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Table of Contents
Unit 6 Overview: Open Economy-International Trade and Finance
6.1 Balance of Payments Accounts
6.2 Exchange Rates
6.3 Foreign Exchange Market
6.4 Effect of Changes in Policies & Economic Conditions on the Foreign Exchange Market
6.5 Changes in the Foreign Exchange Market and Net Exports
6.6 Real Interest Rates and International Capital Flows
6.6 Real Interest Rates and International Capital Flows

💶ap macroeconomics review

Unit 6 Overview: Open Economy-International Trade and Finance

Verified for the 2025 AP Macroeconomics exam•Citation:

Intro to Unit 6

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Open Economy - International Trade and Finance

You’ve made it to the last and final unit of AP Macroeconomics! 👊 Take a moment to embrace that feeling because we are heading on a trip around the world! 🌎 Sadly, I’m just kidding! There will be no physical trip around the world, but we are going to explore the world of International Trade and Finance, which is a close second! This look at the open economy can be challenging, but rest assured that a slow and steady approach will make you an expert in International Trade and Finance in no time 🕕

6.1 Balance of Payments Account

This unit begins with an overview of the Balance of Payments Accounts 📋, which at first glance may seem a bit daunting. However, you’ll quickly learn a few rules of thumb to help you keep the Current Account and the Capital Account straight. The Current Account includes net exports (our friend from GDP), net investments, and net transfers. Essentially trade, interest and dividends, and economic aid or grants. The Capital account includes investments, both financial and real (actual land and businesses). 

Any time money flows into an economy you add to it, and when it flows out (you guessed it) you subtract it! With a little practice, you’ll be quick to assign transactions to the capital or current account. The coolest thing about these two accounts is that if you add them together—they will always equal 0! 

6.2 Exchange Rates

Next, let’s move on to exchange rates. These are the prices of currency in terms of other currencies. For example, how many Euros 💶 will a US Dollar 💵 cost? As exchange rates go up (known as appreciation), currency is more expensive and so are goods and services from that country. 

As exchange rates go down (known as depreciation), currency gets cheaper, as do goods and services from that country. In today’s ever changing world, exchange rates adjust by the second and the trade of foreign currency has become an economic venture for many people 💹

6.3 Foreign Exchange Market

The Foreign Exchange Market (also referred to as FOREX) exchanges all that currency. The basics of the FOREX market are much like the other markets you’ve already studied—an upward sloping supply curve that meets a downward sloping demand curve at a point that establishes the market equilibrium. The big difference is the way the axes are labeled and this is often the most confusing part of this topic, but it’s actually quite simple! 

The easy part is the x-axis labeled with the quantity of one currency. The y-axis is the second currency over the currency found on the x-axis. And that’s it! Wasn’t too bad, was it? After we have the basics of the market graph down, we can explore the factors that will shift these curves and create changes in the FOREX market. 

6.4 Effect of Changes in Policies and Economic Condition on the Foreign Exchange Market

Several years ago, a chain reaction began when Great Britain exited the European Union. Brexit, as it was called, affected economies all over the world! But, why did it do that? Why was this decision thousands of miles away lowering mortgage rates across the United States? As you probably already know, globalization is in full force in our modern world which means everything connects to everything else! Changes in one place can affect other places through the foreign exchange market. 

These changes can be as simple as a rise in tourism somewhere and as complex as fiscal policies enacted by governments. Monetary policy can also influence the economy and therefore exchange rates. Not only do these things affect the foreign exchange market, but that in turn impacts other economic indicators - most notably GDP. 

6.6 Changes in the Foreign Exchange Market and Net Exports

Even though we learned about GDP a long time ago, you surely remember that the formula is C + G + I + Nx. And, of course, that Nx stands for net exports 🚢 That’s our connection back to this unit. All of this trade (both foreign exchange and goods/services) directly affects our GDP! The more we export, the higher our GDP. 

As mentioned earlier, monetary policy includes influencing the interest rate. When real interest rates differ from place to place, the flow of financial capital is affected. The higher the interest rate, the more financial capital will flow into that country 🔁 

Don’t be fooled by this unit’s placement at the end of the macroeconomics curriculum. It includes crucial concepts that will definitely 💯 be on your AP exam and, more importantly, will help you understand our world even better. These concepts also connect to comparative advantage from Unit 1. Making connections between these topics is the key 🔑 to cementing these in your economics mind! 

