Open-Economy Macroeconomics: Basic Concepts

Practice flashcards covering the fundamental 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 freely with other economies around the world.

Exports

Domestically-produced goods and services sold abroad.

Imports

Foreign-produced goods and services sold domestically.

Net exports (NX)

The value of exports minus the value of imports, also known as the trade balance.

Trade deficit

An imbalance in trade where the value of imports exceeds the value of exports.

Trade surplus

An imbalance in trade where the value of exports exceeds the value of imports.

Balanced trade

A state where the value of exports equals the value of imports.

Foreign direct investment (FDI)

A flow of capital where domestic residents actively manage a foreign investment, such as McDonalds opening a fast-food outlet in Moscow.

Foreign portfolio investment

A flow of capital where domestic residents purchase foreign stocks or bonds, supplying loanable funds to a foreign firm.

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.

Capital outflow

A situation where NCO > 0, meaning domestic purchases of foreign assets exceed foreign purchases of domestic assets.

Capital inflow

A situation where NCO < 0, meaning foreign purchases of domestic assets exceed domestic purchases of foreign assets.

NCO = NX Identity

An accounting identity where net capital outflow equals net exports because every transaction affecting one also affects the other by the same amount.

S = I + NCO Identity

An accounting identity where national saving ($S$) equals domestic investment ($I$) plus net capital outflow ($NCO$).

Nominal exchange rate

The rate at which one country’s currency trades for another, typically expressed as foreign currency per unit of domestic currency.

Appreciation

An increase in the value of a currency as measured by the amount of foreign currency it can buy; also known as strengthening.

Depreciation

A decrease in the value of a currency as measured by the amount of foreign currency it can buy; also known as weakening.

Real exchange rate

The rate at which the goods and services of one country trade for those of another, defined by the formula $\frac{e \times P}{P^<em>}$, where $e$ is the nominal exchange rate, $P$ is the domestic price, and $P^</em>$ is the foreign price.

Law of one price

The notion that a good should sell for the same price in all markets.

Arbitrage

The process of buying a good in a low-price market and selling it in a high-price market to make a quick profit, which eventually equalizes prices across markets.

Purchasing-power parity (PPP)

A theory of exchange rates whereby a unit of any currency should be able to buy the same quantity of goods in all countries, implying that $e = \frac{P^*}{P}$.