Transcript Mankiw: Brief Principles of Macroeconomics, Second Edition

Mankiw: Brief Principles of
Macroeconomics, Second Edition
(Harcourt, 2001)
Ch. 12: Open Economy
Macroeconomics: Basic Concepts
Definitions
• Closed economy: Self-sufficient economy.
• Open economy: involved in international trade
and international flow of capital.
• Exports: goods and services sold abroad.
• Imports: goods and services bought from
abroad.
• Trade balance: Exports – imports = net exports
• Trade deficit: Imports > exports.
• Trade surplus: Exports > imports.
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Factors That Influence Net Exports
• Tastes
1. Tastes of American consumers change
toward domestic products.
2. Tastes of foreign consumers change
toward American products.
3. Tastes of American consumers change
toward foreign products.
4. Tastes of foreign consumers change
toward their own products.
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Factors That Influence Net
Exports
•
1.
2.
3.
4.
Prices
Domestic prices rise.
Domestic prices fall.
Foreign prices rise.
Foreign prices fall.
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Factors That Influence Net
Exports
• Exchange rates
1. The dollar appreciates (100 yen to 110 yen).
2. The dollar depreciates (2 pounds to 1.5
pounds).
3. The peso appreciates ($0.1 to $0.2).
4. The peso depreciates ($0.1 to $0.08).
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Factors That Influence Net
Exports
•
1.
2.
3.
4.
Incomes
Incomes of American consumers increase.
Incomes of foreign consumers increase.
Incomes of American consumers decrease.
Incomes of foreign consumers decrease.
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Factors That Influence Net
Exports
• Transportation and transaction costs
1. Transportation costs increase.
2. Transportation costs decrease.
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Factors That Influence Net
Exports
•
1.
2.
3.
4.
Government policies
US imposes tariffs on imports.
US imposes quotas on imports.
Trading partners impose tariffs.
Trading partners impose quotas.
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Net Foreign Investment
• Foreign assets purchased by Americans minus
American assets purchased by foreigners is
American NFI.
• Canadian purchases of foreign assets minus
foreign purchases of Canadian assets is Canadian
NFI.
• Coca Cola establishing a plant in Ukraine to
produce coke there, is foreign direct investment
by US.
• You send $500 to a mutual fund that buys
Japanese stocks. That is foreign portfolio
investment by US.
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Factors That Influence NFI
• The real interest paid on foreign assets (real rate
of return).
• The real interest paid on domestic assets.
• The perceived economic and political risks of
holding assets abroad.
• The government policies that affect foreign
ownership of domestic assets.
• The expected exchange rate in the future.
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NFI = NX
• Net exports are matched by net foreign investment.
• Trade surplus is equal to net positive foreign
investment.
• Trade deficit is equal to net negative foreign
investment.
• When Dell sells a computer to the French, it acquires a
bank deposit in France.
– US NFI increases.
• When VW sells a Beetle in US, it acquires a bank
deposit in US.
– US NFI decreases.
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Circular Flow Equilibrium
Y = C + I + G + NX
Y=C+S+T
C + S + T = C + I + G + NX
S + (T – G) = I + NX
Private Saving + Government Saving =
Investment + Net Exports
National Saving = Investment + Net Foreign
Investment
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National Saving
• If the national saving is low and NFI is
zero, we would invest less and grow slowly
and have lower standard of living in the
future.
• If the national saving is low foreign savings
(negative net foreign investment) help us
grow more.
• Low national saving forces trade deficits if
investments are to be high.
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Exchange Rates
• Nominal exchange rate is the price of one
currency in terms of another.
– $1 is equal to C$1.50
– $0.87 equal to €1.
• Depreciation means the price of a
currency loses value in terms of another
currency.
• Appreciation means the price of a
currency rises.
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Exchange Rates
• Real exchange rates show the value of a product in both
countries.
• Real exchange rates will determine who will export and
who will import a product under free trade.
• Suppose a TV monitor sells for $100 in the US and for
¥5000 in Japan. If the exchange rate between $
and ¥ is ¥100=$1, then the price of TV in US
compared to Japan will be [($100)(¥100/$)]/¥5000
= 2.
• TVs are twice as expensive in the US compared to
Japan.
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Real Exchange Rate
• For the whole economy, real exchange rates will
be a comparison of price levels.
• Nominal and real exchange rates will be the
same when both countries use the base year CPI.
• What will happen to the real $ exchange rate
when US inflation is higher than Japanese
inflation.
• R.E.R. = (¥100/$)($P)/¥P
• US real exchange rate would appreciate and
US exports would fall and US imports would
rise.
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Purchasing Power Parity
• PPP is a theory that explains how exchange
rates adjust in the long run.
• PPP is based on law of one price.
– If the same product has two different prices in
two localities people will buy at the cheap place
and sell at the expensive place: arbitrage.
– Demand up in cheap place: price up.
– Supply up in expensive place: price down.
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Purchasing Power Parity
• PPP between two currencies will affect both
local prices and the exchange rates.
• Arbitrage makes the prices converge.
• To buy in the cheap country, say Mexico,
foreigners should buy pesos.
–
–
–
–
Demand for pesos goes up.
Price of pesos goes up: $0.15/peso to $0.20/peso.
Peso appreciates and USD depreciates.
Mexican products become more expensive; US
products cheaper.
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Purchasing Power Parity
• If PPP holds the same basket of goods in US
and Mexico should cost the same.
• Mexican basket costs Pp.
• US basket costs P$.
• Exchange rate is $/peso (or peso/$).
• Pp($/peso)=P$
• P$(peso/$)=Pp
• $/peso=P$/Pp or peso/$=Pp/P$
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Purchasing Power Parity
• According to PPP, the nominal exchange
rates between two currencies must reflect
their respective price levels.
• Inflation in a country will depreciate its
nominal exchange rate.
• For PPP to hold, the real exchange rate
remains constant at 1.
($/peso)(Pp/P$)=1.
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Purchasing Power Parity
• PPP can explain movements between
exchange rates over 5-10 years.
• It doesn’t explain why exchange rates
fluctuate from day to day.
– Many services are not traded.
– Many products are not perfect substitutes.
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Source: http://www.economist.com/markets/bigmac/displaystory.cfm?story_id=305167&CFID=143098&CFTOKEN=58326587
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