AP Macro Unit 6

Trade Surplus

exporting more than is imported

Trade Deficit

exporting less than is imported

Balance of Payments (BOP)

the summary of a country’s international trade

→ the BOP summary is within a given year prepared in the domestic country’s currency

→ made up of two accounts: the current account (CA) and the capital and financial account (CFA)

→ includes the sale and purchase of goods, services, and assets

Current Account (CA)

( 1 ) Trades in Goods and Services (Net Exports) → the difference between a nation’s exports of goods and services and its imports of goods and services

( 2 ) Investment Income → income from the factors of production including payments made to foreign investors

( 3 ) Net Transfers → money flows from the private or public sectors

Capital and Financial Account (CFA)

measures the purchase and sale of financial assets abroad

→ purchases of things that continue to earn money

Foreign Direct Investment

when a foreign company buys a business in a different country

Net Capital Outflow

the difference between the purchase of foreign assets and domestic assets purchased by foreigners

Financial Account Surplus

inflow > outflow

Financial Account Deficit

inflow < outflow

CA + CFA = 0

the CA and the CFA must balance out (if one has a surplus, the other has a deficit)

Exchange Rate

price of one currency relative to another currency

→ the buyer (importer) must exchange their currency for that of the seller’s (exporter)

Depreciation

the loss of value of a country’s currency with respect to a foreign currency

Appreciation

the increase of value of a country’s currency with respect to a foreign currency

Overview of Demand

→ in general, foreigners demand dollars

→ there is an inverse relationship between the exchange rate (price) and quantity demanded

Overview of Supply

→ in general, Americans supply dollars

→ there is a direct relationship between the exchange rate (price) and quantity supplied

Disequilibrium

→ shortages cause the exchange rate to rise

→ surpluses cause the exchange rate to fall

FOREX Supply & Demand Simplified

if you demand one currency, you must supply your currency

FOREX Shifters

( 1 ) Changes in Tastes

( 2 ) Changes in Relative Incomes (resulting in more imports)

( 3 ) Changes in Relative Price Level (resulting in more imports)

( 4 ) Changes in Relative Interest Rates

FOREX Double Shifters

changes in price level and interest rates are double shifters

→ they effect the behavior of both buyers and sellers of the currency

Fixed Exchange Rate

the government actively manages the country’s currency

Floating Exchange Rate

the market determines the value of a country’s currency

→ some governments attempt to depreciate their country’s currency in order to promote exports

Tariff

a tax on imports

Quota

a limit on the quantity of imports

Trade Restrictions

tariffs and quotas decrease the supply of the currency, restricting trade since fewer transactions are taking place

Currency and Net Exports

a change in the international value of a country’s currency can drastically affect their exports and imports

Appreciation → Net Exports ↓

Depreciation → Net Exports ↑

What happens if American tourists increase visits to Japan? (Practice example with USD and Japanese Yen)

Shifter: Change in Tastes

US Dollar Supply ↑, dollar depreciates

Japanese Yen Demand ↑, yen appreciates

What happens if the US government significantly decreases income tax? (Practice example with USD and Japanese Yen)

Shifter: Change in Income

US Dollar Supply ↑, dollar depreciates

Japanese Yen Demand ↑, yen appreciates

What happens if inflation in Japan rises significantly faster than in the US?

Shifter: Change in Price Level

US Dollar Demand ↑, US Dollar Supply ↓, dollar appreciates

Japanese Yen Supply ↑, Japanese Yen Demand ↓, yen depreciates

Explain why higher inflation causes a shift in both the demand for dollars and the supply of dollars?

Demand ↓, Supply ↑

with higher inflation, fewer people demand the dollar but the US will demand more of other currencies

When the dollar price of the Indian rupee increases, how is the value of the dollar affected?

the dollar depreciates in value

How will inflation in Venezuela affect their currency, the bolivar?

the bolivar will depreciate

Net Exports

exports - imports

A Canadian buys lumber in the US - included in the US’s CA or CFA?

Current Account (CA)

An American buys a beach resort in Mexico - included in the US’s CA or CFA?

Capital/Financial Account (CFA)

An American on vacation buys Japanese government bonds - included in the US’s CA or CFA?

Capital/Financial Account (CFA)

An immigrant in the US sends a portion of their earnings to family overseas - included in the US’s CA or CFA?

Current Account (CA)

Why can’t two currencies both appreciate relative to each other at the same time?

exchange rates between countries are reciprocals of each other; if one currency appreciates, the other must depreciate

Assume $1 went from equaling £0.9 to equaling £1 - which currency appreciated/depreciated?

the dollar appreciated, the pound depreciated

Assume it now takes ￥100 to purchase $1 instead of ￥120 - which currency appreciated/depreciated?

the dollar depreciated, the yen appreciated

Why is Demand downward sloping?

when exchange rates increase, foreigners are willing and able to buy less; when the rate falls, they buy more

Why is supply upward sloping?

when the exchange rate increases, citizens are willing and able to supply more of their currency; when the rate falls, they supply less

If a country’s currency appreciates, net exports will…

decrease

If a country’s currency depreciates, net exports will…

increase

Net Capital Inflow

the difference between the amount of money coming into a country to buy domestic assets and the amount of money leaving a country to buy foreign assets

Why does an increase in the real interest rate cause an increase in net capital inflow?

when interest rates are higher, foreigners want to buy more domestic assets (like bonds) because they provide a higher rate of return

Will a decrease in the real interest rate move a country’s CFA toward a deficit or toward a surplus?

towards a deficit because a lower real interest rate would cause foreigners to purchase less domestic financial assets and decrease net capital inflow

How will an increase in private savings in the United States most likely affect financial capital flows and the value of the dollar in foreign exchange markets?

The United States will experience financial capital outflows and the dollar will depreciate