Unit 6; Foreign Exchange Market

Define comparative advantage

The country that can produce something more efficiently than the compared country

Define terms of trade

ratio of a country’s exports vs imports

Define gains from trade

the net benefit a country can earn through trade

Explain comparative advantage using opportunity cost

comparative advantage can be explained with opportunity cost because **the country with the smaller opportunity cost should produce the good or service**

Demonstrate how specialization and trade allow consumption possibilities to exceed production possibilities

Other countries may have access to more or better natural resources including human labor, techniques, wage options

Determine the terms of trade

Can be shown with a ratio of terms such as 1 bike = 1/2 shoes.

Output based problems = other goes over

Input based problems = other goes under

Define tarrifs

An extra tax placed imported goods (discourages imports)

Define quotas

Import or export restrictions on quantities that can be bought or sold by a country (discourages trade from economic or environmental reasons)

Define regulations to limit trade

Regulations usually restrict how much a supply can be made or consumed (usually safety or environmentally related

Describe policies that are intended to protect the domestic economy from the effects of international trade

Tariffs and quotas are meant to protect domestic firms and workers, leads to higher prices

Explain the effects of tariffs, quotas, subsidies on domestic production and the prices domestic consumers pay

As supply is less, the prices will rise from tariffs and quotas due to lower amounts of resources and supply. Subsides use tax money to bring the prices down and supplier’s cost to produce goods and services

Explain the arguments for and against protectionist policies.

In Favor: less use of foreign products where cheaper wages exist, allows domestic firms to compete despite required higher wages

Against: leads to higher prices from domestic consumers, less disposable income and a need to work more, less domestic demand

Define current account

All imports/exports, interest payments, foreign aid (transfer payments)

define capital accounts

purchases of real estate, businesses, stocks, and bonds (changes in ownership)

Define balances of trade

differences in value between a country’s imports and exports

Define balance of payments

record of all transactions between the residents of one nation to another

What is the difference between debit and credit

Debit is money going out. Credit is money coming in.

Explain how international transactions affect the balance of trade and the balance of payments

the rate or demand that people from one nation purchase good or services from another country can lead to a lopsided balance of trade (USA and China)

Explain how the international value of the dollar is determined

1. Changes in taste (consumer preferences)
2. Changes in relative incomes
3. Changes in relative prices (inflation)
4. Changes in relative interest rates (inflation by country’s central bank)
5. Speculation of future changes in value of money

Explain the effects of monetary and fiscal policy on foreign exchange markets

When a country’s central bank adjust interest rates the inflation levels go up or down, fiscal policy also aims to adjust inflation. Can affect speculation demand for foreign currency as well, people dont like to convert money to an unpredictable economy (Brazil had 1000% inflation in one year)

Explain the effects of changes in the international value of the dollar on foreign trade

When the dollar is strong: US import firms do well, exports do poorly. Think about purchasing power.

Explain the effects of changes in net exports on domestic aggregate demand

Net exports can lead to higher domestic aggregate demand since Americans have more disposable income, or if it’s severe with trade deficits can lead to lower AD since less American are employed therefore less money

Define exports

the sale of goods and services created by domestic producers and sold to foreigners

Define imports

the purchasing of goods and services created by foreigners

define Net exports

Exports - imports, the difference between a nation’s exports of goods and services and its imports of goods and services

Define trade deficit

exporting less than is imported (trade gap)

Define trade surplus

Exporting more than is imported. China has a huge trade surplus with the U.S.

What is the balance of payments

Summary of all international transactions within a given year prepared in the domestic country’s currency. It has two accounts, the current account and the financial account

What is current account

Measures the international trade in goods and services, investment income and net transfer payments

What is the Financial account

Measures the international trade of financial assets like stocks, bonds, and real estate

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.

What is the difference between capital inflows and capital outflows

Inflows looks at money coming into the country to buy domestic assets and outflows looks at money going out of the country to buy foreign assets

What kind of relationship do interest rates and capital inflows

positive (interest rates go up, capital inflow goes up)

What kind of relationship do interest rates and capital outflows

inverse (interest rates go up, capital outflow goes down)

Define appreciation

the increase of value of a country’s currency relative to a foreign country

Define depreciation

the decrease of value of a country’s currency relative to a foreign country

What happens to the value of the U.S. dollar if Americans want more Japanese products

American supply more dollars to get yen. the U.S. dollar depreciates. causes rightward shift of supply line.

What happens to the value of pesos relative to the US dollar if interest rates in Mexico increase

Americans demand more Mexican financial assets and Mexicans supply less pesos because they can earn a higher rate of return at home. Leftward shift of demand rightward shift of supply