Chapter 2
International Flow of Funds
Lecture Outline
Balance of Payments
Current Account
Financial Account
Capital Account
Growth in International Trade
Events That Increased Trade Volume
Impact of Outsourcing on Trade
Factors Affecting International Trade Flows
Cost of Labor
Inflation
National Income
International Capital Flows
Factors Affecting Direct Foreign Investment
Agencies that Facilitate International Flows
International Monetary Fund
World Bank
World Trade Organizations
International Flow of Funds ❖ 2
Chapter Theme
Topics to Stimulate Class Discussion
1. Is a current account deficit something to worry about?
POINT/COUNTER-POINT:
Should Trade Restrictions be Used to Influence Human Rights Issues?
POINT: Yes. Some countries do not protect human rights in the same manner as the U.S. When
necessary, the U.S. should threaten to restrict U.S. imports from or investment in a country if it does not
correct human rights violations. The U.S. should use its large international trade and investment as
leverage to ensure that human rights violations do not occur. Other countries with a history of human
rights violations are more likely to honor human rights if their economic conditions are threatened.
COUNTER-POINT: No. International trade and human rights are two separate issues. International trade
should not be used as the weapon to enforce human rights. Firms engaged in international trade should
not be penalized by the human rights violations of a government. If the U.S. imposes trade restrictions on
a country in an effort to change its human rights policies, that country will retaliate. As a consequence,
U.S. firms that export to that foreign country will be adversely affected. By imposing trade sanctions, the
U.S. government is indirectly penalizing the MNCs that are attempting to conduct business in specific
foreign countries. Trade sanctions cannot solve every difference in the beliefs or morals between the more
developed countries and the developing countries. By restricting trade, the U.S. will slow down the
economic progress of developing countries.
WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support?
Offer your own opinion on this issue.
ANSWER: There is no perfect solution, but the tradeoff should be recognized. When trade is used as the
© 2021 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1. Balance of Payments.
a. What are the main components of the current account?
b. What are the main components of the financial account?
2. Inflation Effect on Trade.
a. How would a relatively high domestic inflation rate affect the home country’s current account,
other things being equal?
b. Is a negative current account harmful to a country? Discuss.
3. Government Restrictions. How can government restrictions affect international payments among
countries?
4. IMF.
a. What are some of the major objectives of the IMF?
© 2021 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
5. Exchange Rate Effect on Trade Balance. Would the U.S. balance of trade deficit be larger or
smaller if the dollar depreciates against all currencies, versus depreciating against some currencies but
appreciated against others? Explain.
6. Demand for Exports. A relatively small U.S. balance of trade deficit is commonly attributed to a
strong demand for U.S. exports. What do you think is the underlying reason for the strong demand
for U.S. exports?
7. Impact on International Trade. Why do you think international trade volume has increased over
time? In general, how are inefficient firms affected by the reduction in trade restrictions among
countries and the continuous increase in international trade?
8. Effects of the Euro. Explain how the existence of the euro may affect U.S. international trade.
9. Currency Effects. When South Korea’s export growth stalled, some South Korean firms suggested
that South Korea’s primary export problem was the weakness in the Japanese yen. How would you
interpret this statement?
10. Effects of Tariffs. Assume a simple world in which the U.S. exports soft drinks and beer to France
and imports wine from France. If the U.S. imposes large tariffs on the French wine, explain the likely
impact on the values of the U.S. beverage firms, U.S. wine producers, French beverage firms, and
French wine producers.
Advanced Questions
11. Free Trade. There has been considerable momentum to reduce or remove trade barriers in an effort
to achieve “free trade.” Yet, one disgruntled executive of an exporting firm stated, “Free trade is not
conceivable; we are always at the mercy of the exchange rate. Any country can use this mechanism
to impose trade barriers.” What does this statement mean?
12. International Investments. U.S.-based MNCs commonly invest in foreign securities.
a. Assume that the dollar is presently weak and is expected to strengthen over time. How will these
expectations affect the tendency of U.S. investors to invest in foreign securities?
b. Explain how low U.S. interest rates can affect the tendency of U.S.-based MNCs to invest abroad.
c. In general terms, what is the attraction of foreign investments to U.S. investors?
