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302-05 - C H A P T E R The Open Economy University of...

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C H A P T E R The Open Economy University of Wisconsin Charles Engel 5
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CHAPTER 5.01 slide 2 In this chapter, you will learn… accounting identities for the open economy the small open economy model what makes it “small” how the trade balance and exchange rate are determined how policies affect trade balance & exchange rate
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CHAPTER 5.01 slide 3 Trade-GDP ratio, selected countries,  2004 (Imports + Exports) as a percentage of GDP  Luxembourg 275.5% Ireland 150.9 Czech Republic 143.0 Hungary 134.5 Austria 97.1 Switzerland 85.1 Sweden 83.8 Korea, Republic of 83.7 Poland 80.0 Canada 73.1 Germany 71.1% Turkey 63.6 Mexico 61.2 Spain 55.6 United Kingdom 53.8 France 51.7 Italy 50.0 Australia 39.6 United States 25.4 Japan 24.4
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CHAPTER 5.01 slide 4 In an open economy, spending need not equal output saving need not equal investment
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CHAPTER 5.01 slide 5 Preliminaries EX = exports = foreign spending on domestic goods IM = imports = C f + I f + G f = spending on foreign goods NX = net exports ( a.k.a. the “trade balance”) = EX IM d f C C C = + d f I I I = + d f G G G = + superscripts: d = spending on domestic goods f = spending on foreign goods
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CHAPTER 5.01 slide 6 GDP = expenditure on  domestically produced g & s d d d Y C I G EX = + + + ( ) ( ) ( ) f f f C C I I G G EX = - + - + - + ( ) f f f C I G EX C I G = + + + - + + C I G EX I M = + + + - C I G NX = + + +
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CHAPTER 5.01 slide 7 The national income identity  in an open economy Y  =  C  +  I  +  G  +  NX or,     NX     Y     –    ( C     I    +  G   ) net exports domestic spending output
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CHAPTER 5.01 slide 8 Trade surpluses and deficits trade surplus: output > spending and exports > imports Size of the trade surplus = NX trade deficit: spending > output and imports > exports Size of the trade deficit = NX NX    =   EX   –  IM    =   Y     –    ( C      +  )
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U.S. net exports , 1950-2006 U.S. Net Exports, 1950-2006 -800 -600 -400 -200 0 200 1950 1960 1970 1980 1990 2000 billions of dollars -8% -6% -4% -2% 0% 2% percent of GDP NX ($ billions) NX (% of GDP)
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CHAPTER 5.01 slide 10 International capital flows Net capital outflow = S   –  I = net outflow of “loanable funds” = net purchases of foreign assets the country’s purchases of foreign assets minus foreign purchases of domestic assets When S   >  I , country is a net lender When S   <  I , country is a net borrower
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CHAPTER 5.01 slide 11 The link between trade & cap. flows NX     Y     –    ( C     I     ) implies NX    =  ( Y     –  C     –  ) –   I    =          S       –     I trade balance = net capital outflow Thus, a country with a trade deficit ( NX < 0 ) is a net borrower ( S  <   ).
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CHAPTER 5.01 slide 12 “The world’s largest debtor nation” U.S. has had large trade deficits, been a net borrower each year since the early 1980s.
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