Unit 5

International Trade and

Finance

1
 Closed vs. Open Economies
A closed economy focuses only on the
domestic price, and the open economy trades
for the lower world price.

2
 A trade deficit is a sit
uation in which net e
xports are negative.
Open-Economy M • Imports > Exports
acroeconomics: B
asic Concepts A trade surplus is a sit
uation in which net
exports are positive.
• Exports > Imports
 •Balanced trade refer
Open-Econom s to when net export
y Macroecono s are zero—exports a
nd imports are exactl
mics: Basic Co y equal.
ncepts
Balance of Trade vs.
Balance of Payments
 Balance of Trade
Net Exports (XN) = Exports – Imports
Trade Surplus = Exporting more than is imported
Trade Deficit (aka. trade gap) = Exporting less than
is imported
Balance of Trade
 Balance of Payments (BOP)
Balance of trade includes only goods and
services, but balance of payments considers ALL
international transactions.
•The balance of payments is a broader
measure of international trade.
Details:
The BOP summary is within a given year and is
prepared in the domestic country’s currency
Ex. If accounting the BOP of the U.S., it would be in
the Dollar.
The balance of payments is made up of two
accounts. The current account and the capital
account.
Balance of Payment
Factor income: payment for the use of factors of production owned by residents of
other countries. =investment income
Include factor income

Eg. Interest paid on loans from overseas, the profits of foreign-owned corporations.
上海迪斯尼乐园的收益；在美国的日本公司的运营利润；美国人在迪拜的收入
International transfers—funds sent by residents of one country to residents of another. T
he main element here is the remittances that immigrants, such as the millions of Mexica
n-born workers employed in the United States, send to their families in their country of or
igin.
Notice that Table 41.2 shows only the net value of transfers. That’s because the U.S. go
vernment provides only an estimate of the net, not a breakdown between payments to fo
reigners and payments from foreigners.
 Current Account
The Current Account is made up of three parts:
1. Trades in Goods and Services (Net Exports)-
Difference between a nation’s exports of goods
and services and its imports of goods and
services.
Ex: Toys imported from China, U.S. cars exported to
Mexico
2. Investment Income- income from the factors of
productions including payments made to
foreign investors.
Ex: Money earned by Japanese car producers in U.S.
3. Net Transfers- Money flows from the private or
public sectors
Ex: donations, aids and grants, official assistance
 Current Account
The Current Account is made up of three parts:
1. Trades in Goods and Services (Net Exports)-
An export is marked as a credit(money coming in) and
an import is noted as a debit(money going out)

2. Investment Income-
Money going in(credit) or out(debit)

3. Net Transfers- Money flows from the private or

public sectors
Ex: donations, aids and grants, official assistance
Row 4 shows transactions that involve governments or government agencies, m
ainly central banks. most of the U.S. sales in this category involved the accumul
ation of foreign exchange reserves by the central banks of China and oil-exporti
ng countries.
 Capital (Financial) Account
The Capital Account measures the purchase and
sale of financial assets abroad.
Purchases of things that stay in the foreign
country.
Examples:
– U.S. company buys a hotel in Russia
– A Korean company sells a factory in Ohio
– Dividends earned by Chinese citizens in the New
York Stock Exchange (NYSE)
– Australian company owns local Mall
 Current or Capital Account
Identify if the examples are counted in the current or capital account
and determine if it is a credit or debit for the US.
1. Bill, an American, invests $20 million in a ski resort in
Canada
2. A Korean company sells vests to the U.S. military
3. A U.S. company, Boeing, sells twenty 747s to France
4. A Chinese company buys a shopping mall in San Diego
5. An illegal immigrant sends a portion of his earning to
his family
6. An German investor buys $50,000 U.S. Treasury
Bonds
7. Italian tourists spend $5 million in the U.S. while
American tourists spend $8 million in Italy.
 Current or Capital Account
Identify if the examples are counted in the current or capital account
and determine if it is a credit or debit for the US.
1. Capital Account (financial asset), Debit
2. Current Account (trade of goods/services),
Debit
3. Current Account (trade of goods/services),
Credit
4. Capital Account (financial asset), Credit
5. Current Account (net transfer), Debit
6. Capital Account (financial asset), Credit
7. Current Account (service), Debit
 Current account vs. capital account
• Transactions that don’t create liabilities are
considered current account.
• Eg.balance of payments on goods and services +
factor income +net international transfer payments.
• Transactions that involve the sale or purchase of
assets, and do create future liabilities are
considered capital account (financial account)
• Eg.Real estate, stocks, bonds, dividends
• Pay attention!! Dividends and interest paid are not
assets, so counted in current account.
 Practice
1. U.S. income increases relative to other countries. Does
the balance of payments move toward a deficit or a
surplus?
- Imports are cheaper
- Americans import more
- Net exports (Xn) decrease
- The current account balance decreases and moves
toward a deficit.
2. If the U.S. dollar depreciates relative to other
countries does the balance of payments move toward a
deficit or a surplus?
- US exports are desirable
- America exports more
- Net exports (Xn) increase
- The current account balance decreases and moves
toward a surplus.
CA+FA=0
CA+FA=0
 Modeling the Financial Account
• Financial account measures net sales of assets, such as
currencies, securities, and factories to foreigners.

• These assets are exchanged for financial capital, which is

funds from savings that are available for investment
spending.

