Econ test 31 & 32

Trade policy

A goverment policy that directly influences the quantity of goods and services that a country imports or exports

Capital flight

A large and sudden reduction in the demand for assets located in a country

Balanced trade

A situation in which exports equal imports

Purchasing-power parity

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

Why are budget deficits and trade deficits sometimes called twin deficits?

After Reagan was elected in 1980, the fiscal policy of the US federal goverment changed dramatically. They made large tax cuts, but not significant spending cuts, so they had a large budget deficit. This lead to a huge trade deficit. During this period, trade and budget deficits were so linked that they were called twin deficits. However, they are not identical twins as trade deficits have many factors besides fiscal policy.

Open economy

An economy that interacts freely with other economies around the world

What is capital flight? When a country experiences capital flight, what is the effect on its interest rate and exchange rate?

Capital flight is a large and sudden reduction in demand for assets located in a country. Net capital outflow increases, causing greater demand for loanable funds to finance purchases of foriegn assets. So the demand curve for loanable funds shifts right. This increases the real interest rate. This causes the net capital outflow curve to shift right, which invreases the supply of currency in the market for foriegn-currency exchange, decreasing the real exchange rate.

Imports

Goods and services that are produced abroad and sold domestically

Exports

Goods and services that are produced domestically and sold abroad

Describe the economic logic behind the theory of purchasing-power parity.

If prices are unequal in different locations, in the long run demand rises in the cheaper location and falls in the more expensive location until they are equal.

Describe supply and demand in the market for loans le funds and the market for foreign- currency exchange. How are these markets linked?

In the market for foriegn-currency exchange, supply comes from net capital outflow, demand comes from net exports, and the real exchange rate balances supply and demand. In the market for loanable funds, the supply comes from national saving and the demand comes from domestic investment and net capital outflow. The interest rate also balances these. Net capital outflow links these markets. In the market for loanable funds it is the demand; in the market for foriegn-currency exchange it is the supply.

If the Fed started printing large quantities of U.S. dollars, what would happen to the number of Japanese yen a dollar could buy? Why?

It would decrease because the supply of money is increaing. This would cause inflation to increase which would make the real value of the real value of the dollar decrease.

Define net exports and net capital outflow. Explain how and why they are related.

Net exports are the value of a nation's exports minus the value of its imports. Net capital outflow is the purchase of domestic assets by domestic residents minus the purchase of domestic assets by foriegners. These two will always be equal because everytime an item is sold outside the country, the seller gets some of their currency. This invests in Japan's economy, which increases capital outflow. So the good sold increases exports and the money earned from it increases capital outflow.

If a Japanese car cost 500,000 yen, a similar American car costs $10,000, and a dollar can buy 100 yen, what are the nominal and real exchange rates?

Nominal: $1 to 100 yen Real: 2 cars in Japan per 1 car in America

Explain the relationship among saving, investment, and net capital outflow.

Saving, investment, and international capital are inextricably linked. When a nation's saving exceeds its domestic investment, its net capital outflow is positive, indicating that the nation is buying assets abroad and vice versa

Suppose a textile workers' union encourages people to buy only American-made clothes. What would this policy do to the trade balance and the real exchange rate? What is the impact on the textile industry? What is the impact on the auto industry?

The imports decrease, and this effects the net exports. Net exports are the source of demand in the foriegn-exchange market. Net exports increase, so demand for dollars increases. The real exchange rate appreciates. Appreciation encourages imports and discourages exports. Thus net exports return to the same amount and the trade balance is uneffectsd; nothing changes but the real exchange rate. The textile industry has less competition and can export more, but higher real exchange causes the auto industry to export less.

Net capital outflow

The purchase of foriegn assets by domestic residents minus the purchase of domestic assets by foriegners

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

trade balance

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

Net exports

The value of a country's exports minus the value of its imports; also called the trade balance

Depreciation

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

Closed economy

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

Trade surplus

an excess of exports over imports

trade deficit

an excess of imports over exports

Appreciation

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

nominal exchange rate

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