The Open Economy

Question 1

If you produce less than what you buy

Answer 1

then your income Y is less than C + I + G so you have to borrow

Question 2

If saving is
less than investment, they will be?

Answer 2

borrowing from abroad

Question 3

In an open economy savings spending not equal to income and savings may not
equal

Answer 3

investment

Question 4

Exports

Answer 4

are foreign spending on domestic goods

Question 5

Imports are equal to

Answer 5

C – I – G

Question 6

Net Exports =

Answer 6

= Y – C + I + G
this actually gives the global imbalance

Question 7

NFI

Answer 7

Net foreign investment - which accounts for overseas
investors investing money into an economy and earning interest

Question 8

If you take C and G out of the bracket in NX = Y – C + G + I, you get ___?
Ø There is perfect capital mobility which means?
Ø Economy is small – so cannot affect the world _____ – denoted as r*
Ø And since domestic bonds and foreign bonds are perfect ____ and
there is ______ so r = r*

Answer 8

NX = S – I,

no restrictions on trade on assets,

interest rate

substitutes, perfect capital mobility

Question 9

Due to it being a small economy – if a fiscal policy at home is implemented
savings will move but interest rate will stay the same – this will just lower
the NX

Answer 9

Question 10

If, however, the world adopts an expansionary fiscal policy this will lower
savings all over the world – which will lead to higher world interest rate
increasing the NX and investment will increase

Answer 10

Question 11

so monetary policy does not affect

Answer 11

NX

Question 12

Fiscal policy does affect the NX because it will

Answer 12

reduce or increase savings

Question 13

Exchange does not affect NX

Answer 13

in the long run

Question 14

e =

Answer 14

nominal exchange rate

Question 15

nominal exchange rate

Answer 15

– the relative price of domestic currency in terms of
foreign currency

Question 16

E

Answer 16

real exchange rate

Question 17

E formula

Answer 17

=e x P/P* where P is domestic price and P* is foreign price

Question 18

If real exchange increases that means the domestic goods are more ____ relative to ___ goods and so people buy ______. So ____fall, and ____ increase – NX ____.

Answer 18

expensive, foreign, less of it. Exports, Imports, falls

Question 19

As we know from the demand equation it shows that ______. exchange rate may
change the ___ but until left hand-side changes the right side ______. so in
the long-run __ comes back to ____

Answer 19

S – I = NX

NX

will not change

NX, S-I

Question 20

Savings - Investment(S-I) What are they determined by

Answer 20

Savings is determined by domestic factors such as output, fiscal policy and policy
variables
Ø Investment is determined by the world interest rate

Question 21

Expansionary fiscal policy will lead to a fall in savings – leading to an
increase in the real exchange rate and lower NX

Answer 21

Question 22

If the rest of the world is running an expansionary fiscal policy – this will
cause the real interest rate to increase
Ø This will increase the net capital outflow and the supply of the dollar in
the foreign exchange market so NX increases

Answer 22

Question 23

Increase in investment demand – will reduce____ – so
the currency becomes scarcer and so prices for it ___– real
exchange rate increases

Answer 23

the net capital outflow, increases

Question 24

Trade policy – if import is restricted – this will increase NX – so the
demand for the dollar shifts to the right
Ø There will be no change in net exports as in the long run it will shift back
to the original point
Ø This policy does not affect S and I so supply will remain the same

Answer 24

Question 25

Monetary policy can only change the nominal exchange rate

Answer 25

through changing the
inflation rate

Question 26

PPP

Answer 26

A doctrine that states that goods must sell at the same (currency-adjusted)
price in all countries