Chapter 5

# Chapter 5 - ® CHAPTER 5 The Open Economy A PowerPoint...

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1 ® A PowerPoint Tutorial To Accompany MACROECONOMICS, 6th. ed. N. Gregory Mankiw By Mannig J. Simidian

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Chapter Five 2 When an economy is so-called, “open,” it means that a country’s spending in any given year is not equal to its output of goods and services. A country can spend more that it produces by borrowing from abroad, or it can spend less and lend the difference to foreigners. Let’s turn to national income accounting to explain.
3 Y = C + I + G + NX Y = C + I + G + NX Total demand for domestic output Consumption spending by households Investment spending by businesses and households Net exports or net foreign demand Notice we’ve added net exports, NX, defined as EX - IM . Also, note that domestic spending on all goods and services is the sum of domestic spending on domestics goods and services and on foreign goods and services. is composed of

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Chapter Five 4 Y = C + I + G + NX Y = C + I + G + NX After some manipulation, the national income accounts identity can be re-written as: NX = Y - (C + I + G) NX = Y - (C + I + G) Net Exports Output This equation shows that in an open economy, domestic spending need not equal the output of goods and services. If output exceeds domestic spending, we export the difference: net exports are positive. If output falls short of domestic spending, we import the difference: net exports are negative. Domestic Spending
Start with the national income accounts identity. Y = C + I + G + NX . Subtract C and G from both sides and obtain Y – C - G = I + NX . Let’s call this S , national saving . So, now we have S = I + NX . Subtract I from both sides to obtain the new equation, S I = NX . This form of the national income accounts identity shows that an economy’s net exports must always equal the difference between its saving and its investment . S I = NX Trade Balance Net Foreign Investment

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Chapter Five 6 S I = NX If S - I and NX are positive, we have a trade surplus . We would be net lenders in world financial markets, and we are exporting more goods than we are importing. If S - I and NX are negative, we have a trade deficit . We would be 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 have balanced trade since the value of imports equals the value of exports. Net Capital Outflow = Trade Balance
7 A bilateral trade balance between two countries means that the value of what a country sells to one country is equal to the value of what it buys from that country. For example, there would be a bilateral trade balance between the United States. and China if the United States buys a pair of shoes from China valued at \$300, but also sells a pair of jeans to China for \$300. A nation can have large trade deficits and surpluses with different countries but have balanced trade overall. For example, there would be balanced trade overall if the United States sells a \$300 pair of jeans to Japan, Japan sells a \$300 car seat to China, and China sells a \$300 pair of shoes to the United States. In this case, each country that bought somethin

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## This note was uploaded on 04/02/2008 for the course ECON 420 taught by Professor Hill during the Fall '08 term at UNC.

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Chapter 5 - ® CHAPTER 5 The Open Economy A PowerPoint...

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