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Exam 3
Section 1
Tuesday April 21
Section 3
Monday April 20
Chapter 33
A Macroeconomic
Theory of the
Open Economy
Key Terms
trade policy
capital flight
Model
Simplified version of reality
Variables
Net Exports
Net Capital Outflow
Real Exchange Rates
Nominal Exchange Rates
Focus
Trade Balance
Exchange Rate
Two Markets
Loanable funds market
Foreign currency market
Loan Market
Savers and Borrowers
S = I + NCO
Savings =
Domestic Investment + Net Capital Outflow
Supply = Demand
Two Things
Invest at home
Invest abroad
NCO > 0
Less Invest at home
More Invest abroad
Investing more in other
countries than your own
NCO < 0
More Invest at home
Less Invest abroad
Other countries want to
invest in your country
Supply and Demand
of Loanable Funds
Depends on the
real interest rate
Remember
Nominal Rate =
Real Rate + Inflation Rate
Nominal = Real + Inflation
N = R + I
Country A Country B Country C
Nominal 10% 12%
Real 8% 10%
Inflation 3% 7%2%
13%
5%
Interest Rates
High
Encourage Savers
Discourage Borrowers
Low
Discourage Savers
Encourage Borrowers
Low High
Savers
Borrowers
Interest Rates
Saudi U.A.E.
Nominal Rate 10% 12%
Inflation
Real Rate
Which Investment?
4% 7%
6% 5%
Real
Interest
Rate
Quantity of Loanable Funds
Equilibrium
Rate
Equilibrium
Quantity
Market for Loanable Funds
Demand
For d...
Foreign Currency
Exchange Market
NCO = NX
Net Capital Outflow = Net Exports
Foreign Currency
Exchange Market
If NX > 0
Selling more than buying
What to do with cash?
Must buy foreign assets
Remember...
Foreign Currency
Exchange Market
If NX < 0
Buying more than selling
Must sell domestic assets
to pay for purchases
Foreign Currency
Exchange Market
At the Equilibrium Exchange Rate:
Demand for currency from
foreigners from net exports =
...
Real
Exchange
Rate
Quantity of Riyals Exchanged into Foreign Currency
Equilibrium
Rate
Equilibrium Quantity
Market for
For...
Linking
The Loanable Funds Market
S = I + NCO
with
Foreign Currency Exchange
Market
NCO = NX
Where did the riyals
come from?
Saudi Savers
Loanable Funds Market
Where did I buy the
riyals?
Foreign Currency Market
Cur...
S = I + NCO
demand side
NCO = NX
supply side
Real
Interest
Rate
0
Net Capital Outflow
Depends on Real Interest Rate
NCO is positive
NCI is negative
NCO is negative
NCI ...
Linking
Real
Interest
Rate
Quantity of Loanable Funds
Equilibrium
Interest
Rate
Demand
Supply
Loanable Funds Market
Real
I...
Policy
Real
Interest
Rate
Quantity of Loanable Funds
Equilibrium
Interest
Rate
Demand
Supply
Loanable Funds Market
Real
In...
Ch 33 macroeconomic theory open economy
Ch 33 macroeconomic theory open economy
Ch 33 macroeconomic theory open economy
Ch 33 macroeconomic theory open economy
Ch 33 macroeconomic theory open economy
Ch 33 macroeconomic theory open economy
Ch 33 macroeconomic theory open economy
Ch 33 macroeconomic theory open economy
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Ch 33 macroeconomic theory open economy

  1. 1. Exam 3 Section 1 Tuesday April 21 Section 3 Monday April 20
  2. 2. Chapter 33 A Macroeconomic Theory of the Open Economy
  3. 3. Key Terms trade policy capital flight
  4. 4. Model Simplified version of reality
  5. 5. Variables Net Exports Net Capital Outflow Real Exchange Rates Nominal Exchange Rates
  6. 6. Focus Trade Balance Exchange Rate
  7. 7. Two Markets Loanable funds market Foreign currency market
  8. 8. Loan Market Savers and Borrowers S = I + NCO Savings = Domestic Investment + Net Capital Outflow Supply = Demand
  9. 9. Two Things Invest at home Invest abroad
  10. 10. NCO > 0 Less Invest at home More Invest abroad Investing more in other countries than your own
  11. 11. NCO < 0 More Invest at home Less Invest abroad Other countries want to invest in your country
  12. 12. Supply and Demand of Loanable Funds Depends on the real interest rate
  13. 13. Remember Nominal Rate = Real Rate + Inflation Rate
  14. 14. Nominal = Real + Inflation N = R + I Country A Country B Country C Nominal 10% 12% Real 8% 10% Inflation 3% 7%2% 13% 5%
  15. 15. Interest Rates High Encourage Savers Discourage Borrowers Low Discourage Savers Encourage Borrowers
  16. 16. Low High Savers Borrowers Interest Rates
  17. 17. Saudi U.A.E. Nominal Rate 10% 12% Inflation Real Rate Which Investment? 4% 7% 6% 5%
  18. 18. Real Interest Rate Quantity of Loanable Funds Equilibrium Rate Equilibrium Quantity Market for Loanable Funds Demand For domestic and foreign investment Supply From national savings Too high More supply than demand push rate down Too low More demand than supply push rate up
  19. 19. Foreign Currency Exchange Market NCO = NX Net Capital Outflow = Net Exports
  20. 20. Foreign Currency Exchange Market If NX > 0 Selling more than buying What to do with cash? Must buy foreign assets Remember foreign currency is a foreign asset
  21. 21. Foreign Currency Exchange Market If NX < 0 Buying more than selling Must sell domestic assets to pay for purchases
  22. 22. Foreign Currency Exchange Market At the Equilibrium Exchange Rate: Demand for currency from foreigners from net exports = Supply of currency from citizens from net capital outflow
  23. 23. Real Exchange Rate Quantity of Riyals Exchanged into Foreign Currency Equilibrium Rate Equilibrium Quantity Market for Foreign Currency Exchange Demand For net exports Supply From net capital outflow Vertical - does not depend on exchange rate Low rates stimulate exports High rates discourage exports Too low More demand than supply Pressure to push rate up Too high More supply than demand Pressure to push rate down
  24. 24. Linking The Loanable Funds Market S = I + NCO with Foreign Currency Exchange Market NCO = NX
  25. 25. Where did the riyals come from? Saudi Savers Loanable Funds Market Where did I buy the riyals? Foreign Currency Market Currency Traders move funds between the two markets
  26. 26. S = I + NCO demand side NCO = NX supply side
  27. 27. Real Interest Rate 0 Net Capital Outflow Depends on Real Interest Rate NCO is positive NCI is negative NCO is negative NCI is positive Cash comes in Cash goes out
  28. 28. Linking Real Interest Rate Quantity of Loanable Funds Equilibrium Interest Rate Demand Supply Loanable Funds Market Real Interest Rate Quantity of Loanable Funds Demand Net Capital Outflow Real Exchange Rate Quantity of Riyals Equilibrium Exchange Rate Demand Supply Foreign Currency Exchange Market Loanable Funds Market Interest Rate Foreign Currency Market Exchange Rate
  29. 29. Policy Real Interest Rate Quantity of Loanable Funds Equilibrium Interest Rate Demand Supply Loanable Funds Market Real Interest Rate Quantity of Loanable Funds Demand Net Capital Outflow Real Exchange Rate Quantity of Riyals Equilibrium Exchange Rate Demand Supply Foreign Currency Exchange Market Government deficits push up interest rates which increase exchange rates which increase trade deficits

macroeconomic theory open economy

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