Goods Market Equilibrium in an Open Economy that the country has available for net foreign lending). Equation (5.2) also reminds us that (assumingno net
Discuss goods market equilibrium in an open economy.
Because Eq.
(5.2) is an identity, it must always hold (by definition). For the economy to be in goods market equilibrium, actual national saving and investment must also equal their desired levels. If actual and desired levels are equal, Eq. (5.2) becomesSd = Id + CA = Id + (NX + NFP), (5.3)
where Sd and Id represent desired national saving and desired investment, respectively. Equation (5.3) is the goods market equilibrium condition for an open economy, in which the current account balance, CA, equals net lending to foreigners, or financial outflows. Hence Eq. (5.3) states that in goods market equilibrium in an open economy, the desired amount of national saving, Sd, must equal the desired amount of domestic investment, Id, plus the amount lent abroad, CA. Note that the closed-economy equilibrium condition is a special case of Eq. (5.3), with CA = 0.
If for simplicity we assume that net factor payments, NFP, are zero, the current account equals net exports and the goods market equilibrium condition, Eq. (5.3), becomes
Sd = Id + NX. (5.4)
Equation (5.4) is the form of the goods market equilibrium condition that we will work with. Under the assumption that net factor payments are zero, we can refer to the term NX interchangeably as net exports or as the current account balance.
As for the closed economy, we can also write the goods market equilibrium condition for the open economy in terms of the aggregate supply and aggregate demand for goods. In an open economy, where net exports, NX, are part of the aggregate demand for goods, this alternative condition for goods market equilibrium is
Y = Cd + Id + G + NX, (5.5)
where Y is output, Cd is desired consumption spending, and G is government purchases. This way of writing the goods market equilibrium condition is equivalent to the condition in Eq. (5.4).[83]
We can rewrite Eq. (5.5) as
NX = Y -(Cd + Id + G). (5.6)
Equation (5.6) states that in goods market equilibrium the amount of net exports a country sends abroad equals the country's total output (gross domestic product), Y, less total desired spending by domestic residents, Cd + Id + G. Total spending by domestic residents is called absorption. Thus Eq. (5.6) states that an economy in which output exceeds absorption will send goods abroad (NX > 0) and have a current account surplus and that an economy that absorbs more than it produces will be a net importer (NX < 0), with a current account deficit.
5.3