Lecture Notes Week 12
Lecture Notes Week 12 Econ 253-101
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This 2 page Class Notes was uploaded by Kayla Notetaker on Friday November 13, 2015. The Class Notes belongs to Econ 253-101 at Marshall University taught by Dr. Yuanyuan (Catherine) Chen in Fall 2015. Since its upload, it has received 170 views. For similar materials see Principles of Macroeconomics in Economcs at Marshall University.
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Date Created: 11/13/15
Macroeconomics 253, 1 Chapter 18 Macroeconomics in an Open Economy The Balance of Payments In chapter 7, we learned that a closed economy is an economy that has no interactions in trade/finances with others. However, economies like that today are rare. Most operate in an open economy, which is an economy that has interactions in trade/finance with other countries. To understand interactions between two different economies, we use what is referred to as a Balance of Payments—the record of a country’s trade with other countries for goods, services, and assets (stocks and bonds). This is measured in the form of three accounts: Current Account—current (short-term) flow of funds into and out of a country. Records: o Imports and exports (the difference being net exports) o Income received and paid by U.S. residents from investments in other countries ( difference between received and paid would be net investments) o The difference between transfers made to other countries and transfers received by the U.S. (net transfers) Any payment received is a positive number; any payment made is a negative number o Balance of Trade: the difference of the value between goods a country exports and goods a country imports. Does NOT include services and does NOT equal NX This is the largest amount on the Current Account If Exports > Imports, there’s a trade surplus. If Exports are < Imports, there’s a trade deficit. If Exports = Imports, there’s a balance. o Balance of Services—the difference of the value between services a country exports and services a country imports. Does NOT include goods. Financial Account—part of the balance sheet for long-term flows of funds into and out of the country. It records: o Capital outflow—when an investor in the U.S. buys a bond issued by a foreign company or gov. or when a U.S. firm builds a factory in another country o Capital inflow—when foreign investor buys U.S.-issued bond or when a foreign firms builds a factory in the U.S. The word “capital” includes both physical assets (like factories) and financial assets (bonds) Net Capital Flows—the difference between capital outflows and capital inflows Foreign Direct Investment—when firms build/buy facilities in foreign countries Foreign Portfolio Investment—when investors buy stock/bond from other countries Net Foreign Investment—equal to net Foreign Direct Investment (FDI) + net Foreign Portfolio Investment (FPI) Net Capital Flows = Net Foreign Investment in absolute value; the signs are always OPPOSITE Capital Account—the smallest amount on the balance of payments. Records: o Minor transactions, such as sales and purchases of nonfinancial assets o Always is 0 on balance of payments Macroeconomics 253, 2 Making it Balance Statistical Discrepancy—added to balance of payments to make the current account equal the financial account Changes in foreign holding of dollars are known as official reserve transactions A current account deficit must be offset exactly by the financial account surplus Foreign Exchange Market and Exchange Rates Nominal Interest Rate—vale of currency in term of other country’s currencies; determines how many units of a foreign currency can be purchased with $1. Ex. $1 = ¥100 ($0.01 = ¥1) Currency Appreciation—increase in market value of one currency related to another country’s currency Currency Depreciation—decrease in market value of one currency related to another country’s currency There are 3 Sources of Foreign Currency Demand for U.S. dollars 1. Foreign firms and households that want to buy goods and services produced in U.S. 2. Foreign firms and households that want to invest in U.S. either through foreign direct investment or through FPI 3. Currency traders who believe that value of the U.S. dollar will increase in the near future There are also 3 Sources of Foreign currency Supply for U.S. dollars 1. Demand for goods and services 2. FDI and FPI related to other countries from the U.S. 3. Currency traders believe the value of another currency will increase compared to the U.S. dollar Equilibrium in the Market for Foreign Exchange and Shifts in Supply and Demand Exchange Rate Surplus of Dollars S (¥/$) (Market for USD) 150 120 100 D Shortage of Dollars Q Speculators—currency traders who buy and sell foreign exchange in an attempt to profit from exchange. This shifts the demand curve to the right when Japan’s income increases and interest rates in the U.S. increased Three factors that greatly influence shifts in Supply and Demand: 1. Changes in Demand for U.S. goods and services and changes in Demand for foreign goods and services 2. Changes in desire to invest in the U.S. and changes in desire to invest in foreign contries 3. Changes in expectations of currency traders about future value of the dollar and likely future value of foreign currencies.
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