Open Markets

Question 1

Openness in goods markets means…

Answer 1

• Lack of free trade restrictions including tariffs and quotas
• Low transport costs

Question 2

Openness in financial markets means…

Answer 2

Lack of capital controls which place restrictions on the ownership of foreign assets

Question 3

Openness in factor markets means…

Answer 3

The ability of firms to choose where to locate production, and workers to choose where to work

Question 4

What is the real exchange rate?

Answer 4

The price of domestic goods relative to foreign goods

Question 5

What affects the nominal exchange rate (E) in the S.R.?

Answer 5

S&D in the currency markets and it moves in the same direction an i

Question 6

Real exchange rate =

Answer 6

EP/Pw

Question 7

What affects the real exchange rate in the short run?

Answer 7

Due to sticky inflation moves with unanticipated changes in E

Question 8

What is the law of one price?

Answer 8

Says that goods must sell for the same price in all countries in the long run due to arbitrage price convergence

Question 9

What can cause the law of one price to not hold?

Answer 9

Differences in taxes, tariffs and transport costs

Question 10

Nominal exchange rate with law of one price =

Answer 10

E = Pw/P

Question 11

What is the real exchange rate in the Long run?

Answer 11

EP/Pw = 1, If the law of one price holds, then foreign goods and domestic goods should sell for the same price, so that the real exchange rate should equal 1

Question 12

What is the nominal exchange rate in the long run?

Answer 12

Determined by the amount of money in one country relative to another as the quantity theory tells us that one of the key determinants of the price level is the money supply

Question 13

Reasons for intratemporal trade:

Answer 13

Differences in preferences/productivity

Question 14

Reasons for intertemporal trade:

Answer 14

Differences in patience, investment opportunities (ideas against cash)

Question 15

Reasons for pure asset trade:

Answer 15

Differences in risk aversion, expectations about future

Question 16

What does intertamporal trade allow for?

Answer 16

Risk-sharing where economies can trade to neutralize the impact of unanticipated shocks (to income, consumption, natural disaster etc.) in an attempt to smooth consumption

Question 17

What is the Intertemporal budget constraint and why is it so?

Answer 17

PDV of the trade balance must = 0, because no one is willing to lend goods and services unless they will be repaid

Question 18

When NX < 0 …

Answer 18

C + I + G > Y

Question 19

What does financial market openness allow for?

Answer 19

Financial investors to diversify - to hold domestic & foreign assets and speculate on foreign interest rate movements
Countries to run trade surpluses & deficits - a country that buys more than it sells must pay for the difference from borrowing from the rest of the world

Question 20

What is the balance of payments?

Answer 20

Account that summarises a country’s transactions with the rest of the world. The current account (trade balance) must be financed by inflow (borrowing) of capital.

Question 21

What constitutes the current account?

Answer 21

Net exports (Exports & Imports)
Net investment income & transfers

Question 22

What constitutes the capital account?

Answer 22

Private investment
Public investment (general government & reserve bank)

Question 23

When is the capital account positive/negative?

Answer 23

Positive/negative if foreign holdings of domestic assets are greater/less than domestic holdings of foreign assets, in which case there is a capital account surplus/deficit

Question 24

Domestic saving S =

Answer 24

(Y-T-C) + (T-G)

Question 25

The trade balance =

Answer 25

The net capital outflow, which is equal to domestic saving minus investment

Question 26

If a country runs a trade deficit…

Answer 26

it will invest more than it saves

Question 27

The trade deficit is…

Answer 27

the additional borrowing done to finance the gap between investment and domestic savings

Question 28

The net flow of goods associated with net exports is associated with…

Answer 28

a net flow of financial assets in the opposite direction - running a trade deficit is the same thing as having foreigners finance some of your investment

Question 29

Why does China run trade surpluses?

Answer 29

It has so much domestic saving (exceeding investment) that it can ship goods abroad and invest more than foreigners invest in China.

Question 30

What are net foreign assets?

Answer 30

The difference between foreign assets held domestically and domestic assets held abroad

Question 31

What is the relationship between the budget deficit and the trade deficit?

Answer 31

The budget deficit and trade deficit move together most of the time