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Questions and Answers
What does the equation 'net capital outflow = S - I' represent?
What does the equation 'net capital outflow = S - I' represent?
When a country's savers supply more funds than what firms wish to borrow for investment, what occurs?
When a country's savers supply more funds than what firms wish to borrow for investment, what occurs?
What happens when a Japanese resident buys a bond issued by the U.S. government?
What happens when a Japanese resident buys a bond issued by the U.S. government?
What term describes borrowing and lending that occurs internationally?
What term describes borrowing and lending that occurs internationally?
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If a country is borrowing more than its domestic savers are lending, what is the relationship between savings and investment?
If a country is borrowing more than its domestic savers are lending, what is the relationship between savings and investment?
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The net capital outflow can also be termed as what?
The net capital outflow can also be termed as what?
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What is one effect of a U.S. resident purchasing stock in a foreign company?
What is one effect of a U.S. resident purchasing stock in a foreign company?
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Which of the following best explains why a country might experience net capital inflow?
Which of the following best explains why a country might experience net capital inflow?
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What happens to net exports (NX) when national saving decreases?
What happens to net exports (NX) when national saving decreases?
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How does an increase in government purchases by foreign countries affect the world economy if they are a large part of it?
How does an increase in government purchases by foreign countries affect the world economy if they are a large part of it?
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What effect does expansionary fiscal policy abroad have on the world interest rate?
What effect does expansionary fiscal policy abroad have on the world interest rate?
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What is the relationship between saving (S), investment (I), and net exports (NX) in an open economy?
What is the relationship between saving (S), investment (I), and net exports (NX) in an open economy?
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What occurs to investment (I) in a small open economy when the world interest rate rises?
What occurs to investment (I) in a small open economy when the world interest rate rises?
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When saving exceeds investment in a small open economy, what happens to net exports (NX)?
When saving exceeds investment in a small open economy, what happens to net exports (NX)?
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Which of the following statements is true regarding the impact of foreign fiscal policy on investment?
Which of the following statements is true regarding the impact of foreign fiscal policy on investment?
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What happens to domestic savings when investment decreases due to rising world interest rates?
What happens to domestic savings when investment decreases due to rising world interest rates?
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What does a nominal exchange rate express?
What does a nominal exchange rate express?
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If the exchange rate is 80 yen per dollar, how much dollar do you get for 80 yen?
If the exchange rate is 80 yen per dollar, how much dollar do you get for 80 yen?
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How is the real exchange rate different from the nominal exchange rate?
How is the real exchange rate different from the nominal exchange rate?
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What does the term 'terms of trade' refer to in the context of exchange rates?
What does the term 'terms of trade' refer to in the context of exchange rates?
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If a pound of Swiss cheese costs twice as much as a pound of American cheese, what is the real exchange rate?
If a pound of Swiss cheese costs twice as much as a pound of American cheese, what is the real exchange rate?
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How can an exchange rate be expressed?
How can an exchange rate be expressed?
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What does the symbol 'ε' represent in economics?
What does the symbol 'ε' represent in economics?
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Which of the following currencies has the lowest exchange rate relative to the dollar as of the given data?
Which of the following currencies has the lowest exchange rate relative to the dollar as of the given data?
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What does the accounting identity NX = S - I represent?
What does the accounting identity NX = S - I represent?
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What contributes to the determination of net capital outflow (NCO)?
What contributes to the determination of net capital outflow (NCO)?
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How does the world interest rate (r*) influence investment (I)?
How does the world interest rate (r*) influence investment (I)?
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What does an increase in net exports imply about net capital outflow?
What does an increase in net exports imply about net capital outflow?
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What is the implication of a vertical net capital outflow curve?
What is the implication of a vertical net capital outflow curve?
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Which factor does NOT affect domestic savings (S)?
Which factor does NOT affect domestic savings (S)?
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In the context of foreign exchange markets, what do foreigners demand dollars for?
In the context of foreign exchange markets, what do foreigners demand dollars for?
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Why does ε need to adjust in the open economy model?
Why does ε need to adjust in the open economy model?
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What occurs at the equilibrium real exchange rate?
What occurs at the equilibrium real exchange rate?
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If government spending (G) increases by $250, how does ΔS change?
If government spending (G) increases by $250, how does ΔS change?
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How does a decrease in taxes (T) by $700 affect ΔS?
How does a decrease in taxes (T) by $700 affect ΔS?
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What is the effect on ΔS when national income (Y) increases by $1200?
What is the effect on ΔS when national income (Y) increases by $1200?
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What would be the result for ΔS if labor (L) is decreased by 1200?
What would be the result for ΔS if labor (L) is decreased by 1200?
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If the value of capital (K) increases by $3500, how does that affect ΔS?
If the value of capital (K) increases by $3500, how does that affect ΔS?
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What type of production function is used in the given scenarios?
What type of production function is used in the given scenarios?
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What happens to the equilibrium point in the event of a technological decline affecting firms?
What happens to the equilibrium point in the event of a technological decline affecting firms?
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What is needed to calculate the real exchange rate between American and Japanese rice?
What is needed to calculate the real exchange rate between American and Japanese rice?
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If the price of a U.S. Big Mac is $2.50 and the nominal exchange rate is 120 Yen/$, how much would a Japanese consumer effectively pay for a U.S. Big Mac in Japanese Yen?
