Question

An open economy interacts with the rest of the world through its involvement in world markets for goods and services and world financial markets. Although it can often result in an imbalance in these markets, the following identity must remain true:

Net Capital OutflowNet Capital Outflow

=  =

Net ExportsNet Exports

In other words, if a transaction directly affects the left side of this equation, then it must also affect the right side. The following problem will help you understand why this identity must hold.

Suppose you own a toy store in the United States, where there is high demand for the PlayNation Perfect, a video game console. Because of this, you spend $10,000 to increase your inventory of the gaming system, which is manufactured by Zony, a Japanese company, in Japan.

Determine the effects of this transaction on exports, imports, and net exports in the U.S. economy, and enter your results in the following table. If the direction of change is "No change," enter "0" in the Magnitude of Change column.

Hint: The magnitude of change should always be positive, regardless of the direction of change.

	Direction of Change	Magnitude of Change
		(Dollars)
Exports	increase, decrease or no change
Imports	increase, decrease or no change
Net Exports	increase, decrease or no change

Because of the identity equation that relates to net exports, the____ in U.S. net exports is matched by_____ in U.S. net capital outflow. Which of the following is an example of how the United States might be affected in this scenario? Check all that apply.

Zony purchases $10,000 worth of stock in a U.S. company.

Zony purchases $10,000 worth of U.S. bonds.

Zony exchanges the $10,000 for yen at the local bank, which then uses the dollars to purchase U.S. bonds.

Answer 1

Answer:

As the United States spend $10,000 to buy a gaming system manufactured by Zony, a Japanese company.

That means, United States import the gaming system from Japan.

So, the import of the United States increases.

And, as there is no change in exports by the United States, so the net export, which is nothing but (Export - Import) decreases.

The amount of net export of the United States is now - $10,000.

	Direction of change	Magnitude of change (Dollars)
Exports	No change	0
Imports	Increases	10,000
Net Exports	Decreases	10,000

Now, as we know from the question, that,

Net Capital outflow = Net Exports

So, a decrease in net exports leads to a same amount of decrease in net capital outflow by the United States.

So,

Because of the identity, that relates to net exports, the decrease in U.S. net exports is matched by decreasein the U.S. net capital outflow.

Net capital outflow means, purchase of domestic assets by the foreigners or the purchase of foreign assets by the domestic consumers.

Here, we knew that the net capital outflow decreases.

That means, the purchase of domestic assets by the foreigners increases and the purchase of foreign assets by the domestic consumers decreases.

So,

The United States might be affected in this scenario as follows:

Zony purchases $10,000 worth stock in a U.S. company.

Zony purchases $10,000 worth of U.S. bonds.

Zony exchanges the $10,000 for yen at the local bank, which then uses the dollars to purchase U.S.