Openness in goods market Flashcards
What does openness result in for domestic consumers?
How much to buy and save
Whether to buy domestic or foreign goods
What is the current account
Trade balance: exports - imports
Capital account: Purchases of domestic assets by foreigners - income paid to the rest of the world
What is the capital account
Capital Account balance: Purchases of domestic assets by foreign countries - purchases of foreign assets by the country
Statistical discrepancy
What is a Current Account
A country that is in a current account deficit is generally buying from the rest of the world more than what it is selling
How would a country finance this overspending
They would have to borrow from the rest of the world by selling more assets to foreigners than the domestic market is buying from the rest of the world
what is the equation for the balance of payments
Stotal - I = X - IM
What does this mean in word form?
Stotal - I = X - IM
Total savings - Investments = Exports - Imports
Country in Current account surplus ?
Saving more than it invests, providing resources to other countries
A country in a Currents account deficit?
Investing more than it saves, using resources from other economies
What is meant by the Nominal exchange rate
The price of domestic currency in terms of domestic currency
so if 4TL is = to 1 GBP then the nominal exchange rate between Turkish Lira and GBP is E=4
What are the 2 exchange rate regimes
Flexible exchange rate - Central bank lets the exchange rate adjust freely on the foreign exchange market
Fixed exchange rate - Central bank sets a target and uses monetary policy to achieve it
Flexible exchange rate vocab
Appreciation of the domestic currency, increase in the nominal exchange rate
Depreciation of the domestic currency, decrease in the nominal exchange rate
Fixed exchange rate vocab
Revaluation of the currency, increase in the nominal exchange rate
Devaluation of the currency, a decrease of the nominal exchange rate
What is the equation for openness in the goods market?
Y = C(Y-T) + G +NX (Y, Y*, E)
What are the Marshall-Lerner conditions?
- Exports increase enough and imports decrease enough to compensate for the increase in the price of imports that a real depreciation leads to an increase in net exports
- Ensures a real depreciation will ultimately improve the trade balance
What are the direct effects of depreciation?
- Exports increase (quantity effect)
- Imports decreased (quantity effect)
- The relative price of foreign goods in terms of domestic goods, 1/epsilon pushing the import bill up (price effect)
What are the indirect effects of depreciation?
- Net exports increase (Marshall-Lerner), the NX line shifts upwards
- Increase in demand increases output causing ZZ to shift upwards
- Same analysis as an increase in foreign demand
- Improvement of trade balance even if imports increase
What is the J-curve in depreciation?
- We assumed that exports and imports immediately adjusted to changes in the real exchange rate
- This is not the case
- Because it will take customers some time to adjust to their consumption habits
- It also takes time for exports to increase and imports to decrease we first observe the price effect
Explain the J-curve
- Because quantities are not changing immediately after a depreciation, imports just become more expensive
- This causes net exports to become even more negative
- However, over time consumers will switch from foreign goods to domestic ones
- Hence the name J-curve as this effect makes a J shape
What is the demand for goods?
The demand for domestic goods is
Z = C + I + G + X - IM
C = Consumption which is a function of the disposable income (Y-T)
I = function of the level of output Y and the interest rate
G = Government Spending
X = Exports
IM = Imports
What are the determinants of imports?
IM = IM(Y, RER)
Domestic Income Y: The higher the domestic income, the higher the demand for goods, domestic and foreign
Real Exchange Rate: The higher the price of domestic goods in terms of foreign goods, the higher the demand for goods both domestic and foreign
What are the determinants of exports?
X = X(Y*, RER)
Foreign income Y*: The higher the foreign income, the higher the demand for goods, domestic and foreign
Real Exchange Rate: The higher the price of domestic goods in terms of foreign goods, the lower the level of exports as it would be cheaper for foreigners to purchase their own domestic goods
What is the equation for equilibrium in the goods market ?
Z = C(Y-T) + I(Y,i) + G = X(Y*,RER) - IM(Y, RER)
What is the IS relation in a good market open economy
Y = C(Y-T) + I(Y,i) + G = X(Y*,RER) - IM(Y, RER)
What happens when gov spending increases?
- Would cause an increase in aggregate demand, which will increase income, part will be used to finance investment, part will be used to increase domestic consumption
- If exports remain the same and imports increase then the country will experience a trade deficit
Is the multiplier effect smaller or larger in an open economy than in a closed economy?
- An increase in gov spending increases demand and output
- The increase in output means an increase in income and consumption increases
- However, the increase in consumption falls not only on domestic goods but on foreign goods aswell
- Thus, the multiplier effect on consumption is smaller in an open economy than it would be in a closed economy
