Textbook Notes (270,000)
CA (160,000)
UTSC (20,000)
Chapter

Week 7 chapter notes


Department
Economics for Management Studies
Course Code
MGEB06H3
Professor
Jack Parkinson

This preview shows half of the first page. to view the full 2 pages of the document.
Chapter 5 The Open Economy Notes
5.1 The International Flows of Capital and Goods
x in an open economy, a country’s spending in any given year need not equal its output of goods and services
x a country can spend more than it produces by borrowing from abroad, or it can spend less and lend the difference to foreigners
The Role of Net Exports
x net exports Æ exports minus imports
x if output exceeds domestic spending, the difference is exported: net exports are positive
x if output falls short of domestic spending, the difference is imported: net exports are negative
Net Foreign Investment and the Trade Balance
x S = I + NX Æ S – I = NX Æ net capital outflow = trade balance
x this shows that an economys net exports must always equal the difference between its saving and its investment
x trade balance Æ the receipts from exports minus the payments for imports
x net capital outflow Æ net flow of funds being invested abroad; domestic saving minus domestic investment; also net foreign I
x net capital outflow equals amount that domestic residents are lending abroad minus amount that foreigners are lending to them
x if net capital outflow is positive, the economy’s saving exceeds its investment, and it is lending the excess to foreigners
x if net capital outflow is negative, the economy is experiencing a capital inflow: investment exceeds saving, and the economy is
financing this extra investment by borrowing from abroad
x thus, net capital outflow reflects the international flow of funds to finance capital accumulation
x trade surplus Æ when domestic saving minus domestic investment and net exports are negative
x trade deficit Æ when domestic saving minus domestic investment and net exports are positive
x balanced trade Æ a situation in which the value of imports equals the value of exports, so net exports equal zero
x the national accounts identity shows that the international flow of funds to finance capital accumulation and the international
flow of goods and services are two sides of the same coin
Trade Surplus Balanced Trade Trade Deficit
Exports > Imports Exports = Imports Exports < Imports
Net Exports > 0 Net Exports = 0 Net Exports < 0
Y > C + I + G Y = C + I + G Y < C + I + G
Saving > Investment Saving = Investment Saving < Investment
5.2 Saving and Investment in a Small Open Economy
Capital Mobility and the World Interest Rate
x small open economy Æ an open economy that takes its interest rate as given by world financing markets; an economy that, by
virtue of its size, has a negligible impact on world markets and, in particular, on the world interest rate
x world interest rate Æ the interest rate prevailing in world financial markets
x foreign lenders demand a risk premium when lending funds to Canadian firms and governments if they anticipate that the
Canadian dollar may fall in value while the loan is outstanding, which means that the foreign lenders will suffer a capital loss
Evaluating Economic Policy
x the impact of economic policies on the trade balance can always be found by examining their impact on domestic S and I
x policies that increase I or decrease S tend to cause a trade deficit, and policies that decrease I or increase S tend to cause a surplus
5.3 Exchange Rates
x the exchange rate between two countries is the price at which residents of those countries trade with each other
Nominal and Real Exchange Rates
x nominal exchange rate Æ the rate at which one country’s currency trades for another country’s currency
x when people refer tothe exchange rate” between two countries, they usually mean the nominal exchange rate
x real exchange rate Æ the rate at which one country’s goods trade for another country’s goods
x real exchange rate = (nominal exchange rate × price of domestic good) / price of foreign good
x real exchange rate = nominal exchange rate × ratio of price levels
x if the real exchange rate is high, foreign goods are relatively cheap, and domestic goods are relatively expensive
x if the real exchange rate is low, foreign goods are relatively expensive, and domestic goods are relatively cheap
The Determinants of the Real Exchange Rate
x combining the relationship between net exports and real exchange rate with the model of the trade balance developed earlier:
o The real exchange rate is related to net exports. When the real exchange rate is lower, domestic goods are less expensive
relative to foreign goods, and net exports are greater.
o The trade balance (NX) must equal net foreign investment, which in turn equals saving minus investment. Saving is fixed
by the consumption function and fiscal policy; investment is fixed by the investment function and the world interest rate.
x at the equilibrium real exchange rate, the supply of Canadian dollars available for net foreign investment balances the demand
for dollars by foreigners buying Canadian net exports (S – I = NX)
The Determinants of the Nominal Exchange Rate
x real exchange rate = nominal exchange rate × ratio of price levels
x percentage change in nominal exchange rate = percentage change in real exchange rate + difference in inflation rates
www.notesolution.com
You're Reading a Preview

Unlock to view full version