Possible Short Answer Terms for midterm 2

Possible Short Answer Terms for midterm 2 - Possible Short...

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Possible Short Answer Terms Chapter 5 1. Trade Balance: a. In an open economy, the trade balance is represented by Net Exports, which is Savings minus Investment. Or, Output minus Domestic Spending. If NX is positive, we have a trade surplus. In this case we are net lenders in the world financial markets and we are exporting more goods than we are importing. If NX is negative, we have a trade deficit. In this case, we are net borrowers in world financial markets and we are importing more goods than we are exporting. If S – I and NX are exactly zero, we are said to have balanced trade. b. Also, if trade surplus, output is greater than domestic spending and if a trade deficit, output is less than domestic spending 2. Net Capital Outflow: a. Represented as saving minus investment which equals net exports. 3. How Policies Influence the Trade balance a. Fiscal Policy at Home i. Increase in Government Spending in small open economy 1. Reduces national saving because S = Y – C – G 2. Unchanged world real interest rate, investment remains the same 3. Saving falls below investment and now we have a trade deficit ii. Decrease in taxes 1. Lowers T 2. Raises disposable income (Y – T) 3. Stimulates consumption 4. Reduces national saving iii. Starting from a balanced trade, a change in fiscal policy that reduces national saving leads to a trade deficit b. Fiscal Policy Abroad i. Foreign government increases government spending 1. If small, nothing changes for our country 2. If large, a. Reduces world saving b. World interest rate rises c. Raises cost of borrowing d. Reduces investment in our small open economy e. No change in domestic saving, saving S now exceeds investment I and we have a trade surplus 3. Starting from balanced trade, an increase in the world interest rate due to a fiscal expansion abroad leads to a trade surplus c. Shifts in Investment Demand i. If the demand for investment goods at every interest rate increases (would occur if for example, the government changed the tax laws to encourage investment by providing an investment tax credit) an outward shift in the investment schedule would cause a trade deficit 1. Net capital outflow is negative 4. Nominal Exchange Rate a. The relative price of the currency of two countries i. 1 dollar is 120 yen for example
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5. Real Exchange Rate a. The relative price of the goods of two countries b. Tells us the rate at which we can trade the goods of one country for the goods of another c. If the real exchange rate is high, foreign goods are relatively cheap, and domestic goods are relatively expensive. If real exchange rate is low, foreign goods are relatively expensive and domestic goods are relatively cheap. 6.
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This note was uploaded on 04/21/2008 for the course ECON 302 taught by Professor Gold during the Spring '07 term at Wisconsin.

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Possible Short Answer Terms for midterm 2 - Possible Short...

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