Topic 11- Open Economy MacroEconomics Flashcards
Closed Economy
one that does not interact with other economics
Open Economy
one that interacts freely with other economies
How does an open economy interact with other countries (2)
1) Trade (Buying and selling goods in world market)
2) Financial Markets (buying and selling capital assets such as stocks and bonds)
Exports and Imports
Exports: g/s produced domestically, sold abroad
Imports: g/s produced abroad, brough domestically
Net Exports
TARADE BALANCE (EXPORTS-IMPORTS)
Openness in Goods Market
The opportunity for consumers and
firms to choose between domestic and foreign goods
Tariffs and Quotas
Trade Restrictions
TARIFFS= TAXES
QUOTAS: QUANTITIY RESTRICSTS
Trade Surplus
Exports >Imports
Trade Deficit
Exports < Imports
Trade Balance
Exports=Imports
Oppennes in Finacial Markets
The opportunity for financial investors to choose between domestic and foreign financial assets
Restrictions on openness in financial markets
Capital Controls
Capital Controls
restrictions on the foreign assets domestic residents could hold as well as on the domestic assets foreigners could hold
How is a trade deficit difference financed
When you buy more than you sell to the rest of the world, yo must issue bonds or stocks to the rest of the world.
In a closed economy, what is total saving equal to?
S=I
In a open eocnomy, what is total saving equal to?
S=I+NX
Y=C+G+I+NX
Y-C-G=I+NX
S=I+NX
Investment+Net Exports
If there is a trade surplus ( NX>0), then what
S=I+NX
and NX>0
THEN
S>I
Which means that the supply of laonable funds in this economy is high, therefore, the economy will lend money to the rest of the world
If NX<0, or there is a trade deficit, then what
S=I+NX
and NX<0
THEN
S<I
Which means that the supply of loanable funds in the eocnomy is low, therefore the economy will borrow money from the rest of the world
How do countries borrow or lend from the rest of the world
by issuing bonds or stocks
Balance of payments
a country’s transactions with the rest of the world, summarized by a set of accounts
Balance of payments lay out
Current Account
Financial Account
The Current Account
the transactions above the line, that record payments to and from the world
The Financial Account
the transactions below the line, represeting a country’s borrowing or lending in International market
Balance of Payments
Above the line: trade of goods
Below the line: trade of financial securities
Net Capital Outflow
the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners- its called net foreign investment
purchase of foreign assets by dom resdidents- purchase of dom assets by foreigners
The flow of capital in net capital outflow are determined by
Foreign direct INvestmetn
and
Foreign portfolio investment
Foreign Direct Investment
Foreign Portfolio Investment
Net Exports vs Net Capital Outflow
Net Exports: imblanace of country’s exports and imports
Net Capital Outflow: imbalance between amount of foreign assets bought by dom res and amount of dom assets bought by foreigners
When NCO>0, what is it
“Capital Outflow”
more domestic residents buying foreign assets then foreign residents buying domestic assets
Lending>Borrowing
When NCO<0, what is it
“Capital Inflow”
more domestic assets exceed domestic purchases of foreign assets
Borrowing>Lending
What is the relationship between NCO and NX
They are NCO=NX
What happens to NCO when NX>0
Country is selliing more goods and servies to foreigners than buying
buying foreign assets w foreign currency it recieves from selling goods and services abroad
capital fllowing out of the country
NCO>0
What happens to NCO when NX<0
WHEN there is a trade deficit, country must borrow money from international market
MONEY IS FLOWING IN!!!!! SO! NCO<0 AS WELL
THERE IS NET CAPITAL INFLOW
What is NCO when exonomy closed
0
How is gdp fromula impacted by NCO=NX
Y=C+I+G+NX
Y=C+I+G+NCO
HOW is savings related to Net Capital Outfllow
If in a open econ S=I+NX
IF S>I, then more supply moey, money flowing outwards, SO NCO>0
IF S<I, less supply of money, money flowing inwards, so NCO<0
If S<I IN open economy, what happens to NCO
borrow, NCO<0, capital inflow
If S>I in open economy, what happens to NCO
lend, because more money, NCO>0
Real Exchange Rate
Not observable (relative prices of goods)
Nominal Exchange rate
relative price of currencies (USD TO CAD)
Nominal Exchange rate
the rate at which a person can trade the currency of one country for the currency of another
Appreciation OF DOMestic currency
increas in tthe value of the domestic currency as measured by the amount of foreign currency it can buy
10 CAD=1 Usd
Deprecaiiton of domestic currency
decrease in the value of domestic currency as measured by the amount of foreign currency it can buy
0.0001 CAD= USD
Real Exchange Rate, what is the price of domestic goods in domestic CURRENCY
What is the price of foreign goods in foreign dollars
NOMINAL exchange rate
price of domestic good in foreign dollar
so wha tis the real exchange rate
P
P*
e
e x P
reak exchange rate = (e x P)/P*
Can the nominal rate be in 2 ways?
Yeah!
0.5 CAD= 1 USD
1 USD= 0.5 CAD
When you compare nominal and real exchange rates, what does it mean when they are close together vs far apart
close together, means that the price of the goods are relatively equal in both countries
Far apart, means the price of the goods are relatively unequal in tboh countries
Purchasing Power Partiy
theory of exchange rates where a unit of any given currency should be able to buy the same quantitiy of goods in all countries
PPP based on?
LOP(law of one price)
basically this theory says that a currency should have the same purchasing power in all countrises
why is ppp model not always accurate
because exchange rates do not always move together
Balnce payment sheet wont be included
THE CAPITAL ACCOUNTS STUFF
Oppeness in financial markets
ability to choose between domestic and foreign financial assets
financial assets
stock and bond
where are ifnancial assets sold
financial markets
where are ifnancial assets sold
financial markets
what is the financial market eqivalent of trade restrictions
capital controls
WHY IS TRADE SURPLUS GOOD!
BECAUSE S=I+NX
TRADE SURPLUS MEANS THAT S>I, WHICH MEANS THERE IS MORE SAVINGS AND COUNTRY CAN LEND GLOBALLY
WHY IS TRADE DEFIICT BAD
BECAUSE S=I+NX
TRADE DEFICIT MEANS S<I, WHICH MEANS THERE IS LESS SAVINGS AND COUNTRY HAS TO BORROW GLOBALLY
what does purchasing power parity imply
the real exchange rate should be equal to 1
what does ppp say about exhange rate
that it should be a reflection of the different price levels in both countries
e= P*/P
exchange rate= foreign price/dome price
