AP Macroeconomics Unit 6: Open Economy: International Trade and Finance | Notes and practice

Notes

The current account records trade in goods and services (net exports), investment income, and transfers.
The capital and financial account records purchases of assets (stocks, bonds, factories) across borders.
The current account and the financial account balance each other: a current account deficit is matched by a financial account surplus (foreigners buying U.S. assets).

An exchange rate is the price of one currency in terms of another. If the dollar appreciates, it buys more foreign currency; U.S. exports become more expensive for foreigners and imports become cheaper, so net exports fall.
If the dollar depreciates, U.S. exports become cheaper, and net exports rise.
In the foreign exchange market, demand for dollars comes from foreigners buying U.S. goods and assets; supply of dollars comes from Americans buying foreign goods and assets.
Things that change exchange rates: relative interest rates (higher U.S. rates attract foreign capital and appreciate the dollar), relative inflation, incomes, and tastes.
In one market, if the dollar appreciates against the euro, the euro must depreciate against the dollar.

Expansionary monetary policy lowers U.S. interest rates, which leads to capital outflow, a depreciating dollar, and higher net exports, adding to AD.
Contractionary policy does the reverse.
Tariffs and quotas protect domestic producers but raise prices for consumers and can reduce efficiency; trading partners may retaliate.

The current account mainly records:

If the U.S. dollar appreciates against the yen, U.S. exports to Japan:

Higher U.S. interest rates relative to other countries will tend to:

A depreciation of the dollar would most likely:

A U.S. current account deficit is balanced by:

Americans buying more European goods will:

A tariff on imported steel will likely:

Expansionary monetary policy in the U.S. tends to:

Write your answer first, then open the scoring guide.

Free-response question

The Federal Reserve raises interest rates to fight inflation.

(a) Explain the effect on international capital flows into the United States.

Show the answer and scoring guide

Higher U.S. interest rates make U.S. assets more attractive, so foreign investment (capital inflow) into the United States increases.

Check off the points you earned:

(b) Explain the effect on the value of the dollar.

Show the answer and scoring guide

Foreigners need dollars to buy U.S. assets, so demand for dollars rises and the dollar appreciates.

Check off the points you earned:

(c) Explain the effect on U.S. net exports and aggregate demand.

Show the answer and scoring guide

A stronger dollar makes U.S. exports more expensive and imports cheaper, so net exports fall, which reduces aggregate demand.

Check off the points you earned: