§13 Introduction to Open Economy

Introduction to Open Economy

Openness in Goods and Financial Markets

• In goods markets: Can choose between domestic and foreign goods.
  • Impediments: Tariffs and quotas
• In financial markets: Can choose between domestic and foreign assets.
  • Impediments: Capital controls
• (In factor markets): Firms can choose location of production and workers where to work (NAFTA/USMCA).

Strong Linkages

• Macro: Openness also implies that booms and recessions spread from one country to the others (e.g. Great recession started in the US…).

The (Nominal) Exchange Rate

• Nominal exchange rate: The price of the domestic currency in terms of foreign currency*.*
• (Nominal) appreciation: An increase in the price of the domestic currency in terms of a foreign currency.
• (Nominal) depreciation: A decrease in the price of the domestic currency in terms of a foreign currency.

The Real Exchange Rate

• Real exchange rate: The price of the domestic goods relative to foreign goods.

  $$\epsilon=\frac{EP}{P^*}$$

• Real appreciation: An increase in the relative price of domestic goods in terms of a foreign goods.

• Real depreciation: A decrease in the relative price of domestic goods in terms of a foreign goods.

— Apr 21, 2025

§13 Introduction to Open Economy by Lu Meng is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License. Permissions beyond the scope of this license may be available at About.