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Net Capital Outflow: Trade Balance

If a small open economy cuts defense spending: 1. Government saving increases and national saving increases. 2. The trade balance rises due to the increase in saving shifting the (S-I) schedule to the right. 3. The real exchange rate falls. If the economy bans imports of Japanese DVD players: 1. Imports are lower and the trade balance is higher. 2. The trade balance rises due to the outward shift of the net export schedule. 3. The real exchange rate rises due to the S-I schedule not changing. If Leverett's exports become less popular: 1. The real exchange rate depreciates to maintain the original trade balance despite the

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241 views

Net Capital Outflow: Trade Balance

If a small open economy cuts defense spending: 1. Government saving increases and national saving increases. 2. The trade balance rises due to the increase in saving shifting the (S-I) schedule to the right. 3. The real exchange rate falls. If the economy bans imports of Japanese DVD players: 1. Imports are lower and the trade balance is higher. 2. The trade balance rises due to the outward shift of the net export schedule. 3. The real exchange rate rises due to the S-I schedule not changing. If Leverett's exports become less popular: 1. The real exchange rate depreciates to maintain the original trade balance despite the

Uploaded by

hnin scarlet
Copyright
© © All Rights Reserved
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Download as DOCX, PDF, TXT or read online on Scribd
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Yangon University of Economics

Executive Master of Development Studies Programme (EMDevS)


16th Batch (2018-2019)
Macroeconomics
Assignment - II

Name : Hnin Yee Hpwe


Roll No: EMDevS - 14
Date : 4th Nov 2018
Question for Review

1. What are the net capital outflow and the trade balance? Explain how they are related?
Net capital Outflow:
The difference between domestic saving and domestic investment.
Trade Balance:
Another name for net exports tells us how our trade in goods and services departs from the
benchmark of equal imports and exports
Relationship:
When the net capital outflow is positive, domestic residents are buying more foreign assets than
foreigners are purchasing domestic assets. ... Imbalances in the net capital outflow (NCO) are
associated with imbalances in the trade balance (ornet exports, NX), following the identity NCO = NX.

3. If a small open economy cuts defense spending, what happens to saving, investment, the trade balance,
the interest rate, and the exchange rate?
If a small open economy cut in defense spending:
1. Increases government saving
2. Increases national saving
3. Does not affect Investment
4. Due to increase in saving causes the  (S – I) schedule to shift to the  right
5. Trade balance rises
6. Real exchange rate falls.

4. If a small open economy bans the import of Japanese DVD players, what happens to saving, investment,
the trade balance, the interest rate and the exchange rate?
If a small open economy  bans the  import of Japanese DVD player,  
1. Imports are  lower
2. Net  exports are  higher
3. Net export schedule shifts out
4. Does  not  affect  saving
5. Does not affect investment
6. Does not affect world  interest rate
7. Does not affect trade balance
8. Due to S – I schedule does not change
9. Real Exchange rate higher

Problem and Applications


2. Consider an economy described by the following equations:
Y= C+I+G+X
Y = 8000
G = 2500
T = 2000
C = 500+2/3(Y-T)
I = 900 – 50r
NX = 1500 - 250
R = r*=8
a. In this economy, solve for private saving, public saving, national saving, the trade balance, and
equilibrium exchange rate
b. Suppose now that G is cut to 2000. Solve for private saving, public saving, national saving, the trade
balance, and equilibrium exchange rate. Explain what you find.
c. Now suppose that the world interest rate falls from 8 to 3 percent. (G is again 2500) Solve for
private saving, public saving, national saving, the trade balance, and equilibrium exchange rate.
Explain what you find.

Answer A
private savings
Private saving is what remains after households and firms have paid all their taxes and consumed.
Private savings=Y−C−TY−C−T
=800−(500+23(8000−2000))−2000=1500=800−(500+23(8000−2000))−2000=1500
Public savings
Public saving is what left after government has spend all its revenues. Public savings
=T−G2000−2500=−500T−G2000−2500=−500(deficit budget)
National savings
National savings is public savings plus private savings.
1500+(−500)=10001500+(−500)=1000
Investment
I=900−50(8)=500I=900−50(8)=500
Trade balance
Trade balance is Exports minus Imports.
Y=C+I+G+NXNX=Y−C−I−GNX=8000−4500−500−2500=500Y=C+I+G+NXNX=Y−C−I−GNX=8000−4500−5
00−2500=500
Equilibrium exchange rate
NX=1500−250e500=1500−250e500−1500=−250e−1000=−250ee=4NX=1500−250e500=1500−250e5
00−1500=−250e−1000=−250ee=4
Part B
Private savings will remain unaffected as a result of change in government spending.
Public savings
=T−G2000−2000=0=T−G2000−2000=0(balanced budget)
National savings.
=0+1500=1500=0+1500=1500
Investment will remain unaffected as a result of change in government spending.
Trade balance
NX=Y−C−I−GNX=8000−4500−500−2000=1000NX=Y−C−I−GNX=8000−4500−500−2000=1000
Equilibrium exchange rate
100=1500−250e−500=−250ee=2

3. The country of leverett is as small open economy. Suddenly, a change in world fashions makes the exports
of Leverett unpopular.
a.What happens in Leverett to saving, investment, net export, the interest rate and the exchange rate?
b. The citizens of Leverett like to travel abroad. How will this change in the exchange rate affect them?
c.The fiscal policymakers of leveret want to adjust taxes to maintain the exchange rate at the previous
level. What should they do? If they do this, what are the overall effects on saving, investment, net export
and the interest rate?

a. When Leverett’s exports become less popular,


 domestic saving Y – C – G does not change.
 Investment also does not change
 Because neither saving nor investment changes, net exports, which equal S – I, do not change.
 This is shown below as the unmoving S – I curve. The decreased popularity of Leverett’s exports lead to a
shift inward of the net exports curve.
 At the new equilibrium, net exports are unchanged but the real exchange rate has depreciated.
 Even though Leverett’s exports are less popular, its trade balance has remained the same.
 The reason for this is that the depreciated currency provides a stimulus to net exports, which overcomes
the unpopularity of its exports by making them cheaper.

b. Leverett’s currency now buys less foreign currency, so traveling abroad is more expensive. This is an
example of the fact that imports (including foreign travel) have become more expensive – as required to
keep net exports unchanged in the face of decreased demand for exports.

c. If the government reduces taxes, then disposable income and consumption rise. Hence, saving falls so
that net exports also fall. This fall in net exports puts upward pressure on the exchange rate that offsets
the decreased world demand. Investment and the interest rate would be unaffected by this policy since
Leverett takes the world interest rate as given.

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