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