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

2. 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

3. 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

4. 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

5. 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

6. 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)

7. Practice Test