Key Terms to Review (18)

Appreciation: Appreciation refers to the increase in the value of a currency relative to other currencies. This can have significant effects on international trade, capital flows, and the overall economy, influencing how much imports and exports cost, as well as affecting investment decisions by foreign investors.
Balance of Payments Account: The Balance of Payments Account is a comprehensive record of all economic transactions between residents of a country and the rest of the world over a specific period. This account includes the trade balance, capital flows, and financial transfers, reflecting how much money is entering and leaving a country. It provides critical insights into a nation's economic position, helping to assess its financial health and global standing.
Capital Account: The capital account is a component of a country's balance of payments that records all transactions involving the purchase and sale of assets. It reflects the net flow of financial assets into and out of a country, including foreign direct investment, portfolio investment, and other investments. This account is crucial for understanding how capital moves across borders and influences a nation's economy.
Current Account: The Current Account is a key component of a country's balance of payments that records all transactions related to the exchange of goods, services, income, and current transfers between residents and non-residents. It reflects a nation's trade balance and includes imports and exports of goods and services, as well as income earned from investments abroad and payments made to foreign investors. Understanding the Current Account is crucial for analyzing a country's economic health and its position in global trade.
Demand Curve: A demand curve is a graphical representation that shows the relationship between the price of a good or service and the quantity demanded by consumers at various price levels. It typically slopes downward from left to right, illustrating that as prices decrease, the quantity demanded generally increases, and vice versa. This curve is essential for understanding consumer behavior and market dynamics.
Depreciation: Depreciation is the reduction in the value of an asset over time, often due to wear and tear, age, or obsolescence. In economic contexts, it also reflects the consumption of capital goods that contribute to production. Understanding depreciation is crucial as it affects calculations of GDP, influences investment decisions, and is relevant in discussions about real interest rates and international capital flows.
Exchange Rates: Exchange rates are the prices at which one currency can be exchanged for another, determining the relative value of currencies in the foreign exchange market. They play a crucial role in international trade and finance, influencing how much goods and services cost when bought or sold across borders. Exchange rates can fluctuate due to various factors, including economic conditions, interest rates, and political stability, impacting both consumers and businesses engaged in global transactions.
Financial Capital: Financial capital refers to the funds that businesses use to acquire their assets and sustain their operations. This type of capital is essential for investment, growth, and the management of daily business activities. It is often raised through various means such as equity, debt, or retained earnings, allowing companies to finance projects, purchase equipment, and expand operations.
Foreign Exchange Market (FOREX): The Foreign Exchange Market (FOREX) is a global marketplace for trading national currencies against one another. It operates 24 hours a day and is the largest financial market in the world, with daily trading volumes exceeding $6 trillion. This market plays a vital role in determining exchange rates, facilitating international trade, and providing liquidity to businesses and investors.
Gross Domestic Product (GDP): Gross Domestic Product (GDP) is the total monetary value of all final goods and services produced within a country's borders in a specific time period. This measure helps gauge the health of an economy and is closely connected to various economic concepts such as inflation, economic cycles, and the flow of money within the economy.
International Trade and Finance: International trade and finance refers to the exchange of goods, services, and capital across international borders, facilitating economic interactions between countries. This process not only includes the buying and selling of products but also involves investments, currency exchange rates, and financial transactions that are crucial for global economic integration and growth.
Market Equilibrium: Market equilibrium occurs when the quantity of a good or service supplied equals the quantity demanded, resulting in a stable market price. At this point, there is no inherent force causing price or quantity to change, creating a balance between buyers and sellers. Understanding this concept helps analyze how changes in demand and supply can shift equilibrium and affect market dynamics.
Monetary Policy: Monetary policy refers to the actions taken by a country's central bank to manage the money supply and interest rates to achieve macroeconomic goals such as controlling inflation, managing employment levels, and stabilizing the currency. It influences economic activity by affecting how much money is available for businesses and consumers to spend and invest, which can also impact international trade and capital flows.
Net Exports (Nx): Net Exports (Nx) refers to the value of a country's total exports minus its total imports. This key economic indicator helps assess a nation's economic health and global trade position, indicating whether it has a trade surplus or deficit. A positive Net Exports figure shows that a country is exporting more than it is importing, which can lead to higher domestic production and employment, while a negative figure suggests reliance on foreign goods and potential impacts on local industries.
Net Exports: Net exports refer to the value of a country's total exports minus its total imports. This figure is crucial in understanding a nation's trade balance and plays a significant role in determining its economic health and influences aggregate demand.
Open Economy: An open economy is an economic system that engages in international trade and allows for the free flow of goods, services, and capital across its borders. This type of economy interacts with others, impacting and being impacted by global markets, exchange rates, and trade policies. Open economies are characterized by their ability to import and export freely, which can lead to increased competition, efficiency, and access to a wider variety of products for consumers.
Real Interest Rates: Real interest rates represent the nominal interest rate adjusted for inflation, indicating the true cost of borrowing and the real yield on savings. Understanding real interest rates is essential because they influence investment decisions, consumer spending, and overall economic growth. Additionally, they play a significant role in international capital flows, as investors seek to maximize returns on their investments while considering inflationary pressures.
Supply Curve: A supply curve is a graphical representation that shows the relationship between the price of a good or service and the quantity supplied by producers over a given period. Typically, the supply curve slopes upward, indicating that as prices increase, producers are willing to supply more of the good. This concept is vital for understanding how prices and quantities interact in markets, affecting both producers and consumers.
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Glossary
6.1 Balance of Payments Accounts