Assignment
In Partial Fulfillment of the
Requirements for the subject
“Macroeconomics”
Presented by: Andrea Joy Gargoles
Presented to: Ms. Regine Batino
Date: March 27, 2019
An Open Economy is an economy in which there are economic activities between
the domestic community and outside. People and even businesses can trade in goods and
services with other people and businesses in the international community, and funds can flow
as investments across the border. Trade can take the form of managerial exchange, technology
transfers, and all kinds of goods and services. (However, certain exceptions exist that cannot be
exchanged; the railway services of a country, for example, cannot be traded with another
country to avail the service.)
It contrasts with a closed economy in which international trade and finance cannot take place.
The act of selling goods or services to a foreign country is called exporting. The act of buying
goods or services from a foreign country is called importing. Exporting and importing are
collectively called international trade.
There are a number of economic advantages for citizens of a country with an open economy.
A primary advantage is that the citizen consumers have a much larger variety of goods and
services from which to choose. Additionally, consumers have an opportunity to invest their
savings outside the country. There are also economic disadvantages of opened economy.
First, Open economy are interdependent on other economics and this exposes them to certain
unavoidable risk.
If a country has an open economy, that country's spending in any given year need not equal its
output of goods and services. A country can spend more money than it produces by borrowing
from abroad, or it can spend less than it produces and lend the difference to foreigners.
In a closed economy, all output is sold domestically, and
FORMULA expenditure is divided into three components: consumption,
investment, and government purchases.
Y=C+I+G In an open economy, some output is sold domestically and some
is exported to be sold abroad. We can divide expenditure on
anopen economy’s output Y into four components: Cd,
Y = Cd + Id + Gd + X. consumption of domestic goods and services, Id, investment in
domestic goods and services, Gd, government purchases of
domestic goods and services, X, exports of domestic goods and
services.
Tariffs from Quotas and from Non-Tariff Trade Barriers
A tariff is a tax on imports. It is normally imposed by the government on the imports of a particular
commodity. On the other hand, quota is a quantity limit. It restricts imports of commodities
physically. It specifies the maximum amount that can be imported during a given time period. The
main difference is that quotas restrict quantity while tariff works through prices.
A nontariff barrier is a way to restrict trade using trade barriers in a form other than a tariff.
Nontariff barriers include quotas, embargoes, sanctions, and levies. Non-tariff barriers to trade
(NTBs) or sometimes called "Non-Tariff Measures (NTMs)" are trade barriers that restrict imports or
exports of goods or services through mechanisms other than the simple imposition of tariffs.
Foreign Direct Investment and Portfolio Investment
Foreign Direct Investment
Foreign direct investment (FDI) involves establishing a direct business interest in a foreign country,
such as buying or establishing a manufacturing business, building warehouses, or buying buildings.
Foreign direct investment tends to involve establishing more of a substantial, long-term interest in
the economy of a foreign country. Due to the significantly higher level of investment required,
foreign direct investment is usually undertaken by multinational companies, large institutions, or
venture capital firms. Foreign direct investment tends to be viewed more favorably since they are
considered long-term investments, as well as investments in the well-being of the country itself.
At the same time, the nature of direct investment, such as creating or acquiring a manufacturing
facility, makes it much more difficult to liquidate or pull out of the investment. For this reason, direct
investment is usually undertaken with essentially the same attitude as establishing a business in
one's own country—with the intention of making the business profitable and continuing its operation
indefinitely. Direct investment includes having control over the business invested in and being able
to manage it directly, but it also involves more risk, work, and commitment.
Foreign Portfolio Investment
Foreign portfolio investment (FPI) refers to investing in the financial assets of a foreign country,
such as stocks or bonds available on an exchange. This type of investment is at times viewed less
favorably than direct investment because portfolio investments can be sold off quickly and are at
times seen as short-term attempts to make money, rather than a long-term investment in the
economy.
Portfolio investment typically has a shorter time frame for investment return than direct investment.
As with any equity investment, foreign portfolio investors usually expect to quickly realize a profit on
their investments. As securities are easily traded, the liquidity of portfolio investments makes them
much easier to sell than direct investments. Portfolio investments are more accessible for the
average investor than direct investments because they require much less investment capital and
research.
