Open-Economy Macroeconomics: Basic Concepts

Vocabulary practice flashcards covering basic concepts of open-economy macroeconomics, including trade balances, capital flows, and exchange rate theories.

Closed Economy

An economy that does not interact with other economies in the world.

Open Economy

An economy that interacts with other economies by buying and selling goods and services in world product markets and capital assets in world financial markets.

Exports

Goods and services that are produced domestically and sold abroad.

Imports

Goods and services that are produced foreignly and sold domestically.

Net Exports ($NX$)

The value of a nation’s exports minus the value of its imports, also referred to as the trade balance.

Trade Surplus

A situation where net exports are greater than zero ($NX > 0$).

Trade Deficit

A situation where net exports are less than zero ($NX < 0$).

Balanced Trade

A situation where net exports equal zero ($NX = 0$).

Net Capital Outflow ($NCO$)

The purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners, also known as net foreign investment.

Foreign Direct Investment ($FDI$)

A form of asset acquisition where a domestic entity actively manages a foreign operation, such as McDonald’s opening a branch in Japan.

Foreign Portfolio Investment

A form of asset acquisition where a domestic resident buys foreign stocks or bonds, such as an American purchasing shares of Toyota.

The Accounting Identity

The principle that net exports must equal net capital outflow ($NX = NCO$).

Open-Economy Saving Identity

The identity stating that national saving equals domestic investment plus net capital outflow ($S = I + NCO$).

Nominal Exchange Rate

The rate at which a person can trade the currency of one country for the currency of another country.

Appreciation

A ‘strengthening’ of a currency, meaning it can buy more foreign currency.

Depreciation

A ‘weakening’ of a currency, meaning it can buy less foreign currency.

Real Exchange Rate

The rate at which a person can trade the goods and services of one country for those of another, calculated as $E = \frac{e \times P}{P^*}$.

Law of One Price

An economic principle based on arbitrage asserting that a good must sell for the same price in all locations.

Purchasing-Power Parity ($PPP$)

A theory of exchange rates stating that a unit of any given currency should be able to buy the same quantity of goods in all countries.

PPP Nominal Exchange Rate Formula

Based on PPP, the nominal exchange rate between two countries equals the ratio of the price levels: $e = \frac{P^*}{P}$.