What traumatic event does Zitkala-Sa describe at the school?

The forcible cutting of her long hair

Why was the cutting of her hair so humiliating to Zitkala-Sa?

Among her people, shingled hair was worn by cowards and mourners

Differentiate between the balance of trade and the current account balance.

The balance of trade is only the difference between exports and imports of goods; the current account balance also includes services, income and transfers (invisibles).

What does the capital account of the BoP record?

All international transactions in assets, such as foreign direct and portfolio investment, external borrowings and loans.

How is a current account deficit financed?

By a capital account surplus (net capital inflow) or by drawing down the country’s foreign-exchange reserves.

What is the foreign exchange rate?

The price of one currency in terms of another, determined in the foreign exchange market by demand and supply.

Distinguish between depreciation and appreciation.

Depreciation is a fall in the value of the domestic currency (more rupees per dollar); appreciation is a rise in its value (fewer rupees per dollar).

Differentiate between devaluation and depreciation.

Devaluation is a deliberate reduction in the value of the domestic currency under a fixed exchange-rate system; depreciation is a market-driven fall under a flexible system.

What is a managed floating exchange rate system?

A mixture of flexible and fixed systems in which the rate is largely market-determined but central banks intervene to moderate fluctuations.

What is the purchasing power parity theory?

In the long run, exchange rates adjust so that the same good costs the same in different currencies, reflecting differences in price levels.

What is the marginal propensity to import?

The fraction of an extra unit of income spent on imports, \(m\), which makes the open-economy multiplier smaller.

Why is the open-economy multiplier smaller than the closed-economy one?

Because part of each round of additional income leaks out as spending on imports, reducing the multiplier to \(\dfrac{1}{1-c+m}\).

Open Economy Macroeconomics

Class 12 Economics · Introductory Macroeconomics · Chapter 6

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Summary

An open economy interacts with the rest of the world through trade in goods and services, financial assets and (to a limited extent) labour. The Balance of Payments (BoP) records all transactions between residents and the rest of the world over a period. It has two main accounts: the current account, which records trade in goods (the balance of trade) and services, plus net income and transfers (the invisibles); and the capital account, which records international transactions in assets such as foreign investment, loans and borrowings. A current account deficit must be financed by a capital account surplus or by drawing down foreign-exchange reserves; official reserve transactions are accommodating items while others are autonomous. The foreign exchange rate is the price of one currency in terms of another, set in the foreign exchange market by the demand for and supply of foreign currency. Under a flexible (floating) exchange rate the rate is market-determined, and a rise in the rate is a depreciation of the domestic currency while a fall is an appreciation. Under a fixed exchange rate the government pegs the rate, and changing it is called devaluation or revaluation; most countries today use a managed floating system. The chapter also introduces purchasing power parity and the open-economy national income identity \(Y=C+I+G+(X-M)\), the marginal propensity to import \(m\), and the smaller open-economy multiplier \(\dfrac{1}{1-c+m}\).

Key terms

Open economy

An economy that trades in goods, services and assets with the rest of the world.

Balance of payments

A record of all economic transactions between residents and the rest of the world over a period.

Current account

The BoP account recording trade in goods and services, income and transfers.

Capital account

The BoP account recording international transactions in assets.

Exchange rate

The price of one currency in terms of another.

Open economy multiplier

The autonomous-spending multiplier in an open economy, \(\dfrac{1}{1-c+m}\).

Extra questions & answers

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An open economy is one that:

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