Econ Ch 13
real exchange rate =
(e x P) / P*
when a foreigner purchases a good from the US,
- US exports and NX increase - the foreigner pays with currency or assets, so the US acquires some foreign assets, causing NCO to rise
when a US citizen buys foreign goods,
- US imports rise - NX falls - the US buyer pays with US dollars or assets, so the other country acquires US assets, causing US NCO to fall
variables that influence net exports
1. consumers' preferences for foreign and domestic goods 2. prices of goods at home and abroad 3. incomes of consumers at home and abroad 4. the exchange rates at which foreign currency trades for domestic currency 5. transportation costs 6. government policies toward international trade
Two limitations of PPP theory
1. many goods cannot easily be traded 2. foreign, domestic goods not perfect substitutes
variables that influence NCO
1. real interest rates paid on foreign assets 2. real interest rates paid on domestic assets 3. perceived risks of holding foreign assets 4. government policies affecting foreign ownership of domestic assets
A farmer in Mexico purchases a tractor made in the U.S. This purchase is an example of
A US export and a Mexican import
When Jamie, a U.S. citizen, purchases a wool jacket made in Ireland, the purchase is
A US import and an Irish export
The law of one price states that
A good must sell at the same price at all locations
A country purchases more goods and services from residents of foreign countries than residents of foreign countries purchase from it. This country has
A trade deficit and negative net exports
A country purchases more goods and services from residents of foreign countries than residents of foreign countries purchase from it. This country has:
A trade deficit and negative net exports
If purchasing-power parity holds, a dollar will buy:
As many goods in foreign countries as it does in the US
A Finnish corporation builds a factory that produces ceiling fans in the United States. This is an example of Finish:
Foreign direct investment that increases Finnish net capital outflow
example of foreign direct investment
McDonalds opens a fast-food outlet in Moscow
NCO must always equal
NX
Other things the same, if a country has a trade deficit and saving rises,
Net capital outflow rises, so the trade deficit decreases
If a dollar currently purchases 12.5 pesos and someone forecasts that in a year it will purchase 14 pesos, then the forecast is given in
Nominal terms and implies the dollar will appreciate
If a dollar currently purchases 12.5 pesos and someone forecasts that in a year it will purchase 14 pesos, then the forecast is given in:
Nominal terms and implies the dollar will appreciate
what does each variable mean in: (e x P)/P*
P = domestic price P* = foreign price (in foreign currency) e = nominal exchange rate
e =
P*/P
The theory of purchasing-power parity primarily explains
The determination of the real exchange rate
A depreciation (fall) in the US real exchange rate means that
US goods have become cheaper relative to foreign goods. as a result, US exports rise and US imports fall
An appreciation (rise) in the US real exchange rate means that
US goods have become more expensive compared to foreign goods. as a result, US net exports fall
Depreciation (or "weakening"):
a decrease in the value of a currency as measured by the amount of foreign currency it can buy
Purchasing-power parity
a theory of exchange rates whereby a unit of any currency should be able to buy the same quantity of goods in all countries
trade surplus
an excess of exports over imports E > I
trade deficit
an excess of imports over exports E < I
Appreciation (or "strengthening"):
an increase in the value of a currency as measured by the amount of foreign currency it can buy
Other things the same, if the U.S. real exchange rate appreciates, U.S. net exports
and U.S. net capital outflow both decrease.
If the exchange rate changes so that a dollar buys more foreign currency, that change is called an ________________ of the dollar
appreciation
If the purchasing power of the dollar is always the same at home and abroad, then the real exchange rate - the relative price of domestic and foreign goods -
cannot change
NCO < 0 =
capital inflow (-)
NCO > 0 =
capital outflow (+)
A Swiss company sells chocolates to a retailer in the United States. These sales by themselves
decrease US net exports and increase Swiss net exports (increase US imports)
If the exchange rate changes so that a dollar buys less foreign currency, that change is called a ______________ of the dollar
depreciation
closed economy
does not interact with other economies in the world Y=C + I + G
When NCO > 0, "capital outflow"
domestic purchases of foreign assets exceed foreign purchases of domestic assets (trade surplus)
foreign direct investment
domestic residents actively manage the foreign investment
foreign portfolio investment
domestic residents purchase foreign stocks and bonds, supplying "loanable funds" to a foreign firm
net capital outflow (NCO)
domestic residents' purchases of foreign assets minus foreigners' purchases of domestic assets
exports
domestically-produced g&s sold abroad
net exports =
exports - imports
net exports
exports - imports aka. trade balance
If inflation is higher in the US than in Japan, then P rises faster than P*, so e
falls - the dollar depreciates against the yen
When NCO < 0, "capital inflow"
foreign purchases of domestic assets exceed domestic purchases of foreign assets
imports
foreign-produced g&s sold domestically
when S < I,
foreigners are financing some of the country's investment and have negative net capital inflow (NCO < 0) - trade deficit
example of foreign portfolio investment
if an American buys stock in a Russian corporation
open economy
interacts freely with other economies around the world Y = C + I + G + NX
Saving =
investment + net exports or investment + NCO
A depreciation of the U.S. real exchange rate induces U.S. consumers to buy
more domestic goods and fewer foreign goods.
When a nation's domestic investment exceeds its saving (I > S), its net capital outflow is
negative, indicating that foreigners are financing some of this investment by purchasing domestic assets (trade deficit)
A country has a trade deficit. Its net capital outflow must be _____ and its saving is ______
net capital outflow must be negative and saving is smaller than investment.
Every international transaction involves the exchange of an asset for a good or service, so
net exports equal net capital outflow
When a nation's saving exceeds its domestic investment (S > I), its net capital outflow is
positive, indicating that the nation is using some of its saving to buy assets abroad (trade surplus)
According to the theory of purchasing-power parity, the nominal exchange rate between the currencies of two countries must reflect the _________ in those countries
price levels
Nominal exchange rates change when
price levels change
Net capital outflow equals the difference between a country's
purchases of foreign assets and sales of domestic assets abroad.
If inflation is higher in Mexico than in the US, then P* rises faster than P, so e
rises - the dollar appreciates against the peso
If France had positive net exports last year, then it
sold more abroad than it purchased abroad and had a trade surplus.
When the Mexican peso gets "stronger" relative to the dollar,
the U.S. trade deficit with Mexico falls.
when S > I,
the excess loanable funds flow abroad in the form of positive net capital outflow (NCO > 0) - trade surplus
The dollar is said to appreciate against the euro if
the exchange rate rises. Other things the same, it will cost more euros to buy U.S. goods.
Law of one price:
the notion that a good should sell for the same price in all markets
the real exchange rate measures
the price of a basket of g&s available domestically relative to a basket of g&s available abroad
arbitrage
the process of taking advantage of price differences for the same item in different markets
Nominal exchange rate:
the rate at which one country's currency trades for another
Real exchange rate:
the rate at which the goods and services of one country trade for the goods and services of another
PPP implies that the nominal exchange rate between two countries should equal
the ratio of price levels
The nominal exchange rate equals
the ratio of the foreign price level (measured in units of the foreign currency) to the domestic price level (measured in units of domestic currency)
The nominal exchange rate is
the relative price of the currency of two countries
The real exchange rate is
the relative price of the goods and services of the two countries
If saving is greater than domestic investment, then
there is a trade surplus and Y > C + I + G.
balanced trade
when exports = imports E = I