Chapter 17

Question 1

What three distinct dimensions does openness have?

Answer 1

1. Openness in goods markets: the ability of consumers and firms to choose between domestic goods and foreign goods. In no country this choice is completely free of restrictions. Tariffs and quotas.
2. Openness in financial markets: the ability of financial investors to choose between domestic assets and foreign assets. Until recently, capital controls (restrictions on the foreign assets their domestic residents could hold and vice versa) existed.
3. Openness in factor markets: the ability of firms to choose where to locate production and workers to choose where to work.

Question 2

What are tradable and non-tradable goods?

Answer 2

Tradable goods: cars, computers, etc.

Non-tradable goods: housing, most medical services, haircuts, etc.

Question 3

Can exports exceed GDP?

Answer 3

Exports can exceed GDP due to that export and import may include intermediate goods that then are made into final products with a higher value.

Question 4

What is nominal exchange rate?

Answer 4

Nominal exchange rate: the price of the domestic currency in terms of the foreign currency. Denoted by E.

Question 5

Define appreciation and depreciation in open market.

Answer 5

Appreciation: an appreciation of the domestic currency is an increase in the price of the domestic currency in terms of a foreign currency. (increase in the exchange rate)

Depreciation: a depreciation of the domestic currency is a decrease in the price of the domestic currency in terms of a foreign currency. (decrease in exchange rate)

Question 6

How is real exchange rate constructed and defined?

Answer 6

The real exchange rate is the price of the domestic goods in the foreign currency’s terms of goods.

It’s constructed by multiplying the domestic price level by the nominal exchange rate and then dividing by the foreign price level.

It’s an index number, its level is arbitrary, and therefore uninformative

Question 7

What is real appreciation and depreciation?

Answer 7

Real appreciation: an increase in the real exchange rate - an increase in the relative price of domestic goods in terms of foreign goods.

Real depreciation: a decrease in the real exchange rate - a decrease in the relative price of domestic goods in terms of foreign goods.

Question 8

Can nominal and real exchange rates move in different directions?

Answer 8

Nominal and real exchange rates can move in opposite directions.

This is possible because E can increase, while P/P* can decrease, if, for example, the price level increased less in the domestic country than in the foreign country (due to lower average inflation, or similar) —> a decrease in ε - a decrease in the relative price of domestic goods in terms of foreign goods.

Question 9

What would happen if inflation rates were exaclty equal?

Answer 9

If inflation rates were exactly equal, P/P* would be constant, and ε and E would move exactly together.

Question 10

What is balance of payments?

Answer 10

• The balance of payments is a record of all payments or monetary transactions between a particular country and the rest of the world during a specific time period.
• The balance of payments encompasses all transactions between a country’s residents and its nonresidents involving goods, services and income; financial claims on and liabilities to the rest of the world; and transfers such as gifts.
• It consists of two parts, which are mirror images of one another: Current Account and Capital Account.

Question 11

What is current account?

Answer 11

• Trade balance: exports - imports
• Net income: income received - income paid
  (salaries, income from asset holdings -dividends-, …)
• Net transfers received
  (aids, donations, workers’ remittances…)

Question 12

What is capital account?

Answer 12

Capital account balance:

• Purchases of domestic assets by foreigners - purchases of foreign assets by the domestic country
• Statistical discrepancy