Ch18 Open-Economy Macroeconomics: Basic Concepts
18-1b The Flow of Financial Resources: Net Capital Outflow
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18-1c The Equality of Net Exports and Net Capital Outflow
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18-1d Saving, Investment, and Their Relationship to the International Flows
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18-1e Summing Up
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18-2a Nominal Exchange Rates
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Important variables that influence net capital outflow:
1. The real interest rates paid on foreign assets 2. The real interest rates paid on domestic assets 3. The perceived economic and political risks of holding assets abroad 4. The government policies that affect foreign ownership of domestic assets
An open economy interacts with other economies in two ways:
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.
Net Exports measure an imbalance between
A country's exports and its imports.
Balanced Trade
A situation in which exports equal imports
Net Exports and Net Capital Outflow each measure
A type of imbalance in these markets
Closed Economy
An economy that does not interact with other economies in the world
Open Economy
An economy that interacts freely with other economies around the world
Trade Deficit
An excess of exports over imports
Trade Surplus
An excess of exports over imports
Appreciation
An increase in the value of a currency as measured by the amount of foreign currency it can buy, a dollar buys more foreign currency
Total expenditure on the economy's output of goods and services is the sum of expenditure on
Consumption, Investment, Government purchases, and Net Exports. Y = C + I + G + NX.
The Real exchange rate
Depends on the nominal exchange rate and on the prices of goods in the two countries measured in the local currencies.
Foreign Direct Investment
Example: If McDonald's opens up a fast-food outlet in Russia. The American owner (McDonald's Corporation) actively manages the investment.
Foreign Portfolio Investment
Example: If an American buys stock in a Russian corporation. The American owner - stockholder - has a more passive role.
The sale of software is an export of the United States, so it increases U.S. net exports.
Example: Imagine that you are a computer programmer residing in the United States. One day, you write some software and sell it to a Japanese consumer for 10,000 yen.
Imports
Goods and Services that are produced abroad and sold domestically
Factors that might influence a country's exports, imports, and net exports 6 of 6
Government policies toward international trade
18-1 The International Flows of Goods and Capital
Here they discuss these two activities and the close relationship between them.
Trade Deficit
If net exports are negative, exports are less than imports, indicating that the country sells fewer goods and services abroad than it buys from other countries, the country is said to run a Trade Deficit
Trade Surplus
If net exports are positive, exports are greater than imports, indicating that the country sells more goods and services abroad than it buys from other countries, the country is said to run a Trade Surplus.
Balanced Trade
If net exports are zero, its exports and imports are exactly equal, and the country is said to have Balanced Trade.
Exports, Imports, the Trade Balance, and Exchange Rates
In this chapter, they develop a model to explain how these variables are determined and how they are affected by various government policies.
National Saving
Is the income of the nation that is left after paying for current consumption and government purchases. National saving - S - equals Y − C − G
Net Capital Outflow - sometimes called
Net Foreign Investment
Net Exports of any country are the difference between the value of its exports and the value of its imports:
Net exports = Value of country's exports − Value of country's imports.
Example Real exchange rate
Real exchange rate = (80yen/dollar) x ($100/bushel of US rice) / 16k yen / bushels of Japanese rice
Real Exchange Rate formula
Real exchange rate = Nominal exchange rate × Domestic price / Foreign price
Since NX = NCO Because net exports - NX - also equal net capital outflow - NCO, we can write this equation as
S = I + NX => S = I + NCO
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.
Factors that might influence a country's exports, imports, and net exports 5 of 6
The cost of transporting goods from country to country
Factors that might influence a country's exports, imports, and net exports 3 of 6
The exchange rates at which people can use domestic currency to buy foreign currencies
Factors that might influence a country's exports, imports, and net exports 4 of 6
The incomes of consumers at home and abroad
Factors that might influence a country's exports, imports, and net exports 2 of 6
The prices of goods at home and abroad
When a Japanese resident buys a bond issued by the U.S. government,
The purchase increases the second term on the right side of this equation and, therefore, decreases U.S. net capital outflow.
