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notes1 - Notes on Obstfeld-Rogoff Ch.1 Open Economy =...

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1 Notes on Obstfeld-Rogoff Ch.1 • Open Economy = domestic economy trading with ROW • Macro level: focus on intertemporal issues (not: multiple good, added later) OR 1.1-1.2: Small economy = Easiest setting to convey basic ideas - Two periods t=1 (now) and t=2 (future) - Representative agents in each country; given incomes. - Small economy: takes international prices are given; incl. interest rate r. 1/(1+r) = relative price of period-2 consumption • Individual problem (person i):

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2 • Problem: • Indifference curve diagram: MRS = relative price. - Special case of β = 1/(1+r) => c 1 = c 2 . • Macroeconomics: Solution to country problem with identical individuals = Solution to individual problem. • Notation: Capital letters for country (in per capita units, or normalize population = 1)
3 • Definition of Current Account = income – consumption = net lending. with B t = foreign assets - Decompose: Trade balance + Net factor incomes from abroad. - Application to the two period model: because B 1 = 0, B 2 = Y 1 – C 1 , B 3 = 0. • Distinction: GDP vs. GNP (Data: See Table 1, p.7) - Here: GDP = Y 2 vs. GNP = Y 2 + r B 2

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4 • Comparison to Autarchy (Key graph: Fig.1.1, p.8) - Define the autarchy rate r A = equilibrium rate in closed economy (Y t =C t ) - Special case of β = 1/(1+r) with r = world interest rate. - If r A > r, then current resources are scarce => borrow; if r A < r, lend. - Variations in endowments: Y 1 up or Y 2 down => r A down, borrow less Find r A = r, iff Y 1 = Y 2 . Only output fluctuations motivate CA<>0.
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