Open market Economy

Balance of Trade

shows us the difference between exports and imports of goods and services in a nation, showing its economic interactions with the world

Trade surplus

occurs when a nations exports exceeds its imports (ireland)

Trade deficit

occurs when a nations imports exceeds its exports (USA)

Net Exports (NX)

Equal to exports minus imports and a key component of GDP and Aggregate Demand

Factors that influence Trade

1) Tastes of consumers for domestic and foreign goods

2) Prices of goods and services at home and abroad

3) Exchange Rates at which people can use domestic currency to buy foreign currencies

4) The need by firms for raw materials and resources for use in production

5) Income of consumers at home and abroad

6) The cost of transporting goods from country to country

7) The policies of the government towards international trade

Exchange Rates

the value at which one currency can be exchanged for another

Currency Depreciation

when a currency decreases in value relative to another currency. This means now more of that currency will be needed to purchase a single unit of another currency

Reasons for currency depreciation

trade imbalance: a country facing a trade deficit, where imports exceed exports, may see its currency depreciate as demand for foreign currencies increases to pay for the excess imports

Inflation: higher inflation rates compared to other countries can lead to currency depreciation. Inflation erodes the purchasing power of a currency, reducing its value relative to other currencies

Interest Rates: lower interest rates in a country can make its currency less attractive to foreign investors, leading to a decrease in demand and depreciation

Political and Economic Stability: political instability, economic uncertainty, or unfavourable government policies can undermine investor confidence and cause currency depreciation

Speculation: Speculators anticipating currency depreciation may sell off the currency, leading to its devaluation in the foreign exchange market

Capital outflows: when investors move their capital out of a country due to perceived risks or better investor opportunities elsewhere, it can result in a depreciation of the country’s currency

When a currency depreciates it increases export competitiveness as it is now….

cheaper for other countries to export from this country. This may lead to an increase in demand for exports, improving the trade balance, and stimulating economic growth (GDP)

How does currency depreciation contribute to inflation?

When a currency depreciates, it makes exports cheaper and imports more expensive 

Higher import costs leads to…

goods and services being more expensive, making foreign goods more expensive for consumers and businesses and this can lead to inflationary pressure

cost-push inflation

both a rise in demand for exports and an increase in import costs contribute to cost-push inflation. This can reduce purchasing power and discourage consumer spending

the real value of a currency declines when…

inflation rises. This further depreciates the value

Reasons for Currency Appreciation

trade surplus; a country experiencing trade surplus, where exports exceed imports, may see its currency appreciate as foreign currencies are demanded to purchase its goods and services

Economic growth and stability; strong economic growth, low inflation, and political stability can attract foreign investors, leading to increased demand for the countrys currency and its appreciation

High Interest Rates; Higher interest rates can make a countrys currency more attractive to foreign investors seeking better returns on their investments, resulting in appreciation of the currency

Increased foreign investment; inflows of foreign investment into a country can drive up the demand for its currency, leading to its appreciation

Favourable economic policies; sound economic policies, such as fiscal discipline and structural reforms, can enhance investor confidence and attract capital inflows, causing currency appreciation

Global demand for commodities; If a country is a major exporter for commodities and experiences an increase in global demand and prices, its currency may appreciate due to higher export revenues

When a currency appreciates…

the value of the currency rises against the value of another currency in the foreign exchange market. This means it is now cheaper for this currency to purchase another currency

When a currency appreciates imports become cheaper as….

you can now buy the same amount of goods from abroad at a lower cost, causing the demand for imports to rise and exports become more expensive

Balance of Payments

shows the economic transactions of an economy with the resr of the world over a specific period of time (quarterly, annually) . Consists of the current account, capital account and the financial account

Net Captial Outflow

the term NCO refers to the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners

Factors of Net Capital Outflow

1) the real interest rates being paid on foreign assets

2) the real interest rates being paid on domestic assets

3) the perceived economic and political risks of holding assets abroad

4) the government policies that affect foreign ownership of domestic assets