Flows of Goods and Capital - Open Economy, Macroeconomics | Macro Economics - B Com PDF Download

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)