Understanding Net Exports and Capital Outflow in Open Economies
Chapter 6 Homework: Key Concepts in Open Economies
Net Exports and the Relationship with National Saving and Investment
The value of net exports is also the value of the difference between national saving and domestic investment.
Positive Net Capital Outflow
If net capital outflow is positive, then the trade balance must be positive.
National Saving Exceeds Domestic Investment
If national saving exceeds domestic investment, then net exports are positive, and net capital outflows are positive.
Calculating Net Capital Outflow
In a small open economy, if exports equal $20 billion, imports equal $30 billion, and national saving equals $25 billion, then net capital outflow equals -$10 billion.
Balanced Trade Scenario
In a small economy, if domestic saving equals $50 billion and domestic investment equals $50 billion, then there is balanced trade, and net capital outflow equals 0.
US Corporation Selling to Canada
If a US corporation sells a product to Canada and uses the proceeds to purchase a product manufactured in Canada, then US net exports do not change.
Small Open Economy with Perfect Capital Mobility
A small open economy with perfect capital mobility is one in which the domestic interest rate equals the world interest rate.
Defining the World Interest Rate
The world interest rate is the interest rate prevailing in world financial markets.
Characteristics of a Small Open Economy
A small open economy with perfect capital mobility is characterized by all of these except: its domestic interest rate always exceeds the world interest rate.
World Interest Rate and Trade Balance
In a small open economy, if the world’s real interest rate is above the rate at which national saving equals domestic investment, then there will be a trade surplus and positive net capital outflow.
Trade Surplus and Deficit
- R1 = Trade surplus
- R3 = Trade deficit
Negative Net Exports
In a small, open economy, if net exports are negative, then domestic spending is greater than output.
Exports Exceed Imports
When exports exceed imports, all of these are true except: domestic investment exceeds domestic saving.
Trade Deficit and Negative Net Capital Outflow
In a small open economy, if exports equal $5 billion and imports equal $7 billion, then there is a trade deficit and negative net capital outflow.
Government Purchases and Trade Balance
In a small open economy, starting from a position of balanced trade, if the government increases domestic government purchases, this produces a tendency toward a trade deficit and negative net capital outflow.
Income Tax Increase and Trade Balance
In a small open economy, starting from a position of balanced trade, if the government increases the income tax, this produces a tendency toward a trade surplus and positive net capital outflow.
Tax Cuts and Trade Deficit
Holding other factors constant, legislation to cut taxes in an open economy will reduce national saving and lead to a trade deficit.
Foreign Government Purchases
Starting from a small open economy with balanced trade, if large foreign countries increase their domestic government purchases, this policy will tend to increase exports by the small open economy.
World Interest Rate Falls
Starting from a trade balance, if the world interest rate falls, then, holding other factors constant, in a small open economy the amount of domestic investment will increase, and net exports will decrease.
Reducing a Trade Deficit
If the government of a small open economy wishes to reduce a trade deficit, which policy action will be successful in achieving this goal? Increasing taxes.
Investment Tax Credit
The adoption of an investment tax credit in a small open economy is likely to lead to an increase in domestic investment but no change in domestic saving.
Policies that Increase Investment
In a small open economy, policies that increase investment tend to cause a trade deficit.
Foreign Government Purchases and World Interest Rate
If foreign countries decide to increase their government purchases, this causes the world interest rate to rise.
Foreign Tax Cuts and Net Capital Outflow
If foreign countries decide to cut their taxes to stimulate their economy, then the net capital outflow increases.