Open Economy

Question 1

Define balance of payments?

Answer 1

Record of all transactions between the residents of that country and the rest of the world

Question 2

What is the BofP made up of?

Answer 2

Current account and capital and financial accounts

Question 3

What are inflows?

Answer 3

Any transaction that leads to a receipt of payment from foreigners is a CREDIT item (+ sign)

Question 4

What are outflows?

Answer 4

Any transaction that receives receipt of payment to foreigners is a DEBIT item (- sign)

Question 5

3 main parts of a CA?

Answer 5

1) net exports of goods and services (X-M)

2) net income flows - income receipts from abroad minus income payments to foreigners
(Eg. Wages paid to residents working abroad, interest payments on bonds)

3) net current transfers - payments between countries that do not correspond to the purchase of goods, services or assets (eg. foreign aid)

Question 6

2 parts of capital and financial account (KFA), explained and examples?

Answer 6

Capital account: records of capital transfers of non-produced, non financial assets
Eg. Parents, copyrights, franchises

Financial account: records transactions of financial assets
Eg. Shares, bonds, bank deposits

Question 7

What is FDI?

Answer 7

Investments with significant influence on the operations of a firm in a different country

Question 8

What are brownfield investments and examples?

Answer 8

Investments in bonds/stocks by UK/foreign companies in foreign/UK branches

Eg. Mergers, joint ventures

Question 9

What are greenfield investments and examples?

Answer 9

Investing by setting up subsidiaries or associate companies abroad

Eg. Building factories abroad

Question 10

What is FPI?

Answer 10

Foreign portfolio investment: investments in bonds and stocks where the investor has no appreciable say in the operation of the firm

Question 11

What is meant by ‘other investments’ in the financial account?

Answer 11

Short term monetary movements (eg. Deposits, loans)

Question 12

What are reserves wrt to the financial account?

Answer 12

Financial assets held as part of the UK’s reserves assets (eg. Currency, bonds)

Question 13

Why is CA+KFA=0?

Answer 13

Because every international transaction involves a ‘swap’ between countries

Question 14

Net exports = ?

Answer 14

Output - domestic spending(on foreign and domestic goods)

Question 15

If output > domestic spending?

Answer 15

Trade surplus

And vice versa

Question 16

See open economy diagrams l16 pages 2-5

Answer 16

Now

Question 17

What are X and M?

Answer 17

X = value of domestically produced goods that are sold abroad

M = value of foreign produced goods that are sold domestically

Question 18

Define capital outflow (CO)?

Answer 18

Value of foreign financial assets purchased by domestic residents

Question 19

Define capital inflow(CI)?

Answer 19

Value of domestic financial assets purchased by foreigners

Question 20

See diagrams pages 6+7 L16

Answer 20

Now

Question 21

2 reasons Britain supplies £s?

Answer 21

M and CO

Question 22

2 reasons foreign countries demand £s?

Answer 22

X and CI

Question 23

M+CO = ?

Answer 23

X+CI

Tf

CO-CI=X-M

Tf NCO = NX

Question 24

What can we deduce if a country runs a trade deficit?

Answer 24

It also runs an NCO deficit since NCO=NX

Question 25

See question in notes, summary in notes, and diagram page 9

Answer 25

Now

Question 26

Saving?

Answer 26

S=I+NCO

Question 27

What does it mean for S and I if NCO is: A) less than zero B) greater than zero

Answer 27

A) means saving is less than investment tf borrowing from abroad B) means saving is more than investment tf lending abroad

Question 28

Since NX=NCO?

Answer 28

S-I=NX

Question 29

Draw diagram for open economy loanable funds market?

Answer 29

Now

Question 30

In an open economy, how does a rise in the UK's real interest rate relative to abroad affect (Both) economies?

Answer 30

Makes UK investments more attractive: Tf: - domestic investors buy less foreign financial assets (FALL IN CO) - foreign investors buy more UK financial assets (RISE IN CI)

Question 31

What is the relationship between NCO and r?

Answer 31

Negative

Question 32

Draw diagram for NCO(r)

Answer 32

Now

Question 33

Define exchange rate?

Answer 33

The price at which residents of two countries trade with each other

Question 34

Define nominal exchange rate(e)?

Answer 34

The relative price of the currencies of the two currencies (rate at which you can trade one currency for another)

Question 35

What do appreciation and depreciation mean for the £ in buying foreign currency X?

Answer 35

Appreciation: £ buys more X Depreciation: £ buys less X

Question 36

Define real exchange rate?

Answer 36

The relative price of the goods of two countries (ie. Rate at which we can trade goods between goods countries)

Question 37

How to calculate ratio of foreign:domestic prices?

Answer 37

1/ε

Question 38

What determines whether you should buy a good domestically or abroad?

Answer 38

The REAL exchange rate

Question 39

What is the relationship between NX and ε?

Answer 39

Negative

Question 40

Draw NX(ε) diagram?

Answer 40

Now

Question 41

Draw diagram of NCO and NX against ε?

Answer 41

Now

Question 42

What is the link between loanable funds market and foreign currency exchange market and why?

Answer 42

S=I+NCO NCO=NX Tf NCO

Question 43

Show on a diagram and explain how expansionary fiscal policy affects the market for loanable funds, the net capital outflow and therefore the market for foreign exchange?

Answer 43

Now

Question 44

Show on a diagram and explain how contractionary fiscal policy affects the market for loanable funds, the net capital outflow and therefore the market for foreign exchange?

Answer 44

Now

Question 45

Explain what happens if via trade policy the government prohibits the import of a good using a diagram?

Answer 45

Now

Question 46

See pages 11-14 L17

Answer 46

Now

Question 47

When does NX(ε)=NCO(r)?

Answer 47

In equilibrium

Question 48

Open economy equation when in equilibrium?

Answer 48

Y=C+I(r)+G+NCO(r)

Question 49

How to derive LN curve in an open economy?

Answer 49

Same as in closed economy

Question 50

Mechanism and diagram for deriving IS curve in open economy?

Answer 50

Increase r -> decrease (I(r)+NCO(r)) -> decrease Y

Question 51

Show how the IS-LM diagram in an open economy can show the equilibrium NCO, NX, r, ε?

Answer 51

Now

Question 52

Explain the effect of expansionary FP in an open economy on the IS-LM model, and tf the NCO, r, NX and ε? Do the same for expansionary MP and trade policy(eg. Government restricts imports on foreign cars)?

Answer 52

See notes for answers

Question 53

Important thing to remember when doing mechanisms between NCO, NX, r and ε?

Answer 53

That change in NCO doesn't cause change in NX directly, and vice versa; a change in NCO changes the ε and this in turn changes NX. A change in NX changes ε and this in turn changes NCO