The Open Economy (in the Long Run)

Flashcards based on lecture notes about the open economy in the long run, covering international flows, exchange rates, and trade policies.

What equation represents the components of GDP in an open economy?

Y = C + I + G + NX

How is the trade balance (NX) calculated?

EX - IM

What is the trade balance equal to in terms of output and domestic spending?

Output (Y) - Domestic Spending (C + I + G)

What does it mean if NX > 0?

Trade Surplus (Net Seller)

What does it mean if NX < 0?

Trade Deficit (Net Buyer)

How is the trade balance (NX) related to saving (S) and investment (I)?

NX = S - I

What happens when S > I?

Capital flows out (Net Lender)

What happens when S < I?

Capital flows in (Net Borrower)

What is the nominal exchange rate?

Relative price of the currencies of two countries

How is 'e' defined, representing the nominal exchange rate?

Foreign currency/domestic currency ($1)

What does a higher 'e' indicate?

Dollar appreciation

What is the real exchange rate?

Relative price of the goods of two countries

What is the formula for the real exchange rate?

ε = (eP) / P*

What happens when the real exchange rate (ε) is lower?

Exports (EX) increase, Imports (IM) decrease, Higher NX

What is a key assumption regarding the economy in the long-run exchange rate determination?

Small open economy with perfect capital mobility

What does r* represent?

World interest rate

What is the relationship between the domestic interest rate (r) and the world interest rate (r*) in equilibrium?

r = r*

What is the relationship between net exports and the real exchange rate, and what does the demand curve look like?

NX = NX(ε), downward sloping

What happens to saving (S), the real exchange rate (ε), and net exports when there is expansionary fiscal policy at home (G rises or T falls)?

S falls, ε increases, NX falls

What are the effects of trade policies like tariffs and quotas on imports, net exports, and the real exchange rate?

IM decreases, NX increases, ε increases

What is the overall effect of protectionist trade policies on the trade balance?

Trade balance unchanged

What is the Law of One Price?

The same good cannot sell for different prices in different locations at the same time.

What is Purchasing-Power Parity (PPP)?

A dollar must have the same purchasing power in every country.

According to PPP, what is the formula for the nominal exchange rate (e)?

e = P*/P

What equation determines the percentage change in the nominal exchange rate?

% change in e = % change in ε + % change in P* – % change in P