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ECN Ch 12.docx

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ECN 204
Christos Shiamptanis

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 abroad.  Imports: Goods and services that are produced abroad and sold domestically.  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 currencies. - 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 Russia.  Foreign Portfolio Investment: If a Canadian buys stock in a Russian corporation. 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 Flows  GDP is divided into 4 parts  (Y) = GDP  (C)= Consumption  (I)= Investment  (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  Trade Surplus  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  Trade Deficit:  Exports < Imports  Net exports < 0  Income must be less than domestic spending: (Y) < (C + I + G)  Saving is less than investment because you are investing more than it is saving. (Y – C – G) < (I)  Net capital outflow < 0  Balanced Trade:
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