If the price of a U.S. Big Mac is $2.50 and the nominal exchange rate is 120 Yen/$, how much would a Japanese consumer effectively pay for a U.S. Big Mac in Japanese Yen?
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The variable ε in the context of real exchange rates primarily represents what?
The variable ε in the context of real exchange rates primarily represents what?
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Using the values provided, what is the real exchange rate ε for Big Macs between the USA and Japan?
Using the values provided, what is the real exchange rate ε for Big Macs between the USA and Japan?
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When discussing the relationship between nominal exchange rates and real exchange rates, what key factor is necessary for computation?
When discussing the relationship between nominal exchange rates and real exchange rates, what key factor is necessary for computation?
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How does a change in the nominal exchange rate primarily affect real exchange rates?
How does a change in the nominal exchange rate primarily affect real exchange rates?
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What does the formula ε = e × P / P * indicate in terms of the variables e, P, and P *?
What does the formula ε = e × P / P * indicate in terms of the variables e, P, and P *?
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In a model where only one output is considered, what does ε represent?
In a model where only one output is considered, what does ε represent?
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Study Notes
Open Economy Introduction
- An open economy is one where a country's spending in a given year does not need to equal its output of goods and services.
- A country can either borrow from abroad or lend to foreigners to cover any difference between its spending and output.
National Income Identity
- In an open economy, the national income identity is Y = C + I + G + NX.
- Nx represents net exports
- This equation shows that spending in an open economy does not need to equal the output of goods and services.
Trade Surpluses and Deficits
- If a country's output exceeds its domestic spending, it exports the difference. This results in positive net exports.
- If a country's output falls short of its domestic spending, it imports the difference. This results in negative net exports.
Trade Surpluses/Deficits/Balanced Trade
- Trade Surplus: Output is greater than spending, and exports are greater than imports.
- Trade Deficit: Spending is greater than output, and imports are greater than exports.
- Balanced Trade: Output equals spending, and exports equal imports.
International Capital Flows and the Trade Balance
- Net capital outflow (NCO) is the difference between domestic saving and domestic investment.
- NCO = S − I
- If a country saves more funds than its firms wish to borrow for investment, the excess loanable funds flow abroad, resulting in positive NCO. This results in the purchase of foreign assets
Equality of Net Exports and Net Capital Outflow
- For an entire economy, net capital outflow (NCO) must always equal net exports (NX).
- NX = NCO
Trade Surpluses and Deficits in an Open Economy
- Output > Spending = Trade Surplus, NX>0
- Output < Spending = Trade Deficit, NX<0
- Output = Spending = Balanced Trade, NX = 0
Saving and Investment in a Small Open Economy (SOE)
- A small open economy has a negligible impact on the global economy.
- Perfect capital mobility: Residents of a small open economy have full access to world markets, allowing them to borrow and lend internationally without restrictions set by the government.
Saving and Investment in a Small Open Economy
- The real interest rate in an SOE equals the world interest rate
- This means investment in the SOE is set by the world real interest rate
Saving and Investment in a Small Open Economy
- The saving in an SOE is independent of the world interest rate.
- The world real interest rate determines investment
The Link Between Trade and Capital Flows
- Trade balance (NX) = National saving (S) - Domestic Investment (I) A trade deficit (NX < 0) means net borrowing
U.S.: The World's Largest Debtor Nation
- Since the 1980s, the U.S. has consistently run trade deficits.
- This led to net capital inflows and the country's net indebtedness to the rest of the world, which stands at an extraordinary amount higher than that of other countries.
- The U.S. is recognized as the world's largest debtor nation as of 2014.
Exchange Rates
- The exchange rate between two countries represents the price at which residents of those countries exchange currencies.
- Nominal exchange rate: The rate at which a person can trade the currency of one country for the currency of another. (e.g., yen to dollar).
- Real exchange rate: The relative price of goods in two countries. (e.g., cost of the same good in one country vs. the cost of the same good in another country).
The Nominal Exchange Rate
- The nominal exchange rate is expressed as a rate: the price per unit of a foreign currency.
The Real Exchange Rate
- The relative price of one country's goods in terms of another countries' goods. (e.g., cost of the same good in one country vs the cost of the same good in another country)
How NX depends on ε
- The real exchange rate (ε) is computed from the nominal exchange rate and the price levels of the two countries involved.
- A high real exchange rate indicates that foreign products are cheaper than domestic products. This makes imports rise, and exports fall, so net exports decline.
- A low real exchange rate indicates that foreign products are more expensive compared to domestic products. This makes imports fall, and exports rise, so net exports rise.
The Net Exports Function
- NX = NX(ε)
The NX curve and how it relates to the real exchange rate, ε:
- A negative relationship between net exports and the real exchange rate: As ε increases, NX decreases.
How ε is Determined
- The accounting identity states that Net Exports = Net Capital Outflow
- The supply of dollars from net capital outflow equals the demand for dollars by foreigners buying net exports.
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Description
Test your knowledge of key concepts related to international economics, including net capital outflow, saving and investment relationships, and the effects of government purchases on the global economy. This quiz will help reinforce your understanding of how capital flows between countries and the implications for net exports.
