Net exports the value of a nations exports the value

This preview shows page 14 - 16 out of 25 pages.

Net exports: (the value of a nation’s exports) – (the value of a nation’s imports) Net capital outflow: (the purchase of foreign assets by domestic residents) – (the purchase of domestic assets by foreigner) $ Net capital outflow = $ Net exports (must balance) o When a nation is running a trade surplus (NX>0), it is selling more goods and services to foreigners than it is buying from them. What is it doing with the foreign currency it receives from the net sale of goods and services abroad? It must be using it to buy foreign assets. Capital is flowing out of the country (NCO>0). o When a nation is running a trade deficit (NX<0), it is buying more goods and services from foreigners than it is selling to them. How is it financing the net purchase of these goods and services in world markets? It must be selling assets abroad. Capital is flowing into the country (NCO<0) Recall, Y=C+I+G+NX; with rearrangement, we get: S = I+NX and S = I+NCO **in an open economy** o In a closed economy, it is S = I Nominal exchange rate: the rate at which a person can trade the currency of one country for the currency of another Appreciation: an increase in the value of a currency as measured by the amount of foreign currency it can buy Depreciation: a decrease in the value of a currency as measured by the amount of foreign currency it can buy Real exchange rate: the rate at which a person can trade the goods and services of one country for the goods services of another Real exchange rate = (Nominal exchange rate x Domestic price) / Foreign price o E.g. (4 rubles per dollar x $200 per bushel of Canadian wheat) / 1600 rubles per bushel of Russian wheat = 0.5 bushel of Russian wheat per bushel of Canadian wheat Real exchange rate = (e x P) / P* (simplified version of equation above) o P: price index for a Canadian basket of goods and services o P*: price index for a foreign basket of goods and services o E: exchange rate between Canadian dollar and foreign currencies (i.e. nominal exchange rate) Purchasing-power parity: a theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries o i.e. the exchange rate adjusts so that an identical good in 2 different countries has the same price when expressed in the same currency o Law of one price: goods must sell for one price in all locations, otherwise, opportunities for profit would be left unexploited (supply and demand) o Arbitrage: process of taking advantage of differences in prices in different markets (locations)
` o Purchasing-power parity states that a unit of all currencies must have the same real value in every country o If the purchasing power of the dollar is always the same at home and abroad, then the real exchange rate—the relative price of domestic and foreign goods —cannot change o According to the theory of purchasing-power parity, the nominal exchange rate between the currencies of two countries must reflect the different price levels in those countries

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture