hi everybody jacob reed here from reviewecon.com today we're going to be looking at unit 6 for macro economics this unit is all about foreign exchange markets these videos go alongside the total review booklet from reviewecon.com if you want to pick yourself up a copy and support this channel head down to the links below also don't forget to like and subscribe let's get into the content for the last unit finally the first topic we need to know for this unit is called the balance of payments it has a lot of moving parts in it but it's not too bad if you look at each one individually the balance of payments is an accounting of transactions between countries it has two parts it has the current account and the capital and financial account let's go over the transactions that are included in the current account first of all we have the purchases of goods between countries purchases of services between countries also investment income that is money earned on investments from other countries also we have net transfers that's when people in other countries transfer money to people in our country or vice versa the capital account on the other hand counts purchases of assets between countries these could be physical assets or they can also be financial assets which is the focus of the ap economics exam and those include stocks currency and bonds when it comes to keeping track of those payments money into an economy is a credit also called an inflow those are positive numbers that increase the balance in one of these accounts money going out of an economy are negative numbers and these are called debits or outflows and these will decrease the balance of one of these accounts if an account has more credits than debits then that account is said to be in a surplus if on the other hand we have debits that are greater than credits then that account has a deficit the sum of the current account and the capital and financial account will always be zero what that means is when the capital and financial account decrease in value then the current account must increase in value likewise if that capital and financial account see an increase in the balance we will see a decrease in the current account balance that also means when one account has a surplus the other one must have a deficit and that's because the sum of these two accounts always equal zero one component of the current account is the balance of trade that's the goods and services that are purchased between countries we call those imports and exports when exports are greater than imports it is said that the country has a trade surplus in the united states in recent history we have had greater amounts of imports than we have for exports and we have had a trade deficit now since the trade balance is only one portion of the current account it is possible that we could have a trade deficit and not have a deficit in the overall current account let's go over some examples of things that could change the current account let's say there's an increase in the domestic price level within a country that will make domestic goods relatively more expensive than foreign goods that will increase imports and decrease exports that will cause a decrease in the current account if on the other hand we saw an increase in national income with one of our foreign trade partners the citizens within that country would purchase more goods and services including imports from the united states that would mean we would see an increase in our exports and that would increase the united states current account and of course if we saw decreases of these things instead there would be an opposite direction shift in the current account value for another example let's look at interest rates if interest rates within a country increase then foreign investors will seek that higher interest rate the united states will have a capital inflow that's financial capital coming into the economy and that will increase the capital and financial account as foreign investors purchase united states bonds and other assets if the united states had a decrease in the interest rate instead we would see a capital outflow and that would cause a decrease in the capital financial account the next thing we're going to look at is exchange rates an exchange rate is the price of one currency in terms of another currency right now the exchange rate for the united states dollar is approximately 20 mexican pesos if you flip it around that means one mexican peso is worth approximately five american cents you can use that exchange rate to calculate the price in u.s dollars of mexican-made goods let's say we have a soda made in mexico and it costs 40 pesos if we multiply that by the .05 cents per peso or you can divide it by the 20 pesos per dollar and that will give us a price of 2 for this soda made in mexico of course exchange rates do change and when the value of a currency increases that means the exchange rate is going to increase and we say that the currency has appreciated that means it's more valuable if on the other hand the exchange rate decreases then we say that the currency has lost value and has depreciated so if the exchange rate changes and we have now one dollar being worth 25 pesos which is the same thing as one peso being worth four cents that means that the us dollar has appreciated and the mexican peso has depreciated the next thing we're going to look at is foreign exchange markets and since the price of most things is determined by supply and demand it's not going to be any different for the prices of currencies which we call the exchange rate first we're going to look at the demand for u.s dollars in the international foreign exchange markets here we have the price of dollars in pesos that's the exchange rate on that y-axis down here on the x-axis we're going to have the quantity of u.s dollars just like most other demand curves we have a downward sloping demand curve because there's a inverse relationship between the exchange rate and the quantity of u.s dollars that will be demanded within the international markets so at high exchange rates we're going to have a low quantity of dollars demanded and at low exchange rates we're going to have a high quantity of dollars demanded the supply curve on the other hand is going to look like supply curves you've already seen we're going to have an upward sloping supply curve that shows the direct relationship between the exchange rate and the quantity of dollars that will be supplied and at high exchange rates we're going to have a high quantity of dollars supplied and at low exchange rates we will have a low quantity of dollars supplied put those two graphs together and we get our equilibrium exchange rate where the two curves intersect that gives us our equilibrium exchange rate and of course the equilibrium quantity of dollars supplied and demanded just like all other markets we've learned those demand and supply curves will shift around let's look at the demand shifters first well first of all we have the demand for exports because if you want to buy a us product you're going to need u.s dollars so when people in other countries want to buy our stuff they must demand u.s currency and buy it with their own within that demand for