The International Flows of Goods and Capital International trade in goods and capital increase consumption possibilities beyond production possibilities

Factors Influencing the International Flow of Goods Domestic Income and Foreign Income; Relative Price Level--The Ratio of the Domestic Price Level to the Foreign Price Level; The Exchange Rate; and Other Non-Economic Factors such as Tastes, Preferences, etc.

Exchange Rates Nominal Exchange Rate (r): Price of a foreign currency in the units of home currency: $0.50 = DM1 or DM2 = $1.00 $/DM = 0.50 or DM/$ = 2 Nominal Exchange Rates: Spot Exchange Rate (rs) Forward Exchange Rate (rf)

Functions of the Foreign Exchange Market Clearing the act of helping international traders to end up with the kind of currency they prefer; Hedging the act of reducing or eliminating a net asset or a net liability position in a foreign currency; and Speculating the act of taking a net asset position (long) or a net liability (short) position in a foreign currency

If Trade is Balanced: Goods, services and assets move internationally from exporters to importers; Payments move domestically from importers to exporters; and Foreign exchange market’s holdings of each currency are unchanged.

If Trade is not Balanced: Goods, services and assets move internationally from exporters to importers; Payments move domestically from importers to exporters; and Foreign exchange market’s holdings of each currency change, i.e., currency of the surplus country becomes scarce; currency of the deficit country becomes abundant.

If Trade Imbalance Persists: Currency of the deficit country depreciates this results in improvement in the competitive position of the deficit country’s goods in world markets (i.e., exports will increase and imports will decrease); and Currency of the surplus country appreciates this results in deterioration in the competitive position of the surplus country’s goods in world markets (i.e., exports will decrease and imports will increase).

Exchange Rate Management Systems (Regimes) Flexible (Floating) Exchange Rate System Markets determine and manage exchange rates Fixed Exchange Rate System Governments manage exchange rates Managed Float Exchange Rate System Combination of Flexible and Fixed Systems Exchange Controls Governments monopolize currency markets

The Flexible (Floating) Exchange Rate Regime Under a flexible (floating) exchange rate regime, demand and supply determine the exchange rate without intervention by governments or central banks. The major countries have been on something close to this system since 1973.

Sources of Demand for the U.S.$: American exports of goods and services; American capital inflows; U.S.$ being used as a medium of exchange by other countries; U.S.$ being used as an official reserve by other countries; and Foreign speculators dealing in U.S.$

Sources of Supply of U.S.$: American imports of goods and services; American capital outflows; American speculators dealing in foreign currencies; and The Federal Reserve System