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Canada (511,185)
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ECN 204 (348)
Lecture

Chapter #12 ECN.doc

7 Pages
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Department
Economics
Course Code
ECN 204
Professor
Christopher Gore

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Description
Chapter #12  One of the Ten Principles of Economics from Chapter 1: Trade can make everyone better off.  This chapter introduces basic concepts of international macroeconomics: o The trade balance (trade deficits, surpluses) o International flows of assets o Exchange rates Closed vs. Open Economies  A closed economy does not interact with other economies in the world.  An open economy interacts freely with other economies around the world. o It buys and sells goods and services in world product markets. o It buys and sells capital assets in world financial markets. The Flow of Goods & Services  Exports: domestically-produced g&s sold abroad  Imports: foreign-produced g&s sold domestically  Net exports (NX), aka the trade balance = value of exports – value of imports  Net exports: the value of a nation’s exports minus the value of its imports; also called the trade balance  Trade surplus: an excess of exports over imports  If net exports are positive, exports are greater than imports, indicating that country sells more goods and services abroad than it buys from other countries  Trade deficit: an excess of imports over exports  If net exports are negative, exports are less than imports, indicating that the country sells fewer goods and services abroad than it buys from other countries  Balanced Trade: a situation in which exports equal imports  If net exports are zero, its exports and imports are exactly equal, and the country is said to have balanced trade  Trade is influenced through; 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, and gov’t policies toward international trade EXAMPLE- Variables that affect NX 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. 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 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: the purchase of foreign assets by domestic residents minus the purchase of domestic by foreigners o Net Capital Outflow = Purchase of foreign assets by domestic residents – Purchase of domestic assts by foreigners  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 gov’t, the purchase reduces Canadian net capital outflow  The flow of capital abroad takes two forms: o 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. o Foreign portfolio investment: Domestic residents purchase foreign stocks or bonds, supplying “loanable funds” to a foreign firm.  In both cases, Canadian residents are buying assets located in another country, so both purchases increase Canadian net capital outflow.  NCO measures the imbalance in a country’s trade in assets:  When NCO > 0, “capital outflow” o Domestic purchases of foreign assets exceed foreign purchases of domestic assets. o Capital is flowing out of the country.  When NCO < 0, “capital inflow” o Foreign purchases of domestic assets exceed domestic purchases of foreign assets. o Capital is flowing into the country Variables that Influence NCO  Real interest rates paid on foreign assets  Real interest rates paid on domestic assets  Perceived economic and political risks of holding foreign assets  Gov’t policies affecting foreign ownership of domestic assets The Equality of NX and NCO  An accounting identity: NCO = NX o arises because every transaction that affects NX also affects NCO by the same amount (and vice versa)  When a foreigner purchases a good from Canada, o Canadian exports and NX increase o the foreigner pays with currency or assets, so the Canadian acquires some foreign assets, causing NCO to rise.  An accounting identity: NCO = NX o arises because every transaction that affects NX also affects NCO by the same amount (and vice versa)  When a Canadian citizen buys foreign goods, o Canadian imports rise, NX falls o the Canadian buyer pays with Canadian dollars or assets, so the other country acquires Canadian assets, causing Canadian NCO to fall.  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. o What is it doing with the foreign currency it receives from the net dale of goods and services abroad? o It must be using it to buy foreign assets o Capital is flowing out of the country (NCO>0)  When a nation is running a trade deficit (NX<0), it is buying more foods and services from foreigners than it is selling to them o How is it financing the net purchase of these goods and services in world markets? o It must be selling assets abroad. Capital is flowing into the country (NCO<0) Saving, Investment, and International Flows of Goods & Assets Y = C + I + G + NX accounting identity Y – C – G = I + NX rearranging terms S = I + NX since S = Y – C – G S = I + NCO since NX = NCO  Savings = Domestic Investments + Net Capital Outflow  When S > I, the excess loanable funds flow abroad in the form of positive net capital outflow, NCO >0.  When S < I, foreigners are financing some of the country’s investment, and NCO < 0. International Flows of Goods and Capital-Summary THE PRICES FOR INTERNATIONAL TRANSACTIONS: REAL AND NOMINAL EXCHANGE RATES  International transactions are influenced by international prices.  The two most important international prices are the nominal exchange rate and the real exchange rate. The Nominal Exchange Rate  Nominal exchange rate: the rate at which one country’s currency trades for another  Is expressed in two ways: • in units of foreign currency per one Canadian dollar, and • in units of Canadian dollars per one unit of the foreign currency.  Some exchange rates as of 6 Oct 2010, all per CDA$ U.S. dollar: 0.98 Euro: 0.71 Japanese yen: 81.77 Appreciation and Depreciation  Appreciation (or “strengthening”): an increase in the value of a currency as measured by the amount of foreign currency it can buy  a dollar buying more foreign currency  When farmers appreciate a ‘stronger’ price of wheat, consumers of bread prefer a ‘weaker’ price  A stronger dollar is good for those buying foreign currencies but bad for those trying to sell foreign currencies  Depreciation (or “weakening”): a decrease in the value of a currency as measured by the amount of foreign currency it can buy  a dollar buys less of the foreign currency The Real Exchange Rate  Real exchange rate: the rate at which the g&s of one country trade for the g&s of another  Real exchange rate = e x P P = domestic price P* = foreign price (in foreign currency) e = nominal exchange rate, i.e., foreign currency per unit of domestic currency Example With One Good  A Big Mac costs $2.50 but 400 yen in Japan  e = 120 yen per $  e x P = price in yen of a Canadian Big Mac = (120 yen per $) x ($2.50 per Big Mac) = 300 yen per Canadian Big Mac  Compute the real exchange rate: e x P 300 yen per Canadian Big Mac = 400 yen per Japanese Big Mac P* Interpreting the Real Exchange Rate  “The real exchange rate = 0.75 Japanese Big Macs per Canadian Big Mac”  This does not mean a Japanese citizen literally exchanges Japanese burgers for Canadian ones.
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