1. Unemployment-What steps can be taken to ensure full employment in the economy open to trade?
  2. Savings-affects domestic employment and future levels of national wealth
  3. Trade Imbalances
  • Exports rarely=imports
  • Play roll in distribution of wealth amongst countries and main channel through which one country’s macroeconomic policies affect its trading policies
  • Source of international discord
  1. Money and Price level
  • Barter point of view: Good are exchanged directly for other goods on basis of relative prices
  • More convenient to use money as a medium of exchange
  • Fluctuations in Supply and Demand of money affect output and employment
  • Effects of money exchange in one country can spill over to another


Excludes intermediate goods, 2nd hand goods-goods moving out of inventory, Illegal activity, non-market transactions, U.S. firms producing services, unreported illegal activity, health care and life expectancy, leisure time, environmental quality, purely financial transactions, and public transfer payments

C=Domestic Consumption                        G=government purchases                        M=

I=Domestic Investment                        T=                                                            S=

Y=GNP or National Income                        X=

Y=C+I+G all output consumed or invested by citizens or government


CA=X-M; change in output and employment; measures size and direction of international borrowing; Current Account Balance

GNP (Gross National Product)-equals GDP plus net receipts of factor income from the rest of the world:

  • Represents the sum of the following expenditure categories: consumption, investment, government purchases, and the current account balance
  • Includes the market value, of all final goods and services within a given period of time
  • In an open economy holding GNP and consumption spending constant and where private spending constant and where private savings equals domestic investment, a government budget deficit must be matched by: a current account deficit
  1. Open-economy:
  • Private Savings + Public Savings=I + CA
  • CA=GNP-C-I-G
  • May spend some of their income on imports
  • Country’s foreign trade is rarely balanced exactly
  • CA deficits add up to large foreign debt
  • Closed Economy Savings
  • National Savings=portion of output, Y, not devoted to household consumption or government surplus
  • S=Y-C-G
  • Y=C+I+G
  • Therefore S=I
  • Open economy Y=C +I+G+CA
  • S=I+CA
  • Can save either by building its capital stock or by acquiring foreign wealth
  • Ex:

New Zealand builds a new hydroelectric plant; Increase I

Imports raw materials from U.S.

This is a decrease in CA

New Zealand’s Savings (S) didn’t have to change, Even though I rises

  1. Closed Economy:


  • CA surplus means national output Y > National Consumption=Foreign wealth of surplus country is rising
  • CA deficit means Y is < National Consumption=It is borrowing shortage from foreigners to pay for excess imports; Foreign wealth of surplus country is falling

Private savings=Y-C-T

Government Savings=T-G

Investment=Private Savings+Government Savings

Closed economy can increase its wealth only by accumulating new capital

Balance of Payments: Current account +financial account + capital account=0

CA=Exports of goods and services+Invest income received in the United States-Imports of goods and services-Income paid abroad by the U.S.+Net unilateral transfers

Export Expenditure: Credit, Current Account

Income Payments: Debit, Current Account

Foreign Assets held in the U.S.: Credit, Financial Account

Official Reserve Assets:  Credit, Financial Account

U.S. Assets held abroad: Debit, Financial Account

Capital Account: In the current Post-Industrial economy, international trade in services (including banking and finance) is relatively small.  Net increase in foreign ownership of U.S.-based reserve assets+Net increase in foreign ownership of U.S.-based nonreserve assets-Net increase in U.S. Private assets abroad-net increase in the U.S. government’s nonreserve foreign assets

Statistical discrepancy=-1 x (Current account + Capital account)

For example, U.S. Government sells gold for dollars= credit in the capital account.  Migrant worker in California sends 500 home to his village in Mexico=debit in the current account.  An American mutual fund manager uses the deposits of his fund investors to buy Brazilian telecommunication stocks=debit in the capital account.  Japanese firm in Tennesse buys car parts form a subsidiary in Malaysia=Debit in the current account.  An American church donates five tons of rice to the Sudan to help with famine relief: Debit in the current account.  An American retired couple flies from Seattle to Tokyo on Japan Airlines=Debit in the current account.  The Mexican government sells pesos to the United States Treasury and buys dollars=debit in the capital account

Positives of having a large trade deficit: can signal the positive expectations of the future prospects of the economy, can signal that foreigners have confidence in the current set of economic policies, and a it allows for a higher level of investment than possible solely from domestic savings.  Countries official reserve assets are mostly composed of other country’s currencies.  After the breakdown of the Bretton Woods system, the dominant exchange rate regime in the U.S. was a managed float.  If the U.S. dollar depreciates in terms of the Euro: American goods would be cheaper for Europeans.  A fall in the value of the pound sterling affects British consumers because foreign goods are now relatively more expensive.  British consumers are hurt.  This fall in the value of the pound affects American exporters by making them worse off.  A contract that contains a promise that a specified amount of foreign currency will be delivered on the specified data in the future is traded in the forward market.  Current account will increase if the real exchange rate depreciates or disposable income goes down.  Some countries peg to a basket of currencies.  A currency devaluation under fixed exchange rates in the short run an increase in exports

In a fixed exchange rate system:

countries address the problem of currency market pressures that threaten to lower or raise the value of their currency: If demand rises, countries must fill the excess demand for foreign currency by selling their reserves, If demand falls, then countries must increase demand by buying up the excess supply with domestic currency

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