PS 3: CH 6 & CH 7

if 5 Swiss francs, trade for $1, the U.S. price level equals $1 per good, and the Swiss price level equals 2 francs per good, then the real exchange rate ~e~, btw Swiss goods and U.S. goods is ______ Swiss good(s) per U.S. good.

(nominal exchange rate x price of domestic good) / price of foreign good ~e~ = r (nom exchange rate) x (P/P*) (ratio of prices) 5 francs / $1 US dollar x ($1 per good / 2 francs per good) = 5 x 1 / 2 = *2.5*

in our CH 6 small open economy (SOE) with perfect capital mobility, a reduction in the government's budget deficit ______ (decreases; increases) net exports and the real exchange rate ______ (depreciates; appreciates).

*INCREASES NX, depreciates exchange rate* gov't budget deficit is diff between T - G (aka, gov't's income - what they spend) if the final difference of these is smaller, either initial taxes T collected INCREASED, or, gov't spending G, DECREASED, aka some kind of fiscal policy that increases saving S (bc, S = Y - C - G, and both C & G are now smaller, so remainder of Y is bigger, and so is S) in our market for loanable funds, S is now greater than I, aka we have a trade surplus, and since NCO = NX, we will have outflows > inflows, so there is an *INCREASE* in NX, and in our market for foreign currency, higher NX to the right, means a lower exchange rate, and a *DEPRECIATED* currency

in our CH 6 small open economy (SOE), if domestic investment exceeds domestic saving, then the extra investment will be financed by:

*borrowing from abroad* remember, SOE has a fixed r* (doesn't move!) domestic investment I exceeds domestic saving S means that S - I = < 0, negative #, aka trade deficit (importing more than > exporting) so - NCO, aka outflows < inflows, and those inflows are financing the extra investment

if a U.S. corporation, sells a product in Canada, and uses the proceeds to purchase a product manufactured in Canada, then U.S. net exports ______ (increase; decrease; do not change) and net capital outflows ______. (increase; decrease; do not change)

*do not change; do not change* 1) selling US product in Canada: exports go up (balances out below), 2) purchasing Canadian product: imports go up (balanced out to neutral); since NX is neutral, we can assume NCO is too

an effective policy to reduce a trade deficit (S < I) in a small open economy would be to:

*increase taxes* the goal is to increase saving S, to have a difference that is positive btw S & I so, policies that would increase saving S, which as usual, is S = Y - C - G, would be to decrease consumption C, and/or gov't spending G (considering Y is pinned down), and increasing taxes T would actually do both of these at the same time, bc public saving is T - G, so larger final #, and private saving is Y - T - C, which would imply a smaller C^, so larger Y leftover, and larger final #

a statement that is generally true about capital in a large open economy (LOE) is that it is: - perfectly mobile, the country does NOT influence world financial markets - perfectly mobile, the country DOES influence world financial markets - not perfectly mobile, but the country does NOT influence world financial markets. - not perfectly mobile, but the country DOES influence world financial markets.

*not perfectly mobile, but the country DOES influence world financial markets* in a large open economy (LOE) capital is NOT perfectly mobile like it is in a small open economy (SOE), however, the country DOES influence world financial markets, bc like the US, it is large enough to influence others.

according to our discussion in class, 2 reasons why capital may not flow to poor countries are that the poorer countries may:

1) have inferior production capabilities (i.e. low value of A in production function) and 2) not enforce property rights (so investments in poor countries might be expropriated/taken away by the gov'ts there)

a trade deficit can be financed in all of the following ways except by: - borrowing from foreigners/abroad - selling domestic assets to foreigners - selling foreign assets owned by domestic residents to foreigners - borrowing from domestic lenders

NOT by borrowing from 'domestic' lenders during trade deficit, S - I = < 0, negative # how is bigger I being financed? note that all other financing options involve foreigners/someone abroad supporting the deficit

in our CH 6 small open economy (SOE), if exports equal $20 billion, imports equal $30 billion, and domestic national saving equals $25 billion, then net capital outflow equals:

NX = NCO NX = exports - imports NX = $20 bil exports - $30 bil imports NX = *-$10 bil* = NCO

in a large open economy (LOE), the real interest rate r is determined by:

in a large open economy (LOE), the real interest rate is determined in the market for loanable funds, (like in a small closed economy), and it is determined by national saving S as "supply", and then investment I (aka, the "investment function) and net capital outflows CF as parts of "demand" (aka the net capital outflow NCO function)

starting from a trade balance (S = I), if the world interest rate r* falls, then, holding other factors constant, in a small open economy (SOE) the amount of domestic investment will _____ and net exports will _____.

in our market for loanable funds, S is the supply line, decrease in r* causes a mvmt along the I curve to the right, so now S & I no longer equal / in trade balance, and I is greater than > S, causing a trade deficit. so the *increase* in investment I, leads to a *decrease* in NX (trade deficit)

in our CH 6 small open economy (SOE) if the world interest rate r* increases, then the supply of domestic currency on the foreign exchange market will _____ (decrease; increase) and the real exchange rate will _____ (depreciate; appreciate), holding all else constant.

in our market for loanable funds, S is the supply line, increase in r* causes a mvmt along the I curve to the left, so now S & I no longer equal / in trade balance, and I is smaller than < S, causing a trade surplus so there is an *INCREASE* in supply S, and then in our market for foreign currency, bc positive NX means NX goes more the right, then exchange rate will move down & *DEPRECIATE*

in a "steady state," what is the relationship btw s the rate of job separation, and f the rate of job finding:

in the steady state, s = f, bc the # of ppl finding jobs equals the # of ppl losing jobs

the lower the real exchange rate ~e~ is, the ______ (less; more) expensive domestic goods are, relative to foreign goods, and the ______ (lower; higher) the demand is for net exports NX.

lower exchange rate means, weaker dollar, means more appealing dollar, and *LESS expensive domestic goods* so more ppl buying these exported goods, thereby increasing NX and creating a *HIGHER demand for net exports*

in a large open economy (LOE), an increase in "animal spirits" for investment I raises the real interest rate, it ______ (decreases; increases) the trade balance, and ______ (decreases; increases) net capital outflow.

picture the LOE "trifecta": 1) an increase in phi, aka "animal spirits" for investment I, means increased investment, thereby shifting the I + CF curve to the right, and climbing up the static, vertical saving S line, to increase the real interest rate r. 2) this higher r, translates into the CF chart, as a higher vertical pt, aka a pt more to the left of the CF curve itself meaning a *DECREASE* in CF (S - I trade balance) 3) lastly, this leftward decrease of CF, is also a similarly leftward shift in the market for foreign exchange, so the NX curve will also move to the left, demonstrating a trade deficit and a *DECREASE* in the trade balance

if "s" is the rate of job separation, "f" is the rate of job finding, and both rates are constant, then the unemployment rate is approximately:

s / (s + f)

in a large open economy (LOE), if political instability abroad lowers the net capital outflow function (CF or NCO), then the real interest rate:

simply put, if NCO goes down, so will NX, so then consider the graph for the market of foreign currency, and a decrease of NX to the left, implied an increase in the exchange rate

according to our discussion in class, which of the following shifts the Beveridge Curve?

structural factors, like an increase in mismatching, or some other factor that causes a DECLINE in matching efficiency, thereby causing more to be unemployed U (to the right) despite more job vacancies V (up above)

assume that the job finding rate f has fallen bc of a decline in matching efficiency. what is also likely to have happened to the Beveridge Curve?

the Beveridge Curve shifted out

a Beveridge Curve plot, shows the empirical rltnshp, btw what two labor-market variables?

unemployment U and job vacancies V