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Principles of Macroeconomics for AP® Courses

Introduction to the International Trade and Capital Flows

Principles of Macroeconomics for AP® CoursesIntroduction to the International Trade and Capital Flows
  1. Preface
  2. 1 Welcome to Economics!
    1. Introduction
    2. 1.1 What Is Economics, and Why Is It Important?
    3. 1.2 Microeconomics and Macroeconomics
    4. 1.3 How Economists Use Theories and Models to Understand Economic Issues
    5. 1.4 How Economies Can Be Organized: An Overview of Economic Systems
    6. Key Terms
    7. Key Concepts and Summary
    8. Self-Check Questions
    9. Review Questions
    10. Critical Thinking Questions
  3. 2 Choice in a World of Scarcity
    1. Introduction to Choice in a World of Scarcity
    2. 2.1 How Individuals Make Choices Based on Their Budget Constraint
    3. 2.2 The Production Possibilities Frontier and Social Choices
    4. 2.3 Confronting Objections to the Economic Approach
    5. Key Terms
    6. Key Concepts and Summary
    7. Self-Check Questions
    8. Review Questions
    9. Critical Thinking Questions
    10. Problems
  4. 3 Demand and Supply
    1. Introduction to Demand and Supply
    2. 3.1 Demand, Supply, and Equilibrium in Markets for Goods and Services
    3. 3.2 Shifts in Demand and Supply for Goods and Services
    4. 3.3 Changes in Equilibrium Price and Quantity: The Four-Step Process
    5. 3.4 Price Ceilings and Price Floors
    6. 3.5 Demand, Supply and Efficiency
    7. Key Terms
    8. Key Concepts and Summary
    9. Self-Check Questions
    10. Review Questions
    11. Critical Thinking Questions
    12. Problems
  5. 4 Labor and Financial Markets
    1. Introduction to Labor and Financial Markets
    2. 4.1 Demand and Supply at Work in Labor Markets
    3. 4.2 Demand and Supply in Financial Markets
    4. 4.3 The Market System as an Efficient Mechanism for Information
    5. Key Terms
    6. Key Concepts and Summary
    7. Self-Check Questions
    8. Review Questions
    9. Critical Thinking Questions
    10. Problems
  6. 5 The Macroeconomic Perspective
    1. Introduction to the Macroeconomic Perspective
    2. 5.1 Measuring the Size of the Economy: Gross Domestic Product
    3. 5.2 Adjusting Nominal Values to Real Values
    4. 5.3 Tracking Real GDP over Time
    5. 5.4 Comparing GDP among Countries
    6. 5.5 How Well GDP Measures the Well-Being of Society
    7. Key Terms
    8. Key Concepts and Summary
    9. Self-Check Questions
    10. Review Questions
    11. Critical Thinking Questions
    12. Problems
  7. 6 Economic Growth
    1. Introduction to Economic Growth
    2. 6.1 The Relatively Recent Arrival of Economic Growth
    3. 6.2 Labor Productivity and Economic Growth
    4. 6.3 Components of Economic Growth
    5. 6.4 Economic Convergence
    6. Key Terms
    7. Key Concepts and Summary
    8. Self-Check Questions
    9. Review Questions
    10. Critical Thinking Questions
    11. Problems
  8. 7 Unemployment
    1. Introduction to Unemployment
    2. 7.1 How the Unemployment Rate Is Defined and Computed
    3. 7.2 Patterns of Unemployment
    4. 7.3 What Causes Changes in Unemployment over the Short Run
    5. 7.4 What Causes Changes in Unemployment over the Long Run
    6. Key Terms
    7. Key Concepts and Summary
    8. Self-Check Questions
    9. Review Questions
    10. Critical Thinking Questions
    11. Problems
  9. 8 Inflation
    1. Introduction to Inflation
    2. 8.1 Tracking Inflation
    3. 8.2 How Changes in the Cost of Living Are Measured
    4. 8.3 How the U.S. and Other Countries Experience Inflation
    5. 8.4 The Confusion Over Inflation
    6. 8.5 Indexing and Its Limitations
    7. Key Terms
    8. Key Concepts and Summary
    9. Self-Check Questions
    10. Review Questions
    11. Critical Thinking Questions
    12. Problems
  10. 9 The International Trade and Capital Flows
    1. Introduction to the International Trade and Capital Flows
    2. 9.1 Measuring Trade Balances
    3. 9.2 Trade Balances in Historical and International Context
    4. 9.3 Trade Balances and Flows of Financial Capital
    5. 9.4 The National Saving and Investment Identity
    6. 9.5 The Pros and Cons of Trade Deficits and Surpluses
    7. 9.6 The Difference between Level of Trade and the Trade Balance
    8. Key Terms
    9. Key Concepts and Summary
    10. Self-Check Questions
    11. Review Questions
    12. Critical Thinking Questions
    13. Problems
  11. 10 The Aggregate Demand/Aggregate Supply Model
    1. Introduction to the Aggregate Demand/Aggregate Supply Model
    2. 10.1 Macroeconomic Perspectives on Demand and Supply
    3. 10.2 Building a Model of Aggregate Demand and Aggregate Supply
    4. 10.3 Shifts in Aggregate Supply
    5. 10.4 Shifts in Aggregate Demand
    6. 10.5 How the AD/AS Model Incorporates Growth, Unemployment, and Inflation
