Studied by 21 peopleTrade Surplus
exporting more than is imported
Trade Deficit
exporting less than is imported
Balance of Payments (BOP)
the summary of a country’s international trade
→ the BOP summary is within a given year prepared in the domestic country’s currency
→ made up of two accounts: the current account (CA) and the capital and financial account (CFA)
→ includes the sale and purchase of goods, services, and assets
Current Account (CA)
( 1 ) Trades in Goods and Services (Net Exports) → the difference between a nation’s exports of goods and services and its imports of goods and services
( 2 ) Investment Income → income from the factors of production including payments made to foreign investors
( 3 ) Net Transfers → money flows from the private or public sectors
Capital and Financial Account (CFA)
measures the purchase and sale of financial assets abroad
→ purchases of things that continue to earn money
Foreign Direct Investment
when a foreign company buys a business in a different country
Net Capital Outflow
the difference between the purchase of foreign assets and domestic assets purchased by foreigners
Financial Account Surplus
inflow > outflow
Financial Account Deficit
inflow < outflow
CA + CFA = 0
the CA and the CFA must balance out (if one has a surplus, the other has a deficit)
Exchange Rate
price of one currency relative to another currency
→ the buyer (importer) must exchange their currency for that of the seller’s (exporter)
Depreciation
the loss of value of a country’s currency with respect to a foreign currency
Appreciation
the increase of value of a country’s currency with respect to a foreign currency
Overview of Demand
→ in general, foreigners demand dollars
→ there is an inverse relationship between the exchange rate (price) and quantity demanded
Overview of Supply
→ in general, Americans supply dollars
→ there is a direct relationship between the exchange rate (price) and quantity supplied
Disequilibrium
→ shortages cause the exchange rate to rise
→ surpluses cause the exchange rate to fall
FOREX Supply & Demand Simplified
if you demand one currency, you must supply your currency
FOREX Shifters
( 1 ) Changes in Tastes
( 2 ) Changes in Relative Incomes (resulting in more imports)
( 3 ) Changes in Relative Price Level (resulting in more imports)
( 4 ) Changes in Relative Interest Rates
FOREX Double Shifters
changes in price level and interest rates are double shifters
→ they effect the behavior of both buyers and sellers of the currency
Fixed Exchange Rate
the government actively manages the country’s currency
Floating Exchange Rate
the market determines the value of a country’s currency
→ some governments attempt to depreciate their country’s currency in order to promote exports
Tariff
a tax on imports
Quota
a limit on the quantity of imports
Trade Restrictions
tariffs and quotas decrease the supply of the currency, restricting trade since fewer transactions are taking place
Currency and Net Exports
a change in the international value of a country’s currency can drastically affect their exports and imports
Appreciation → Net Exports ↓
Depreciation → Net Exports ↑
What happens if American tourists increase visits to Japan? (Practice example with USD and Japanese Yen)
Shifter: Change in Tastes
US Dollar Supply ↑, dollar depreciates
Japanese Yen Demand ↑, yen appreciates
What happens if the US government significantly decreases income tax? (Practice example with USD and Japanese Yen)
Shifter: Change in Income
US Dollar Supply ↑, dollar depreciates
Japanese Yen Demand ↑, yen appreciates
What happens if inflation in Japan rises significantly faster than in the US?
Shifter: Change in Price Level
US Dollar Demand ↑, US Dollar Supply ↓, dollar appreciates
Japanese Yen Supply ↑, Japanese Yen Demand ↓, yen depreciates
Explain why higher inflation causes a shift in both the demand for dollars and the supply of dollars?
Demand ↓, Supply ↑
with higher inflation, fewer people demand the dollar but the US will demand more of other currencies
When the dollar price of the Indian rupee increases, how is the value of the dollar affected?
the dollar depreciates in value
How will inflation in Venezuela affect their currency, the bolivar?
the bolivar will depreciate
Net Exports
exports - imports
A Canadian buys lumber in the US - included in the US’s CA or CFA?
Current Account (CA)
An American buys a beach resort in Mexico - included in the US’s CA or CFA?
Capital/Financial Account (CFA)
An American on vacation buys Japanese government bonds - included in the US’s CA or CFA?
Capital/Financial Account (CFA)
An immigrant in the US sends a portion of their earnings to family overseas - included in the US’s CA or CFA?
Current Account (CA)
Why can’t two currencies both appreciate relative to each other at the same time?
exchange rates between countries are reciprocals of each other; if one currency appreciates, the other must depreciate
Assume $1 went from equaling £0.9 to equaling £1 - which currency appreciated/depreciated?
the dollar appreciated, the pound depreciated
Assume it now takes ￥100 to purchase $1 instead of ￥120 - which currency appreciated/depreciated?
the dollar depreciated, the yen appreciated
Why is Demand downward sloping?
when exchange rates increase, foreigners are willing and able to buy less; when the rate falls, they buy more
Why is supply upward sloping?
when the exchange rate increases, citizens are willing and able to supply more of their currency; when the rate falls, they supply less
If a country’s currency appreciates, net exports will…
decrease
If a country’s currency depreciates, net exports will…
increase
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
Why does an increase in the real interest rate cause an increase in net capital inflow?
when interest rates are higher, foreigners want to buy more domestic assets (like bonds) because they provide a higher rate of return
Will a decrease in the real interest rate move a country’s CFA toward a deficit or toward a surplus?
towards a deficit because a lower real interest rate would cause foreigners to purchase less domestic financial assets and decrease net capital inflow
How will an increase in private savings in the United States most likely affect financial capital flows and the value of the dollar in foreign exchange markets?
The United States will experience financial capital outflows and the dollar will depreciate
Note
Flashcard