Fixed exchange-rate system, Open economy, Ceteris paribus

Learning Objectives

Topic 10
in an Open
Chapter 19

1. Explain the main components of the balance
of payments and understand how it is
2. Explain how exchange rates are determined
and how changes in exchange rates affect the
prices of imports and exports.
3. Analyse the determinants of exchange rates.
4. Explain the link between saving, investment &
the current account balance.
5. Is Australia’s foreign debt a problem?

Part I
Balance of

An Open Economy
Open economy: An economy that has
interactions in trade and finance with
other economies.
Closed economy: An economy that has
no interactions in trade or finance with
other economies.
W hy do countries engage in trade?
Trade can be in goods, services & financial

What drives international trade?
Comparative advantage is the
fundamental force that generates trade
between nations
The basis for comparative trade is
differences in opportunity costs between
A country has a comparative advantage
in producing a good if it can produce that
good at a lower opportunity cost than
any other country.

What drives international trade?
Which is more important: exports or
Exports increase producer surplus but
decrease consumer surplus but the
gain > loss
Imports increase consumer surplus but
decrease producer surplus but the gain
> loss
Countries gain from both exports &
Countries lose from restricting trade

Gibson and Fraser: Business Law 4e © 2009 Pearson Education Australia

The current account

The balance of payments
The balance of payments is a
summary of financial transactions
between one country and others over
a period of time.

The current account records trade in
goods, services & income. It consists of
balances on

This summary records the nature and
value of inflows and outflows of goods,
services, income and financial assets.

Merchandise trade (goods)

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