In a small open economy, goods market equilibrium occurs when ...

[tatyanajohnson]

In a small open economy, goods market equilibrium occurs when desired saving minus desired investment equals net exports. Explain.
 
  What will be an ideal response?

Question 2

A principal reason that purchasing power parity does not hold exactly in practice is
 
  A) that foreign and domestic assets are not perfect substitutes.
  B) the existence of non-traded goods.
  C) that consumers in different countries have different preferences.
  D) that costs of production are not the same in all countries.

[catron30]

Answer to Question 1

The domestic interest rate equals the world interest rate, regardless of the quantities of saving and investment. If saving is greater than investment at this interest rate, the excess of saving is used to purchase foreign assets. Then, the money paid to acquire foreign assets returns to purchase domestic goods, increasing net exports. If saving is lower than investment, domestic assets are being sold to foreigners, a capital inflow that enables the purchase of imports, reducing net exports.

Answer to Question 2

B