Reference no: EM131241479

When trade does occur across national boundaries there are many types of financial transactions that take place. These transactions are recorded in a summary called the balance of payments which generally consists of a current account and a capital account. Each transaction recorded in the balance of payments requires an exchange of currencies. The demand and supply of a nation's currency in the international exchange rate market determines the rate of exchange or value of that nation's currency. Exchange rate refers to the number of units of one currency that equals one unit of another nation’s currency. A currency depreciation refers to a fall in the price of one currency relative to another, while an appreciation refers to a rise in the price of one currency relative to another. Just as with any other item traded in a market, changes in demand and supply cause changes in its value. An appreciation or an increase in the value of the dollar will create a balance of trade deficit - imports will exceed exports. Similarly, a depreciation or a decrease in the value of the dollar will create a balance of trade surplus - exports will exceed imports. Changes in a nation's imports and exports will affect its total spending and therefore its GDP, employment, and income levels. Also, in a nation runs a trade deficit it is able to consume more than it is currently producing. Although this has its advantages, the drawback is that the country will have to sell off assets to foreigners to sustain their trade deficits over time. Any future income from these assets will now be received by foreigners. Note: An expansion in relative U.S. income causes a depreciation of the dollar; a rise in a trading in a trading partner’s relative price level causes the dollar to appreciate; when the dollar is weak, or depreciates, U.S. goods and services cost foreign consumers less, so they buy more U.S. exports. At the same time, a weak dollar means foreign goods and services cost U.S. consumers more, so, they buy fewer imports; when the dollar is strong, or appreciates, U.S. goods and services cost foreign consumers more, so, they buy fewer U.S. exports. At the same time, a strong dollar means foreign goods and services cost U.S. consumers less, so they buy more foreign imports.