Lecture 6 open economy

LECTURE 10 CHAPTER 3,9,31 OPEN-ECONOMY MACROECONOMICS and comparative advantage and their application How everyone can benefit from trade LECTURE OBJECTIVES Examine the trade restrictions and the arguments for and against them The International flows Nominal and Real OPEN AND CLOSED ECONOMIES  A closed economy: one that does not interact with other economies in the world  No exports  No imports  No capital flows An open economy: one that interacts freely with other economies around the world INTERDEPENDENCE AND TRADE ECONOMICS IS THE STUDY OF HOW SOCIETIES PRODUCE AND DISTRIBUTE GOODS IN AN ATTEMPT TO SATISFY THE WANTS AND NEEDS OF ITS MEMBERS HOW DO WE SATISFY OUR WANTS AND NEEDS IN A GLOBAL ECONOMY? Economically self-sufficient Specialize and trade with others, leading to economic interdependence INTERDEPENDENCE AND TRADE Individuals and nations rely on specialized production and exchange as a way to address problems caused by scarcity This gives rise to two questions: Why is interdependence the norm? What determines production and trade? WHY IS INTERDEPENDENCE THE NORM? Interdependence occurs because people are better off when they specialize and trade with others WHAT DETERMINES THE PATTERN OF PRODUCTION AND TRADE? Patterns of production and trade are based upon differences in opportunity costs A PARABLE FOR THE MODERN ECONOMY  Imagine only two goods: potatoes and meat only two people: a potato farmer and a cattle rancher  What should each produce?  Why should they trade? 10 THE FLOW OF CAPITAL NCO OR NFI When a U.S resident buys stock in Telmex, the Mexican phone company, the purchase raises U.S NCO When a Japanese residents buys a bond issued by the U.S government, the purchase reduces the U.S NCO THE FLOW OF CAPITAL NCO OR NFI When an Australian resident buys shares in British Telecom (a British phone company), the purchase ……… Australian net foreign investment When a Japanese resident buys a bond issued by the Australian government, the purchase ……… Australian net foreign investment VARIABLES INFLUENCING NCO OR NFI The real interest rates being paid on foreign assets The real interest rates being paid on domestic assets The perceived economic and political risks of holding assets abroad The government policies that affect foreign ownership of domestic assets NX = NCO  Net exports (NX) and net capital outflow (NCO) are closely linked  For an economy as a whole, NX and NCO must balance each other so that: NCO = NX  Every transaction that affects one side must also affect the other side by the same amount SAVING, INVESTMENT & INTERNATIONAL FLOWS Net exports: a component of GDP Y = C + I + G + NX National saving: the income of the nation that is left after paying for current consumption and government purchases Y - C - G = I + NX SAVING, INVESTMENT & INTERNATIONAL FLOWS National saving (S) equals Y-C-G so: S = I + NX or Saving = Domestic + Foreign Investmen Investmen t t REAL AND NOMINAL EXCHANGE RATES International transactions are influenced by international prices The two most important international prices are the nominal exchange rate and the real exchange rate NOMINAL EXCHANGE RATES The nominal exchange rate: the rate at which a person can trade the currency of one country for the currency of another, expressed in two ways:  In units of foreign currency per one unit of domestic currency:  In Australia:USD1 = AUD1.2850  In units of domestic currency per one unit of the foreign currency  In Australia:AUD1 = USD0.7782 (1/1.2850) NOMINAL EXCHANGE RATES  Appreciation of a domestic currency  Depreciation of a domestic currency REAL EXCHANGE RATES  The real exchange rate:  The rate at which a person can trade the goods and services of one country for the goods and services of another  Comparing the prices of domestic goods and foreign goods in the domestic economy REAL EXCHANGE RATES Determinants of the real exchange rate:  the nominal exchange rate  the prices of goods in the two countries measured in local currencies REAL EXCHANGE RATES Real Nominalexchangeratex Domesticprice Exchange  Foreignprice Rate The real exchange rate is a key determinant of how much a country exports and imports REAL EXCHANGE RATES  A depreciation (fall) in the U.S real exchange rate U.S goods have become cheaper relative to foreign goods Consumers both at home and abroad would buy more U.S goods and fewer goods from other countries U.S exports rise, and U.S imports fall U.S net exports increase REAL EXCHANGE RATES  An appreciation in the U.S real exchange rate U.S goods have become ………………… relative to foreign goods So consumers both at home and abroad would buy ………… U.S goods and ………… goods from other countries U.S exports …………, and U.S imports ………… U.S net exports ……… and comparative advantage and their application How everyone can benefit from trade LECTURE REVIEW Examine the trade restrictions and the arguments for and against them The International flows Nominal and Real ... Nominal and Real OPEN AND CLOSED ECONOMIES  A closed economy: one that does not interact with other economies in the world  No exports  No imports  No capital flows An open economy: one that.. .OPEN- ECONOMY MACROECONOMICS and comparative advantage and their application How everyone can benefit from trade LECTURE OBJECTIVES Examine the trade restrictions... that impose trade restrictions on the domestic economy  Strategic trade policy  Government actions encouraging large firms to locate in domestic economy  Anti-dumping  Selling products below