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3 economies

by: Emmaroseglaser

3 economies Econ3020

Intermediate Macroeconomics
Antonio Bojanic

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About this Document

These notes compare a closed economy, small open economy, and large open economy
Intermediate Macroeconomics
Antonio Bojanic
Class Notes
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This 8 page Class Notes was uploaded by Emmaroseglaser on Sunday October 11, 2015. The Class Notes belongs to Econ3020 at Tulane University taught by Antonio Bojanic in Fall 2015. Since its upload, it has received 41 views. For similar materials see Intermediate Macroeconomics in Economcs at Tulane University.


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Date Created: 10/11/15
CHAPTER 1 Relationship between savings and investment In closed economy small open economy and large open economy 1Closed economy Assume o No exports or imports 0 Work in the long run 0 Prices are exible 0 Level of production comes from how much factors of production is available Goods market equilibrium Savings investment 0 Y C I G o Y G C savings Y G C Real interest rate determines how we save and how we invest S Y C G I o Cquot Autonomous spending regardless of other variables 0 C Y T r Spending based on disposable income Y T amp real interest rate Direct relationship between disposable income and spending Indirect relationship between real interest rate and spending 0 G G o T T We cannot determine scal policy so we keep it constant 0 Y I F 612 There is a xed level of K and L FOP This countries production is based on how much K and L they have S i Ci Tr c39 o Exogenous variables shift savings curve Y C T G o Endogenous variables movement along savings curve r Investment and real interest rates le 0 A rm wants to expand but it does not have the money to do so It will borrow the money to nance his investments If the real interest rate is v CHAPTER 1 Real interest rates 0 Change in real interest rate leads to movement along the savings or investment curves Savings shifters 1 Consumption If consumption goes up less money is being saved and real interest rates rise oCTSirT C o If people consume less they save more and real interest rates go down oCiSTriB 2 Taxes 0 If taxes are higher disposable income falls so consumption falls and savings rise oTTYdiCiST B o If taxes are lower disposable income rises so consumption rises and savings falls oTlYdTCTSlC 3 Government Spending Has same impact as consumption spending 0 If the government spends more private savings falls quotCrowding outquot o G T S i o If the government spends less private savings rises o G i S T Practice prob assume increase in government budget 0 So taxes T or spending i Savings T real interest rate i The in uence of taxes on national savings 0 National savings private savings government savings 59 T G Sp Y T C 0 Assume Taxes are raised 0 An increase tax causes Private savings to nearly stay the same It also makes consumption spending go down This nearly balances out the equation because T is getting bigger while C is getting smaller 0 An increase in taxes causes government savings to go up CHAPTER 1 0 So Raised taxes leads to raised national savings Investment Shifters I i Anything that would change autonomous investment will shift investment curve Businesses become more optimistic o Investments increase real interest rate increase S and I increase Businesses become more pessimistic 0 Investment decrease real interest rate decrease S and I decrease Business regulation increase fees and taxes 0 Investment decreases real interest rate decrease S and I decrease Reduced business regulation 0 Investment increases real interest rate increases S and I increase 2Small open economy A small open economy means that they are real world interest rate takers Their economy does not have in uence over the real world interest rate due to its small size Assume Perfect capital mobility 0 Domestic r world r rw I o No transaction costs or inhibitors to trade Why can we assume this Because if a country s real interest rate is lower than the world s they will lend abroad and take the world interest rate And If a country s real interest rate is above the world s they will borrow to get the lower rates and take the world interest rate Goods market equilibrium when what s produced Y equals what s demanded C I G NX Y C I G NX Y C G I NX S I NX S l is the net capital out ow identity Calculating equilibrium in a small open economy CHAPTER 1 rw so to calculate equilibrium NX1 we subtract S l A B o A B is positive so we have trade surplus 0 Trade surplus net capital out ow net foreign assets l wealth rw1 Calculate new equilibrium NX2 D C is negative so we have trade de cit 0 Trade de cit net capital in ow low net foreign assets l less wealth What causes uctuations in real world interest rates 0 We must imagine the world as a closed economy so that rw is based on world savings and world investment Assume that taxes worldwide are raised so world savings increase and world real interest rate decreases Assume the world is pessimistic so consumer expenditures decrease so world savings increase and real interest rate decreases Small Open Economy Practice 1 Assume we are at r1 There is a trade surplus and net capital out ow a What would happen to NX if taxes wentwv lvw Savings would increase i NX2 C A a o C A g B A wk c 0 so NX would increase 39 39 39 39 0 Capital out ow increase 0 Foreign assets increase 0 Wealth increase l f 51225 sm 39 CHAPTER 1 2 Twin de cit dilemma in 1979 the US government ran a massive budget de cit Also the trade de cit increased a Explain this phenomenon ui Before 1979 US ran a small capital out Then gvt expenditures increased 0 Savings decreased 0 S 2 I So began running trade de cit NX any WWW 3 If spirits improve and Investment increase a Show impact on NX and wealth 0 Investment moves right NX becomes smaller 0 Wealth does not decrease though 0 We have decreased foreign assets 0 But domestic investment makes up r39 3 Large Open Economies A combination of small open and closed economies In regards to trade balance and capital out ow 0 Similar to small open economy 0 In regards to impact on real interest rates 0 Similar to a closed economy We divide the world into 2 parts 1 The large open economy CHAPTER 1 2 The rest of the world closed economy interest rate is where Sl a Equilibrium i Excess savings in one investment in another ii Trade surplus in one trade de cit in other iii Net capital out ow in one net capital in ow in other Practice K Mm pt f HR 63 W01 d RN r S 39 g i 0 0 a l I Ni f l l l g 55 i 4 atquot i I aw A large open economy ismatr experiencig a trade surplus NX1 500 Surplus is greater than the de cit here so in order to induce NX2 300 people to borrow lower real interest rates to r2 NX3 400 Equilibrium NX4 400 f r is below equilibrium raise r to induce people to lend moreinvest less 7 39 n r l0 f f c M L L7 an 17 wry NX1 400 equilibrium NX2 400 What would happen to the large open economy if consumption decreases What would this mean for net capital out ows CHAPTER 1 NX3 500 What people want to lend is greater than what people want to borrow NX2 400 so we lower the interest rate to r2 induce people to borrow Now trade surplus trade de cit Real world example 0 Global savings glut 2005 stated that Asian economies created a savings glut This glut explained the US trade de cit and low interest rates 0 As seen in the graphs above Asia as large open economy an increase in savings creates a de cit for the world US at r NX1 400 equilibrium NX2 400 0 Assume people become optimistic so investment goes up NX3 300 so we must raise r to induce lenders NX4 400 r2 NX4 350 equilibrium NX5 350 Comparing economies Similarities Large and closed CHAPTER 1 1 Savings goes up in a large open economy the interest rate goes down in a closed economy interest rates go down same result 2 Difference closed has no in ow or out ows


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