ECN Ch. 12
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
Imports: Goods and services that are produced abroad and sold
Net Exports: The value of nation’s exports minus the value of its imports;
also called the trade balance
Trade Balance: The value of a nations exports minus the value of its
imports; also called net exports.
Trade Surplus: An excess of exports over imports
Trade deficit: An excess of imports over exports
Balanced trade: A situation in which exports equal imports
Factors that influence a country’s exports, imports and net exports.
- Tastes of consumers for domestic and foreign goods
- Prices of goods at home and abroad
- Exchange rates at which people can use domestic currency to buy foreign
- Incomes of consumers at home and abroad
- Cost of transporting goods from country to country
- Government policies toward international trade.
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.
- When net capital outflow is positive, residents are buying more foreign
assets then foreigners are buying domestic assets. Capital is said to be
flowing out of the country.
- When net capital outflow is negative, domestic residents are buying less
foreign assets than foreigners are buying domestic assets.
Foreign direct investment: If Tim Horton’s opens a fast food outlet in
Foreign Portfolio Investment: If a Canadian buys stock in a Russian
The Equality of Net Exports and Net Capital
Net Capital Outflow always equals Net Exports NCO= NX
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. What is it doing with the foreign currency it receives from the net sale of the goods and services
abroad? It must be using it to buy foreign assets (NC0>0).
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 goods and services in the world markets? It must be selling
assets abroad. Capital is flowing into the country (NC0<0)
Saving Investment, and Their Relationship to the International
GDP is divided into 4 parts
(Y) = GDP
(G)= Government purchases
(NX)= Net exports
Y = C + I + G + NX
National Saving: income of the nation after paying for current
consumption and government purchases.
National Saving (S) = Y - C – G
If we rearrange the equation: Y – C – G = I + NX
Therefor S = I + NX
Because NX also equals NCO we can write the equation like this:
S= I + NCO
Exports > Imports
Net exports > 0
Income must be greater than Domestic Spending: (Y) > (C +
I + G)
Saving must exceed investment because the country is
saving more than it is investing: (Y – C – G) > (I)
Net capital outflow > 0
Exports < Imports
Net exports < 0
Income must be less than domestic spending: (Y) < (C + I
Saving is less than investment because you are investing
more than it is saving. (Y – C – G) < (I)
Net capital outflow < 0