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Chapter 32

Economics 10b Chapter Notes - Chapter 32: Capital Outflow, Import Quota, International Finance

Course Code
Economics 10b
Gregory Mankiw

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Chapter 32 – A Macroeconomic Theory of the Open Economy
Supply and Demand for Loanable Funds and for Foreign-Currency Exchange
- S = I + NCO
- Supply of loanable funds comes from national saving, demand for loanable funds
from domestic investment and net capital outflow
- Loanable funds are the domestically generated flow of resources available for
capital accumulation
- When NCO > 0, net purchase of capital overseas adds to demand for domestically
generated loanable funds
- When NCO < 0, capital resources from abroad reduce demand for domestically
generated loanable funds
- High real interest rate reduces net capital outflow  more profitable to buy
domestic assets
- At equilibrium, saving = domestic investment + net capital outflow, balanced by
real interest rate
- NX = NCO, net exports represents quantity of dollars demanded to buy the net
exports which is net capital outflow
- Market for foreign-currency exchange  supply of dollars has vertical curve (NCO
does not depend on real exchange rate, only interest), intersect with demand for
dollars for net exports
- Real exchange rate on vertical axis, quantity of dollars exchanged into foreign
currency on horizontal axis
- As the equilibrium real exchange rate, the demand for dollars by foreigners
arising from the U.S., net export of goods and services exactly balances the
supply of dollars from Americans arising from U.S. net capital outflow
Equilibrium in the Open Economy
- market for loanable funds: S = I + NCO (balanced by real interest rate)
- market for foreign-currency exchange: NCO = NX (balanced by real exchange
- connected by NCO curve that is steeper than the demand curve of loanable funds
- net capital outflow can be positive when domestic real interest rate is low
How Policies and Events Affect an Open Economy
- government budget deficit  reduces supply of LF, drives up interest rate, crowds
out investment, higher interest rate reduces net capital outflow, reduces supply of
dollars in market for foreign-currency exchange, real exchange rate increases,
domestic products more expensive compared to foreign ones, trade deficit
(imports > exports)
-trade policy: government policy that directly influences the quantity of goods
and services that a country imports or exports ex: tariffs and quotas
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