CHAPTER 28

OPEN-ECONOMY
MACROECONOMICS
Group: 4Zi
Marcela Garca Borghardt
Enrique Damin Longoria Alejandro
Edgar Ramrez Ramrez
A. FOREIGN TRADE AND ECONOMIC
ACTIVITY
Net Exports and Output in the Open Economy
Foreign trade involves imports and exports. Although the United States
produces most of what it consumes, it nonetheless has a large quantity of
imports, which are goods and services produced abroad and consumed
domestically. Exports are goods and services produced domestically and
purchased by foreigners.

Net exports are defined as exports of goods and services minus imports of
goods and services.
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.
In a open economy, a nations expenditures may differ from its production.
Total domestic expenditures (sometimes called domestic demand) are
equal to consumption plus domestic investment plus government
purchases. This measure differs from GDP for two reasons:
1. Some part of domestic expenditures will be on goods produced abroad,
these items being imports.
2. Some part of Americas domestic production will be sold abroad as
exports.
To calculate the total production of American goods and services, we need
to know the total production for American residents as well as the net
productions for foreigners.
Total output, or GDP, equals consumptions plus domestic investment plus
government purchased plus net exports:
=
= + + +
Determinants of Trade and Net Exports
Imports into the United States are positively related to US income and
output. When US GDP rises, imports into the US increase because some of
the increased C+I+G purchases come from foreign productions and also
because America uses foreign-made inputs in producing its own goods. The
demand for imports depends upon the relative price of foreign and
domestic goods.
Short-run Impact of Trade on GDP
The multiplier model shows how, in the short run where there are
unemployed resources, changes in trade will affect aggregate demand,
output, and employment.
There are two major new macroeconomic elements in the presence of
international trade:
1. We have a fourth component of spending, net exports, which adds to
aggregate demand.
2. An open economy has different multipliers for private investment and
government domestic spending because some spending leaks out to the
rest of the world.
The Marginal Propensity to Import and the Spending Life
The marginal propensity to import is the increase in the dollar value of
imports for each $1 increase in GDP.
The marginal propensity to import is closely related to the marginal
propensity to save (MPS).
The marginal propensity to import tells how much of additional output and
income leaks into imports.
The Open-Economy Multiplier
Opening up and economy lowers the expenditure multiplier.
Because a fraction of any income increase leaks into imports in an open
economy, the open-economy multiplier is smaller than the multiplier for a
closed economy. The exact relationship is
=
1
+

Where MPS = marginal propensity to save and MPm = marginal propensity to
import.
Trade and Finance for the United States Under Flexible
Exchange Rates






The Monetary Transmission Mechanism in an Open Economy
When financial investments can flow easily among countries and the
regulatory barriers to financial investments are low, we say that these
countries have high mobility of financial capital.
Fixed Exchange Rates. The key feature of countries with fixed exchange
rates and high capital mobility is that their interest rates must be very
closely aligned. Any divergence in the interest rates between two such
countries will attract speculators who will sell one currency and buy the
other until the interest rate are equalized.
Flexible Exchange Rates. A flexible exchange rate has reinforcing effect o
monetary policy.
B. INTERDEPENDENCE IN THE GLOBAL
ECONOMY
Economic Growth in the Open Economy
Perhaps the single most important approach for promoting rapid economic
growth is to ensure high levels of saving and investment.
Economic growth requires moving toward the technological frontier by
adopting the best technological practices.
Other issues, such as trade policies, intellectual property rights, policies
toward direct investment, and the overall macroeconomic climate, are
essential ingredients in the growth of open economics.
Saving and Investment in the Open Economy
Open economies can draw upon world financial markets for investment
funds, and other countries can be an outlet for domestic saving.
We first review the investment-saving relationship, and then we examine
the mechanisms for allocating saving among different countries.
Determination of Saving and Investment at Full Employment
We need to go beyond the identities to understand the mechanism by which
saving and investment are equalized in open economy.
Closed Economy. We begin with a closed economy where there is no
inflation and no uncertainty.
In a full-employment closed economy, higher government spending, lower
taxes, or lower desired private saving will raise the real interest rate and
lower equilibrium saving and investment.

Open-Economy Equilibrium. Now consider the situation of an open
economy in which financial markets are integrated with world markets. And
open economy has alternative sources of investment and alternative outlets
for saving. We simplify by assuming that the economy is small and cannot
affect world interest rates. We show this situation in the next figure:
Changes in exchange rates are the mechanism by which saving and
investment adjust. That is, exchange rates move to ensure that the level of
net exports balances the difference between domestic saving and
investment.
Other important examples of the open-economy saving-investment theory
in the small open economy are the following:
oAn increase in private saving or lower government spending will increase
national saving as represented by a rightward shift in the national saving
schedule in figure 28-8.
oAn increase in domestic investment will lead to a shift in the investment
schedule.
oAn increase in world interest rates will reduce the level of investment.
Promoting Growth in the Open Economy
Over the long run, the single most important way of increasing per capita
output and living standards is to ensure that the country adopts best-practice
techniques in its production processes.
Promoting economic growth in an open economy involves ensuring that
business is attractive for foreign and domestic investors who have a wide
array of investment opportunities in the world economy.
The ultimate goals of policy are to have high rates of saving and investment
in productive channels and to ensure that businesses use best-practice
techniques.
C. INTERNATIONAL ECONOMIC ISSUES
Competitiveness and Productivity
Competitiveness refers to the extent to which a nations goods can compete
in the marketplace; this depends primarily upon the relative prices of
domestic and foreign products.
Productivity is measured by the output per unit of input. It is fundamental to
the growth of living standards in a nation; to a first approximation, a
nations real income grows in step with its productivity growth.
The European Monetary Union
An ideal exchange-rate system is one that allows high levels of predictability
of relative prices while stabilizing the economy in the face of economic
shocks. In a well-functioning system, people can trade and invest in other
countries without worrying that exchange rates will suddenly change and
make their ventures unprofitable.
An optimal currency area is one whose regions have high labor mobility of
have common and synchronous aggregate supply or demand shocks.
Final Assessment
If we step back, an impartial jury of historians would surely rate the last half-
century as one of the unparalleled success foe the countries of North
America and Western Europe:
oRobust economic performance
oThe emerging monetary system
oThe reemergence of free markets.
Questions!!!!
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M A R G I N A L P R O P E N S I Y T O I M P O R T
C O M P E T I T I V E N S S
P T I M A L C U R R E C Y A R E A
Vertical
1. Are goods and services produced abroad and
consumed domestically.
3. It denotes net US savings abroad and is
approximately equal to the value of net exports.
5. In this type of economy there is no inflation and
no uncertainty.
7. It is measured by the output per unit of output.
Horizontal
2. Are defined as exports of goods and services
minus imports of goods and services.
4. It is the increase in the dollar value of imports
for each $1 increase in GDP.
6. How is called the extent to which a nations
goods can compete in the marketplace?
8. In this area, regions have high labor mobility of
have common and synchronous aggregate supply
or demand shocks.
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