Open Economy Macroeconomics

Introduction In the context of trade, economies can be of two types: Closed economy and Open economy. Open Economy refers to an economy that trades with other nations. Balance of Payment is a systematic record of all economic transactions between the residents of a country and the rest of the world carried out during an accounting year. It is composed of two sections: current account and capital account. Current account records imports and exports of goods and services and unilateral transfers. The capital account records all the economic capital transactions related to change in assets. Sometimes there is a situation Disequilibrium in Balance of Payment that can either be deficit BOP or surplus BOP. Balance of Trade is merchandise balance in the current account showing balance of visible international trade transactions during a year. Foreign Exchange Market is defined as a market in which foreign currencies are bought and sold. Foreign Exchange Rate is the rate at which one unit of currency of a country is exchanged for the number of units of currency of another country. There are two types of exchange rates: nominal exchange rate and real exchange rate. Purchasing Power Parity means that a basket of goods costs the same in two countries when measured in the same currency. Equilibrium foreign exchange rate is studied under three major exchange rate regimes, namely Flexible Exchange Rate (exchange rate is determined by the forces of market demand and supply of foreign exchange), Fixed Exchange Rate (exchange rate is officially fixed by the government) and Managed Floating (a combination of the other two). An Increase in value of domestic currency in terms of foreign currency under flexible exchange rate regime is called appreciation. An increase in the value of currency in terms of foreign currency under fixed rate regime is called revaluation. A fall in value of domestic currency in terms of foreign currency under flexible exchange rate regime is depreciation. A fall in the value of currency in terms of foreign currency under fixed rate regime is called devaluation. National Income Identity, for an open economy is Y = C + I + G + NX, Where: C is Private Consumption Expenditure, I is Private Investment Expenditure, G is Government Expenditure, Y is Aggregate Supply of domestic goods and NX is Exports minus Imports. Other Important Keywords: Degree of Openness, Balance of Invisibles, Autonomous Transactions, Accommodating Transactions, Gold Standards, Mint Par Value of Exchange, Goods market equilibrium, Equilibrium output and Trade balance, Changes in autonomous expenditure, Speculation, Interest rate differential, Closed Economy Multiplier, Open Economy Multiplier.

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