Chapter5 - Inthischapter,youwilllearn accounting identities...

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slide 1 CHAPTER 5 The Open Economy 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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slide 2 CHAPTER 5 The Open Economy Trade-GDP ratio, selected countries,  2005 (Imports + Exports) as a percentage of GDP  Luxembourg 297.2% Ireland 149.9 Czech Republic 141.5 Hungary 134.2 Austria 103.8 Sweden 89.8 Switzerland 89.0 Korea, Republic of 82.2 Germany 76.2% Poland 74.7 Canada 72.0 Mexico 61.5 Turkey 61.4 United Kingdom 56.8 Spain 56.4 France 53.0 Italy 52.2 Australia 42.1 Japan 27.3 United States 26.8
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slide 3 CHAPTER 5 The Open Economy In an open economy, spending need not equal output saving need not equal investment
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slide 4 CHAPTER 5 The Open Economy 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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slide 5 CHAPTER 5 The Open Economy 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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slide 6 CHAPTER 5 The Open Economy 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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slide 7 CHAPTER 5 The Open Economy 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 , 1950-2007 -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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slide 9 CHAPTER 5 The Open Economy 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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slide 10 CHAPTER 5 The Open Economy 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  <   ). Thus, a country with a trade deficit ( NX < 0 ) is a net borrower ( S  <   ).
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slide 11 CHAPTER 5 The Open Economy “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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