Before I built a wall I’d ask to know

What I was walling in or walling out . . .

Robert Frost

What is Open Economy?

Economic activity between domestic community and outside

video

FOREIGN TRADE AND

ECONOMIC ACTIVITY

Open-economy macroeconomics is the study of

how economies behave when the trade and financial
linkages among nations are considered.

Total Aggregate demand (or AD ) is the total or aggregate

quantity of output that is willingly bought at a
given level of prices, other things held constant. AD
is the desired spending in all product sectors: consumption,
private domestic investment, government
purchases of goods and services, and net exports.

Total aggregate demand = C+I+G+X

It has four components:

1. Consumption
2. Investment
3. Government purchases
4. Net exports

Net exports are defined as exports of goods and

services minus imports of goods and services.

imports, which are goods and services produced

abroad and consumed domestically. Exports are
goods and services produced domestically and purchased
by foreigners.

X= Ex – Im

In
2007, net exports for the United States were minus
$708 billion, as calculated from $1662 billion worth of exports minus $2370 billion worth of
imports.
When a country has positive net exports, it is accumulating
foreign assets. The counterpart of net
exports is net foreign investment, which denotes
net U.S. savings abroad and is approximately equal
to the value of net exports. Because the U.S. had
negative net exports, its net foreign investment
was negative, implying that the U.S. foreign indebtedness
was growing.

Exports are the mirror image of imports: U.S.

exports are other countries’ imports.

Figure 28-1

Determinants of Trade and Net Exports

What determines the levels of exports and imports

and therefore of net exports?

(1) because some of the increased C +I +G purchases (such as

cars and shoes) come from foreign production and
also
(2) because America uses foreign-made inputs
(like oil or lumber) in producing its own goods.

Total domestic output =GDP

=C +I +G +X

Imports and exports are determined primarily by incomes, relative price differences, and foreign
exchange rates. When a nation’s exchange rate rises, the prices of imported goods fall while its
exports become more expensive to foreigners.

Two basic exchange rate systems:

Flexible exchange rate - the market forces of supply and demand determine the rate at which
currencies are traded

Fixed exchange rate - the government specifies the rate at which its nation’s currency will be
traded for other currencies.

SHORT-RUN IMPACT OF
TRADE ON GDP

How do changes in a nation’s trade fl ows affect its

GDP and employment?

There are two major new macroeconomic elements

in the presence of international trade: First, we have a fourth component of spending, net
exports, which adds to aggregate demand. Second,
an open economy has different multipliers for private
investment and government domestic spending
because some spending leaks out to the rest of the
world.

Table 28-1

Figure 28.2

Marginal propensity to import, Mpm- measures the changes in spending on imports for each
dollar change in GDP

Mpm= change in imports

Change in GDP

Slope of total spending line= total change in spending

Change in GDP