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  • Chap 18: Open-Economy Macroeconomics: Basic Concepts

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    Trần Ngọc Châu Giang
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    The document discusses key concepts in open-economy macroeconomics. It defines an open economy as one that interacts freely with other economies through international trade and capital flows. It describes the flows of goods and capital between countries. The trade balance measures the flow of goods and is equal to exports minus imports. The net capital outflow measures the flow of financial capital and is equal to domestic purchases of foreign assets minus foreign purchases of domestic assets. By accounting identity, the trade balance always equals the net capital outflow. The exchange rate measures the value of one country's currency relative to others and impacts trade balances. Purchasing power parity theory holds that exchange rates should adjust so that the same goods cost the same in all countries when

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    The document discusses key concepts in open-economy macroeconomics. It defines an open economy as one that interacts freely with other economies through international trade and capital flows. It describes the flows of goods and capital between countries. The trade balance measures the flow of goods and is equal to exports minus imports. The net capital outflow measures the flow of financial capital and is equal to domestic purchases of foreign assets minus foreign purchases of domestic assets. By accounting identity, the trade balance always equals the net capital outflow. The exchange rate measures the value of one country's currency relative to others and impacts trade balances. Purchasing power parity theory holds that exchange rates should adjust so that the same goods cost the same in all countries when

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    48 views4 pages

    Chap 18: Open-Economy Macroeconomics: Basic Concepts

    Uploaded by

    Trần Ngọc Châu Giang
    The document discusses key concepts in open-economy macroeconomics. It defines an open economy as one that interacts freely with other economies through international trade and capital flows. It describes the flows of goods and capital between countries. The trade balance measures the flow of goods and is equal to exports minus imports. The net capital outflow measures the flow of financial capital and is equal to domestic purchases of foreign assets minus foreign purchases of domestic assets. By accounting identity, the trade balance always equals the net capital outflow. The exchange rate measures the value of one country's currency relative to others and impacts trade balances. Purchasing power parity theory holds that exchange rates should adjust so that the same goods cost the same in all countries when

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    of 4

    CHAP 18: OPEN-ECONOMY MACROECONOMICS: BASIC CONCEPTS

    Open economy: interact freely with other economies


     Buy and sell: + Goods and Services
    + Stocks and Bonds
    I. The international flows of Goods and Capital
    1. The flow of Goods
    - Trade balance:
    Net exports = Value of export – value of imports
     Trade surplus: NX >0
     Trade deficit: NX <0
     Balanced trade: NX=0
    - Factors influence NX:
    + Consumers’ preferences for foreign and domestic good
    + Prices of goods at home and abroad
    + Exchange rate
    + Income of consumer
    + Transportation cost
    + GO policies
    Active learning 1:
    What do you think would happen to U.S. net exports if:
    A. Canada experiences a recession (falling incomes, rising unemployment)
    B. U.S. consumers decide to be patriotic and
    buy more products “Made in the U.S.A.”
    C. Prices of goods produced in Mexico rise faster than prices of goods produced in
    the U.S.
    D. US currency appreciates.
     Solve:
    A. U.S. net exports would fall due to a fall in Canadian consumers’ purchases of
    U.S. exports
    B. U.S. net exports would rise due to a fall in imports
    C. This makes U.S. goods more attractive relative to Mexico’s goods. Exports to
    Mexico increase, imports from Mexico decrease, so U.S. net exports increase
    D. This makes U.S. goods less attractive because foreign consumers have to pay
    more. US exports decrease, so U.S. net exports decrease
    2. The flow of Financial Resources
    - Net capital outflow, NCO:
    NCO = purchase of foreign assets by domestic residents – purchase of
    domestic asset by foreigners
     NCO >0: capital outflow
     NCO <0: capital inflow
    Ex:
    •When Toyota corporation in Japan invest to build a new factory in
    India  the investment raise Japan’s NCO.
    •When a V.N. resident buys stock of Tesla in US,  the purchase raises
    V.N. NCO.
    •When a Japanese residents buys a bond issued by the U.S. government,
     the purchase reduces the U.S. NCO
    - Factors influences NCO:
    + Real interest paid on foreign asset
    + Real interest paid on domestic assets
    + Perceived risks of holding foreign asset
    + GO policies affecting foreign ownership of domestic asset
    3. The equality of NX and NCO
    An accounting identity:
    NCO = NX
     Every transactions that affect NX also affect NCO by the same amount (vice
    versa)
    Ex:
    + When a foreigner purchase a good from the U.S
    → U.S export ↑ so NX ↑. The foreigner pays with currency or assets, so the U.S acquires
    some foreign asset, causing NCO ↑
    + When a U.S citizen buys foreign goods
    → U.S imports ↑ so NX ↓. The U.S buyer pays with U.S dollar or assets, so other country
    acquires U.S asset, causing U.S NCO ↓
    4. Saving and Investment
    Recall: National saving: S = Y – C – G *
    In open economy: Y = C + I + G + NX
     Y – C – G = I = NX
    From *, we have National Saving: S = I + NX = I + NCO
     After all, National Saving in open economy is : S = I + NX
    = I + NCO

    II. Real and Nominal exchange rate


    1. Nominal exchange rate
    - Rate at which one country’s currency trades for another
    - We express all exchange rates as foreign currency per unit of domestic
    currency
    - 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 measured by the
    amount of foreign currency it can buy
    2. Real exchange rate
    - The rate at which the G&S of one country trade for the G&S of another

    Active learning 2:
    e = 23,500 VND per $
    price of a tall Starbucks Latte:
    • P = $3 in U.S.,
    • P* = 60,000 VND in Vietnam
    A. What is the price of a U.S. latte measured in VND?
    B. Calculate the real exchange rate, measured as VN lattes per U.S. latte.
     Solve:
    A. e x P = (23,500 VND per $) x (3 $ per U.S. latte)
    = 70,500 VND per U.S. latte
    B. e x P / P* = 70,500 VND per U.S. latte / 60,000 VND per VN latte = 1.175 VN
    lattes per U.S. latte
    III. Purchasing Power Parity, PPP
    - Law of one price: a good should sell fro the same price in all markets
    - State: theory of exchange rates that a unit of any given currency should
    be able to buy the same quantity of goods in all countries
    - Implications of PPP:
    + If purchasing power of the dollar is always the same at home and
    abroad → real exchange rate cannot change
    + Theory of PPP:
     Nominal exchange rate between the currencies of 2 countries must
    reflect the price levels in those countries
     Nominal exchange rates change when price levels change
     When a central bank in any country increase the money supply
     Cause price level to rise
     Country’s currency depreciate
    - Limitations of PPP:
     Many goods are not easily traded
     Even tradable goods are not always perfect substitutes

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