Chapter 31
real exchange rate formula
(e x P)/P* P= domestic price P*= foreign price e= nominal exchange rate
variables that influence net capital outflow
-Real interest rates paid on foreign assets -Real interest rates paid on domestic assets -Perceived economic and political risks of holding assets abroad -Government policies that affect foreign ownership of domestic assets
When a foreigner purchases a good from the US
-U.S. exports and NX increase -the foreigner pays with currency or assets, so the U.S. acquires some foreign assets, causing NCO to rise.
When a U.S. citizen buys foreign goods
-U.S. imports rise, NX falls -the U.S. buyer pays with U.S. dollars or assets, so the other country acquires U.S. assets, causing U.S. NCO to fall.
trade deficit
An excess of imports over exports
Which of the following statements about a country with a trade deficit is not true? Exports < imports B. Net capital outflow < 0 C. Investment < saving D. Y < C + I + G
C
variables that influence net exports
Consumers' preferences for foreign and domestic goods Prices of goods at home and abroad Incomes of consumers at home and abroad The exchange rates at which foreign currency trades for domestic currency Transportation costs Govt policies
depreciation
a decrease in the value of a currency as measured by the amount of foreign currency it can buy
Purchasing Power Parity (PPP)
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
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
closed economy
does not interact with other economies in the world
When NCO is greater than 0
domestic purchases of foreign assets exceed foreign purchases of domestic assets
Foreign Direct Investment
domestic residents actively manage the foreign investment
foreign portfolio investment
domestic residents purchase foreign stocks or 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 goods and services sold in other countries
Imports
foreign produced goods and services sold domestically
When NCO is less than 0
foreign purchases of domestic assets exceed domestic purchases of foreign assets
When S < I
foreigners are financing some of the country's investment, and NCO < 0
open economy
interacts freely with other economies around the world
two reasons why exchange rates do not always adjust to equalize prices across countries
many goods cannot easily be traded foreign, domestic goods not perfect substitutes
Net capital outflow equals
net exports
PPP implies
that the nominal exchange rate between two countries should equal that ratio of price levels
When S > I
the excess loanable funds flow abroad in the form of positive net capital outflow
Net exports measures the:
the imbalance in a country's trade in goods and services
law of one price
the notion that a good should sell for the same price in all markets
Arbitrage
the process of buying a currency low and selling it high
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
net exports (trade balance)
value of exports - value of imports
balanced trade
when exports = imports