Macroeconomics Chapter 32 - Theory Of The Open Economy

Front 1

The Market for Loanable Funds:

I + NCO = _____

Back 1

I + NCO = S
(Domestic investment + Net capital outflow = saving)

Front 2

The Market for Loanable Funds:

Supply of loanable funds = ______

Back 2

Supply of loanable funds = saving (upward-sloping)

Front 3

The Market for Loanable Funds:

Demand for loanable funds = _____

Back 3

Demand for loanable funds = I + NCO (downward-sloping)

Front 4

The Market for Loanable Funds:

A dollar of saving can be used to finance: (2)

Back 4

- The purchase of domestic capital
- The purchase of a foreign asset

Front 5

How the Market for Loanable Funds depends on Real Interest Rate (r)

Back 5

- S depends positively on r
- I depends negatively on r
- A fall in r causes NCO to rise (fall in r makes domestic assets less attractive relative to foreign assets)

Front 6

The Market for Foreign-Currency Exchange:

NCO = ___

Back 6

NCO = NX
(Net Capital Outflow = Net Exports)

In the market for foreign currency exchange:
- NX is the demand for dollars (foreigners need dollars to buy US net exports)
- NCO is the supply of dollars (US sells dollars to obtain the foreign currency they need to buy foreign assets

Front 7

The Market for Foreign-Currency Exchange;

The (US) ______________ is the real value of a dollar in the market for foreign-currency exchange

Back 7

Real exchange rate (E)

Front 8

When a US resident buys imported goods, how does the transaction affect supply and demand of dollars in the foreign exchange market?

Back 8

1. The supply of dollars increases.
2. The demand for dollars decreases. (increase in imports reduces NX: which is really the net demand for dollars)

Front 9

When a foreigner buys a US asset, how does the transaction affect supply and demand of dollars in the foreign exchange market?

Back 9

1.. The supply of dollars falls
(the transaction reduces NCO, which is really the net supply of dollars
2. The demand for dollars increases
(the foreigner needs dollars in order to purchase the U.S. asset)

Front 10

The Effects of a Budget Deficit:
- National saving (rises/falls)
- The real interest rate (rises/falls)
- Domestic investment and net capital outflow both (rise/fall)
- The real exchange rate (appreciates/depreciates)
- Net exports (rise/fall)
- Trade deficit (increases/decreases)

Back 10

- National saving FALLS
- The real interest rate RISES
- Domestic investment and net capital outflow both FALL
- The real exchange rate APPRECIATES
- Net exports FALL
- Trade deficit INCREASES

Front 11

The Effects of a Budget Deficit:
As foreigners acquire more domestic assets....

Back 11

...the country's debt to the rest of the world increases.

Front 12

What determines supply of dollars in the foreign exchange market?

Back 12

The Value of NCO

Front 13

The Connection Between Interest Rates and Exchange Rates:

The Order and Direction of Causality of Graphs -

1. The LF market determines the equilibrium value of _____
2. The value of _____ and the _____ curve determine the equilibrium value of NCO
3. This value of NCO determines the position of the ______ ______ curve in the foreign exchange market.
4. The real exchange rate adjusts to equate demand (____) with supply (_____) in the foreign exchange market.

Back 13

1. The LF market determines the equilibrium value of r
2. The value of r and the NCO curve determine the equilibrium value of NCO
3. This value of NCO determines the position of the vertical supply curve in the foreign exchange market.
4. The real exchange rate adjusts to equate demand (NX) with supply (NCO) in the foreign exchange market.

Front 14

Effects of a tax incentive for investment:
r (rises/falls)
NCO (rises/falls)
E (rises/falls)
NX (rises/falls)

Back 14

r rises
NCO falls
E rises
NX falls

Front 15

Investment tax incentive (increases/reduces) investment

Back 15

INCREASES - Increases productivity growth and living standards in the long run

Front 16

Budget deficit (increases/reduces) investment

Back 16

REDUCES - Reduces productivity growth and living standards

Front 17

A gov't policy that directly influences the quantity of goods and services that a country imports or exports is a ______

Back 17

Trade Policy

Front 18

A tax on imports is a(n) ______

Back 18

Tariff

Front 19

A limit on the quantity of imports is a(n) _______

Back 19

Import quota

Front 20

________ is when the gov't pressures another country to restrict its exports; essentially the same as an import quota

Back 20

"Voluntary export restrictions"

Front 21

2 common reasons for policies that restrict imports

Back 21

- Save jobs in a domestic industry that has difficulty completing with imports
- Reduce the trade deficit

Front 22

Macroeconomic effects of an Import Quota

Back 22

E rises (the real exchange rate)

It does not affect the equilibrium values of r, S, I, NCO, or NX

Front 23

A large and sudden reduction in the demand for assets located in a country is called _____

Back 23

Capital flight

Front 24

Myth and Reality:

We should be careful about the US blaming our problems on the international economy

Back 24

- Our trade deficit is not caused by other countries' "unfair" trade practices, but by our own low saving
- Stagnant living standards are not caused by imports, but by low productivity growth