Key Takeaways
Foreign direct investment is building or purchasing businesses and their associated
infrastructure in a foreign country.
Foreign portfolio investment is purchasing securities of foreign countries, such as stock and
bonds, on an exchange.
Direct investment is seen as a long-term investment in the country's economy, while
portfolio investment can be viewed as a short-term move to make money.
Direct investment is likely only suitable for large corporations, institutions, and private equity
investors.
Multinational and Transnational Companies
A Multinational corporation (MNC) or worldwide enterprise is a corporate organization which
owns or controls production of goods or services in at least one country other than its home
country. Black's Law Dictionary suggests that a company or group should be considered a
multinational corporation if it derives 25% or more of its revenue from out-of-home-country
operations. A multinational corporation can also be referred to as a multinational enterprise (MNE),
a transnational enterprise (TNE), a transnational corporation (TNC), an international corporation, or
a stateless corporation. There are subtle but real differences between these three labels, as well as
multinational corporation and worldwide enterprise.
Example of Multinational Companies
Uniliver, Coca Cola, UBER, McDo, Starbucks, Adidas, Amazon, Canon, Dell, Dunkin Donut,
Epson, Nokia, Nike, Motorola, Yakult, Yamaha, Microsoft, Lenovo, LG, Honda, Huawei,
Jollibee, KFC, Kia, and etc.
A Transnational Companies A commercial enterprise that operates substantial facilities, does
business in more than one country and does not consider any particular country its national home.
One of the significant advantages of a transnational company is that they are able to maintain a
greater degree of responsiveness to the local markets where they maintain facilities.
Example of Transnational Companies
Shell, Acceture, Telus,
Protectionist Policies
Protectionism, policy of protecting domestic industries against foreign competition by means of
tariffs, subsidies, import quotas, or other restrictions or handicaps placed on the imports of foreign
competitors. Protectionist policies have been implemented by many countries despite the fact that
virtually all mainstream economists agree that the world economy generally benefits from free
trade.
Different Protectionist Policies
Tariffs
A tariff is a tax on imports, which can either be specific (so much per unit of sale) or ad valorem (a
percentage of the price of the product). Tariffs reduce supply and raise the price of imports. This
gives domestic equivalents a comparative advantage. As such, tariffs are distorting the market
forces and may prevent consumers from gaining the benefit of all the advantages of international
specialisation and trade. The impact of a tariff is shown in Figure 1 below.
Quotas
Quotas have the effect of restricting the maximum amount of imports allowed into an economy.
Once again, they reduce the amount of imports entering an economy and increase the equilibrium
price within the market. The government receives no revenue from a quota, as it does with a tariff,
unless it can set up a system of licences.
Exchange controls
The government could limit the amount of foreign currency available for paying for imports. These
are not allowed amongst member states of the European Union (EU), for example, and have
become more difficult to sustain in a world of highly mobile capital.
Export subsidies
Export subsidies allow exporters to supply the market with more product than the natural
equilibrium would have allowed. Foreign consumers will enjoy increased economic welfare as the
price of their purchases fall. Domestic employees might enjoy more wages and job security. But
taxpayers are footing the bill for this. Domestic firms might divert trade into exports and ignore the
home market. This could lead to increases in domestic prices.
Voluntary export restraints (VER's)
Some quotas are voluntarily agreed between countries. This happened on a significant number of
occasions with Japanese firms (e.g. cars, televisions, videos) during the 1990s. Where the quotas
have been agreed, they are known as Voluntary Export Restraints (VER's). In fact over 200 VER's
were in force in the early 1990s. So why did the firms agree to these restrictions voluntarily? Well,
the answers to this are varied. Often it may have been because they felt it would help avoid more
punitive restrictions, but sometimes it was in their interests. Where the Japanese firms had a
significant cost advantage over the domestic producers, the voluntary quotas meant that they could
charge significantly higher prices. The higher margins they earned more than made up for the
restricted number they sold and profitability was maintained or improved.
