Week eight learning

Question 1

What is a closed economy?

Answer 1

An economy that does not interact with other economies; no exports, imports, or capital flows.

Question 2

What is an open economy?

Answer 2

An economy that interacts freely with other economies through buying and selling goods and services and financial assets.

Question 3

What are exports?

Answer 3

Goods and services produced domestically and sold abroad.

Question 4

What are imports?

Answer 4

Goods and services produced abroad and sold domestically.

Question 5

What is the trade balance (net exports)?

Answer 5

The value of a nation’s exports minus the value of its imports.

Question 6

What is a trade deficit?

Answer 6

A situation where net exports (trade balance) are negative, meaning imports exceed exports.

Question 7

What is a trade surplus?

Answer 7

A situation where net exports (trade balance) are positive, meaning exports exceed imports.

Question 8

What factors affect net exports?

Answer 8

Tastes of consumers, prices of goods at home and abroad, exchange rates, incomes of consumers at home and abroad, costs of transporting goods, and government trade policies.

Question 9

What is net foreign investment (NFI)?

Answer 9

The purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners.

Question 10

What are the two forms of foreign investment?

Answer 10

Foreign direct investment (ownership and operation by a foreign entity) and foreign portfolio investment (financed with foreign money but operated by domestic residents).

Question 11

What variables influence net foreign investment (NFI)?

Answer 11

Real interest rates on foreign and domestic assets, perceived economic and political risks, and government policies affecting foreign ownership of domestic assets.

Question 12

How does net foreign investment relate to net exports?

Answer 12

Net foreign investment (NFI) must equal the current account balance (CAB), which is the net value of goods and services sold (net exports).

Question 13

What is the saving-investment identity?

Answer 13

S = I + NFI, where saving can be used to finance domestic investment or to purchase foreign assets.

Question 14

What is the nominal exchange rate?

Answer 14

The rate at which one currency can be traded for another, expressed as units of foreign currency per unit of domestic currency or vice versa.

Question 15

What is appreciation of a currency?

Answer 15

An increase in the value of a currency as measured by the amount of foreign currency it can buy.

Question 16

What is depreciation of a currency?

Answer 16

A decrease in the value of a currency as measured by the amount of foreign currency it can buy.

Question 17

What is the real exchange rate?

Answer 17

The rate at which goods and services of one country can be traded for goods and services of another country, comparing domestic prices with foreign prices

Question 18

How does a depreciation of the real exchange rate affect exports and imports?

Answer 18

It makes domestic goods cheaper relative to foreign goods, encouraging more exports and reducing imports, which increases net exports.

Question 19

What is purchasing-power parity (PPP)?

Answer 19

The theory that a unit of currency should be able to buy the same quantity of goods in all countries.

Question 20

What is the law of one price?

Answer 20

A principle stating that a good must sell for the same price in all locations when expressed in a common currency, assuming no transportation costs and perfect substitutes.

Question 21

How does purchasing-power parity (PPP) relate to exchange rates?

Answer 21

PPP implies that the nominal exchange rate between two currencies should reflect the price levels of a basket of goods in those countries.

Question 22

What are some limitations of purchasing-power parity?

Answer 22

Transport costs, non-tradable goods and services, and differences in product substitutes can affect PPP

Question 23

What does a persistent change in nominal exchange rates usually reflect?

Answer 23

Changes in price levels at home and abroad.

Question 24

What is the summary of the relationship between net exports, net foreign investment, and saving?

Answer 24

Net exports equal net foreign investment; saving can finance either domestic investment or foreign asset purchases. The nominal exchange rate reflects currency values, while the real exchange rate reflects relative prices of goods.