ECON Ch. 13-17

What is an export?

A good or service produced domestically and sold abroad.

What is an import?

A good or service produced abroad and bought domestically.

What is net exports (NX)?

Exports minus imports.

What is another name for net exports?

Trade balance.

What does a trade surplus mean?

Exports are greater than imports, so NX is positive.

What does a trade deficit mean?

Imports are greater than exports, so NX is negative.

What does balanced trade mean?

Exports equal imports, so NX is zero.

Why do exports increase net exports?

Because they add foreign spending on domestic goods.

Why do imports decrease net exports?

Because domestic spending goes to foreign goods instead of domestic goods.

Name 5 factors that influence trade.

Consumer preferences, exchange rates, relative prices, income levels, transportation costs, and government trade policies.

What is an open economy?

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

What is net capital outflow (NCO)?

The purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners.

What does positive NCO mean?

Domestic residents are buying more foreign assets, so money flows out of the country.

What does negative NCO mean?

Foreigners are buying more domestic assets, so money flows into the country.

Give one example of positive NCO.

A Canadian buying shares in a U.S. company.

Give one example of negative NCO.

A foreign investor buying Canadian government bonds.

What is foreign direct investment (FDI)?

When a company directly owns or builds a business abroad.

What is portfolio investment?

When investors buy foreign stocks or bonds.

What 3 things affect NCO?

Interest rates, government regulations, and risk/political stability.

What is the key identity linking trade and finance in an open economy?

NCO = NX

Why does NCO always equal NX?

Because every international transaction has two sides: a trade side and a financial side.

What happens in a trade surplus in terms of capital flows?

NX > 0, so NCO > 0; extra foreign currency is used to buy foreign assets.

What happens in a trade deficit in terms of capital flows?

NX < 0, so NCO < 0; the deficit is financed by selling domestic assets to foreigners.

What is the saving identity in an open economy?

S = I + NCO

What does the equation S = I + NCO mean?

National saving finances domestic investment and net foreign investment.

In a closed economy, what is the saving identity?

S = I

If a country has a trade surplus, what is the relationship between saving and investment?

S > I

If a country has a trade deficit, what is the relationship between saving and investment?

S < I

If trade is balanced, what is the relationship between saving and investment?

S = I and NCO = 0

What is a nominal exchange rate?

The rate at which one country’s currency can be exchanged for another.

What is currency appreciation?

When a currency rises in value and buys more foreign currency.

What is currency depreciation?

When a currency falls in value and buys less foreign currency.

What is a strong currency?

An appreciating currency.

What is a weak currency?

A depreciating currency.

Who benefits from an appreciating currency?

Travellers and buyers of foreign goods.

Who is hurt by an appreciating currency?

Exporters.

What determines the exchange rate in the supply-and-demand model?

Supply and demand for the currency in the foreign exchange market.

Where does demand for Canadian dollars come from?

Foreign buyers of Canadian goods, foreign investors in Canada, and currency traders expecting CAD to rise.

Where does supply of Canadian dollars come from?

Canadians exchanging CAD for foreign currency.

What happens if the exchange rate is above equilibrium?

There is a surplus of CAD, so the exchange rate is pushed down.

What happens if the exchange rate is below equilibrium?

There is a shortage of CAD, so the exchange rate is pushed up.

What can shift demand for Canadian dollars right?

A foreign boom that increases demand for Canadian exports, or higher Canadian interest rates.

What can shift demand for Canadian dollars left?

A foreign recession or lower Canadian interest rates.

What can shift supply of Canadian dollars right?

More Canadian imports or higher foreign interest rates.

What can shift supply of Canadian dollars left?

A Canadian recession or lower foreign interest rates.

What happens to net exports when CAD appreciates?

Exports fall, imports rise, so NX falls.

What happens to net exports when CAD depreciates?

Exports rise, imports fall, so NX rises

What is the real exchange rate?

The relative price of domestic goods and services compared with foreign goods and services.

What does the real exchange rate depend on?

The nominal exchange rate, the domestic price level, and the foreign price level.

The nominal exchange rate, the domestic price level, and the foreign price level.

It affects exports and imports by comparing the relative prices of goods across countries.

What is purchasing power parity (PPP)?

The theory that exchange rates adjust so the same basket of goods costs the same in different countries.

What is the law of one price?

Identical goods should sell for the same price in different places once expressed in a common currency.

