CH18: The Goods mqrket in an open economy

What is the identity for total demand for domestic goods in an open economy?

ZZ= C+I+G+X- IM/ε

What happens to imports and exports when ε (exchange rate) increases?

Imports increase, exports decrease

What does ε represent in an open economy?

ε is the real exchange rate: , where E is the nominal exchange rate, P domestic price, and foreign price.

What does a trade surplus imply?

X > IM/ε

What condition defines equilibrium in the open goods market?

Y= ZZ

What is the shape of the Net Exports (NX) curve with respect to income?

Downward sloping; higher income leads to more imports

What is the effect of an increase in domestic demand?

Output increases, but trade balance worsens (more imports)

What is the effect of an increase in foreign demand?

Output increases and trade balance improves (more exports).

Why is the multiplier smaller in an open economy?

Part of increased demand leaks to imports instead of boosting domestic production

What is the Marshall-Lerner condition?

A depreciation improves the trade balance if the sum of price elasticities of exports and imports is > 1

What is the J-curve effect?

A depreciation first worsens the trade balance (price effect), then improves it (quantity effect)

How can depreciation and fiscal policy be combined to correct trade imbalance without changing output?

Combine depreciation (to improve NX) with reduced government spending (to offset rise in output)

What is the identity linking saving, investment, and the trade balance?

S=I+(T-G)+NX

What is the current account (CA) in terms of savings and investment?

CA=S+(T-G)-I

When does a current account deficit occur?

When domestic investment exceeds total savings (private + public)

Can a current account deficit be good?

Yes, if it finances productive investment. But risky if financed by volatile portfolio flows