Unit 6: Open Economy, International Trade, and Finance (Princeton Review AP Macroeconomics 2023 [21st Edition])

Balance of Payments

a statement of all inernational flows of money over a given period

The three balances within the balance of payments are…

merchandise trade balance, current-account balance (financial account balance), and the final account balance

Merchandise Trade Balance

merchandise exports - merchandise imports

Current-Account Balance

trade balance + services balance + transfers

Final Account Balance

foreign purchases of home assets - home purchases of foreign assets

Merchandise Trade Deficit

when imports exceed exports

Merchandise Trade Surplus

when exports exceed imports

International Currency Market

global marketplace where currencies are traded, influencing exchange rates and international trade

An international market for US dollars exists when…

international citizens want to purchase US goods or services, international citizens want to invest in US firms, or international citizens want to give monetary gifts to individuals in the US

As the value of a foreign currency goes up, the quantity of US dollars…

decreases

As the value of a foreign currency goes down, the quantity of US dollars…

increases

Exchange Rate

the rate at which dollars are exchnaged for another currency

When someone in Japan demands US dollars, they increase supply of Japanese yen, showing…

a reciprocal relationship between two currencies

When the value of the dollar increases…

it costs more of a foreign currency to buy the dollar

Increases in demand for the US dollar (or any currency)…

increase in another nation’s income, lesser US inflation, increased consumer preference for US goods, and increase in national confidence seen by foreign nations

Decreases in demand for the US dollar (or any currency)…

decrease in another nation’s income, greater US inflation, decreased consumer preference for US goods, and decrease in national confidence seen by foreign nations

Appreciation vs Depreciation

appreciation refers to an increase in the value of a currency relative to others, while depreciation indicates a decrease in its value. These fluctuations impact international trade and purchasing power.

Arbitrage

the practice of buying at a ow price and selling at a high price for a certain profit

The Fed controls the…

exchange rate

Fixed Exchange Rate

changes in demand affect only the quantity of dollars purchased (shown by a horizontal S curve)

Flexible Exchange Rate

changes in demand affect only the foreign currency per dollar (shown by a vertical S curve)

Managed Exchange Rate

chnages in demand for dollars affects supply (shown by a positive slope S curve)

Open Economy

a nation that trades with other nations to acquire goods not produced domestically and sells goods in international markets

Closed Economy

nations that don’t engage in foreign trade

Expansionary fiscal policy tends to make net exports…

decrease

Contractionary fiscal policy tends to make net exports…

increase

The money market is used to determine the value of money in the…

short-run

The loanable funds market is used to determine the value of money in the…

long-run

Liquidity Trap

changes in money supply has no effect on interest rates

Keynesians believe in…

fiscal policy, and believe the investment demand curve is relatively steep

Monetarists believe in…

monetary policy, and believe the investment demand curve is relatively elastic

Equation of Exchange

MV = PQ (money supply times money velocity = price times quantity of goods and services sold)

Monetarists explain the power of monetary policy through the…

equation of exchange

Velocity of Money

the number of times per period (usually per year) that the average dollar is spent on final goods and services

If one variable in the equation of exchange changes….

then another variable has to change as well

Quantity Theory of Money

when the velocity of money is stable (V), the quantity of goods and services is stable (Q)

Keynesians want to fight inflatin by…

decreasing the money supply to drive up both real and nominal interest rates and to reduce consumption and investment

Natural Rate of Real Interest

a monetarist belief in which fluctuations in nominal interest rate simply reflect changes in anticipated inflation

Fisher Effect

when the Fed tightens the money supply, nominal interest rates fall and inflation falls when market participants predict these actions