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slide 2
d =spending on
I I I
domestic
d
f
goods
G G G
f = spending on
foreign goods
EX = exports =
foreign spending on domestic goods
IM = imports = C f + I f + G f
= spending on foreign goods
d
GDP = expenditure on
domestically produced g & s
slide 3
Y Cd I
G d EX
(C C ff) (I I ) (G G f ) EX
C I G EX (C ff I
C I G EX I M
C I G NX
Gf )
Y = C + I + G + NX
or,
NX = Y (C + I + G )
net
exports
domestic
spending
output
NX = EX IM = Y (C + I + G )
trade surplus:
output > spending and exports > imports
Size of the trade surplus = NX
trade deficit:
spending > output and imports > exports
Size of the trade deficit = NX
slide 7
NX = Y (C + I + G )
implies
NX
= (Y C G ) I
=
S
I
trade balance = net capital outflows
Thus,
Thus,
aa country
country with
with aa trade
trade deficit
deficit ((NX
NX <
<
00))
is
is aa net
net borrower
borrower ((SS <
< II ).).
slide 8
C C (Y T )
I I (r )
aa &
& bb imply
imply rr =
= r*
r*
cc implies
implies r*
r* is
is exogenous
exogenous
the
exogenous
world interest
rate
determines
and the
investment
difference
between
saving and
investment
determines
net capital
outflows and
net exports
S
NX
r*
rc
I (r )
I1
S, I
slide 11
demand
slide 12
An increase in
G or decrease
in T reduces
saving.
*
1
S 2 S1
NX2
NX1
Results:
I 0
I (r )
NX S 0
I1
S, I
slide 13
Expansionar
y fiscal
policy
abroad
raises the
world
interest rate.
Results:
NX2
r2*
S1
NX
*
1
I 0
I (r )
NX I 0
*
2
I (r )
I (r1* )
S, I
slide 14
3. An increase in investment
demand
r
An Increase in
investment demand
leads to a trade deficit
NX
I (r )2
I (r )1
I,S
Exchange Rate
slide 15
e =
nominal exchange
rate,
the relative price of
domestic currency
in terms of foreign currency
(e.g. Yen per Dollar)
slide 16
=
the
lowercase
Greek letter
epsilon
e P
P*
NX = NX ( )
How is determined
slide 20
NX( ) S I r( * )
demand:
Foreigners need
dollars to buy
U.S. net exports.
supply:
The net capital
outflow (S I )
is the supply
of dollars to be
invested
abroad.
S1 I (r *)
NX 1
NX(
)
NX
Four experiments
slide 22
demand
4. Trade policy to restrict imports
slide 23
causing the
real exchange
rate to rise
and NX to
fall.
S 2 I (r *)
S1 I (r *)
2
1
NX 2
NX 1
NX(
)
NX
An increase in r*
reduces investment,
increasing net
capital outflows and
the supply of dollars
in the foreign
exchange market
causing the
real exchange
rate to fall
and NX to
rise.
S1 I (r1*)
S1 I (r2* )
1
2
NX 1
NX 2
NX(
)
NX
3. An increase in investment
demand
slide 25
An increase in
investment
reduces net
capital outflows
and the supply
of dollars in the
foreign
exchange
market
causing the
real exchange
rate to rise
and NX to
fall.
S1 I 2
S1 I 1
2
1
NX 2
NX 1
NX(
)
NX
Trade policy
doesnt affect S or
I , so capital flows
and the supply of
dollars remains
fixed.
S I
2
1
NX ( )2
NX ( )1
NX1
NX
Results:
> 0
(demand
increase)
NX = 0
(supply
fixed)
IM < 0
(policy)
EX < 0
(rise in )
S I
2
1
NX ( )2
NX ( )1
NX1
NX
e P
*
P
P*
Two definitions:
Reasoning:
e P = P*
Cost of a basket
of foreign
goods, in foreign
currency.
Cost of a basket
Cost of a basket
of domestic
of domestic
goods, in foreign
goods, in
currency.
domestic
Solve for e : currency.
e = P*/ P
PPP:
If e = P*/P,
then
P
P* P
e *
* 1
P
P
P
S I
=1
NX
NX
Under PPP,
changes in (S
I ) have no
impact on or e.
nontraded goods
transportation costs
Chapter summary
slide 34
a countrys output (Y )