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Open-Economy Macroeconomics: Basic Concepts

  • Open and Closed Economies

  • A closed economy is one that does not interact with other economies in the world.

  • There are no exports, no imports, and no capital flows.

  • An open economy is one that interacts freely with other economies around the world.

  • An open economy interacts with other countries in two ways.

  • It buys and sells goods and services in world product markets.

  • It buys and sells capital assets in world financial markets.


THE INTERNATIONAL FLOW OF GOODS AND CAPITAL

  • An Open Economy

  • The United States is a very large and open economy—it imports and exports huge quantities of goods and services.

  • Over the past four decades, international trade and finance have become increasingly important.

The Flow of Goods: Exports, Imports, Net Exports

 

 

 

 

 

 

 

 

 

 

  • Exports are goods and services that are produced domestically and sold abroad.
  • Imports are goods and services that are produced abroad and sold domestically.
  • Net exports (NX) are the value of a nation’s exports minus the value of its imports.
  • Net exports are also called the trade balance.
  • A trade deficit is a situation in which net exports (NX) are negative.
    • Imports > Exports
  • A trade surplus is a situation in which net exports (NX) are positive.

 

 

 

 

 

 

 

  • Exports > Imports•Balanced trade refers to when net exports are zero—exports and imports are exactly equal.
    • Factors That Affect Net Exports
    • The tastes of consumers for domestic and foreign goods.
    • The prices of goods at home and abroad.
    • The exchange rates at which people can use domestic currency to buy foreign currencies. The incomes of consumers at home and abroad.
    • The costs of transporting goods from country to country.
    • The policies of the government toward international trade.

The Flow of Financial Resources: Net Capital Outflow

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  • Net capital outflow refers to the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners.
  • A U.S. resident buys stock in the Toyota corporation and a Mexican buys stock in the Ford Motor corporation.
  • When a U.S. resident buys stock in Telmex, the Mexican phone company, the purchase raises U.S. net capital outflow.
  • When a Japanese residents buys a bond issued by the U.S. government, the purchase reduces the U.S. net capital outflow.
  • Variables that Influence Net Capital Outflow
    • The real interest rates being paid on foreign assets.
    • The real interest rates being paid on domestic assets.
    • The perceived economic and political risks of holding assets abroad.
    • The government policies that affect foreign ownership of domestic assets.

The Equality of Net Exports and Net Capital Outflow

 

 

 

 

 

 

 

 

  • Net exports (NX) and net capital outflow (NCO) are closely linked.
  • For an economy as a whole, NX and NCO must balance each other so that: NCO = NX
  • This holds true because every transaction that affects one side must also affect the other side by the same amount.

Saving, Investment, and Their Relationship to the International Flows

  • Net exports is a component of GDP: Y = C + I + G + NX
  • National saving is the income of the nation that is left after paying for current consumption and government purchases: Y - C - G = I + NX
  • National saving (S) equals Y - C - G so: S = I + NX or Saving (S) = Domestic Investment (I) + Net Capital Outflow (NCO)

 

The document Flows of Goods and Capital - Open Economy, Macroeconomics | Macro Economics - B Com is a part of the B Com Course Macro Economics.
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FAQs on Flows of Goods and Capital - Open Economy, Macroeconomics - Macro Economics - B Com

1. What is an open economy in macroeconomics?
Ans. An open economy is a macroeconomic system in which a country engages in international trade and interacts with other countries in terms of imports and exports of goods, services, and capital. In an open economy, there is a free flow of goods and services across borders and countries can also invest in each other's economies.
2. What are the flows of goods and capital in an open economy?
Ans. In an open economy, the flow of goods refers to the imports and exports of physical goods between countries. The flow of capital refers to the movement of funds between countries, including foreign direct investment, portfolio investment, and borrowing and lending.
3. How do the flows of goods and capital impact the economy of a country?
Ans. The flows of goods and capital can impact the economy of a country in various ways. Imports can increase the availability of goods and services in a country, while exports can generate income and create employment opportunities. In terms of capital flows, foreign investment can help to finance domestic investment and promote economic growth. However, excessive capital inflows can lead to inflation and currency appreciation, while outflows can lead to currency depreciation and financial instability.
4. What are some examples of government policies that can influence the flows of goods and capital in an open economy?
Ans. Governments can use various policies to influence the flows of goods and capital in an open economy. For example, a government can impose tariffs or quotas on imports to protect domestic industries, or offer subsidies to promote exports. In terms of capital flows, a government can regulate foreign investment and restrict capital outflows to maintain financial stability. It can also use exchange rate policies to influence the value of its currency and its competitiveness in international trade.
5. How does globalization impact the flows of goods and capital in an open economy?
Ans. Globalization has led to an increase in the flows of goods and capital in open economies. Advances in technology and transportation have made it easier and cheaper to trade across borders, while financial liberalization has facilitated the movement of capital across countries. Globalization has also led to greater competition and specialization, as countries focus on their comparative advantages in producing goods and services. However, globalization has also led to concerns over job losses and inequality, as some industries and workers are adversely affected by increased trade and foreign investment.
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