ECON 2301 Module 12: Open Economy Macroeconomics, Exchange Rates, and PPP

Vocabulary flashcards covering open economy macroeconomics, international trade, capital flows, exchange rates, purchasing-power parity, and the Big Mac Index.

Open economy

An economy that trades goods, services, and financial assets with other countries.

Closed economy

An economy that does not interact economically with other countries.

Exports ($X$)

Goods and services produced domestically and sold abroad.

Imports ($M$)

Goods and services produced abroad and purchased domestically.

Net exports ($NX$)

The value of a nation's exports minus the value of its imports, expressed as $NX = X - M$.

Trade surplus

A condition where exports exceed imports, resulting in a positive net exports balance ($NX > 0$).

Trade deficit

A condition where imports exceed exports, resulting in a negative net exports balance ($NX < 0$).

Balanced trade

A situation in which exports equal imports, resulting in net exports of zero ($NX = 0$).

Net capital outflow ($NCO$)

The domestic purchases of foreign assets minus the foreign purchases of domestic assets.

Foreign direct investment (FDI)

Actively owning and operating a business abroad, such as establishing an overseas factory.

Portfolio investment

Purchasing foreign stocks or bonds without actively managing the underlying company.

National saving ($S$)

The total income in the economy that remains after paying for consumption and government purchases, defined as $S = Y - C - G$.

Saving identity

The open-economy macroeconomic identity stating that national saving equals domestic investment plus net capital outflow, expressed as $S = I + NCO$ or $S = I + NX$.

Nominal exchange rate

The rate showing how much of one country's currency you can receive in exchange for another currency.

Appreciation

An increase in the value of a currency relative to another currency, which makes domestic exports more expensive, imports cheaper, and decreases net exports ($NX$).

Depreciation

A decrease in the value of a currency relative to another currency, which makes domestic exports cheaper, imports more expensive, and increases net exports ($NX$).

Real exchange rate

The rate that compares domestic goods prices against foreign goods prices, calculated as $\epsilon = \frac{eP}{P^*}$.

Purchasing-Power Parity (PPP)

An economic theory stating that a unit of a given currency should buy similar amounts of goods and services across different countries after exchange-rate conversion.

Law of one price

The economic principle asserting that an identical good should cost about the same in all locations after currency conversion.

Arbitrage

The practice of buying a good where it is cheap and selling it where it is expensive, which helps equalize prices across markets.

Nontradables

Goods or services that are difficult or impossible to trade across national borders, such as haircuts, rent, and restaurant labor.

Big Mac Index

An informal economic indicator created in 1986 by Pam Woodall at The Economist that uses Big Mac prices across countries to compare currency values based on purchasing-power parity.

Overvalued currency

A currency whose market exchange rate value is higher than what purchasing-power parity (such as the Big Mac Index) suggests it should be.

Undervalued currency

A currency whose market exchange rate value is lower than what purchasing-power parity (such as the Big Mac Index) suggests it should be.