Summary EC 108 Openness in goods and financial markets review

Openness in goods and financial markets

1. Openness in goods markets
● The ability to choose between domestic and foreign goods
● Countries still have tariffs and quotas
2. Openness in financial markets
● The ability to choose between domestic and foreign assets
● Capital controls restrict the foreign assets domestic residents can hold
3. Openness in factor markets
● The ability of firms to choose where to locate production and of workers
to choose where to work

Openness in goods markets

● US exports and imports have more than tripled in relation to GDP since 1960
● Volume of trade is not always a good measure of openness
○ Trade depends on geography and international competition
● Tradable goods are goods that compete with foreign goods in domestic or
foreign markets
○ The proportion of GDP composed of tradable goods is a good index of
openness
○ Represent 60% of aggregate output in the US
● Differences in export ratios depend on geography, country size and distance
from other markets
○ Smaller countries must specialise in a few products and import the
majority of other products
● Exports can be greater than GDP because exports and imports include
intermediate goods
● Consumers must choose whether to consume domestically or import goods
○ Depends on the relative prices and the real exchange rate
● The nominal exchange rate is the price of domestic currency in terms of
foreign currency
○ Appreciation - an increase in the price of domestic currency in terms of
foreign currency
○ Depreciation - a decrease in the price of domestic currency in terms of
foreign currency
○ E$/£ = 1 / E£/$
● Fixed exchange rate system - 2 or more countries maintain a constant
exchange rate
○ Revaluations - increases in the exchange rate
○ Devaluations - decreases in the exchange rate
● Real exchange rate - the price of domestic goods relative to foreign goods
○ Calculated by (nominal exchange rate x price of domestic goods) /
price level