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Lecture 12

ECON 102 Lecture 12: ECON 102 - Chapter 12 Notes

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ECON 102
Karl Pinno

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Tuesday, November 22, 2016 ECON 102 Chapter 12: Open-Economy Macroeconomics: Basic Concepts • One of the ten principles of economics highlighted in Chapter 1 is that trade can make everyone better off. • 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 The International Flows of Goods and Capital • Exports: goods and services that are produced domestically and sold abroad • Imports: goods and services that are produced abroad and sold domestically • Net exports (or trade balance): the value of a nation’s exports minus the value of its imports The Flow of Financial Resources: Net Capital Outflow • **Net Capital Outflow: the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners • Some of the variables that influence net capital outflow (NCO): • Real interest rates being paid on foreign assets • Real interest rates being paid on domestic assets • Perceived economic and political risks of holding assets abroad • Government policies that affect foreign ownership of domestic assets The Equality of Net Exports and Net Capital Outflow • Net exports measure an imbalance between a country’s exports and its imports. • Net capital outflow measures an imbalance between the amount of foreign assets bought by domestic residents and the amount of domestic assets bought by foreigners. • That is, net capital outflow (NCO) always equals net exports (NX): This equation holds because every transaction that affects NCO = NX one side of this equation must also affect the other side by exactly the same amount. This equation is an identity. 1 Tuesday, November 22, 2016 • When NX > 0, the country is selling more goods ad services to foreigners than it is buying from them. • What is it doing with the foreign currency it receives from the net sale of goods and services abroad? • It must be using it to buy foreign assets. • Capital is flowing out of the country (e.g. NCO > 0) • When NX < 0, the country 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 seeing assets abroad. • Capital is flowing into the country (e.g. NCO < 0) Saving, Investment, and Their Relationship to the International Flows Saving, investment, and international capital flows are inextricably linked. Y = C +I +G+XN Closed Y C G = I +XN Econom S = I + XN y S = I + NCO NCO =0 S = I International Flows of Goods and Capital: Summary 2 Tuesday, November 22, 2016 The Prices for International Transactions: Real and Nominal Exchange Rates • Two important international prices discussed here: 1. The nominal x-rate 2. The real x-rates Nominal Exchange Rates • Nominal exchange rate: the rate at which a person can trade the currency of one country for the currency of another • Appreciation: an increase in the value of a currency as measured by the amount of foreign currency it can buy • Depreciation: a decrease in the value of a currency as measured by the amount of foreign currency it can buy NOTE: For example, when the exchange rate rises from 80 to 90 yen per dollar, the dollar is said to appreciate. At the same time, because a Japanese yen now buys less of the Canadian currency, the yen is said to depreciate. When the exchange rate falls from 80 to 70 yen per dollar, the dollar is said to depreciate, and the yen is said to appreciate. Real Exchange Rates 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 • It is a key determinant of how much a country exports and imports Nominal x-rate⇥ Domestic price Real x-rate = Foreign price Suppose that a bushel of Canadian wheat sells for $200, and a bushel of Russian wheat sells for 1600 rubles. What is the real exchange rate between Canadian and Russian wheat? To answer this question, we must first use the nominal exchange rate to convert the prices into a common currency. If the nominal exchange rate is 4 rubles per dollar, then a price for Canadian wheat of $200 per bushel is equivalent to 800 rubles per bushel. Canadian wheat is half as expensive as Russian wheat. The real exchange rate is one-half bushel of
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