VII_goods_market_openeconomy_ho

VII_goods_market_openeconomy_ho - 118 ECON110B VII. The...

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Unformatted text preview: 118 ECON110B VII. The Goods market in an open economy • To expand our treatment of the goods market in the closed economy to take into openness in goods markets • To characterize equilibrium in the goods market for an open economy • To show the effects of domestic shocks and foreign shocks on the domestic economy’s output and trade balance • To look at the effects of a real depreciation on output and the trade balance • Alternative description of the equilibrium: the close connection between saving, investment, and the trade balance 1. The IS relation in the open economy 1) The demand for domestic goods a. Demand for domestic goods ( Z ) - X IM G I C Z + − + + ≡ ε /- C + I + G : Domestic demand for goods 119- IM/ ε : The value of imports in terms of domestic goods - Now we must be able to distinguish between the domestic demand for goods and the demand for domestic goods . - Some domestic demand falls on foreign goods, and some of the demand for domestic goods comes from foreigners. b. Domestic demand for goods - C + I + G ⇒ Also the demand for domestic goods if the economy was closed- Two adjustments i) First, we must subtract imports - Part of the domestic demand that falls on foreign goods rather than on domestic goods - To express the value of imports in terms of domestic goods ⇒ IM/ ε- ε : The price of domestic goods in terms of foreign goods - 1/ ε : The price of foreign goods in terms of domestic goods 120 ii) Second, we must add exports ( X ) - Part of the demand for domestic goods that comes from abroad 2) The determinants of C, I, and G a. Domestic demand - G r Y I T Y C G I C + + − = + + − + + ) , ( ) ( b. No role of expectations at the moment 3) The determinants of imports a. Imports - The part of domestic demand that falls on foreign goods i) They depend on domestic income: - Higher income ⇒ Higher domestic demand for domestic goods and foreign goods ⇒ ↑ Imports ii) They also depend on the real exchange rate - More expensive domestic goods relative to foreign goods ⇒ Cheaper foreign goods relative domestic goods ⇒ Higher domestic demand for foreign goods ⇒ Higher imports 121 b. Imports function - ( , ) IM IM Y ε + + =- An increase in domestic income, Y , leads to an increase in imports. - An increase in the real exchange rate, ε , leads to an increase in imports, IM 4) The determinants of exports a. Exports ( X ) - The part of foreign demand that falls on domestic goods i) It depends on foreign income ( Y * ) - Higher foreign income ⇒ Higher foreign demand for foreign and domestic goods ⇒ Higher exports ii) It depends also on the real exchange rate - Higher price of domestic goods in terms of foreign goods (higher real exchange rate) ⇒ Lower foreign demand for domestic goods ⇒ Lower exports b. Exports function - ) , ( * − + = ε Y X X 122- An increase in foreign income, Y* , leads to an increase in exports - An increase in the real exchange rate, ε , leads to a decrease in exports...
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This note was uploaded on 09/18/2008 for the course ECON 100B taught by Professor Rauch during the Winter '07 term at UCSD.

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VII_goods_market_openeconomy_ho - 118 ECON110B VII. The...

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