AP Macroeconomics Section 8
Terms in this set (25)
Balance of Payments Accounts
A summary of the country's transactions with other countries
Connection: A simplified version of the U.S. balance of payment accounts can be represented in a table with sources of cash for the U.S. as a whole (as well as payments out). This would include sales and purchases of goods and services, factor income, transfers, official asset sales and purchases, and private sales and purchases of assets.
Balance of Payments on the Current Account
Current Account; A country's balance of payments on goods and services plus net international transfer payments and factor income (don't create liabilities)
Connection: As depicted in the table format, the current account value is the sum of sales and purchases of goods and services, factor income, and transfers. -$534 + $224 + -$130 = -$440
Balance of Payments on Goods and Services
The difference between the value of a country's exports and imports in a given period
Connection: The balance of payments on goods and services is one of the key components of the current account. In the table, it is given a value of -$534, as there are $2211 payments from foreigners and $2745 payments to foreigners.
Merchandise Trade Balance
Trade Balance; The difference between a country's exports and imports of goods
Connection: Economists often focus on the merchandise trade balance, even though it is an incomplete measure, because data on international trade in services aren't as accurate as data on trade in physical goods, and they are also slower to arrive.
Balance of Payments on the Financial Account
Financial Account; The difference between a country's sales of assets to foreigners and its purchases of assets from foreigners during a given period (create liabilities)
Connection: Until a few years ago, this account was referred to as the capital account. The financial account value is the sum of official asset sales and purchases and private sales and purchases of assets. $475 + -$28 = $447.
Foreign Exchange Market
Where currencies are traded
Connection: In general, goods, services, and assets produced in a country must be paid for in that country's currency. Thus, the foreign exchange market is needed to convert currencies. It is a global electronic market that traders around the world use to buy and sell currencies.
The prices at which currencies are traded
Connection: One example of an exchange rate is that 1 U.S. dollar can be exchanged for 103.97 Yen and 0.7269 Euros, as of April 3, 2014 at 12:50 AM. Exchange rates change constantly.
When a currency becomes more valuable in terms of other currencies
Connection: If the value of 1 Euro went from 1 U.S. dollar to 1.25 U.S. dollar, we say that the Euro appreciated.
When a currency becomes less valuable in terms of other currencies
Connection: If the value of 1 Euro went from 1 U.S. dollar to 1.25 U.S. dollar, we say that the U.S. dollar depreciated.
Equilibrium Exchange Rate
The exchange rate at which the quantity of a currency demanded in the foreign exchange market is equal to the quantity supplied
Connection: The equilibrium exchange rate is found by observing the intersection between the supply for a currency and the demand for a currency in the Foreign Exchange Market. The exchange rate is on the y-axis and the quantity of the currency is on the x-axis.
Real Exchange Rates
Exchange rates adjusted for international differences in aggregate price levels
Connection: The formula to find the real exchange rate is (Amount of Currency per U.S. Dollar) x (Price Level of U.S. / Price Level of Other Country). The exchange rate that is not adjusted for aggregate price levels is often referred to as the nominal exchange rate.
Purchasing Power Parity
The nominal exchange rate at which a given basket of goods and services would cost the same amount in each country
Connection: If a basket of goods and services that costs $100 in the U.S. costs 1000 Pesos in Mexico, the purchasing power parity is 10 Pesos per U.S. dollar: at that exchange rate, 1000 Pesos=$100, so the market basket costs the same amount in both countries. Nominal exchange rates almost always differ from purchasing power parities, but in the long run purchasing power parities are good at predicting actual changes in nominal exchange rates.
Exchange Rate Regime
A rule governing policy toward the exchange rate
Connection: There are two kinds of exchange rate regimes: fixed exchange rate and floating exchange rate. With so much power to influence prices, governments adopt a variety of exchange rate regimes to fit different scenarios.
Fixed Exchange Rate
When the government keeps the exchange rate against some other currency at or near a particular target
Connection: For example, Hong Kong has an official policy of setting the exchange rate of HK$7.80 per US$1. Countries fix their exchange rates in a variety of ways, but fixing exchange rates is not always the best idea.
Floating Exchange Rate
When the government lets the exchange rate go wherever the market takes it
Connection: Britain, Canada, and the Unites States all have floating exchange rates, allowing the exchange rates to rise and fall according to other market behavior.
Exchange Market Intervention
Government purchases or sales of currency in the foreign exchange market
Connection: One way a government can support their currency is to "soak up" the excess of currency by buying its own currency. Similarly, they can also sell their currency to other foreign nations for other currencies (to fix a shortage).
Foreign Exchange Reserves
Stocks of foreign currency that governments maintain to buy their own currency on the foreign exchange market
Connection: Most countries maintain these foreign exchange reserves (usually as U.S. dollars or euros) so they can buy their own currency to support its price.
Foreign Exchange Controls
Licensing systems that limit the right of individuals to buy foreign currency
Connection: Other things equal, foreign exchange controls increase the value of a country's currency. Foreign exchange controls limit the supply of currency to foreign markets by requiring domestic residents who want to buy foreign currency to get a license (and only giving licenses for approved transactions).
A reduction in the value of a currency that is set under a fixed exchange rate regime
Connection: Devaluation is essentially a depreciation (a downward move in currency) that is due to a revision in a fixed exchange rate target. This makes domestic goods cheaper in terms of foreign currency, which leads to higher exports. Still, it makes foreign goods more expensive in terms of domestic currency, which reduces imports. *Increases aggregate demand
An increase in the value of a currency that is set under a fixed exchange rate regime
Connection: A revaluation makes domestic goods more expensive in terms of foreign currency, which leads to reduced exports. And, it makes foreign goods less expensive in terms of domestic currency, which increases imports. *Reduces aggregate demand
The practice of limiting trade to protect domestic industries
Connection: Tariffs and import quotas are the primary tools of protectionism. The motivation for protectionism comes from the idea that some industries may not initially be competitive at the international level, but they could attain a comparative advantage after a period of protection from lower-priced imports.
Taxes on imports
Connection: Tariffs make prices higher for domestic consumers and can spark trade wars. In American history, tariffs provided a majority of revenue for the U.S. government, but this gradually decreased as income and payroll taxes were adopted.
A limit on the quantity of a good that can be imported within a given period
Connection: By restricting the supply of imports, import quotas reduce equilibrium quantity and increase the equilibrium price. These quotas help domestic firms compete with foreign suppliers, but they can also cause prices to be higher for domestic consumers.
Raise Interest Rates
Restrict Individuals from Buying Foreign Currency
Lower Interest Rates
Restrict Foreigners from Buying Currency