Chapter 18 Macro Notes
Chapter 18 Macro Notes EC 111
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This 5 page Class Notes was uploaded by Carter Cox on Tuesday April 12, 2016. The Class Notes belongs to EC 111 at University of Alabama - Tuscaloosa taught by Zirlott in Spring 2015. Since its upload, it has received 20 views. For similar materials see Principles of Macroeconomics in Economcs at University of Alabama - Tuscaloosa.
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Date Created: 04/12/16
Chapter 18 Notes Macro Introduction - Trade can make everyone better of - International macroeconomics o Trade balance (trade deficits, surpluses) o International flows of assets o Exchange rates Closed VS Open Economies - Closed- does not interact with other economies in the world - Open- interacts freely with other economies around the world Flow of Goods and Services - Exports o Domestically produced goods and services sold abroad - Imports o Foreign produced goods and services sold domestically - Net Exports or the Trade balance o Exports – imports Variables the Influence Net Exports - Consumer preferences for foreign and domestic goods o Prefer goods from other places - Prices of goods at home and abroad - Income of consumers at home and abroad - The exchange rates at which foreign currency trades for domestic currency - Transportation costs - Government policies Trade Surpluses and Deficits - Net Exports measures the imbalance in a countries trade in goods and services o Trade Deficit Excess of imports over exports, NX < 0 and Y < C + I + G o Trade Surplus Excess of exports over imports, NX > 0 and Y> C + I + G o Balance Trade Exports = imports, NX = 0 and Y = C + I + G Increasing openness of the US economy - Increasing importance of international trade and finance o Our country greatly relies on international trade o 1950s, imports and exports: 4- 5 % of GDP o Recent Years Exports – increased more than twice Imports- increased more than 3 times o Increase in international trade Improvements in transportation Advances in telecommunications Technological progress Gov. trade policies NAFTA GATT Very easy to ship goods The Flow of Capital - Net capital outflow (NCO)- Flow of assets o Domesic residents purchases of foreign assets o Foreigners purchases of domestic assets - NCO is also called net foreign investment - Two Forms o Foreign direct investment Set up foreign subsidiary and actively manage the foreign investment o Foreign Portfolio investment Purchase foreign stocks or bonds, supplying “loanable funds” to a foreign firm, such as an American buys stock in Toyota - NCO measures the imbalance in a country’s trade in assets o When NCO is positive “capital outflow Domestic purchases of foreign assets exceed foreign purchases of domestic assets o When NCO is negative = to “capital inflow” Foreign purchases of domestic assets exceed domestic purchases of foreign assets Variables that Influence NCO - Real interest rates paid on foreign assets - Real interest rates paid on domestic assets - Perceived risks of holding foreign assets - Government policies afecting foreign ownership of domestic assets The Equality of NX and NCO - accounting identity; o NCO= NX NX- if something happens over there something happens over here o Arises because every transaction that afects NX also afects NCO by the same amount, and vice versa - When a foreigner purchases a good from the US o US exports and NX increase o Foreigner pays with currency or assets, so the US acquires some foreign assets, causing NCO to rise - IF they use a diferent currency we use their currency to buy stuf from them - Accounting Identity o Arises because every transaction that afects NX and also afects NCO by the same amount - When a US citizen buys foreign goods o US imports rise, NX falls o US buyer pays with US dollars or assets, so the other country acquires US assets, causing US NCO to fall Saving, Investment, and International Flow of Goods and Assets - National Income Identity o Y= C+ I+ G+ NX - In an open economy o S= I+ NCO - NX= NCO - S-I = NCO o Positive, and capital will flow out of the country - When S>I then NCO>0 and the excess loanable funds flow abroad in the form of positive net capital outflow o Trade Surplus - The opposite, foreigners are financing some of the country’s investment in the form of negative net capital outflow o Trade Deficit Nominal Exchange Rate - Nominal Exchange Rate; o Rate at which one country’s currency trades for another - We express all exchange rates as foreign currency per unit of domestic currency Appreciation - strengthening - increase in the value of a currency as measured by the amount of foreign currency it can buy o takes more foreign currency to buy one US dollar - Strong dollar causes US goods to become more expensive compared to foreign goods, so US exports will fall and imports to the US will rise Depreciation - weakening - Decrease in the value of a currency as measured by the amount of foreign currency it can buy o Takes less foreign currency to buy one US dollar - Weak dollar causes US goods to become less expensive compared to foreign produced goods, US exports will rise and imports will fall Real Exchange Rate - Rate at which the goods and services of one country trade for the goods and service of another - e x P/ P* o e= nominal exchange rate o P*= foreign price o P= domestic price Interpreting Real Exchange Rate - .75 Japanese Big macs per US Big Mac - Correct o US big mac can be exchanged/ traded for .75 Japanese big mac - This is called terms of trade Purchasing Power Parity - Theory of exchange rates whereby a unit of any currency should be able to buy the same quantity of goods in all countries - Law of One price o Notion that a good should sell for the same price in all markets o Implies that nominal exchange rates adjust to equalize the price of a basket of goods across countries PPP an its implications - Implies that the nominal exchange rate (e) between two countries should equal the ratio of price levels - If two countries have diferent inflation rates, then (e) will change over time Limitations to PPP - Many goods cannot easily be traded o Haircuts, going to the movies o Price diferences on such goods cannot be arbitraged away - Foreign, domestic goods not perfect substitutes o Some US consumers prefer Toyotas over Chevys o Price diferences reflect taste