AP Macro Unit 6: Open Economy – International Trade and Finance

TOPIC 6.1 Balance of Payment Accounts

Balance of payment (BOP)

accounting system to keep track of transactions between countries over a period of time.

current account (CA)

Net Exports: Difference in value between exports (positive, credit) and imports (negative, debit).

Net Investments: Interests or dividends paid to/from domestic investors.

Net Transfers: Aid or grants paid to/from the domestic economy.

What does a trade surplus and trade deficit signify?

Trade surplus: Occurs when a country exports more than it imports.

Trade deficit: Occurs when a country imports more than it exports.

What are Financial Investments in the Capital and Financial Account?

Purchases of foreign and domestic financial assets:

Surplus (financial capital inflow): Foreign purchases of domestic assets.

Deficit (financial capital outflow): Domestic purchases of foreign assets.

What are Real Investments in the Capital and Financial Account?

Purchases of tangible assets like land, businesses, plants, and factories:Positive (+) when foreign entities purchase domestic assets.Negative (-) when domestic entities purchase foreign assets.

TOPIC 6.2 Exchange Rates

exchange rate

the price of one currency in terms of another

currency appreciation

A rise in value of one currency in terms of another currency

Currency Depreciation

fall in the value of one currency in terms of another currency

TOPIC 6.3 Foreign Exchange Market

foreign exchange market

Interaction of buyers and sellers exchanging the currency of one country for the currency of another

Foreign Exchange Demand

Quantity of international currency desired and purchased by domestic and foreign entities at different exchange rates.

Exchange rate ⬆️

Quantity of currency demanded ⬇️

Exchange rate ⬇️

Quantity of currency demanded ⬆️

foreign exchange market: equilibrium

when exchange rate is such that quantities demanded and supplied of the currency are equal

TOPIC 6.4 Effects of Changes in Policies and Economic Conditions on the FOREX Market

who participates in the foreign exchange market?

- those looking to purchase goods from another country

- those looking to earn income from another country

Expansionary Fiscal (Gov. spending ⬆️ or taxes ⬇️)

Aggregate Demand (AD) ⬆️

Real GDP ⬆️, Price level ⬆️

US goods more expensive →AD ⬇️

Demand for USD ⬇️ → USD depreciates

Contractionary Fiscal (Gov. spending ⬇️ or taxes ⬆️)

Aggregate Demand (AD) ⬇️

Real GDP ⬇️, Price level ⬇️

US goods less expensive →AD ⬆️

Foreign demand ⬆️ → Demand for USD ⬆️ → USD appreciates

Expansionary Monetary (Reserve ratio ⬇️, discount rate ⬇️, or buy bonds)

Interest rate ⬇️ → Investment spending ⬆️

Aggregate Demand (AD) ⬆️, Price level ⬆️

US goods more expensive →Foreign demand ⬇️

Demand for USD ⬇️ → USD depreciates

Contractionary Monetary (Reserve ratio ⬆️, discount rate ⬆️, or sell bonds)

Interest rate ⬆️ → Investment spending ⬇️

Aggregate Demand (AD) ⬇️, Price level ⬇️

US goods less expensive →Foreign demand ⬆️

Demand for USD ⬆️ → USD appreciates

TOPIC 6.4 CONTINUED FIVEABLE - Trade Barriers

revenue tariffs

Imposed on goods not produced domestically

Raises government revenue

protective tariffs

Imposed on domestically produced goods

Protect domestic jobs

import quotas

limits on the numbers of a product that can be imported

TOPIC 6.5 Changes in the Foreign Exchange Market and Net Exports

currency value appreciates

⬆️ Currency becomes stronger

⬆️ Exports become more expensive

⬇️ Imports become cheaper

⬇️ Decrease in net exports

⬇️ Decrease in aggregate demand

⬆️ Increase in unemployment

⬆️ Increase in the price level

currency value depreciates

⬇️ Currency becomes weaker

⬇️ Exports become cheaper

⬆️ Imports become more expensive

⬆️ Increase in net exports

⬆️ Increase in aggregate demand

⬇️ Decrease in unemployment

⬇️ Decrease in the price level

TOPIC 6.6 Real Interest Rates and International Capital Flows

What drives the change in capital flows?

INTEREST RATES

changes in interest rates: Monetary Policy

Expansionary: Rates ⬇️

Contractionary: Rates ⬆️

Household savings behavior

Increase: Rates ⬇️

Decrease: Rates ⬆️

changes in interest rates: Budget Balance

Deficit: Rates ⬆️

Surplus: Rates ⬇️

changes in interest rates: Demand for money

Increase: Rates ⬆️

Decrease: Rates ⬇️