Other protectionist measures
Countries can also use a range of other protectionist measures to restrict imports. These might
include:
Administrative obstacles - countries can set administrative hurdles. For example, they may
require significant levels of paperwork and then deal with these processes slowly making it difficult
for importers to compete on a level playing field with other firms.
Health and safety standards - countries may set onerously high health and safety standards for
goods that are imported, once again making life difficult for importers.
Environmental standards - countries can set high environmental standards that they know only
domestic firms are likely to be able to achieve, once again making life difficult for importers.
Balance of Payments
The balance of payments (BOP) is a statement of all transactions made between entities
in one country and the rest of the world over a defined period of time, such as a quarter or a
year. The balance of payments (BOP), also known as balance of international payments,
summarizes all transactions that a country's individuals, companies and government bodies
complete with individuals, companies and government bodies outside the country. These
transactions consist of imports and exports of goods, services and capital, as well as transfer
payments, such as foreign aid and remittances.
The balance of payments divides transactions in two accounts: the current account and the
capital account. Sometimes the capital account is called the financial account, with a separate,
usually very small, capital account listed separately. The current account includes transactions
in goods, services, investment income and current transfers. The capital account, broadly
defined, includes transactions in financial instruments and central bank reserves. Narrowly
defined, it includes only transactions in financial instruments. The current account is included in
calculations of national output, while the capital account is not.
The sum of all transactions recorded in the balance of payments must be zero, as long as the
capital account is defined broadly. The reason is that every credit appearing in the current
account has a corresponding debit in the capital account, and vice-versa. If a country exports an
item (a current account credit), it effectively imports foreign capital when that item is paid for (a
capital account debit).
Interest, Monetary and Fiscal Policy
Interest
The policy interest rate is an interest rate that the monetary authority (i.e. the central bank) sets
in order to influence the evolution of the main monetary variables in the economy (e.g.
consumer prices, exchange rate or credit expansion, among others). The policy interest rate
determines the levels of the rest of the interest rates in the economy, since it is the price at
which private agents-mostly private banks-obtain money from the central bank. These banks will
then offer financial products to their clients at an interest rate that is normally based on the
policy rate.
Monetary Policy
Central banks typically have used monetary policy to either stimulate an economy or to check its
growth. By incentivizing individuals and businesses to borrow and spend, monetary policy aims
to spur economic activity. Conversely, by restricting spending and incentivizing savings,
monetary policy can act as a brake on inflation and other issues associated with an overheated
economy.
Fiscal Policy
Generally speaking, the aim of most government fiscal policies is to target the total level of
spending, the total composition of spending, or both in an economy. The two most widely used
means of affecting fiscal policy are changes in government spending policies or in government
tax policies.
If a government believes there is not enough business activity in an economy, it can increase
the amount of money it spends, often referred to as stimulus spending. If there are not enough
tax receipts to pay for the spending increases, governments borrow money by issuing debt
securities such as government bonds and, in the process, accumulate debt. This is referred to
as deficit spending.
Key Takeaways
Monetary policy addresses interest rates and the supply of money in circulation, and it
generally is managed by a central bank.
Fiscal policy addresses taxation and government spending, and it generally is
determined by legislation.
Monetary policy and fiscal policy together have great influence over a nation's economy.
REFERENCES
https://en.wikipedia.org/wiki/Open_economy
http://www.economicsdiscussion.net/difference-between/difference-between-tariff-and-
quotas-with-diagram/6437
https://www.investopedia.com/terms/n/nontariff-barrier.asp
https://en.wikipedia.org/wiki/Non-tariff_barriers_to_trade
https://www.investopedia.com/ask/answers/060115/what-difference-between-foreign-
portfolio-investment-and-foreign-direct-investment.asp
http://www.businessdictionary.com/definition/transnational-company.html
https://www.britannica.com/topic/protectionism
http://www.sanandres.esc.edu.ar/secondary/economics%20packs/international_economics/pa
ge_18.htm
https://www.investopedia.com/terms/b/bop.asp
https://www.focus-economics.com/economic-indicator/policy-interest-rate
https://www.investopedia.com/ask/answers/100314/whats-difference-between-monetary-
policy-and-fiscal-policy.asp
