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ch5amemo2 - Economics 3307 Main Points of Chapter 5: The...

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Economics 3307 Main Points of Chapter 5: The Open Economy 1. Y = C + I + G + NX, where NX = net exports = exports - imports. Remember that C, I, and G include spending on imports . 2. We will sometimes also refer to NX as the trade balance . NX > 0 means EX > IM, exports exceed imports, and the economy has a trade surplus . If NX < 0, then EX < IM, imports exceed exports, and the economy has a trade deficit . 3. NX = Y - (C+I+G). If domestic spending exceeds output (C+I+G > Y), then NX is negative and a country has a trade deficit. If output exceeds domestic spending (Y > C+I+G), then NX is positive and a country has a trade surplus (NX > 0). 4. The difference between domestic saving (S) and domestic investment (I) is called net foreign investment . So, net foreign investment = (S - I). But (S - I) also equals NX, so net foreign investment is equal to the trade balance. a. If S > I, then net foreign investment and NX are positive. That is, part of domestic savings goes to fund foreign investment. An economy with positive net foreign investment will necessarily have a trade surplus. Japan has been in this position for the last several years. b. If S < I, then net foreign investment and NX are negative. Domestic savings is less than domestic investment, so part of domestic investment is funded with foreign savings. An economy with negative net foreign investment will necessarily have a trade deficit. This has been the case for the US in the last several years. 5. In talking about international trade, economists use the term “small country” to refer to a country that can borrow or lend any amount at the prevailing world interest rate (r*). More generally, a small country is the international trade theory equivalent of a perfectly competitive firm: it can take all prices as given, assuming that its buying and selling decisions have no effect on prices. 6. The world real interest rate (r*) is determined by equilibrium between world savings and world investment. 7. NX = S - I(r*). In a small open economy, the world real interest rate (r*) determines the level of investment. K and L determine Y, which in turn determines C and S. NX > 0 if S > I, and NX < 0 if S < I. The trade balance is determined by the difference between saving and investment at the world real interest rate. 8.
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This note was uploaded on 04/30/2008 for the course ECO 3307 taught by Professor Green during the Spring '08 term at Baylor.

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ch5amemo2 - Economics 3307 Main Points of Chapter 5: The...

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