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 Outflow = Net 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 small electronics store in the United States, and you need to purchase a PlayNation 2, a video game console, for your inventory. You pay $50 for the gaming system, which is manufactured by Octendo, a Japanese company, in Tokyo. 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.
Because of the identity equation that relates net capital outflow 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 net capital outflow from the United States might be affected in this scenario? Check all that apply.
❑ The United States sells $50 worth of bonds to Octendo.
❑ Octendo exchanges the $S0 for yen at the local bank, which then uses the dollars to purchase U.S. assets.
❑ Octendo purchases $50 worth of stock in a U.S. company.
