Brainscape's Knowledge GenomeTM


Top Flashcards (Certified)
All Flashcards

Macroeconomics > Open economy > Flashcards

Open economy Flashcards

(45 cards)

Start Studying
1
Q

What is a closed economy

A

Does not interact with other economies in the world (extremely rare)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

What is an open economy

A
  • does interact with other economies
  • interacting includes buying and selling goods, services and assets
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

What are exports

A

Goods and services produced domestically and sold abroad

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

What are imports

A

Goods and services produced abroad but consumed domestically

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

What are net exports (NX)

A

Exports - imports

(can also be referred to as trade balance)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What is a trade surplus

A

Positive NX

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

What is a trade deficit

A

Negative NX

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

What are the factors which influence a countries NX

A
  • tastes of consumers for domestic and foreign goods
  • prices of goods
  • income of consumers
  • cost of transporting goods
  • policies to international trade
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

How have imports and exports changed historically

A
  • was 5% of GDP in 1950
  • now it is 10-15%
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

Define net capital outflow (NCO)

A

Purchase of foreign assets by domestic resident minus the purchase of domestic assets by foreigners

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

What are the forms of capital flow

A
  • FDI
  • FPI
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

What identity links NX and NCO

A

NX = NCO

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

What is the national savings identity

A
  • S = Y-C-G
  • S=I+NX
  • since NX=NCO,
    S=I+NCO
  • in other words, national savings = domestic investment + net capital outflow
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

How does the national savings identity act in deficit or surplus

A
  • in surplus NX>0
  • NCO=S-I > 0 (since NCO=NX)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

What happens in an open economy in trade deficit

A

Y<C+I+G
Saving<investment
NCO/NX<0

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

What happens in an open economy in balanced trade

A

Y=C+I+G
Saving=investment
NCO/NX=0

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

What happens in an open economy in trade surplus

A

Y>C+I+G
Saving>investment
NCO/NX>0

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

What is nominal exchange rate

A

The rate at which a person can trade one currency of a country for currency of another

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

Define appreciation

Study These Flashcards
A
  • an increase in the value of a currency
  • measured by the amount of foreign currency that one unit of domestic currency can buy
  • an appreciation means you can buy more foreign currency for one unit of domestic currency
20
Q

Define depreciation

Study These Flashcards
A

Opposite of appreciation

21
Q

What is the real exchange rate

Study These Flashcards
A

The ratio at which you can trade goods and services in one country for goods and services in another

22
Q

How do you calculate real exchange rate

Study These Flashcards
A

(Nominal exchange rate x domestic price)/ (foreign price)

23
Q

Give an example of calculating real interest rate

Study These Flashcards
A
  • a banana costs £P in the UK
  • use the exchange rate to convert into dollars giving $eP
  • divide this by the price of US banana

real exchange rate is calculated using a price index (basket of goods) and not bananas

24
Q

What is purchasing power parity (PPP)

Study These Flashcards
A
  • the first long run theory of exchange rates
  • states that any given currency should be able to buy the same quantity of goods in all countries
  • essentially the real exchange rate must equal 1
25
What are the implications of PPP
- since eP/P1 = 1 under PPP - it holds that when domestic prices (P) change, its exchange rate (e) must also change - therefore when a country increases money supply (hence increasing prices), its exchange rate depreciates
26
Limitations of PPP
- does not hold in practice as real exchange rates are not 1 - because many goods (for example haircuts) are not easily traded - tradable goods are also not always perfect substitutes (Ford vs BMW)
27
How is PPP useful
- it is a good starting point for understanding long run currency movements - useless in the short term
28
What are the two markets in the open economy model
- supply and demand for loanable funds: coordinates a country's saving, investment and NCO - supply and demand for foreign currency: coordinates people who want to exchange
29
How is S=I+NCO interpreted in open economy model
- S is the supply of loanable funds - I+NCO is seen as the demand for loanable funds
30
Supply and demand for open economy market for loanable funds
- the supply curve S(r) is increasing as a higher rate of interest encourages more savings - the demand curve I(r)+NCO(r) is decreasing as higher interest rates makes investing less attractive and no point spending on foreign assets when domestic assets are profitable
31
How does NCO depend on interest rates
High interest rates mean negative NCO, low interest rates means positive NCO
32
What is the supply and demand of foreign currency exchange (forex or FX)
- demand for £ is equal to net exports as net export is paid in £ - supply of £ is equal to NCO since when UK residents want to buy foreign assets, they must sell £ in exchange for foreign currency
33
Describe the supply and demand curves for the forex market
- supply (NCO) is fixed given the interest rate so the supply curve is vertical - demand curve (NX) is decreasing - y axis is real exchange rate - x axis is quantity of £ exchanged into foreign currrency
34
So what does the open economy model determine
- the equilibrium rate of real interest - this then determines the NCO - which determines the real exchange rate alongside NX
35
What is trade policy
Government policy that directly influences that quantity of goods and services that a country imports or exports
36
Give examples of trade policies
- tariffs - import quota - voluntary export restrictions
37
Macroeconomic impact of import quota
- directly lowers imports which naturally increases net exports - since NX is the demand on the forex market, this increases demand for the £ - thus a shift to the right and an increase in exchange rates
38
What is the surprise conclusion regarding trade policies
- it does not affect the UK's trade balance at all - NX=NCO=S-I, since trade policies do not adjust S or I, the exchange rate must adjust to keep trade balance the same
39
What is the point of an import quota
It will benefit domestic firms
40
What is capital flight
Large and sudden reduction in demand for assets located in a country
41
What are the effects of capital flight
- an increase in net capital outflow increases the demand for loanable funds - this in turn increases the interest rate as of the market for loanable funds - this simultaneously increases the quantity of the currency on the forex market - this depreciates the currency
42
How does capital flight affects both markets
- causes real interest rates to rise - causes currency to depreciate
43
What is a government budget deficit
When government spending exceeds government revenue which reduces national savings and the supply of loanable funds
44
What are the effects of government budget deficit
- a budget deficit reduces the supply of loanable funds which increases real interest rate - this reduces NCO - the decrease in NCO reduces the supply of £ that can be exchanged into foreign currency - this appreciates the real exchange rate
45
What is the twin deficits phenomenon
- the close relationship between budget deficits and trade deficits - as explained previously, government deficit leads to an appreciation of the £ which makes domestic goods more expensive and less attractive to followers, thus reducing net exports

Macroeconomics (16 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2025 Bold Learning Solutions. Terms and Conditions