ch.13 - Ch.13 Open Economy There are clear benefits to be...

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Ch.13 Open Economy There are clear benefits to be open to international trade: - international trade can raise the living standards in all countries by allowing each country to specialize in producing those goods and services in which it has a comparative advantage. So far, however, our development of macroeconomics has largely ignored the economy’s interaction with other economies around the world. A closes economy is one that does not interact with other economies in the world: - there are no exports, no imports, and no capital flows. An open economy is one that interacts freely with other economies around the world: - it buys and sells goods and services in world product markets. - It buys and sells capital assets in world financial markets. Exports, imports and net exports Exports (X): goods and services produced domestically and sold abroad. Imports (M): goods and services produced abroad and sold domestically. Net exports (NX): exports minus imports (i.e. X-M) Net exports are also called the trade balance. If NX<0 (if exports less than imports) we say we have a trade deficit. If NX>0, we have a trade surplus. Balanced trade: when NX=0 Factors that affect net exports The tastes of consumers for domestic and foreign goods. The prices of goods at home and abroad. The exchange rates at which ppl can use domestic currency to buy foreign currencies. The incomes of consumers at home and abroad. The cost of transporting goods from country to country. The policies of the government toward international trade. Net Capital Outflow Net capital outflow (NCO): Purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners (Also sometimes called net foreign investment)
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When a Canadian buys stock in BMW, Canadian NCO increases. When a Japanese resident buys a Canadian government bond, Canadian NCO decreases. The flow of capital abroad takes two forms - foreign direct investment (FDI): Purchases by Canadian resident of foreign real assets (e.g Tim Hortons opens a fast food outlet in Russia) - Foreign portfolio investment: purchases bu Canadian residents of foreign financial assets (e.g BMW stocks) Variables that Influence NCO Real interest rates being paid on foreign assets compared to real interest rates - For example, if Canadian real interest rates are lower than U.S real interest rates (and assuming that investors anticipated no change in exchange rates), then investment capital will move from Canada to the U.S (i.e NCO will increase) Perceived economic and political risks of holding assets abroad. Government policies that affect foreign ownership of domestic assets. The equality of Net Exports and Net capital outflow For an economy as a whole, NX, and NCO must balance each other so that: NCO=NX This holds true because every transaction that affects one side must also affect the other side by the same amount. For example suppose Bombardier sells a place to the U.S. for 100 million USD.
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This note was uploaded on 12/08/2009 for the course TEFLER ADM1300 taught by Professor Koppel during the Fall '09 term at University of Ottawa.

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ch.13 - Ch.13 Open Economy There are clear benefits to be...

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