Macroeconomics
Lecture 18
An Open Economy
Born to Choose Middle English chosen, from Old English ceosan; akin to Old High German kiosan
to choose, Latin gustare to taste.
Asset Value to You
Capital Value to Others
Five Ages
Hunter - GatherAgricultureIndustrial
InformationMobile
Economic Progress
Innovation
Getting something to work and think for us.
Hunter-Gatherer AgeMuscle PowerStrongest Won
Agricultural AgeAnimal Strength
PlowFurlong “furrow’s length”
220 yardsby 22 yards
4,840 square yards43,560 square feet
=1 Acre
Used to pump wateroff of potential cropland
Industrial AgeWaterWindSteam
StoreProcessTransmitNetwork
WiredTelephonesComputers
Information Age
Internet • Network • Fixed Points
Information Age LawsMoore’s Law:
Power doubles every 18 months
Segate’s LawStorage doubles every 12 months
Gilder’s LawBandwidth doubles every 6 months
Medcalf ’s LawNetwork value = members squared
Information Age LawsNine Years
2025
Computers 64 xStorage 512 x
Bandwidth 262,144 x7 billion internet users
Wireless Networks
Mobile Age
HunterGatherer Agricultural Industrial Information Mobile
Five Ages
Open Economy
An economy that interacts freely with other economies
around the world
Closed EconomyAn economy that does not
interact with other economies around the
world
Exports
Goods and services that are produced domestically and
sold abroad
Imports
Goods and services that are produced abroad and sold
domestically
Net Exports
The value of a nation’s exports minus the value of its imports; also called the trade
balance
Trade Balance
The value of a nation’s exports minus the value of its imports; also called the
net exports
Net Exports
= Exports - Imports
Trade Surplus
An excess of exports over imports
Trade Deficit
An excess of imports over exports
Balanced Trade
When imports equal exports
Net Capital Outflow
The purchase of foreign assets by domestic residents
minus the purchase of domestic assets by foreigners
Two ways to invest
Direct
Indirect
Foreign Direct Investment
FDI
Directly investing in creating a company
Foreign Portfolio Investment
FPI
Buying stock in a foreign company
StockPortfolio
Carry Stock
Certificates
FirstStock
Exchange
AmsterdamNetherlands
1602
Wall StreetNew York City
Nominal Exchange Rate
The rate at which a person can trade the currencyof one country for the currency of another
Appreciation
An increase in the value of a currency as measured by the amount of foreign currency it
can buy
Depreciation
A decrease in the value of a currency as measured by the amount of foreign currency it
can buy
Foreign Exchange Rate
The rate at which a person can trade the goods and services of one country for the goods and
services of another
Law of One Price
Identical products should sell for identical prices
(ignore transportation and transaction costs)
Arbitrage
Buy low in one market
Sell high in another market
Close the value gap
Purchasing Power Parity
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
Efficient Market
No impediments
No trade barriers
Good information
Purchasing Power Parity PPP
Identical products should sell for identical prices
(ignore transportation and transaction costs)
3.75 0.267
Always two rates
The inverse of each other
1 3.75 = 0.267
1 0.267= 3.75
Cost the same around the world?
Purchasing Power Parity
$4.27x
3.75=
SAR 16
SAR 15÷
3.75=
$4.00
$4.27 x 3.75
Implied Exchange Rate 15 to 4.27 = 3.51 to 1
15
Buy Big Macs in Saudi for 15($4.00) and resell in the U.S. for 16 ($4.27) and make
6.75% profit
Currency is undervalued by 6.4% (3.75 to 3.51)
16
x 3.75$4.00