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Econ Exam Textbook Notes -Amrit.docx

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Chemical Engineering
Joe Kim

Econ Exam Notes Chapters 12-15 *Definiton #Formula @Theory ↓↑ Chapter 12 – Open Economy Macroeconomics • Trade is beneficial due to absolute advantage • *Closed economy – country doesn’t interact with other countries • *Open economy – country does interact with other countries • Imports, Exports, Exchange Rate • We can sell goods/ services in world product markets or stocks/ bonds financial market • *Exports – produced domestically sold abroad, *Imports – produced abroad sold to us • #Net exports = Exports – Imports, also called *trade balance • *Trade surplus: exports > imports, deficit opposite, Balanced trade imports = exports • @Factors affecting im/ex ports: tastes for consumer goods, prices at home or abroad, exchange rates people use domestic currency, income, cost of transportation, government policies • @Buying car = flow of goods, buying bonds = flow of capital • **#Net capital outflow = purchase of foreign assets by domestic residents – purchase of domestic from foreigners • Buy foreign bond ↑ net capital outflow ↑ • @Recall, foreign direct investment vs. foreign portfolio investment, but both count to NCO • When NCO +ve, capital flowing out • @Factors affecting NCO: real interest rates on domestic/ foreign assets, political risks of holding assets abroad, government policies about foreign ownership • #NCO = NX (net capital outflow = net exports) • This is due to international trade is exchange • **#Current account balance = Net Exports + Net Inflow of Dividends and interest payments • #Y – C – G = I + NX, S = Y – C – G, S = I + NX OR S= I + NCO • @In closed economy NCO/ NX = 0, so S = I • Trade deficit: S < I, NX < 0, Y < C + I + G, opposite for surplus • **Nominal Exchange Rate – rate which person can trade currency of one country with another • *Appreciation – money can buy more foreign currency, opposite for Depreciation • **Real Exchange Rate – rate which person can trade goods/service from one country to another • #Real exchange rate = (Nominal exchange rate * Domestic Price) / Foreign Price • @Economists use overall price index, Canadian Basket (P), price index (P*), nominal exchange rate: • RER = (e*P)/ P* • RER↓ will cause, Canadian stuff price ↓, NX↑ • @@Purchasing Power Parity – theory of exchange rates where unit of one currency gets same quantity in all countries (one dollar is one dollars’ worth everywhere) • **Arbitrage – taking advantage of price differences • Nominal Exchange Rate depends on Price Level • # 1/ P = e/ P* P = price of goods at home, P* = price of good in foreign currency • @Limitations of PPP – goods aren’t traded easily, not all foreign goods are perfect substitutes (quality difference). This causes RER to fluctuate • @Canada is Small Open Economy with perfect mobility • *Small Open Economy – no impact on world market and interest rates • **Perfect Capital Mobility – access to world financial markets, #r = r , r = interest rate, rw = world interest rate • @In long run r = rw • @@Interest rate parity – theory of interest rate determination where real interest rate on financial assets (stocks/bonds) should be same in economy with access to world market • @Limitations on IRP: financial assets have risk of defaulting (creating default risk, higher risk = higher interest rate), and financial assets are not perfect substitutes (possible different taxation) Chapter 13 – Macroeconomic Theory of Open Economy • NCO has been –ve for 40 years, many firms in Canada owned by foreign companies, last 10 years NCO went positive, but causes flow of money out of country • @@ 3 assumptions: real GDP is determined by factors of production, price level adjusts to bring money supply/ demand in balance, and we take real interest rate as given • 2 related markets: loanable funds & foreign-currency exchange, both with S&D curves • @Loanable Funds – saving and investment abroad (NCO), with one interest rate for saving/ burrowing • # S = I + NCO, NCO can be –ve, supply and demand depend on real interest rate • @↑ Interest Rate, ↑ Supply of Loanable Funds, ↓ Investment and ↓ Demand for Loans • @When R< Rw, Canadians sell domestic/ buy foreign, but have to change R to get somewhere • @Demand curves down, Supply goes up, Supply shows National Saving • The supply and demand graphs for Market of Loanable Funds are Real Interest Rate (y-axis) vs. Quantity of Loanable Funds (x-axis) • #Market for Foreign Currency, recally NCO = NX, so S – I = NX • @#The difference between S and I (NX or NCO) is the quantity of dollars supplied in the Market for Foreign Currency • The price that affects the Market for Foreign Currency is the Real Exchange Rate • @When RER↑, Canadian goods more expensive and NX↓ which results in ↓ of Quantity of Dollars Demanded • The supply and demand graphs for Market for Foreign Currency are Real Exchange Rate (y-axis) vs. Quantity of Dollars Exchanged (x-axis) • The supply curve for Foreign Currency is Vertical • @Net Exports are the source of demand for dollars, Supply is NCO • A change in NCO means Canadian is buying or selling foreign asset • When NCO is +ve, means saving is more than enough for investment, so we purchase foreign • In Demand for Foreign Currency demand is NX (downward slope) • Variables and how they affect graphs are listed below: 1. Increase in World Interest Rate; Rw↑, R↑, NCO ↑, Supply of dollars ↑ causes depreciation of dollar, RER↓, Net Exports ↑ o This ↑in Rw causes crowding out of domestic investment 2. Government Deficit/ Surplus; Supply of loanable funds↓(shifted left), R↑, crowds out investment, NCO ↓, Supply of money↓ (shifted left), RER↑, Net Exports ↓ o Deficit is negative public saving 3. Trade Policy; ↑ Demand for dollars (shift right), RER↑, imports↓, exports↓ NX stays the same o *Tariff – tax on goods coming in country, *Import Quota – limit on imports o Net exports is affected by these, so Demand for dollars shifts o Net exports will not change as NX = S – I, neither I or S changed 4. Political Instability, Rw↑, R↑, NCO ↑, Supply of dollars ↑ causes depreciation of dollar, RER↓, Net Exports ↑ o Capital Flight; large sudden reduction of demand for assets o This causes it to be more risky, causes interest rate to go up Chapter 14 – Aggregate Supply and Demand • *Recession – period of declining income and slower economy and higher unemployment • *Depression – severe recession • *Variables studies; GDP, unemployment, interest rates, exchange rates, price level • *Policies used; government spending, taxes, money supply • @@3 Facts about Economic Fluctuations: 1. Economic Fluctuations are irregular and unpredictable; fluctuations called business cycle 2. Most macroeconomic quantities change together; Real GDP measures long run fluctuations, short run not affective, also other quantities change different amounts 3. Output Falls, Unemployment Rises; unemployment never is 0 • @@Assumptions of Classical Economics based on Classical Dichotomy and Monetary Neutrality • @Classical dichotomy separation of real variables from nominal, so changes in money supply affect nominal only • Real variables: real GDP, real interest rate, unemployment • Nominal variables: money supply and price level • Classical Theory – changes in money supply affect prices & other nominal variables but don’t affect real GDP, unemployment • But in short run, real/ nominal variables intertwined, money supply can temporarily ↑real GDP • @For modeling aggregate S & D, variables are real GDP and price level, one real one nominal • **Model of aggregate S & D; model used to explain short-run changes in economic activity around its long run trend • Graph is overall price level (y-axis) vs. overall quantity of goods/ services • Demand Curve – quantity of goods/ services that everyone wants to buy at price level • Supply Curve – quantity of goods/ services that firms wants to sell at price level • @Demand downwards because as p
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