1. Trade Surplus Trade Deficit Balance of Trade

2. Exchange Rates: Types of exchange rates; 1. Flexible (floating) exchange rate systems; supply and demand determine the exchange rate with no government intervention. 2. Fixed exchange rate system; government determines the rate of exchange by making economic adjustments.

3. 3. Managed floating exchange rate system; Exchange rates are free to float to the equilibrium levels, but nations occasionally use currency interventions to stabilize rates.

4. U.S. exports create a foreign demand for dollars, and the fulfillment of that demand increases the supply of foreign currency held by U.S. banks. The increase in supply of foreign currency decreases its value to U.S. dollars. $ 1.50 $ 1.00 $ A.50.50 Q of Pesos S2S2S2S2 S1S1S1S1

5. Also, U.S. imports create a domestic demand for foreign currency, and the fulfillment of that demand reduces the supplies of foreign currency held by U.S. banks and available to U.S. consumers. Thus there is an increase in the value of the foreign currency to the dollar. $ 1.50 $ D $ 1.00.50.50 Q of Pesos S2S2S2S2 S1S1S1S1 So in a broad sense, any nation’s exports pay for its imports. Because exports provide the foreign currency needed to pay for imports.

6. Factors that will appreciate the dollar: Factors that will appreciate the dollar: Taste for U.S. goods; 1. Taste for U.S. goods; A decrease in U.S. demand for foreign product or an increase in the foreign demand for U.S. products. Rate of interest in U.S.; 2. Rate of interest in U.S.; Higher IR in U.S. leads to more foreign investments, increasing foreign demand for dollar. Income nationally; 3. Income nationally; Increase in foreign national incomes will increase demand for U.S. G/S and increase the demand for the dollar. Price levels; 4. Price levels; Lower price levels in the U.S. increase exports to foreign nations, which will increase demand for dollar. Speculation; 5. Speculation; Predictions of U.S. dollar appreciation will cause currency speculators to demand more dollars causing the foreign price of the dollar to rise.

7. Goods exports…………….. Goods imports…………….. + U.S. Goods export………………….…….…..+$100 - U.S. Goods imports…………………………….. - 80 + U.S. Service exports…………………………... +40 - U.S. Service imports………………………….… - 90 + Net Investment income………………..……….+20 - Net transfers………………………………….…. - 15 + Capital inflows to the U.S…………………..….+40 - Capital outflows from the U.S……………..…. - 10 - Official reserves ………………......................… - 5 Official Res. Acct. Bal. on Curr. Acct. Bal. on Cap. Acct. A balance of payment statement shows all the payments a nation receives from foreign countries and all the payments it makes to them. Its divided into three parts: Current accounts; all exports & imports of goods/services in a year. Capital accounts; the purchase or sale of real or financial assets in a year. Official reserves accounts; the reserves of foreign currency held by central banks to make up any net deficits.

8. The three parts of the balance of payment statement must together equal zero. So when the U.S. runs constant deficits, we must pay for that deficit with our reserves of foreign currency. So constant deficits run the risk of depleting our official reserves.

9. Goods exports…………….. Goods imports…………….. on goods Goods exports (_____) – goods imports (_____) = $_______ + U.S. Goods export………………….…….…..+$100 - U.S. Goods imports……………………………...-80 + U.S. Service exorts…………………………...…+40 - U.S. Service imports………………………….…-90 + Net Investment income………………..……….+20 - Net transfers………………………………….…..-15 + Capital inflows to the U.S…………………..….+40 - Capital outflows from the U.S……………….…-10 - Official reserves ………………......................….-5 1. The U.S. is experiencing a balance on goods(deficit/surplus)of ($10/$20/$30 ). Goods exports (____) – goods imports (____) = $_____

10. Goods exports…………….. Goods imports…………….. on goods Goods exports (_____) – goods imports (_____) = $_______ + U.S. Goods export………………….…….…..+$100 - U.S. Goods imports…………………………….. - 80 + U.S. Service exports…………………………... +40 - U.S. Service imports………………………….… - 90 + Net Investment income………………..……….+20 - Net transfers………………………………….…. - 15 + Capital inflows to the U.S…………………..….+40 - Capital outflows from the U.S……………..…. - 10 - Official reserves ………………......................… - 5 surplus $20 1. The U.S. is experiencing a balance on goods(deficit/surplus)of ($10/$20/$30 ). $100$80$20 Goods exports ($100) – goods imports ($80) = $20 20 -30 G/S Curr. Acct - 25 30 Balance on Goods Bal. on Curr. Acct. Bal. on Cap. Acct.

