The document discusses key concepts in open-economy macroeconomics. It defines closed and open economies and describes how open economies interact through international flows of goods and capital. Specifically, it explains trade balances, factors that influence trade flows, how trade surpluses and deficits relate to net capital outflows, and how exchange rates affect trade quantities through relative price effects. Exchange rates, their appreciation and depreciation, as well as their behavior during hyperinflation are also summarized.

1. Open-Economy Macroeconomics:
Basic Concepts
Principles: Chapter 31
PowerPoint Slides prepared by:
Andreea CHIRITESCU
Eastern Illinois University
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2. Basic Concepts
• Closed economy
– Economy that does not interact with other
economies in the world
• Open economy
– Economy that interacts freely with other
economies around the world
– It has imports and exports
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3. International Flow of Goods
• Trade surplus
– Excess of exports over imports
– Net exports > 0
• Trade deficit
– Excess of imports over exports
– Net exports < 0
• Balanced trade
– Exports equal imports
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4. International Flow of Goods
• Factors that affect a country’s net exports:
– Prices of goods at home and abroad
– Exchange rates
– Incomes of consumers at home and
abroad
– Transportation cost
– Government trade policies
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5. The increasing openness of the U.S. economy
• Why increase in international trade?
– Lowering transportation costs
– Advances in telecommunications
– Government’s trade policies
• NAFTA
• GATT
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6. Figure 1
The Internationalization of the U.S. Economy
This figure shows exports and imports of the U.S. economy as a percentage of U.S. gross
domestic product since 1950. The substantial increases over time show the increasing
importance of international trade and finance.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

7. International Flow of Capital
• Capital Flows
– Purchase of one country’s assets
residents of another country
• physical capital investment + financial
investment (stock/bonds)
• Net Capital Flows
– Amount of foreign assets bought by
domestic residents minus the amount of
domestic assets bought by foreigners
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8. International Flow of Capital
• Factors that affect net capital outflow
– Real interest rates and returns
– Economic and political risks of holding
assets abroad
– Government policies that affect foreign
ownership of domestic assets
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9. Net Exports=Net Capital Outflow
• When NX > 0 (trade surplus)
– Selling more goods and services to
foreigners than it is buying from them
– From net sale of goods and services
• Receives foreign currency
• Buy foreign assets
• Capital - flowing out of the country: NCO > 0
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

10. Net Exports=Net Capital Outflow
• When NX < 0 (trade deficit)
– Buying more goods and services from
foreigners
• Than it is selling to them
– The net purchase of goods and services
• Needs financed
• Selling assets abroad
• Capital - flowing into the country: NCO < 0
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11. Figure 2
Net Capital Outflow … how is it related to net exports?
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12. Figure 1
The Internationalization of the U.S. Economy
This figure shows exports and imports of the U.S. economy as a percentage of U.S. gross
domestic product since 1950. The substantial increases over time show the increasing
importance of international trade and finance.
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 12
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

13. Exchange Rates
• Nominal exchange rate
– Rate at which a person can trade currency
of one country for currency of another
• Appreciation
– Increase in the value of a currency
• Buy more foreign currency
• Depreciation
– Decrease in the value of a currency
• Buy less foreign currency
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

14. Exchange Rates
• Depreciation in the U.S. exchange rate
– U.S. goods - cheaper relative to foreign
goods
– Consumers at home and abroad - buy
more U.S. goods and fewer goods from
other countries
• Higher exports
• Lower imports
• Higher net exports
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

15. Exchange Rates
• Appreciation in the U.S. exchange rate
– U.S. goods - more expensive compared to
foreign goods
– Consumers at home and abroad - buy
fewer U.S. goods and more goods from
other countries
• Lower exports
• Higher imports
• Lower net exports
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

16. Nominal exchange rate during a hyperinflation
• Natural experiment – hyperinflation
– High inflation
– Arises when a government prints money
to pay for large amounts of government
spending
• German hyperinflation, early 1920s
– Money supply, price level, nominal
exchange rate
• Move closely together
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

17. Figure 3
Money, Prices, and the Nominal Exchange Rate during the
German Hyperinflation
This figure shows the
money supply, the price
level, and the exchange
rate (measured as U.S.
cents per mark) for the
German hyperinflation
from January 1921 to
December 1924. Notice
how similarly these
three variables move.
When the quantity of
money started growing
quickly, the price level
followed, and the mark
depreciated relative to
the dollar. When the
German central bank
stabilized the money
supply, the price level
and exchange rate
stabilized as well.
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 17
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.