Econ 203 Chapter 13

NCO link between two markets and variables

- National saving (S) - Domestic investment (I) - Net capital outflow (NCO) - Net exports (NX) NCO is the variable that links the two markets - S=I+NCO (S and NCO have inverse relationship)

increase in world interest rates

-NCO will change -Real exchange rate will change

Capital flight

-a large and sudden reduction in the demand for assets located in a country, -ex) capital flight from Mexico increases Mexican interest rates and decreases the value of the Mexican peso in the market for foreign-currency exchange -price change from capital flight influence macroeconomic quantities, exports become cheaper, imports become more expensive, net exports increase, interest rate increases, capital accumulation slows, economic growth slows

How policies and events affect a small open economy

-determine which of supply and demand curves the event affects -determine which way the curves shifts -use supply and demand diagrams to examine how shifts alter equilibrium

market for foreign-currency exchange

-exists from people's want to trade goods, services, assets with people in other countries but want to be paid in own currency -Remember: NCO=NX, S=I+NCO, S-I=NCO (the two sides of the identity represent two sides of market for foreign-currency exchange) -difference between national saving and investment represent NCO (and therefore quantity of dollars supplied in market for foreign-currency exchange to buy foreign assets) -real exchange rate balances supply and demand in market for foreign-currency exchange -at equilibrium real exchange rate, the demand for dollars to buy net exports exactly balances supply of dollars to be exchanged into foreign currency to buy assets abroad

trade policy

-government policy that directly influences the quantity of goods and services that a country imports or exports, trade policies do not affect trade balance (NX=NCO=S-I)

Government budget deficits and surpluses

-in a closed economy, a government budget deficit reduces supply of loanable funds, drives up domestic interest rate, and crowds out investment -in a small open economy with perfect capital mobility, a decrease in government budget deficits causes the dollar to depreciate and cause net exports to rise

Assumptions for small open economy model

-level of GDP is given -price level is fixed -real interest rate is equal to the world interest rate and is taken as given

market for loanable funds

-market for loanable funds in small open economy with perfect capital mobility is different from in a closed economy (real interest rate isn't determined by demand of supply of loanable funds) -quantity of loanable funds made available by saving doesn't need to equal quantity of loanable funds demanded for domestic investment (difference between two amounts=NX=NCO) - Demand=exports (NCO inflow) - Supply=imports (NCO outflow)

import quota

a limit on quantity of a good that is produced abroad and sold domestically

tariff

tax on goods produced abroad and sold domestically