11. Goods exports…………….. Goods imports…………….. on goods Goods exports (_____) – goods imports (_____) = $_______ + U.S. Goods export………………….…….…..+$100 - U.S. Goods imports……………………………...-80 + U.S. Service exorts…………………………...…+40 - U.S. Service imports………………………….…-90 + Net Investment income………………..……….+20 - Net transfers………………………………….…..-15 + Capital inflows to the U.S…………………..….+40 - Capital outflows from the U.S……………….…-10 - Official reserves ………………......................….-5 2. The U.S.’s balance on goods and services is a (deficit/surplus) of $30 billion. (goods/services exports(____) – goods/services imports (____) = ______)

12. Goods exports…………….. Goods imports…………….. on goods Goods exports (_____) – goods imports (_____) = $_______ + U.S. Goods export………………….…….…..+$100 - U.S. Goods imports…………………………….. - 80 + U.S. Service exports…………………………... +40 - U.S. Service imports………………………….… - 90 + Net Investment income………………..……….+20 - Net transfers………………………………….…. - 15 + Capital inflows to the U.S…………………..….+40 - Capital outflows from the U.S……………..…. - 10 - Official reserves ………………......................… - 5 deficit 2. The U.S.’s balance on goods and services is a (deficit/surplus) of $30 billion. $140$170-$30 (goods/services exports($140) – goods/services imports ($170) = -$30) 20 -30 G/S Curr. Acct - 25 30 Balance on Goods Bal. on Curr. Acct. Bal. on Cap. Acct.

13. Goods exports…………….. Goods imports…………….. on goods Goods exports (_____) – goods imports (_____) = $_______ + U.S. Goods export………………….…….…..+$100 - U.S. Goods imports……………………………...-80 + U.S. Service exorts…………………………...…+40 - U.S. Service imports………………………….…-90 + Net Investment income………………..……….+20 - Net transfers………………………………….…..-15 + Capital inflows to the U.S…………………..….+40 - Capital outflows from the U.S……………….…-10 - Official reserves ………………......................….-5 3. The U.S.’s balance on the current account is (+25/-$25). [Balance on g/s(___) + net investment income(___) + net transfers(___) = C.A.(___)].

14. Goods exports…………….. Goods imports…………….. on goods Goods exports (_____) – goods imports (_____) = $_______ + U.S. Goods export………………….…….…..+$100 - U.S. Goods imports…………………………….. - 80 + U.S. Service exports…………………………... +40 - U.S. Service imports………………………….… - 90 + Net Investment income………………..……….+20 - Net transfers………………………………….…. - 15 + Capital inflows to the U.S…………………..….+40 - Capital outflows from the U.S……………..…. - 10 - Official reserves ………………......................… - 5 -$25 3. The U.S.’s balance on the current account is (+25/-$25). (-$30)($20)(-$15)(-$25)]. [Balance on g/s(-$30) + net investment income($20) + net transfers(-$15)=C.A.(-$25)]. 20 -30 G/S Curr. Acct - 25 30 Balance on Goods Bal. on Curr. Acct. Bal. on Cap. Acct.

15. Goods exports…………….. Goods imports…………….. on goods Goods exports (_____) – goods imports (_____) = $_______ + U.S. Goods export………………….…….…..+$100 - U.S. Goods imports……………………………...-80 + U.S. Service exorts…………………………...…+40 - U.S. Service imports………………………….…-90 + Net Investment income………………..……….+20 - Net transfers………………………………….…..-15 + Capital inflows to the U.S…………………..….+40 - Capital outflows from the U.S……………….…-10 - Official reserves ………………......................….-5 4. The balance on the capital account is a (surplus/deficit) of ($20/$30/$40). [capital inflow(___) – capital outflow(___) = _______]

