1 International Economic Activity

2 Basic look at interaction with the rest of the world. When we talk about interactions with the rest of the world in economics we typically use the phrases open economy and international trade. US of A R est O f W orld Give up Get With all trade

3 Perhaps the most well know interaction with other nations is the flow of goods and services – often called the trade flow. Exports are goods and services made in the country and sold to folks from other countries. Imports are goods and services made elsewhere and sold to folks in the country. The % of US goods and services being exported has grown over time and is about 11% of all goods and services made (What we call the gross domestic product) in the US. Imports have also grown as a % of total product over time. In fact, imports have tended to be larger than exports for the last several decades.

4 Exports minus imports will result in a number we might in general call the trade pattern. If exports - imports > 0 we have a trade surplus, and if exports – imports < 0 we have a trade deficit, and if exports – imports = 0 we have a miracle! (or zero trade balance). Again, overall the US has had a deficit for many years. Our main trade partners in the US are Canada, Mexico and the European Union.

5 Currencies You probably know this, but not ever country uses the same currency, or money. In the US we use the dollar, in Japan they have then yen, and in Mexico they have the peso. There are other currencies, as well. Inside each country one currency is mainly used. In the US, when you go to the store you use dollars. In Japan, when they go to the store they use yen. What happens when we want to trade with them? Well, there is a market where dollars and yen can be traded. This market is called the foreign exchange market.

6 Exchange rates Just as one dollar will not always buy the same amount of gas at a gas station, one dollar will not always buy the same amount of another country’s currency. At any point in time, though, we talk about the exchange rate. The exchange rate can be stated 1 of two ways: 1) The number of dollars (which could include fractions) you need for 1 unit of the foreign currency, or 2) The number of units of the foreign currency needed for 1dollar. Using the gas analogy again, we might say gas prices change because of some change in supply or demand. We also see exchange rates change and we have a supply and demand theory in this case as well.

7 Changes in exchange rates The US dollar appreciates in value when the dollar exchanges for more units of foreign currency than it used to. For example, if last year you needed a penny to buy 1 Japanese yen and today you needed one-half a penny, you would appreciate the increased power of the dollar and the dollar would be said to have appreciated. 1 dollar would have exchanged for 100 yen but now change for 200 yen. Note when the dollar appreciates against the yen, the yen is said to depreciate against the dollar. Similarly, the dollar depreciates against the yen when the dollar buys fewer yen than it used to in the past. Next let’s see why the dollar value might change over time.

8 Supply and demand for yen Dollars per yen Quantity of yen D S Note the demand for yen is downward sloping and supply of yen is upward sloping from left to right similar to what we saw before in a market. Here the price in the market is dollars per yen (similar to the market for gas where we would talk of the dollar price per gallon).

9 Yen market -demand Every now and yen people in the US get a hankerin for a Japanese product. The people in the US have a demand for importing Japanese goods and therefore they have a demand for yen because US folks need the yen to pay the Japanese sellers. Note the demand for yen is downward sloping meaning at a lower price a greater quantity is demanded. The demand for yen would shift right if people in US have increased income (and therefore want more imports, as well as domestic goods) or if their taste and preference for Japanese goods would grow. The demand for yen would shift left if the opposite would happen.

10 Demand for Yen Grows Dollars per yen Quantity of yen D1 S1 As the demand for yen grows (Because we want more Japanese stuff), the exchange rate rises and the quantity traded rises. E1 D2 E2 Q1 Q2 The result here is to have the exchange rate rise. Thus is takes more dollars to buy one yen. This means the dollar depreciates and the Yen has appreciated in value.

11 Yen market - Supply Japanese folks want US goods and services and with this they supply yen in the currency market. Note the supply of yen is upward sloping from left to right indicating at higher dollar prices for yen they would supply a greater quantity of yen. The supply would shift to the right if the Japanese earn more income or if their taste and preference for US goods and services grow. The supply would shift left if the opposite things happen.

12 Changes in the exchange rate If the demand for yen should grow (a reason is listed on a previous slide, right?), or if the supply of yen should fall the dollar price of yen will rise. This means the dollar depreciates or the yen appreciates. In other words, if our desire for their goods rises or their desire for our goods falls, then their currency appreciates while our depreciates. The reverse happens if we do not like their goods as much as in the past or if they have a greater desire for ours.