Openness in goods market

Question 1

What does openness result in for domestic consumers?

Answer 1

How much to buy and save
Whether to buy domestic or foreign goods

Question 2

What is the current account

Answer 2

Trade balance: exports - imports

Capital account: Purchases of domestic assets by foreigners - income paid to the rest of the world

Question 3

What is the capital account

Answer 3

Capital Account balance: Purchases of domestic assets by foreign countries - purchases of foreign assets by the country

Statistical discrepancy

Question 4

What is a Current Account

Answer 4

A country that is in a current account deficit is generally buying from the rest of the world more than what it is selling

Question 5

How would a country finance this overspending

Answer 5

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

Question 6

what is the equation for the balance of payments

Answer 6

Stotal - I = X - IM

Question 7

What does this mean in word form?

Stotal - I = X - IM

Answer 7

Total savings - Investments = Exports - Imports

Question 8

Country in Current account surplus ?

Answer 8

Saving more than it invests, providing resources to other countries

Question 9

A country in a Currents account deficit?

Answer 9

Investing more than it saves, using resources from other economies

Question 10

What is meant by the Nominal exchange rate

Answer 10

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

Question 11

What are the 2 exchange rate regimes

Answer 11

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

Question 12

Flexible exchange rate vocab

Answer 12

Appreciation of the domestic currency, increase in the nominal exchange rate

Depreciation of the domestic currency, decrease in the nominal exchange rate

Question 13

Fixed exchange rate vocab

Answer 13

Revaluation of the currency, increase in the nominal exchange rate

Devaluation of the currency, a decrease of the nominal exchange rate

Question 14

What is the equation for openness in the goods market?

Answer 14

Y = C(Y-T) + G +NX (Y, Y*, E)

Question 15

What are the Marshall-Lerner conditions?

Answer 15

• 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

Question 16

What are the direct effects of depreciation?

Answer 16

• 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)

Question 17

What are the indirect effects of depreciation?

Answer 17

• 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

Question 18

What is the J-curve in depreciation?

Answer 18

• 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

Question 19

Explain the J-curve

Answer 19

• 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

Question 20

What is the demand for goods?

Answer 20

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

Question 21

What are the determinants of imports?
IM = IM(Y, RER)

Answer 21

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

Question 22

What are the determinants of exports?
X = X(Y*, RER)

Answer 22

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

Question 23

What is the equation for equilibrium in the goods market ?

Answer 23

Z = C(Y-T) + I(Y,i) + G = X(Y*,RER) - IM(Y, RER)

Question 24

What is the IS relation in a good market open economy

Answer 24

Y = C(Y-T) + I(Y,i) + G = X(Y*,RER) - IM(Y, RER)

Question 25

What happens when gov spending increases?

Answer 25

• 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

Question 26

Is the multiplier effect smaller or larger in an open economy than in a closed economy?

Answer 26

• 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