• formula: (e x P)/P*
  
  • -where: P=domestic P; P*=foreign P; e=nominal exchange rt

Question 16

Law of one Price…

Answer 16

notion that G should sell for the same in all markets b/c if don’t then arbitrage can occur. If transported w/o cost can sell cheaper goods which drives up their price and down the other until equal.

Question 17

Arbitrage is…

Answer 17

buy cheap goods in one market + transport w/o cost to sell in a more expensive market.

Question 18

Purchasing Power Parity is…

-implies…

Answer 18

exchange rate theory where a unit of any currency should purchase same Q of Goods everywhere.
-implies that nominal exchange rates adjust to balance P of baskets across countries

Question 19

Formula for PPP theory…

Answer 19

• e = (P*/P)

- –nominal exchange rates b/w two countries should equal P levels.

Question 20

PPP theory example.

• if inflation rates differ: 1. higher in Mex than Can.
  2. higher in Can than Mex.

Answer 20

1. then P* rises (dollar appreciates vs. peso)

2. then P rises (dollar depreciates vs. peso)

Question 21

Limitations of PPP Theory (2)

Answer 21

1. Many G/S cannot be traded (eg. haircuts)

2. Foreign + domestic G not perfect subs.

Question 22

PPP theory results suggest that the higher inflation causes faster depreciation (t/f)

Answer 22

true

Question 23

Real Interest Parity is…

Answer 23

in open markets (w/ full access in and out) the inflation rate in Canada should mirror the inflation rate in the world
- r = r (world)