13. Exchange Rate Effects on Trade.
a. Explain why a stronger dollar could enlarge the U.S. balance of trade deficit. Explain why a
weaker dollar could affect the U.S. balance of trade deficit.
ANSWER: A stronger dollar makes U.S. exports more expensive to importers and may reduce
b. It is sometimes suggested that a floating exchange rate will adjust to reduce or eliminate any
current account deficit. Explain why this adjustment would occur.
c. Why does the exchange rate not always adjust to a current account deficit?
14. Impact of Government Policies on Trade. The governments of many countries enact policies that
can have a major impact on international trade flows.
a. Explain how governments might give their local firms a competitive advantage in the
international trade arena.
b. Why might different tax laws on corporate income across countries allow firms from some
countries to have a competitive advantage in the international trade arena?
c. If a country imposes lower corporate income tax rates, does that provide an unfair advantage?
15. China – U.S. Balance of Trade. There is an ongoing debate between the U.S. and China regarding
whether the Chinese yuan’s value should be revalued upward. The cost of labor in China is
substantially lower than that in the U.S.
a. Would the U.S. balance of trade deficit in China be eliminated if the yuan was revalued upward
by 20%? By 40%? By 80%?
b. If the yuan was revalued to the extent that it substantially reduced the U.S. demand for Chinese
products, would this shift the U.S. demand toward the U.S. or toward other countries where wage
rates are relatively low? In other words, would the correction of the U.S. balance of trade deficit
have a major impact on U.S. productivity and jobs?
CRITICAL THINKING
Cause and Effects of International Trade Conflict Conduct an online search of the terms
“international trade conflict” and also insert the prevailing month and year. You will likely see that an
international trade conflict exists at the time that you conduct your search. Review the online articles on a
recent conflict. Write a short essay to summarize the source of the conflict and whether one country’s
trade barriers represents retaliation due to actions by the other country. Describe the types of MNCs that
are most likely to suffer from the trade conflict.
ANSWER:
Solution to Continuing Case Problem: Blades, Inc.
1. How could a higher level of inflation in Thailand affect Blades (assuming U.S. inflation remains
constant)?
2. How could competition from firms in Thailand and from U.S. firms conducting business in Thailand
affect Blades?
ANSWER: Blades would be favorably affected relative to Thai roller blade manufacturers and
© 2021 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
3. How could a decreasing level of national income in Thailand affect Blades?
ANSWER: At first glance, it would appear that a decreasing level of national income in Thailand
could hurt Blades financially, as Thai consumers will have less money to spend. Furthermore, this
4. How could a continued depreciation of the Thai baht affect Blades? How would it affect Blades’
relative to U.S. exporters that invoice for their roller blades in U.S. dollars?
ANSWER: A continued depreciation of the Thai baht would hurt Blades, especially because the firm
invoices its roller blades in baht. A continued depreciation of the baht means that the baht-
5. If Blades increases its business in Thailand and experiences serious financial problems, are there any
international agencies that the company could approach for loans or other financial assistance?
ANSWER: An agency extending direct loans to corporations involved in international trade is the
Solution to Supplemental Case: Savanta Company
a. Savanta’s business could be adversely affected because its imports from Ketraz may be prevented by
the U.S. government due to violations of child labor laws. Even if the U.S. government does not
b. Savanta could consider establishing an arrangement with a specific business in Ketraz that has an
excellent reputation for treatment of its employees (including the avoidance of child labor).
International Flow of Funds ❖ 9
© 2021 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Alternatively, it may establish its own subsidiary in Ketraz to obtain the stones and produce them
there. This would allow it to have full control over the employment.
c. The U.S. government could impose restrictions on all imports from Ketraz due to violations of child
Small Business Dilemma
Identifying Factors That Will Affect the Foreign Demand at the Sports Exports Company
Identify the factors that affect the current account balance between the U.S. and the U.K. Explain how
each factor may potentially affect British demand for the footballs produced by the Sports Exports
Company.
ANSWER:
1. High inflation in the U.K. could cause a shift in the demand for U.S. products instead of British
2. High national income in the U.K. could increase the amount of spending by British consumers and
3. Government restrictions could be imposed by the British government on goods (such as the footballs)
4. The exchange rate of the British pound will change over time. However, since the Sports Exports