Chapter 12: Open-Economy Macroeconomic Basic Concepts
Closed VS. Open Economies:
Closed economy – does not interact with other economies in the world
Open economy – interacts freely with other economies around the world
- It buys and sells goods and services in world product markets
- Its buys and sells capital assets in world financial markets
How are international flows if goods and assets related?
The flows of goods and services
Exports- domestically-priduced G&S abroad
Imports – foreign-produced G&S sold domestically
Net exports (NX), aka the trade balance = value of exports – value of imports
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
Trade Surpluses & Deficits
NX measures the imbalance in a country’s trade in goods and services.
Trade deficit: an excess of imports over exports
Trade surplus: an excess of exports over imports
Balanced trade: when exports = imports
The Flow of Capital
Net capital outflow (NCO): domestic residents’ purchases of foreign assets minus foreigners’
purchases of domestic assets
NCO is also called net foreign investment.
When a Canadian resident buys stock in Telmex, the Mexican phone company, the
purchase raises Canadian net capital outflow.
When a Japanese resident buys a bond issued by the Canadian government, the purchase
reduces Canadian net capital outflow.
The flow of capital abroad takes two forms:
Foreign direct investment: Domestic residents actively manage the foreign investment, e.g., Tim
Hortons opens a fast food outlet in Russia, that is an example of foreign direct investment.
Foreign portfolio investment: Domestic residents purchase foreign stocks or bonds, supplying
“loanable funds” to a foreign firm.
What do you think would happen to Canadian net exports if:
A. The U.S. experiences a recession
(falling incomes, rising unemployment)
Canadian net exports would fall due to a fall in American consumers’ purchases of Canadian exports
B. Canadian consumers decide to be patriotic and buy more products “Made in Canada”
Canadian net exports would rise due to a fall in imports
C. Prices of goods produced in Mexico rise faster than prices of goods produced in Canada.
This makes Canadian goods more attractive relative to Mexico’s goods. Exports to Mexico increase,
imports from Mexico decrease, so Canadian net exports increase.