Section 12.5— Exchange Rates & Balance of Payments

  • 💱 Exchange Rates

  • 💪 Strong Dollar

  • 📉 Weak Dollar

  • 🌍 Balance of Payments

💱 Exchange Rates:

  • The exchange rate = value of one currency compared to another.

  • It determines how expensive imports and exports are between countries.

💪 Strong Dollar

  • The U.S. dollar strengthens when it buys more foreign currency.

  • Effects:

    • U.S. exports decrease (foreigners pay more for U.S. goods).

    • Imports increase (foreign goods are cheaper in the U.S.).

    • Inflation tends to fall because cheaper imports keep prices down.

  1. Example:
    If the dollar strengthens against the yen:

    • Ford Focus (U.S.) costs more yen, so fewer sales in Japan.

    • Toyota Corolla (Japan) costs fewer dollars, so more sales in the U.S.

📉 Weak Dollar:

  • The U.S. dollar weakens when it buys less foreign currency.

  • Effects:

    • U.S. exports increase (foreigners pay less for U.S. goods).

    • Imports decrease (foreign goods cost more in the U.S.).

    • Inflation tends to rise because imported goods are more expensive.

  1. Example:
    If the dollar weakens against the yen:

    • Ford Focus costs less yen, so more sales in Japan.

    • Toyota Corolla costs more dollars, so fewer sales in the U.S.

🌍 Balance of Payments:

  • Measures the flow of money between the U.S. and other countries.

  • It can be:

    • Surplus → more money flows into the U.S.

    • Deficit → more money flows out of the U.S.

  1. Effects:

    • Surplus → dollar tends to strengthen.

    • Deficit → dollar tends to weaken.

Rates & Payments

〰️

Rates & Payments 〰️

⚖️ Balance of Trade (Largest Part of Balance of Payments):

  • Compares exports (credits) vs. imports (debits).

  1. Credits (money in):

    • U.S. exports (foreigners buy American goods)

    • Foreign investment in the U.S.

    • Foreign banks lending to the U.S.

  2. Debits (money out):

    • U.S. imports (Americans buy foreign goods)

    • U.S. investments abroad

    • U.S. banks loaning to foreign countries

    • U.S. aid to foreign nations

  3. When credits > debits → surplus.
    When debits > credits → deficit.

✅ Key Takeaways:

  • Strong dollar → imports rise, exports fall, low inflation.

  • Weak dollar → exports rise, imports fall, higher inflation.

  • Balance of trade drives the balance of payments, which influences the strength of the dollar.

✺ Review questions ✺

  • Decrease

  • Increase

  • Balance of trade

  • Balance of payments surplus

  • Foreign investment in the U.S.

  • Decreases inflation

  • A) Toyota
    B) Ford
    C) Neither

    Answer: B) Ford