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Credit Sprint's Guide to Macroeconomics Unit 6: Open Economy: International Trade & Finance

AP® weight 10–13%CLEP® weight 5–10%

The balance of payments tracks a country's transactions with the world. Exchange rates are set by supply and demand for currencies, and they change with interest rates, prices, incomes and tastes. Exchange rates feed back into net exports and AD.

What you need to know

  • The current account records trade in goods and services, investment income and transfers.
  • The financial account records purchases of assets like stocks, bonds, factories and real estate.
  • A current account deficit is matched by a financial account surplus.
  • Foreigners buying U.S. goods or assets demand dollars; Americans buying foreign goods or assets supply dollars.
  • Higher U.S. real interest rates attract capital, raise demand for dollars and appreciate the dollar.
  • A stronger dollar makes U.S. exports pricier abroad, so net exports fall.
  • When one currency appreciates, the other depreciates.

Formulas

Current account + Financial account (+ Capital account) = 0
Value of currency B in A = 1 ÷ (value of A in B)

Exam traps

Watch forWhen one currency appreciates, the other one depreciates. Always name which.
Watch forBuying a foreign stock goes in the financial account; the dividends it pays go in the current account.

Key terms

  • Balance of payments: The record of all transactions between a country and the rest of the world.
  • Current account: Records trade in goods and services, net investment income and net transfers.
  • Financial account: Records cross-border purchases of assets like stocks, bonds and real estate.
  • Exchange rate: The price of one currency in terms of another.
  • Appreciation: A currency buys more of another currency than before. Makes exports pricier abroad.
  • Depreciation: A currency buys less of another currency than before. Makes exports cheaper abroad.
  • Demand for dollars: Comes from foreigners buying U.S. goods, services and assets.
  • Supply of dollars: Comes from Americans buying foreign goods, services and assets.
  • Capital inflow: Foreign money buying domestic assets. Raises demand for the domestic currency.
  • Net exports: Exports − imports. Negative means a trade deficit.

Practice questions

Five of the 45 Unit 6 questions in Credit Sprint. Every choice is explained in the app.

1. U.S. interest rates rise relative to those in Europe. In the foreign exchange market:
  1. The supply of dollars rises and the dollar depreciates
  2. The supply of euros falls
  3. Demand for dollars rises and the dollar appreciates
  4. Demand for dollars falls and the dollar depreciates
  5. Nothing changes
Show answer

Demand for dollars rises and the dollar appreciates. Investors need dollars to buy U.S. assets.

2. Interest that U.S. residents earn on foreign bonds is recorded in the:
  1. Financial account
  2. It isn't recorded
  3. The trade balance
  4. Current account
  5. Capital account only
Show answer

Current account. Investment income is part of the current account.

3. Interest rates abroad rise relative to U.S. rates. All else equal:
  1. Financial capital flows out of the U.S. and the dollar depreciates
  2. Capital flows into the U.S. and the dollar appreciates
  3. Demand for dollars rises
  4. U.S. exports fall
  5. Nothing changes
Show answer

Financial capital flows out of the U.S. and the dollar depreciates. Investors sell dollars to buy foreign assets.

4. International students pay tuition to U.S. universities. In the U.S. balance of payments, this is:
  1. A financial account inflow
  2. A capital account transfer
  3. An import
  4. Not recorded
  5. An export of services in the current account
Show answer

An export of services in the current account. Foreigners are buying a U.S. service.

5. How is the current account different from the balance of trade?
  1. The current account also includes investment income and transfers
  2. They are identical
  3. The current account excludes services
  4. The balance of trade includes asset purchases
  5. The current account excludes goods
Show answer

The current account also includes investment income and transfers. The trade balance covers only goods and services.