IE - International Economics Overview

International Economics

Introduction

An open economy interacts with the rest of the world both through the goods market and the financial markets, and it is important to understand how a country’s transactions with the rest of the world are recorded in the balance of payments accounts. Students should understand the meaning of trade balance, the distinction between the current account balance and the financial account (formerly known as capital account) balance, and the implications for the foreign exchange market.

Module Lessons Preview

In this module, we will study the following topics:

Barriers to Trade: Countries sometimes impose trade barriers to protect domestic industries. Trade barriers include tariffs and quotas. A quota is a limit on the quantity of imports allowed into a country. A tariff is a tax on imports.

Balance of Payment Accounts: A country’s balance of payments accounts is the summary of all of the country’s transactions with other countries. There are two important accounts within the balance of payments: the current account and the financial account (also known as the capital account).

Foreign Exchange Market: Currencies are traded in foreign exchange markets. The equilibrium price at which currencies are traded is called the exchange rate. An exchange rate is the rate at which the currency of one country is exchanged for the currency of another.

Policies that Affect Exchange Rates: Changes in a nation’s monetary and fiscal policies affect its exchange rates and its balance of trade through the real interest rate, income, and the price level.

Net Exports & Capital Flows: The term capital flow refers to the movement of financial capital (money) between economies. An economy may have a high level of trade in goods and services relative to GDP, but if exports and imports are balanced, the net flow of foreign investment in and out of the economy will be zero.

 

Key Terms

Open Economy – A market economy mostly free from trade barriers and where exports and imports form a large percentage of GDP.

Closed Economy – a self-sufficient economy, which means that no imports are brought in and no exports are sent out.

Imports – products of foreign origin brought into a country.

Exports – products of local origin sold to other countries.

Trade Balance or Balance of Trade – the difference between a country’s imports and its exports for a given time period.

Current Account – a record of the nation’s transactions with the rest of the world- specifically its net trade in goods and services, its net earnings on cross border investments, and its net transfer payments over a defined period of time.

Trade Deficit – when a country’s imports exceeds its exports.

Trade Surplus – when the value of a country’s exports exceeds the value of its imports.

Financial Account or Capital Account or Net Capital Outflow – the net flow of funds being invested abroad by a country during a defined period of time. A positive NCO means that a country invests outside more than the world invests in it and vice versa.

Loanable Funds Market – the sum total of all the money people and entities in an economy have decided to save and lend out to borrowers as an investment rather than use for personal consumption.

Foreign Exchange Market – the market in which you are able to buy, sell, exchange, and speculate on currencies. Made up of banks, commercial companies, central banks, investment management firms, hedge funds, and retail brokers and investors.

Exchange Rate – the value of one currency for the purpose of conversion to another.

Appreciate VS Depreciate – a currency that is gaining value versus a currency that is losing value.

“Strong” VS “Weak” – a strong currency has more value that a weak currency.

Trade Restrictions – a restriction on the trade of goods and/or services between two or more countries. The byproduct of protectionism.

Tariff – a tax or duty to be paid on a particular export or import.

Quota – a limited quantity of a particular good or service.

Voluntary Export Restraint – arrangements between exporting and importing countries in which the exporting country agrees to limit the quantity of specific exports below a certain level in order to avoid mandatory restrictions.

Embargo – a ban on trade with a particular country. No goods or services will be traded with the country.

Comparative Advantage – when a country can produce a particular good more efficiently (at a lower opportunity cost) than other goods or services, it has comparative advantage in that good or service.

Absolute Advantage – the ability of a country to produce a greater quantity of a good, product, or service than competitors, using the same amount of resources.

Terms of Trade – the ratio of an index of a country’s export prices to an index of its import prices.

Foreign Direct Investment – (FDI) an investment made when a company or individual in one country invests in business interests in another country, in the form of either establishing business operations, or acquiring business assets in another country.

Flexible or Floating Exchange Rate – means that currencies change in relative value all the time.

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