Chapter 32, titled 'A Macroeconomic Theory of the Open Economy' helps establish the interdependence of a number of
economic variables in an open economy. Chapter 32 specifically demonstrates the
relationships between the prices and quantities in the market for loanable funds and the
prices and quantities in the market for foreign-currency exchange. Using these markets, readers are taught how to analyze the impact of a variety of government policies on an economy’s exchange rate
and trade balance. This chapter constructs a model of the open economy that allows readers to
analyze the impact of government policies on net exports, net capital outflow, and
exchange rates. This model is based on the previous long-run analysis that we learned in two ways. First, one must assume that output is determined by technology and factor supplies so output is
fixed or given. Second of all, prices are determined by the quantity of money so prices are
fixed or given. The model constructed in this chapter is composed of two markets—the
market for loanable funds and the market for foreign-currency exchange. These markets
simultaneously determine the interest rate and the exchange rate, as well as the level of
overall investment and the trade balance.
Overall, I would give this week's chapter a difficulty rating of 2 out of 3. The three policy problems demonstrated in the text take a lot of concentration to understand so that is something I am having a hard time with. I also don't comprehend why capital flight is considered bad for the economy rather than good if it raises net exports.
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