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World Markets in Goods and Credit
Assumptions:
the goods are physically identical.
transport costs and barriers to trade small enough to neglect.
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World Markets in Goods and Credit
law of one price.
Markets work to ensure that the same good sells at the same price for all buyers and sellers in all locations. We also simplify by ignoring inflation, so that the price level, P, is constant over time.
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World Markets in Goods and Credit
it = if t
home nominal interest rate
= foreign nominal interest rate
rt = rft
home real interest rate
= foreign real interest rate
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The Balance of International Payments
Closed economy:
Yt = Ct+ It+ Gt
real GDP = real domestic expenditure
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The Balance of International Payments
Open Economy
Exports are the goods and services produced in the home country that are sold to the rest of the world, and
imports are the goods and services produced by the rest of the world that are bought by the home country.
The difference between exports and imports, exports, is called the trade balance.
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The Balance of International Payments
Yt + Impt = Ct+ It+ Gt + Expt
trade balance = Expt - Impt
= Yt −(Ct+ It+ Gt)
trade balance = real GDP − real domestic expenditure
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The Balance of International Payments
Bft : nominal holdings of foreign assets by the home country at the end of year t.
These assets or debts could be held by the home country’s households or government.
The addition to the home country’s ownership of capital located in the rest of the world is called foreign direct investment.
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The Balance of International Payments
net real asset e from abroad
= rt−1 ·Bft−1/P
The total real e of domestic residents in year t is the sum of real GDP, Yt, and real asset e from abroad, rt−1 · Bft−1/P. This total is called the real gross national product (real GNP).
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The Balance of International Payments
real GNP= Yt + rt−1 ·B ft−1/ P
real G
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