CHAPTER 6
(MACRO CHAPTER 6)
An Introduction to the Foreign Exchange Market
and the Balance of Payments
FUNDAMENTAL QUESTIONS
1. How do individuals of one nation trade money with individuals of another nation?
OVERVIEW AND OBJECTIVES
The primary purpose of this chapter is to introduce the student to the international dimension of the
world economy. The exchange rate, or the price of foreign exchange, affects international trade by
altering the price that foreign purchasers must pay for domestic goods. The chapter also introduces the
balance of payments system, which accounts for the flows of goods, services, and capital between
countries.
After reading and reviewing this chapter, the student should be able to:
1. Define foreign exchange and the foreign exchange market.
KEY TERM REVIEW
foreign exchange
foreign exchange market
exchange rate
38 Chapter 6: An Introduction to the Foreign Exchange Market and the Balance of Payments
.
financial account
LECTURE OUTLINE AND TEACHING STRATEGIES
I. The Foreign Exchange Market
The foreign exchange market is a global market in which people trade one currency for another.
Teaching Strategy: Note that foreign exchange markets are not located in any particular place.
Rather, they are made up of decentralized currency traders linked by telecommunications
equipment and computer networks.
A. Exchange rates: The exchange rate is the price of one country’s money in terms of another
II. The Balance of Payments
The balance of payments is a record of a country’s trade in goods, services, and financial assets
with the rest of the world.
A. Accounting for international transactions: The balance of payments is a balance sheet based
on double-entry bookkeeping.
transaction through the balance of payments accounts to show how the accounts balance.
OPPORTUNITIES FOR DISCUSSION
1. What would be gained if countries adopted a single currency?
2. Why don’t more countries choose to adopt a single currency like those who have chosen to adopt
the euro?
Chapter 6: An Introduction to the Foreign Exchange Market and the Balance of Payments 39
ANSWERS TO EXERCISES
1.
a.
1.11 euros $1=
2.
3.
a. The dollar has depreciated against the krona because the dollar now buys fewer krona (5.78
instead of 6.36 krona).
8. During the 1980s and the early and mid-1990s, private savings in the United States were not large
enough to finance investment expenditures and the government budget deficit. The U.S. economy
10.
a. The dollar value of the London hotel is $180 and the Hanover hotel is $200, so the hotel in
London is cheaper.
40 Chapter 6: An Introduction to the Foreign Exchange Market and the Balance of Payments
.
14. Accounting for international transactions involves much measurement error because governments
15. Negative net exports would indicate that consumption is greater than production, that more
ANSWERS TO STUDY GUIDE HOMEWORK
1. Appreciation means the dollar increased in value relative to the euro.
2. Depreciation means the dollar decreased in value relative to the Japanese yen.
ACTIVE LEARNING EXERCISE
This exercise is designed to assist students in obtaining a more thorough knowledge of the balance of
payment accounts by discussing the impact of certain international transactions on the current account
categories.
Section 2.b discussed how the balance of payments is made up of different accounts. Divide students
into groups of three or four. Have each group meet for five minutes to determine how the following
transactions would be classified in the current account of the U.S. balance of payments (as either
merchandise, services, income, or unilateral transfers). In each case, the balancing entry is to the
financial account, so students should just find the correct classification for the component of the current
account. After the five minutes are over, groups will be called upon to provide their classifications
(which account is relevant and whether the transaction is a debit or credit).
1. Telefonos de Mexico pays $5 million to the Bank of America in San Francisco for interest on a
loan.
Chapter 6: An Introduction to the Foreign Exchange Market and the Balance of Payments 41
3. The U.S. government gives the government of Egypt $3 million in foreign aid to build a new
irrigation system.
4. Lisa from Los Angeles, California, travels to Rome, Italy, and spends $4,000 on hotels and
sightseeing.