CH 18- Open Economy Macroeconomics: Basic Concepts

The flow of capital between the U.S. economy and the rest of the world takes two forms

1. foreign direct investment 2. foreign portfolio investment

appreciation

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

parity

equality

Which of the following would directly increase U.S. net capital outflow? a. Microsoft builds a new distribution facility in Sweden. b. Toyota buys stock in AT&T. c. Honda builds a new plant in Ohio. d. General Electric sells an aircraft engine to Airbus in Great Britain.

a. Microsoft builds a new distribution facility in Sweden.

closed economy

an economy that does not interact with other economies in the world

imports

are goods and services that are produced abroad and sold domestically

If Japan exports more than it imports, a. Japan's net exports are negative. b. Japan's net capital outflow must be positive. c. Japan's net capital outflow must be negative. d. Japan is running a trade deficit.

b. Japan's net capital outflow must be positive.

foreign portfolio investment

building or purchasing businesses and their associated infrastructure in a foreign country

a. lower, higher b. lower, lower c. higher, higher d. higher, lower

c. higher, higher

arbitrage

The process of taking advantage of price differences for the same item in different markets

balanced trade

a situation in which exports equal imports aka country's net exports are zero, its exports and imports are exactly equal

net exports

are the difference between the value of its exports and the value of its imports

Which of the following is an example of foreign direct investment? a. General Motors buys stock in Volvo. b. McDonald's builds a restaurant in Moscow. c. General Motors buys steel from Japan. d. Columbia Pictures sells the rights to a movie to a Russian movie studio.

b. McDonald's builds a restaurant in Moscow.

trade deficit (NX < 0)

buying more goods and services from foreigners than it is selling to them. How is it financing the net purchase of these goods and services in world markets? It must be selling assets abroad. Capital is flowing into the country (NCO<0)

2 uses for saving in an open economy

domestic investment and net capital outflow.

exports

goods and services that are produced domestically and sold abroad

national saving

the income of the nation that is left after paying for current consumption and government purchases

real exchange rate

the rate at which a person can trade the goods and services of one country for the goods and services of another

factors affecting a country's exports, imports and net exports

- Consumer tastes for domestic and foreign goods - The prices of goods at home and abroad - The exchange rates at which people can use domestic currency to buy foreign currencies - The incomes of consumers at home and abroad - The cost of transporting goods from country to country - Government policies toward international trade

variables that influence net capital outflow

- The real interest rates paid on foreign assets - The real interest rates paid on domestic assets - The perceived economic and political risks of holding assets abroad - The government policies that affect foreign ownership of domestic assets

2 ways an open economy interacts with other economies

1. it buys and sells goods and services in world product markets 2. it buys and sells capital assets such as stocks and bonds in world financial markets

et the theory of purchasing-power parity is not completely accurate. That is, exchange rates do not always move to ensure that a dollar has the same real value in all countries all the time. There are two reasons the theory of purchasing-power parity does not always hold in practice.

1. many goods are not easily traded. 2. purchasing-power parity does not always hold is that even tradable goods are not always perfect substitutes when they are produced in different countries

net capital outflow formula

= purchase of foreign assets by domestic residents minus purchase of domestic assets by foreigners

in a closed ecoonomy, net capital outflow is zero

NCO = 0 so saving equals investment (S = I)

net capital outflow (NCO) must always equal net exports (NX)

NCO = NX

depreciation

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

law of one price

a good must sell for the same price in all locations. Otherwise, there would be opportunities for profit left unexploited

purchasing-power parity

a theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries

purchasing-power parity.

a unit of currency must have the same real value in every country

If the nominal exchange rate between British pounds and dollars is 0.5 pound per dollar, how many dollars can you get for a British pound? a. 2 dollars b. 1.5 dollars c. 1 dollar d. 0.5 of a dollar e. None of the above is correct.

a. 2

If the value of a nation's imports exceeds the value of its exports, which of the following is NOT true? a. The nation is experiencing a net outflow of capital. b. Net exports are negative. c. GDP is less than the sum of consumption, investment, and government purchases. d. Domestic investment is greater than national saving.

a. The nation is experiencing a net outflow of capital.

The most accurate measure of the international value of the dollar is a. an exchange rate index that accounts for many exchange rates. b. the British pound/dollar exchange rate. c. the peso/dollar exchange rate. d. the Brazilian real/dollar exchange rate. e. the yen/dollar exchange rate.

a. an exchange rate index that accounts for many exchange rates.

In an open economy, national saving equals domestic investment a. plus the net outflow of capital. b. plus the government's budget deficit. c. minus foreign portfolio investment. d. minus the net exports of goods and services.

a. plus the net outflow of capital.

open economy

an economy that interacts freely with other economies around the world

identity

an equation that must hold because of how the variables in the equation are defined and measured

trade surplus

an excess of exports over imports aka: country's net exports are positive, its exports are greater than its imports, indicating that the country sells more goods and services abroad than it buys from other countries

trade deficit

an excess of imports over exports aka: country's net exports are negative, its exports are less than its imports, indicating that the country sells fewer goods and services abroad than it buys from other countries

net exports measure

an imbalance between a country's exports and its imports

Net capital outflow measures

an imbalance between the amount of foreign assets bought by domestic residents and the amount of domestic assets bought by foreigners

