OpenMarket Macroeconomics:

1
Chapter 29

• Open-Market Macroeconomics
• Basic Concepts

2
Open or Closed Economies

• CLOSED ECONOMY
• There are few economic relations with other
  countries. Exports, imports, and capital flows
  are restricted.
• OPEN ECONOMY
• Exports, imports and capital flow in and out of
  the country with few restrictions.

3
An Open Economy

• An open economy interacts with other countries in
  two important ways
• 1. It buys and sells goods and services in world
  product markets.
• 2. It buys and sells capital assets in world
  financial markets (e.g foreign exchange is
  traded, foreign investment is allowed).

4
The Flow of Goods

• U.S. Exports
• Are domestically (U.S.) produced goods that are
  sold abroad.
• Example U.S. aircraft manufacturer, Boeing,
  building planes in Seattle and selling them to
  Air France.

5
The Flow of Goods

• U.S. Imports
• Are foreign produced goods and services that are
  sold to U.S. residents.
• Examples Computer monitors made in Korea and
  wine produced in France but shipped for
  consumption in U.S.

6
The Flow of Goods

• Net Exports (NX) or Trade Balance
• The value of exports minus the value of imports.
  
• Trade Deficit
• A situation when net exports (NX) are negative.
  (i.e. Exports lt Imports)
• Trade Surplus
• A situation when net exports (NX) are positive.
  (i.e. Exports gt Imports)

7
U.S. Economy

• The U.S. is a very large, open economy. It
  imports and exports huge quantities of goods and
  services.
• Capital flows freely in and out of the U.S.
• U.S. trade has been increasing the U.S. has a
  persistent trade deficit (see Figure 29-1 and
  link).

8
Factors That Influence a Countrys Exports,
Imports, and Net Exports

• The tastes of consumers for domestic and foreign
  goods.
• The prices of goods at home and abroad (impacted
  by transportation costs).
• Exchange rates.
• Government policies toward international trade.
• Economic conditions.

9
Net Foreign Investment (the flow of capital)

• Net Foreign Investment (NFI) difference between
  foreign assets purchased by residents and
  domestic assets purchased by foreigners.
• Example U.S. company invests in a plant in
  Mexico. A Mexican citizen buys stock in the Ford
  Motor Corporation.

10
Net Foreign Investment (NFI)

• When U.S.residents purchase more financial assets
  in foreign economies than foreigners purchase in
  the U.S., there is a net capital outflow to other
  countries.
• If foreigners purchase more U.S. financial assets
  than U.S. residents spend on foreign financial
  assets, then there will be a net capital inflow
  into the U.S.

11
U.S. Net Foreign Investment

• Negative net foreign investment for U.S.
  indicates that we are attracting foreign savings
  (net capital inflow).
• Domestic Investment in the U.S. exceeds U.S.
  Savings (see Figure 29-2).

12
The Equality of NX, NFI and S-I

• NX NFIS-I
• For the U.S., we have a trade deficit (NXlt0), our
  investment exceeds our savings (S-Ilt0 ) and we
  have a net capital inflow (NFIlt0 ).

13
Real and Nominal Exchange Rates

• International transactions are influenced by
  international prices. The two most important
  international prices are
• Nominal Exchange rate
• Real Exchange Rate

14
The Nominal Exchange Rate

• The nominal exchange rate is the rate at which a
  person can trade the currency of one country for
  the currency of another.

15
The Nominal Exchange Rate

• Exchange rate table (see handout). An exchange
  rate is expressed in two ways
• 1. In units of foreign currency per one U.S.
  dollar,
• 2. In units of U.S. dollars per one unit of the
  foreign currency.

16
Changing Exchange Rates

• If the exchange rate changes so that a dollar
  buys more foreign currency, that change is called
  an appreciation of the dollar. The opposite is
  called a depreciation of the dollar.
• The yen appreciated vs. the dollar from 1970 to
  1995
• The dollar depreciated vs. the pound from 1976 to
  1980

17
The Real Exchange Rate

• The real exchange rate is the rate at which a
  person can trade the goods and services of one
  country for the goods and services of another.
  Also the Terms of Trade.

18
Calculating the Real Exchange Rate

• Real exchange rates are derived from nominal
  rates. Computing the real exchange rate involves

19
Calculating the Real Exchange Rate

• Real exchange rates are derived from nominal
  rates. Computing the real exchange rate involves

Real Exchange Rate

20
Calculating the Real Exchange Rate

• Real exchange rates are derived from nominal
  rates. Computing the real exchange rate involves

Nominal Exchange Rate x Domestic Price
Real Exchange Rate

21
Calculating the Real Exchange Rate

• Real exchange rates are derived from nominal
  rates. Computing the real exchange rate involves

Nominal Exchange Rate x Domestic Price
Real Exchange Rate

Foreign Price
22
The Real Exchange Rate Sample Calculation

• American Car 10,000
• Japanese Car (imported) 2,400,000 Yen
• Nominal Exchange Rate 120 yen1
• Real Exchange Rate.5 Japanese car per American
  car
• Implication Buy the American Car (it cost 1/2
  the Japanese import)

23
The Real Exchange Rate

• The real exchange rate is a key determinant of
  how much a country exports and imports.
• When a countrys real exchange rate is low, its
  goods are cheap relative to foreign goods, so
  consumers both at home and abroad tend to buy
  more of that countrys goods and fewer foreign
  produced goods.

24
Purchasing-Power Parity (PPP)

• The variation of currency exchange rates has
  different sources. An increase in demand will
  cause a currency to appreciate. A decrease in
  demand will cause a currency to depreciate.
• The simplest and most widely accepted theory
  (about long run changes) is called
  Purchasing-Power Parity Theory.

25
Purchasing Power Parity

• Purchasing-Power Parity Theory states that a
  unit of any given currency should be able to buy
  the same quantity of goods in all countries.
• Based upon The Law of One Price (i.e. A good
  must sell for the same price in all locations)

26
The Law of One Price and Exchange Rates

• This Law of One Price applies in the
  international market.
• The nominal exchange rate between the currencies
  of two countries will adjust in the long run to
  achieve parity in prices between countries.

27
PPP Example

• Assume 2 Marks1 Ton of steel costs 100 in
  U.S. Ton of steel costs 200 marks in Germany.
  Do we have parity? (Why yes?)
• U.S. experiences inflation (steel price in U.S.
  rises to 133). What is the new dollar/mark
  exchange rate which will achieve parity? (Why 1.5
  marks/?)

28
Limitations of The Purchasing-Power Parity

• Two things may keep nominal exchange rates from
  exactly equalizing purchasing power
• 1. Many goods are not easily traded or shipped
  from one country to another.
• 2. Traded goods are not always perfect
  substitutes.