International Trade & Finance Foundations (AP Macroeconomics Unit 6)

Balance of Payments (BOP)

An accounting system that records all economic transactions between residents of a country and the rest of the world over a period of time.

Double-entry accounting (BOP)

The rule that every international transaction creates two equal entries—one credit and one debit—so the BOP accounts sum to zero overall (aside from statistical discrepancy).

Credit (BOP)

An entry that generally indicates money flows into the country (foreigners pay you) or residents receive income from abroad.

Debit (BOP)

An entry that generally indicates money flows out of the country (you pay foreigners) or residents pay income to foreigners.

Current account (CA)

The BOP account that records trade in goods and services plus certain cross-border income flows and net transfers (current production and income-related flows).

Trade in goods

Exports and imports of physical products recorded in the current account.

Trade in services

Exports and imports of services (e.g., tourism, shipping, financial services, streaming sold abroad) recorded in the current account.

Primary income (net primary income)

Cross-border income from investments and work (e.g., interest, dividends), measured as income received from abroad minus income paid to foreigners.

Secondary income / net transfers (net current transfers)

Money sent or received without a good, service, or asset in return (e.g., remittances, foreign aid transfers).

Net exports (NX)

Exports minus imports of goods and services: NX = X − M.

Open-economy GDP identity

A macro identity showing GDP components: Y = C + I + G + NX.

Current account identity (expanded)

A more complete measure of the current account: CA = NX + NPI + NCT (net exports + net primary income + net current transfers).

Current account deficit

A negative current account balance indicating the country buys more goods/services (and makes more net transfers) than it sells, requiring financing via asset sales/borrowing or reserve changes.

Financial account (FA)

The BOP account that records transactions in financial assets (stocks, bonds, real estate, bank deposits, direct investment), capturing net borrowing/lending with the rest of the world.

Financial inflow (financial account surplus)

Occurs when foreigners buy domestic assets, creating net demand for domestic assets/currency and a positive financial account balance.

Financial outflow (financial account deficit)

Occurs when domestic residents buy foreign assets, creating net demand for foreign assets/currency and a negative financial account balance.

Official reserves account (OR)

The BOP account tracking central bank purchases and sales of foreign currency reserves (official reserve transactions).

Official reserve transaction

A central bank action that changes foreign currency reserves (buying foreign currency increases reserves; selling foreign currency uses reserves to buy its own currency).

BOP accounting relationship (AP framework)

The simplified balancing condition: CA + FA + OR = 0, meaning a deficit in one area must be offset by a surplus in another (given consistent sign conventions).

Exchange rate

The price of one currency in terms of another currency.

Appreciation

An increase in a currency’s value so it buys more foreign currency than before; tends to reduce exports, increase imports, and decrease NX.

Depreciation

A decrease in a currency’s value so it buys less foreign currency than before; tends to increase exports, decrease imports, and increase NX.

Foreign exchange market (FOREX)

The market where currencies are traded; exchange rates are determined by supply and demand for currencies, influenced by trade and financial capital flows.

Demand for domestic currency (FX model)

Foreigners’ desire to buy domestic currency to purchase domestic goods, services, or assets; higher demand tends to appreciate the domestic currency.

Supply of domestic currency (FX model)

Domestic residents selling domestic currency to buy foreign goods, services, or assets; higher supply tends to depreciate the domestic currency.