1. International Trade

2. Exports v. Imports Exports – goods sold to other countries Imports - goods bought from other countries

3. Trade Deficit Occurs when the United States buys more goods from overseas than it sells Imports > Exports

4. Trade Surplus Occurs when the United States sells more goods to other countries than it buys Exports > Imports

5. Balance of Trade Balance of Trade measures a country’s exports minus its imports Positive trade imbalance = trade surplus Negative trade imbalance = trade deficit

6. Exchange Rate How much foreign currency the U.S. dollar can be exchanged for. For example, One U.S. dollar =.75 Euros (3/4) 1 Euro = 1.33 dollars (4/3) (reciprocals of each other)

7. Real Exchange Rate The rate at which you can trade the goods of one country for the goods of another country Used to compare foreign currencies b/c it accounts for changes in price level Measures how much more or less foreign “stuff” you can buy with another currency

8. Purchasing Power Parity Theory – a unit of one currency should be able to buy the same quantity of goods in all countries WHY? –If goods cost different real amounts, then people could take advantage of this by selling a good for cheaper: “arbitrage” –Ex. If coffee cost a higher “real” amount in Japan than the US, then traders would buy coffee in the US and sell it in Japan….eventually the increase of supply in Japan would lower price (supply & demand) and coffee would then cost the same amount in the US & Japan

9. Limitations of Purchasing Power Parity –many goods are not easily transported. Haircuts in Paris may be more expensive than haircuts in New York, but one haircut cannot be transported to another country –People prefer some goods over others If French wine is more expensive than American wine, even American wine is imported to France, people may still demand the French wine more, keeping the price higher

10. Increasing Exchange Rate When the exchange rate increases, your currency becomes more valuable & appreciates

11. Appreciation Effects: Example: 1 US dollar =.75 Euros - > 1 US dollar =.9 Euros –The dollar is “stronger” & can buy more –BUT, US goods are more expensive for Europeans (takes more Euros to buy the same good) Imports increase Exports decrease Leads to a trade deficit for the US & trade surplus for Europe SO, appreciation -> trade deficit

12. Decreasing Exchange Rate When the exchange rate decreases, your currency becomes less valuable & depreciates The other currency appreciates

13. Depreciation Effects: Example: 1 US dollar =.75 Euros - > 1 US dollar =.5 Euros –The dollar is “weaker” & can buy less –BUT, US goods are cheaper for Europeans Imports decrease Exports increase Leads to a trade surplus for the US and a trade deficit for Europe SO, depreciation -> trade surplus

14. How the Exchange Rate is “expressed” 1 US dollar = 80 Yen, 80 Yen per dollar Or 80 ¥/$

15. FOREX Graph “FOReign EXchange” Graph

16. FOREX graph Represents how supply & demand for a currency affects the exchange rate Supply & Demand for currency used to “save” in other markets –Whichever country has the highest real interest rate, that’s where people want to save their money to make the most profit –To “save” their money there, they must have that country’s currency

17. Supply Supply = Domestic residents willing to supply the domestic currency (and want the foreign currency to buy foreign stocks/bonds) Positively sloped bc when the exchange rate is really low, that means that American currency is cheap & foreign currency is expensive, so they want to keep American currency When the exchange rate is really high, domestic currency is expensive & foreign currency is cheap, so they are supplying a LOT of domestic currency so they can get a LOT of foreign currency

18. Demand Demand = Foreign residents demanding the domestic currency (and want the currency to buy domestic stocks/bonds) Negatively sloped bc when the exchange rate is really high, that means the domestic currency is expensive, so they don’t want domestic currency –When the exchange rate is really low, domestic currency is cheap, so they want a LOT of domestic currency

19. FOREX for US Dollars Supply = Americans who want foreign currency to “save” in foreign markets –Increase in supply -> lower exchange rate -> depreciation of American currency -> cheap American goods - > trade surplus –Reverse effects for Decrease in supply

20. FOREX for US Dollars Demand = Foreigners who want American currency to “save” in American markets –Increase in demand -> higher exchange rate -> appreciation of American currency -> expensive American goods - > trade deficit –Reverse effects for Decrease in Demand

21. Quantity of $ (being traded) e (exchange rate) ¥/$ S$ D$ Market for $ High value of American currency ¥/$ (domestic currency always in denominator) Low value of American currency

22. Why would the lines shift? People want to put their money wherever they think they’ll earn the highest interest rate In the US FOREX market, when interest rates in America rise, people want American currency so they can buy American stocks & bonds, so Demand increases OR supply decreases (same effect on interest rate) When interest rates decrease in America, people want to save their money in other countries, so Supply increases OR demand decreases (same effect on interest rate)

23. Example: Interest Rates in China Increase Q$ e1e1 ¥/$ S$ 1 D$ Market for $ S$ 2 e2e2 Supply increases because American want Chinese Yuan (they are “supplying” their $$ to get Yuan) Effect: American currency depreciates, leads to trade surplus for America

24. Balance of Payments Accounts Summary of a country’s transactions with other countries

25. Balance of Payments Accounts Example Payments from Foreigners Payments to Foreigners Net Sales and purchases of goods and services $1,827$2,523-$696 Sales of financial assets (stocks and bonds) 534-4530 Total-166

26. “Current Account” Measures balance of payments for goods and services (GDP)

27. “Financial Account” aka “Capital Account” Measures balance of payments for assets/liabilities (e.g. stocks, bonds, mutual funds)

28. Financial Account measures “capital inflows” Positive financial account = more money coming into the US -money is being used to buy American stocks & bonds -this is “supply of loanable funds” ….so what happens in the loanable funds graph?