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Lecture 18

LGS 200 Lecture 18: Macroeconomics Chapter 18 Notes

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Legal Studies
LGS 200

Macroeconomics Chapter 18 Notes Introduction • One of the Ten Principles of Economics from Chapter 1: Trade can make everyone better off • This chapter introduces basic concepts of international macroeconomics. ➢ The trade balance (trade deficits, surpluses) ➢ International flow of assets ➢ Exchange rates Closed versus 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. The Flow of Goods and Services • Exports: domestically-produced goods and services sold abroad • 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. • Transportation costs • Government 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, NX < 0 and Y < C+I+G • Trade surplus: an excess of exports over imports, NX > 0 and Y > C+I+G • Balanced trade: when exports = imports, NX = 0 and Y=C+I+G • Table 1, page 384 (KNOW THIS INFO) The Increasing Openness of the US Economy • Increasing importance of international trade and finance ➢ 1950s, imports and exports: 4-5% of GDP ➢ Recent years: o Exports – increased more than twice o Imports – increased more than three times • Increase in international trade ➢ Improvements in international trade ➢ Advances in telecommunications ➢ Technological progress ➢ Governments trade policies – NAFTA and GATT 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 • The flow of capital abroad takes two forms: • Foreign direct investment: domestic residents or firms set up a foreign subsidiary and actively manage the foreign investment, such as, McDonalds opens a fast-food outlet in Moscow, Disney builds a theme park in Hong Kong • Foreign portfolio investment: domestic residents purchase foeign stocks or bonds, supplying “loanable funds” to a foreign firm, such as, an American buys stock in Toyota. • NCO measures the imbalance in a country’s trade in assets. ➢ When NCO > 0, “capital outflow”. Domestic purchases of foreign assets exceed foreign purchases of domestic assets ➢ When NCO < 0, “capital inflow”. Foreign purchases of domestic assets exceed domestic purchases of foreign assets. Variables That Influence NCO • Real interest rates paid on foreign assets. • Real interest rates paid on domestic assets. • Perceived risks of holding foreign assets. • Government policies affecting foreign ownership of domestic assets. The Equality of NX and NCO • An accounting identity: NCO = NX ➢ Arises because every transaction that affects NX also affects NCO by the same amount (and vice versa) • When the foreigner purchases a good from the US., ➢ US exports and NX increase ➢ The foreigner pays with currency or assets, so he US acquires some foreign assets, causing NCO to rise • When a US citizen buys foreign goods, ➢ US imports rise, NX falls ➢ The US buyer pays with the US dollars or assets, so the country acquires US assets, causing US NCO to fall. Savings, 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 • Thus, in an open economy, S =I +NCO • Then S – I = NCO and NX • When S > I, then NCO > 0 and the excess loanable funds flow abroad in the form of positive net capital outflow (trade surplus) • When S < I, then NCO < 0 and foreigners are financing some of the country’s investment in the form of negative net capital outflow (trade deficit) Case Study: The US Trade Deficit • The US trade deficit reached record levels in 2006 and remained high in 2007-2008. • Recall, NX = S – I = NCO • A trade deficit means I > S, so the nation borrows the difference from foreigners • In 2007, foreign purchases of US assets exceeded US purchases of foreign assets by $775 million. • Is the US trade deficit a problem? ➢ The extra capital stock from the ‘90s investment boom may well yield large returns. ➢ The fall in saving of the ‘80s and ‘00s, while not desirable, at least did not depress domestic investment, a
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