Attempt 1
Closed Economy
All output is sold domestically, and expenditure is divided into Consumption, Investment, and Government purchases.
S - I = NX
Net Capital Outflow = Trade Balance
Policies that increase investment, or decrease saving...
cause a trade deficit.
Policies that decrease investment or increase saving...
cause a trade surplus.
If money supply is stable...
the price level will be stable
If money supply rapidly increases...
the price level will rise rapidly.
Balanced Trade
when S - I = NX is exactly 0
Trade Deficit
when S - I = NX is negative
Trade Surplus
when S - I = NX is positive
Interest Rate of a Small Open Economy
r = r*
Determination of Trade Balance
Difference between saving and investment at the world interest rate.
Perfect Capital Mobility
Full access to world financial markets; the government does not impede international borrowing or lending.
What determines the rate of inflation?
The rate of growth in the quantity of money.
What happens to the real value of your money as prices rise?
The real value of your money falls.
NX = NX(e)
The relationship between the real exchange rate and net exports.
What happens when output exceeds domestic spending?
We export the difference; net exports are positive.
What happens if output falls short of domestic spending?
We import the difference; net exports are negative.
Money Demand Function [Equation]
(M/P)^d = kY
Real Exchange Rate Formula
(Nominal Exchange Rate * Price of Domestic Good) / Price of Foreign Good
Government Financing
1. Raise revenue through taxes 2. Borrow from the public through bonds 3. Print money
Quantity Theory of Money
A theory asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate
Hyperinflation
A very rapid rise in the price level; an extremely high rate of inflation.
Small Open Economy
An economy that trades goods and services with other economies and, by itself, has a negligible effect on world prices and interest rates
Negative NCO
Economy is experiencing a capital inflow; investment exceeds saving, an the economy is financing the extra investment by borrowing from abroad.
Positive NCO
Economy's saving exceeds its investment; it lends the excess to foreigners.
High Real Exchange Rate
Foreign goods are relatively cheap, domestic goods are relatively expensive.
Low Real Exchange Rate
Foreign goods are relatively expensive, and domestic goods are relatively cheap.
Quantity Equation
M * V = P * Y
Real Money Balances
Measure the purchasing power of the stock of money, M/P
Income Velocity of Money
Measures the number of times a dollar bill enters someone's income in a given period of time.
Transactions Velocity of Money
Measures the rate at which money circulates in the economy.
Net Capital Outflow
Reflects the international flow of funds to finance capital accumulation.
Nominal Exchange Rate
Relative price of the currencies of two countries.
Real Exchange Rate (Terms of Trade)
Relative price of the goods of two countries.
Money Demand Function
Shows the determinants of the quantity of real money balances people wish to hold.
Open Economy
Some output is sold domestically, and some is exported to be sold abroad. Can be divided into Consumption, Investment, Government purchases, Exports.
Real Interest Rate
The increase in your purchasing power.
Nominal Interest Rate
The interest rate the bank pays.
Inflation
The percentage change in the overall level of prices - varies greatly over time and across countries.
What affect does a low real exchange rate have on net exports?
The quantity of our net exports demanded will be high.
What affect does a high real exchange rate have on net exports?
The quantity of our net exports demanded will be low.
What determines price level?
The quantity of money