    7. 10.6 Keynes’ Law and Say’s Law in the AD/AS Model
    8. Key Terms
    9. Key Concepts and Summary
    10. Self-Check Questions
    11. Review Questions
    12. Critical Thinking Questions
    13. Problems
  12. 11 The Keynesian Perspective
    1. Introduction to the Keynesian Perspective
    2. 11.1 Aggregate Demand in Keynesian Analysis
    3. 11.2 The Building Blocks of Keynesian Analysis
    4. 11.3 The Expenditure-Output (or Keynesian Cross) Model
    5. 11.4 The Phillips Curve
    6. 11.5 The Keynesian Perspective on Market Forces
    7. Key Terms
    8. Key Concepts and Summary
    9. Self-Check Questions
    10. Review Questions
    11. Critical Thinking Questions
  13. 12 The Neoclassical Perspective
    1. Introduction to the Neoclassical Perspective
    2. 12.1 The Building Blocks of Neoclassical Analysis
    3. 12.2 The Policy Implications of the Neoclassical Perspective
    4. 12.3 Balancing Keynesian and Neoclassical Models
    5. Key Terms
    6. Key Concepts and Summary
    7. Self-Check Questions
    8. Review Questions
    9. Critical Thinking Questions
    10. Problems
  14. 13 Money and Banking
    1. Introduction to Money and Banking
    2. 13.1 Defining Money by Its Functions
    3. 13.2 Measuring Money: Currency, M1, and M2
    4. 13.3 The Role of Banks
    5. 13.4 How Banks Create Money
    6. Key Terms
    7. Key Concepts and Summary
    8. Self-Check Questions
    9. Review Questions
    10. Critical Thinking Questions
    11. Problems
  15. 14 Monetary Policy and Bank Regulation
    1. Introduction to Monetary Policy and Bank Regulation
    2. 14.1 The Federal Reserve Banking System and Central Banks
    3. 14.2 Bank Regulation
    4. 14.3 How a Central Bank Executes Monetary Policy
    5. 14.4 Monetary Policy and Economic Outcomes
    6. 14.5 Pitfalls for Monetary Policy
    7. Key Terms
    8. Key Concepts and Summary
    9. Self-Check Questions
    10. Review Questions
    11. Critical Thinking Questions
    12. Problems
  16. 15 Exchange Rates and International Capital Flows
    1. Introduction to Exchange Rates and International Capital Flows
    2. 15.1 How the Foreign Exchange Market Works
    3. 15.2 Demand and Supply Shifts in Foreign Exchange Markets
    4. 15.3 Macroeconomic Effects of Exchange Rates
    5. 15.4 Exchange Rate Policies
    6. Key Terms
    7. Key Concepts and Summary
    8. Self-Check Questions
    9. Review Questions
    10. Critical Thinking Questions
    11. Problems
  17. 16 Government Budgets and Fiscal Policy
    1. Introduction to Government Budgets and Fiscal Policy
    2. 16.1 Government Spending
    3. 16.2 Taxation
    4. 16.3 Federal Deficits and the National Debt
    5. 16.4 Using Fiscal Policy to Fight Recession, Unemployment, and Inflation
    6. 16.5 Automatic Stabilizers
    7. 16.6 Practical Problems with Discretionary Fiscal Policy
    8. 16.7 The Question of a Balanced Budget
    9. Key Terms
    10. Key Concepts and Summary
    11. Self-Check Questions
    12. Review Questions
    13. Critical Thinking Questions
    14. Problems
  18. 17 The Impacts of Government Borrowing
    1. Introduction to the Impacts of Government Borrowing
    2. 17.1 How Government Borrowing Affects Investment and the Trade Balance
    3. 17.2 Fiscal Policy, Investment, and Economic Growth
    4. 17.3 How Government Borrowing Affects Private Saving
    5. 17.4 Fiscal Policy and the Trade Balance
    6. Key Terms
    7. Key Concepts and Summary
    8. Self-Check Questions
    9. Review Questions
    10. Critical Thinking Questions
    11. Problems
  19. 18 Macroeconomic Policy Around the World
    1. Introduction to Macroeconomic Policy around the World
    2. 18.1 The Diversity of Countries and Economies across the World
    3. 18.2 Improving Countries’ Standards of Living
    4. 18.3 Causes of Unemployment around the World
    5. 18.4 Causes of Inflation in Various Countries and Regions
    6. 18.5 Balance of Trade Concerns
    7. Key Terms
    8. Key Concepts and Summary
    9. Self-Check Questions
    10. Review Questions
    11. Critical Thinking Questions
    12. Problems
  20. A | The Use of Mathematics in Principles of Economics
  21. B | Indifference Curves
  22. C | Present Discounted Value
  23. Answer Key
    1. Chapter 1
    2. Chapter 2
    3. Chapter 3
    4. Chapter 4
    5. Chapter 5
    6. Chapter 6
    7. Chapter 7
    8. Chapter 8
    9. Chapter 9
    10. Chapter 10
    11. Chapter 11
    12. Chapter 12
    13. Chapter 13
    14. Chapter 14
    15. Chapter 15
    16. Chapter 16
    17. Chapter 17
    18. Chapter 18
  24. References
  25. Index
This is a picture of many different currencies from around the world.
Figure 9.1 A World of Money We are all part of the global financial system, which includes many different currencies. (Credit: modification of work by epSos.de/Flickr Creative Commons)

