7a- Circular Flow (Sectors and Markets)-summary of the country’s transactions with other countries - By definition every dollar has a source and every dollar received gets used somewhere- factor income(payments for the use of factors of production owned by residents of other countries)- Balance of payments on the current account (Current Account): transactions that don’t create liabilities, the balance of payments in goods and serves + factor income and net international transfer payment (row 1+ row 2+ row 3)- Balance of payments on g/s. the difference between the value of exports and the value of imports during a given period - Merchandise trade balance (trade balance): difference between a country’s exports and imports o goods alone(not services) - Balance of payments on financial account (Financial Account)- things that create liabailies (row 4+ row 5)- As in all circular flow diagrams, the flow into a box and the flow out of a box must be equal. The sum of the red and green arrows going into the USis = to the sum of the red and green arrows going out of the US. 7b- Foreign Exchange Market- the market in which currencies are traded - Exchange rate- the price at which currencies trade - Prices change based upon the: forces of supply and demand - An increase in capital flows into the U.S. leads to a stronger dollar which then creates a decrease in US net exports- A decrease in capital flows into the U.S. leads a weaker dollar which then creates an increase in US net exports- real exchange rates-exchange rates adjusted for international differences in aggregate price levels- purchasing power parity- is between two countries’ currencies is the nominal exchange rate at which a given basket of goods and services would cost the same amount in each country7c- Exchange Rate Regimes- rules governing policy toward exchange rateTwo Kinds of Exchange Rate Regimes:1. Fixes Exchange Rate- when the government keeps the XR against another currency at or near a particulartarget Ex. Hong Kong has an official policy of setting an exchange rate of HK$7.80 per US$12. Floating Exchange Rate –when the government lets the exchange rate go wherever the market takes it7D- This depreciation of the rash would be called a devaluation- Why would a nation want to devalue its own currency? Maybe sarash is experiencing a recessionary gap - What would happen if the nation revalued the rash so that it took $3 to buy one rash?- Why would a nation want to revalue its own currency?Maybe sarash is experiencing an inflationary gap - Monetary Policy under a floating exchange rate regime- Monetary policy is used to stabilize the economy, but it can also have an impact on the foreign
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