The open economy Flashcards
(34 cards)
Openness in goods market
Free trade
Restrictions include tariffs and quotas
Openness in financial markets
Country allows capital to move freely across its borders. Investors can buy foreign or domestic without restriction
Openness in factor markets
Ability of firms to choose production location
Ability of workers choosing where to work
UK exports and imports over time
X and IM : 20% of GDP in 1960,
30% of DGP now
Main factors behind export differences
Geography: distance from other markets.
Country size: smaller the country the more it will specialize in fewer goods, importing the rest.
Domestic consumers have to chose what?
How much to consumer and save
Also whether to buy domestic or foreign (dependent on real exchange rate)
Real exchange rate
price of domestic goods relative to foreign goods.
Two concepts to better understand openness
Balance of payments
Real exchange rate
Balance of payments
Summary of all the transactions between a country and rest of world
Current account + capital account = 0 (ignoring errors)
Two primary components of balance of payments
Current account
Capital account
Current account
Trade balance = Exports - Imports
Net income = Wages, dividends, interest recieved from abroad minus those paid to foreigners
Net current transfers = foreign aid, remittances, pensions etc
Current account surplus or borrower
Exports > Imports - country net lender
Imports > exports - country net borrower
Capital account
Foreign direct investment
Portfolio investment
Loans and banking capital
Official reserves transactions
Capital account surplus or deficit
Surplus - more money coming in from foreign investors
Deficit- more money flowing out to invest abroad
Nominal exchange rate
The nominal exchange rate is the price of one currency in terms of another
Nominal exchange rate example
For example, if £1 = 4 TL, then:
The price of the domestic currency (GBP) in terms of the foreign currency (TL) is E = 4.
This means 1£ = 4 TL
Flexible exchange rate
The central bank lets the exchange
rate adjust freely on the foreign exchange market
Fixed exchange rates
The central bank has an explicit exchange target and uses monetary policy to achieve this target
Vocab: flexible exchange rate
Appreciation of the domestic currency:
increase in the nominal exchange rate
Depreciation of the domestic currency:
decrease in the nominal exchange rate
Vocab: fixed exchange rate
Revaluation of the domestic currency:
increase in the nominal exchange rate
Devaluation of the domestic currency:
decrease in the nominal exchange rate
What does E denote - nominal exchange rate
Price of the domestic currency in terms of foreign currency
What does e denote - real exchange rate
Price of the domestic goods in terms of the foreign goods.
e= E x P / P*
E = nominal exchange rate
P = domestic price level
P* = foreign price level
Real appreciation
When e increases - domestic goods become more expensive relative to foreign goods
Real depreciation
When e decreases - domestic goods become cheaper relative to foreign goods
