Econ Chapter 31

depreciation

a decrease in the value of a currency as measured by the amount of foreign currency it can buy; if the exchange rate changes so that a dollar buys less currency, that change is called this; it weakens a currency because it can buy less foreign currency

balanced trade

a situation in which exports equal imports Exports = Imports Net Exports = 0 Y = C + I + G Saving = Investment Net Capital Outflow = 0

purchasing-power parity

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; tells us that the nominal exchange rate between the currencies of two countries depends on the price levels in those countries 1 = eP/P*

closed economy

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

open economy

an economy that interacts freely with other economies around the world; buys and sells goods and services in world product markets, and it buys and sells capital assets such as stocks and bonds in world financial markets

identity

an equation that must hold because of the way the variables are defined and measured; NCO (net capital outflow) = NX (net exports)

trade surplus

an excess of exports over imports Exports > Imports Net Exports > 0 Y > C + I + G Saving > Investment Net Capital Outflow > 0

trade deficit

an excess of imports over exports Exports < Imports Net Exports < 0 Y < C + I + G Saving < Investment Net Capital Outflow < 0

appreciation

an increase in the value of a currency as measured by the amount of foreign currency it can buy; if the exchange rate changes so that a dollar buys more foreign currency, that change is called this; this strengthens a currency because it can buy more foreign currency

imports

goods and services that are produced abroad and sold domestically

exports

goods and services that are produced domestically and sold abroad

foreign direct investment

in this type of investment, the owner actively manages the investment; example: if McDonald's opens up a fast-food outlet in Russia

foreign portfolio investment

in this type of investment, the owner has a more passive role; example: if an American buys stock in a Russian corporation

national saving

the income of the nation that is left after paying for current consumption and government purchases; must equal domestic investment plus net capital outflow (when US citizens save a dollar of their income for the future, that dollar can be used to finance accumulation of domestic capital or it can be used to finance the purchase of capital abroad) S = I + NX S = I + NCO

arbitrage

the process of taking advantage of price differences for the same item in different markets

net capital outflow (net foreign investment)

the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners; when this is positive, domestic residents are buying more foreign assets than foreigners are buying domestic assets, and capital is said to be flowing out of the country; when this is negative, domestic residents are buying less foreign assets than foreigners are buying domestic assets, and capital is said to be flowing into the country

nominal exchange rate

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

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 Nominal Exchange Rate X Domestic Price/Foreign Price (e X P) / P* an appreciation of this causes a country's net exports to fall; a depreciation of this causes a country's net exports to rise

net exports (trade balance)

the value of a nation's exports minus the value of its imports; if these are positive, exports are greater than imports, indicating that the country sells more goods and services abroad than it buys from other countries (trade surplus); if these are negative, exports are less than imports, indicating that the country sells fewer goods and services abroad than it buys from other countries (trade deficit); if these are zero, exports and imports are exactly equal (balanced trade)

law of one price

this law asserts that a good must sell for the same price in all locations; otherwise, there would be opportunities for profit left unexploited.