1. ECON 100 Lecture 25
Monday, May 12

2. MIDTERM 2 FRIDAY May 16
6 30 PM

3. Open economy A short lecture of about 30 minutes
Then a few words about the exam
Wednesday May 14 REVIEW LECTURE

4. Course/Instructor evaluation surveys

5. Lecture – 30 minutes

6. In a closed economy Savings = Investment S = I What is the mechanism that ensures that savings equal investment?

7. The loanable funds market equilibrium

8. The loanable funds market in a closed economy
S, I
the real interest rate adjusts to equate investment and saving:
I (r ) r*
I(r*) = S

9. A numerical example: Savings and Investment in the closed economy
Y = 1,200 C = (Y – T) I = I(r) = 200 – 10r, r is the interest rate in percentage points (r = 10 means 10%) G = 150, T = 100 Please compute consumption (C), private savings, and public savings, the equilibrium real interest rate (r), and investment (I). Help: First compute C, then S.

10. ANSWERS
Consumption C = (Y – T) = (1200 – 100) = x 1100 = 950. Savings S = Y – C – G = 1200 – 950 – 150 = 100, We use the “supply = demand” condition to compute the equilibrium real interest rate r*: 100 = 200 – 10r  r* = 10%.

11. ANSWERS, continued
Private savings are SP = Y – T – C = 1200 – 100 – 950 = 150, Public savings are SG = T – G = 100 – 150 = – 50.

12. Savings and Investment in the open economy

13. In an open economy we can have Savings > Investment, or Saving < Investment

14. Start with Y = C + I + G + NX
#1 rearrange it : Y – C – G – I = NX NX < 0  Y – C – G – I < 0  Y < C + I + G A country that has a trade deficit is spending beyond its current income. #2 rearrange it : Y – (C + G) – I = NX S – I = NX. NX < 0  S – I < 0  S < I. A country that has a trade deficit is not saving enough to finance its investment.

15. (International) Capital Flows (uluslararası sermaye hareketleri)
Net capital outflows (NCO) NCO = S – I ←− this is a definition NCO is the net outflow of “loanable funds” NCO can be negative, positive, or zero.

16. The meaning of NCO = S – I
When S > I, NCO > 0, the country is a net lender (borç veren) S > I means that the country saves more funds than its firms wish to borrow for investment. The excess of loanable funds will flow abroad in the form of NCO (the purchase of foreign assets), S > I  NCO > 0.

17. The meaning of NCO = S – I
When S < I, NCO < 0, the country is a net borrower (borçlanan) S < I means that the firms wish to borrow more than domestic savings. Then the firms can borrow on international financial markets; in this case, there’s a net inflow of loanable funds, S < I  NCO < 0.

18. Formally,
NCO (net capital outflow) is defined as the domestic residents’ purchases of foreign assets minus the foreigners’ purchases of domestic assets. NCO is also called net foreign investment (NFI).

19. An important lesson
A country (like Turkey) that has persistent, large trade deficits (NX < 0) has low savings, relative to its investment, and is a net borrower of financial assets. X < M  NX < 0  S < I  NCO < 0

20. A small exercise
France saves €1,000 billion and French net capital outflow is ‒€200 billion. Then, French domestic investment (I as in the GDP = C + I +G +NX) must be
‒€200 billion.
€200 billion.
€800 billion.
€1,000 billion.
€1,200 billion.

21. The loanable funds market equilibrium for the small open economy

22. A small open economy can lend or borrow in international markets at world interest rate r*…
S, I
the world interest rate determines the level of investment…
I (r )
NCO < 0 rc
…and the difference between S and I determines the net capital outflow r*
This graph really determines net capital outflows, not NX. But, the national accounting identities say that NX = net capital outflows, so we can also write “NX” on the graph. S I*

23. Y = 5000; C = (Y – T) ; I = 1000 – 50r, G = T = 1000 Compute the open economy equilibrium (C, S, I, NX, and NCO) when the world interest rate is 10%.

24. A few words about the second midterm exam

25. Extra office hours for midterm exam #2
Wednesday lecture: Review Wednesday – Thursday to and – Friday to and – Friday Midterm exam #2

26. Midterm 2 topics GDP CPI Unemployment Production and growth
The financial system: saving and investment
The open economy
Lecture note slides for Midterm 2: LN 16 – 25.
Midterm #1 topics will not be on the exam!
You will be tested on the material covered in the lectures and lecture note slides.

27. Exam format 50 multiple choice questions 60 minutes Closed book exam
For each question
Correct answer 2 points
Wrong answer 0 points
Unmarked question ½ point
Bring your pocket calculator

28. Make up exam policy
Same format, same topics, same level of difficulty as the regular midterm exam #2
Must have valid excuse
Will be scheduled either before or during the first days of the final exam period, which is May 22 to June 1
No make up for the make up!

29. Studying for the second midterm
Do the midterms for 2012 and 2013
(re)Do the exercise sets
Come to office hours
Go to KOLT
Read the slides
Read the book (last resort if nothing else works)

30. COURSE EVALUATIONS

31. Thank you for participating!

32. 11 00 section Instructor’s name: Murat Usman
Course code/number: Econ 100 Lec 4
Semester/year: Spring 2014
Course unique number: 24056

33. End of the lecture

34. 9 30 section Instructor’s name: Murat Usman
Course code/number: Econ 100 Lec 3
Semester/year: Spring 2014
Course unique number: 24055