VI_openness_goods_financial_market_ho

VI_openness_goods_financial_market_ho - ECON110B VI...

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97 ECON110B VI. Openness in Goods and Financial Markets Openness has three distinct dimensions: i) Openness in goods markets: the ability of consumers and firms to choose between domestic goods and foreign goods ii) Openness in financial markets: the ability of financial investors to choose between domestic assets and foreign assets. iii) Openness in factor markets: the ability of firms to choose where to locate production, and of workers to choose where to work - We focus on openness in goods and financial markets Openness in the goods markets, the determinants of the choice between domestic goods and foreign goods , and the role of the real exchange rate Openness in financial markets, the determinants of the choice between domestic assets and foreign assets , and the role of interest rates and exchange rates 98 1. Openness in goods markets To think about the choice between domestic goods and foreign goods The role of the relative price of domestic goods in terms of foreign goods: the real exchange rate 1) Exports and imports a. U.S. exports and imports as ratios of GDP since 1960 b. Two main conclusions of the figure i) The U.S. economy is becoming more open over time, and trades more than twice as much (relative to its GDP) with the rest of the world as it did just 40 years ago
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99 ii) Although imports and exports have followed broadly the same upward trend, they have also diverged for long periods of time, generating sustained trade surpluses and trade deficits c. A better index of openness i) Media: a volume of trade (measured by the average of the ratios of exports and imports to GDP) - 12% of GDP: small portion ii) Better index : the proportion of aggregate output composed of tradable goods —or goods that compete with foreign goods in either domestic markets or foreign markets. - Estimates are that tradable goods represent around 60% of aggregate output in the United States today. d. Exports to GDP - The main factors behind these differences are geography and size 2) The choice between domestic goods and foreign goods a. First and second decisions - First decision: to save or to consume in the goods market of the closed economy 100 - Second decision: Whether to buy domestic goods or to buy foreign goods in the openness goods market - This decision has a direct effect on domestic output: To buy more domestic goods Higher demand for domestic goods Higher domestic output b. Real exchange rate - The relative price: the price of domestic goods relative to foreign goods - Not directly observable 3) Nominal exchange rates a. Nominal exchange rate between two currencies - Two expressions: i) Case 1: The price of the domestic currency in terms of foreign currency - Example: the price of dollar (domestic currency) in terms of pounds (foreign currency) £0.50/ $1 ii) Case 2: The price of the foreign currency in terms of the domestic currency - Example: $2.0/£1
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101 b. Nominal exchange rate (E) here - Case 1 The price of the domestic currency in terms of
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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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VI_openness_goods_financial_market_ho - ECON110B VI...

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