Transcript Unit 2

Unit 14. International Trade and
the Balance of Payments
IES Lluís de Requesens (Molins de Rei)
Batxillerat Social
Economics (CLIL) – Innovació en Llengües Estrangeres
Jordi Franch Parella
International Trade and the
Balance of Payments
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A closed economy is one that does not
interact with other nations (no exports,
no imports, no capital flows)
An open economy interacts freely with
other nations (both in product and
financial markets)
Trade Balance = Export – Imports
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Exports > Imports --> trade surplus
Exports < Imports --> trade deficit
International Trade and the
Balance of Payments
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Factors that affect net exports:
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Prices of goods at home and abroad
Exchange rates
Tastes for domestic and foreign goods
Incomes at home and abroad
Capital outflow is the purchase of foreign
assets by domestic residents
Capital inflow is the purchase of national
assets by foreign residents (a mexican
that buys Telefonica shares)
International Trade and the
Balance of Payments
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Factors that influence net capital outflow:
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The real interest rates (foreign and
domestic, abroad and at home)
The risk of holding assets abroad
Net exports = Net capital outflows
Y = C + I + G + NX
Y – C – G = I + NX
Saving = Investment + Net Capital Outflow
International Trade and the
Balance of Payments
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The exchange rate is the price of a
currency in terms of another currency
Appreciation is the increase in the value
of a currency
Depreciation is the decrease in the value
of a currency
The real exchange rate is the rate at
which a person can trade the goods and
services of one country in terms of
another country
International Trade and the
Balance of Payments
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Real exchange rate = Nominal exchange
rate x domestic price / foreign price
A depreciation in euro real exchange
rate means that european goods have
become cheaper relative to foreign
goods
As a result european imports fall and
exports rise
International Trade and the
Balance of Payments
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According to the Purchasing-Power
Parity Theory, a good must sell for the
same price in all nations
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If 1 € = 1,3 $, and 1 Burger King costs you
2 € in Spain and 2,5 $ in New York, the € is
overvalued and the $ undervalued
You buy $ and sell € --> the $ appreciates
and the € deppreciates until 1 € = 1,25 $
Arbitrage is taking advantage of
differences in prices in different markets
International Trade and the
Balance of Payments
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If arbitrage occurs, prices that differ in
two different markets would converge
According to Purchasing-Power Parity,
exchange rates have to ensure that the
currencies have the same purchasing
power in all countries
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Nominal exchange rates must change with
prices. If 1 € = 1 $ and prices double in
Europe, then 1 € = 0,5 $
Limitations of PPP: many goods are not
easily traded and are not perfect substitutes
International Trade and the
Balance of Payments
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Net exports = Capital outflow (Net
imports = Capital inflow)
Domestic Saving = Investment (at home)
+ Purchase of assets (abroad)
The nominal exchange rate is the
relative price of the currency of two
countries
The real exchange rate is the relative
price of the goods of two countries
International Trade and the
Balance of Payments
International Trade and the
Balance of Payments
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According to Power-Purchasing Parity, a
unit of currency should buy the same
quantity of goods in all countries
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The nominal exchange rate between the
currencies of two countries should reflect
the countries' price levels in those countries
At the equilibrium of the (real) interest
rate, the amount that people save
exactly balances the domestic
investment plus the net foreign
investment
International Trade and the
Balance of Payments
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In an open economy, government budget
deficits:
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Reduce the total saving and the supply of
loanable funds
Crowd oud private sector
Drive up the interest rate
Cause net foreign investment to fall