ECON 102: Chapter 18 - Open-Economy Macroeconomics: Basic Concepts.

What happens when a nation's domestic investment exceeds its saving?

-Its NCO is negative, indicating that foreigners are financing some of this investment by purchasing domestic assets. -Domestic spending = C + I + G. -If income is more than spending, then saving must be more than investment. -Because the country is investing more than it is saving, it must be financing some domestic investment by selling assets abroad. The NCO must be negative.

What happens when a nation's saving exceeds its domestic investment?

-Its NCO is positive, indicating that the nation is using some of its saving to buy assets abroad.

Saving and investment...

-Saving and investment are equal in a closed economy.

What factors influence NCO?

1. The real interest rates paid on foreign assets. 2. The real interest rates paid on domestic assets. 3. The perceived economic and political risks of holding assets abroad. 4. The government policies that affect foreign ownership of domestic assets. -The higher a bond's real interest rate, the more attractive it is. -NCO must always equal NX.

What is a trade surplus?

A trade surplus is where a country sells more goods and services abroad than it buys from other countries.

What happens with an appreciation (rise) in the U.S. real exchange rate?

Conversely, an appreciation (rise) in the U.S. real exchange rate means that U.S. goods have become more expensive relative to foreign goods, so U.S. net exports fall.

An open economy has 2 uses for its saving...

Domestic investment and NCO. Example: If the Garcias deposit their saving in a mutual fund, the mutual fund may use some of the deposit to buy stock issued by General Motors, which uses the proceeds to build a factory in Ohio.

What is a trade deficit?

Exports < Imports.

What are exports?

Exports are domestically produced goods and services that are sold abroad.

What is the difference between FDI and FPI?

FDI is where the owner actively manages the investment, whereas FPI involves a more passive role.

When a nation is running a trade deficit (NX < 0), it is buying more goods and services from foreigners than it is selling to them.

How is it financing the net purchase of these goods and services in world markets? It must be selling assets abroad. Capital is flowing into the country (NCO < 0).

Depreciation:

If the exchange rate changes so that a dollar buys less foreign currency, that change is called a depreciation of the dollar.

Appreciation:

If the exchange rate changes so that a dollar buys more foreign currency, that change is called an APPRECIATION of the dollar. -Strengthens because it can now buy more foreign currency.

What are imports?

Imports are foreign-produced goods and services that are sold domestically.

What is true of a closed economy?

In a closed economy, NCO = 0. So, saving equals investment (S = I)

When a nation is running a trade surplus (NX > 0), it is selling more goods and services to foreigners than it is buying from them.

It must be using the foreign currency to buy foreign assets. Capital is flowing out of the country (NCO > 0).

What is national saving?

National saving is the income of the nation that is left AFTER paying for current consumption and government purchases. National Saving (S) = Y - C - G. Y - C - G = I + NX. S = I + NX. I is the domestic investment. Because NX = NCO, we can write this equation as S = I + NCO. -When a U.S. citizen saves a dollar of her income for the future, that dollar can be used to finance the accumulation of domestic capital or it can be used to finance the purchase of foreign capital.

What is the equation for Net Capital Outflow?

Net Capital Outflow = Purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners. -When a U.S. resident buys stock in a Brazilian company, it increases the U.S. Net Capital Outflow. -When NCO is negative, a country is experiencing a capital inflow.

Net exports:

Net exports = Value of country's exports - value of country's imports. -Net exports are also called the trade balance.

What is purchasing-power parity?

PPP states that a unit of any given currency should be able to buy the same quantity of goods in all countries.

What is purchasing power?

Purchasing power refers to the value of money in terms of the quantity of goods it can buy. -Purchasing-power parity states that a unit of a currency must have the same real value in every country.

What is the law of one price?

The law of one price asserts that a good must sell for the same price in all locations. -Export of coffee from the United States to Japan would drive up the U.S. price of coffee and drive down the Japanese price. -Import of coffee into the U.S. from Japan would drive down the U.S. price of coffee and drive up the Japanese price. -The law of one price tells us that a dollar must buy the same amount of coffee in all countries.

What is the nominal exchange rate?

The nominal exchange rate is the rate at which a person can trade the currency of one country for the currency of another.

What is the real exchange rate?

The real exchange rate is the rate at which a person can trade the goods and services of one country for the goods and services of another. Real exchange rate = (Nominal exchange rate x Domestic price) / Foreign price. -The real exchange rate is a key determinant of how much a country exports and imports. Real exchange rate = e (nominal exchange rate) x P (domestic price) / P* (foreign price). -The real exchange rate measures the price of a basket of goods and services available domestically relative to a basket of goods and services available abroad. -A depreciation (fall) in the U.S. real exchange rate means that U.S. goods have become cheaper relative to foreign goods. -This change (depreciation) encourages consumers both at home and abroad to buy more U.S. goods and fewer goods from other countries.

What is the economy's GDP (Y) equal to?

Y = C + I + G + NX.