Macroeconomics Chapter 7

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Macroeconomics Chapter 7

• The Foreign Exchange Market the Balance of
  Payments

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Homework 5

• 1. 2,300
• 5. Different products have different values,
  thus, we must convert all products into their
  market value in order to have a common measure of
  goods.

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Homework 5

• 7. GDP C I G X 400 40 100 10
  550
• 8. GNP GDP net factor income from abroad
  550 2 552
• 9. NNP GNP capital consumption allowance
  552 - 20 532
• 10. NI NNP indirect business taxes 532 -
  5 527
• 11. Gross Investment net investment capital
  consumption allowance 20 20 40

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The Foreign Exchange Market

• What is foreign exchange?
• Foreign Money
• Paper money
• Bank deposits
• What is the foreign exchange market?

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The Foreign Exchange Market

• The foreign exchange market is a global market in
  which people trade one currency for another.
• Where is the foreign exchange located
  geographically?
• Most transactions take place
• Electronically
• Telephone

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The Foreign Exchange Market

• How do we participate in the foreign exchange
  market?
• Transactions include
• Buying selling bank deposits
• Tourism (small part of foreign exchange market)
• All exchanges in the foreign exchange market
  require that monies have a price. This price is
  called the exchange rate.

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Exchange Rates

• An exchange rate is the price of one countrys
  money in terms of another countrys money (Table
  1, page 149).
• Column 1 indicates a countrys currency.
• Column 2 indicates how much one unit of foreign
  currency is worth in U.S. dollars.
• Column 3 indicates how much 1 U.S. dollar is
  worth in foreign currency.

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Exchange Rates

• You would use a current exchange rate if you
  wanted to buy foreign currency with US dollars or
  if you wanted to exchange foreign money for US
  dollars (most banks have current exchange rates
  can exchange money).
• The exchange rate allows us to convert the
  foreign currency price into its domestic currency
  equivalent.

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Finding the Domestic Currency Equivalent

• Example
• Lets say we find an item we want to buy on Ebay
  that is being sold for 50 Canadian dollars. The
  exchange rate between the U.S. dollar and the
  Canadian dollar is .75. We want to know what the
  price would be in U.S dollars.
• The value of a good in a domestic currency
• Foreign currency price x exchange rate
• Plug in numbers
• U.S. dollar value 50 x .75 37.50 US dollars

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International Standards Organization (ISO)

• The ISO assigns symbols for each individual
  countrys currency.
• See page 150, Table 2
• This allows us to distinguish between two
  countrys currencies that have the same name.
• Example U.S. and Canada both call their currency
  dollar. The ISO distinguishes the two by the
  symbols CAD USD.

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International Trade

• Why would exchange rates affect international
  trade?
• Because the exchange rate determines the domestic
  currency value of foreign goods, changes in the
  rates affect the supply and demand of goods
  traded internationally.

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Currency Appreciation

• A currency appreciates in value when its value
  rises in relation to another currency.
• Example If the exchange rate changes from .75 to
  .80 U.S. dollars per Canadian dollar, then we
  would say the Canadian dollar has appreciated in
  relation to the U.S. dollar.
• How would this affect trade between the U.S. and
  Canada?

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Currency Appreciation

• As Canadas currency appreciates, U.S. demand for
  its products falls, other things equal.
• This is because now U.S. buyers have to pay a
  higher price for Canadian goods, thus their
  demand goes down.
• Example
• 50 x .75 37.50 (original exchange rate)
• 50 x .80 40.00 (new exchange rate)
• This applies to all countries engaged in
  international trade.

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Currency Depreciation

• A currency depreciates in value when its value
  falls in relation to another currency.
• Example If the exchange rate changes from .75 to
  .70 U.S. dollars per Canadian dollar, then we
  would say the Canadian dollar has depreciated in
  relation to the U.S. dollar.
• How would this affect trade between the U.S.
  Canada?

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Currency Depreciation

• As Canadas currency depreciates, its goods will
  sell for lower prices in the U.S., thus the
  demand for its products increases, other things
  being equal.
• Example
• 50 x .75 37.50 (original exchange rate)
• 50 x .70 35.00 (new exchange rate)

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Balance of Payments

• The balance of payments is a record of a
  countrys trade in goods, services, and financial
  assets with the rest of the world. It is divided
  into categories (accounting).
• Why is it important to understand the balance of
  payments?

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Balance of Payments

• The balance of payments is recorded so that every
  transaction is recorded in at least two accounts.
  This is called double-entry bookkeeping.
• The two accounts are usually referred to as
  debits credits.
• The sum of debits and credits must always equal
  each other as to stay balanced.

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Example-International Accounting
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Balance of Payments

• The balance of payments uses several different
  accounts to categorize transactions.
• Accounts include
• Merchandise
• Services
• Income
• Unilateral transfers

The sum of these accounts is called the current
account.
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1. Merchandise Account

• The merchandise account records all transactions
  involving goods.
• Exports by the US are merchandise credits
• Imports of foreign goods are merchandise debits

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Merchandise Account-Continued

• When exports (credits) exceed imports (debits)
  the merchandise account reflects a surplus.
• When imports (debits) exceed exports (credits)
  the merchandise account reflects a deficit.
• The balance on the merchandise account is often
  referred to as the balance of trade.

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2. Services

• The services account measures trade involving
  services.
• This can include
• Travel
• Tourism
• Royalties
• Transportation costs

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3. Income

• The income account includes both employee
  compensation and investment income.

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4. Unilateral Transfers

• Unilateral transfers occur when one party gives
  something but gets nothing in return.
• Example If a farm worker in California sends
  money to his family in Mexico, this would be
  considered a unilateral transfer from the U.S. to
  Mexico.

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Current Account

• The current account (sum of merchandise,
  services, income, unilateral accounts) is a
  practical measure of international transactions
  because it contains all of the activities
  involving goods and services.

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Financial Account

• The financial account is where trade involving
  financial assets and international investment are
  recorded. It tracks the flow of financial assets
  into and out of a country.

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Balance of Payments-Table 4, pg 153
The statistical discrepancy is also called the
errors omissions. This account reflects all
the transactions that are not accurately measured
by the government.
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Balance of Payments

• The balance of payments accounts must always have
  a net balance of zero (the sum of credits must
  the sum of debits).
• When we talk about a deficit or surplus, we are
  referring to only ONE of the balance of payment
  accounts. The balance of payments itself is
  always in balance.

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Balance of Payments

• Since the balance of payments must always be in
  balance, if the current account is running a
  deficit, then the financial account must be
  running a surplus (and vice versa).
• What does it mean if we are running a deficit in
  our current account?

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Current Account Deficit

• A current account deficit indicates that our
  nation is a net borrower from the rest of the
  world.
• In other words, we must borrow from abroad in
  order to finance that deficit. We sell bonds and
  other debts to other countries in order to gain
  our financial account surplus.

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U.S. Current Account Balance

• We see that the U.S. is a net debtor.
• A net debtor owes more to the rest of the world
  than it is owed, while a net creditor is owed
  more than it owes.

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Homework 6

• Page 158, 4, 5, 6, 11