Summary of chapter 28 of the book Economics. Written by N. Gregory Mankiw and Mark P. Taylor, 3rd edition. Written for IBMS students of Avans or for the course Economics. ISBN 9781408093795.
An open economy interacts with other economies in 2 ways:
- it buys and sells goods and services in world product markets.
- it buys and sells capital assets such as stocks and bonds in world financial markets.
The flow of goods and services: Exports, Imports and Net Exports
Exports – domestically produced goods and services that are sold abroad.
Imports – foreign produced goods and services that are sold domestically.
Net exports – the value of its exports minus the value of its imports.
Trade balance – other word for net exports.
Trade surplus – an excess of exports over imports.
Trade deficit – an excess of imports over exports.
Balanced trade – a situation in which exports equal imports.
Some factors that influence exports, imports and net exports:
- tastes of consumers for domestic and foreign goods
- prices of goods at home and abroad.
- exchange rates
- incomes of consumers at home and abroad.
The flow of financial resources: Net Capital Outflow
Net capital outflow – the purchase of foreign assets by domestic residents minus the purchase of
domestic assets by foreigners.
The flow of capital abroad takes 2 forms:
- foreign direct investment (French company opens store in Germany)
- foreign portfolio investment (French citizen buys shares in German company)
Some important variables that influence net capital outflow:
- real interest rates being paid on domestic assets.
- real interest rates being paid on foreign assets.
- perceived economic and political risks of holding assets abroad.
- government policies that affect foreign ownership of domestic assets.
The equality of net exports and net capital outflow
Both net exports and capital outflow measure of type of imbalance in the world markets for goods
and services and in world financial markets.
Net exports measure an imbalance between exports and imports.
Net capital outflow measures an imbalance between the amount of foreign assets bought by
domestic residents and the amount of domestic assets bought by foreigners.
These two imbalances must offset each other: 𝑁𝐶𝑂 = 𝑁𝑋
Saving and Investment, and their relationship to the international flows
Remember the following equations:
1. Gross domestic product (Y) = consumption (C) + investment (I) + government purchases (G) + net
exports (NX)
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