This section covers the following topics:

• Balance of payment accounts
• Balance of trade
• Benefits of international trade
• Trade restrictions
• The foreign exchange market
• Government intervention

Section Summary

Balance of payments accounts provide a snapshot showing all of the transactions between citizens of the United States and other countries. The balance of payments accounts, which include the current account and the capital account, show all purchases and sales of dollars. The current account also includes the balance of trade, which is equal to exports – imports.

Specialization (in production of goods in which a country has a comparative advantage, or the lowest opportunity cost) and trade allow countries to consume more than would otherwise be possible. However, trade is still sometimes restricted, because trade often hurts a small group of people very badly. This group then lobbies for trade restrictions.

Trade can be restricted through tariffs, which are per-unit taxes that transfer surplus from consumers to the government. Trade can also be obstructed by quotas, which set limits on imports and transfer surplus from consumers to producers.

The foreign exchange (“forex”) market sets exchange rates between world currencies. As with most markets, traditional supply and demand curves determine the equilibrium exchange rate.

When a currency appreciates, it becomes more valuable compared to other currencies. This hurts domestic exporters but helps people who buy imports. Currency depreciation is the opposite. If the market is free to operate, a few fundamental factors generally influence exchange rates. These factors include the country’s income, interest rates and inflation. Purchasing power parity can also be used to determine reasonable exchange rates.

There are a few different foreign exchange systems. The government can impose fixed exchange rates and refuse to buy and sell currency at any other price. It can also adopt... Sign up to continue reading International Trade and Finance >

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