Open Economy Macro: I

1. International flow of goods and services

• imports
• exports
• net exports (i.e., trade balance)
• trade surplus
• trade deficit
• balanced trade
• NX = X - M

2. International flow of capital

• net foreign investment = net capital outflow - the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners
• NCO = NX

3. Savings and investment

• Y = C + I + G + NX
• I = S + (G - T) - NX = S - NCO

4. Exchange Rates

• nominal exchange rate - the rate at which a person can trade the currency of one country for the currency of another
• cross rates
• appreciation
• depreciation
• fixed vs flexible exchange rate regimes

5. Purchasing power parity

• Definition: a theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries
• real exchange rate (PPP): E = (e × P)/P*
• Law of one price and arbitrage (the real exchange rate = 1)
• Nominal exchange rates depend on price levels: e = P*/P
• According to the quantity theory of money, nominal exchange rates depend on the money supply
• PPP takes into account different living standards across countries when comparing per capital GDP (Wikipedia).
• Big Mac index [image]