What is Foreign Trade And Economic Activity

By Allan GK on July 13, 2010
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Net Exports: Concepts and Trends

Open-economy macroeconomics involves the interactions of trade, output, spending, employment,and price levels among different nations.Foreign trade involves imports and exports. A country's imports are its purchases of goods and services from other nations. Although the United States produces most of what it consumes, it nonetheless has a large quantity of imports, which are goods and services produced abroad and consumed domestically. Exports are goods and services produced domestically and purchased by foreigners. Net exports are defined as exports of goods and services minus imports of goods and services. An important component of trade involves merchandise trade, which is trade in goods like foodstuffs and manufacturing. The U. S. has had a merchandise trade deficit in recent years. When a country has positive net exports, it is accumulating foreign assets. The counterpart of net exports is therefore net foreign investment, which denotes net saving or investment abroad and is approximately equal to the value of net exports.

Once we acknowledge the possibility of exports and imports, we must also recognize that a nation's expenditures may differ from its production. Total domestic expenditures (sometimes called domestic demand) are equal to consumption plus domestic investment plus government purchases. This measure differs from total domestic product (or GDP) for two reasons. First, some part of domestic expenditures will be on goods produced abroad, these items being imports (denoted by 1m) like Mexican oil and Japanese automobiles. In addition, some part of America's domestic production will be sold abroad as exports (denoted by Ex) — items like wheat and Boeing aircraft. The difference between national output and domestic expenditures is Ex - Im = net exports = X.
To calculate the total production of American goods and services, we need to include not only domestic demand but also trade, that is, we need to know the total production for American residents as well as the net production for foreigners. This total must include domestic expenditures ( C + I + G) plus sales to foreigners (Ex) less domestic purchases from foreigners (Im). Total output, or GDP, equals consumption plus domestic investment plus government purchases plus net exports: total domestic output = GDP = C + I + G + X

Foreign Exchange Rates

Foreign trade involves the use of different national currencies. The relative price of two currencies is called the foreign exchange rate, which measures the price of 1 unit of domestic currency in terms of foreign currency. The foreign exchange rate is determined in the foreign exchange market, which is the market where different currencies are traded. For example, if the French franc sells at 5 francs to the U. S. dollar, we say that the foreign exchange rate is 5 francs per dollar.

The foreign exchange rate is an important determinant of international trade because it has a large effect on the relative prices of the goods of different countries. To see how the foreign exchange rate affects foreign trade, take wine as an example. The relative prices of U. S. wine and French wine will depend upon the domestic prices of the wines and upon the foreign exchange rate. Say that California Chardonnay wines sell for $6 per bottle, while the equivalent French Chardonnay sells for 40 French francs. Then at the 1984 exchange rate of 10 French francs to the dollar, French wine sells at $4 per bottle while California wine sells at $6,cartier love ring platinum, giving an advantage to the imported variety.

Say that by 1996 the foreign exchange rate of the dollar fell (or depreciated) to 5 francs. Then with unchanged domestic prices,cartier love ring replica, the French wine would sell for $8 as compared to $6 for the California wine. Note that when the dollar was expensive, in 1984, French wine sold for only two-thirds the price of the California variety, while the fall in the value of the dollar over the next decade left French wine selling at a one-third premium over California wines. The fall in the exchange rate on the dollar had the effect of making imports less "competitive" by turning relative prices against imports and in favor of domestic products. If the dollar's price had risen (or appreciated), relative prices would have moved in favor of imports and against domestic production.
Foreign trade involves a new factor — a nation's exchange rate, or the price of the nation's currency relative to other currencies. When a nation's exchange rate rises or "appreciates", the prices of imported goods fall while exports become more expensive in world markets. The result is that the nation becomes less competitive in world markets and its net exports decline. Changes in exchange rates can have major effects on output, employment, and inflation. All these impacts make the exchange rate increasingly important for all nations.

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