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Unformatted text preview: EC 151 Ch: 18 Openeconomy Macroeconomics: Basic concepts
The international flows of goods and capital The prices for international transactions: Real and nominal exchange rates A first theory of exchange rate determination: Purchasingpower parity Intro Trade can make everyone better off International trade can rise living standards in all countries by allowing each country to specialize in producing those goods and services in which it has a comparative advantage Closed vs. Open economy The flow of goods: Exports, Imports, and Net Exports Open economy interacts with other economies in two ways: Buy and sell goods and services Buy and sell capital assets Exports Imports Net exports Trade balance Trade surplus Trade deficit Balanced trade Stocks, bonds The flow of goods: Exports, Imports, and Net Exports Factors that might influence a country's exports, imports and net exports: tastes for domestic and foreign goods P of goods at home and abroad exchange rates at which people can use domestic currency to buy foreign currencies incomes of consumers home and abroad C of transporting goods from country to country Policies of the government toward international trade The flow of goods: Exports, Imports, and Net Exports Case study: The increasing openness of the U.S. Economy improvement in transportation advances in telecommunications technological progress government's trade policies The flow of financial resources Net capital outflow (net foreign I) Two forms of flow of capital The purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners foreign direct investment foreign portfolio investment Variables that influence net capital outflow: both cases U.S. residents are buying assets located in another country the real IR being paid on foreign assets the real IR being paid on domestic assets the perceived economic and political risk of holding assets abroad the government policies that affect foreign ownership of domestic assets The Equality of Net exports and Net capital outflow NCO = NX Two things happen simultaneously: U.S. sales to a foreigner some of its output
Increase NX U.S. acquires some foreign assets in return Increase in NCO Works the other way around Saving, Investment, and their relationship to the international flows Y = C + I + G + NX I = S S = Y C G Y C G = I + NX S = I + NX NX = NCO S = I + NCO Saving, Investment, and their relationship to the international flows Trade deficit Trade surplus Balanced trade Saving, Investment, and their relationship to the international flows Case study: Is the trade deficit a national problem? The prices for international transactions: real and nominal exchange rates Nominal exchange rate currency appreciation (strengthens) currency depreciation (weakens) Real exchange rate Real exchange rate = (e * P)/P*
e = nominal exchange rate P = domestic P level P* = foreign P level A first theory of exchangerate determination Purchasingpower parity Theory of exchange rates whereby a unit of any given currency should be able to buy the same Q of goods in all countries Based on principle called law of one P arbitrage Implications of PPP If the purchasing power of the dollar is always the same at home and abroad, then the real exchange the relative price of domestic and foreign goods cannot change According to PPP the nominal exchange rate between currencies of two countries must reflect the different P levels in those countries 1/P = e/P* 1 = e * P / P* Connection to the money supply e = P* / P Implications of PPP Case study: The nominal exchange rate during hyperinflation Limitations of PPP Not completely accurate many goods are not easily traded goods not always perfect substitutes For these reasons real exchange rates will fluctuate in the LR Does provide a useful first step in understanding exchange rates Limitations of PPP Case study: The hamburger standard www.economist.com Country South Korea Japan Sweden Mexico Euro area Britain P of Big Mac 3,100 won 262 yen 26 kronor 21.90 pesos 2.67 euros 1.99 pounds PPP predicted exchange rate 1,245 won/$ 105 yen/$ 10.4 kronor/$ 8.80 pesos/$ 1.07 euros/$ 0.80 pound/$ Actual exchange rate 1,304 won/$ 130 yen/$ 10.3 kronor/$ 9.28 pesos/$ 1.12 euros/$ 0.69 pound/$ ...
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