Chapter 18

Question 1

In an open economy

Answer 1

S = I + NCO
Saving = Domestic investment + Net capital outflow

Question 2

Closed economy

Answer 2

Economy that does not interact with other economies in the world

Question 3

Open economy

Answer 3

Economy that interacts freely with other economies around the world

Question 4

Exports

Answer 4

Goods and services that are produced domestically and sold abroad

Question 5

Imports

Answer 5

Goods and services that are produced abroad and sold domestically

Question 6

Net exports(Trade balance)

Answer 6

Value of a nation’s exports minus the value of its imports

Question 7

Trade surplus (Positive net exports)

Answer 7

Exports are greater than imports

The country sells more goods and services abroad than it buys from other countries

Question 8

Trade deficit (Negative net exports)

Answer 8

Imports are greater than exports

The country sells fewer goods and services abroad than it buys from other countries

Question 9

Factors that might influence a country’s exports, imports, and net exports:

Answer 9

1. Tastes of consumers for domestic &foreign goods
2. Prices of goods at home and abroad
3. Exchange rates at which people can use domestic currency to buy foreign currencies

Question 10

Higher income/economic growth in a foreign country

Answer 10

increases exports, net exports increases

Question 11

Higher income/economic growth domestically

Answer 11

increases imports, net exports decreases

Question 12

Variables that influence net capital outflow

Answer 12

Real interest rates paid on foreign assets
Real interest rates paid on domestic assets
Perceived economic and political risks of holding assets abroad
Government policies that affect foreign ownership of domestic assets

Question 13

Net capital outflow

Answer 13

Purchase of foreign assets by domestic residents

=Domestic Investment Abroad − Foreign Investment

Question 14

Higher interest rate paid on foreign assets increases purchases of foreign assets by domestic consumers

Answer 14

Net capital outflow increases

Question 15

Higher interest rate paid on domestic assets increases purchases of domestic assets by foreign consumers.

Answer 15

Net capital outflow decreases

Question 16

Higher risk of holding assets in a foreign country reduces purchases of foreign assets by domestic consumers

Answer 16

Net capital outflow decreases

Question 17

Higher risk of holding assets in a domestic country reduces purchases of domestic assets by foreign consumers

Answer 17

net capital outflow increases

Question 18

NCO

Answer 18

=NX

Question 19

When NX > 0 (trade surplus)

Answer 19

Selling more goods and services to foreigners

Capital is flowing out of the country: NCO > 0

Question 20

When NX < 0 (trade deficit)

Answer 20

Buying more goods and services from foreigners

Capital is flowing into the country: NCO < 0

Question 21

Savings

Answer 21

=Domestic Investment+ Net capital outflow

Question 22

Trade surplus: Exports > Imports

Answer 22

Net exports > 0
Y > Domestic spending (C+I+G)
S > I
NCO > 0

Question 23

Trade deficit: Exports < Import

Answer 23

Net exports < 0
Y < Domestic spending (C+I+G)
S < I
NCO < 0

Question 24

Balanced trade : Exports = Imports

Answer 24

Net exports = 0
Y = Domestic spending (C+I+G)
S = I
NCO = 0

Question 25

Nominal exchange rate

Answer 25

Rate at which a person can trade currency of one country for currency of another Example

Question 26

Appreciation

Answer 26

Increase in the value of a currency as measured by the amount of foreign currency it can buy Buy more foreign currency

Question 27

Depreciation

Answer 27

Decrease in the value of a currency As measured by the amount of foreign currency it can buy Buy less foreign currency

Question 28

Real exchange rate

Answer 28

Rate at which a person can trade goods and services of one county =(Nominal*Domestic Price) ---------------------------------------- Foreign Price

Question 29

Real exchange rate

Answer 29

(e ˣ P) / P* e: nominal exchange rate between the U.S. dollar and foreign currencies P: price index for U.S. basket P*: price index for foreign basket

Question 30

Depreciation (fall) in the U.S. real exchange rate

Answer 30

1.U.S. goods: cheaper relative to foreign goods 2.Consumers at home and abroad buy more U.S. goods and fewer goods from other countries A)Higher exports, Lower imports B)Higher net exports

Question 31

An appreciation (rise) in the U.S. real exchange rate

Answer 31

1.U.S. goods - more expensive compared to foreign goods 2.Consumers at home and abroad - buy fewer U.S. goods and more goods from other countries A)Lower exports, Higher imports B)Lower net exports