Bring It Home

More than Meets the Eye in the Congo

How much do you interact with the global financial system? Do you think not much? Think again. Suppose you take out a student loan, or you deposit money into your bank account. You just affected domestic savings and borrowing. Now say you are at the mall and buy two T-shirts “made in China,” and later contribute to a charity that helps refugees. What is the impact? You affected how much money flows into and out of the United States. If you open an IRA savings account and put money in an international mutual fund, you are involved in the flow of money overseas. While your involvement may not seem as influential as someone like the president, who can increase or decrease foreign aid and, thereby, have a huge impact on money flows in and out of the country, you do interact with the global financial system on a daily basis.

The balance of payments—a term you will meet soon—seems like a huge topic, but once you learn the specific components of trade and money, it all makes sense. Along the way, you may have to give up some common misunderstandings about trade and answer some questions: If a country is running a trade deficit, is that bad? Is a trade surplus good? For example, look at the Democratic Republic of Congo (often referred to as “Congo”), a large country in Central Africa. In 2013, it ran a trade surplus of $1 billion, so it must be doing well, right? In contrast, the trade deficit in the United States was $508 billion in 2013. Do these figures suggest that the economy in the United States is doing worse than the Congolese economy? Not necessarily. The U.S. trade deficit tends to worsen as the economy strengthens. In contrast, high poverty rates in the Congo persist, and these rates are not going down even with the positive trade balance. Clearly, it is more complicated than simply asserting that running a trade deficit is bad for the economy. You will learn more about these issues and others in this chapter.

Introduction to International Trade and Capital Flows

In this chapter, you will learn about:

  • Measuring Trade Balances
  • Trade Balances in Historical and International Context
  • Trade Balances and Flows of Financial Capital
  • The National Saving and Investment Identity
  • The Pros and Cons of Trade Deficits and Surpluses
  • The Difference between Level of Trade and the Trade Balance

The balance of trade (or trade balance) is any gap between a nation’s dollar value of its exports, or what its producers sell abroad, and a nation’s dollar worth of imports, or the foreign-made products and services that households and businesses purchase. Recall from The Macroeconomic Perspective that if exports exceed imports, the economy is said to have a trade surplus. If imports exceed exports, the economy is said to have a trade deficit. If exports and imports are equal, then trade is balanced. But what happens when trade is out of balance and large trade surpluses or deficits exist?

Germany, for example, has had substantial trade surpluses in recent decades, in which exports have greatly exceeded imports. According to the Central Intelligence Agency’s The World Factbook, in 2013, Germany ran a trade surplus of $260 billion. In contrast, the U.S. economy in recent decades has experienced large trade deficits, in which imports have considerably exceeded exports. In 2014, for example, U.S. imports exceeded exports by $539 billion.

A series of financial crises triggered by unbalanced trade can lead economies into deep recessions. These crises begin with large trade deficits. At some point, foreign investors become pessimistic about the economy and move their money to other countries. The economy then drops into deep recession, with real GDP often falling up to 10% or more in a single year. This happened to Mexico in 1995 when their GDP fell 8.1%. A number of countries in East Asia—Thailand, South Korea, Malaysia, and Indonesia—came down with the same economic illness in 1997–1998 (called the Asian Financial Crisis). In the late 1990s and into the early 2000s, Russia and Argentina had the identical experience. What are the connections between imbalances of trade in goods and services and the flows of international financial capital that set off these economic avalanches?

We will start by examining the balance of trade in more detail, by looking at some patterns of trade balances in the United States and around the world. Then we will examine the intimate connection between international flows of goods and services and international flows of financial capital, which to economists are really just two sides of the same coin. It is often assumed that trade surpluses like those in Germany must be a positive sign for an economy, while trade deficits like those in the United States must be harmful. As it turns out, both trade surpluses and deficits can be either good or bad. We will see why in this chapter.

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