open economy- ch 31

7/28/2019 Open Economy- Ch 31

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Open Economy


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Open Economy

Overview

Trade

Allows people to

produce what theyproduce best and

consume the great

variety of goods and

services produced

around the world.

Trade makes everyone

better off

Closed Economy

Open Economy


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International Flow of Goods and

Capital

Exports

Imports

Net exports (NX)

Value of CountrysExports- Value of

Countrys Imports

Net Exports is also

known as TradeBalance

Trade Balance can be

(Trade)Surplus or

Deficit


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Factors influencing on Countrys

IMPEX? Tastes of Consumers

for Domestic andForeign goods

The price of goods athome and abroad

The exchange rates atwhich people can usedomestic currency tobuy foreign currencies

The incomes of

consumers athome/abroad

Cost of transportation ofgoods

Govt. policies towards

international trade.


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Flow of Financial Resources-Net

Capital Outflow Capital flows

Sale /purchase of realor financial assets

Net Capital Outflow Purchase ofForeign

Assetby DomesticResidentsPurchase ofDomesticAssets by Foreigners

Buying of F-16s from

USA shall reflect asCapital outflow? T or F?

Setting up a Steel Mill inPakistan by USA shallreflect as Capital

inflow?


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Net Capital Outflow Capital flow takes in two

forms

Foreign Direct

Investment (FDI)

Opening up a ToyotaFactory in Pakistan by

Japan is a FDI

Foreign Portfolio

Investment.

Buying shares in PTCLby Abu Dhabi group

(UAE) is Foreign portfolio

investment

In both cases, capital is

flown out of Japan andUAE


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Important Variables that Influence

Net Capital Outflow

Investments are dearto everyone

Real interest rate paid

on foreign assets

Real interest ratespaid on domestic

assets

Perceived economic

risks of holding assets Govt. policies that

affect foreign

ownership of

domestic assets


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NCO= NX (Identity Equation)

NX measuresimbalance in countrys

exports and in its

imports

NCO measures

imbalance between

the amount of foreign

assets bought by

domestic residentsand the amount of

domestic assets

bought by foreign

residents.


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NCO=NX

Example US Software Engineer sells a software to Japanese

company

Receives 10,000 Yen

He has two choices Buy a Japanese Nintendo

Buy stocks in Japanese Stock market


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Buy a Nintendo

NX= Exports- Imports Exports= Software

Imports= Nintendo

NX= 10,000-10,000

NX= Zero

So NCO=NX

As exportsimports are zero, there is no effect on

NCO so NCO = zero


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Buy a Stock

Buying Japanese Stock Exports Software (+10,000)

Capital outflow (+10,000)

NCO=F.A Purchased-D.APurchased

Net Exports = +10,000

NCO= +10,000

NCO=NX


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Saving, Investment & Relationship

with International Flows

Y=C+I+G+NX (GDP)

Y - C - G = I + NX

Y-C-G= S (National Saving)

As NX =NCO so,

S = I + NCO That is why in a closed economy, we have S=I

(excluding NCO)


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Concluding the Debate

As NX=NCORise in NX results in Rise in NCO

People not only Invest in Domestic Economybut also send money abroad for investment

NX makes Y , so S

As Y-C-G=S NX+I=S

Y=C+I+G+NX

If there is Trade Surplus NX


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Relation Between NCO and NX

ExportsC+I+G Saving > Investment

Net Capital Outflow is >0TradeSurplus


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CASE STUDY

Is U.S Trade Deficit a NationalProblem?


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open economy- ch 31

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