exports we have foreign tastes for us-made goods we have foreign national income the richer countries are the more u.s goods they're going to demand and price levels within our country and within other countries because that impacts the relative cost of foreign and domestic goods and the next one is interest rates both foreign and domestic and that's because foreign investors seek high rates of return found with high interest rates the last one is expected future exchange rates now remember these ones here can be actually impacted by monetary and fiscal policy and that will impact the foreign exchange markets as well now the supply of currency within the international markets comes from the following first of all we've got demand for imports if americans buy more imports they are going to supply more u.s dollars with that we have the domestic taste for foreign-made goods we have domestic national income and of course again we have price levels which changes the relative expense of buying foreign or domestic goods just like with demand we have interest rates that will impact the supply of currency as well because if i want to save my money in a foreign bank i'm going to have to buy that foreign currency and supply u.s dollars and just like with demand we have the expected future foreign exchange rate as being a shifter of the supply curve and make special note that these ones here are impacted by monetary and fiscal policy as well so monetary and fiscal policy can shift the demand curve and the supply curve within foreign exchange markets now we're going to look at some examples and put them on the foreign exchange market graph let's say the united states has a decrease in national income when that happens the united states will import fewer goods from other countries including mexico let's put that on the graph right here we have our market for u.s dollars and there's our equilibrium exchange rate and equilibrium quantity when americans buy fewer goods made in mexico that will mean we will supply fewer u.s dollars and when we see that decrease in supply that will cause a increase in the equilibrium exchange rate and that means the us dollar has appreciated now remember a decrease in u.s imports means a decrease in exports for some of our trade partners including mexico let's look at the impact on the foreign exchange market for the mexican peso here we have the price of pesos in u.s dollars on that y-axis and the quantity of pesos on the x-axis for the united states we will see a decrease in the supply but for mexico we will see a decrease in the demand because we will demand fewer pesos as we buy fewer goods needing pesos to buy them that will cause the currency to depreciate as we now have a lower equilibrium exchange rate now we're going to do one that's a little bit more complicated let's say that the united states has an increase in the price level that will mean imports are going to increase because imports are going to be relatively cheaper and when imports increase that will cause an increase in the supply of u.s dollars at the same time exports are going to decrease because exports have gotten more expensive to people in foreign countries that means that the demand for us dollars is also going to decrease and the combined action means that our equilibrium is going to plummet but since we have a double shift here that equilibrium quantity will be indeterminate if you see a question like this on your ap macro economics exam you're probably going to be asked to just shift one of those curves so just shift the one they're asking for but the reality is both curves shift driving that equilibrium interest rate down with each shift next we're going to look at what an increase in the united states interest rate could do remember monetary and fiscal policy can both impact those interest rates if that occurs foreign investors are going to seek that higher interest rate mexico is going to see a financial capital outflow and the united states is going to see a financial capital inflow let's take a look at the impact on the foreign exchange market for mexican pesos not us dollars here pesos when investors in mexico want to put their money in u.s banks they will have to supply their pesos that shifts the supply of pesos in the international markets to the right at the same time demand for pesos is going to decrease because fewer international investors will want to put their money in mexican banks since it has a relatively lower interest rate both of those shifts will drive the equilibrium exchange rate for the peso downward and the quantity will of course be indeterminate because of that double shift little side note the supply of loanable funds in mexico will decrease and the supply of loanable funds in the united states will increase as foreign investors seek that high interest rate now changes in the foreign exchange rate can impact the overall economy let's look at how that happens let's say that the united states produces some soda and so does mexico if the price of a united states made soda is three dollars while the price of a mexican-made soda is 40 pesos well then an exchange rate of one dollar equaling 20 pesos will mean that the international value or the exported value of that united states made soda will be 60 pesos at the same time that mexican-made soda will cost two u.s dollars if the exchange rate changes and one u.s dollar becomes worth 40 pesos that means the united states dollar has appreciated at the same time by the way the mexican peso has depreciated then that will change the relative costs of these imports and exports while the domestic price of these sodas didn't change the united states soda now costs 120 pesos if it is exported at the same time that mexican soda costs one dollar if it is imported so as a result of the us dollar appreciating that means exports of u.s sodas are going to cost more at the same time imports of mexican soda will cost less that means that whenever currencies appreciate imports are going to be cheaper and exports for foreign consumers are going to be more expensive that means exports are going to decrease and imports are going to increase that means net exports are going to decrease and that will cause a leftward shift of the aggregate demand curve if on the other hand a currency depreciates then that means imports are going to be more expensive at the same time us exports will be cheaper for foreign consumers and when that occurs exports are going to increase imports are going to decrease that means net exports as a whole will increase and that will shift aggregate demand to the right increasing our price level and real output within the economy we got through it that was a lot of information there and if you knew it all you are on your way to acing your next exam if you need a little more help head down to the links below where there are lots of games and activities from reviewecon.com to help you study and practice the skills you need for that next exam if you want to support this channel make sure you like and subscribe and then head over to reviewecon.com and pick up the total review booklet with everything you need to know to pass your final exam or ap economics exam thank you very much i'll see you guys next time