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NewPage Paper versus China. Learning Objectives. Under existing international trade agreements, governments are not allowed to subsidize firms that export to other countries…. Learning Objective 17.1. The Balance of Payments: Linking the United States to the International Economy.

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NewPage Paper versus China

Learning Objectives

Under existing international trade agreements, governments are not allowed to subsidize firms that export to other countries…


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Learning Objective 17.1

The Balance of Payments: Linking theUnited States to the International Economy

Open economy An economy that has interactions in trade or finance with other countries.

Closed economy An economy that has no interactions in trade or finance with other countries.

Balance of payments The record of a country’s trade with other countries in goods, services, and assets.


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Learning Objective 17.1

The Balance of Payments: Linking theUnited States to the International Economy

The Current Account

Current account The part of the balance of payments that records a country’s net exports, net investment income, and net transfers.

The Balance of Trade

Balance of trade The difference between the value of the goods a country exports and the value of the goods a country imports.


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Learning Objective 17.1

The Balance of Payments: Linking theUnited States to the International Economy

The Current Account

FIGURE 17.1

Trade Flows for the United States and Japan, 2006


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Learning Objective 17.1

The Balance of Payments: Linking theUnited States to the International Economy

The Current Account

Net Exports Equals the Sum of the Balance of Trade and the Balance of Services

Table 17-1

The Balance of Payments of the United States, 2006 (billions of dollars)


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Learning Objective 17.1

The Balance of Payments: Linking theUnited States to the International Economy

The Current Account

Net Exports Equals the Sum of the Balance of Trade and the Balance of Services

Table 17-1

The Balance of Payments of the United States, 2006 (billions of dollars) (continued)


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Learning Objective 17.1

The Balance of Payments: Linking theUnited States to the International Economy

The Financial Account

Financial account The part of the balance of payments that records purchases of assets a country has made abroad and foreign purchases of assets in the country.

Net foreign investment The difference between capital outflows from a country and capital inflows, also equal to net foreign direct investment plus net foreign portfolio investment.


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Learning Objective 17.1

The Balance of Payments: Linking theUnited States to the International Economy

The Capital Account

Capital account The part of the balance of payments that records relatively minor transactions, such as migrants’ transfers, and sales and purchases of nonproduced, nonfinancial assets.


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Learning Objective 17.1

The Balance of Payments: Linking theUnited States to the International Economy

Why Is the Balance of Payments Always Zero?

The sum of the current account balance, the financial account balance, and the capital account balance equals the balance of payments.

To make the balance on the current account equal the balance on the financial account, the balance of payments includes an entry called the statistical discrepancy.

Don’t Let This Happen to YOU!Don’t Confuse the Balance of Trade, the Current Account Balance, and the Balance of Payments


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Learning Objective 17.1

17-1

Solved Problem

Understanding the Arithmetic of Open Economies

Test your understanding of the relationship between the current account and the financial account by evaluating the following assertion by a political commentator:

“The industrial countries are committing economic suicide. Every year, they invest more and more in developing countries. Every year, more U.S., Japanese, and European manufacturing firms move their factories to developing countries. With extensive new factories and low wages, developing countries now export far more to the industrial countries than they import.”


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Learning Objective 17.2

The Foreign Exchange Market and Exchange Rates

Nominal exchangerateThe value of one country’s currency in terms of another country’s currency.


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Learning Objective 17.2

MakingtheConnection

  • Exchange Rates in the Financial Pages

The financial pages of most newspapers provide information on exchange rates.


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Learning Objective 17.2

The Foreign Exchange Market and Exchange Rates

There are three sources of foreign currency demand for the U.S. dollar:

1 Foreign firms and households who want to buy goods and services produced in the United States.

2 Foreign firms and households who want to invest in the United States either through foreign direct investment—buying or building factories or other facilities in the United States—or through foreign portfolio investment—buying stocks and bonds issued in the United States.

3 Currency traders who believe that the value of the dollar in the future will be greater than its value today.


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Learning Objective 17.2

The Foreign Exchange Market and Exchange Rates

Equilibrium in the Market for Foreign Exchange

FIGURE 17.2

Equilibrium in the Foreign Exchange Market


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Learning Objective 17.2

The Foreign Exchange Market and Exchange Rates

Equilibrium in the Market for Foreign Exchange

Currency appreciation An increase in the market value of one currency relative to another currency.

Currency depreciation A decrease in the market value of one currency relative to another currency.

Don’t Let This Happen to YOU!Remember That Modern Currencies Are Fiat Money


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Learning Objective 17.2

The Foreign Exchange Market and Exchange Rates

How Do Shifts in Demand and Supply Affect the Exchange Rate?

