OPEN

OPENECONOMYMACROECONOMICS
ECONOMY MACROECONOMICS
LectureIX

OPENECONOMY
GDP=C+I+G+X
GDP = C + I + G + X
X netexport
X exportofgoodsandservices(X)minusimportofgoods
andservices
X=X M
M>X
M>X deficit
M<X surplus
M=X balance

USNETEXPORT

OPENECONOMY

Adding Net Exports to domestic demand gives Equilibrium

p economyy
GDP in the open
4

SandI closedeconomyy

SandI asmallopeneconomy
p
y

Openeconomymacroeconomics
p
y

Trade and specialization

Balance of payment and foreign exchange rate
International trade and financial system
Competitiveness and economic growth

1. TRADE AND SPECIALIZATION

1.TRADEANDSPECIALIZATION
Specifics of international trade:
International trade with political barriers (customs,
quotes limits,
quotes,
limits ...))
Payments in international exchange need for
foreign exchange rates
Contemporary
p
y economies more or less open
p
economies (X/GDP; M/GDP; X-M/GDP)

Benefitsofinternationaltrade
Thebenefitsofinternationaltrade:
Expandedtradingopportunitiesbasedonproductivityand
specialisation
p
Increasedtradeproducesexternalityeffectinsidenational
economy
Differentcostsofproductionsupportinternationaltradein
practicallyallcountries
Differentpricesofgoodsandservicesstimulateinternationaltrade
Diff
t i
f
d
d
i
ti l t i t
ti
lt d

Benefitsofinternationaltrade
Internationaltradewithsurpluses
Surpluses
Surplusescanbe:
can be
Absolute ADcannotabsorbAS
Relative higherlevelofproductionand
diversificationofeconomicstructure

Internationaltradetheory
Economictheoryfocuses oninternationaleconomic
relations(internationaltradeandbalanceofpayment)
Internationaltradetheoryexplains:
Motiveswhichstimulateinternationaltrade(criteria
ofspecialization)
p
)
Relationshipbetweeninternationaltradeand
economic growth
economicgrowth

Specialization
Internationaltradebasedoncomparative/competitive
advantages
Theprincipleofcomparativeadvantageholdsthateach
country will benefit if it specilizes in the production and
countrywillbenefitifitspecilizesintheproductionand
exportofthosegoodsthatitcanproduceat(relatively)
low costs
lowcosts
Twoapproachestocomparativeadvantages:
Absolute (A.Smith)
Relative (D.Ricardo)
(
)
Neoclassic approach competitiveadvantages

Absolute comparative advantages

Absolutecomparativeadvantages
Smith twocountriesandtwoproducts

Production
X

Country

Absolute comparative advantages

Absolutecomparativeadvantages
Summary:
CountryAhasabsolutecomparativeadvantageinX
CountryB hasabsolutecomparativeadvantageinY
Ifbothcountriesproducesthebothproducts,economiceffects
weaker
BenefitsfrominternationaltradeandspecializationifcountryA
p
producesonlyXandcountryBproducesonlyYandifthey
y
y p
y
y
exchangetheirsurpluses

Relativecomparativeadvantages
D.RikardoextendsSmithstheoryofabsolute
comparative advantages
comparativeadvantages
Ifonecountrydoesnothaveabsolutecomparative
advantageinanyproduct,itcanspecializebyrelyingon
relativecomparativeadvantagesprinciples
Production
X

Country

Relative comparative advantages

Relativecomparativeadvantages
Summary:
CountryAhasabsoluteadvantagesinthebothproduct
Ifwecomparecostsofproductionofthebothproducts(8:3;8:2;
2:1;3:1)itisbetterforbothcountriestospecializeinproductionof
)i i b
f b h
i
i li i
d i
f
oneproduct(XorY)
ForcountryAitisbettertospecializeinX(moregainsfromthe
For country A it is better to specialize in X (more gains from the
principleofrelativecomparativeadvantages)
y
p
(
ForcountryBisbettertospecializeinY(lesslossesfromthe
principleofrelativecomparativeadvantages)

TOT termsoftrade
TOT
terms of trade
ContributionofJ.S.Milltointernationaltradetheoryis
b
f
ll
l d h
termsoftradeanalysis(TOT)
TOTrepresentstheratioofexportpricestoimport
p
prices
Animportantmacroeconomicinstrument

BALANCEOFPAYMENTANDFOREIGN
EXCHANGE RATES
EXCHANGERATES

BALANCE OF PAYMENT
BALANCEOFPAYMENT
BALANCE
BALANCEOFPAYMENT(BP)isasystematicstatement
OF PAYMENT (BP) is a systematic statement
ofalleconomictransactionsbetweenthatcountryand
the rest of the world
therestoftheworld
Twoconcepts:
T
t
BroaderconceptBP(alltransactionnomatterifthey
h
havebeenpaidornot)
b
id
)
NarrowconceptBP onlytransactionswhichhavebeen
paid
d