Suppose the nominal exchange rate between the Japanese yen and the U.S. dollar is 100 yen per dollar. Further, suppose that a pound of hamburger costs $2 in the United States and 250 yen in Japan. What is the real exchange rate between Japan and the United States? a. 0.5 pound of Japanese hamburger/pound of American hamburger b. 0.8 pound of Japanese hamburger/pound of American hamburger c. 1.25 pounds of Japanese hamburger/pound of American hamburger d. 2.5 pounds of Japanese hamburger/pound of American hamburger e. none of the above

b. 0.8 pound of Japanese hamburger/pound of American hamburger

The dollar-yen exchange rate falls from 100 to 80 yen per dollar. At the same time, the price level in the United States rises from 180 to 200, and the price level in Japan remains the same. As a result, a. American goods have become more expensive relative to Japanese goods. b. American goods have become less expensive relative to Japanese goods. c. the relative price of American and Japanese goods has not changed. d. both American and Japanese goods have become relatively less expensive.

b. American goods have become less expensive relative to Japanese goods.

Which of the following statements is true about a country with a trade deficit? a. Net capital outflow must be positive. b. Net exports are negative. c. Net exports are positive. d. Exports exceed imports. e. None of the above is true.

b. Net exports are negative.

An economy that interacts with other economies is known as a. a balanced trade economy. b. an open economy. c. an import economy. d. an export economy. e. a closed economy.

b. an open economy.

If a nation's currency doubles in value on foreign exchange markets, the currency is said to ________, reflecting a change in the ________ exchange rate. a. depreciate; nominal b. appreciate; nominal c. appreciate; real d. depreciate; real

b. appreciate; nominal

The theory of purchasing-power parity says that higher inflation in a nation causes the nation's currency to ________, leaving the ________ exchange rate unchanged. a. depreciate, nominal b. depreciate, real c. appreciate, nominal d. appreciate, real

b. depreciate, real

If the exchange rate changes from 3 Brazilian reals per dollar to 4 reals per dollar, a. the dollar has depreciated. b. the dollar has appreciated. c. the dollar could have appreciated or depreciated depending on what happened to relative prices in Brazil and the United States. d. none of the above is true.

b. the dollar has appreciated.

Each of the following is a reason why the U.S. economy continues to engage in greater amounts of international trade except which one? a. There are larger cargo ships and airplanes. b. High-technology goods are more valuable per pound and, thus, more likely to be traded. c. NAFTA imposes requirements for increased trade between countries in North America. d. There have been improvements in technology that have improved telecommunications between countries. e. All of the above are reasons for increased trade by the United States.

c. NAFTA imposes requirements for increased trade between countries in North America.

If the U.S. dollar appreciates and prices remain the same at home and abroad, foreign goods become ________ expensive relative to American goods, pushing the U.S. trade balance toward ________. a. more; surplus b. more; deficit c. less; deficit d. less; surplus

c. less; deficit

If a cup of coffee costs 2 euros in Paris and $6 in New York and purchasing-power parity holds, what is the exchange rate? a. 4 euros per dollar b. 1/4 euro per dollar c. 3 euros per dollar d. 1/3 euro per dollar

d. 1/3 euro per dollar

Suppose the real exchange rate between Russia and the United States is defined in terms of bottles of Russian vodka per bottle of U.S. vodka. Which of the following will increase the real exchange rate (that is, increase the number of bottles of Russian vodka per bottle of U.S. vodka)? a. a decrease in the ruble price of Russian vodka b. an increase in the dollar price of U.S. vodka c. an increase in the number of rubles for which the dollar can be exchanged d. All of the above will increase the real exchange rate. e. None of the above will increase the real exchange rate.

d. All of the above will increase the real exchange rate.

Which of the following people or firms would be pleased by a depreciation of the dollar? a. a French exporter of wine to the United States b. a U.S. tourist traveling in Europe c. a Saudi Arabian prince exporting oil to the United States d. an Italian importer of U.S. steel e. a U.S. importer of Russian vodka

d. an Italian importer of U.S. steel

when ner capital outflow is negative

domestic residents are buying fewer foreign assets than foreigners are buying domestic assets, and capital is said to be flowing into the country - a country is experiencing a capital inflow.

when net capital outflow is positive

domestic residents are buying more foreign assets than foreigners are buying domestic assets, and capital is said to be flowing out of the country

If the United States saves $1,000 billion and U.S. net capital outflow is -$200 billion, U.S. domestic investment is a. $1,000 billion. b. $200 billion. c. $800 billion. d. -$200 billion. e. $1,200 billion.

e. $1,200 billion.

trade surplus (NX>0)

selling more goods and services to foreigners than it is buying from them. What is it doing with the foreign currency it receives from the net sale of goods and services abroad? It must be using it to buy foreign assets. Capital is flowing out of the country(NCO>0)

net capital outflow/ net foreign investment

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

foreign direct investment

the purchase of securities of foreign countries, such as stocks and bonds, on an exchange

nominal exchange rate

the rate at which a person can trade the currency of one country for the currency of another

trade balance

the value of a nation's exports minus the value of its imports; also called net exports

purchasing power

the value of money in terms of the quantity of goods it can buy

net exports formula

value of country's exports minus value of country's imports