Question

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:
      
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 are the purchasing manager for a large chain of restaurants in the United States, and you need to make your semiannual purchase of tea. You pay $1,500,000 for a shipment of tea from an Indian tea producer.
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.
Hint: The magnitude of change should always be positive, regardless of the direction of change.
Direction of Change
Magnitude of Change
(Dollars)
Exports      
Imports      
Net Exports      
Because of the identity equation that relates 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 the United States might be affected in this scenario? Check all that apply.

   The Indian tea producer hangs on to the $1,500,000 so that it can use the U.S. dollars to make investments.
   The United States sells $1,500,000 worth of bonds to the Indian tea producer.
   The Indian tea producer purchases $1,500,000 worth of stock spread out over a few U.S. companies.

Answer 1

Imports increase in this transaction by US$ 1,500,000 (direction is from India to US)
US exports are not impacted by this transaction - magnitude of change is 0.
Net exports = exports- imports.
This, net exports decrease by US$1,500,000 (direction is from India to US). It may be noted that this is a current account transaction.

Beacause of the identity equation that relates to net exports, the decrease in
US net exports is matched by an increase in US net capital inflow.

The last two scenarios explain how the US net capital inflow increases (in both cases, US
bonds / stocks are purchased by Indian tea producer. These are financial account transations.