• So we can think of the financial account as a measure of c

apital inflows in the form of foreign savings that become a
vailable to finance domestic investment spending.
Loanable funds market revisted
international capital flows will equalize the interest rates in t
he two countries.
capital tends to flow from slowly growing to rapidly growing economies.
 重难点！常考！！
• CA+FA=0

• Net capital inflow=current account deficit

• Net capital outflow=current account surplus
 Foreign Exchange
Exchange Rate = Relative Price of Currencies
 Exports and Imports
1. U.S. sells cars to Mexico
2. Mexico buys tractors from Canada
3. Canada sells syrup to the U.S.
4. Japan buys Fireworks from Mexico
For all these transactions, there are different
national currencies.
Each country must be paid in their own currency
The buyer (importer) must exchange their
currency for that of the sellers (exporter).
 Exchange Rates
In the FOREX market we only look at two
countries/currencies at a time.
Ex: US Dollars and British Pounds
We examine the price of one currency in
terms of the other currency. Ex:$2 = £1
The Exchange Rate depends on which
currency you are converting.
The price of one Dollar in terms of Pounds is
1 Dollar = £1/$2 = £.5
The price of one Pound in terms of Dollars is
1 Pound = $2/£1 = $2
 What happens if you need more dollars to
buy one pound (the price for a pound
increases)?
Ex: From $2=£1 to $5=£1
•The U.S. Dollar DEPRECIATES relative
to the Pound.
Depreciation
•The loss of value of a country’s currency
with respect to a foreign currency
•More units of dollars are needed to buy a
single unit of the other currency.
•The dollar is said to be “Weaker”
 What happens if you need fewer dollars to
buy one pound (the price for a pound
decreases)?
Ex: From $2=£1 to $1=£4
•The U.S. Dollar APPRECIATES relative
to the Pound.
Appreciation
•The increase of value of a country’s
currency with respect to a foreign currency
•Fewer units of dollars are needed to buy a
single unit of the other currency.
•The dollar is said to be “Stronger”
Price of U.S.
S&D for the US Dollars
Dollars
Pound£ Supply by
Equilibrium:
Americans
Dollar$ $1 = £1

2£/1$
U.S. Dollar
1£/1$ appreciates
U.S. Dollar
depreciates
1£/4$

Demand
by British

Quantity of US Dollars Q
Inflation and Real exchange rate
Real exchange rates are exchange rates a
djusted for international differences in ag
gregate price levels.
Suppose that the Mexican peso depreciates against the U.S. dollar
, with the exchange rate going from 10 pesos per U.S. dollar to 15
pesos per U.S. dollar, a 50% change.
But suppose that at the same time the price of everything in Mexi
co, measured in pesos, increases by 50%, so that the Mexican pric
e index rises from 100 to 150. We’ll assume that there is no chang
e in U.S. prices, so that the U.S. price index remains at 100. The in
itial real exchange rate is:
 Purchasing power parity
consider again the example of a hotel room. Suppose that this room in
itially costs 1,000 pesos per night, which is $100 at an exchange rate of
10 pesos per dollar. After both Mexican prices and the number of pes
os per dollar rise by 50%, the hotel room costs 1,500 pesos per night
—but 1,500 pesos divided by 15 pesos per dollar is $100, so the Mexic
an hotel room still costs $100. As a result, a U.S. tourist considering a
trip to Mexico will have no reason to change plans.
the current account responds only to changes in the real exchange rat
e, not the nominal exchange rate.
 Purchasing power parity
The purchasing power parity between two countries’ currencies is t
he nominal exchange rate at which a given basket of goods and servi
ces would cost the same amount in each country.

suppose that a basket of goods and services that costs $100 in the Uni
ted States costs 1,000 pesos in Mexico. Then the purchasing power p
arity is 10 pesos per U.S. dollar.
At that exchange rate, 1,000 pesos = $100, so the market basket costs
the same amount in both countries.
 Exchange Rates
Currency Shifters
1. Changes in Tastes-
Ex:British tourists flock to the U.S.
Demand for U.S. dollar increases
Supply of British pounds in the
FOREX market increases
Pound-depreciates
Dollar-appreciates
 Exchange Rates
2. Changes in Relative Incomes
(Resulting in more imports)
Ex: U.S. growth increases income….
U.S. buys more imports…
Demand for pounds increases
Supply of U.S. dollars in FOREX
increases
Pound- appreciates
Dollar- depreciates
 Exchange Rates
3. Changes in Relative Price Level
(Resulting in more imports)
Ex: U.S. prices increase relative to
Britain….
Demand for cheaper imports
increases…
Demand for pound increases
Supply of dollars in FOREX increases
Pound- appreciates
Dollar- depreciates
 Exchange Rates
4. Changes in relative Interest
Rates
Ex: US has a higher interest rate than
Britain.
British people want to invest in US
(Capital Flow increases)
Demand for U.S. dollars increases…
Supply of pounds in FOREX
increases
Pound-depreciates
Dollar- appreciates
 Practice
For each of the following examples, identify what
happens to values of U.S. Dollars and Japanese Yen.
1. American tourists increase visits to Japan.
2. The U.S. government significantly decreases
personal income tax.
3. Inflation in the Japan rises significantly faster
than in the U.S.
4. Japan has a large budget deficit that
increases Japanese interest rates.
5. Japan places high tariffs on all U.S. imports.
6. The U.S. suffers a large recession.
7. The U.S. Federal Reserve sells bonds at high
interest rates.
How do these scenarios affect exports and imports?
 Practice
For each of the following examples, identify what will
happen to the value of US Dollars and Japanese Yen.
1. USD depreciates and Yen appreciates
2. USD depreciates and Yen appreciates
3. USD appreciates and Yen depreciates
4. USD depreciates and Yen appreciates
5. USD depreciates (Demand Falls) and Yen
appreciates (Supply Falls)
6. USD appreciates (Supply Falls) and Yen
depreciates (Demand Falls)
7. USD appreciates and Yen depreciates
Scenarios 1, 2, and 4 will increase U.S. exports because
U.S. products are now relatively “cheaper”