Exports, Imports, and Net Exports

The Flow of Goods and Services: Exports, Imports and Net Exports

• Trade balance: The value of a nation's exports minus the value of its imports; also called net exports
• Trade surplus: An excess of exports over imports
• Trade deficit: An excess of imports over exports
• Balanced trade: A situation in which exports equal imports

Factors Influencing a Country's Exports, Imports, and Net Exports

• Consumer preferences for domestic and foreign goods impact trade flows
• The prices of goods at home and abroad affect import and export levels
• Exchange rates, which affect the cost of domestic currency when buying foreign currencies, play a crucial role
• The need for raw materials and resources in production affects import levels
• Consumer incomes at home and abroad influence the demand for imports
• Transportation costs impact the competitiveness of goods in international trade
• Government policies toward international trade can either promote or restrict trade flows

The Flow of Financial Resources: Net Capital Outflow

• Net Capital Outflow = Purchase of foreign assets by domestic residents - Purchase of domestic assets by foreigners
• Net capital outflow signifies the purchase of foreign assets by domestic residents, less the purchase of domestic assets by foreigners

The Equality of Net Exports and Net Capital Outflow

• Net exports measure the imbalance between a country's exports and its imports in the goods market
• Net capital outflow measures the imbalance between the amount of foreign assets bought by domestic residents and the amount of domestic assets bought by foreigners
• NCO = NX

International Flows of Goods and Capital Summary

• Trade Deficit: Exports < Imports, Net exports < 0, Y0, Y>C+I+G, Saving > Investment, Net capital outflow > 0

The Balance of Payments

• The balance of payments records international trade money flows
• It is the official account of international payments for goods, services and capital imports and exports
• The balance of payments includes the current, financial and capital accounts

The Current Account

• The current account records payments for goods and services between domestic and foreign economies
• Includes physical goods (visible trade) and services (invisible trade)
• The balance of trade tracks the difference between import and export values
• The current account includes net income flows and net current transfers

The Financial Account

• The financial account tracks investment fund flows between domestic and foreign economies
• Includes foreign company expansions as a credit
• Funds moving between countries to pay for bonds, stocks and other financial instruments are portfolio investments
• Speculative money flows based on interest rate changes, also known as "hot money flows", are tracked here

The Capital Account

• The capital account records funds transferred for buying and selling non-financial assets, like land, aid for capital works, debt forgiveness, and embassy sales

Factors Affecting the Balance of Payments

• Interest rates, exchange rates, government policies, productivity levels, inflation rates, and consumer spending affect trade
• Some countries must import resources, while others have strong export sales
• Compared to its trading partners, a country's economy affects its balance of payments

Appreciation and Depreciation of Currencies

• Appreciation is an increase in the value of a currency relative to other currencies, measured by the amount of foreign currency it can buy
• Depreciation is a drop in a currency's value as measured by the amount of foreign currency it can buy

Real Exchange Rate

• Rate at which the goods and services of one country trade for the goods and services of another country

Case Study: Exchange Rates and Political Changes

• Political changes can significantly influence foreign exchange markets due to their impact on currency demand and supply
• The decision by UK voters to leave the EU in 2016 (Brexit) led to considerable exchange rate fluctuations
• In the immediate aftermath of the Brexit referendum on June 26, 2016, the UK pound depreciated by about 12%
• Uncertainty surrounding the "divorce" agreement caused the pound to continue to fall
• The depreciation of the pound and appreciation of the euro had economic effects on firms and consumers
• A weaker pound made import prices more expensive, while exports from Europe and the US became less competitive
• Disagreements between the United States and China over trade also influenced exchange rates due to concerns about global economic growth
• Changes in exchange rates do not have an immediate impact on trade, as buyers and sellers need time to adjust and often have contractual agreements in place
• The UK trade balance slightly narrowed between November 2016 and November 2018 due to a faster increase in exports compared to imports
• Political issues such as Brexit can significantly impact exchange rates

Purchasing Power Parity (PPP)

• PPP is a theory saying that a currency unit should buy the same goods quantity in all countries
• PPP is based on arbitrage, buying a good at a low price in one market and selling it higher in another for profit

Supply and Demand For Loanable Funds and For Foreign Currency Exchange

• S = I + NCO, Saving = Domestic investment + Net capital outflow

The Market for Loanable Funds

• In an open economy, the interest rate determined by loanable funds supply and demand
• National saving is the supply of loanable funds
• Domestic investment and net capital outflow are the sources of demand for loanable funds
• At equilibrium, savings equals borrowing for domestic capital and foreign assets

The Market for Foreign Currency Exchange

• NCO = NX, Net capital outflow = Net exports

• Determined by FX supply and demand

• Pounds supply for exchange from net capital outflow

• The supply curve is vertical because net capital outflow does not depend on the real exchange rate

• The demand from net exports

• Lower real exchange rate stimulates Exports

• Number of pounds bought to buy foreign assets exactly balances number of pounds people demand to buy net exports

How Net Capital Outflow Depends on the Interest Rate

• A higher domestic real interest rate reduces net capital outflow, making domestic assets more attractive

The Real Equilibrium in an Open Economy

• The supply and demand for loanable funds determine the real interest rate
• The interest rate determines net capital outflow
• The supply and demand for pounds determine the real exchange rate

How Policies and Events Affect An Open Economy

• The effects of a Government budget deficit
• The effects of Capital Flight
• Trade policy

The Effects of a Government Budget Deficit

• Increased government budget deficits lowers the supply of loanable funds
• Higher interest rates reduce net capital outflow
• Reduced net capital outflow lowers the euros supply in foreign currency exchange
• The real exchange rate appreciates, and the trade balance moves toward deficit

Trade Policy

• An import quota increases the demand for euros
• The real exchange rate appreciates
• Net exports remains the same

The Effects of Capital Flight

• Increased net capital outflow increases interest rate and the demand for loanable funds
• Supply of currency increases
• Currency depreciates

Summary of Connections

• In loanable funds, the interest rate adjusts to balance the supply of loanable funds (national saving) and the demand for loanable funds (domestic and net capital outflow)
• In foreign currency exchange, the real exchange rate adjusts to balance the domestic currency supply (net capital outflow) and demand (net exports)
• Net capital outflow connects markets, part of the demand for loanable funds and provides domestic currency for foreign currency exchange