Nominal Exchange Rate
The rate at which a person can trade the currency of one country for the currency of another
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
Why does the real exchange rate matter?
The real exchange rate is a key determinant of how much a country exports and imports.
Factors that might influence a country's exports, imports, and net exports 1 of 6
The tastes of consumers for domestic and foreign goods
Trade Balance
The value of a nation's exports minus the value of its imports; also called net exports
Net Exports
The value of a nation's exports minus the value of its imports; also called the trade balance
Openness to international trade yields clear benefits:
Trade allows people to produce what they produce best and to consume the great variety of goods and services produced around the world.
Both cases increase U.S. net capital outflow.
U.S. residents are buying assets located in another country, so both purchases increase U.S. net capital outflow.
Boeing sale raises U.S. net exports
Volvo sale reduces U.S. net exports
Chapter Introduction
We begin in this chapter by discussing the key macroeconomic variables that describe an open economy's interactions in world markets. They are: Exports, Imports, the Trade Balance, and Exchange Rates
Macroeconomists often assume a closed economy
When we discussed the natural rate of unemployment and the causes of inflation, the effects of international trade could safely be ignored.
Gross Domestic Product
Y = C + I + G + NX.
S = I + NX
Y − C − G = I + NX
What happens to the 10,000 yen you are paid.
You're using some of your income to invest in the Japanese economy. That is, a domestic resident (you) have acquired a foreign asset - the Japanese yen. The increase in U.S. Net Exports is matched by an increase in the U.S. Net Capital Outflow.
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
A nation's saving and investment
are crucial to its long-run economic growth.
Exports
are domestically produced goods and services that are sold abroad,
an open economy has two uses for its saving:
domestic investment and net capital outflow.
software export and the Wii import represent balanced trade.
example. Suppose that instead of using the 10,000 yen to buy a Japanese asset, you use it to buy a good made in Japan, such as a Nintendo Wii. As a result of the Wii purchase, U.S. imports increase.
When a U.S. resident buys stock in Telmex, the Mexican telecommunications company,
he purchase increases the first term on the right side of this equation and, therefore, increases U.S. net capital outflow.
Net Capital Outflow 1 of 3 NCO
the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners
Example: When Boeing, the U.S. aircraft manufacturer, builds a plane and sells it to Air France
the sale is an export for the United States and an import for France.
When Volvo, the Swedish car manufacturer, makes a car and sells it to a U.S. resident
the sale is an import for the United States and an export for Sweden.
18-2 The Prices for International Transactions: Real and Nominal Exchange Rates
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18-2b Real Exchange Rates
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18-3 A First Theory of Exchange-Rate Determination: Purchasing-Power Parity
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18-3a The Basic Logic of Purchasing-Power Parity
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18-3b Implications of Purchasing-Power Parity
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Define nominal exchange rate and real exchange rate , and explain how they are related. Bullet If the nominal exchange rate goes from 100 to 120 yen per dollar, has the dollar appreciated or depreciated?
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The flow of capital between the U.S. economy and the rest of the world takes two forms.
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International trade can raise living standards in all countries
By allowing each country to specialize in producing those goods and services in which it has a comparative advantage.
one of the Ten Principles of Economics
Is that trade can make everyone better off
Net Capital Outflow -NCO - must always equal Net Exports -NX
NCO = NX
Net Capital Outflow 3 of 3
Net Capital Outflow = Purchase of foreign assets by domestic residents − Purchase of domestic assets by foreigners
price index for a U.S. basket ( P ), a price index for a foreign basket ( P *), and the nominal exchange rate between the U.S. dollar and foreign currencies ( e ),
Real exchange rate = (e × P)/P*.
Net Capital Outflow 2 of 3
Refers to the difference between the purchase of foreign assets by domestic residents and the purchase of domestic assets by foreigners.
Real exchange rate = (e × P)/P*.
This real exchange rate measures the price of a basket of goods and services available domestically relative to a basket of goods and services available abroad.