Why does PPP not hold perfectly in reality?

Because of non-tradable goods, differences in goods, and consumer preferences.

According to PPP, what happens if domestic prices rise faster than foreign prices?

The domestic currency tends to depreciate.

What is perfect capital mobility?

Financial assets can move easily across borders.

What is interest rate parity in a small open economy?

The domestic real interest rate equals the world real interest rate: r = rʷ.

Why do Canadian rates tend to move with world rates?

Because capital flows across borders until return differences are removed.

Why might interest rate parity not hold perfectly?

Default risk, taxes, and differences in asset characteristics.

What is a key feature of economic fluctuations?

They are irregular and unpredictable.

What tends to happen to many macro variables during a recession?

Real GDP, income, profits, spending, and production tend to fall together.

What happens to unemployment when GDP falls?

Unemployment rises.

What are the axes on the AD-AS graph?

Price level on the vertical axis and real GDP on the horizontal axis.

What does the aggregate demand (AD) curve show?

The quantity of goods and services demanded at each price level.

What does the aggregate supply (AS) curve show?

The quantity of goods and services supplied at each price level.

What determines macroeconomic equilibrium in the AD-AS model?

The intersection of AD and AS.

Why does the AD curve slope downward?

Because of the wealth effect, interest rate effect, and real exchange rate effect.

What is the wealth effect?

A lower price level increases the purchasing power of money, making households feel wealthier and spend more.

What is the interest rate effect?

A lower price level reduces money demand, lowers interest rates, and raises investment spending.

What is the real exchange rate effect?

A lower domestic price level makes domestic goods relatively cheaper, increasing exports and reducing imports.

What causes a movement along the AD curve?

A change in the price level.

What causes a shift of the AD curve?

Changes in consumption, investment, government spending, or net exports not caused by the current price level.

What shifts AD right through consumption?

Higher consumer confidence, higher wealth, or tax cuts.

What shifts AD left through consumption?

Lower confidence, lower wealth, or tax increases.

What shifts AD right through investment?

Business optimism, new technology, tax incentives, or lower interest rates.

What shifts AD left through investment?

Pessimism, fewer incentives, or higher interest rates.

How does government spending affect AD?

More government spending shifts AD right; less shifts it left.

How do foreign booms affect AD?

They increase exports and shift AD right.

How does an appreciation of the Canadian dollar affect AD?

It reduces net exports and shifts AD left.

What is long-run aggregate supply (LRAS)?

The economy’s natural level of output determined by labour, capital, natural resources, and technology.

Why is LRAS vertical?

Because in the long run, the price level does not affect real output.

What is another name for the natural level of output?

Potential output or full-employment output.

What shifts LRAS right?

More labour, more capital, more natural resources, or better technology.

What shifts LRAS left?

Less labour, less capital, fewer resources, or negative technology/productivity shocks.

Why does SRAS slope upward?

Because sticky wages, sticky prices, and misperceptions cause output to rise when actual prices are above expected prices.

What do sticky wages mean?

Wages adjust slowly, so unexpected changes in prices affect firms’ profits and output.

What do sticky prices mean?

Some firms do not adjust prices immediately, so unexpected inflation or deflation changes their sales and output.

What do misperceptions mean in SRAS theory?

Firms may confuse changes in the general price level with changes in their own relative prices.

What shifts SRAS right?

Better technology, more resources, lower expected prices, or lower input costs.

What shifts SRAS left?

Higher expected prices, higher input costs, or negative supply shocks such as oil price increases.

What is stagflation?

A combination of higher inflation and lower output caused by a negative supply shock.

What happens in the short run after AD shifts left?

Output falls and the price level falls.

What happens in the long run after an adverse AD shock?

Output returns to its natural level, but the price level stays lower.

How can policymakers respond to an adverse AD shock?

By using expansionary monetary or fiscal policy to shift AD back right.

What happens after SRAS shifts left?

Output falls and the price level rises.

Why are supply shocks difficult for policymakers?

Fighting inflation can worsen unemployment, while fighting unemployment can worsen inflation.

What is liquidity preference theory?

The theory that interest rates adjust to balance money supply and money demand.

Why do people demand money?

Because it is liquid and useful for transactions and convenience.

What is the opportunity cost of holding money?

The interest income you give up by not holding interest-bearing assets.

What happens to money demand when interest rates rise?

Money demand falls.

What happens to money demand when interest rates fall?

Money demand rises.