Welcome to the open economy! The scope of macroeconomics starts to get bigger and I assure you that this will be more of interesting than intimidating because we are simply expanding on the ISLM model with things like the NX line and BP line. Don’t worry, you’ll get to know more about them later. It is needless to say why we have to study opened economies. International trade has been expanding rapidly since the 60’s and it makes up a substantial portion of any country’s GDP.
The terms exports and imports may seem like complicating concepts initially. Well, I don’t disagree. If you think it’s easy to define them then that’s great! If you can’t, just imagine that economies are people who buy and sell things to each other. Let’s say there’s only you and me in this lonely world. Whenever I receive money from you because I’ve sold you something or done you some service(nope, not that kind), it means that I’ve exported! If I give you money in exchange for your goods and services, I have imported!
But wait, we’ve gotta make this imagination a little bit more realistic to the actual world economy right? So we gotta imagine that we both use different forms of money! So let’s say I have Quickiebucks but you only accept the US dollar, I’ve gotta change my Quickiebucks into USD right? So how much Quickiebucks do I have to give to the money changer before I get back one USD? That’s the exchange rate!
But the exchange rate isn’t the only factor that stimulates trade. It also depends on the price of my goods and the price of your goods! These 3 factors combine to form the real exchange rate!
So what keeps you and I trading for life? I cannot be the only one buying and you also cannot be the only one selling. I will run out of money and you will run out of things to sell! I will need to sell something for money and you will need to buy things to sell! Therefore, at an equilibrium, the total number of export less the total number of import for EACH of us has to be equal to zero! But you know, in reality, economists don’t really make sense sometimes, so we can take that it is an equilibrium that we constantly work towards to.
With this in mind, the idea that Net Exports (Exports – Imports) must be zero, we can say that there is a “rule” or some kinda “constraint” that we have to follow. The income that we derive from all of our activity must end up in a position where Net Exports equals zero. So why income? That’s because income affects exports and imports! You are now one step closer to understanding the NX line!
At the end of this video, you should be able to:
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