Three main factors cause the demand and supply curves in the foreign exchange market to shift:

1 Changes in the demand for U.S.-produced goods and services and changes in the demand for foreign-produced goods and services

2 Changes in the desire to invest in the United States and changes in the desire to invest in foreign countries

3 Changes in the expectations of currency traders about the likely future value of the dollar and the likely future value of foreign currencies


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Learning Objective 17.2

The Foreign Exchange Market and Exchange Rates

How Do Shifts in Demand and Supply Affect the Exchange Rate?

Shifts in the Demand for Foreign Exchange

Speculators Currency traders who buy and sell foreign exchange in an attempt to profit from changes in exchange rates.

Shifts in the Supply of Foreign Exchange

The factors that affect the supply curve for dollars are similar to those that affect the demand curve for dollars.


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Learning Objective 17.2

The Foreign Exchange Market and Exchange Rates

How Do Shifts in Demand and Supply Affect the Exchange Rate?

Adjustment to a New Equilibrium

FIGURE 17.3

Shifts in the Demand and Supply Curve Resulting in a Higher Exchange Rate


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Learning Objective 17.2

The Foreign Exchange Market and Exchange Rates

Some Exchange Rates Are Not Determined by the Market

Some currencies have fixed exchange rates that do not change over long periods.

How Movements in the Exchange Rate Affect Exports and Imports

If the economy is currently below potential GDP, then, holding all other factors constant, a depreciation in the domestic currency should increase net exports, aggregate demand, and real GDP.

An appreciation in the domestic currency should have the opposite effect: Exports should fall, and imports should rise, which will reduce net exports, aggregate demand, and real GDP.


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Learning Objective 17.2

17-2

Solved Problem

The Effect of Changing Exchange Rates on the Prices of Imports and Exports

In March 2001, the average price of goods imported into the United States from Canada fell 3.3 percent. This decline was the largest since the federal government began gathering such statistics in 1992. Is it likely that the value of the U.S. dollar appreciated or depreciated versus the Canadian dollar during this period? Is it likely that the average price in Canadian dollars of goods exported from the United States to Canada during March 2001 rose or fell?


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Learning Objective 17.2

The Foreign Exchange Market and Exchange Rates

The Real Exchange Rate

Real exchange rate The price of domestic goods in terms of foreign goods.


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Learning Objective 17.3

The International Sector and NationalSaving and Investment

FIGURE 17.4

U.S. Imports and Exports, 1970–2006


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Learning Objective 17.3

The International Sector and NationalSaving and Investment

Net Exports Equal Net Foreign Investment

Current Account Balance + Financial Account Balance = 0

or:

Current Account Balance = -Financial Account Balance

or:

Net Exports = Net Foreign Investment


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Learning Objective 17.3

The International Sector and NationalSaving and Investment

Domestic Saving, Domestic Investment, and Net Foreign Investment

National Saving = Private Saving + Public SavingS = Sprivate + Spublic

Private Saving = National Income – Consumption - Taxes

Sprivate = Y – C – T

Government Saving = Taxes – Government Spending

Spublic = T – G


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Learning Objective 17.3

The International Sector and NationalSaving and Investment

Domestic Saving, Domestic Investment, and Net Foreign Investment

Remember the basic macroeconomic equation for GDP or national income:

Y = C + I + G + NX

Saving and investment equation An equation that shows that national saving is equal to domestic investment plus net foreign investment.

National Saving = Domestic Investment + Net Foreign Investment

S = I + NFI


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Learning Objective 17.3

17-3

Solved Problem

Arriving at the Saving and Investment Equation

S = Sprivate + Spublic = (Y − C − T) + (T − G) = Y − C − G

S = (C + I + G + NX) − C − G

S = I + NX

S = I + NFI


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Learning Objective 17.4

The Effect of a Government Budget Deficit on Investment

FIGURE 17.5

The Twin Deficits, 1978–2006


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Learning Objective 17.4

MakingtheConnection

  • Why Is the United States Called the “World’s Largest Debtor”?

Large current account deficits have resulted in foreign investors purchasing large amounts of U.S. assets.


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Learning Objective 17.5

Monetary Policy and Fiscal Policyin an Open Economy

Monetary Policy in an Open Economy

When the Federal Reserve engages in an expansionary monetary policy, it buys Treasury securities to lower interest rates and stimulate aggregate demand.

Fiscal Policy in an Open Economy

To engage in an expansionary fiscal policy, the federal government increases its purchases or cuts taxes. Increases in government purchases directly increase aggregate demand.


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Can the U.S. Current Account Deficit Be Sustained?

LOOK

An Inside

Sustaining the Unsustainable

U.S. trade-weighted exchange index: Major currencies.


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K e y T e r m s

Net foreign investment

Nominal exchange rate

Open economy

Real exchange rate

Saving and investment equation

Speculators

Balance of payments

Balance of trade

Capital account

Closed economy

Currency appreciation

Currency depreciation

Current account

Financial account


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