Chapter 13- Econ test 3

Appreciation

(or "strengthening"): an increase in the value of a currency as measured by the amount of foreign currency it can buy

Depreciation

(or "weakening"): a decrease in the value of a currency as measured by the amount of foreign currency it can buy

In an open economy setting, understand that S = I + NCO, where S is....I is... and NCO is...

.., where S is National Savings, I is domestic Investment, and NCO is Net Capital Outflow.

Understand the factors that influence Net exports (income growth or decline in other countries, inflation in other countries).

1.Consumers preferences for foreign and domestic goods 2.Prices of goods at home and abroad 3.Incomes of consumers at home and aborad 4.The exchange rates at which foreign currency trades for domestic currency 5.Transportation costs 6.Government policies

Understand the meaning of Net Exports, Exports and Imports.

Exports- domestically produced goods and services sold abroad Imports- foreign-produced goods and services sold domestically Net Exports (NX)- AKA the trade balance= Value of exports- value of imports

Purchasing Power Parity (PPP)

a theory of exchange rates whereby a unit of any currency should be able to buy the same quantity of goods in all countries suggests that real exchange rate equals 1

Understand Net Capital Outflow. Understand that a negative NCO number means that a country is experiencing a net inflow of capital funds. Understand that capital flows around the world chasing high returns.

• Net Capital Outflow( NCO)- Domestic residents purchases of foreign assets MINUS foreigners purchases of domestic assets •The "0" stands for outflow •NCO measures the imbalance in a country's trade in assets •When NCO is GREATER than O= capital outflow This means domestic purchases of foreign assets exceed foreign purchases •When NCO is LESS than 0= Capital inflow This means foreign purchases of domestic assets exceed domestic purchases

Understand the impact that changes in nominal exchange rates have on a country's net exports. As the dollar appreciates..

•Dollar Appreciates, NetX Falls •EX: As the dollar appreciates against the Peso (Mexico) •Mexican good become cheaper in the US US imports of Mexican goods increase •American goods become more expensive in Mexico US exports to Mexico fall •Net Exports Fall

Understand the impact that changes in nominal exchange rates have on a country's net exports. As the dollar depreciates..

•Dollar Depreciates, NetX Increases •As the dollar depreciates against the pound (UK) British goods become more expensive in the US US imports of British goods decrease •American goods become cheaper in the UK US exports to the UK increase •Net Exports Increase

Understand the Law of One Price and the process of arbitrage.

•Law of one price- the notion that a good should sell for the same price in all markets •Suppose coffee sells for $4/pound in Seattle and $5/pound in Boston, and can be costlessly transported. •There is an opportunity for arbitrage, making a quick profit by buying coffee in Seattle and selling it in Boston. •Such arbitrage drives up the price in Seattle and drives down the price in Boston, until the two prices are equal

Understand real exchange rates and know the equation (E = e P/P*). Be able to perform this calculation.

•Real Exchange Rate- the rate at which the goods and services of one country trade for the goods and services of another •E= (e)(p)/P* •P= domestic price •P*= foreign price (IN FOEIGN CURRENCY) •e= nominal exchange rate •look at example of this on slide 11