Assignment in Macroeconomic (N. Gregory Mankiw), - Question for review, page 398, chapter 18.
1. Define net exports and net capital outflow. Explain how and why they are related.
Net exports: Net exports (NX) are the value of a nation’s exports minus the value of its imports. Net exports are also called the trade balance.
Net Capital Outflow: Net capital outflow (NCO) refers to the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners. NCO is also called net foreign investment.
How they related? With The Equality of NX and NCO
• Net exports (NX) and net capital outflow (NCO) are closely linked.
• For an economy as a whole, NX and NCO must balance each other so that: NCO = NX
Why they are related? Because every transaction that affects one side must also affect the other side by the same amount.
The Equality of NX and NCO
An accounting identity: NCO=NX
- Arises because every transaction that affects NX also affects NCO by the same amount (and vice versa)
When a foreigner purchases a good from the U.S.,
- U.S. exports and NX increase
- The foreigner pays with currency or assets, so the U.S. acquires some foreign assets, causing NCO to rise.
When a U.S. citizen buys foreign goods,
- U.S. imports rise NX falls
- The U.S. buyer pays with U.S. dollars or assets, so the other country acquires U.S. assets, causing U.S. NCO to fall.
2. Explain the relationship among saving, investment, and net capital outflow.
Net exports is a component of GDP:
Y = C + I + G + NX
National saving is the income of the nation that is left after paying for current consumption and government purchases:
Y - C - G = I + NX
National saving (S) equals Y - C - G so:
S = I + NX
or
Saving = Domestic Investment + Net capital Outflow
S = I + NCO
Y = C + I + G + NX Accounting identity
Y – C – G = I + NX Rearranging terms
S = I + NX since S = Y–C–G
S = I + NCO since NX = NCO -
When S > I, the excess loanable funds flow abroad in the form of positive net capital outflow.
When S < I, foreigners are financing some of the country’s investment, and NCO < 0.
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