AP Macroeconomics Unit 7: Balance of Payments

The Balance of Payments

o   A nation’s balance of payments is the measure of money inflows and outflows between the U.S. and the rest of the world.

inflows: credits outflows:debits

• BOP is divided into 3 separate accounts: Current, Capital, Official Resserves

o   Three Components

 The Current Account

·         The current account summarizes U.S. trade in currently produced goods and services

·         US Exports have a plus (+) sign – they creditand create revenue

·         US Imports have a minus (-) sign – they aredebit and reduce the stock of foreign currencies in the United States

·         Balance on Goods

o   A country’s balance of trade on goods is the difference between its exports and its imports of goods

·         Balance on Services

o   Services include insurance, consulting, travel, and brokerage services

·         Balance on Goods & Services

o   The difference between U.S. exports of goods and services and U.S. imports of goods and services

§  Trade deficit – imports > exports

§  Trade surplus – exports > imports

·         Balance on Current Account

o   Represents the net investment income, represents the difference between

§  1. The interest and dividend payments foreigners paid the United States for the use of exported U.S. capital

§  2. The interest and dividends the United States paid for the use of foreign capital invested in the United States

o   Includes Net transfers and Net investment Income

§  Net Transfers include foreign aid, pensions paid to U.S. citizens living abroad, and remittances by immigrants to relatives abroad

·         “The exporting of goodwill and the importing of ‘thank-you notes’.”

o   By adding all transactions in the current account, obtain the balance on current account

§  The Capital Account

·         The capital account summarizes the purchase or sale of real or financial assets and the corresponding flows of monetary payments that accompany them.

o   Items (an office building or bonds) bought from the U.S. count as exports (+) as they represent in--payments of foreign currencies

§  Key Point – foreign purchases of assets in the U.S.

o   Items located in foreign countries and sold to companies in that country count as imports (-) as they represent out-payments of domestic currencies

§  Key Point- U.S. purchases of assets abroad

·         Exports and Imports balance on the balance on capital account

§  The Official Reserves Account

·         The central banks of nations hold quantities of foreign currencies called official reserves.

·         Functions just the same as reserves in any other bank

·         Basically used to make up any final balancing amount

§  The three components of the balance of payments (the current account, the capital account, and the official reserves account) must together equal zero.

§  Every unit of foreign exchange used (as reflected in a minus out-payment or debit transaction) must have source (a plus in-payment or credit transaction)

o   Payments Deficits and Surpluses

§  Balance-of-payments deficits and surpluses, though the balance of payments must always sum to zero, this refers to imbalances between the current and capital accounts

·         The US favors balance-of-payments deficits – a drawing down of official reserves

·         A balance-of-payments surplus is a building up of official reserves

A BOB "Chart"

	Assets/Creditr (Inflow)	Debits/Liabilities (Outflow)
Current Account
-Balance on goods and services -Net exports -Balance of trade	-Exports -Tourism here	-Imports -Tourism there
Net Investments	-Interest/dividend payments -Foreign ppay to U.S. for use of exported capital	-Interest/dividend payments -The U.S. made for the use foreign capital invested in U.S.
Net Transfers	-Aid to U.S. -Include royalties	-Aid to their country -Their royalties
Financial Account	-Capital inflows -Direct investment by foreigners -Purchases of stocks and bonds by foreigners	-Capital ooutflows -Direct investment by U.S. over there -Purchases of stocks and bonds by U.S.
Official Reserves	-Currencies -Gold -IMF	-Currencies -Gold -IMF

Comparative and Absolute Advantage

• The division of labor into specific task and roles intended to increase the productivity of workers is called known specialization
• Globalization is the process of increasing the productivity and interdependence of the world's markets and businesses
• Absolute advantage refers to a country's ability to produce a certain more of a good or service than another country
• The absolute advantage rule states that two countries should specialize and trade when each other partner has an output advantage over the other
• Comparative advantage refers to a country's ability to produce a particular good with a lower opportunity cost than another country
• Gains from trade or based on comparative advantage, not absolute advantage
• Comparative advantage is the basis for all trade between individuals, regions, and nations

The Foreign Exchange Market

• A foreign exchange market is a market in which currencies are exchanged for one another
• The equilibrium prices in these markets are called exchange rates
• The rate at which the currency of one nation can be exchanged for the currency of another nation
• Depreciation and Appreciation: an increase in the U.S. demand for Japanese goods will increase the demand for yen and raise the dollar price of yen

Supply of the Dollar	Demand of the Dollar
-Comes from U.S. citizens, banks, and industries wanting to purchase foreign goods, investments assets and to make payments to transfer foreigners	-Comes from foreigners, banks, and industries wanting to purchase our goods, investments, assets, and to make transferred payments to U.S.

• 5 Determinants of Supply and Demand in Foreign Exchange Market

1. Change in buyers taste
2. Change in relative incomes
3. Change in relative prices
4. Change in interest rates
5. Change in expectations

Exchange Currencies

• Sell exports and buy imports
• Invest in a countries stocks and bonds
• Build stores and factories in other markets
• Hold currencies in bank accounts for future exports, imports, and business loans 
• To speculate on currency values