International Trade

Exports v. Imports

• Exports – goods sold to other countries• Imports - goods bought from other countries

Trade Deficit

• Occurs when the United States buys more goods from overseas than it sells

• Imports > Exports

Trade Surplus

• Occurs when the United States sells more goods to other countries than it buys

• Exports > Imports

Balance of Trade

• Balance of Trade measures a country’s exports minus its imports

• Positive trade imbalance = trade surplus• Negative trade imbalance = trade deficit

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)

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

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

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

Increasing Exchange Rate

• When the exchange rate increases, your currency becomes more valuable & appreciates

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 EuropeSO, appreciation -> trade deficit

Decreasing Exchange Rate

• When the exchange rate decreases, your currency becomes less valuable & depreciates

• The other currency appreciates

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 EuropeSO, depreciation -> trade surplus

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

FOREX Graph“FOReign EXchange” Graph

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

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

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

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

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

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

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)

Example: Interest Rates in China Increase

Q$

e1

¥/$

S$1

D$

Market for $

S$2

e2

• Supply increases because American want Chinese Yuan (they are “supplying” their $$ to get Yuan)

• Effect: American currency depreciates, leads to trade surplus for America

Balance of Payments Accounts

• Summary of a country’s transactions with other countries

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 -4 530

Total -166

“Current Account”

• Measures balance of payments for goods and services (GDP)

“Financial Account” aka “Capital Account”• Measures balance of payments for

assets/liabilities (e.g. stocks, bonds, mutual funds)

• 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?