Question 32

Arbitrage

Answer 32

Take advantage of price differences for the same item in different markets Result: the law of one price

Question 33

Purchasing-power parity, PPP

Answer 33

Parity: Equality | Purchasing-power: Value of money in terms of quantity of goods it can buy

Question 34

Theory of purchasing-power parity

Answer 34

Nominal exchange rate between the currencies of two countries Must reflect the price levels in those countries

Question 35

When NCO > 0, net outflow of capital

Answer 35

Net purchase of capital overseas | Adds to the demand for domestically generated loanable funds

Question 36

When NCO < 0, net inflow of capital

Answer 36

Capital resources coming from abroad | Reduce the demand for domestically generated loanable funds

Question 37

Higher real interest rate

Answer 37

Encourages people to save: increases quantity of loanable funds supplied Discourages investment: decreases quantity of loanable funds demanded Discourages Americans from buying foreign assets: reduces U.S. net capital outflow Encourages foreigners to buy U.S. assets: reduces U.S. net capital outflow

Question 38

The market for foreign-currency exchange

Answer 38

Identity: NCO = NX | Net capital outflow = Net exports

Question 39

If trade surplus, NX > 0

Answer 39

Exports > Imports Net sale of goods ad services abroad Americans use the foreign currency to buy foreign assets Capital is flowing abroad, NCO > 0

Question 40

If trade deficit, NX < 0

Answer 40

Imports > Exports Some of this spending is financed by selling American assets abroad Foreign capital is flowing into U.S. NCO < 0

Question 41

A higher real exchange rate

Answer 41

Makes U.S. goods more expensive | Reduces the quantity of dollars demanded to buy those goods

Question 42

Equilibrium real exchange rate

Answer 42

Demand for dollars By foreigners Arising from U.S. net exports of goods and services

Question 43

Market for loanable funds: S =

Answer 43

I + NCO

Question 44

Net-capital-outflow curve

Answer 44

Link between Market for loanable funds Market for foreign-currency exchange

Question 45

Market for loanable funds

Answer 45

Supply: national saving Demand: domestic investment and net capital outflow Equilibrium real interest rate, r

Question 46

Net capital outflow

Answer 46

Slopes downward | Equilibrium interest rate, r

Question 47

Market for foreign-currency exchange

Answer 47

Supply: net capital outflow Demand: net exports Equilibrium real exchange rate, E

Question 48

Equilibrium real interest rate, r

Answer 48

Price of goods and services in the present | Relative to goods and services in the future

Question 49

Equilibrium real exchange rate, E

Answer 49

Price of domestic goods and services | Relative to foreign goods and services

Question 50

E and r adjust simultaneously

Answer 50

To balance supply and demand In both markets Loanable funds Foreign-currency exchange

Question 51

Government budget deficits

Answer 51

``` When government spending exceeds government revenue Negative public saving Reduces national saving Reduces supply of loanable funds Increase in interest rate Reduces net capital outflow Crowd-out domestic investment Decrease in supply of foreign-currency exchange Currency appreciates Net exports fall Push the trade balance toward deficit ```

Question 52

Tariff:

Answer 52

tax on imports

Question 53

Import quota

Answer 53

limit on quantity of imports

Question 54

import quota impact

Answer 54

``` Decrease imports Increase in net exports Increase in demand for dollars in the market for foreign-currency exchange Real exchange rate appreciates Discourage exports No change in real interest rate No change in net capital outflow No change in net exports Decrease in imports Decrease in exports ```

Question 55

Trade policies affect specific

Answer 55

Firms Industries Countries

Question 56

Political instability

Answer 56

Leads to capital flight

Question 57

Capital flight

Answer 57

Large and sudden reduction in the demand for assets located in a country

Question 58

Interest rate in Mexico – increases

Answer 58

Reduce domestic investment Slows capital accumulations Slows economic growth

Question 59

The peso depreciates

Answer 59

Exports – cheaper Imports – more expensive Trade balance moves toward surplus

Question 60

Mexico - capital flight affects both markets | U.S. market

Answer 60

Fall in U.S. net capital outflow The dollar appreciates in value U.S. interest rates fall Relatively small impact on the U.S. economy Because the economy of the United States is so large compared to that of Mexico