Open Economy - International Trade and Finance

Flashcards about Open Economy - International Trade and Finance

Why does the balance of payments always equal zero?

Because every international transaction has an equal and opposite entry in either the current or capital/financial account.

What causes a country's currency to appreciate or depreciate?

Changes in supply and demand for the currency in the foreign exchange market cause appreciation or depreciation.

How does a change in currency value affect imports and exports?

Appreciation decreases exports and increases imports, while depreciation increases exports and decreases imports.

What three components make up the current account (CA)?

Net exports, net income from abroad, and net unilateral transfers make up the CA.

Why can a country run a CA surplus or deficit?

Because exports, income, and transfers may not equal imports and outflows.

What is the balance of trade, and how is it related to the CA?

The balance of trade is net exports, a major part of the current account.

What does the capital and financial account (CFA) include?

It includes purchases and sales of assets and capital transfers between nations.

Why can the CFA show a surplus or a deficit?

Because financial capital can either flow into or out of the country.

What does a CFA surplus indicate?

It indicates that more financial capital is entering the country than leaving.

What does a CFA deficit indicate?

It means more capital is leaving the country than coming in.

What is the purpose of the balance of payments (BOP)?

To record and track all of a country’s international economic transactions.

Why must the CA and CFA always sum to zero in the BOP?

Because every inflow (credit) must be matched by an outflow (debit), ensuring balance.

What is a credit in the BOP?

A transaction that brings money into the country.

What is a debit in the BOP?

A transaction that sends money out of the country.

What happens when a currency appreciates?

It becomes more expensive relative to other currencies.

What happens when a currency depreciates?

It becomes less expensive relative to other currencies.

Why do exchange rates fluctuate?

Because of changing demand and supply for currencies in global markets.

How does an exchange rate represent the price of a currency?

It shows how much of one currency is needed to buy another.

How do you convert between currencies using an exchange rate?

Multiply or divide by the given rate depending on the direction of conversion.

Why do people demand a foreign currency?

To buy that country’s goods, services, or financial assets.

Why do people supply their currency in the forex market?

To obtain foreign currency for imports or investment.

What kind of relationship exists between exchange rate and currency demand?

An inverse relationship—higher exchange rates lower demand.

What kind of relationship exists between exchange rate and currency supply?

A direct relationship—higher exchange rates increase supply.

What happens when the currency market is in disequilibrium?

There is either a surplus or shortage of a currency.

How does the forex market return to equilibrium?

Changes in exchange rates eliminate shortages or surpluses.

How do changes in demand for a country's goods affect its currency?

Increased demand for goods raises demand for the currency, causing appreciation.

How do trade barriers affect the supply or demand for a currency?

Tariffs or quotas can reduce imports, changing currency supply or demand.

How does fiscal policy impact the exchange rate?

By influencing output and prices, it affects demand for currency through trade and investment.

How does monetary policy affect exchange rates?

It changes interest rates, which alters capital flows and currency demand.

Why do capital flows respond to policy changes?

Because investors seek higher returns, which depend on domestic interest rates and economic stability.

How does a stronger currency affect the trade balance?

It reduces exports and increases imports, worsening the trade balance.

How does a weaker currency affect the trade balance?

It increases exports and reduces imports, improving the trade balance.

Why does appreciation reduce aggregate demand?

Because net exports fall, reducing overall spending in the economy.

Why does depreciation increase aggregate demand?

Because net exports rise, increasing total spending in the economy.

How do real interest rate differences influence investment flows?

Investors move capital to countries with higher real interest rates.

What effect do higher interest rates have on a country’s currency?

They attract capital inflows, increasing demand for the currency.

How does a lower interest rate affect a country’s currency value?

It causes capital to flow out, reducing demand and depreciating the currency.

Why do central banks monitor interest rates in open economies?

Because interest rates impact exchange rates and capital movements.

How do capital flows affect the loanable funds market?

Inflows increase the supply of loanable funds, potentially lowering interest rates

What causes an appreciation of the U.S. dollar relative to the Chinese yuan in flexible currency markets?

A higher demand for U.S. goods, services, or assets causes an appreciation of the dollar relative to the Chinese yuan.

What is the effect of an import quota on imported sugar in the United States?

An import quota on sugar reduces imports and can lead to an appreciation of the dollar due to decreased demand for foreign currency.

What is an example of a current account transaction?

A U.S. company exporting goods to a foreign buyer is a current account transaction.

What is an example of Foreign Direct Investment (FDI)?

A U.S. company building a factory in Mexico is an example of foreign direct investment.

What is the dollar cost of a restaurant meal that costs 30 euros in Paris if the exchange rate is 1.2 euros per U.S. dollar?

The meal would cost $25 to a U.S. tourist (30 euros ÷ 1.2 euros per dollar).

What happens to exchange rates when they are freely floating?

If exchange rates are freely floating, they adjust based on supply and demand without government intervention.

What could cause an appreciation of the U.S. dollar on the foreign exchange market?

A decrease in U.S. imports could cause the U.S. dollar to appreciate.

What happens in a country with a flexible exchange rate system if there is an increase in the government budget deficit?

An increase in the government budget deficit would cause interest rates to rise, leading to currency appreciation due to capital inflows.