16. Goods exports…………….. Goods imports…………….. on goods Goods exports (_____) – goods imports (_____) = $_______ + U.S. Goods export………………….…….…..+$100 - U.S. Goods imports…………………………….. - 80 + U.S. Service exports…………………………... +40 - U.S. Service imports………………………….… - 90 + Net Investment income………………..……….+20 - Net transfers………………………………….…. - 15 + Capital inflows to the U.S…………………..….+40 - Capital outflows from the U.S……………..…. - 10 - Official reserves ………………......................… - 5 surplus 4. The balance on the capital account is a (surplus/deficit) of ($20/$30/$40). ($40)($10)$30 [capital inflow($40) – capital outflow($10) = $30] 20 -30 G/S Curr. Acct - 25 30 Balance on Goods Bal. on Curr. Acct. Bal. on Cap. Acct.

17. Goods exports…………….. Goods imports…………….. on goods Goods exports (_____) – goods imports (_____) = $_______ + U.S. Goods export………………….…….…..+$100 - U.S. Goods imports……………………………...-80 + U.S. Service exorts…………………………...…+40 - U.S. Service imports………………………….…-90 + Net Investment income………………..……….+20 - Net transfers………………………………….…..-15 + Capital inflows to the U.S…………………..….+40 - Capital outflows from the U.S……………….…-10 - Official reserves ………………......................….-5 5. The U.S. is experiencing a balance of payments (surplus/deficit) of $5. [don’t include official reserves here] 6. The “official reserves account indicates the U.S. (imported/exported) $5 billion of its stock of foreign reserves.

18. Goods exports…………….. Goods imports…………….. on goods Goods exports (_____) – goods imports (_____) = $_______ + U.S. Goods export………………….…….…..+$100 - U.S. Goods imports…………………………….. - 80 + U.S. Service exports…………………………... +40 - U.S. Service imports………………………….… - 90 + Net Investment income………………..……….+20 - Net transfers………………………………….…. - 15 + Capital inflows to the U.S…………………..….+40 - Capital outflows from the U.S……………..…. - 10 - Official reserves ………………......................… - 5 surplus 5. The U.S. is experiencing a balance of payments (surplus/deficit) of $5. [don’t include official reserves here] imported 6. The “official reserves account indicates the U.S. (imported/exported) $5 billion of its stock of foreign reserves. 20 -30 G/S Curr. Acct - 25 30 Balance on Goods Bal. on Curr. Acct. Bal. on Cap. Acct.

19. Goods exports…………….. Goods imports…………….. on goods Goods exports (_____) – goods imports (_____) = $_______ + U.S. Goods export………………….…….…..+$100 - U.S. Goods imports……………………………...-80 + U.S. Service exorts…………………………...…+40 - U.S. Service imports………………………….…-90 + Net Investment income………………..……….+20 - Net transfers………………………………….…..-15 + Capital inflows to the U.S…………………..….+40 - Capital outflows from the U.S……………….…-10 - Official reserves ………………......................….-5 +exportenter [A + here means we will export a stock of foreign money($’s will enter U.S.] - importexit [A - here means we will import a stock of foreign money($’s will exit U.S.]

20. Dollar Price of 1 pound $ 2 Quantity of pounds S1S1S1S1 D1D1D1D1 Under flexible exchange rates, a shift in the demand for pounds from D 1 to D 2 would cause a U.S. balance deficit (ab). That deficit could be correct by changing the dollar price for pounds to $3. The short-run shortage can be covered by using official reserves. But in the LR the imbalance will correct itself. Q1Q1Q1Q1 $ 3 $ 1 0 a Q2Q2Q2Q2 D2D2D2D2 c Q3Q3Q3Q3 balance deficit x b

21. Dollar Price of 1 pound $ 2 Quantity of pounds S1S1S1S1 D1D1D1D1 By selling part of its reserves of pounds, the U.S. government would increase the supply of pounds, shifting the supply curve S 1 to the right so that it intersects with D 2 at point b. But long term deficits will exhaust U.S. reserves and lead to abandoning fixed exchange rates. Q1Q1Q1Q1 $ 3 $ 1 0 a Q2Q2Q2Q2 D2D2D2D2 c Q3Q3Q3Q3 balance deficit x b S2S2S2S2

22. Goodbye Hassle, Hello Tassel.

24. Juniors