International Flow of Goods and Capital
Closed Economy- Economy that does not trade with other economies in the world.
Open-Economy- Economy that trades freely with other economies in the world in 2
ways.
1. Buys and sells G&S in world product markets
2. Buys and sells capital assets such as stocks/bonds in world financial markets
Exports (EX) - Domestically produced G&S sold abroad
Imports(IM) - G&S produced abroad and sold domestically.
Net Exports: The Flow of Goods and Services
● Net Exports(NX also Trade Balance)- Value of nation’s exports minus imports.
NX=EX-IM
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Trade Surplus (NX>0) - Exports greater than imports
Trade Deficit (NX<0) - Exports less than imports
Balanced Trade (NX=0) - Exports equal imports
○ NX=EX-IM>0, Trade Surplus
○ NX=EX-IM<0, Trade Deficit
○ NX=EX-IM=0, Balanced Trade
Factors that influence Net Exports
● Consumer tastes for domestic and foreign goods
● Prices of goods at home and abroad
● Exchange rates, people use domestic currency to buy foreign currency
● Consumer income at home and abroad
● Transportation costs
● International trade policy
Increasing Openness of U.S. Economy
● In 1950s, imports/exports 4-5% of GDP
● Recent years, approximately 3 times that level
● Largest trading partners in 2018
○ China
○ Canada, Mexico, Japan, Germany, S. Korea. U.K.
●
Improvements due to:
○ Transportation
○ Telecommunications
○ Technological progress
○ Trade policies
Net Capital Outflow (NCO, also Net Foreign Investment)NCO= Purchase foreign assets by domestic residents-purchase of domestic assets by
foreign residents
Purchase of foreign assets by domestic residents (2 Types):
● Foreign Direct Investment, E.G. Mcdonal’s opens outlet in Russia. American owner
actively manages investment.
● Foreign Portfolio Investment, e.g. American owner buys stock in Russian corporation.
American owner has a passive role.
Net Capital Outflow (NCO) can be:
● Positive (capital outflow)
● Negative (capital inflow)
Variables that can influence NCO:
● Real interest rate paid on foreign assets.
● Real interest rate paid on domestic assets.
● Perceived economic and political risks of holding assets abroad.
● Government policies that affect foregn ownership of domestic assets.
Open economy interacts with the rest of the world (ROW) in 2 ways:
● World markets for G&S (NX)
● World financial markets (NCO)
Net Exports (NX)- measures imbalance between a country’s exports and imports of G&S.
Net Capital Outflow (NCO)- measures imbalance between amount of foreign assets bought by
domestic residents and amount of domestic assets bought by foreigners.
NX=NCO
What happens when programmer sells software to japan for 10,000 yen?
● What happens to NX=NCO?
● NX: Sale of software increases U.S. Exports (EX) by 10,000 yen.
● NCO:
○ Yen under mattress (SAVE) ⇒ Increases U.S. NCO (acquire Japanese asset, i.e.
currency)
○ Buy Japanese stock/bond ⇒ increases U.S. NCO (acquire japanese asset, i.e,
stock or bond)
○ Buy Sony TV ⇒ Increases U.S. Imports (IM) by 10,000 yen (EX=IM), i.e. NX
1. WHen NX>0 (trade surplus)
a. Sells more G&S to foreing residents than it buys from them.
b. From net sales of G&S
i.
Receives foreign currency
ii.
Acquires foreign assets
iii.
Capital flows out of country: NCO>0
2. When NX<0 (trade deficit)
a. Buy more G&S from foreign residents than it sells to them
b. From net sales og G&S
i.
Sends domestic currency abroad
ii.
Foreigners acquire domestic assets
iii.
Capital flows into country (NCO>0)
Open Economy Model:
National Income (1) Y
= C + I + G + NX
(2) Y - C - G = I + NX
(3) S
= I + NX
------------- Where S = Y - C - G = National Saving
(4) S
= I + NCO
------------- Where NX = NCO
IMPORTANT NOTE FOR QUESTIONS:
● When given a question about NCO or NX or IM or anything about foreign and domestic
assets, then always refer back to formula NX=EX-IM.
● Remember Trade surplus, Trade Deficits
● NX=NCO