Components of BP
ComponentsofBP
BPrecordseachtransactionaseitheraplusoraminus
p
TransactionsinBP:
Currentandcapital(current transferGDPfromonecountrytoanother,
capital transfercapital)
Privateandpublic(basedonresidents)
Private and public (based on residents)
Unilateralandbilateral(unilateraltransactionsdonothavecounter
transactions,bilaterdohave)
Autonomousandcompensatory(compensatoryusedtocompensatethe
BP,autonomousnotlinkedwiththestateofBP)

BP components
BPcomponents
Currentaccount
Summarizesthedifferencebetweenanationstotal
exportsandimportsofgoodsandservices
Private: Merchandise(tradebalance),invisibles(services
andnetinvestmentincomes),
Government:governmentexportsorimportsofgrants

Capitalaccount
Capital account
Privateandgovernmenttransfersofcapital

Statisticaldiscrepancy
Statistical discrepanc
Officialsettlements

BP settlements
BPsettlements
Automatic mechanism
Exchangeratemovementsserveasabalancewheel
g
toremovebalanceofpaymentssurplusesanddeficits
If
Ifexchange
exchangerate
rateisfixed,abalanceisachievedby
is fixed a balance is achieved by
movementsofgoldandchangesindomesticprices
andinterestrates.
Today,IMFhelpstocoordinateeconomicpolicies
between countries
betweencountries

BP settlements
BPsettlements
Discretion
Discretionmechanism
mechanism threemethodsofBP
three methods of BP
settlements
1. Realsettlements achievedby:
a) Priceandincomedeflationincountrieswithdeficits
b) Priceandincomeinflationincountrieswithsurpluses
c) Currencydepreciationsincountrieswithdeficits
d) Currencyappreciationsincountrieswithsurpluses

BP settlements
BPsettlements
2. Financingdeficits achievedby:
a)) Decreasingmonetaryreserves
D
i
t
b) Increasingforeignpublicdebts
c) Postponingfinancingofdebts
d) Decreasingofimportedgoodsinventories

BP settlements
BPsettlements
3. Compensations mostlyachievedby:
a)) D
Decreasingcostsofproductioninordertoincreaseexportand
i
t f
d ti i
d t i
t d
decreaseimport
b) Stimulating
Stimulatingconsumptionofdomesticproductswhichusedtobe
consumption of domestic products which used to be
importedgoods
c) Increasinginterestratesinordertodecreasecapitaloutflowand
increasecapitalinflow
d) Customs,contingents,...

EconomicmeaningofBP
g
LinkedwithSNA
Linked with SNA
Linkwithdomesticproduction
Y=C+I+G+(X M)
X M=Y (C+I+G)or
X M
X
M =A
A I(A
I (A accumulation)
Interdependencesofdomesticandforeignsectors
I t d
d
fd
ti
df i
t
Deficit higherconsumptionthandomesticproduction

TERMINOLOGYFOREHCHANGERATE
CHANGES
DEPRECIATION whenacountrysforeignexchange
ratedeclinesrelativetothatofanothercountry
APPRECIATION whenacountrysforeignexchange
rateincreasesrelativetothatofanothercountry
DEVALUATION whenacountrysofficialforeign
e c a ge a e e a e o o e cu e c es s o e ed
exchangeraterelativetoothercurrenciesislowered
REVALUATION whenacountrysofficialforeign
exchange rate relative to other currencies is
exchangeraterelativetoothercurrenciesis
increased

EXCHANGE RATES
EXCHANGERATES
The
Theforeignexchangerate
foreign exchange rate thepriceofoneunitof
the price of one unit of
foreigncurrencyintermsofdomesticcurrency
Theforeignexchangemarketisthemarketinwhich
currenciesofdifferentcountriesaretrades
Foreignexchangeistradedattheretaillevelinmany
banks and firms specializing in that business
banksandfirmsspecializinginthatbusiness
Wecanusefamiliarsupplyanddemandcurvesto
illustratehowmarketsdeterminethepriceofforeign
currencies

Exchange rate determination

Exchangeratedetermination

DEPRECIATIONOF$
A decrease in demand for Dollars leads to Dollar depretiation

APRECIATIONOF$
A monetary tightening increases demand for $ and leads to appretiation

FIXEDEXCHANGERATE
A government intervention to defend fixed exchange rates

Foreign exchange systems

Foreignexchangesystems
Flexibleexchangerates
g
Exchangeratesestablishedatthemarket
Highfluctuations
Realexchangerates

Fixedexchangerates
Fixed exchange rates
Exchangeratesbetweencurrenciesfixed interventionof
monetary authorities
monetaryauthorities

Managedfluctuations themostoftencasein
practices