Unit 5:

International Trade and

1
Balance of Trade vs.
Balance of Payments
 Balance of Trade
Net Exports (XN) = Exports – Imports
Trade Surplus = Exporting more than is imported
Trade Deficit (aka. trade gap) = Exporting less than
is imported
Balance of Trade
 Balance of Payments (BOP)
Balance of trade includes only goods and service
but balance of payments considers ALL
international transactions.
Balance of Payments (BOP)- Summary of a
country’s international trade.
The BOP summary is within a given year
Prepared in the domestic country’s currency
Ex. If accounting the BOP of the U.S. it would be in
the Dollar.
The balance of payments is made up of two
accounts. The current account and the financial
account.
Which countries have the highest account surpluses and
account deficits?
 Current Account
The Current Account is made up of three parts:
1. Trades in Goods and Services (Net Exports)-
Difference between a nation’s exports of goods
and services and its imports of goods and
services
Ex: Toys imported from China, US cars exported to
Mexico
2. Investment Income- income from the factors of
production including payments made to foreign
investors.
Ex: Money earned by Japanese car producers in the US
3. Net Transfers- Money flows from the private or
public sectors
Ex: donations, aids and grants, official assistance, and
remittance
 Financial (Capital) Account
The Financial Account measures the purchase and
sale of financial assets abroad.
Purchases of things that continue to earn money
Examples:
– A Korean company buys a factory in Ohio
– An American buys a Japanese government bond
– When a foreign company buys business in a
different country that is Foreign Direct Investment
Net Capital Outflow- The difference between the
purchase of foreign assets and domestic assets
purchased by foreigners
Financial Account Surplus = Inflow > Outflow
Financial Account Deficit = Inflow < Outflow
 If a country has a deficit in the current account,
they must have a surplus in the financial account
 Current or Financial Account?
Identify if the examples are counted in the current or
capital account and determine if it is a credit or debit
for the US.
1. Bill, an American, invests $20 million in a ski resort in
Canada
2. A Korean company sells vests to the US Military
3. A US company, Boeing, sells twenty 747s to France
4. A Chinese company buys a shopping mall in San Diego
5. An illegal immigrant living in the US sends a portion
of his earning to his family in Bora Bora
6. A German investor buys $50,000 US Treasury Bonds
7. Italian tourists spend 5 million in the US while
American tourists spend 8 million in Italy.
 Current or Financial Account?
Identify if the examples are counted in the current or
capital account and determine if it is a credit or debit
for the US.
1. Financial Account (financial asset), Debit
2. Current Account (trade of goods/services),
Debit
3. Current Account (trade of goods/services),
Credit
4. Financial Account (financial asset), Credit
5. Current Account (net transfer), Debit
6. Financial Account (financial asset), Credit
7. Current Account (net transfer), Debit
 Practice
1. U.S. income increase relative to other countries. Does
the balance of payments move toward a deficit or a
surplus?
- U.S. citizens have more disposable income
- Americans import more
- Net exports (Xn) decrease
- The current account balance decreases and moves
toward a deficit.
2. If the U.S. dollar depreciates relative to other
countries does the balance of payments move toward a
deficit or a surplus?
- U.S. exports become more desirable
- America exports more
- Net exports (Xn) increase
- The current account balance increases and moves
toward a surplus.
FOREX Shifters
Let’s use the example of the US
Dollar and the British Pound
1. Changes in Tastes-
Ex: British tourists flock to the U.S…
Demand for U.S. dollars increases (shifts right)
Supply of British pounds increases (shifts right)
Pound-depreciates
Dollar-appreciates
2. Changes in Relative Incomes (Resulting
in more imports)-
Ex: US growth increase US incomes….
U.S. buys more imports…
U.S. Demand for pounds increases
Supply of U.S. dollars increases
Pound- appreciates
Dollar- depreciates
3. Changes in Relative Price Level
(Resulting in more imports)-
Ex: US prices increase relative to Britain….
U.S. demand for cheaper imports increases…
U.S. demand for pounds increases
Supply of U.S. dollars increases
Pound- appreciates
Dollar- depreciates
4. Changes in relative Interest Rates-
Ex: US has a higher interest rate than Britain.
British people want to put money in US banks
Capital Flow increase towards the US
British demand for U.S. dollars increases…
British supply more pounds
Pound-depreciates
Dollar- appreciates
What will happen to the international value of the
Mexican peso if there is high inflation in Mexico?
The demand for pesos
Pesos will decrease since
Mexico's trading
partners will not
want to purchase
higher priced
Mexican products.
The supply will
increase as Mexicans
look to buy lower
The peso DEPRECIATES priced imports.
 Practice
Value of Value of
Shifter
Dollar ($) Yen (¥ )
1
2
3
4
5
6
7

18
 Practice
For each of the following examples, identify what will
happen to the value of US Dollars and Japanese Yen.
1. American tourists increase visits to Japan.
2. The US government significantly decreases
personal income tax.
3. Inflation in the Japan rises significantly faster
than in the US.
4. Japan has a large budget deficit that
increases Japanese interest rates.
5. Japan places high tariffs on all US imports.
6. The US suffers a larger recession.
7. The US Federal Reserve sells bonds at high
interest rates.
How do these scenarios affect exports and imports?
 Practice
Value of Value of
Shifter
Dollar ($) Yen (¥ )
1 Tastes (S↑) Depreciates (D↑)
Appreciates
2 Income (S↑) Depreciates (D↑)
Appreciates
3 Price Level (D↑) (S↑) Depreciates
Appreciates
4 Interest Rate (S↑) Depreciates (D↑)
Appreciates
5 Regulation (D↓) Depreciates (S↓) Appreciates
Scenarios 1, 2, and 4 will increase US exports because
6 Income
US products (S↓)Appreciates (D↓)
are now relatively Depreciates
“cheaper” 20
2008 Audit Exam
 2008 Audit Exam

High interest rates attract foreign currency