Foreign Exchange & Balance of Payments Review Day #3: Friday May 6th Unit- #5 Macro Review Foreign Exchange & Balance of Payments

Determinants of Exchange Rates Market for Foreign Exchange 1. Changes in Consumer Tastes 2. Relative Income Changes 3. Relative Inflation 4. Relative Real Interest Rates 5. Speculation & Investment Where people go to “swap” currencies U.S. Income Rises Demand Imports Demand Foreign Currency Dollar Depreciates Foreign Currency Appreciates

If U.S. Price Level Falls => Market for Foreign Exchange Graphing Exchange Rates U.S. goods look “cheap” => Europeans ↑U.S. exports => Demand for dollars ↑ => Dollar appreciates If U.S. Price Level Falls => Dollars Euros Euro Price of a dollar Qty of Dollars D1 S1 -------------- .75 Euro Q1 Dollar Price of a Euro Qty of Euros D1 S1 -------------- 1.3 $ Q1 D2 S2

a Financial Account Surplus with China Balance of Payments Current Account Considered the U.S. Trade Balance (Exports – Imports) (NX) + Investment Income (bond interest, stock dividends) Financial Account Foreign purchase of US assets – U.S. purchase of foreign assets Assets = Stocks, bonds, factories, land, etc… Example: Financial Act. Surplus = Money flows into US If one account is positive the other Must be negative. They generally sum to ZERO! Example: USA has a Current account deficit & a Financial Account Surplus with China

China & Balance of Payments China buys U.S. Bonds Financial Account Surplus Imports > Exports Current Account Deficit Official Reserves Fed holds quantities of foreign currency called reserves Used to offset discrepancy in current account vs. financial account If both accounts do Not sum to zero, reserves are used to Offset minor difference

Tariffs & Quotas Revenue Tariff - designed to raise revenue Protective Tariff – designed to protect domestic market Quotas- limit # of goods imported Price S World Price: when above domestic price we export P ------------- World Price: when below domestic price we import ------------ D US Market (Wheat)

Practice Test